Minimizing Frivolous Litigation: Yes to Choice of Forum, No to Fee-Shifting, and Hello to Minimum Stake to Sue

Last year, I advised Delaware corporations to refrain from rushing out to adopt fee-shifting corporate bylaws – bylaws that shift litigation fees from corporations to losers of certain types of suits (“loser pays”) –even though the Delaware Supreme Court had ruled in 2014 that the state does not prevent fee shifting (as a reminder, the case ATP Tour, Inc. v. Deutscher Tennis Bund involved a non-stock corporation).

I advised against it because proposed legislation that would restrict stock companies from fee shifting was on the horizon. Approximately one year later in June 2015, Governor Jack Markell of Delaware did in fact sign into law a bill that bans stock corporations from adopting fee-shifting bylaws.

Delaware now prohibits fee-shifting for "internal corporate claims," which are “claims in the right of the corporation [derivative suits], (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.”

Before the ATP decision, only two publicly traded Delaware companies had adopted fee-shifting bylaws. After the ATP decision, however, the number skyrocketed to 32.

As the National Law Review points out, it’s unclear whether or not the amendments will apply retroactively, and that can only be determined as future litigation arises where corporations attempt to apply their bylaws.

Companies that adopted fee-shifting bylaws were reacting to the abundance of frivolous lawsuits filed against corporations today. The thinking was that there would be fewer frivolous suits if losing plaintiffs had to pay the legal fees of defendants, in addition to their own.

Choice of Forum

All is not lost, however, when it comes to a corporation’s ability to attempt to limit frivolous suits filed against it. While the General Corporation Law of Delaware was amended to prohibit fee shifting, additional amendments were made that are friendlier to the goal of reducing frivolous litigation.

Specifically, the General Corporation Law in Delaware now specifically allows Delaware-incorporated companies to designate Delaware as the exclusive forum for litigation.

Such a provision should reduce the number of duplicative suits brought in other jurisdictions on matters concerning the internal corporate governance affairs of a company. As a reminder, the Delaware Court of Chancery had come to this conclusion back in 2013. That decision didn’t particularly specify that the chosen forum had to be Delaware the way Delaware legislature has now specified.

When it comes to limiting the forum where cases like breach of fiduciary duty suits can be brought, a 2014 study from Cornerstone Research showed just how beneficial forum selection bylaws can be.

In 2014, 60 percent of litigation was filed in only one jurisdiction; a reversal from the 2009 to 2013 period when multi-jurisdictional litigation was much more common.

The report speculates that the widespread adoption of forum selection may have been a contributing factor to this change. More than 300 companies adopted forum selection bylaws in 2013 and 2014, according to the report.

Those who may be contemplating forum selection bylaws should include as part of the decision process an understanding that some proxy advisory services may not like this type of provision, potentially regarding it as unfriendly to shareholders..

In any case, clear communication with shareholders ahead of unilaterally adopting provisions that drastically change the shareholder-rights landscape is warranted.

What’s Next?

When it comes to trying to reduce incidents of frivolous litigation through corporate law, choice of forum has been cemented in Delaware and fee shifting has been shut down.

Many smart people are continuing to think of ways to reduce the plethora of frivolous lawsuits that continue to beset Corporate America, not to mention the shareholders who own the resources companies must use when forced to respond to these suits.

For example, consider the “minimum stake to sue” proposal.

Minimum stake bylaws typically state how many shares a person must own or get consent from in order to bring suit. The idea is that larger shareholders have a real stake in ownership. As a consequence, they will not be inclined to bring frivolous suits that can often seem like an exercise in merely enriching plaintiffs’ lawyers with legal fees.

One public company based in Florida, Emergent Capital (NYSE: EMG, formerly known as Imperial Holdings), adopted minimum stake bylaws.

Emergent’s version of the bylaw would require a shareholder who wants to sue the company and its Ds and Os to obtain the consent of at least 3 percent of shareholders. The board approved this bylaw, and a majority of shareholders subsequently approved it.

Nevertheless, a shareholder plaintiff sued. In its suit, the plaintiff alleged that the directors had breached their fiduciary duties, and had behaved disloyally and in bad faith because their sole intent in adopting the bylaw was to “reduce their risk of being held accountable to the  . . . shareholders for any violations of law . . . .”

However, the plaintiff ultimately agreed to have the case dismissed with prejudice. This was a win for the Emergent Capital board, but there was no ruling per se by the court on the merits of minimum stake bylaws.

It remains to be seen if other boards will take the bold step of adopting minimum stake bylaws. While innovation can be more difficult for public companies for a variety of reasons, minimum stake bylaws may be something worth considering by private companies as well as IPO companies.

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.