DGCL Amendments on Fee-shifting and Forum Selection Passed by Delaware General Assembly

Practical Law Legal Update 7-616-4789 (Approx. 14 pages)

DGCL Amendments on Fee-shifting and Forum Selection Passed by Delaware General Assembly

by Practical Law Corporate & Securities

Forum Selection Authorized

The amendments add a new Section 115 to the DGCL that:

Permits a provision in either the certificate of incorporation or the by-laws that requires any or all "internal corporate claims" be brought solely in a Delaware court.
Prohibits a provision in either the certificate of incorporation or the by-laws that precludes internal corporate claims from being brought in Delaware. The provision can designate both Delaware and another jurisdiction, but cannot exclusively designate a non-Delaware jurisdiction.

Under the statute, the term "internal corporate claims" is defined as "claims, including claims 'in the right of the corporation'" (meaning derivative claims), that either:

Are based on a violation of a duty by a current or former director, officer or stockholder in that capacity.
Come under the jurisdiction of the Delaware Court of Chancery based on another provision of the DGCL.

This amendment addresses the concern over the prevalence, expense and inefficiency of multi-forum litigation, in which the same issue is litigated in multiple forums or in both state and federal courts. The amendment enshrines the Delaware Court of Chancery's holding in Boilermakers Local 154 Retirement Fund v. Chevron Corporation, which upheld forum-selection by-laws that were unilaterally adopted by the boards of directors of two companies (73 A.3d 934 (Del. Ch. 2013); see Legal Update, Delaware Court of Chancery Upholds Boards' Unilaterally Adopted Forum Selection By-laws).

By prohibiting charter or by-law provisions that select a non-Delaware venue as the exclusive forum for internal corporate claims, the amendment has the effect of overturning the Court of Chancery's ruling in City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014). The City of Providence decision allowed a Delaware corporation's board to adopt North Carolina as the company's exclusive forum for internal corporate litigation (see Legal Update, Delaware Court of Chancery Upholds Board-adopted By-law Selecting Foreign Jurisdiction as Exclusive Forum). However, the new Section 115 does not forbid corporations from agreeing to exclusive non-Delaware forum provisions in a stockholders agreement or other writing signed by the stockholder against whom the provision is to be enforced.

Although forum-selection provisions are permitted as a legal matter, the statute does not prevent a court from considering issues of equity in the adoption of the provision.

Fee-shifting Invalidated

The amendments add a new Section 102(f) and amend Section 109(b) of the DGCL to invalidate any provision in the certificate of incorporation or by-laws, respectively, of a stock corporation that shifts the corporation's or any other party's attorney's fees or expenses to the stockholder in an internal corporate claim (as defined in Section 115). The amendments effectively prohibit fee-shifting charter or by-law provisions applicable to most stockholder litigation related to corporate governance and M&A transactions.

The impetus for this amendment is the Delaware Supreme Court's decision in ATP Tour, Inc. v. Deutscher Tennis Bund, in which the court ruled that the board of a Delaware non-stock corporation can, for a proper purpose, adopt a fee-shifting by-law that requires a plaintiff-stockholder to pay the corporation's legal expenses if the plaintiff loses on a claim it has brought against the corporation (91 A.3d 554 (Del. 2014)). The underlying principles of the decision had been widely understood as applying equally to ordinary, stock-issuing Delaware corporations, which ignited a backlash from stockholders and practitioners. For more information on the ATP Tour decision, see Legal Update: ATP Tour: Delaware Supreme Court Upholds Fee-shifting By-laws if Adopted for Proper Purpose.

Supporters of fee-shifting provisions have argued that fee shifting would help stem the tide of rote class-action suits that are brought over nearly every public M&A deal, which often cause the corporation expense with little commensurate benefit. In proposing a ban on fee-shifting provisions in charters and by-laws, however, the Corporate Law Council reasoned that the amendments were necessary because:

Fee-shifting provisions could effectively eliminate all stockholder litigation, because litigation can be unpredictable and plaintiffs are unlikely to voluntarily take on the risk of exposure, even if their claim is meritorious.
The gaps in the DGCL's fiduciary duty and corporate law are filled in by judicial decisions. Overly limiting stockholder litigation may harm the continued development of Delaware's case law.
Stockholder litigation in the Delaware courts is the primary enforcement mechanism of the relationships between directors and stockholders of Delaware corporations. Without stockholder litigation challenging perceived misconduct, investor confidence could erode and other regulators may feel obligated to step in to enforce the corporation's statutory and fiduciary obligations.
There are less drastic tools at the courts' disposal to limit frivolous litigation, including:
- motions to dismiss, which enable a court to terminate litigation early where the complaint lacks merit on its face;
- judicially developed doctrines of fee shifting; and
- disapproving settlements of class or derivative actions where the case lacks merit (a tool that the Court of Chancery has increasingly used, as discussed in Legal Update, Settlement and Rejection in Public M&A Deals).

