Paving the Delaware Way: Equitable Limits on Bylaws after ATP

Abstract

In ATP Tours Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court held that a private company’s fee-shifting bylaw was facially valid. That bylaw was especially wide-reaching, applying to current shareholders, former shareholders, and anybody who assisted them in investigating or suing on their claim; requiring fee shifting in any case where the litigants obtained anything short of a full judgment in their favor and that was virtually the same as the relief initially sought in the complaint; and shifting not just lawyers’ fees but costs of every kind. Many have interpreted ATP as a broad endorsement of fee-shifting bylaws and a move by the Delaware courts to curtail shareholder litigation. They have warned or celebrated (depending on their point of view), that ATP would permit public companies to adopt similar fee-shifting bylaws for all sorts of shareholder and securities lawsuits.

In this article, we show that claims that ATP will result in calamity for investors and a silver bullet for companies to end shareholder and securities litigation are overblown. Rather, ATP — when carefully and fairly read — simply reaffirms the Delaware Way. Under the Delaware Way, corporate managers are vested with broad legal authority, but that authority is tempered by principles of equity. Likewise, in ATP, the Delaware Supreme Court held that fee-shifting bylaws are legal, but principles of equity limit their application.

Using ATP and fee-shifting bylaws as a point of departure, we provide a template for equitable analysis of not only fee-shifting bylaws, but also forum-selection bylaws and other bylaws relating to litigation. Further, as we argue in this article, when equitable principles are properly applied, they will likely preclude the use of such bylaws to extinguish meritorious shareholder or securities litigation. As we demonstrate, before a court will enforce a fee-shifting bylaw, the board of directors must meet its burden of proving that adopting and implementing that bylaw comports with their duty of care and duty of loyalty. Specifically, the only kind of fee-shifting bylaw that is likely to survive equitable scrutiny is one that is proportionate — one that provides that a neutral arbiter can approve of two-way shifting of reasonable fees in response to frivolous litigation. Moreover, we find that the fee-shifting bylaws that will survive equitable review simply duplicate Delaware’s existing mechanism for patrolling frivolous litigation: Delaware Rule 11. That Rule also provides for a neutral arbiter to approve of two-way shifting of reasonable fees in response to frivolous litigation. Ultimately, we question whether there is still a need for years of litigation surrounding fee-shifting bylaws simply to arrive at the state of the law already in place. Perhaps the most compelling reason for legislative intervention here is to spare litigants and the system the lengthy, common-law process that will get us to a world that already exists.