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Recent Delaware legislation that would prohibit a likely curb to shareholder lawsuits means business' rising litigation costs remain largely unaddressed.
Experts say there may still be ways to address costs in a manner equitable to both sides without “the sledgehammer” approach reflected in S.B. 75, which prohibits publicly traded corporations from adopting bylaws that force shareholders to pay legal fees if they do not win their lawsuits against the corporation.
S.B. 75 addresses a May 2013 ruling by the Delaware Supreme Court in ATP Tour v. Deutscher Tennis Bund in which the court upheld a corporate bylaw that requires plaintiff shareholders who lose derivative litigation to pay defense costs.
The legislation is not going to help reduce the high percentage of companies that get sued after they announce a merger or acquisition deal, said Rob Yellen, New York-based executive vice president of FINEX North America, a unit of Willis Group Holdings P.L.C. “Instead, it's going in the other direction,” he said.
Ninety-three percent of merger and acquisition deals valued at more than $100 million were litigated in 2014, according to a report by Boston-based Cornerstone Research Inc.
The legislation “just returns the playing field to the status quo that existed before the fee-shifting bylaws entered the field,” said Francis G.X. Pileggi, a partner at Eckert, Seamans, Cherin & Mellott L.L.C. in Wilmington, Delaware.
Observers say the legislature approved the measure, despite the state's business-friendly reputation, because of general agreement that permitting the fee-shifting bylaws went too far in favoring businesses.
Corporations are not required to pay all legal fees if they lose, noted Donna Ferrara, Chicago-based senior vice president and managing director at Arthur J. Gallagher & Co. “It's one-sided,” she said.
Some observers say the issue calls for a more measured approach. “Both sides are using sledgehammers when scalpels are needed,” said Ed Batts, a partner with DLA Piper in East Palo Alto, California.
Kevin LaCroix, executive vice president at RT ProExec, a division of R-T Specialty L.L.C. in Beachwood, Ohio, said other proposed litigation reform bylaws have included so-called minimum-stake-to-sue bylaws, which require, for example, that shareholders filing litigation represent a specified percentage of the company's outstanding shares, typically 1%-3%.
Others have proposed bylaws requiring that a shareholder must own a stock for a certain period of time before he or she can sue or capping losing shareholders' responsibility for litigation costs at, say, $200,000.
Though the ATP Tour is not publicly held, it is estimated that in light of the ruling about 30 publicly held Delaware firms subsequently adopted comparable bylaws, along with an unknown number of privately held companies, observers say.
They believe many more held off in anticipation of the Delaware legislation, signed into law by Gov. Jack Markell in June. A majority of publicly held firms are domiciled in Delaware.
Observers say the measure clearly reinstates the so-called “American rule,” under which each side pays its own legal costs. But there is some question among experts regarding whether the legislation prohibits fee shifting in federal securities litigation.
The legislation also provides that certificates of incorporation and corporate bylaws may specify that “intracorporate claims” must be brought only in Delaware courts, in an apparent effort to address the issue of parallel litigation filed in multiple states (see story, page 4). Some observers believe this provision is intended to balance the impact of the law prohibiting fee shifting.
Lisa A. Rickard, president of the Washington-based U.S. Chamber of Commerce's Institute for Legal Reform, which had opposed the legislation, said in a statement that she was disappointed Delaware “chose not to enact measures to deter abusive merger-and-acquisition lawsuits while prohibiting an important and useful tool for combating these unjustified lawsuits.”
Referring to the intracorporate claims provisions, however, the statement adds that Delaware has also “effectively authorized consolidation of much of merger-and-acquisition litigation in its own courts, and promised the business community that its system will not tolerate lawsuit abuse and actively weed out frivolous shareholder cases. The business world will be watching carefully to see if that promise holds true.”
Some experts believe the legislation will encourage firms to move from Delaware and new ones to incorporate elsewhere, but others say this is unlikely because of the state's concentration of judicial expertise.
As of early February 2015, about 50 bylaws allowing fee shifting have been adopted without shareholder vote, according to the Rockville, Maryland-based Institutional Shareholder Services.
Many observers believe corporations will choose to remain in Delaware despite the legislation. Delaware has a “well-developed body of case law and excellent judges with experience,” said Claudia H. Allen, a partner with Katten Muchin Rosenman L.L.P. in Chicago. “You have to question whether a corporation would incorporate in other states based on a single factor.”
However, others believe S.B. 75 may make other states more attractive to firms. “Basically, this opens the door to companies looking at other states a lot more seriously on whether to incorporate” there, said Keith P. Bishop, a partner with Allen, Matkins, Leck, Gamble, Mallory & Natsis L.L.P. in Irvine, California.
Oklahoma adopted a provision mandating fee shifting in derivative lawsuits in 2014. “I think a lot of other states are looking” at comparable legislation, said Ms. Allen. Observers say to their knowledge, Oklahoma is the only state to have approved such legislation.
Companies that have adopted protective measures include the Chinese mobile commerce firm Alibaba Group Holding Ltd., whose Cayman Islands certificate of incorporation states shareholders are obligated to reimburse the company's “reasonable “ attorneys' fees if it does not obtain a judgment based on merit.
The Delaware law that prohibits fee-shifting to losing shareholders includes a provision validating that Delaware corporations can adopt bylaws designating the state's courts as the exclusive forum for shareholder litigation.