
So where does that leave us? The Delaware legislature may yet act to bar or limit fee-shifting provisions. 5 Delaware may be motivated to act by the very plausible fear that such bylaws will reduce the volume of litigation in Delaware courts and thereby adversely affect Delaware's leading local industry (i.e., corporate litigation). Still, even if Delaware were to act, the issue would still not disappear for three distinct reasons: (1) Delaware might only modestly limit the use of such bylaws, still permitting a substantial chill; (2) Corporations incorporated in other jurisdictions may adopt similar bylaws (and the prestige of the Delaware Supreme Court may lead other courts to accept its ruling, even if the Delaware legislature were to reverse or amend it); and (3) Corrective action by Delaware might start an interjurisdictional competition, as other, more conservative states (think, Texas) might seek to lure companies to reincorporate there to exploit their tolerance for such provisions. This brief memorandum

will not attempt any brief-like statement of the complicated case law on preemption, 6 but will focus instead on the policy issues and the need for SEC action.

As our starting point, the initial question is: when will the Delaware Chancery Court (in the absence of new legislation) find that a fee-shifting provision was adopted for an improper purpose? Here, a particularly relevant statement in ATP Tour, Inc. is that:

"The intent to deter litigation, however is not invariably an improper purpose. Fee-shifting provisions, by their nature, deter litigation. Because the fee-shifting provisions are not per se invalid, an intent to deter litigation would not necessarily render the bylaw unenforceable in equity." 91 A. mmorris@example.com.

Although it is certainly conceivable that a bylaw adopted after a specific corporate transaction was initiated by the board (or even after a lawsuit challenging the transaction had been filed) could be seen as a self-interested and "improper" attempt by the board to immunize itself, it is far less likely that a feeshifting provision adopted well in advance of the transaction would be similarly invalidated-at least by Delaware courts. To be sure, the Delaware Supreme Court did not need to address these questions because the ATP Tour case came to it as a certified question from another court, and it properly limited itself to questions of law. Nonetheless, within Delaware and absent legislation, the message of ATP Tour seems clear: fee-shifting will be upheld unless evidence of bad faith or improper purpose can be shown.
I. Fee-Shifting Provisions in Federal Court
But what is the status of such a board-adopted bylaw in federal court? Here, it is important to note that the ATP Tour case was in fact brought in federal court in Delaware. The plaintiff lost at trial, 7 and the defendant moved for its costs pursuant to the bylaw. The District Court denied this motion, effectively ruling that federal law preempts the enforcement of fee-shifting agreements when antitrust claims are involved. was the exclusive mechanism for enforcing a forum-selection clause. Both further concluded that the district court had to undertake a balancing-of-interests analysis. On appeal, the Supreme Court partially disagreed. Although it found that Section 1404 (and not the contract, itself) governed, it held that the District Court's analysis improperly placed the burden on the defendant to prove that the requested transfer was appropriate. Instead, it said the burden was on the plaintiff, as the party "flouting" its contractual obligations, to show that public-interest factors overwhelmingly disfavored the requested transfer to Virginia:
I. Fee-Shifting Provisions in Federal Court
"Only under extraordinary circumstances unrelated to the convenience of the parties should a §1404(a) motion be denied."
16
Because there was no preemption issue in Atlantic Marine, its relevance is limited, but it does have two implications: (1) contracts governing litigation are not necessarily enforced as written but must be interpreted through the prism of the Federal Rules of Civil Procedure; and (2) public policy questions may retain some modest relevance, even when there is no federal statute involved. On this basis, a forum selection bylaw requiring federal securities class actions to be brought in a preferred federal forum (for example, federal district court in Delaware) is likely enforceable, but will have to be implemented by means of Section 1404.
16
Atlantic Marine implies that fee shifting bylaws must at least be consistent with the Federal Rules of Civil Procedure, and these rules address the award of attorneys fees in Rules 54(d)(2) and 23(h).
