| July 7
July 7 A handful of mostly tiny U.S. companies
have become the first to adopt controversial bylaws that would
shift legal fees to investors who sue and lose, which legal
experts said could upend the economics of shareholder
The Delaware Supreme Court ruled in May that "loser pays,"
or fee-shifting, bylaws were valid and could be used to deter
Six companies in recent weeks have adopted the bylaws, which
govern relations between a company and its shareholders.
At least two of the companies, small medical device makers
Echo Therapeutics Inc and Biolase Inc, have
been sued by shareholders this year over the make-up of their
"The Echo board determined that the adoption of a
fee-shifting bylaw provision and its potential effect in
deterring future frivolous litigation was in the best interests
of all shareholders," the company said in a statement.
Biolase declined to comment.
The bylaws would apply to cases brought under Delaware
corporate law, which governs the internal workings of companies.
It would not affect securities fraud cases, which are brought
under federal law.
The majority of U.S. companies incorporate in Delaware, in
part because the state's court protects directors from
second-guessing by shareholders as long as they act in good
Critics sketched out scenarios in which small shareholders
would be too intimidated by the fee-shifting provisions to sue
big companies over executive pay or deals to sell the company
But the bylaws have been used in situations where the
company is small, and the potentially larger party is the
"I think it's notable that we're not seeing the
well-established, large-cap companies do it," said Claudia
Allen, an attorney with Katten Muchin Rosenman who tracks
companies adopting the bylaws.
Earlier this year Echo settled a lawsuit brought by Platinum
Partners by putting one of the hedge fund's nominees on its
board. Egan-Jones Proxy Services said in its report on Echo's
proxy vote that the settlement was driven in part by the
potential expense of litigation.
The other companies adopting the bylaws were Westlake
Chemical Partners LP, Townsquare Media LLC, Viper Energy
Partners LP and LGL Group Inc. All but LGL are
planning or recently completely initial public offerings and at
least three of the six have a market capitalization under $100
Allen said most companies are probably reluctant to adopt
the bylaw because of the potential to harm investor relations.
"It's not the U.S. system so you'll become a lightning rod
of controversy," she said.
Under the "American Rule" in U.S. litigation, each party
bears its own legal costs regardless of the outcome.
The Delaware Supreme Court ruled in May that the
fee-shifting bylaw of ATP Tour Inc, an organization that
oversees men's professional tennis, was valid.
The ATP ruling prompted the state's Senate to try to ban the
use of fee-shifting bylaws, but the effort failed after heavy
lobbying by the U.S. Chamber of Commerce.
Allen said it was far from clear if the bylaws adopted by
Echo and Biolase would withstand scrutiny of a court, which
would examine if it was an appropriate response to a perceived
threat. That will have to wait until a shareholder sues, loses
and gets stuck with the company's legal bill.
(Reporting by Tom Hals in Wilmington, Delaware; Editing by