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Companies Add Fee Shifting Provisions to By-Laws to the Detriment of Shareholder Rights

Shareholders are not philanthropists. They are investors who expect to see a return on the money they put into a company. Because companies have a vested interest in attracting shareholders, laws have been put in place to make sure they act fairly and honestly when communicating with their shareholders about the state of the company. This generally means requiring companies to reveal the state of their finances, market value, any legal issues they may be having that could affect their profits, etc.

Before handing over large sums of money to the control of another, it makes sense that shareholders would want to make sure their money is in safe hands. If it turns out the shareholders were deceived or lied to, filing a lawsuit against the company for fraud and/or breach of fiduciary duties is common. Unfortunately, thanks to a new ruling by the Delaware Supreme Court, shareholders have a new reason to hesitate before taking their grievances to the courts.

In a recent proceeding, the state supreme court ruled that a company can adopt, without shareholder approval, bylaws that require investors who file lawsuits against the company to pay the company’s legal fees if the shareholders are unsuccessful in their suit. Although it has long been common practice in the United States for the defendants to bear the burden of all legal fees if they lose, plaintiffs have never been required to pay the legal expenses for their defendants.

In its ruling, the Delaware Supreme Court said that the new measure might be proper for deterring litigation. In fact, the court has a point that the new ruling might have the benefit of prohibiting shareholders from filing frivolous lawsuits.

On the other hand, it could also deter shareholders without much money from filing perfectly valid lawsuits. It seems the wealthy corporate leaders of the world have found another way to give themselves the advantage in our court system. The new ruling means that shareholders can be punished for filing a perfectly valid lawsuit against a company with the intention of righting a wrong or bringing to light a company’s dishonesty.

The news out of Delaware is not all bad, though. The fee-shifting bylaws will not apply to lawsuits in which the parties settle, which gives plaintiffs a greater incentive to settle their lawsuits. This could benefit companies that don’t want to handle expensive, lengthy court battles that might end in an injunction against the company.

Many companies have lost no time in taking advantage of the new ruling. Since the court made its decision in May, dozens of companies have already added fee-shifting language to their governing documents. Some have adopted new bylaws that require shareholders to pay legal costs, while others have simply disclosed the fee-shifting requirement in initial public offering statements.

For example, Smart & Final, a warehouse grocery store chain based in California, has an initial public offering statement that reads, “Our bylaws include a requirement that, to the fullest extent permitted by law, a stockholder reimburse us for all fees, costs and expenses incurred by us in connection with a proceeding initiated by such stockholder in which such stockholder does not obtain a judgment on the merits that substantially achieves the full remedy sought.” A spokeswoman for Smart & Final even said the company believes the new measure to be beneficial to stockholders, as it reduces the chance that they will bear the expenses of lawsuits without merit.

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