SEC and others closely monitoring fee-shifting bylaws
The debate over board accountability is gaining ground with a noteworthy increase in the number of companies that have unilaterally adopted fee-shifting bylaws since last May, when the Delaware Supreme Court ruled they were free to do so. These bylaws stipulate that shareholders that decide to sue a board over a corporate governance matter and don’t completely win their case must pay all the company’s incurred legal expenses.
‘There are strenuous objections to this because the argument is that it effectively deprives shareholders of access to the courts as most can’t possibly afford to pay for the company’s fees if they lose,’ says Richard Gallagher, a partner in Ropes & Gray’s litigation group in its San Francisco office. By his firm’s internal count, roughly 70 companies have adopted such a bylaw. A substantial percentage of those are oil & gas entities structured as partnerships and limited liability corporations that aren’t publicly listed.
Proxy advisory firms have expressed their opposition to fee-shifting provisions that boards adopt without first getting shareholder approval, and say they will recommend shareholders vote against any director on the governance committee of a company that does so.
To be sure, the vast majority of 'meritless litigation' that companies hope to discourage through fee-shifting bylaws are shareholder challenges to M&A deals. But in a letter to the Washington Post in December, the Council of Institutional Investors (CII) voiced its opposition to these provisions ‘because they establish a structure that significantly deters or eliminates meritorious shareowner claims, thereby eliminating a company’s accountability to its owners, an important safeguard to ensure good corporate governance.’
Although the case decided last year by the Delaware Supreme Court, ATP Tour vs Deutscher Tennis Bund, involved a non-stock corporation, ‘pretty much everyone who follows this jumped to the conclusion that conceptually the holding would apply to a regular [publicly traded] corporation,’ says Gallagher. ‘The holding was that management can use bylaws to pretty much do what it wants if it relates to the powers of the company and the organization of its affairs.’
The legality of these bylaws is now up in the air. In early March the Delaware Corporation Law Council (DCLC) recommended that the Delaware General Corporation Law be amended to prohibit bylaw and charter provisions that ‘would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an intra-corporate claim,’ as reported by the National Law Review.
Shortly after DCLC made its proposal CII released a statement that said ‒ in part ‒ that barring fee-shifting provisions would not only strengthen the accountability of Delaware companies to their shareholders but ‘also safeguard Delaware’s pre-eminence as the adjudicator of US business disputes.’
The SEC is also closely monitoring these bylaws, as chair Mary Jo White told attendees at a corporate law conference at Tulane University last week, out of concern that they may reduce shareholders’ ability to file federal securities claims. ‘I am concerned about any provision in the bylaws of a company that could inappropriately stifle shareholders’ ability to seek redress under the federal securities laws. All shareholders can benefit from these types of actions,’ White said. ‘If the commission comes to believe these provisions improperly hinder shareholders’ exercise of their rights, it may need to weigh in more directly in this discussion.’
White also said a company that chooses to adopt such provisions should clearly communicate to shareholders their specific features and their effect on shareholders’ ability to bring a claim, specifically ‘so the issue can be considered in voting and investment decisions.’
It’s too soon to say whether adoption of fee-shifting bylaws should make investors question the overall trend toward shareholder engagement, given that ‘the great majority of companies have not adopted these fee-shifting provisions and they’re waiting for more clarity in the law before they do it,’ Gallagher says.
By contrast, a fairly substantial percentage of companies have adopted exclusive forum provisions that require shareholders to bring suit against Delaware corporations in a Delaware court. That’s another provision proxy advisers and others have opposed and recommended be taken into consideration by investors when voting proxies.