M OST mergers will draw a legal challenge, as has been the case for - - PDF document

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THE VALIDITY OF LITIGATION-REFORM BYLAWS IN OHIO

Geoffrey Ritts and Brandon Mordue* INTRODUCTION OST mergers will draw a legal challenge, as has been the case for many years.1 Yet, empirical studies have suggested that much of this litigation is of dubious value to the stockholders on whose purported behalf these lawsuits are filed.2 In response to this problem, practitioners have developed a number of innovative corporate-governance mechanisms designed to reduce the burden of stockholder litigation.3 Three such mechanisms are forum-selection provisions, fee-shifting provisions, and minimum-stake-to-sue provisions.4 This article considers the viability of these devices under Ohio law. As discussed below, forum-selection bylaws and fee-shifting provisions likely would be upheld under Ohio law. Minimum-stake-to-sue provisions, on the other hand, might face more doubtful

• dds in court. Moreover, it may be that in Ohio, unlike Delaware, the courts would

require that some or all of these provisions be adopted by stockholders and not by

* The authors are a partner and an associate, respectively, at Jones Day, resident in the firm’s

Cleveland office. The views set forth herein are the authors’ and do not necessarily reflect those of their law firm.

• 1. RAVI SINHA, CORNERSTONE RESEARCH, SHAREHOLDER LITIGATION INVOLVING ACQUISITIONS

OF PUBLIC COMPANIES: REVIEW OF 2015 AND 1H 2016 M&A LITIGATION 1 (2016),

https://www.cornerstone.com/Publications/Reports/Shareholder-Litigation-Involving-Acquisitions- 2016.pdf (showing that at least 50% of mergers have been challenged in court every year since 2008, with a 64% challenge rate in the first half of 2016).

• 2. See, e.g., Jill E. Fisch, Sean J. Griffith, & Steven Davidoff Solomon, Confronting the

Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93

• TEX. L. REV. 557, 566, 572, 585 (2015) (observing that over 70% of merger lawsuits settle, with more

than three-quarters of those settlements being disclosure-only settlements that generate attorneys’ fees and supplemental disclosures that the authors show have a statistically insignificant effect on stockholder votes on the mergers).

• 3. See Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 DEL. J. CORP.
• L. 851, 862 (2016) (reviewing the economic literature on stockholder lawsuits and concluding that a

“shareholder class action[ ] thus is a wealth transfer from the company’s current shareholders to those who held the shares at the time of the alleged wrongdoing,” a transfer that likely results in “an overall loss of wealth” to the average diversified investor).

• 4. See generally BETH I.Z. BOLAND, MICHAEL KIRWAN, & NEDA SHARIFI, CORPORATE BOARD,

BYLAW WARS: BOARDS AWAKEN (2016), https://www.foley.com/files/uploads/News/1603 BolandKirwanSharifi.pdf (describing various types of litigation-reform bylaws).

M

28 VALIDITY OF OHIO LITIGATION-REFORM BYLAWS [Vol. 49 directors unilaterally.5 Aside from legal validity, there are other factors for a company to consider before adopting any of these provisions.

• I. FORUM-SELECTION PROVISIONS

A forum-selection bylaw operates like a forum-selection clause in a contract: it mandates that all claims of a certain type—for example, fiduciary-duty claims against directors—be brought in a specific forum, typically the corporation’s state