16
Under Rule 54(d)(2)(C), the court must give a party "an opportunity for adversary submissions on the motion in accordance with Rule 43(a) or 78" and the court "must find the facts and state its conclusions of law as provided in Rule 52(a)." Under Rule 23(h), the court must hold a hearing and any class member may object to the motion. These restrictions are minimal, but they do provide a hearing at which the SEC could appear.
II.
Is One-Sided Fee-Shifting Inconsistent With the Policies Underlying the Federal Securities Laws?
II.
To ask this question is not to answer it. The specific provision needs to be considered to determine the extent of the burden it imposes. Most such provisions will presumably require a losing shareholder who sued the company unsuccessfully to pay all the defendants' expenses, but many go even further and require the plaintiff to be completely successful on all its claims and obtain most of the relief sought-or face fee-shifting. 17 Thus, if a plaintiff sued for $100 million and obtained only $40 million (a notable victory by any realistic standard), it may not have been sufficiently successful to escape feeshifting. Most (if not all) such bylaws will not pay the successful plaintiff's fees or expenses. 18 Thus, without more, such provisions have two key faults: (1) they are one-sided in that they reimburse successful defendants, but not successful plaintiffs (thus, they are unlike the English Rule which shifts fees both ways evenly); and (2) they require fee-shifting even in cases that were reasonable or even meritorious (but lost on a technical legal defense or were largely, but not entirely, successful).
II.
But there is more. Some of these provisions are drafted so broadly that they expressly apply to "investigations" as well as to legal actions and some purport to require anyone who assists a plaintiff in such litigation to also share liability for fee shifting. Thus, a shareholder/whistleblower could be arguably held liable for the corporation's fees and expenses in defending a civil or criminal investigation by regulators-at least if not all the charges raised by the whistleblower were fully confirmed. Efforts to cover those who assist the shareholder plaintiff might even apply to expert witnesses and attorneys who assist the litigation (at least if they own shares).
II.
Depending on one's perspective, these deficiencies may or may not seem as egregious as indemnifying a knowingly culpable defendant (which was the fact pattern in Globus), but they may do much more to deter and chill private enforcement of law. Inherently, defendants' fees and expenses will often exceed plaintiffs' expected fee award (in part because there tend to be multiple counsel representing the various defendants), and thus plaintiffs' attorneys must accept a potential liability greater than their potential gain. Since at least J. I. Case Co. v. Borak in 1964, 19 federal decisions and the SEC have asserted that private enforcement of law is a "necessary supplement" to public enforcement by the SEC and the Department of Justice. 20 Although the Supreme Court's attitude may be more equivocal today on this point (and clearly it will no longer imply a federal private cause of action, absent clear legislative direction), the Court has still shown itself unwilling to dismantle Rule 10b-5 class actions. 21 The SEC has not formally retreated from its support for private enforcement, but it is currently on the sidelines, and this issue will put its resolve to the test.
II.
The incentives created by an automatic "loser pays" rule seem particularly perverse. A reckless or incompetent attorney who files a half-baked complaint will face only a modest to moderate sanction when the action is dismissed on a motion to dismiss (because the defendant will not yet have incurred substantial legal expenses). But if the action is more meritorious and survives the motion to dismiss, it will proceed into the discovery stage. Now, the expenses really begin to mount (and can easily exceed several million dollars a year). The harder and longer the plaintiff's attorney works to prepare the case, the greater the potential sanction he faces. As a result, the incentive effect here is to encourage early (and probably premature) settlement before the facts are really developed. If the plaintiff's attorney loses (at trial, summary judgment, or whenever), the plaintiff's attorney has a strong incentive to negotiate a deal under which the attorney waives the right to appeal in return for defendants' waiver of fee-shifting. As a result, little appellate law may be made.
II.
These outcomes seem inconsistent with Congress's attitude towards fee-shifting in securities class actions. Preemption seems especially justified in this area because Congress struck a special balance in this area. That balance recognizes that fee-shifting against the losing side may sometimes be appropriate, but it is conditioned on judicial oversight and applies to both sides. Under Section 21D(c)(3) of the Securities Exchange Act of 1934 (which provision was added by the Private Securities Litigation
II.
