Adoption Of Fee-Shifting Bylaws By Pennsylvania Corporations

Recently, there has been some unusual excitement in the corporate bar in Delaware after the Supreme Court of Delaware held that a nonstock corporation could adopt a bylaw requiring a losing plaintiff in a lawsuit involving the governance of the corporation to pay the corporation's legal fees (although the court left open the possibility that the bylaw could be invalid depending on the circumstances surrounding its adoption and use).1 Interest in the subject significantly increased when the Delaware Bar Association quickly moved to propose legislation invalidating that type of bylaw. The U.S. Chamber of Commerce weighed in on the other side from the bar association and the Delaware Legislature then pushed off consideration of the issue until next year.2

We believe that the reasons cited by the Supreme Court of Delaware that validate a fee-shifting bylaw adopted by a Delaware corporation will also validate a fee-shifting bylaw adopted by a Pennsylvania corporation. But we also believe that Pennsylvania corporations should seriously consider the same issues that are being debated in Delaware before acting.

Background on the Delaware Decision

In its decision in ATP Tour, Inc. v. Deutscher Tennis Bund, the Supreme Court of Delaware held that a nonstock corporation's bylaws may contain a fee-shifting provision and that such a provision could be enforceable against members who joined the corporation before as well as after the adoption of the bylaw.

ATP Tour Inc. ("ATP") was formed in the 1990s, and its membership consisted of various entities operating professional tennis tournaments. In 2006, the board of directors of ATP adopted a fee-shifting bylaw applicable to intra-corporate disputes that required a plaintiff member to reimburse the corporation for its legal fees if the plaintiff "[did] not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought." After successfully defending litigation brought against the company by some of its members, ATP sought to recover its legal fees under this bylaw provision. The federal district court handling the litigation between ATP and the losing members certified several questions of law to the Delaware Supreme Court relating to the validity and enforceability of the bylaw.

The Supreme Court of Delaware concluded that it did not have enough of a factual basis to determine whether the ATP bylaw was valid as adopted and applied in the pending lawsuit. However, the court answered the question in the abstract, holding that a fee-shifting bylaw was facially valid under Section 109(b) of the Delaware General Corporation Law (the "DGCL") and that the bylaw would be enforceable against members who joined before the adoption of the bylaw so long as the bylaw was not adopted or used for an improper purpose.

Delaware law presumes that a corporation's bylaws are valid and the courts will seek to uphold...