• f incorporation or principal place of business.6 These provisions emerged as a

relatively early response to the explosion of multijurisdictional merger litigation, and they have received extensive attention in Delaware.7 In Boilermakers Local 154 Retirement Fund v. Chevron Corp.,8 the Delaware Court of Chancery upheld forum-selection bylaws adopted unilaterally by the boards of directors of Chevron and FedEx. The court began from the premise that bylaws are a contract among a corporation and its stockholders, officers, and directors that “is, by design, flexible and subject to change,” including via unilateral amendment by the directors, a possibility that is known by stockholders when they purchase shares.9 The court concluded that forum-selection bylaws were valid because the provisions were process-oriented, as opposed to substantive: “[T]hey regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation.”10 Recently, the Delaware legislature enacted legislation codifying the outcome in Boilermakers by permitting forum-selection bylaws, but also requiring that any such bylaw designate Delaware as an available forum.11 To the authors’ knowledge, no court has directly addressed the validity of such provisions under Ohio law. But, the existing case law suggests that an analysis similar to that applied by the Delaware courts would carry the day. Regulations, Ohio’s term for bylaws, “have the force of contracts between the corporation and its shareholders,”12 just as in Delaware. Similarly, existing Ohio case law provides strong support for upholding forum-selection clauses in the

• 5. See OHIO REV. CODE ANN. § 1701.11(B)(11) (West, Westlaw through 2017 Files 1 to 13 and

15 to 17 of the 132d Gen. Assemb. (2017-2018)).

• 6. See In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 960 (Del. Ch. 2010) (suggesting in

dicta that “if boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes”).

• 7. See generally Verity Winship, Shareholder Litigation by Contract, 96 B.U. L. REV. 485

(2016).

• 8. 73 A.3d 934, 963 (Del. Ch. 2013).
• 9. Id. at 939.
• 10. Id. at 951-52.
• 11. DEL. CODE ANN. tit. 8, § 115 (West, Westlaw through 81 Laws 2017, chs. 1-66. Revisions

to 2017 Acts by the Delaware Code Revisors were unavailable at the time of publication), superseding in part City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014).

• 12. Carr v. Acacia Country Club Co., 970 N.E.2d 1075, 1086 (Ohio Ct. App. 2012).

Fall 2017] THE UNIVERSITY OF TOLEDO LAW REVIEW 29 commercial context.13 “Absent evidence of fraud or overreaching, a forum selection clause contained in a commercial contract between business entities is valid and enforceable, unless it can be clearly shown that enforcement of the clause would be unreasonable and unjust.”14 The “business entities” language appears to be interpreted loosely, because an unincorporated sole proprietor is considered a “business entity.”15 It is reasonable to expect that purchasing stock (buying an equity interest in a business) would be viewed by Ohio courts as a commercial transaction. One potential difference between Delaware and Ohio is that Ohio’s corporate code limits directors’ ability to amend the bylaws unilaterally.16 Ohio’s corporate law specifies that the “regulations may include provisions ... [d]efining, limiting,

• r regulating the exercise of the authority of the shareholders; provided, that any

amendment of the regulations that would change or eliminate any such provision shall be adopted only by the shareholders.”17 This unfortunately vague provision appears never to have been interpreted by a court, and the drafting history offers little guidance on its meaning.18 Depending on how courts interpret it, an Ohio corporation adopting a forum-selection bylaw may be required to do so by stockholder vote, rather than by unilateral action of the directors. A final concern is that, even if forum-selection bylaws would be valid under Ohio law, other states may not enforce them. Both Ohio and Delaware, for example, permit as-applied equitable challenges to forum-selection provisions.19 Fortunately, the cases addressing this issue so far suggest that other states will favor comity and will enforce forum-selection bylaws.20

• II. FEE-SHIFTING PROVISIONS

Fee-shifting provisions require a losing litigant to pay the prevailing party’s attorneys’ fees.21 Currently, in stockholder litigation, the corporation pays its own fees every time—win or lose—and, pursuant to the corporate benefit doctrine, the

• 13. See generally Kennecorp Mortg. Brokers, Inc. v. Country Club Convalescent Hosp., 610

N.E.2d 987 (Ohio 1993).

• 14. Id. at 989.
• 15. See Info Leasing Corp. v. Jaskot, 784 N.E.2d 1192, 1196 (Ohio Ct. App. 2003) (“It is

immaterial that [defendant] is a sole proprietor.”). See also Preferred Capital, Inc. v. Power Eng’g Grp., Inc., 860 N.E.2d 741, 745 (Ohio 2007).

