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Solak v. Sarowitz et al., C.A. No. 12299-CB (Del. Ch. Dec. 27, 2016) (Bouchard, C.)

December 27, 2016

In this opinion, the Court of Chancery held that Section 109(b) of the Delaware General Corporation Law (the “DGCL”) prohibits a bylaw shifting to a stockholder plaintiff the attorneys’ fees and other expenses incurred by the corporation in a suit filed outside of Delaware in violation of the corporation’s exclusive forum bylaw. 

The Chancellor began his analysis by reviewing the legislative response to the Delaware Supreme Court’s decision in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), which upheld as valid a bylaw shifting litigation expenses of a nonstock corporation to a plaintiff bringing an internal corporate claim (e.g., a claim for breach of fiduciary duty against directors) who does not obtain a judgment on the merits that substantially achieves the remedy sought.  In response to ATP, effective August 1, 2015, Section 109(b) of the DGCL was amended to provide that the bylaws of Delaware stock corporations “may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim.”  At the same time, Section 115 was added to the DGCL to codify the Court of Chancery’s decision in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), that Delaware corporations could adopt “exclusive forum” charter or bylaw provisions requiring that all internal corporate claims be filed exclusively in Delaware courts.

On February 2, 2016, the board of Paylocity Holding Corporation adopted a bylaw (the “Fee-Shifting Bylaw”) purporting to shift Paylocity’s litigation expenses, including attorneys’ fees, to any stockholder who brings, substantially assists, or has a direct financial interest in any suit regarding an internal corporate claim in a forum other than Delaware in violation of Paylocity’s exclusive forum bylaw. 

On May 5, 2016, the plaintiff filed a putative class action alleging that the Fee-Shifting Bylaw violated Sections 109(b) and 102(b)(6) of the DGCL, and that the Paylocity directors breached their fiduciary duties in adopting it.  The defendants moved to dismiss the complaint as unripe because no stockholder had filed an action outside of Delaware that would trigger the Fee-Shifting Bylaw, and for failure to state a claim upon which relief can be granted.  The Court held that the dispute was ripe for review because the Fee-Shifting Bylaw would likely have a substantial deterrent effect on litigation outside of Delaware and would therefore, as a practical matter, likely never be subject to judicial review if it were necessary to wait for it to be triggered. 

As to the merits of the claim, the Court held that the plaintiff, having asserted a facial validity challenge, had the burden to show that the Fee-Shifting Bylaw cannot operate lawfully “under any circumstances.”  The plaintiff met that burden, the Court concluded, because Section 109(b) unambiguously prohibits the inclusion of “any provision” in a corporation’s bylaws that would shift to a stockholder litigation expenses in connection with an internal corporate claim, irrespective of whether the action was filed in violation of an exclusive forum bylaw.  Accordingly, the Court rejected defendants’ argument that Section 109(b) “must be read in tandem” with Section 115 to permit fee-shifting if a plaintiff violates an exclusive forum bylaw.  The Court similarly rejected defendants’ argument that Section 109(b) did not displace common law permitting an award of costs for breach of a contractual exclusive forum provision because, to the extent fee-shifting bylaws were permissible for stock corporations at common law, that common law was in conflict with, and therefore was displaced by, Section 109(b). 

In contrast, the plaintiff failed to meet his burden with respect to Section 102(b)(6) of the DGCL, which provides that, absent approval in the certificate of incorporation, stockholders “shall not be personally liable for the payment of the corporation’s debts except as they may be liable by reason of their own conduct or acts.”  The Court held that the plaintiff failed to demonstrate that Section 102(b)(6) renders the Fee-Shifting Bylaw invalid under “any circumstances” because it was plausible that (i) the term “debts” in Section 102(b)(6) does not encompass the type of expenses enumerated in the Fee-Shifting Bylaw and (ii) the exception in Section 102(b)(6) may apply given that the Fee-Shifting Bylaw is triggered by a stockholder’s “own conduct or acts” in filing a claim outside of Delaware. 

Finally, the Court dismissed the plaintiff’s claim that the Paylocity directors breached their fiduciary duties by adopting the Fee-Shifting Bylaw after the enactment of Section 109(b) and by failing to disclose the rationale for believing that the bylaw was permissible.  Because Paylocity’s certificate of incorporation included a Section 102(b)(7) provision exculpating directors from liability for breaches of the duty of care, the plaintiff had the burden to plead facts showing it was reasonably conceivable that Paylocity’s independent directors acted in bad faith.  The Court held that the complaint, which did not include allegations concerning the board’s process or whether the board was advised by counsel, failed to support a reasonable inference that the directors knew they were violating the law when they adopted the Fee-Shifting Bylaw.  Additionally, the Court found that the “savings clause” providing that the Fee-Shifting Bylaw would operate only “[t]o the fullest extent permitted by law” negated any notion that the directors knew they were violating the law.  Likewise, the board’s failure to disclose a “rationale” for the validity of the Fee-Shifting Bylaw did not constitute an “extreme set of facts” necessary to support an inference that the directors intentionally disregarded their duties or acted in a manner “inexplicable on any ground other than bad faith.” 

The full opinion is available here