John SOLAK, on behalf of himself and all other similarly situated stockholders of Paylocity Holding Corporation, Plaintiff, v. Steven I. SAROWITZ, Mark H. Mishler, Steven R. Beauchamp, Ronald V. Waters III, Andres D. Reiner, Jeffrey T. Diehl, and Paylocity Holding Corporation, Defendants.
C.A. No. 12299-CB
Court of Chancery of Delaware.
Date Submitted: September 27, 2016 Date Decided: December 27, 2016
729
BOUCHARD, C.
John L. Reed, Ethan H. Townsend, and Harrison S. Carpenter of DLA PIPER LLP (US), Wilmington, Delaware; Attorneys for Defendants.
BOUCHARD, C.
In 2015, Section 115 was added to the Delaware General Corporation Law (“DGCL“) codifying this Court‘s decision in Boilermakers Local 154 Retirement Fund v. Chevron Corp.1 that Delaware corporations may adopt bylaws requiring that internal corporate claims be filed exclusively in Delaware.
About six months later, the board of Paylocity Holding Corporation adopted two new bylaws. The first is an exclusive forum bylaw that, absent the company‘s consent, requires internal corporate claims to be filed in a state or federal court located in Delaware. The second bylaw is the point of controversy in this action. It purports to shift to a stockholder who files an internal corporate claim outside of Delaware without the company‘s consent the attorneys’ fees and other expenses that the company incurs in connection with such a claim if the stockholder does not obtain a judgment on the merits that substantially achieves the full remedy sought (the “Fee-Shifting Bylaw“). In other words, to trigger the Fee-Shifting Bylaw, a stockholder must first violate the company‘s exclusive forum bylaw.
In this action, a stockholder of Paylocity seeks a declaration that the Fee-Shifting Bylaw is invalid under
For the reasons that follow, I conclude that plaintiff‘s claims are ripe for review because the validity of the Fee-Shifting Bylaw otherwise may never be subject to judicial review given its deterrent effect. I further conclude that plaintiff‘s challenge under
I. BACKGROUND
The facts in this opinion are drawn from the Verified Class Action Complaint (the “Complaint“) and documents incorporated therein.2
A. The Parties
Defendant Paylocity Holding Corporation, a Delaware corporation, is headquartered in Arlington Heights, Illinois. Paylocity is a cloud-based provider of payroll and human capital management software solutions for medium-sized organizations with between 20 and 1,000 employees. Its stock is publicly traded on NASDAQ.
Individual defendants Steven J. Sarowitz, Steven R. Beauchamp, Jeffrey T. Diehl, Mark H. Mischler, Andres D. Reiner, and Ronald V. Waters III were the six members of Paylocity‘s board of directors when the Fee-Shifting Bylaw was adopted.
B. The Legislative Response to the ATP Decision
In May 2014, the Delaware Supreme Court held in ATP Tour, Inc. v. Deutscher Tennis Bund3 that “the board of a Delaware non-stock corporation may lawfully adopt a bylaw that shifts all litigation expenses to a plaintiff in intra-corporate litigation who does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.”4 Concern that this ruling would lead to the adoption of fee-shifting bylaws in stock corporations prompted a quick legislative response.
