In 2015, Section 115 of the Delaware General Corporation Law (“DGCL”) was added to clarify that Delaware corporations may adopt bylaws requiring that any litigation regarding internal corporate claims be filed in Delaware (commonly referred to as “forum-selection bylaws”). At the same time, Section 109(b) of the DGCL was amended to make clear that Delaware corporations (other than non-stock corporations) may not adopt bylaws that would shift litigation expenses onto unsuccessful stockholder-plaintiffs in internal corporate litigation (commonly referred to as “fee-shifting bylaws”). These simultaneous amendments left open the question of whether a limited fee-shifting bylaw, which would only be triggered if the stockholder filed an internal corporate claim outside of Delaware in violation of the corporation’s forum-selection bylaw, would be valid under Delaware law.
In its recent decision in Solak v. Sarowitz, the Chancery Court (Bouchard, C.) held that such a bylaw violated Section 109(b) and was invalid on its face.
The complaint in that case alleged that, six months after the two amendments to the DGCL described above became effective, the board of Paylocity Holding Corporation (“Paylocity”) adopted two new bylaws. The first was a standard forum-selection bylaw, providing that specified categories of claims must be filed in state or federal court in Delaware, unless the corporation consented in writing to an alternative forum. The second new bylaw purported to shift the corporation’s litigation expenses onto any stockholder who violated the forum-selection bylaw unless such stockholder obtained a judgment on the merits that substantially achieved the full remedy sought.
A Paylocity stockholder filed an action in the Delaware Court of Chancery seeking a declaration that this fee-shifting bylaw violates, among other things, Section 109(b). Paylocity and its board of directors filed a motion to dismiss, in which they argued that the stockholder-plaintiff’s challenge was not “ripe” because no Paylocity stockholder had filed or disclosed its intention to file an internal corporate claim outside of Delaware and that, on the merits, the DGCL permitted the type of bylaw at issue. In his December 27, 2016 opinion, Chancellor Bouchard first rejected the defendants’ ripeness argument in light of the “practical reality” that no rational stockholder would file an internal corporate claim outside of Delaware because of the deterrent effect of the fee-shifting bylaw; thus, if the Court declined to review the bylaw on ripeness grounds, that “would mean, as a practical matter, that its validity under the DGCL would never be subject to judicial review.”
Turning to the merits, Chancellor Bouchard held that the fee-shifting bylaw plainly violates Section 109(b) because that statute “unambiguously prohibits the inclusion of ‘any provision’ in a corporation’s bylaws that would shift to a stockholder the attorneys’ fees or expenses incurred by the corporation ‘in connection with an internal corporate claim,’ irrespective of where such claim is filed.” The Court rejected defendants’ argument that Section 109(b) “must be read in tandem” with Section 115 to permit limited fee-shifting bylaws where a stockholder violates a valid forum-selection clause, as unsupported by the plain text of those statutory provisions. The Court also rejected defendants’ argument that a “savings clause” in the fee-shifting bylaw alleviated any problem because, the Court held, that bylaw “is wholly invalid.”
Finally, although the Court found the fee-shifting bylaw to be facially invalid, it dismissed the plaintiff’s claim that the board breached its fiduciary duties in adopting it, in light of Paylocity’s Section 102(b)(7) exculpation provision and the lack of any factual allegations in the complaint raising a reasonably conceivable inference that the board adopted the bylaw in bad faith.
The decision thus further evidences Delaware’s resistance to fee-shifting for unsuccessful stockholder-plaintiffs.