Lawrence A. Hamermesh and Norman M. Monhait(fn1)
An exchange last month in the Bank & Corporate Governance Law Reporter among Neil Cohen, Jack Coffee and Jay Brown(fn2) addressed the possibility that corporate bylaws might regulate the award of attorney’s fees in federal securities class actions. The Delaware Supreme Court’s 2014 opinion in ATP(fn3) sparked renewed interest in this possibility, and when the Delaware State Bar Association’s Corporation Law Section proposed legislation limiting the use of charter and bylaw provisions to shift litigation expenses, it was noted (correctly) that the proposed legislation did not apply to federal securities claims.(fn4) From this premise, it has been suggested (incorrectly, we say) that bylaws providing for fee-shifting in federal securities class actions were implicitly endorsed, or at least remained viable as a matter of Delaware law.(fn5)
We are responding to the foregoing suggestion to make two points: first, the now enacted Delaware legislation (“SB 75,” which includes amendments to Sections 102 and 109 and the Delaware General Corporation Law (DGCL), and the addition of Section 115 to that statute(fn6)) does not affect the question of the validity of bylaws providing for fee-shifting in federal securities class actions; and second, in our view the DGCL did not and after passage of SB 75 does not authorize such bylaws.
We begin with a point on which Professors Coffee and Brown appear to agree: namely, that SB 75 does not apply to federal securities class action litigation. By its terms, the legislation only applies to bylaws that provide for fee-shifting in connection with “internal corporate claims.” New Section 115 defines that term as “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.” If federal securities claims are covered by this term, they must fall within at least one of the two definitional clauses. It’s easy to see that clause (ii) does not cover federal securities claims, because the DGCL does not “confer jurisdiction upon the Court of Chancery” to hear such claims.
Nor do federal securities claims typically fall within clause (i) of the definition of “internal corporate claims.” The predominant form of federal securities class action litigation is based on Section 10(b) of the Securities Exchange Act of 1934(fn7) and SEC Rule 10b-5(fn8), and most commonly involves allegations that a material misstatement or omission induced class members to purchase securities before the misstatement or omission was corrected. In that situation, the fraud is visited upon investors, but not stockholders as such: it should be irrelevant whether a class member was or was not already a stockholder at the time of the alleged fraud. As Vice Chancellor Laster recently concluded in the Activision litigation: “A Rule 10b-5 claim under the federal securities laws is a personal claim akin to a tort claim for fraud. The right to bring a Rule 10b-5 claim is not a property right associated with shares, nor can it be invoked by those who simply hold shares of stock.”(fn9)
Accordingly, any duty breached under Rule 10b-5 (or under Sections 11 or 12 of the Securities Act of 1933(fn10)) does not arise from a director or officer’s duty to the corporation or its stockholders, and a Rule 10b-5 claim should not be considered an “internal corporate claim” within the meaning of new Section 115. Of course, if a director’s or officer’s violation of Rule 10b-5 were understood to involve a violation of his or her duty as a director or officer, then the amendments to DGCL Sections 102 and 109 would prohibit a bylaw providing for fee-shifting in connection with litigation of Rule 10b-5 claims. But like Professors Brown and Coffee, we think that a better reading of these amendments would regard them as limited to the Delaware “lane,” namely to breaches of duty arising under the DGCL and Delaware corporate decisional law. Therefore, we believe that the recent amendments to the DGCL do not address the validity of a bylaw purporting to shift fees in federal securities class action litigation.
So where does that leave such bylaws in terms of validity under Delaware law? In our view, their validity remains exactly as it was before the legislation was enacted. There is nothing to suggest any intention to endorse or accomplish, by negative implication, a validation of bylaws (or charter provisions, for that matter) purporting to regulate litigation arising under any body of law (tort, contract, federal securities law) other than Delaware corporation law.
Instead, the efficacy of a fee-shifting charter or bylaw provision purporting to affect federal securities class actions must be determined under Delaware case law interpreting the scope of DGCL Sections 102(b)(1) and 109(b) – most notably, the opinions in ATP and FedEx/Chevron (fn11)(by then Chancellor Strine). And as we read those opinions, Sections 102(b)(1) and 109(b) cannot be read, despite their breadth and the presumptive validity of provisions adopted pursuant to them, to authorize provisions regulating litigation under the federal securities laws.