Within one year of the ATP decision, the Corporation Law Council of the Delaware State Bar Association proposed legislation to “limit ATP to its facts” and prevent the boards of Delaware stock corporations from adopting fee-shifting bylaws.5 In an explanatory memo, the Council expressed concern that such bylaws would deter stockholders from enforcing otherwise meritorious claims.6 The Council further commented that “[p]ermitting fee shifting as a limitation on stockholder litigation would be functionally equivalent to permitting corporate charter or bylaw provisions limiting or eliminating the fiduciary duties of officers and directors,” which the Council had “steadfastly declined to permit,” and that Delaware courts “already have sufficient tools to deter litigation of limited merit” without the need for fee shifting bylaws.7
The legislation the Council proposed was signed into law on June 24, 2015, and became effective on August 1, 2015. It amended the DGCL in two ways pertinent to this case. First, it added
C. Paylocity Adopts the Fee-Shifting Bylaw
On February 2, 2016, about six months after the amendments to the DGCL enact
Section 8.1 is an exclusive-forum provision. It provides that, unless the company otherwise consents, courts located in Delaware shall be “the sole and exclusive forum for” certain specified disputes:
Unless the corporation consents in writing to the selection of an alternative forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any current or former director, officer or other employee of the corporation to the corporation or the corporation‘s stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim governed by the internal affairs doctrine (each an “Action“) shall be a state or federal court located within the state of Delaware (a “Chosen Court“), in all cases subject to the court‘s having personal jurisdiction over the indispensable parties named as defendants.12
Section 8.2 is a fee-shifting provision. In general terms, it shifts the company‘s litigation expenses (including attorneys’ fees) to any stockholder who brings, substantially assists, or has a direct financial interest in any “Action” in a forum not located in Delaware, unless the stockholder obtains a judgment on the merits that substantially achieves the full remedy sought:
8.2 Extra-Forum Claims. To the fullest extent permitted by law, in the event that (A) any current or former stockholder of the corporation acting as such (“Claiming Party“) initiates, joins or asserts any Action in a court, tribunal or other arbitral or judicial body, in each case other than in a Chosen Court (an “Extra-Forum Claim“), or offers substantial assistance to, or has a direct financial interest in (other than simply in such person‘s capacity as a stockholder of the corporation), any Extra-Forum Claim against the corporation and/or any current or former director, officer, employee or agent of the corporation (collectively, an “Aligned Party“), (B) the corporation does not consent in writing to waive applicability of this bylaw to a specified Extra-Forum Claim and (C) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Extra-Forum Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the corporation and any such Aligned Party the greatest amount permitted by law of all fees, costs and expenses of every kind and description (including but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the parties may incur in connection with such Extra-Forum Claim.13
(As defined above, the “Fee-Shifting Bylaw“).
Defendant acknowledges that the term “Action” as defined in Section 8.1 is substantively the same as the term “internal corporate claim” as defined in
D. The Present Action
On May 5, 2016, plaintiff filed this action on behalf of a putative class of Paylocity stockholders. The Complaint contains three claims. In Count I, plaintiff asserts that the Fee-Shifting Bylaw violates the prohibition against fee-shifting bylaws in
II. ANALYSIS
Defendants have moved to dismiss the Complaint under Court of Chancery Rule 12(b)(1) for lack of subject matter jurisdiction on the theory that plaintiff‘s claims are not ripe for review, and under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted. I address these arguments in turn.
A. Plaintiff‘s Facial Challenge to the Fee-Shifting Bylaw is Ripe
In Counts I and II of the Complaint, plaintiff asserts that the Fee-Shifting Bylaw is facially invalid under
“Ripeness, the simple question of whether a suit has been brought at the correct time, goes to the very heart of whether a court has subject matter jurisdiction.”17 The ripeness doctrine prevents Delaware courts from exercising jurisdiction over disputes where doing so would result in the rendering of an advisory or hypothetical opinion:
Courts decline to render hypothetical opinions, that is, dependent on supposition, for two basic reasons. “First, judicial resources are limited and must not be squandered on disagreements that have no significant current impact and may never ripen into legal action [appropriate for judicial resolution]. Second, to the extent that the judicial branch contributes to law creation in our legal system, it legitimately does so interstitially and because it is required to do so by
reason of specific facts that necessitate a judicial judgment.” Whenever a court examines a matter where facts are not fully developed, it runs the risk not only of granting an incorrect judgment, but also of taking an inappropriate or premature step in the development of the law.18
As our Supreme Court recently explained, a “common sense assessment” must be made in determining whether a case is ripe for adjudication:
A ripeness determination requires a common sense assessment of whether the interests of the party seeking immediate relief outweigh the concerns of the court “in postponing review until the question arises in some more concrete and final form.” Generally, a dispute will be deemed ripe if “litigation sooner or later appears to be unavoidable and where the material facts are static.” Conversely, a dispute will be deemed not ripe where the claim is based on “uncertain and contingent events” that may not occur, or where “future events may obviate the need” for judicial intervention.19
Applying these principles, this Court has commented that “[f]acial challenges to the legality of provisions in corporate instruments are regularly resolved by this Court.”20
Despite the facial nature of plaintiff‘s challenge to the validity of the Fee-Shifting Bylaw, defendants contend that plaintiff‘s claims are not ripe because no stockholder of Paylocity has filed an action outside of Delaware that would trigger the Fee-Shifting Bylaw, and because plaintiff has not pled an intention to bring such an action. Although the factual premise of defendants’ position is correct, I disagree that it negates the ripeness of the current dispute.
