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Limited Application Fee-Shifting Bylaw Violates DGCL

Authors: James H. S. Levine, Joanna J. Cline, Douglas D. Herrmann and Christopher B. Chuff

2/08/2017
Limited Application Fee-Shifting Bylaw Violates DGCL

Companies that consider adopting bylaws that may be interpreted as contravening the Delaware General Corporation Law should consider all possible interpretations of the statute before enacting them.

Reprinted with permission from the February 8, 2017 edition of the Delaware Business Court Insider. © 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).

In a legislative response to the Delaware Supreme Court's 2014 opinion in ATP Tour v. Deutscher Tennis Bund, 91 A.3d 554 (2014), a new statute limiting the effect of fee-shifting bylaws became effective on Aug. 1, 2015. It amended Section 109(b) of the Delaware General Corporation Law by prohibiting bylaws "that would impose liability on a stockholder for the attorney fees or expenses of the corporation ... in connection with an internal corporate claim." In a recent decision, Solak v. Sarowitz, C.A. No. 12299-CB (Dec. 27, 2016), Chancellor Andre G. Bouchard rejected an interesting twist on a fee-shifting bylaw, concluding that the bylaw runs afoul of the plain language of Section 109(b).

Paylocity Adopts a Unique Fee-Shifting Bylaw

Most companies that had adopted fee-shifting bylaws in the wake of ATP Tour rescinded them after the General Assembly enacted Section 109(b). At least one company, however—Paylocity Holding Corp.—doubled down. Paylocity adopted a fee-shifting bylaw only after the General Assembly amended Section 109(b) and enacted new Section 115, permitting companies to adopt exclusive forum bylaws. Paylocity joined these new provisions together as a fee-shifting bylaw limited to instances where a stockholder brings or assists in an "internal corporate claim" in a non-Delaware forum, unless the stockholder obtains a judgment on the merits that substantially achieves the full remedy sought. A Paylocity stockholder challenged the bylaw, asserting that it is facially invalid and that the Paylocity board breached its fiduciary duties by enacting it. The company and board moved to dismiss the complaint, asserting that Section 109(b) does not preclude the Paylocity bylaw.

Section 109(b)'s Broad Prohibition on Fee-Shifting Bylaws Invalidates Paylocity's Bylaw

Denying the defendants' motion in part, Chancellor Andre G. Bouchard concluded that the complaint states a claim on which relief may be granted and that the validity of the bylaw is ripe for adjudication, despite the failure of any stockholder's having tested its application through litigation in a non-Delaware forum. Addressing ripeness, the chancellor wrote that, because the bylaw would have a substantial deterrent effect on stockholders who may wish to file claims potentially subjecting them to liability, "to decline to review the bylaw thus would mean, as a practical matter, that its validity under the DGCL would never be subject to judicial review." Bouchard also determined that "deciding 'the basic legal questions presented' by the plaintiff's complaint 'will provide efficiency benefits to not only the defendants and their stockholders, but to other corporations and their investors.'"

The chancellor determined that the plain text of the bylaw violates Section 109(b) because the statute "unambiguously prohibits the inclusion of 'any provision' in a corporation's bylaws that would shift fees to a stockholder ... irrespective of where such a claim is filed." Even though the bylaw would be triggered only where an internal corporate claim was filed outside of Delaware, its language still runs afoul of Section 109(b).

Bouchard overruled defendants' arguments in support of the bylaw, rejecting the assertion that Sections 109(b) and 115 must be read collectively to mean that Section 109(b) was not intended to prohibit fee shifting for internal corporate claims filed outside of Delaware. The court observed that Section 109(b) "makes no distinction between internal corporate claims filed inside or outside of Delaware," and nothing in either Section 109(b) or 115 indicates that the General Assembly intended to create an exception to Section 109(b)'s prohibition on fee-shifting bylaws for actions filed in violation of a forum selection provision.

Despite concluding that the plaintiff's facial challenge to the bylaw was adequate to survive a motion to dismiss, the court did dismiss the second and third counts of plaintiff's complaint. In rejecting count II, which challenged the bylaw under Section 102(b)(6) of the DGCL, Bouchard determined that the plaintiff could not prove that Section 102(b)(6)—prohibiting a corporation from holding a stockholder liable for the corporation's debts absent a specific authorization in the corporation's certificate of incorporation—renders the bylaw invalid under any circumstances. The plaintiff provided no authority interpreting the term "debts" as used in Section 102(b)(6), leaving open the question of whether the expenses described in the bylaw fall with that section's proscription.

Addressing count III, which asserted that the Paylocity board breached its fiduciary duties by adopting the bylaw, the chancellor stated that because the company's charter contains a Section 102(b)(7) exculpation clause, and because the complaint did not set forth facts to support a violation of the duty of loyalty, the directors could only be subject to liability if they acted in bad faith. The court noted that the complaint was bereft of factual allegations concerning the board's process in considering and adopting the bylaw, that the directors did not deliberate diligently, or that they did not seek or consider legal advice. Absent any such allegations, the chancellor determined that count III must be dismissed.

The Paylocity bylaw dispute appears far from over, however. Shortly after the chancellor's ruling, the defendants petitioned the court to certify an interlocutory appeal, arguing that the chancellor construed Section 109(b) too narrowly and that his ruling should be overturned. Bouchard rejected the application on Jan. 26, concluding that "certification of an interlocutory appeal is not warranted because issues remain to be decided in this action and there is no particular urgency to commencing appellate review at this time." If Paylocity and defendants wish to seek Supreme Court review, they must either petition the Supreme Court directly or await the chancellor's final order.

Conclusions

Although Paylocity and the defendants set forth creative arguments in support of the company's bylaw, the court relied on traditional statutory interpretation principles and found the bylaw at odds with the DGCL. Companies that consider adopting bylaws that may be interpreted as contravening the DGCL should consider all possible interpretations of the statute before enacting them. As a consequence of its effort to execute an end run around Section 109(b) (as the chancellor noted in his order denying interlocutory certification), Paylocity will likely not only have to defend the plaintiff's claim, it may ultimately be found responsible for the plaintiff's attorney fees in bringing the action.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.