Investors, companies to fight over who pays litigation fees

Battle lines are being drawn over last year's Delaware court ruling that lets companies shift legal fees to investors bringing lawsuits.

“We are going to be collectively and individually pressing the state Legislature to override the court decision,” said NCPERS Executive Director Hank Kim, Washington.

“Companies should have the option to have fee shifting in their bylaws,” said Matt Webb, senior vice president for legal reform policy at the U.S. Chamber of Commerce's Institute for Legal Reform, Washington.

At the center of the fight is the Delaware Supreme Court decision in ATP Tour Inc. et al. vs. Deutscher Tennis Bund, upholding the corporation's right to unilaterally amend its bylaws to make unsuccessful shareholder litigants personally liable for legal expenses, even if they prevailed on some, but not all, of the issues.

Although ATP Tour is a private company, at least 50 public companies added similar bylaws to their governing documents after the ruling, according to a list compiled by law firm Kessler Topaz Meltzer & Check LLP, which represents institutional investors in securities litigation.

“Investors really do need to understand that this issue is growing, and more companies are adopting these. If these become ubiquitous, then shareholder litigation is going to be fundamentally changed,” said partner Lee Rudy, a partner at the firm in Radnor, Pa.

Christine Azar, a partner with law firm Labaton Sucharow LLP in Wilmington, Del., whose firm represents investors in securities lawsuits, also sees mounting corporate interest in adding fee-shifting bylaws.

“That gives us great concern because it doesn't prevent frivolous litigation, it prevents litigation, period. When you have to win with a capital W, it's just too big a risk.”

For the Council of Institutional Investors in Washington, the trend threatens board accountability by creating “prohibitively high hurdles for shareholders to pursue litigation for meritorious claims,” said CII General Counsel Jeff Mahoney.

If the trend continues, “it would really stop any shareholder litigation in its tracks,” said Anne Sheehan, director of corporate governance for the $189.7 billion California State Teachers' Retirement System, West Sacramento. “It is very troubling.”

CII, which represents $2 trillion in pension assets, and the National Conference on Public Employee Retirement Systems, whose members hold a combined $3 trillion in pension assets, have joined with unions representing public- and private-sector workers to press Delaware Gov. Jack Markell and other state policymakers to undo the decision before it erodes investor rights well beyond the state's borders.

A legislative proposal at the end of 2014 to accomplish that failed to advance after hitting significant opposition from business groups, including the Institute for Legal Reform. Another proposal is expected to reappear early in the 2015 legislative session, once Delaware state bar experts produce recommendations.

Business groups are also on the front lines in Delaware, where they see an opportunity to put the brakes on what they consider an epidemic of shareholder litigation, particularly involving mergers and acquisitions.

“I think there's still an open question what those fee-shifting bylaws should have,” said Mr. Webb of ILR. “Delaware should view this as an opportunity to look at what's going on with their corporations and see what they can do to start cleaning the house.”

Mr. Webb added that interest from other states in tackling the bylaw issue as a way of attracting companies “should be a pretty large warning light” for Delaware to not take an anti-corporate stance.

With corporate shareholder rights governed by state law, the Securities and Exchange Commission has a limited role to play.

That keeps all eyes on Delaware, where an estimated two-thirds of Fortune 500 companies and 83% of all companies launched in 2013 are incorporated.

Delaware officials realize they are walking a fine line, with their state's business-friendly reputation at stake.

“There is concern that there is some litigation that is unwarranted and wastes shareholder and company dollars. But fee-shifting bylaws might also deter meritorious litigation,” Chief Deputy Secretary of State Richard Geisenberger said in an interview. “So how do you balance those two things? We are trying to figure out where are there grounds for agreement and to what extent do you change things.”

“I think at the end of the day we will find consensus,” said Mr. Geisenberger. With trillions of dollars invested in Delaware corporations, “you're not going to see dramatic swings in our law one way or the other. It will be balanced between corporations and investors,” he said.

In the meantime, institutional investors want more of a say in any changes that companies might be contemplating.

“A provision like this — shifting risk to the owner — should require shareholder approval, and management should not be able to adopt it without first submitting it to ownership for approval,” said Chris Supple, deputy executive director and general counsel of the $60.7 billion Massachusetts Pension Reserves Investment Management Board, Boston, and co-chair of the securities litigation committee of the National Association of Public Pension Attorneys.

“Whether that's accomplished by statute, court decision or shareholder vote, that's the way the issue should resolve, with unilateral action by management not permitted,” said Mr. Supple.

New fee-shifting bylaws could be the “corporate equivalent of the California Gold Rush,” said Harvey Pitt, former chairman of the Securities and Exchange Commission. But he cautioned that while they can be useful against frivolous lawsuits, imposing them without shareholder input could undermine the purpose. Along with a mandatory shareholder vote, he advises companies to use a transparent process that distinguishes between frivolous and meritorious claims, and shares the potential fee exposure, among other criteria.

CalSTRS will vote against corporate directors who support fee-shifting bylaws as they come up, and would support shareholder proposals limiting a company's ability to impose such bylaws unilaterally, Ms. Sheehan said. “Those are the steps that shareholders could take at this point,” she said.

“Institutions do have a powerful voice,” said Jill Fisch, a securities law professor at the University of Pennsylvania Law School, Philadelphia, noting shareholder backlash against bylaws aimed at discouraging arbitrage played a role in their falling out of favor. She also sees proxy advisory firms weighing in and forcing companies to decide if fee-shifting bylaws are worth the fight. “At some point,” said Ms. Fisch, “issuers and investors are going to have to make an assessment about their priorities.”