NCPA - National Center for Policy Analysis

Delaware Proposal Threatens Loser-Pays Provisions

December 1, 2014

There is a reason that new corporations choose to incorporate in Delaware: the state's law is very clear, consistent and business-friendly. Last year, 83 percent of new corporations were incorporated in Delaware.

But Lisa Rickard of the Wall Street Journal reports that things may change if a new legislative proposal passes. In Delaware, corporations often include provisions in their bylaws that allow the corporation to be reimbursed for litigation costs if plaintiffs bring a shareholder suit against the company and lose the case.

But some state lawmakers are trying to prevent businesses from including loser-pays provisions. Corporations are concerned, as the provisions allow companies to protect themselves from frivolous, and expensive, lawsuits. Lawsuits against corporations are hardly uncommon: since 2010, Rickard notes that over 90 percent of corporate mergers and acquisitions led to lawsuits. What sort of suits? Some involve investors that sue, claiming that the Board of Directors did not haggle for enough money or made other transactional errors. Others involve investors who insist their shares were undervalued -- these suits, explain Rickard, are especially troublesome for corporations who either have to pay the plaintiffs to settle the case or take the case to court and pay litigation costs, which can cost millions of dollars. If the plaintiffs win, Delaware law also requires corporations to pay the investors 10 percent interest. The ability to recoup litigation costs, therefore, incentivizes corporations to litigate frivolous suits rather than settle them, while at the same time discouraging investors from filing illegitimate claims.

Moreover, the company's other (non-litigating) shareholders benefit from fee-shifting provisions, because any legal costs borne by the corporation are ultimately borne by shareholders.

Source: Lisa A. Rickard, "Delaware Flirts With Encouraging Shareholder Lawsuits," Wall Street Journal, November 15, 2014. 


Browse more articles on Economic Issues