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Corporate Litigation: Delaware Supreme Court’s Decision in ATP Tour, Inc. v. Deutscher Tennis Bund

A recent Delaware Supreme Court decision has a potentially chilling effect on corporate litigation.

In a recent unanimous decision, the Delaware Supreme Court, sitting en banc , held that fee-shifting provisions in a non-stock corporation’s bylaws are facially valid under Delaware Law. The case arose when Delaware’s Federal District Court certified a question to the Delaware Supreme Court: can a private company amend its bylaws to adopt a provision that makes the loser in any shareholder litigation pay the other side’s fees? The Delaware Supreme Court answered “yes.” The Court found that fee-shifting bylaws do not violate Delaware law. Since corporate bylaws are just contracts among shareholders, contracting parties can agree to modify Delaware’s default rule that litigants pay their own attorney’s fees by requiring an unsuccessful litigant to reimburse the other’s fees.

It is important to note that just because a bylaw is facially valid, that does not mean that it is also enforceable. Delaware courts have found bylaws unenforceable because they were adopted or used for an inequitable purpose. The Court noted, however, that the intent to deter litigation is not necessarily an improper purpose.

This holding is in line with the Delaware Supreme Court’s trend to uphold companies’ efforts to use bylaw provisions to protect themselves from the burdens and costs of shareholder litigation. A year ago , the Delaware Chancery Court upheld forum selection clauses in corporate bylaws. This allowed companies to protect themselves from the burdens of multi-forum litigation.

Effects on Future Litigation

This decision may have a great effect on the current large trend of frivolous merger litigation. If a private company can, and does adopt a bylaw provision that would make a losing litigant pay, it could put a serious dent in merger litigation.  Such a provision would deter plaintiffs from bringing a lawsuit for fear that they may have to bear the burden of all litigation costs.

Many firms have commented on the expected effect of the Court’s decision.  Wilson Sonsini Goodrich & Rosati noted that “many boards of directors of private and public Delaware corporations should seriously consider adopting  fee-shifting bylaws of their own.” Sullivan & Cromwell LLP warned that “it is unclear what reaction the adoption of such a bylaw would draw from investors and proxy advisory firms, who generally react negatively to the unilateral adoption by a board of bylaws they view as limiting shareholder rights.” Paul Weiss commented that  although the court’s holding dealt with non-stock corporations, “the holding may be read to apply to all Delaware corporations.”

The effects of these provisions, if adopted, would be drastic. What remains to be seen is whether corporations will choose to adopt such provisions.

The case is  ATP Tour, Inc. v. Deutscher Tennis Bund , C.A. No. 07-178 (GMS).

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ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation), No. 534, 2013

In this en banc decision, the Delaware Supreme Court answered certified questions of law from the United States District Court for the District of Delaware concerning the validity of a fee-shifting provision in a Delaware non-stock corporation’s bylaws.  The Supreme Court held, as a general legal matter, that fee-shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law if adopted through the appropriate corporate procedures and for a proper corporate purpose.  The Supreme Court also held that bylaws normally apply to all members of a non-stock corporation regardless of whether the bylaw was adopted before or after the member in question became a member.  Although the bylaw at issue was adopted by a non-stock corporation, the Court’s reasoning and analysis rely on provisions of the Delaware General Corporation Law (“DGCL”) and court decisions that apply to stock corporations.

ATP Tour, Inc. (“ATP”) is a Delaware non-stock corporation that operates a global professional men’s tennis tour.  Among ATP’s members are entities that own and operate professional men’s tennis tournaments, including the two appellees (referred to together as the “Federations”).  Upon joining ATP in the early 1990s, the Federations agreed to be bound by ATP’s bylaws, as amended from time to time.  In 2006, ATP’s board amended the bylaws to add Article 23, a fee-shifting provision that shifts litigation fees and expenses to a “Claiming Party” in certain circumstances, including in the event litigation initiated by the Claiming Party does not result in “a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought” by the Claiming Party. 

Displeased with changes in 2007 to the ATP tour’s schedule and format, the Federations sued ATP and six of its board members in the District Court, alleging both federal antitrust claims and Delaware fiduciary duty claims.  The Federations did not prevail on any of their claims, and ATP moved to recover its legal fees, costs and expenses, relying on Article 23 of ATP’s bylaws.  The District Court denied ATP’s fee motion because it found the fee-shifting provision in Article 23 was preempted by federal antitrust laws.  On appeal, the United States Court of Appeals for the Third Circuit found that the District Court should have decided whether Article 23 was enforceable as a matter of Delaware law before reaching the federal preemption question and vacated the District Court’s order.  On remand, the District Court reasoned that Article 23’s enforceability was a novel question of Delaware law and certified four questions of law concerning the validity of Article 23 to the Delaware Supreme Court.

