Claims Challenging the Validity of Paylocity’s Fee-Shifting Bylaws Under Section 109(b) of the Delaware General Corporation Law Move Forward

In Solak v. Paylocity Holding Corp., No. 12299-CB, 2016 BL 431917 (Del. Ch. Dec. 27, 2016), the Court of Chancery of Delaware denied in part and granted in part Paylocity Holding Corporation’s (“Paylocity” or the “Company”) Motion to Dismiss John Solak’s Verified Class Action Complaint (the “Complaint”), brought on behalf of Company stockholders (“Plaintiffs”), for lack of subject matter jurisdiction pursuant to Fed. R. Civ. P. 12(b)(1) and failure to state a claim on which relief can be granted pursuant to Fed. R. Civ. P. 12(b)(6).

In 2015, the Delaware state legislature added two new provisions to the Delaware General Corporation Law (“DGCL”) regarding corporate bylaws. First, Section 115 authorized corporations to adopt bylaws requiring internal corporate claims to be filed exclusively in Delaware. Second, amendments to Section 109(b) prohibited the bylaws from containing “any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim.”

Approximately six months after these changes to the DGCL, Paylocity, a publicly-traded Delaware corporation, adopted two new bylaws: the Exclusive Forum Bylaw and the Fee-Shifting Bylaw. The Exclusive Forum Bylaw required internal corporate claims to be filed in a Delaware court absent the Company’s consent. The Fee-Shifting Bylaw shifted attorneys’ fees and other litigation expenses to a stockholder who filed an internal corporate claim outside of Delaware without the Company’s consent if the stockholder failed to obtain “a judgment on the merits that substantially achieve[d] the full remedy sought.”

Plaintiffs sought a declaration that the Company’s Fee-Shifting Bylaw violated Sections 109(b) and 102(b)(6) of the DGCL. Additionally, Plaintiffs asserted that Paylocity’s board members breached their fiduciary duties by adopting the Fee-Shifting Bylaw and failing to include certain information in the disclosure of the bylaw’s adoption. Paylocity and its Board of Directors (“Defendants”) moved to dismiss the Complaint as unripe and for failure to state a claim.

Ripeness is a question of subject matter jurisdiction and concerns whether a suit has been brought at the correct time. Because an “actual controversy” must exist for a court to determine the validity of a bylaw and to issue a declaratory judgment, “the issue in dispute must be ripe for determination.” Where a claim challenges measures that have a substantial deterrent effect on stockholders, Delaware courts have found such claims to be ripe. The courts do so where the claims may repeat but otherwise evade review. Despite no internal corporate claim having been filed nor any intention to file such claim having been pled, the court determined that the Fee-Shifting Bylaw might never be subject to review if a stockholder first had to file a claim outside of Delaware, as such action would violate the Exclusive Forum Bylaw.

To survive a 12(b)(6) motion to dismiss when a challenge to the facial validity of a corporate bylaw is asserted, the plaintiff must show that the “bylaws cannot operate lawfully or equitably under any circumstances.” Because Section 109(b) of the DGCL provides that “bylaws may not contain any provision that impose liability on a stockholder for the attorneys’ fees or expenses of the corporation,” the court found the Fee-Shifting Bylaw invalid. Section 109(b) prohibited “any” provision shifting fees to a stockholder. As a result, the Fee-Shifting Bylaw could not operate lawfully under any circumstances.

Under Section 102(b)(6) of the DGCL, a corporation may include a provision in its articles of incorporation imposing liability on stockholders for the corporation’s debts under certain circumstances and for their own conduct. Because Plaintiffs failed to provide any authority interpreting the term “debts,” the court found Plaintiffs could not demonstrate that the Fee-Shifting Bylaw violated Section 102(b)(6).

Lastly, regarding Plaintiffs’ breach of fiduciary duties claims, the court stated that Plaintiffs failed to allege any facts suggesting any conflicts of interests, personal or financial interests in adopting the bylaws, or bad faith on behalf of the members of the Board of Directors. Further, the court opined Plaintiffs’ allegations that adopting bylaws in violation of applicable law constituted bad faith were insufficient to support an inference that the Board members acted with scienter in adopting the Fee-Shifting Bylaw.

Accordingly, the court denied Defendants’ Motion to Dismiss regarding the Section 109(b) claim, and dismissed Plaintiffs’ claims regarding Section 102(b)(6) and breach of fiduciary duties.

Primary materials for this case may be found on the DU Corporate Governance website.