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Fee-Shifting Provision in Stockholders Agreement Does Not Violate Delaware Law

By | August 12, 2020

Manti Holdings, LLC, et al. v. Authentix Acquisition Company, Inc. considered whether a “loser pays” fee-shifting provision in a stockholders’ agreement violated Delaware law.  In 2008, the Petitioners had all held stock in a prior entity, Authentix, Inc. That year, Authentix, Inc. merged into Authentix Acquisition Company Inc, or Authentix, with two new shareholders—The Carlyle Group and J.H. Whitney & Co.—as the new majority owners. In order to achieve the merger, the Petitioners, the new stockholders, and Authentix negotiated the Stockholders Agreement of Authentix, which was also the Respondent in this action.  Also as a condition of the 2008 merger, the Petitioners agreed to roll over their interest in Authentix, Inc. into Authentix. Along with the Petitioners, Respondent Authentix was itself a party to the Stockholders Agreement and the surviving corporation in the merger.

Petitioners had previously sought appraisal rights with respect to their stock resulting from the merger.  The Delaware Court of Chancery held that appraisal rights were waived in the stockholders’ agreement.  Respondent sought its legal fees as a result of a fee-shifting provision in the stockholders’ agreement.

The fee-shifting provision at issue provided:

“In the event of any litigation or other legal proceeding involving the interpretation of this [Stockholders] Agreement or enforcement of the rights or obligations of the Parties, the prevailing Party or Parties shall be entitled to recover reasonable attorneys’ fees and expenses in addition to any other available remedy.”

The Petitioners did not contest that the Stockholders Agreement provided a clear contractual obligation for the losing party to pay fees incurred by the prevailing party to enforce the contract against them. Instead, they argued that the contractual fee-shifting provision was unenforceable against them, for reasons having to do with statutory precedence, public policy, and equity.

The Court noted in ATP Tour, Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court reaffirmed that fee-shifting by contract, in exception to the American Rule, under which each litigant bears her own legal fees, was enforceable self-ordering by contractual parties. ATP also held a fee-shifting bylaw was facially valid.

In reaction to ATP, the Delaware legislature enacted §§ 102(f) and 109(b) of the DGCL, which proscribe fee-shifting provisions in corporate charters and bylaws with respect to intra-corporate litigation, in recognition of the chilling effect such loser-pays provisions could have on the enforcement by stockholders of fiduciary duties. The Petitioners argued that by extension or analogy, §§ 102(f) and 109(b) prohibited the contractual fee-shifting that the Respondent sought to employ.

The Petitioners noted that our law observes a hierarchy of authority for documents concerning shareholder rights: the DGCL comes first, then the charter, then the bylaws, then contracts. Provisions in lower-order documents cannot trump those in higher-order documents. The Petitioners pointed to the fee-shifting prohibitions of §§ 102(f) and 109(b), and argued based on these sections that enforcing a “loser pays” provision in a contract between a corporation and stockholders violates the hierarchy described above and is thus unenforceable.

The Court rejected this argument noting nothing in the plain language of §§ 102(f) or 109(b) prohibited the fee-shifting Respondent sought to enforce. The plain terms of these sections referred only to certificates of incorporation and bylaws and not to contracts.

In addition, the Court noted the expressed legislative intent shows that stockholder agreements were specifically carved out from these statutory prohibitions.  The Bill synopsis provided for § 102(f) and § 109(b) of the DGCL states that those statutes are “not intended, however, to prevent the application of such [fee-shifting] provisions pursuant to a stockholders agreement or other writing signed by the stockholder against whom the provision is to be enforced.”

Finally, the Court noted the context of the fee-shifting at issue—litigation over stockholders’ contractual agreement to waive appraisal rights—was not perceived by the Vice Chancellor to be the legislature’s animating concern. The matter before the Court did not involve an underlying allegation of breach of fiduciary duty, which was perceived to be the legislature’s focus in prohibiting fee-shifting in charters and bylaws. A contractual fee-shifting provision for a losing allegation of breach of duty could have a perverse chilling effect on the exercise of stockholders’ common law rights to the loyalty and care of corporate fiduciaries. But that question was not before the Court, only whether the fee-shifting provision was valid with respect to the waiver of appraisal rights.

The Court also rejected Petitioners’ arguments that the surviving corporation was not the intended beneficiary of the fee-shifting provision and corporations are not proper parties to stockholders’ agreements based on the same rational that supported the waiver of appraisal rights.

Contact Steve Quinlivan for more information.

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M&A