Fee Shifting Bylaws: Strougo v. Hollander (Part 1)
As the Delaware legislature continues to remain inactive with respect to fee shifting bylaws, the next move looks to come from the courts.
The case where this is currently most likely to occur is Strougo v. Hollander. The complaint in the case alleged a breach of fiduciary duty arising out of a reverse stock split. The transaction was announced on May 16, 2014. According to the complaint, the transaction was consummated on May 30, 2014 and a fee shifting bylaw adopted on June 3, 2014. As the complaint states:
- Bylaw VII.8 was adopted on June 3, 2014, following the announcement of the Transaction, to deter stockholders such as Plaintiff from pursuing litigation challenging the Transaction. The Bylaw imposes an obligation on Plaintiff to pay “for all fees, costs, and expenses of every kind and description” incurred by defendants if Plaintiff fails to “obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” First Aviation Bylaws VII.8.
Because the company is not public (it deregistered as a public company in 2007), there is no obligation to make bylaws or changes in the bylaws public. See Item 5.03 of Form 8-K (requiring amendments to bylaws to be filed within four business days). As a result, shareholders alleged that they were unaware of the bylaw until after a suit challenging the fairness of the stock split was filed.
Again, according to the complaint:
- No public announcement has been made notifying First Aviation stockholders about the existence of a fee-shifting provision, nor has the text of the Bylaw been made publicly available to First Aviation’s stockholders. Plaintiff’s counsel was only allowed access to the text of the Bylaw after Plaintiff caused formal discovery requests to be served on defendants. . . . Plaintiff discovered the existence of the Bylaw shortly after filing this action, when counsel for defendants contacted Plaintiff’s counsel and announced that the Board had adopted a fee-shifting provision.
The complaint also alleges that the bylaw "was adopted to discourage litigation challenging the Transaction." Or as the complaint provides:
- It is obvious from the timing of this Bylaw that it was adopted with the goal of stifling litigation arising out of the Transaction. The Bylaw was enacted on June 3, 2014, mere weeks after First Aviation publicly announced the Transaction in a press release on May 16, 2014. Further, it is entirely possible that the Bylaw was adopted after Plaintiff spoke with a member of the Board and expressed his discontent over the Transaction. The Bylaw was not voted upon by First Aviation stockholders. In fact, it was never even publicly announced to First Aviation stockholders. Plaintiff only learned of the Bylaw when defense counsel threatened Plaintiff’s counsel with the Bylaw after Plaintiff filed the instant action. Plaintiff and his counsel were only able to obtain a copy of the Bylaw after serving a formal discovery request on Defendants and their counsel.
The timing of the bylaw may affect the analysis. In Kastis, it was clear that the timing of the bylaw mattered (although the bylaw was adopted after litigation commenced). To the extent that the court does take into account the close proximity of the bylaw to the challenged transaction, the effect will be to encourage even more companies to adopt fee shifting bylaws. They will know that for litigation purposes its better to have them in place as a prophylactic, well before any possible decision or transaction that can be challenged.
Primary materials, including the complaint, can be found at the DU Corporate Governance website.