Life may have just become a little sweeter for members of corporate boards of directors, and more challenging the shareholders they represent. As any board member has heard a thousand times, a company's board of directors owes certain fiduciary duties to the corporation's shareholders, and failure to execute those duties could lead to a lawsuit against the directors in their individual capacities. While there are numerous protections in place (for example, the business judgment rule), boards are still a favorite target of upset stakeholders, and board members often have to spend significant time and resources fighting sometimes frivolous claims. However, thanks to the Delaware Supreme Court, the plaintiffs in these cases (and their lawyers) will now face a new hurdle: corporate by-laws may include provisions shifting the costs of litigation to the plaintiff, if the plaintiff's claim is unsuccessful.
ATP Tour, Inc. ("ATP") operates a global professional men's tennis tour. In 2006, prior to any controversy (more on why this is important below), ATP's board of directors added a "fee-shifting" provision to ATP's by-laws (the "2006 By-law"). In short, it said that if any member or owner brought an action against ATP or any other member or owner and did not obtain a judgment on the merits that achieved the full remedy sought, then the plaintiff would have to pay the defendant's legal expenses.
In 2007, ATP rearranged its tournament schedule and downgraded a tournament in Hamburg from the highest tier of tournaments to the second highest. The owner of the Hamburg Tournament, a member of ATP, then brought a suit against ATP and ATP's board of directors for, among other claims, a breach of their fiduciary duties. The owner of the Hamburg Tournament lost, and ATP and its board of directors used the 2006 By-law to argue that their legal fees should be paid by the Hamburg Tournament.
The issue of whether the 2006 By-law was legal reached the Delaware Supreme Court, who held that such provisions are not per se invalid so long as they were not introduced for an "improper purpose." Taking it one step further, the Court stated that "deterring litigation...is not invariably an improper purpose." This ruling could open the door to corporations implementing similar by-laws to deter frivolous shareholder litigation. However, if ATP had introduced the 2006 By-law for an improper purpose, perhaps in direct response to the suit by the Hamburg Tournament, the court may have deemed the 2006 By-law invalid.
There are still a few remaining questions that have to be answered. Namely, because ATP is a membership corporation formed under Delaware Law, will courts be willing to translate this ruling into shareholder corporations? To LLCs and other corporate forms? Will states that have their own corporate law, but generally follow Delaware Law, be willing to adopt the Delaware Supreme Court's ruling?
While these questions remain open, members of boards of directors should seriously consider adding such provisions to their by-laws. Even if the provision is eventually deemed invalid, the only cost would be that a corporation and its directors would have to pay their own legal expenses when victorious, which is the current status quo. McDonald Hopkins LLC can work with your board to implement these changes with the goal of giving your new by-laws the maximum chance to be deemed valid.