Fee Shifting Bylaws and the Smart & Final Stores IPO

Smart & Final Stores went public this week.  The Company raised $161.4 million at $12 per share. According to published reports, the final price was at "the low end of its expected price range of $12-$14."  

Interestingly, the Company looks to be the first corporation to do an IPO with a fee shifting provision in the Certificate of Incorporation.  As the Company's Certificate provides: 

• 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.   

The provision applies to "any action, suit or proceeding, whether civil, criminal, administrative or investigative" filed by "any current or prior stockholder or anyone on their behalf.  The provision apparently applies to a cause of action under Section 11 of the Securities Act of 1933.  Indeed, a shareholder bringing a Section 11 claim would presumably have to incur the risk that the shareholder would have to pay the costs associated with challenging the bylaw.

The interference with federal causes of action may violate Section 14 of the 1933 Act.  15 USC 77n ("Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of the Commission shall be void."); see also Section 29(a) of the Exchange Act.  In Shearson, the Supreme Court noted that the provision applied to provisions that denied shareholder the ability "to enforce the statutory rights created by" the 1933 Act.  
Shearson/American Exp., Inc. v. McMahon, 482 US 220, 222 (1987).  The argument exists that a fee shifting provision that effectively prevents shareholders/investors from bringing suits under the federal securities laws is in fact a denial of the ability to enforce statutory rights.  

Perhaps recognizing the legal fragility of the provision, the Article included a savings clause.  

• 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 provision (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.

What is somewhat surprising is that, given the possible effect of the provision on shareholder/investor causes of action, the Registration Statement contained only a thin description of the provision.  As the Registration Statement provided:    

• Attorneys' Fees in Stockholder Actions.  Our certificate of incorporation includes a requirement that, to the fullest extent permitted by law, a stockholder reimburse us for all fees, costs and expenses incurred by us in connection with a proceeding initiated by such stockholder in which such stockholder does not obtain a judgment on the merits that substantially achieves the full remedy sought. This provision may have the effect of discouraging lawsuits against us or our directors and officers.

A more fulsome discussion might have included a specific mention of causes of actions that could be affected by the provision.  Such a discussion could disclose the impact of the provision on actions under Section 11 of the 1933 Act.  

A more fulsome discussion might have included an analysis of the legality of the provision.  This might include mention that the only case in Delaware to date to address validity involved a bylaw propounded by a non-stock company.  It also could include disclosure of the possibility that Delaware will legislatively invalidate these provisions.  

A more fulsome discussion also might include some discussion of the possible impact of such a provision on board behavior.  It is possible that, if the provision effectively eliminates or vastly reduces the number of derivative suits, boards will have a reduced incentive to ensure that their behavior is consistent with fiduciary obligations.  

A more fulsome discussion also might include some discussion of the possible impact of the provision on corporate disclosure.  It is possible that, if the provision effectively eliminates or vastly reduces the number of claims alleging false disclosure under the federal securities laws, companies will have a reduced iincentive to ensure accurate disclosure.