Chancellor Bouchard finds, as a matter of first impression in Delaware, that a non-reciprocal fee-shifting bylaw is inapplicable to a plaintiff stockholder because it was adopted after the plaintiff’s interest in the corporation was eliminated in a reverse stock split.
In Strougo v. Hollander, C.A. No. 9770-CB (March 16, 2015), Plaintiff – a former stockholder of First Aviation Services, Inc. (“First Aviation”) – challenged (on behalf of himself and a putative class) the fairness of a 10,000-to-1 reverse stock split that cashed out the ownership interests of Plaintiff and the putative class at the request of the Chief Executive Officer and controlling shareholder of First Aviation in order to take First Aviation private. Four days after consummation of the reverse stock split, the First Aviation Board adopted a non-reciprocal fee shifting bylaw that required any “current or prior stockholder or anyone on their behalf” who initiates or asserts a claim or counterclaim against First Aviation or any director, officer or employee and who does not obtain a judgment on the merits that substantially achieves the full remedy sought, to be jointly and severally liable for all fees, costs and expenses incurred in connection with the claim or counterclaim. There was no public announcement to the First Aviation stockholders that the board had adopted the bylaw and Plaintiff was notified of the bylaw after the lawsuit was filed.
Plaintiff moved for partial summary judgment that the bylaw does not apply in this case since it was adopted after the Plaintiff’s equity interest in First Aviation had been eliminated pursuant to the reverse stock split. In granting Plaintiff’s motion for partial summary judgment, the Chancery Court held that the lawsuit is governed by the bylaws in effect upon consummation of the reverse stock split, at the time when the former stockholder’s interest as stockholder was eliminated, and that First Aviation would not be able to shift its fees onto Plaintiff in the event that it prevailed in the suit. The court based its conclusion on the principle that “[c]orporate charters and bylaws are contracts among a corporation’s stockholders,” citing Airgas, Inc. v. Air Products & Chems., Inc., 8 A.3d 1182, 1188 (Del. 2010), and that only parties to a contract are bound by that contract. Observing that bylaws are in law and practice an “infinitely flexible” contract between a corporation and its stockholders, the court concluded that a person whose status as stockholder has been terminated is the equivalent of a non-party to the corporate contract, such that a former stockholder is not bound by or subject to bylaw amendments adopted after her interest in the corporation has been eliminated. The court found that a bylaw amendment that purports to regulate the rights of stockholders who are no longer stockholders when the bylaw is adopted is beyond the scope of Section 109(a) of the Delaware General Corporation Law (noting in a footnote that an equivalent limitation would apply to charter provisions). The court recognized that a former stockholder remains subject to the bylaws in effect when the former stockholder’s interest as a stockholder was eliminated.
In dicta, the court raised serious concern about fee-shifting bylaws and questioned whether it would be “statutorily permissible and/or equitable” to adopt bylaws that “functionally deprive” stockholders of the right to sue in order to vindicate their interests as stockholders. Specifically, the court observed that stockholders’ potential damages in connection with the reverse stock split were not sufficient for a stockholder or plaintiff’s lawyer to risk having to pay uncapped attorney’s fees, even though the action taken by the First Aviation board in approving the reverse stock split should be subject to Delaware’s entire fairness standard of review.