This Court repeatedly has recognized disputes to be ripe for review when stockholders challenge measures that have a substantial deterrent effect.21 Here, the
Declining review of the Fee-Shifting Bylaw also could encourage other corporate boards to adopt similar bylaws to take advantage of their potent deterrent effect on stockholders without regard to whether such provisions are legally permissible. Thus, deciding “the basic legal questions presented” by the plaintiff‘s complaint “will provide efficiency benefits to not only the defendants and their stockholders, but to other corporations and their investors.”23 “Corporate fiduciaries must be given clear notice of what conduct is and is not allowed.”24 Given the very real possibility that the Fee-Shifting Bylaw would never be subjected to judicial review if it were necessary to wait for it to be triggered, and because no beneficial purpose is served by perpetuating uncertainty concerning the permissibility of fee-shifting bylaws, particularly in the wake of the recent amendments to the DGCL, my common sense assessment is that plaintiff‘s claims should be reviewed now.
The primary authority on which defendants rely to challenge ripeness, Chancellor Chandler‘s decision in Wayne County Employees’ Retirement System v. Corti,25 is distinguishable. Corti involved a challenge to two provisions in the certificate of incorporation of Activision Blizzard. The plaintiff in Corti, unlike the plaintiff here, did “not allege any present negative or detrimental effect on shareholders that warrants granting declaratory relief.”26 The Chancellor instead found that the plaintiff in Corti was “merely ... able to conjure up hypothetical situations in which the challenged provisions may be applied contrary to Delaware law.”27 By contrast, plaintiff here challenges the facial validity of the Fee-Shifting Bylaw based on the plain text of two provisions of the DGCL.
To be clear, I do not intend to suggest that a stockholder who files an internal
B. Defendants’ Motion to Dismiss under Rule 12(b)(6)
1. Standard of Review
Having determined that plaintiff‘s claims are ripe for review, the next question is whether he has stated claims upon which relief can be granted. Ordinarily, there would be no disagreement over the standard that governs a motion to dismiss brought under Rule 12(b)(6), which, as our Supreme Court held in Central Mortgage, requires denial of “the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof.”30 That analysis is not so straightforward, however, when one challenges the facial validity of a corporate bylaw. That is because, as our Supreme Court held in Frantz Manufacturing, “[t]he bylaws of a corporation are presumed to be valid, and the courts will construe the bylaws in a manner consistent with the law rather than strike down the bylaws.”31
Relying on Central Mortgage and the Delaware Supreme Court‘s decision in VLIW Technology, plaintiff argues that a motion to dismiss a challenge to the facial validity of a corporation‘s bylaw “should be denied unless ‘defendants’ interpretation is the only reasonable construction as a matter of law.‘”32 Put differently, plaintiff seeks to place the burden on defendants to demonstrate that the Fee-Shifting Bylaw is unambiguous and plainly lawful, thereby negating plaintiff‘s construction. Plaintiff‘s reliance on VLIW Technology is misplaced. That case involved a claim for breach of contract, which will survive dismissal under Rule 12(b)(6) where a contractual provision is ambiguous and plaintiff has advanced at least one reasonable interpretation of the provision.33 VLIW Technology did not involve a challenge to the facial validity of a bylaw, which implicates the principle of presumed validity articulated in Frantz Manufacturing.
