Optimal Fee-Shifting Bylaws

Abstract

A fee-shifting bylaw provision requires the plaintiff-shareholder to reimburse the litigation expenses of the defendant-corporation when the plaintiff is not successful in litigation. After the Delaware Supreme Court ruled that the provision is enforceable in 2014, a number of corporations adopted fee-shifting provisions, utilizing the directors’ right to amend bylaws without express shareholder approval. In 2015, the Delaware legislature responded by amending the Delaware General Corporation Law to prohibit fee-shifting. This paper argues that the optimal fee-shifting arrangement lies somewhere between the version adopted by the corporations and no fee-shifting mandated by the Delaware legislature. A more balanced fee-shifting provision will do better in achieving the goal of encouraging meritorious lawsuits and discouraging frivolous ones, especially with respect to direct shareholder lawsuits. For derivative lawsuits, a balanced fee-shifting rule will impose a higher threshold on the merits than the traditional, no-fee-shifting rule. The paper also examines the fee-shifting provisions that are used in commercial agreements, notably stock purchase agreements and bond indentures, that employ more balanced fee-shifting arrangements but with variation. The paper finally argues that, given that there is unlikely one fee-shifting provision that is optimal for all corporations and for all types of litigation, the courts should consider applying the “proper or equitable purpose” requirement more vigorously to maintain flexibility while prohibiting undue restriction on shareholders’ legitimate right to sue.