Although the federal government and FINRA have become increasingly active in matters of corporate governance, the states still remain the primary authority and regulator of corporate law. State corporation law is generally based on the Delaware Model Act and offers corporations a degree of flexibility from a menu of reasonable alternatives that can be tailored to companies’ business sectors, markets and corporate culture. Moreover, state judiciaries review and rule upon corporate governance matters, considering the facts and circumstances of each case and setting factual precedence based on such individual circumstances. In 2014 there were several changes to the Delaware General Corporation Law (DGCL) which impact public and private companies incorporated in Delaware, and elsewhere, since most states follow the DGCL.
The 2014 amendments which became effective on August 1, 2014, address: (1) mergers under DGCL Section 251(h) permitting a merger without a stockholder vote following certain tender or exchange offers; (2) director and stockholder actions by written consent with a future effective date; (3) certain amendments to the certificate of incorporation without stockholder approval (including a name change); and (4) unavailable incorporators.
In addition, the Delaware legislature considered, but did not yet act upon, a provision making it illegal to add attorney fees provisions to corporate charters and bylaws. In particular, in light of the increasing shareholder activism and shareholder lawsuits, many companies have been adding a provision to their corporate charters such that a non-prevailing party in litigation must pay the prevailing parties’ attorney’s fees. In other words, if a shareholder plaintiff sues a corporation and/or its officers and directors and is not successful, such shareholder plaintiff would have to pay each of the defendant’s attorney’s fees, which could be a substantial amount.
Attorney Fee Shifting Provisions
As a result of increasing shareholder activism and filed or threatened shareholder lawsuits, corporations have started adding provisions in their corporate charters (articles and/or bylaws) whereby the non-prevailing party in an inter-company lawsuit must pay the prevailing parties’ attorneys’ fees. Prevailing party attorney’s fees provisions are standard in contracts. In adding such provisions to corporate charter documents, a corporation is taking the position that if a person becomes a shareholder of the corporation, they are agreeing to be bound by the terms of the corporate charter documents, much like being bound by a contract, including the prevailing party attorney fee provision.
Absent a contractual (or statutory) prevailing party fee provision, parties to litigation are required to each pay their own attorneys’ fees. The prevailing party fee provision acts to shift the fees to the shareholder/plaintiff in the event they are not successful. In addition, the fee shifting provisions define “successful” in most cases as the substantial achievement, in substance and amount, of the full remedy sought. For example, a plaintiff can ask for $1,000,000, win $750,000 and be non-prevailing party under a fee shifting provision. Typically, the fee shifting provisions extend beyond just the plaintiff to all those with a financial interest in the outcome, or those which assist the plaintiff. With such a broad extension, the plaintiff’s attorneys could find themselves also directly responsible for the defendant’s attorney’s fees in the event the plaintiff is not successful.
Much like an anti-takeover poison pill, these fee shifting provisions are an anti-shareholder-lawsuit poison pill. Not only do such provisions apply to standard derivative lawsuits for such matters as a corporate breach of fiduciary duty, but they can be broadly applied to inter-company lawsuit, including those involving claims of securities law violations.
Again, the legal basis for adding such a provision is that when a shareholder buys stock, they are agreeing to be bound by the corporate charter documents. This theory is not far-fetched and is actually supported by a broad array of legal dicta. For instance, when a shareholder buys stock in a company, they are agreeing to be bound by the voting rights (including number of votes, notice and similar provisions related to shareholder and director meetings), information rights, dividend and participation rights, liquidation rights, and recently choice of law and jurisdiction provisions. It seems a natural progression to add other standard contractual provisions to such corporate charter documents, but the fee shifting provisions have been met with a great deal of opposition, including by the Delaware legislature itself.
In May of this year, the fee shifting provision was challenged and the Delaware Supreme Court upheld the provision as valid, at least in that case. The court did note that the validity of the provision included an analysis of the “circumstances surrounding its adoption and use” and whether it was “adopted or used for an inequitable purpose.” The intent to deter litigation is not an improper purpose.
The court ruling has faced a great deal of opposition, including from the Delaware corporate bar. The Delaware legislature in turn drafted a bill to make it unlawful to include fee shifting provisions in corporate charters and bylaws. The bill has been tabled until January 2015.
I agree with the Delaware Supreme court and think the provisions should be allowed, though their scope may need an adjustment. Shareholder lawsuits have become so commonplace that they are practically a method of communication—sue now, talk later. Predatory plaintiffs’ attorneys comb for pending merger transactions and/or decreases in stock prices and then solicit shareholders looking for a plaintiff or representative plaintiff for a class action. Whether there has actually been a corporate wrongdoing is secondary and often not even a consideration. As a transactional attorney, I think litigation should be a last, not first, option.