The Council had considered various ways to permit limited fee-shifting provisions (such as where the action brought against the corporation was of limited merit) and to add procedural safeguards to avoid abuse (such as where a majority stockholder adopts the provision). The Council concluded, however, that the task of finding the right balance between necessary and frivolous litigation should be left to the courts on a case-by-case basis.

As with the forum-selection amendments, the amendments on fee-shifting do not affect the enforcement of a stockholders agreement or other writing signed by the stockholder that includes a fee-shifting provision. However, this is of little practical consequence for public corporations. The amendments do not affect the ATP Tour holding's application to non-stock corporations.

By its terms, the amendment invalidates only fee-shifting provisions that shift fees for "internal corporate claims," as defined in the amendment. Whether the amended statute permits fee-shifting in other types of actions, including unsuccessful federal securities law claims, remains unclear. The amendment is also not explicit on whether it applies retroactively or whether existing fee-shifting provisions are grandfathered. This interpretation may only come via litigation brought against a Delaware corporation that has adopted a fee-shifting charter or by-law provision.

Board Approval of Capital Stock Issuance

Section 152 of the DGCL has been amended to allow a board of directors, subject to certain conditions, to authorize one or more future stock issuances and delegate to a person or body other than the board or a board committee the authority to determine the specific times and numbers of shares to be issued.

The amendments help clarify that stock may be issued in "at-the-market" offerings without board or committee authorization of each individual issuance in the offering. There had previously been some uncertainty surrounding the effectiveness of board authorizations approving stock issuances with a delegation of authority to non-director corporate officers to set the terms of individual issuances within broad parameters.

Under amended Section 152, a board resolution authorizing future capital stock issuances to be approved by a person or body other than the board or a committee must:

Fix the maximum number of shares that may be issued.
Set the time frame during which the shares may be issued.
Establish a minimum amount of consideration for which the shares may be issued.

The amendments clarify that the board may set the amount of consideration, or minimum consideration, for which shares may be issued by approving a formula by which the amount is determined. The formula may include reference to, or be made dependent, on extrinsic facts (for example, market prices on one or more dates or averages of market prices on one or more dates). A similar amendment to Section 157(b) of the DGCL makes the same clarifications regarding formulas setting the consideration for stock issued on the exercise of rights and options.

The minimum amount of consideration cannot be less than the consideration required under Section 153 of the DGCL. This generally means that shares with par value may not be issued for consideration having a value less than the par value of the shares.

Clarifications to Ratification of Defective Corporate Acts

On April 1, 2014, new Section 204 of the DGCL became effective. Section 204 provides a safe harbor procedure for ratifying stock issuances and corporate acts or transactions that would otherwise be void or voidable due to a "failure of authorization." For background information about Section 204, see Legal Update, DGCL Amendments on Ratifying Defective Corporate Acts Effective April 1, 2014. The 2015 amendments make certain clarifying changes to ease the use of the Section 204 ratification process.

Scope of Availability of Ratification Process

Section 204(h)(2) of the DGCL has been amended to broaden the definition of the term "failure of authorization" and, by extension, the scope of acts that may be ratified under Section 204. The term had previously been defined only to capture a failure to authorize or effect an act or transaction in compliance with the DGCL, the corporation's certificate of incorporation or by-laws, or any plan or agreement to which the corporation is a party, if and to the extent that such failure would render the act or transaction void or voidable. As amended, a "failure of authorization" also includes any failure by the board of directors or any officer to authorize or approve any act or transaction taken by or on behalf of the corporation that would have required for its due authorization the approval of the board of directors or that officer.

The amendment is intended to clarify that any action taken without the appropriate board or officer approval can constitute a defective corporate act that can be cured by ratification under Section 204. The amendment is intended solely to confirm the broad scope of acts that may be ratified under Section 204, not to imply that any specific acts suffering from such a failure of authorization would necessarily be void or voidable, or that they may not be susceptible to cure by ratification under principles of common law.

