05/05/2015 10:40 am ET Updated May 05, 2016

Delaware Seeks to Restore Balance Between Corporations and Shareholders

This post is co-authored by Hank Kim, Executive Director and Counsel, National Conference on Public Employee Retirement Systems (NCPERS)

It is a basic tenet of corporate law that shareholders should have a remedy if those in charge of a corporation act in ways that violate their duties to shareholders. After all, shareholders own the company.

And "shareholders" means almost all of us. If your 401(k) retirement plan includes stocks, you're a shareholder. If you're a public employee with a state pension, you're a shareholder. We all have a stake in making sure businesses are held accountable. Corporations are held accountable when shareholders go to court; no federal or state law regulates how companies treat their shareholders.

Delaware is currently working to keep a fair balance of power between corporations and shareholders. More than half the nation's Fortune 500 companies are incorporated in Delaware. So Delaware corporate law affects everyone.

A recent case kicked off the need to recalibrate Delaware law. Here's what happened:

A Delaware court ruled that corporations can enact bylaws that force shareholders to pay the corporation's legal fees unless the shareholder achieves total victory. So if a shareholder sues a corporation for wrongdoing and wins on four out of five claims, the shareholder has to pay all of the corporation's legal fees and costs. These fees and costs could easily run into the millions of dollars. This means that corporations that enact these bylaws can effectively shield themselves from shareholder accountability. In the wake of that decision, at least 70 additional corporations have adopted bylaws that are identical or even more extreme. Even in cases involving undeniable violations of federal and/or state law, no responsible investor can risk facing this type of uncontrollable and unpredictable financial exposure.

These bylaws are so oppressive that it's no wonder that Prof. Jay Brown of the University of Denver Law School calls them "a nuclear weapon against shareholders."

In the months since the court ruling, more than 70 corporations have rushed to add these clauses to their bylaws. Some of them made the changes right after they were informed they were being sued -- or might be sued.

  • Hemispherx BioPharma, Inc., adopted such a provision one week after discovery requests were served on the company.
  • Lannett Company, Inc., adopted such a provision one day after disclosing it received subpoenas from the Connecticut attorney general related to a price fixing investigation.
  • Insys Therapeutics, Inc., adopted such a provision after the announcement of a Department of Health and Human Services investigation and the filing of two related lawsuits.

Nearly half a century ago, Chief Justice Earl Warren wrote about the fundamental unfairness of these kinds of provisions:

Since litigation is at best uncertain one should not be penalized for merely defending or prosecuting a lawsuit, and ... the poor might be unjustly discouraged from instituting actions to vindicate their rights if the penalty for losing included the fees of their opponents' counsel.

But the damage can be undone. Legislation has been introduced in the Delaware General Assembly that would prohibit stock corporations from adopting these kinds of bylaws. It's a change that everyone from institutional investors to labor unions to the chief justice of the Delaware Supreme Court thinks should happen. If the bill becomes law, all of us will again have a fighting chance to hold corporate wrongdoers accountable for their misdeeds.

The proposed legislation is critical to restoring corporate accountability, shareholders' access to justice, and striking a fair balance between corporate freedoms and investor. Delaware law is known for balancing the rights of corporations and shareholders. The proposed legislation will restore that balance.