Client Alert

Exploiting the Pre-Litigation Demand Requirement to Tax Attorneys’ Fees, a Continuing Tactic by Plaintiff Firms

December 04, 2019

By Rick Horvath, Peter M. Stone & Austin M. Prouty

Two recently filed complaints in the Delaware Court of Chancery highlight a stratagem increasingly used by plaintiff firms to recover attorneys’ fees from public company clients. Acting on behalf of a stockholder, the firm sends a letter to a public company demanding that it correct a relatively minor regulatory footfall. When the footfall is corrected, the firm then seeks to tax attorneys’ fees on the company for the benefit allegedly conferred by the corrective action. The company will often pay this tax so as to avoid the cost of litigating a fee award, particularly where the amount demanded is equal to or less than the costs of opposing the fee request. So long as this stratagem remains available, public companies should take precautionary steps to avoid exposure to it and understand the options available to counter it if they become a target.

The Demand-and-Tax Stratagem Explained

To understand the stratagem, it is helpful to recall one of the most critical, recent developments in corporate law, the Delaware Court of Chancery’s decision in In re Trulia, Inc. Stockholder Litigation. In Trulia, the Court rejected a disclosure-only settlement to a merger litigation and what would have been an easy payout of attorneys’ fees for plaintiffs’ counsel. In rejecting this settlement, the Trulia decision has curtailed much of the merger litigation that plagued Delaware courts for a decade. As a result, many plaintiff attorneys have sought new avenues to recover fees from public company clients.[1]

One new avenue involves the use of the pre-litigation demand requirement to insist that a public company correct an easily curable defect in its public filings. The demand requirement is an outgrowth of the fundamental precept of Delaware law that the board of directors manages the business and affairs of the corporation. Before commencing litigation on behalf of the corporation, a stockholder must either demand that the board take corrective action or plead with particularity why such a demand would be futile. A pre-litigation demand does not need to threaten litigation to satisfy the demand requirement.[2]

While the demand requirement is the vehicle for targeting a public company, the corporate benefit doctrine is the fuel. Pursuant to this doctrine, a stockholder who confers a benefit upon the corporation may be entitled to an award of attorneys’ fees and expenses for the stockholder’s efforts in creating the benefit.[3] The corporate benefit doctrine may apply when the company acts in response to a pre-litigation demand, even though no litigation is commenced.[4] A settlement of such a claim typically does not require or involve court approval.

The costs for a plaintiff firm to exploit the demand requirement are slight. The firm only must identify an easily curable defect, send a form demand letter (often to more than one public company for the same purported defect), and then negotiate fees once the company corrects the defect. Assuming the stockholder could prove a corporate benefit, these minimal efforts would likely result in fees well below $100,000, but the amount of work undertaken in identifying the defect and sending the letter is far less than that amount.[5] To be sustainable, a plaintiff firm also must balance demanding fees sufficient to reward its efforts, but make its fee demand low enough so that the corporation would rather pay than litigate. If successful, there would be no public record of the demand or payment.

The Demand-and-Tax Stratagem at Work

Not every demand is resolved in private. Two recent complaints, Shiva Stein v. PCTEL, Inc., C.A. No. 2019-0665 (Del. Ch. Aug. 21, 2019), and Shiva Stein v. LivePerson, Inc., C.A. No. 2019-0693 (Del. Ch. Sept 3, 2019), demonstrate the above stratagem in operation where fee negotiations initially stalled.

In each case, the plaintiff sent a letter to the corporation demanding it address an alleged deficiency in the corporation’s annual proxy statement. The plaintiff asserted each company’s proxy violated Item 21(b) of Schedule 14A by failing to “describe the effect of . . . ‘broker non-votes,’” and demanded that the company and its board amend the proxy statement to correct the asserted misstatements or face litigation. After receiving the letter, each corporation amended its proxy statement to address the alleged deficiency.

The companies apparently did not initially agree to attorneys’ fees because the plaintiff then filed suit in the Court of Chancery to recover those fees. Significantly, the plaintiff voluntarily dismissed the PCTEL complaint one week after it was filed. The LivePerson docket also does not reflect any activity since the complaint was filed months ago. It would appear that the attorneys may have achieved the results they sought or are on a path to doing so.

Considerations for Companies Going Forward

The above stratagem presents a collective action problem that cannot be solved unless and until a company incurs the cost to challenge a fee award and where companies are naturally dis-incentivized to incur fees in excess of a demand to oppose a fee application. So what is a company faced with such a demand to do? Several considerations come into play:

  • First, with outside counsel, give greater attention to issues likely to fall within the oversight of the board of directors, including proxy materials and other matters the board is likely to review. A plaintiff firm cannot employ a demand-and-tax stratagem if there is no reason to make a demand.

  • Second, take appropriate action in response to the demand while documenting the board’s process. In so acting, consider the scope of response that is needed.

  • Third, understand the limits of the corporate benefit doctrine and how to push back effectively against any attempt to tax attorneys’ fees. Indeed, the stockholder may not be entitled to fees even if the company takes corrective action.

  • Fourth, recognize that the ultimate leverage a company has is its willingness to fight a fee award. Litigation both would impose on the plaintiff’s firm additional costs and would risk an adverse result that could threaten the viability of the demand-and-tax stratagem.

Plaintiff firms will continue to evolve their tactics for securing corporate paydays. The challenge for in house counsel and their outside attorneys will be in deciding how to respond to these developments in a way that effectively achieves the organization’s goals.

[1] 129 A.3d 884 (Del. Ch. 2016).

[2]  See Solak v. Welch, C.A. No. 2018-0810-KSJM (Del. Ch. Oct. 30, 2019).

[3] Bird v. Lida, Inc., 681 A.2d 399 (Del. Ch. 1996).

[4] Id.; Raul v. Astoria Financial Corp., 2014 WL 2795312 (Del. Ch. June 20, 2014).

[5] See In re Sauer-Danfoss Inc. S’holders Litig., 65 A.3d 1116 (Del. Ch. 2011) (Appendix A).

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