Section 204(i) of the DGCL (which makes explicit that ratification under Section 204 is not the exclusive means for ratification) has been amended to add that the Section 204 process is also available for adopting or endorsing any act or transaction taken by or in the name of the corporation before the commencement of its existence. (The common law "pre-incorporation doctrine" generally provides that a corporation is competent to adopt and ratify agreements made by its organizer or promoter in contemplation of its organization.)

Ratifying Multiple Defective Acts

The amendments to Section 204(b)(1) of the DGCL confirm that the board may approve the ratification of multiple defective corporate acts in a single set of resolutions. However, while multiple defective corporate acts can be corrected in one set of resolutions, the amendments clarify that the quorum and voting requirements applicable to each act contained in a single set of ratifying resolutions are those applicable to each act, viewed on an act-by-act basis. For example, a set of resolutions can simultaneously address one act that requires, under the corporation's charter, the approval of two-thirds of the total number of directors, and another act that requires the affirmative vote of a majority of the directors present at a meeting at which a quorum is present. In that situation, the resolutions must be adopted, regarding the former act, by the affirmative vote of 75% of the total number of directors, and regarding the latter act, by the vote of a majority of the directors present at the meeting at which the resolutions are submitted to a vote of directors (provided a quorum exists at that meeting).

The resolutions ratifying one or more defective acts must state:

The defective corporate act(s) to be ratified.
The date of each defective corporate act.
If the act involved the issuance of shares of putative stock (shares that would have been valid stock but for the failure of authorization):
- the number and type of shares of putative stock issued; and
- the date or dates on which those shares were purported to have been issued.
The nature of the failure of authorization regarding each defective corporate act to be ratified.
That the board of directors approves the ratification of the defective corporate act(s).

The board can, if it so chooses, cross-condition its own ratification of one defective corporate act on the approval of another, or condition its ratification on the approval by the stockholders of one or more other defective corporate acts (even if stockholder approval was not required for that ratification).

Stockholder Ratification of Multiple Defective Acts

Conforming changes to Section 204(c) of the DGCL confirm that multiple defective acts that require stockholder approval and that have been ratified in one set of board resolutions can be submitted to the stockholders for their approval. The necessity for stockholder approval is determined on the basis of the requirements of the DGCL, the corporation's charter, its by-laws, or any other plan or agreement, both as of the time of the defective corporate act and as of the time the board adopted the resolutions ratifying the act. The same holds true for ratification of the election of a director by the stockholders under amended Section 204(d)(2): if the certificate of incorporation or by-laws in effect either at the time of the vote on the ratification or at the time of the defective election require (now) or required (then) a larger portion of stock or of any class or series of stock or of any specified stockholder to elect the director, then the affirmative vote of that number of shares or of that specified stockholder is required to ratify the election.

Conforming changes to Section 204(d) of the DGCL confirm that if multiple acts are being ratified together, stockholder approval of each defective act must meet the relevant quorum and voting requirements for each act on an act-by-act basis.

Because the effect of ratifying a previously defective stock issuance is that the shares are made retroactively valid, Section 204(d) and Section 204(f) have also been amended to confirm that shares of putative stock are not to be counted for purposes of determining the stockholders entitled to vote or to be counted towards a quorum in any stockholder vote on the ratification of a defective corporate act. Only the record holders of stock that was validly issued as of the record date for determining stockholders entitled to vote on the act can count toward the quorum and voting thresholds.

Cross-conditioning stockholder approval is permitted in the same vein as the board's own ratification.

The board's notice to the stockholders must contain either a copy of the board's ratifying resolutions or the information required by Section 204(b)(1) to be stated in those resolutions.

Ratification of Failure to Appoint Initial Directors

A new Section 204(b)(2) addresses a situation in which the initial board of directors was not named in the corporation's original certificate of incorporation or the organizational action of the incorporator (see Standard Document, Organizational Action by Sole Incorporator). The statute now allows those individuals who have been acting as the corporation's de facto directors "under claim and color of an election or appointment" to adopt resolutions ratifying the election of those individuals who first took action on behalf of the corporation as its board of directors. The resolutions must state:

The name(s) of the person(s) who first took action in the name of the corporation as the initial board of directors of the corporation.
The earlier of the date on which such person(s) first took that action or was purported to have been elected as a member of the initial board of directors.
That the ratification of the election of such person(s) as the initial board of directors is approved.