• 16. See David Porter, Competing with Delaware: Recent Amendments to Ohio’s Corporate

Statutes, 40 AKRON L. REV. 175, 191 n.96 (2007).

• 17. OHIO REV. CODE ANN. § 1701.11 (West, Westlaw through 2017 Files 1 to 13 and 15 to 17
• f the 132d Gen. Assemb. (2017-2018)).
• 18. See generally Porter, supra note 16.
• 19. See Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 954 (Del. Ch. 2013);

Preferred Capital, 860 N.E.2d at 743.

• 20. See Roberts v. TriQuint Semiconductor, Inc., 364 P.3d 328, 337 (Or. 2015) (enforcing bylaw

selecting Delaware as exclusive forum); North v. McNamara, 47 F. Supp. 3d 635, 648 (S.D. Ohio 2014) (enforcing, under federal law, board-adopted bylaw of Ohio-domiciled Delaware corporation and transferring derivative suit to Delaware); id. at 642 n.3 (collecting state-court decisions).

• 21. Sean J. Griffith, Correcting Corporate Benefit: How to Fix Shareholder Litigation by

Shifting the Doctrine on Fees, 56 B.C. L. REV. 1, 6 (2015).

30 VALIDITY OF OHIO LITIGATION-REFORM BYLAWS [Vol. 49 corporation also pays the plaintiffs’ fees when they prevail or when there is a settlement.22 Effectively, then, the current regime is that “the corporation always pays.”23 Fee-shifting bylaws do not effect a return to the American Rule, under which each side pays its own fees (and only its own fees); instead, they shift stockholder litigation to something closer to the English Rule, under which the loser pays both sides’ fees.24 In 2014, the Delaware Supreme Court upheld a fee-shifting bylaw for a non- stock corporation,25 and the Court’s reasoning led many to expect that a similar result would follow for stock corporations as well.26 Fee-shifting bylaws proved to be enormously controversial. Following vigorous debate, the Delaware Legislature statutorily banned fee-shifting bylaws for corporations.27 Ohio has no case law regarding fee-shifting bylaws. But the Ohio Supreme Court has upheld fee-shifting provisions in commercial contracts.28 And, as noted already, Ohio, like Delaware, treats bylaws as contracts.29 It seems plausible that an Ohio court would adopt the Delaware Supreme Court’s analysis and uphold the facial validity of a fee-shifting bylaw. One potential roadblock to fee-shifting provisions is Ohio’s right-to-a- remedy constitutional provision, which provides that “every person, for an injury done him in his land, goods, person, or reputation, shall have remedy by due course

• f law.”30 Most of the cases interpreting this clause have occurred in the context
• f challenges to various tort-reform statutes over the years.31 The right-to-a-

remedy clause has been interpreted in a fairly weak manner; it protects only vested rights, and there are no vested rights in common law rules.32 “Consequently, the right to a remedy protects only those causes of action that the General Assembly

• 22. Id.
• 23. Id.
• 24. Id. at 3.
• 25. ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 560 (Del. 2014).
• 26. Bainbridge, supra note 3, at 857-58.
• 27. DEL. CODE ANN. tit. 8, § 102(f), 109(b), 115 (West, Westlaw through 81 Laws 2017, chs. 1-
• 66. Revisions to 2017 Acts by the Delaware Code Revisors were unavailable at the time of

publication); Solak v. Sarowitz, 153 A.3d 729, 733 (Del. Ch. 2016) (interpreting the new provisions and holding fee-shifting bylaw invalid). See also Jill E. Fisch, The New Governance and the Challenge of Litigation Bylaws, 81 BROOK. L. REV. 1637, 1669-71 (2016) (recounting the brief history of fee-shifting bylaws in Delaware). Interestingly, Oklahoma turned in the opposite direction and enacted a mandatory fee-shifting provision for derivative actions. See OKLA. STAT. tit. 18, § 1126 (Westlaw with legislation of the 1st Reg. Sess. of the 56th Leg. (2017) effective through July 1, 2017).