The first certified question asked whether the board of a Delaware non-stock corporation may lawfully adopt a bylaw that shifts all litigation expenses to a member plaintiff in intra-corporate litigation if the member “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.”  Relying on the principle that a corporation’s bylaws are presumed to be valid and citing sections of the DGCL and related decisions about the general validity of bylaws, the Court held that a fee-shifting bylaw is facially valid.  The Court found that neither the DGCL nor any other Delaware statute forbids the enactment of a fee-shifting bylaw, and that such a bylaw would satisfy the DGCL’s requirements for a valid bylaw.  The Court also reasoned that bylaws are contracts “among a corporation’s shareholders,” such that a fee-shifting provision contained in a non-stock corporation’s validly enacted bylaws would be a permissible, contractual exception to the American Rule that litigants generally pay their own attorneys’ fees and costs.   The Court stopped short, however, of finding that ATP’s specific fee-shifting bylaw was enforceable.  Citing Schnell v. Chris-Craft Industries , 285 A.2d 437 (Del. 1971) and other decisions that addressed legally possible but potentially inequitable conduct, the Court stated that the enforceability of a facially valid bylaw may turn on the circumstances surrounding its adoption and use.  Because it did not have those facts before it, and because certifications address questions of law only, the Court ultimately answered the first certified question by holding 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.” 

The second certified question asked whether a fee-shifting bylaw may be “lawfully enforced against a member that obtains no relief at all on its claims against the corporation, even if the bylaw might be unenforceable in a different situation where the member obtains some relief.”  The Court interpreted this question as asking whether a more limited version of the ATP bylaw would be valid.  Subject to the limitations set forth in its answer to the first certified question, the Court held that a fee-shifting bylaw could shift fees if a plaintiff obtained no relief in the litigation.

The third certified question asked whether the bylaw is “rendered unenforceable as a matter of law if one or more Board members subjectively intended the adoption of the bylaw to deter legal challenges by members to other potential corporate action then under consideration.”  The Court reiterated the principle that legally permissible bylaws adopted for an improper purpose are unenforceable in equity.  The Court noted, however, that “[t]he intent to deter litigation … is not invariably an improper purpose” and that “[f]ee-shifting provisions, by their nature, deter litigation.”  The Court then held that “[b]ecause fee-shifting provisions are not per se invalid, an intent to deter litigation would not necessarily render the bylaw unenforceable in equity.”

The fourth certified question asked whether “a fee-shifting bylaw provision is enforceable against members who joined the corporation before the provision’s enactment and who agreed to be bound by rules ‘that may be adopted and/or amended from time to time’ by the board.”  The Court noted that the DGCL permits a corporation’s certificate of incorporation to “confer the power to adopt, amend or repeal bylaws upon the directors.”  The Court then held that if a corporation’s certificate of incorporation confers that power on the directors, then members “will be bound by bylaws adopted unilaterally by their boards.”  The Court thus answered the fourth certified question, assuming the fee-shifting bylaw is otherwise valid and enforceable, in the affirmative.

The Court summarized its conclusions by stating that “[u]nder Delaware law, a fee-shifting bylaw is not invalid per se , and the fact that it was adopted after entities became members will not affect its enforceability.”

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In yesterday’s posting , I noted a recent Form 8-K filing that discloses the adoption of a fee-shifting bylaw.  In   ATP Tour, Inc. v. Deutscher Tennis Bund , 2014 Del. LEXIS 209 (Del. May 8, 2014), the Delaware Supreme Court held that a fee-shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law.  In reaching this conclusion, the Court said:  ”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.’”  Note that the Court held that a fee-shifting bylaw “can be valid and enforceable”.  Thus, the Court only addressed the question of facial validity – it expressly disclaimed any conclusions on either the adoption or use of the bylaw in question.

In my review of the bylaw at issue in the case, it seems to me that it is so broadly worded that it arguably covers situations unrelated to the business of the corporation  et cetera.   Here is the bylaw as quoted in the Court’s opinion:

In the event that (i) any [current or prior member or Owner or anyone on their behalf ("Claiming Party")] initiates or asserts any [claim or counterclaim ("Claim")] or joins, offers substantial assistance to or has a direct financial interest in any Claim against the League or any member or Owner (including any Claim purportedly filed on behalf of the League or any member), and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the League and any such member or Owners for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) (collectively, “Litigation Costs”) that the parties may incur in connection with such Claim.

