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Stemming Shareholder Litigation – Including In The FCPA Context – Through A Bylaw Provision

In this era of FCPA enforcement plaintiffs’ lawyers representing shareholders often target directors and executive officers of companies subject to FCPA scrutiny with civil suits alleging, among other things, breach of fiduciary duty or securities fraud. Indeed, as noted in this Forbes column “plaintiff lawyers have joined the bribery racket.”

Numerous previous posts (see here for instance) have highlighted how, within days of FCPA scrutiny or an enforcement action, plaintiffs’ firms launch so-called “investigations” and FCPA-related civil suits begin to pour in.

When a company’s FCPA violations are the result of board of director or executive officer conduct, or the condoning or encouraging of such conduct by those with fiduciary duties, such civil suits or investigations would seem to be warranted and in the public interest.  While there have been a few such FCPA enforcement actions (Siemens and BizJet come to mind), in the vast majority of FCPA enforcement actions the enforcement agencies do not allege any knowledge, participation or acquiescence in the conduct at issue by the board of directors or executive officers.

Given the frequency in which shareholder litigation follows an FCPA enforcement action or instance of FCPA scrutiny, and given the largely unsuccessful track record of such cases surviving the motion to dismiss stage, the question ought to be asked – does the majority of shareholder litigation in the FCPA context serve a purpose or are such actions merely parasitic attempts to feed-off of FCPA scrutiny and enforcement in this new era?

Indeed, as highlighted in this previous post, FCPA-related civil litigation was identified as a area of litigation abuse in House testimony.  Among other things, it was noted:

“[Shareholder class actions]serve no purpose but to take money from current shareholders and transfer it to former (or other) shareholders – with a hefty slice cut out for the plaintiffs’ lawyers.”

“Derivative shareholder suits are equally problematic in this arena. These suits tend to target senior officers and directors, not the employees who actually paid any bribes or condoned others paying them. The reason is simple enough: directors and officers are backed by the deep pockets of the company’s D&O insurer; culpable employees have little money to pay in private civil damages, especially if they themselves have been the target of an individual enforcement proceeding.”

As with many things in this new era of FCPA enforcement, FCPA related shareholder litigation seems to have spiraled out of control and FCPA practitioners rightly observed:

“Setbacks in court do not appear to have slowed the pace of new cases filed against corporations and their directors after FCPA disclosures. As the DOJ and SEC bring more cases, and as more companies voluntarily disclose potential FCPA violations, the trend of related civil litigation is likely to continue. In attempting to satisfy the expectations of the DOJ and SEC, a company’s thorough internal investigation may also serve as the roadmap for a civil litigant. Companies negotiating with the DOJ and SEC must therefore balance the government’s requests for the results of internal investigations with the risk of waiver of privilege and subsequent production to civil litigants. As a result of these practical considerations, reputational risk, and expenses involved in litigation, companies targeted by civil suits will feel pressure to settle, potentially even before the DOJ or SEC takes action.”

The above is all necessary background in highlighting an important decision from the Delaware Supreme Court.  In this recent decision, the court addressed the validity of a fee-shifting provision (which shifted attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation) in a Delaware non-stock corporation’s bylaws.

Although the court’s opinion arose in the context of a non-stock corporation, the decision discussed the validity of such a bylaw provision under Delaware General Corporate Law – the law of choice for many corporations.

The Delaware Supreme Court stated:

“Under Delaware law, a corporation’s bylaws are “presumed to be valid, and the courts will construe the bylaws in a manner consistent with the law rather than strike down the bylaws.” To be facially valid, a bylaw must be authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation’s certificate of incorporation, and its enactment must not be otherwise prohibited.

That, under some circumstances, a bylaw might conflict with a statute, or operate unlawfully, is not a ground for finding it facially invalid.

A fee-shifting bylaw, like the one described in the first certified question, is facially valid. Neither the DGCL nor any other Delaware statute forbids the enactment of fee-shifting bylaws. A bylaw that allocates risk among parties in intra-corporate litigation would also appear to satisfy the DGCL’s requirement that bylaws must “relat[e] to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” The corporate charter could permit fee-shifting provisions, either explicitly or implicitly by silence.  Moreover, no principle of common law prohibits directors from enacting fee-shifting bylaws.

Delaware follows the American Rule, under which parties to litigation generally must pay their own attorneys’ fees and costs. But it is settled that contracting parties may agree to modify the American Rule and obligate the losing party to pay the prevailing party’s fees. Because corporate bylaws are “contracts among a corporation’s shareholders,” a fee-shifting provision contained in a nonstock corporation’s validly-enacted bylaw would fall within the contractual exception to the American Rule. Therefore, a fee-shifting bylaw would not be prohibited under Delaware common law.

Whether the specific … fee-shifting bylaw [at issue] is enforceable, however, depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose. In the landmark Schnell v. Chris-Craft Industries decision, for example, this Court set aside a board-adopted bylaw amendment that moved up the date of an annual stockholder meeting to a month earlier than the date originally scheduled.  The Court found that the board’s purpose in adopting the bylaw and moving the meeting was to “perpetuat[e] itself in office” and to “obstruct[] the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management.” The Schnell Court famously stated that “inequitable action does not become permissible simply because it is legally possible.”

More recently, in Hollinger International, Inc. v. Black, the Court of Chancery addressed bylaw amendments, enacted by a controlling shareholder, that prevented the board “from acting on any matter of significance except by unanimous vote” and “set the board’s quorum requirement at 80%,” among other changes. The Court of Chancery found, and this Court agreed, that the bylaw amendments were ineffective because they “were clearly adopted for an inequitable purpose and have an inequitable effect.” That finding was based on an extensive review of the facts surrounding the controller’s decision to amend the bylaws.

Conversely, this Court has upheld similarly restrictive bylaws that were enacted for proper purposes. In Frantz Manufacturing Co. v. EAC Industries, a majority stockholder amended the corporation’s bylaws by written consent in order to “limit the [] board’s anti-takeover maneuvering after [the stockholder] had gained control of the corporation.” The amended bylaws, like those invalidated in Hollinger, increased the board quorum requirement and mandated that all board actions be unanimous. The Court found that the bylaw amendments were “a permissible part of [the stockholder’s] attempt to avoid its disenfranchisement as a majority shareholder” and, thus, were “not inequitable under the circumstances.”

[…]

[W]e are able to say only that a bylaw of the type at issue here is facially valid, in the sense that it is permissible under the DGCL, and that it may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose.”

For additional reading on the recent Delaware Supreme Court decision, see herehere and here.

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