Relying on Frantz Manufacturing and analogous principles applicable to facial challenges to a statute, Chief Justice
Although Boilermakers involved a motion for judgment on the pleadings under Rule 12(c), and not a motion to dismiss under Rule 12(b)(6), plaintiff has advanced no principled reason why that should make a difference, and none is readily apparent. To the contrary, given that a facial challenge presents a pure question of law,36 it makes sense that one who has voluntarily chosen to mount a facial attack on the validity of a bylaw must demonstrate that it cannot operate lawfully under any circumstance to state a claim for relief if the presumption of facial validity articulated in Frantz Manufacturing applies as the starting point.37
For these reasons, I will apply the standard of review articulated in Boilermakers in resolving defendants’ motion to dismiss plaintiff‘s claims challenging the facial validity of the Fee-Shifting Bylaw (Counts I and II). For plaintiff‘s breach of fiduciary duty claim (Count III), I will apply the traditional standard of reasonable conceivability.
2. Count I States a Claim that the Fee-Shifting Bylaw is Facially Invalid under DGCL Section 109(b)
In Count I of the Complaint, plaintiff seeks a declaration that the Fee-Shifting Bylaw is invalid because it violates
Our Supreme Court recently summarized the interpretative principles to be applied in construing a corporate bylaw as follows:
The bylaws of a Delaware corporation constitute part of a binding broader contract among the directors, officers and stockholders formed within the statutory framework of the Delaware General Corporation Law. Because corporate charters and bylaws are contracts, our rules of contract interpretation apply.
“Words and phrases used in a bylaw are to be given their commonly accepted meaning unless the context clearly requires a different one or unless legal phrases having a special meaning are used.” “Under the applicable interpretation rules, if the bylaw‘s language is unambiguous, the court need not interpret it or search for the parties’ intent.” In that case, “[t]he bylaw is construed as it is written, and the language, if simple and unambiguous, is given the force and effect required.” If charter or bylaw provisions are unclear, we resolve any doubt in favor of the stockholder‘s electoral rights.40
The Supreme Court similarly has explained that “[a] court should not resort to legislative history in interpreting a statute where statutory language provides unambiguously an answer to the question at hand.”41
Applying these principles here, I agree with plaintiff that the plain text of the Fee-Shifting Bylaw violates
Defendants advance three arguments in defense of the Fee-Shifting Bylaw‘s validity, but none has merit. First, defendants argue that the recent amendment to
Second, defendants argue that fee-shifting is permissible at common law and that
The common law relevant here emanates from the Supreme Court‘s opinion in ATP that the board of a Delaware non-stock corporation may lawfully adopt a fee-shifting bylaw.46 Although no decision has addressed directly whether this holding would apply to stock corporations, it was “widely suggested” after ATP “that stock corporations ... consider adopting such provisions.”47 In A.W. Financial Services, our Supreme Court articulated three ways a statute could oust the common law, including where “the statutory scheme actually conflict[s] with the common law.”48 The Supreme Court more generally explained that repeal of the common law by implication “is deemed to occur only ‘where there is fair repugnance between the common law and the statute, and both cannot be carried into effect.‘”49 To the extent one may have inferred from ATP that fee-shifting bylaws were permissible for stock corporations,50 the recent amendment to
Finally, defendants assert that Count I fails to state a claim for relief because the Fee-Shifting Bylaw contains a savings
For the reasons explained above, plaintiff has demonstrated that the Fee-Shifting Bylaw cannot operate lawfully under any circumstances given the blanket prohibition on fee-shifting bylaws in
3. Count II Fails to State a Claim that the Fee-Shifting Bylaw is Facially Invalid under DGCL Section 102(b)(6)
In Count II of the Complaint, plaintiff seeks a declaration that the Fee-Shifting Bylaw is invalid because it violates
If triggered, the Fee-Shifting Bylaw would require a stockholder to reimburse Paylocity “all fees, costs and expenses of every kind and description (including but not limited to, all reasonable attorneys’ fees and other litigation expenses)” it incurred in connection with litigating an internal corporate claim. Thus, the threshold question to determining if the Fee-Shifting Bylaw violates
The standard of review applicable to this motion is decisive to its resolution with respect to Count II. As explained above, having chosen to challenge the facial validity of the Fee-Shifting Bylaw, plaintiff carries the “heavy” burden of showing that
To start, plaintiff has provided no authority interpreting the term “debts” as used in
To my mind, unguided by having the benefit of any relevant authority to consider, it is plausible that the term “debts” as used in
4. Count III Fails to State a Claim for Breach of Fiduciary Duty
Count III of the Complaint asserts a claim for breach of fiduciary duty against the individual defendants for approving the adoption of the Fee-Shifting Bylaw and for the manner in which the company publicly disclosed its adoption in a Form 8-K filing. In its prayer for relief, the Complaint asks that the Paylocity board be found liable for these alleged breaches.