• 28. See Wilborn v. Bank One Corp., 906 N.E.2d 396, 400 (Ohio 2009) (stating that “agreements

to pay another’s attorney [sic] fees are generally enforceable and not void as against public policy”) (internal citations omitted); 2-J Supply, Inc. v. Garrett & Parker, LLC, No. 13CA29, 2015-Ohio- 2757, 2015 WL 4113330, at *10-12 (Ohio Ct. App. 2015).

• 29. See supra note 12 and accompanying text.
• 30. OHIO CONST. art. I, § 16.
• 31. See, e.g., Antoon v. Cleveland Clinic Found., 71 N.E.3d 974, 984 (Ohio 2016) (upholding

medical-malpractice statute of repose); Arbino v. Johnson & Johnson, 880 N.E.2d 420, 449 (Ohio 2007) (upholding noneconomic damages cap).

• 32. Antoon, 71 N.E.3d at 980.

Fall 2017] THE UNIVERSITY OF TOLEDO LAW REVIEW 31 identifies and for the period of time it determines.”33 Whether a fee-shifting bylaw in practice forecloses a cause of action for all but the most well-heeled stockholders such that the right-to-a-remedy provision is implicated is unanswered under Ohio law.34 It is, however, a risk corporations must consider before adopting a fee- shifting bylaw. Finally, fee-shifting bylaws may fall within the ambit of Ohio’s statutory limit on unilateral board amendment of bylaws.35 Approval by the stockholders would be less risky than unilateral enactment by directors.

• III. MINIMUM-STAKE-TO-SUE PROVISIONS

A third type of litigation-reform bylaw is the minimum-stake-to-sue

• provision. These provisions remain experimental and have not been widely

adopted.36 The concept is that these bylaws or charter provisions would deter nuisance suits by small stockholders that result in little more than the payment of attorneys’ fees.37 In short, these bylaws aim to ensure that litigants have sufficient skin in the game. The most well-known example involved a company in Florida then called Imperial Holdings, Inc. (now named Emergent Capital, Inc.), which adopted a bylaw prohibiting stockholder class actions and derivative litigation unless the suing stockholder first delivered to the company written consents executed by the holders of at least 3% of the company’s outstanding stock.38 The adoption of the bylaw triggered a lawsuit in Florida, but the complaint was voluntarily dismissed before the court addressed the merits.39 To the authors’ knowledge, there are no cases in any state that have addressed the validity of minimum-stake-to-sue provisions. There are several grounds on which these bylaws might be challenged under Ohio law. First, such a bylaw likely could not be adopted by the directors unilaterally, as its purpose seemingly includes “[d]efining, limiting, or regulating the exercise of the authority of the shareholders.”40 Second, the logic of Boilermakers may cut against these sorts of bylaws. There, the court held that forum-selection bylaws were permissible “because they regulate where

• 33. Id. at 982.
• 34. Cf. Vistein v. Am. Registry of Radiologic Technologists, 342 F. App’x 113, 124-25 (6th Cir.

2009) (reviewing Ohio law and concluding that fee-shifting provisions that are not specifically negotiated are unenforceable as against Ohio public policy).

• 35. OHIO REV. CODE ANN. § 1701.11(B)(11) (West, Westlaw through 2017 Files 1 to 13 and 15

to 17 of the 132d Gen. Assemb. (2017-2018)).

• 36. See Boland et al., supra note 4, at 26.
• 37. See, e.g., Fisch et al., supra note 2, at 558-68 (describing how most merger litigation results

in disclosure-only settlements and the payment of attorneys’ fees); Jessica Erickson, The New Professional Plaintiffs in Shareholder Litigation, 65 FLA. L. REV. 1089, 1105-09 (2013) (describing repeat plaintiffs in merger and derivative litigation and observing that many repeat plaintiffs own very few shares in the companies on whose behalf they sue).

