“ATP Tour should have sparked a robust debate among institutional shareholders, corporate managers and their respective counsel about the merits of loser-pays bylaws…
…Instead, plaintiffs attorneys hijacked the moral high ground at the expense of those with the most at stake—long-term shareholders, who, as owners, indirectly bear the costs of frivolous litigation., Avrohom J. Kess and Yafit Cohn, Wall Street Journal, August 28, 2014.
‘Loser Pays’ Rules Make A Comeback
Legislation has not stopped questionable class-action shareholder suits. Corporate bylaws might do the trick.
AVROHOM J. KESS And
Aug. 27, 2014 6:37 p.m. ET
Corporate America is suffering from a costly and inefficient epidemic of questionable shareholder lawsuits. This problem could be mitigated by shifting some of the costs, and risks, of litigation to plaintiffs attorneys through a “loser pays” rule.
The abuse of class-action litigation is clear. In 2013, 612 of the approximately 650 mergers and acquisitions valued over $100 million resulted in litigation. In every year since 2010, shareholders filed lawsuits in more than 90% of such deals. It is difficult to imagine that all of the transactions challenged involved fraud or a breach of fiduciary duties.
Fortune magazine recently estimated that $73 billion in settlements has been extracted from corporations between 1997 and 2012—$17 billion of which went to the pockets of plaintiffs attorneys. Yet many individual shareholders never collect the money that is due to them, with 40%-60% of these settlement amounts going unclaimed. The result is a tax on capital that serves little societal purpose but does encourage more litigation.
Legislative reforms, including the Private Securities Litigation Reform Act of 1995 and the Class Action Fairness Act of 2005, have been somewhat effective. But we think a loser-pays rule, forcing plaintiffs attorneys to be more careful about choosing to file a claim, may be a better reform. And this reform can be adopted without legislation.
The Delaware Supreme Court recently took a step in this direction in ATP Tour v. Deutscher Tennis Bund, ruling on May 8 that a nonstock corporation’s bylaws could shift a company’s litigation expenses to unsuccessful claimants. To be sure, it was only a matter of days before the Corporation Law Section of the Delaware State Bar Association received and approved a legislative proposal that would prohibit publicly held companies from adopting similar bylaws.
The legal community was overwhelmingly negative, lining up solidly behind the “American rule,” where each party pays its own litigation fees and costs. Plaintiffs lawyers claimed that loser-pays bylaws would unfairly discourage meritorious litigation. Many corporate attorneys shied away from advising their clients to adopt such bylaws, likely concerned with attracting criticism from certain shareholders, proxy advisory firms and the media.
ATP Tour should have sparked a robust debate among institutional shareholders, corporate managers and their respective counsel about the merits of loser-pays bylaws. Instead, plaintiffs attorneys hijacked the moral high ground at the expense of those with the most at stake—long-term shareholders, who, as owners, indirectly bear the costs of frivolous litigation.
Loser pays is not a novel or untested idea—it has been the rule in the U.K. for centuries. Loser-pays bylaws, if widely adopted, could threaten the business model of many plaintiffs attorneys and may detour frivolous lawsuits by introducing true financial risk as a factor in the lawyers’ decision to bring a case on behalf of shareholders. The purchase of a company’s stock would constitute an agreement to abide by the loser-pays rule. At the very least, these provisions deserve genuine consideration by corporations and their shareholders.
One compromise might be permitting a loser-pays bylaw triggered only if the plaintiffs do not pass the motion-to-dismiss stage of the litigation. This might deter frivolous shareholder lawsuits while not substantially discouraging meritorious ones. There may be other creative ways to achieve the same result that are worthy of consideration.
But one thing is certain: The current system is broken. Fixing it requires a thoughtful and collaborative approach that is fueled by what should be the primary motivation of corporations and shareholders, and their lawyers—to act in the long-term best interests of the corporation and maximize returns for shareholders.
The Delaware General Assembly is likely to consider legislation to prohibit loser-pays bylaws among public companies early next year. All the more reason for institutional shareholders and corporate management—two groups whose interests should be aligned against frivolous and abusive lawsuits—to open a discussion now. The result could propel both groups to continue to work collaboratively in other areas to drive shareholder value over the long term.
Mr. Kess is a partner and Ms. Cohn is an associate at the law firm Simpson Thacher & Bartlett LLP.