A fee-shifting by-law in the shareholder litigation context, "obligate[s] the plaintiff-shareholder to reimburse the corporation's expenses (including attorneys' fees and other costs) when the plaintiff [is] unsuccessful in litigation."
Shareholder litigation in the United States operates under the "American Rule" which provides that each party is responsible for their own attorney's fees. Unlike South of the border, in Canada lawyers' fees are largely recoverable by the prevailing party. The 2008 financial crisis escalated the number of shareholder-initiated suits, especially in the United States. To address this, American corporations have attempted to avoid bearing the cost burden of unsuccessful shareholder initiated litigation. One method which proved successful for ATP Tour Inc. was a fee-shifting by-law. This by-law was unilaterally adopted by the board of directors without express shareholder consent. The purpose of the by-law was to force the shareholder-plaintiff to accept the financial risk when commencing unsuccessful litigation against the corporation.
While fee-shifting by-laws were initially upheld by the Delaware courts in ATP Tour Inc v Deutchser Tennis Bund in 2014, it did not take long for the legislature to respond. After significant controversy and the adoption of similar by-laws by 70 public companies, legislative changes expressly prohibited the use of fee-shifting by-laws.
The introduction of a balanced, as opposed to one-sided, fee-shifting by-law has the ability to deter non-meritorious claims while encouraging meritorious ones. This is much like the Canadian system in which both parties risk legal costs when claiming or defending an action. This is in contrast to the fee-shifting by-law in ATP Tour. In that case, the fee shifting by-law discouraged even claims with merit: the plaintiff-shareholders were unable to recover costs even upon success and were forced to bear the burden of legal costs even if they were partially successful. The all-out ban put in place by the legislature is on the opposite end of the spectrum. Prohibiting either party from benefitting from success in litigation does not provide an early filter for non-meritorious claims.
As mentioned above, Canada ascribes to the "loser pays" model. As a result, concerns about a "chilling effect" on meritorious claims may not have the same ground in Canada for striking down fee-shifting by-laws. However, there still may be room for fee-shifting by-laws in Canada. The attorney fees recovered are almost never on a "full indemnity basis" and generally are within the range of 50-80% (partial to substantial indemnity). This means that a fee-shifting by-law has the potential to ensure full indemnity recovery, if enforceable. That being said, unlike in the U.S., in the Canadian context, an amendment to the by-laws requires the confirmation of shareholders. Therefore, even if a corporation were to adopt a fee shifting by-law, it is unlikely that the corporation's shareholders would confirm such.
To date, a fee shifting by-law has yet to be tested by the Canadian courts in the context of shareholder litigation.
The author would like to thank Kiri Latuskie, summer law student, for her assistance in preparing this post.
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