Reform Act of 1995), a presumption in favor of fee-shifting is created if any motion or pleading fails to comply with Rule 11(b) of the Federal Rules of Civil Procedure. This two-sided approach is equally punitive to both sides in making full fee-shifting (rather than a lesser financial sanction) the presumptive penalty, but it requires the court to find a violation of Rule 11. Because this approach is tougher and more punitive than the normal approach under Rule 11 of the Federal Rules (which would typically involve lesser financial sanctions), it represents a carefully balanced federal policy, but one that is in sharp conflict with automatic and one-sided fee-shifting without any role for judicial discretion. Effectively, board-adopted bylaws can turn a Congressionally-mandated system of two-sided fee shifting that is dependent on judicial discretion into an automatic system of one-way fee-shifting.
II.
Bottom Line: Although there may be a case for preemption of fee-shifting bylaws in many contexts, this case is stronger in the case of securities litigation.
III. What Should the SEC Do?
The SEC could take a number of steps, all consistent with past practice. First, the SEC could assert the case for preemption selectively as an amicus curiae in cases where no violation of Rule 11 seemed present. This will require some careful case analysis by the SEC and should not be an automatic response. Alternatively, the SEC could assert that automatic fee-shifting is always in violation of the Securities Exchange Act, unless it is predicated on a judicial finding that Rule 11 was violated. This would be a riskier approach, and it might force the SEC to defend a less-than-attractive plaintiff's attorney.
III. What Should the SEC Do?
Second, the SEC has in a closely related area refused to accelerate registration statements where the company's certificate of incorporation or bylaws contained a mandatory arbitration clause. This threat seems to have been effective, and companies that have considered challenging the SEC have ultimately backed down. 22 Yet, the SEC has not held up registration statements with fee-shifting provisions. This is inconsistent. Functionally, the two cases are equivalent, because both provisions effectively bar private enforcement.
III. What Should the SEC Do?
Third, the SEC could require registrants to state in their registration statements that they understand that the SEC believes that the federal securities laws are inconsistent with fee-shifting bylaws.
III. What Should the SEC Do?
Such a statement is already specified in Forms S-1 and S-3 with respect to indemnification provisions. 23 This at least imposes an embarrassment cost on the issuer and alerts courts to the SEC's views without the need for an SEC amicus position.
III. What Should the SEC Do?
Fourth, the SEC could focus disclosure on such provisions, thereby raising the "embarrassment cost" to the issuer. In the case of IPOs that involve such provisions, the SEC could require these terms to be disclosed up front as a major "risk factor." In contrast, in the Alibaba IPO, no disclosure focused on the impact of its fee-shifting charter provision. Although the SEC's staff appears to have missed the forest for the trees here, it must be stressed that enhanced disclosure alone is not an adequate remedy.
III. What Should the SEC Do?
Corporations will still use such provisions, even if they modestly impact the IPO price. Investors cannot adequately price the impact of a provision denying them the ability to enforce their legal rights because they do not know how likely it is that the corporate insiders will breach their duties.
III. What Should the SEC Do?
Finally, the SEC is uniquely positioned to gather relevant data. In assessing the impact of feeshifting bylaws, it would be useful to know what the average costs are that defendant firms incur on such litigation and that they would seek to shift. The impact on the typical plaintiff's firm could also be evaluated empirically. Similarly, the SEC could assess whether insurance could alleviate this problem (if it were available) and at what cost. Lastly, if Delaware were to impose partial curbs (permitting only some limited fee shifting), the SEC could assess the likely empirical impact of such a modified feeshifting bylaw.
Conclusion
The impact of fee-shifting bylaws could be decisive. The defendant's expenses in a securities class action can easily exceed $10 million, and this amount would bankrupt many smaller plaintiff's law firms. It is questionable (and certainly unresolved) whether plaintiff's law firms could obtain liability insurance to cover these amounts. Even if a bold plaintiff's law firm did sue, it would likely have to agree to indemnify the class representative from fee-shifting, and some class representatives might decline the position, fearing that the plaintiff's firm could not fully protect them.