Now, let’s suppose that one member of the corporation is driving to pick up her child at school and collides with an automobile driven by another member who is on her way to a social occasion.  If the first member sues the second member and fails to obtain a judgment on the merits, will that member be liable under the bylaw for attorneys’ fees and other costs?  The bylaw seems to require only that a member assert a claim against another member and fail to obtain a judgment.  The bylaw does not on its face require that the claim be brought by or against a member  qua  member.

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ATP Tour, Inc. v. Deutscher Tennis Bund : The Delaware Supreme Court Upholds the Facial Validity of a Fee-Shifting Provision in the Bylaws of a Delaware Nonstock Corporation

June 12, 2014

Publication | Corporate Transactions | Corporate & Chancery Litigation

In ATP Tour, Inc. v. Deutscher Tennis Bund , No. 534, 2013, 2014 WL 1847446 (Del. May 8, 2014), the Delaware Supreme Court, by Justice Berger, in responding to certified questions of law from the United States District Court for the District of Delaware (the “District Court”), held that a provision of a Delaware nonstock corporation’s bylaws that shifted litigation expenses to the losing party in intra-corporate litigation was facially valid under Delaware law and may be enforced if the provision was adopted through appropriate corporate procedures and for a proper corporate purpose.

ATP Tour, Inc. (“ATP”) is a Delaware nonstock corporation that operates a professional tennis tour. The dispute arose from litigation filed in District Court by plaintiffs, two members of ATP, against ATP and six of its seven directors challenging ATP’s decision to downgrade a tournament owned and operated by plaintiffs. Following a jury trial, judgment was entered in favor of ATP on all claims. Because plaintiffs did not prevail on any of their claims, ATP sought to recover its litigation expenses from plaintiffs pursuant to a provision in ATP’s bylaws providing that, in intra-corporate litigation, a plaintiff who “does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought” is obligated to reimburse ATP “for all fees, costs and expenses of every kind and description.” Because the validity and enforceability of a fee-shifting bylaw presented a novel question of Delaware law, the District Court certified questions to the Delaware Supreme Court.

The Supreme Court began its analysis by noting that, to be facially valid, a bylaw provision must be authorized by the General Corporation Law of the State of Delaware (the “DGCL”), it must be consistent with the corporation’s certificate of incorporation, and its enactment must not be otherwise prohibited. Finding that such a bylaw was not prohibited by the DGCL, any other Delaware statute or common law, the Supreme Court held that a fee-shifting bylaw is facially valid under Delaware law. The enforceability of a fee-shifting bylaw, however, turns on the circumstances under which the bylaw is adopted and applied. Because the Court did not have sufficient facts to determine whether ATP’s fee-shifting bylaw was properly adopted or applied and because certified questions by their nature only address questions of law, the Supreme Court did not opine on the enforceability of ATP’s fee-shifting bylaw. Rather, the Supreme Court held that a fee-shifting bylaw, like the one adopted by ATP, may be enforceable if adopted by appropriate corporate procedures and for a proper corporate purpose. The Court further noted that bylaws that are facially valid will not be enforced if adopted or applied for an inequitable or improper purpose. Because the intent to deter litigation is not invariably an improper purpose, the fact that a board adopted a fee-shifting bylaw for the purpose of deterring litigation would not necessarily render the bylaw unenforceable. Finally, the Court held that, assuming that a fee-shifting bylaw is otherwise valid and enforceable, members who join the corporation prior to its adoption will be bound by the fee-shifting bylaw.

Proposed amendments to the DGCL were introduced in the Delaware General Assembly to clarify the application of the ATP Tour decision to Delaware stock corporations. Although the General Assembly has resolved to defer consideration of this matter until its next session in early 2015, it remains possible that legislation limiting the applicability of the ATP Tour decision to nonstock corporations and clarifying that, subject to certain limited statutory exceptions, charter and bylaw provisions may not be used to impose monetary liability on holders of stock in Delaware stock corporations, may be enacted.

Video: ATP Tour, Inc. v. Deutscher Tennis Bund case summary and discussion

Read the Opinion: ATP Tour, Inc. v. Deutscher Tennis Bund

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