Both ATP and FedEx/Chevron are instructive in this regard. Starting with the latter (but earlier) opinion, we see that what the court was endorsing was a bylaw that it considered to affect forum selection for “the kind of claims most central to the relationship between those who manage the corporation and the corporation’s stockholders” – namely, “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn12) In contrast, the court went out of its way to distinguish a bylaw regulating “external” matters, such as “a bylaw that purported to bind a plaintiff, even a stockholder plaintiff, who sought to bring a tort claim against the company based on a personal injury she suffered that occurred on the company’s premises or a contract claim based on a commercial contract with the corporation.”(fn13) A bylaw regulating selection of a forum to litigate such external claims “would be beyond the statutory language of 8 Del. C. 109(b)” for the “obvious” reason that it “would not deal with the rights and powers of the plaintiff-stockholder as a stockholder.” (emphasis in original). As previously noted, a bylaw purporting to regulate the litigation of claims under Rule 10b-5 “would not deal with the rights and powers of the plaintiff as a stockholder,”(fn14) and would therefore not be within even the broad scope of Section 109(b).
Nothing in ATP altered this analysis. Addressing the principal certified question in that case, the Court was necessarily focused on “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn15) (emphasis added). In the underlying litigation, the plaintiffs alleged “Delaware fiduciary duty claims,” as well as antitrust claims.(fn16) There is no indication in the ATP opinion that the Supreme Court questioned former Chancellor Strine’s view that the “flexible contract” formed by the statute, charter, and bylaws could not extend to any litigation other than “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.” Indeed, if the underlying litigation had involved only antitrust claims, we have no doubt that the Court would have concluded (consistent with FedEx/Chevron) that the bylaw could not have provided for fee-shifting in relation to the claims presented. And having been asked merely to opine about the overall facial validity of the bylaw, the Court had no occasion to parse the facts to determine whether the bylaw could require shifting fees that might have been solely attributable to the antitrust claims.
In sum, the “flexible contract” identified in ATP and established by the DGCL, the certificate of incorporation, and the bylaws encompasses a great deal – the subject matter scope of Sections 102(b)(1) and 109(b) is broad. But it is not limitless, as FedEx/Chevron expressly teaches. And in our view, it does not extend so far as to permit the charter or the bylaws to create a power to bind stockholders in regard to fee-shifting in, or the venue for, federal securities class actions. In addition, we agreed with Professor Coffee’s forceful point that a state authorization of charter and bylaw provisions purporting to control fee-shifting and venue in federal securities class actions is likely to be held pre-empted, regardless of their validity or effect under state law.(fn17) Given our views of Delaware law, we saw no reason for a statutory amendment that purported to reach beyond the confines of internal governance litigation, and we supported drafting that, as Professor Brown rightly suggests, stayed within Delaware’s “lane.”
(1) Mr. Monhait is the immediate past chair, and Professor Hamermesh a prior chair and a member, of the Council of the Delaware State Bar Association’s Corporation Law Section. The views expressed here, however, are solely those of the authors, and do not necessarily represent the views of the Association, the Section, or its Council.
(2) J. Robert Brown, Jr., Staying in the Delaware Corporate Governance Lane: Fee Shifting Bylaws and a Legislative Reaffirmation of the Rules of the Road; John C. Coffee, Jr., What Happens Next?; Neil J. Cohen, What Is the Outlook for Fee-Shifting in Securities Fraud Litigation After Delaware Passes a Ban on These Provisions for “Internal Corporate Claims”?.
(3) 91 A.3d 554 (Del. 2014).
(4) John C. Coffee, Jr., Delaware Throws a Curveball, Mar. 16, 2015, available at http://clsbluesky.law.columbia.edu/2015/03/16/delaware-throws-a-curveball/ (“read literally, the new legislation would not preclude a board-adopted bylaw that shifted the corporation’s and other defendants’ expenses against a plaintiff who lost (or was less than substantially successful) in a federal securities class action (at least so long as the action did not allege a “violation of a duty” by any corporate officer or director).”).
(5) Id. (“the proposed legislation may protect “Delaware-style” litigation from the threat of fee-shifting, but not securities class actions.”).
(6) SB 75, available at http://legis.delaware.gov/LIS/lis148.nsf/vwLegislation/SB+75/$file/legis.html?open.
(7) 15 U.S.C. §78j(b).
(8) 17 C.F.R. §240,10b-5
(9) In re Activision Blizzard Inc. Stockholder Litigation, C.A. No. 8885-VCL (Del. Ch. May 21, 2015), slip op. at 50.
(10) 15 U.S.C. §§ 77k, 77l.
Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013).
(11) 73 A.3d at 952.
(13) Id. In cases involving such external claims, the stockholders indirectly bear the costs of the litigation to the corporation, but FedEx/Chevron makes clear that this circumstance does not convert the matter into one within the internal affairs of the corporation and subject it to regulation by the charter or bylaws of the corporation.
(15) 91 A.3d at 556.
(16) John C. Coffee, Jr., Federal Pre-Emption and Fee-Shifting, (Jan. 26, 2015), available at http://clsbluesky.law.columbia.edu/2015/01/26/federal-preemption-and-fee-shifting/.
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