Conclusion
As the case proceeded, the defendant's expenses will progressively mount, increasing the potential penalty. This will predictably force cheaper settlements, thereby injuring the class. If feeshifting bylaws are upheld, defendant issuers should logically regard them as a riskless move that has little downside. Probably, proxy advisors would object to such board-adopted bylaws, 24 but this is not the kind of board action that could easily fuel a proxy contest or be easily overturned by a shareholder vote. 25 As a result, such provisions, unless challenged by the SEC, will predictably become prevalent.
Conclusion
Bottom Line: For the short-term, the ball is still in Delaware's court while its legislature considers possible curbs. That process will not likely be resolved until 2015. Although the SEC need not oppose all fee-shifting provisions adopted through board or shareholder action, it must be prepared to take on open-ended and more sweeping provision-or concede the decline of private enforcement. At present, the SEC seems to be ducking this issue, but continued irresolution will only further injure the SEC's already damaged reputation.
Conclusion
Final Thought: If Delaware does act to restrain fee-shifting through bylaws, the potential for a "race to the bottom" arises. Other states of a more conservative bent (consider, for example, Texas) might accept or even endorse fee-shifting provisions. At this point, some corporate lawyers will predictably advise their clients to reincorporate in Texas, and many IPO issuers might prefer to incorporate in Texas initially. Even if small changes in corporate law will not produce a migration into or away from Delaware, the permissibility of automatic fee-shifting is a major difference that will fuel interjurisdictional competition because it protects corporate managers and directors from potential personal liability. In this light, an SEC announcement that it will challenge fee-shifting provisions would chill interstate charter competition (and might even be welcomed in Delaware Notwithstanding anything in this Certificate of Incorporation to the contrary, to the fullest extent permitted by law, in the event that (i) any current or prior stockholder or anyone on their behalf (a "Claiming Party") initiates any action, suit or proceeding, whether civil, criminal, administrative, or investigative, or asserts any claim or counterclaim (each, a "Claim") or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Corporation (including any Claim purportedly filed on behalf of any other stockholder) and/or any director, officer, employee or affiliate thereof (each, a "Company Party"), 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 applicable Company Party for all fees, costs, and expenses of every kind and description (including, but not limited to, all reasonable attorneys' fees and other litigation expenses) that the applicable Company Party may incur in connection with such Claim. If any provision (or any part thereof) of this Article SIXTEENTH shall be held to be invalid, illegal or unenforceable facially or as applied to any circumstance for any reason whatsoever: (1) the validity, legality and enforceability of such provision (or part thereof) in any other circumstance and of the remaining provisions of this Article SIXTEENTH (including, without limitation, each portion of any subsection of this Article SIXTEENTH containing any such provision (or part thereof) held to be invalid, illegal or unenforceable that is not itself held to be invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby, and (2) to the fullest extent permitted by law, the provisions of this Article SIXTEENTH (including, without limitation, each such portion containing any such provisions (or part thereof) held to be invalid, illegal or unenforceable) shall be construed for the benefit of the Corporation to the fullest extent permitted by law so as to (a) give effect to the intent manifested by the provision (or part thereof) held invalid, illegal, or unenforceable, and (b) permit the Corporation to protect its directors, officers, employees and agents from personal liability in respect of their good faith service. Any person or entity purchasing or otherwise acquiring any interest in the shares of capital stock of the Corporation shall be deemed to have notice of and consented to the provisions of this Article SIXTEENTH. Obviously, this provision goes beyond a "loser pays" rule and is in effect "a-less-than-100%-successful-plaintiffpays" rule.

{'paper_id': '159876565', 'title': 'Fee-Shifting Bylaw and Charter Provisions: Can They Apply in Federal Court? -- The Case for Preemption', 's2_url': 'https://api.semanticscholar.org/CorpusID:159876565', 'source': 'S2ORC'}