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From Securities Regulation Daily, December 28, 2016

Fee-shifting bylaw is facially invalid

By Rodney F. Tonkovic, J.D.

The Delaware Chancery Court has applied a recent ban on fee-shifting provisions by stock corporations to find that a fee-shifting bylaw was facially invalid. The court first found that a shareholder's facial challenge to the bylaw was ripe for review because the deterrent effect of the provision was such that an action subject to the provision might never be filed. Also, the plain text of Section 109(b) unambiguously prohibits "any provision" that would shift fees in connection with an internal corporate claim (Solak v. Sarowitz, December 27, 2016, Bouchard, A.).

Fee-shifting bylaw. In 2015, Section 109(b) of the Delaware General Corporation Law was amended to prohibit Delaware corporations from adopting bylaws that would impose liability on shareholders for the corporation's attorney fees or expenses in connection with litigating an internal corporate claim. In early 2016, the board of Paylocity Holding Corporation adopted two new bylaws, one of which requires internal corporate claims to be filed in a state or federal court located in Delaware (the "exclusive forum bylaw"). The second, which is at issue in this action, shifts to a stockholder who files an internal corporate claim the attorney fees and other expenses that the company incurs in connection with a claim filed in a forum not located in Delaware, unless the stockholder obtains a judgment on the merits that substantially achieves the full remedy sought (the "fee-shifting bylaw").

The shareholder bringing this action sought a declaration that the fee-shifting bylaw was invalid under the DGCL. The complaint asserted further that Paylocity's board should be liable for breaching their fiduciary duty in adopting the bylaw. Paylocity moved to dismiss the complaint as unripe because no shareholder has filed an internal corporate claim outside of Delaware. The court concluded that the claims were ripe for review and that the complaint's challenge under Section 109(b) stated a claim for relief.

Ripeness is all. The court first found that the claims were ripe for review because the validity of the fee-shifting bylaw might otherwise never be subject to judicial review, given its deterrent effect. The court noted that it has repeatedly recognized disputes as ripe when the challenged measures have a substantial deterrent effect. Here, a rational shareholder would be unlikely to file a claim outside of Delaware because of the significant risk of personal liability presented by the fee-shifting bylaw. If the court declined to review this bylaw, its validity could never be subject to judicial review, and other corporate boards would be encouraged to adopt similar bylaws.

Facially invalid. The court then found that the complaint stated a claim that the fee-shifting bylaw was facially invalid. Section 109(b) of the DGCL provides that "bylaws 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." The court concluded that the plain text of Section 109(b) unambiguously prohibits "any provision" that would shift fees in connection with an internal corporate claim, no matter where it is filed. The fee-shifting bylaw was therefore invalid under Section 109(b)'s blanket prohibition.

The shareholder's remaining two claims, however, were dismissed. First, the court found that the complaint failed to show that the fee-shifting bylaw violates Section 102(b)(6), which concerns when personal liability for the corporation's "debt" may be imposed on stockholders. According to the court, the shareholder offered no support for the interpretation that "debt" encompasses litigation expenses. Next, a claim for breach of fiduciary duty against the individual defendants for approving the adoption of the fee-shifting bylaw was dismissed because the shareholder failed to plead facts sufficient to warrant a reasonable inference that Paylocity's directors acted in bad faith.

The case is No. 12299.

Attorneys: Peter B. Andrews (Andrews & Springer LLC) for John Solak. John L. Reed (DLA Piper) for Steven I. Sarowitz.

Companies: Paylocity Holding Corporation

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