Even if the board adopts these resolutions, the corporation still must correct its certificate of incorporation pursuant to Section 103(f) of the DGCL if the certificate of incorporation inadvertently omitted the provision naming the initial directors or otherwise contains another error regarding the naming of the initial directors.

Certificate of Validation

Section 204 currently provides that a certificate of validation must be filed with the Secretary of State whenever the underlying defective corporate act that is being ratified required the filing of a certificate under another section of the DGCL. Section 204 had required that the certificate of validation include a copy of the board's resolutions ratifying the defective corporate act as well as the information that was required by the other section of the DGCL that required a filing. Section 204(e) of the DGCL has been amended to dispense with the requirement that the certificate of validation set forth the board's resolutions ratifying the defective corporate act. The certificate of validation must instead list the following information regarding the defective corporate act and the related failure of authorization:

Each defective corporate act that is the subject of the certificate of validation (including, in the case of any defective act involving the issuance of shares of putative stock, the number and type of shares of putative stock issued and the date or dates on which those putative shares were purported to have been issued), the date of the defective corporate act and the nature of the failure of authorization concerning the defective act.
A statement that the defective corporate act was ratified in accordance with Section 204, including the date on which the board of directors ratified the defective corporate act and the date, if any, on which the stockholders approved the ratification of the defective corporate act.
The following information, as applicable, regarding any previous filing of a certificate:
- if a certificate for the defective corporate act had previously been filed and no changes to that certificate are necessary to give effect to the ratification of the act, a file-stamped copy of that certificate must be attached to the certificate of validation as an exhibit;
- if a certificate for the defective corporate act had previously been filed and changes to that certificate are necessary to give effect to the ratification of the act, the certificate of validation must also: state the name, title and filing date of that certificate; attach as an exhibit a separate certificate (that need not be separately signed and acknowledged) containing all of the information required under the relevant other section of the DGCL, including the changes necessary to give effect to the ratification of the defective corporate act; and state the date and time when the attached certificate would have become effective; and
- if no certificate had previously been filed and the filing of a certificate was required to give effect to the ratification of the defective corporate act, the certificate of validation must also attach as an exhibit a separate certificate (that need not be separately signed and acknowledged) containing all of the information required under the relevant other section of the DGCL, and the certificate of validation must state the date and time when the attached certificate would have become effective.

The amended Section 204(e) clarifies that a separate certificate of validation must be filed for each defective corporate act that requires the filing of a certificate of validation, except in two cases:

Where the corporation had filed (or was to have filed) a single certificate under another provision of the DGCL to effect multiple acts that were committed defectively. For example, if two subsidiaries of a parent corporation were merged with and into the parent corporation, but with a failure of authorization, and the parent corporation purportedly effected both mergers by filing a single certificate of merger, then a single certificate of validation can be filed to ratify both mergers.
Where two or more overissues of stock are being validated. In that case, a single certificate of validation may be used to correct the number of authorized shares, with the total increase in the authorized capital stock being made effective as of the date of the earliest overissue.

Stockholder Ratification by Written Consent

Under Section 228 of the DGCL, unless otherwise restricted by the certificate of incorporation, stockholders may act by written consent in lieu of a meeting on any matter required or permitted to be acted on at a meeting. If an action is approved by less than unanimous consent, Section 228(e) requires the corporation to provide prompt notice of the action to the stockholders who did not consent and would have been entitled to notice of the meeting (for a form of this notice, see Standard Document, Section 228 Notice to Stockholders). On matters of ratification, Section 204 had previously addressed only the provision of notice to the stockholders of an act of ratification by the board and stockholder ratification at a meeting. Section 204(g) of the DGCL has been amended to clarify the procedures for providing notice of ratification when the stockholders have approved the ratification by written consent in lieu of a meeting.

The amendments provide that the notice of ratification may be included in the notice required to be given under Section 228(e). If a notice sent under Section 204(g) is included in a notice sent under Section 228(e), the notice must be sent to the parties entitled to receive the notice under both Section 204(g) and Section 228(e). The amendments to Section 204(g) also clarify that this notice need not be provided to any holder of valid shares who acted by written consent to approve the ratification or to putative stockholders who otherwise consented to the ratification.

