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Delaware Chancery Court Finds Fee-Shifting Bylaw Facially Invalid Notwithstanding Its Limitation To Actions Brought In Violation Of An Exclusive-Forum Bylaw
01/09/2017On December 27, 2016, Chancellor Andre G. Bouchard of the Delaware Court of Chancery denied in part a motion to dismiss a putative shareholder class action challenging a fee-shifting bylaw recently adopted by Paylocity Holding Corporation. Solak v. Sarowitz, C.A. No. 12299-CB (Del. Ch. Dec. 27, 2016). Specifically, the Court found the fee-shifting bylaw was facially invalid even though it only applied to actions filed outside of Delaware, which would contravene Paylocity’s valid exclusive-forum bylaw.
As explained by the Court, in 2015, Section 115 was added to the Delaware General Corporation Law (“DGCL”) providing that “Delaware corporations may adopt bylaws requiring that internal corporate claims be filed exclusively in Delaware.” At the same time, Section 109(b) was amended “to provide that the bylaws of Delaware 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.’”
In February 2016, Paylocity added two provisions to its bylaws. The first was an exclusive-forum provision that provides that internal corporate claims—such as derivative actions on behalf of the corporation and/or actions asserting breaches of fiduciary duty—are to be brought exclusively in a state or federal court located in Delaware, unless the corporation consents to an alternative forum. The second was a fee-shifting provision that generally “shifts the company’s litigation expenses (including attorneys’ fees) to any stockholder who brings, substantially assists, or has a direct financial interest” in any action asserting such internal corporate claims outside of Delaware, “unless the stockholder obtains a judgment on the merits that substantially achieves the full remedy sought.” This provision contained a “savings clause” that makes it applicable only “[t]o the fullest extent permitted by law.”
Plaintiff, a Paylocity stockholder, filed this suit against Paylocity and its directors seeking a declaration that the fee-shifting bylaw is invalid. In this regard, plaintiff asserted that the bylaw violates DGCL Section 109(b), as well as a separate statutory provision, DGCL Section 102(b)(6), which precludes stockholders from being held “personally liable for payment of the corporation’s debts except as they may be liable by reason of their own conduct or acts” (or unless the corporation’s certificate of incorporation provides otherwise). Additionally, plaintiff claimed that Paylocity’s directors breached their fiduciary duties by approving the fee-shifting bylaw and disclosing the new bylaw without simultaneously mentioning the DGCL amendment to Section 109(b) or explaining how the new bylaw complies with Section 109(b).
Chancellor Bouchard first determined that plaintiff’s declaratory relief claims were “ripe for review” because “the practical reality is that, so long as the Fee-Shifting Bylaw remains in place, it is highly unlikely that any rational stockholder of Paylocity would file an internal corporate claim outside of Delaware because of the significant risk of personal liability that triggering the Fee-Shifting Bylaw presents.” Then, applying a high standard of review by assessing the fee-shifting bylaw under a “presumption of facial validity,” the Court nevertheless upheld plaintiff’s claim for a declaration of invalidity. Chancellor Bouchard explained that Section 109(b) “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.” Therefore, the plain text of the fee-shifting bylaw violates this “blanket prohibition” even though it “is triggered only when an internal corporate claim is filed outside of Delaware.” Moreover, the inclusion of the “savings clause”—applying the fee-shifting only “[t]o the fullest extent permitted by law”—does not “negate a facial challenge to the validity of a bylaw” where, as here, there is nothing “left in the challenged provision for the savings clause to save.” In sum, according to Chancellor Bouchard, the fee-shifting bylaw “cannot operate lawfully under any circumstances.”
The Court, however, dismissed plaintiff’s separate claim that the fee-shifting bylaw violates DGCL Section 102(b)(6) because (a) that statutory provision does not unambiguously cover the type of expenses subject to the fee-shifting bylaw, and (b) the exception therein for a stockholder’s “own conduct or acts” might be applicable to the circumstances implicated by the fee-shifting bylaw. The Court also rejected plaintiff’s breach of fiduciary duty claim because Paylocity’s certificate of incorporation contained a provision exculpating its directors from liability for breaches of the duty of care (as permitted under DGCL Section 102(b)(7)) and the complaint failed to demonstrate that the directors acted in bad faith.