I’m not insensitive to the counter-argument. Fee shifting provisions can have a chilling effect on valid cases to enforce real securities law violations or breaches of corporate fiduciary duty. Broad provisions that include potential attorneys’ fee liability for plaintiffs’ counsel and expert witnesses could effectively wipe out private lawsuits against Delaware corporations.
However, by narrowing the scope of allowable fee shifting provisions to limit liable non-prevailing parties to the parties themselves, or their counsel only in egregious cases, and by limiting the definition of “success,” a balance can be reached.
Some opponents of the fee shifting provisions are calling for SEC intervention. Professor John Coffee and Professor Lawrence Hammermesh both gave testimony recently to the SEC’s Investor Advisory Committee pushing for SEC action. In other words, some are calling for greater federal regulation of corporate law. I don’t think that is the answer either. Over the years the federal government, or quasi-governmental regulators, has enacted regulations that have the effect of imposing on state corporate law. The result has been a piecemeal corporate federalism, often with unintended results. A prime example is illustrated in my blog regarding FINRA’s Rule 6490, which can be read HERE.
Certainly SEC reviewers can require greater disclosure and risk factors related to fee shifting provisions. The SEC could even adopt a view that provisions that are overly broad or expansive are against public policy insofar as they may deter valid claims for securities law violations. However, the matter should really be decided at the state level and respected at the federal level absent statutory change, which statutory change does not create even greater ambiguity for the corporate world.
Amendments to Certificates of Incorporation without the Necessity of Stockholder Approval
In 2014, Section 242 of the DGCL was amended to allow the amendment of certain provisions of an entity’s corporate charter without the necessity of obtaining stockholder approval. Section 242 now allows the following amendments to a corporate charter without stockholder approval: (i) name change; (ii) deletion of provisions naming the initial incorporator, initial board of directors or initial stockholders; and (iii) deletion of provisions that were used to previously effect a change, exchange, reclassification, subdivision, combination or cancellation of stock (such as a prior reverse split).
The allowance of a name change without stockholder approval is significant. In July 2014, I wrote a blog explaining how to change a name without stockholder approval using a subsidiary (see HERE). In Delaware, a corporation will no longer have to go through the machinations of forming and merging with a subsidiary to complete a name change.
Mergers Using DGCL Section 251(h)
In 2014 the Delaware legislature amended Section 251(h) related to mergers following a tender or exchange offer. Section 251(h) itself had only been adopted a year prior. Section 251(h) eliminates the need for shareholder approval to complete a merger, where such merger is completed following a tender or exchange offer and the acquirer owns at least the percentage amount of the target that is needed to approve the merger. That is, Section 251(h) eliminates unnecessary time and expense related to a vote on a merger when certain preconditions have been satisfied. These preconditions include:
- The merger must be consummated as soon as practicable following the tender offer or exchange offer;
- The underlying tender or exchange offer be for all of the outstanding stock of the target, except for the stock owned by the acquirer or any person that directly or indirectly owns all outstanding stock of the acquirer, and any direct or indirect wholly owned subsidiary of any of the foregoing;
- The use of Section 251(h) can be a contractual election by the parties to the merger;
- The amendments remove a prior prohibition on using Section 251(h) when one of the merger parties is an “interested stockholder” under DGCL Section 203. DGCL Section 203 defines an “interested stockholder” to include any person who “has the right to acquire” 15 percent or more of the target’s voting stock.
Director and Stockholder Actions by Written Consent with a Future Effective Date
In 2014, DGCL Section 141(f) and 228(c) were amended to expressly permit director and stockholder consents to corporate action that will take effect at some specified future time. The Section 141(f) amendment allows a person to execute a consent that will be effective at a future time, including a time determined by the occurrence of an event, no later than 60 days after the person gives the consent. The consent will be deemed effective at that future time if the person is then a director and did not revoke the consent. Section 141(f) can be used prior to the consenting person actually becoming a director and therefore can be used to escrow consents by intended directors.
The Section 228(c) amendment clarifies that any person may execute a stockholder consent and provide that it is to be effective at a future time no later than 60 days after the person gives the consent. The consent will be deemed effective on that future date if the consenting person is then a stockholder and did not revoke the consent.
In 2014, the DGCL was amended so that if an incorporator is unavailable to act, such as where they cannot be located, are dead or are incapacitated, any person for whom the incorporator was acting on behalf may proceed in the incorporator’s stead. Many corporations use incorporating service providers (for example, LegalZoom) or attorneys to form a corporation. This provision eliminates issues where such initial incorporator is no longer available to hand the corporation over to its intended owners.
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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