Paylocity‘s certificate of incorporation contains a
Chancellor Allen once described bad faith to mean “a transaction that is authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of applicable positive law.”58 More recently, this Court explained that “to state a bad-faith claim, a plaintiff must show either an extreme set of facts to establish that disinterested directors were intentionally disregarding their duties, or that the decision under attack is so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”59
Plaintiff argues it is reasonably conceivable that the individual defendants’ conduct “could rise to the level of bad faith conduct” because they “knowingly adopted the Fee-Shifting Bylaw in violation of applicable positive law.”60 According to plaintiff, the individual defendants must have known they were violating the law when they approved the Fee-Shifting Bylaw because they took this action “more than six months after [the amendment to] Section 109(b) became effective.”61 This single allegation is insufficient in my view to support a reasonable inference that Paylocity‘s directors acted with scienter—that they knew they were violating the law—when they approved the Fee-Shifting Bylaw.
Noticeably absent from the Complaint are any factual allegations concerning the process the Paylocity board undertook when it considered the Fee-Shifting Bylaw proposal. Nowhere does the Complaint plead facts suggesting, for example, that the directors harbored some nefarious purpose, that they did not deliberate diligently, or that they failed to receive (or ignored) legal advice. It would be hard to imagine that the board of a public corporation would not have been advised by counsel in considering a proposal of this nature, particularly given the alleged “widespread press” surrounding the amendment of
Apart from the absence of factual allegations concerning the board‘s process, it would not be reasonable to infer scienter because of the presence of the savings clause at the outset of the Fee-Shifting Bylaw stating that it would operate only “[t]o the fullest extent permitted by law.” Although the savings clause cannot salvage the Fee-Shifting Bylaw from being rendered invalid for the reasons explained above, its presence negates the notion that the directors knew that they would be violating the law by approving the provision. As Chancellor Chandler remarked when considering an identical savings clause, “[t]o the extent Section 9.3 could possibly be construed as endorsing conduct that would be prohibited by Delaware law, the provision‘s own language bars such an
Plaintiff‘s second theory for the breach of fiduciary duty claim concerns the disclosures the company made when it filed a Form 8-K disclosing the adoption of a new Article VIII, which included the Fee-Shifting Bylaw and the exclusive forum provision. In particular, plaintiff questions the company‘s failure to disclose the adoption of the amendment to
For the reasons explained above, the Complaint fails to plead facts warranting a reasonable inference of scienter necessary to sustain a claim that the members of Paylocity‘s board acted in bad faith in approving the Fee-Shifting Bylaw and with regard to the company‘s disclosure of the same. Accordingly, Count III is dismissed for failure to state a claim for relief.
C. Defendants’ Unclean Hands Defense does not Warrant Dismissal of the Complaint
Defendants argue that the Complaint should be dismissed because plaintiff has come to Court with unclean hands on the theory that his “only possible motivation for this lawsuit” is to facilitate a future violation of Paylocity‘s exclusive-forum bylaw.65 It is inappropriate to dismiss a complaint based on an affirmative defense unless “plaintiff can prove no set of facts to avoid it:”
Because the Court generally is limited to the facts appearing on the face of the pleadings in ruling on a motion to dismiss, affirmative defenses, such as laches, are not ordinarily well-suited for disposition on such a motion. Thus, unless it is clear from the face of the complaint that an affirmative defense exists and that the plaintiff can prove no set of facts to avoid it, dismissal of the complaint based upon an affirmative defense is inappropriate.66
“The question of unclean hands is factual.”67 Given that the filing of this action has served the salutary purpose of ensuring that the adoption of the Fee-Shifting Bylaw does not go unchecked by judicial review, defendants’ conclusory characterization of plaintiff‘s motivations for filing this action is plainly a matter of significant factual dispute, and provides no basis for dismissal.
III. CONCLUSION
For the foregoing reasons, defendants’ motion to dismiss is denied in part and
IT IS SO ORDERED.