• 38. Imperial Holdings, Inc., Definitive Proxy (Form 14A) (Apr. 8, 2015).
• 39. Emergent Capital, Inc., Current Report (Form 8K) (Sept. 11, 2015); Emergent Capital, Inc.,

Current Report (Form 8K) (Oct. 15, 2015).

• 40. OHIO REV. CODE ANN. § 1701.11(B)(11) (West, Westlaw through 2017 Files 1 to 13 and 15

to 17 of the 132d Gen. Assemb. (2017-2018)).

32 VALIDITY OF OHIO LITIGATION-REFORM BYLAWS [Vol. 49 stockholders may file suit, not whether the stockholder may file suit.”41 A minimum-stake-to-sue bylaw does the opposite: it says nothing about where the stockholder may sue, and instead regulates whether the stockholder can sue. Third, Ohio’s constitutional right-to-a-remedy provision could present a roadblock to such a bylaw, as at least some small stockholders presumably would be barred from suing and thus lack a remedy, without regard to the facts allegedly underlying a claim.42

• IV. POLICY CONSIDERATIONS

Companies also should take into account other considerations before adopting any of these bylaws. A first consideration is utility.43 For example, absent a large stockholder in another jurisdiction or some other special circumstance, a company with its principal place of business in the same state in which it is incorporated likely would receive little benefit from a forum-selection bylaw, because it may face little risk of stockholder litigation in an inconvenient forum. Second, companies should be sensitive to the possibility that adopting these sorts of bylaws could detrimentally affect their relationships with various constituencies, including stockholders.44 Companies should be able to explain why the adoption of a given provision is a net-positive development for the company and its investors. For example, companies could justify adopting a forum-selection provision as a means of preventing corporate resources from being wasted in defending duplicative stockholder litigation in multiple fora. Third, public companies—but not private ones—need to consider the proxy advisory firms’ views on these provisions, which can have significant impact.45 Institutional Shareholder Services (ISS) takes a case-by-case approach to forum- selection bylaws, generally opposes fee-shifting bylaws, and will consider punitive measures against boards that unilaterally adopt either provision.46 Glass Lewis recommends that stockholders vote against forum-selection bylaws unless the board provides a “compelling argument” as to why such a provision is beneficial.47 The firm “strongly opposes” fee-shifting bylaws, and adoption of either provision without stockholder approval can trigger a recommendation to vote against the governance committee.48 Both firms presumably would oppose minimum-stake- to-sue provisions as well.

• 41. Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 952 (Del. Ch. 2013).
• 42. OHIO CONST. art. I, § 16.
• 43. See GLASS LEWIS, 2017 PROXY PAPER: GUIDELINES 38 (2016) (arguing that a forum-selection

provision should not be adopted absent “compelling evidence that it will benefit shareholders”).

• 44. See id. at 38-39.
• 45. See Stephen Choi, Jill Fisch, & Marcel Kahan, The Power of Proxy Advisors: Myth or

Reality?, 59 EMORY L.J. 869, 906 (2010) (showing that an ISS recommendation can shift up to 10%

• f a stockholder vote, independently of other factors).
• 46. ISS, UNITED STATES SUMMARY PROXY VOTING GUIDELINES: 2017 BENCHMARK POLICY

RECOMMENDATIONS 13-14, 25-26 (2017).

• 47. LEWIS, supra note 43, at 38.
• 48. Id. at 39.

Fall 2017] THE UNIVERSITY OF TOLEDO LAW REVIEW 33 CONCLUSION Litigation-reform bylaws present opportunities for companies to manage the risks and costs of stockholder litigation. Ohio law in this area is relatively undeveloped and fluid, but there is reason to believe that at least certain types of litigation-reform measures would be upheld in court. There are many factors, legal and otherwise, to consider before adopting one of these bylaws. Companies should consult their legal counsel before adopting any of these provisions.