Section 204(g) has also been amended to provide that corporations that have a class of stock listed on a national securities exchange may give the notice to the stockholders of an act of ratification by the board by means of a public filing with the SEC under the Exchange Act.

Validation Effective Time

The notice provided to the stockholders under Section 204(g) must inform them that they have 120 days from the validation effective time to bring an action challenging the ratification of a defective corporate act. Section 204(h)(6) of the DGCL had previously defined "validation effective time" as the later of:

The time at which the ratification of the defective corporate act is approved by the stockholders, if necessary, or if no vote is required, the time at which the notice required by Section 204(g) is given.
The time at which any certificate of validation has become effective.

Section 204(h)(6) has been amended to confirm that, in respect of the ratification of any defective corporate act that requires stockholder approval but does not require the filing of a certificate of validation, the "validation effective time" is the time at which the stockholders approve the ratification of the defective corporate act, whether the stockholders are acting at a meeting or by consent in lieu of a meeting. A corresponding amendment to Section 204(g) confirms that the 120-day period during which stockholders may challenge the ratification of a defective corporate act commences from the later of:

The validation effective time.
The time at which the notice required by Section 204(g) is given.

The term "validation effective time" has also been amended to permit the board of directors to fix a future validation effective time for any defective corporate act not required to be submitted to a vote of stockholders and that does not require the filing of a certificate of validation. The amendment is intended to avoid logistical issues that may arise when delivering notices for multiple defective corporate acts that are being ratified at the same time. As amended, Section 204(h)(6) enables the board to set one date on which the ratification of all defective corporate acts approved by the board becomes effective, regardless of when the notice under Section 204(g) is sent.

Section 205(f) of the DGCL has been amended to conform to amended Section 204(g) and now provides that the 120-day period during which stockholders may challenge the ratification of a defective corporate act under Section 205 commences from the later of:

The validation effective time.
The time at which the notice required by Section 204(g) is given.

Other Amendments to the DGCL

The amendments also:

Enable the Division of Corporations to waive the requirement for a distinctive corporate name under Section 102(a)(1)(ii) if the corporation demonstrates to the satisfaction of the Secretary of State that:
- the corporation or a predecessor entity previously had made substantial use of that name or a substantially similar name;
- the corporation has made reasonable efforts to obtain written consent to use the name; and
- that a waiver is in the interest of Delaware.
(DGCL § 102(a)(1).)
Clarify that a restated certificate adopted without stockholder approval, which is otherwise required to state that it does not further amend the provisions of the corporation's certificate of incorporation, does not need to include that statement if the only amendment is to change the corporation's name (DGCL § 245(c)).
For a merger of a corporation into a public benefit corporation or conversion into a public benefit corporation by amendment to the corporation's charter, change the approval required under that section from 90% of the outstanding shares of each class of stock, whether voting or nonvoting, to two-thirds of the outstanding stock of the corporation entitled to vote (DGCL § 363(a)).
For a merger of a public benefit corporation into an ordinary corporation or conversion into an ordinary corporation by amendment to the corporation's charter, change the approval required under that section from two-thirds of the outstanding shares of each class of the stock, whether voting or nonvoting, to two-thirds of the outstanding stock of the corporation entitled to vote (DGCL § 363(c)).
Confirm that the Secretary of State may issue public records in the form of photocopies or electronic image copies and need not provide the public records in any other form (including microfiche copies which were deleted as an available medium) (DGCL § 391(c)).

Effective Time

The amendments to Section 204 and Section 205 of the DGCL are effective only with respect to defective corporate acts and proposed issuances of putative stock ratified or to be ratified with resolutions adopted by a board of directors on or after August 1, 2015. The amendment to Section 391(c) will be effective on the bill's enactment into law. All other amendments described in this Legal Update are effective August 1, 2015.

Appraisal Rights

The amendments to the appraisal statute that had been proposed by the Corporate Law Council in March have yet to be introduced in the Assembly. For a summary of the Council's proposal, see Legal Update, DGCL Amendments Proposed on Fee-shifting, Forum Selection and Appraisal Rights.

Rapid Arbitration Act

The Delaware Rapid Arbitration Act, initially proposed together with the amendments to the DGCL, was signed into law by the governor of Delaware in April and has been effective since May. For a summary of the statute, see Legal Update, New Proposed Delaware Rapid Arbitration Act Signed into Law.

DGCL Amendments on Fee-shifting and Forum Selection Passed by Delaware General Assembly | Practical Law