• Delaware’s Court of Chancery Grants in Part, Denies in Part, a Motion to Dismiss a Complaint Alleging Fee-Shifting Bylaw Violates Delaware General Corporation Law
  • February 8, 2017
  • Law Firm: Shaw Fishman Glantz Towbin LLC - Chicago Office
  • In a recent pronouncement on fee-shifting bylaws, the Court of Chancery held that Count I of plaintiff’s complaint survived a motion to dismiss because Section 109(b) of the Delaware General Corporation Law (the “DGCL”) prohibits “any” bylaw that shifts a corporation’s litigation expenses to a stockholder in connection with the pursuit of an internal corporate claim without regard to where such a claim is filed. Solak v. Paylocity Holding Corp., et al., C.A. No. 12299-CB (Del. Ch., Dec. 27, 2016) (opinion).

    Fee shifting bylaws were widely reported upon after the Delaware Supreme Court decided that non-stock corporations may adopt such bylaws to shift all litigation expenses a non-stock corporation incurs to a plaintiff who does not obtain a judgment on the merits that achieves substantially the full remedy sought. ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 557 (Del. 2014). To ensure that the ATP holding was limited to its facts (i.e., non-stock corporations), Section 109(b) of the DGCL was amended to provide that corporations could not hold shareholders liable for fees or costs incurred in connection with an internal corporate claim.

    Paylocity Holding Corporation (“Paylocity”) adopted a bylaw that, to the fullest extent permitted by law, shifted Paylocity’s fees, costs and expenses it incurred to a shareholder pursuing an internal corporate claim outside of Delaware without Paylocity’s consent if the shareholder did not obtain a judgment on the merits substantially achieving the relief sought (the “Bylaw”).

    Plaintiff filed a complaint against Paylocity and its board of directors (collectively, the “Defendants”) alleging that the Bylaw violated Section 109(b) of the DGCL (Count I), the Bylaw violated Section 102(b)(6) of the DGCL (Count II), and the directors breached their fiduciary duty by adopting the Bylaw and by failing to disclose certain information regarding the Bylaw in its 8K filed with the SEC (Count III). In response, Defendants filed a motion to dismiss, arguing that plaintiff’s claims were not ripe because the Bylaw had not yet been triggered and plaintiff failed to state a claim for which the Court could grant relief.

    The Court denied Defendants’ motion as to Count I but granted it as to Counts II and III of the complaint. With regarding to the ripeness issue, the Court concluded that its “common sense assessment” required the review of plaintiff’s claims that the Bylaw violated Section 109(b) and 102(b)(6) of the DGCL. The Court drew this conclusion based on the possibility that the bylaw may never be triggered, thereby eluding judicial review, and “because no beneficial purpose is served by perpetuating uncertainty concerning the permissibility of fee-shifting bylaws....” Solak, C.A. No. 12299-CB, at 13.

    Finding that plaintiff’s claims were ripe, the Court then turned to Defendants’ contention that Count I of plaintiff’s complaint failed to state a claim that the Bylaw is facially invalid under Section 109(b). The Court agreed with plaintiff that the plain language of Section 109(b) specifically prohibits any provision that attempts to shift attorney’s fees and costs incurred by a corporation in connection with an internal corporate claim to a shareholder, no matter where the claim is filed. The Court noted that that Section 109(b) makes “no distinction between internal corporate claims filed inside or outside of Delaware.” Id. at 21. The Court further noted Section 109(b) negated the conclusion that may derive from ATP that fee shifting is permissible for stock corporations. Finally, the Court noted that Paylocity’s use of a savings clause, i.e., “to the fullest extent permitted by law,” did not save the Bylaw when faced with the statute’s blanket prohibition on bylaws. Id. at 24-25. As a result, Count I of the complaint survived, and the Court denied Defendants’ motion to dismiss.

    The Court concluded that Count II failed to state a claim that the Bylaw violated Section 102(b)(6) of the DGCL and, therefore, granted Defendants’ motion to dismiss. It failed, according to the Court, because plaintiff did not carry its “heavy” burden of showing that Section 102(b)(6) rendered the Bylaw invalid under “any circumstances.” Id. at 25-27. Specifically, the Court noted that the plaintiff did not provide the Court with case law or analysis to support the conclusion that “debts,” as used in the statute, included (or not) litigation expenses as contemplated by the Bylaw. Id. Plaintiff also did not offer any explanation regarding the implication of Section 102(b)(6)’s prohibition against liability when a shareholder is “liable by reason of their own conduct or acts.” Id.

    Finally, the Court granted Defendants’ motion to dismiss Count III of plaintiff’s complaint, because the Complaint failed to plead facts necessary to support a reasonable inference that the board acted in bad faith when it approved the Bylaw and its disclosure of same. Id. at 27-32. The Court focused on bad faith because Paylocity’s certificate of incorporation contained a Section 102(b)(7) provision, and there was no contention that the directors were not independent or that they had a financial interest in adopting the Bylaw. Id. at 28. The Court pointed to the lack of facts in the complaint regarding Paylocity’s process in approving the Bylaw, which could have been provided by a Section 220 books and records action. Id. at 29-30. The Court also pointed to the savings clause, finding that it “negate[d] the notion that the directors knew they would be violating the law by approving the provision.” Id. at 30. The Court was not moved by plaintiff’s argument that the lack of disclosure in Paylocity’s Form 8-K announcing the adoption of the Bylaw rose to the level of an “extreme set of facts” to justify an inference that Paylocity’s directors intentionally disregarded their duties or acted in bad faith. Id. at 31. The Court summarily dismissed Defendants’ argument that plaintiff’s motivation for filing the instant complaint was to tee up a future violation of Paylocity’s exclusive forum bylaw approved pursuant to Section 115 of the DGCL. This “unclean hands” argument, the Court noted, constituted a “matter of significant factual dispute, and provides no basis for dismissal.” Id. at 32-33.