October 16, 2017
A recent New York Law Journal article by David F. Wertheimer and Justine S. Brenner, “Mootness Attorney Fee Awards: Will New York Prove Friendly Than Delaware?,” reports on mootness attorney fee awards. This article was posted with permission. Reprinted with permission from the September 29, 2017 edition of the New York Law Journal © 2017 ALM Media Properties, LLC. All rights reserved. The article reads:
Mootness attorney fee awards are an established fixture of Delaware's fee-shifting rules available to plaintiffs in corporate governance litigation. That is not true of New York law, but the legal landscape may change. Over the past few years, there has been a marked trend of corporate governance litigation involving Delaware corporations being filed outside of Delaware's Court of Chancery. New York is seeing its share of that exodus. Whether that share expands may depend, at least partly, on whether New York law on the award of mootness fees evolves to be more or less favorable than Delaware law. Moreover, it is New York law that matters because in corporate governance litigation, even though claims of director misconduct are determined by the law of a company's state of incorporation, New York law governs the award to plaintiffs of their legal fees. Central Laborers' Pension Fund v. Blankfein, 111 A.D.3d 40, 45 n.8, (1st Dep't 2013).
Delaware, like New York, follows the "American Rule," under which each party bears its own legal fees and expenses, subject to certain exceptions. One such exception Delaware recognizes under its Court of Chancery's broad equity jurisdiction is in corporate governance actions, when a plaintiff's efforts have yielded a "corporate benefit." Tandycrafts v. Initio Partners, 562 A.2d 1162, 1164-65 (Del. 1989). Mootness fees, which are within the scope of that exception along with attorney fee awards arising from settlements and judgments, are triggered by a defendant acting to "moot" a plaintiff's claim. Such fee awards can arise in various settings, such as a class action challenging the adequacy of merger disclosures when the target voluntarily amends its proxy to include new disclosures or a derivative action contesting supposedly excessive executive compensation that the company later reduces.
Under Delaware law, mootness fee awards are available in class and derivative corporate governance actions upon a showing of three elements: (1) the litigation was "meritorious when filed;" (2) the defendant took action which rendered the litigation moot and produced "the same or a similar benefit" as sought by the litigation; and (3) there exists "a causal relationship between the litigation and the action taken producing the benefit." Dover Historical Soc'y v. City of Dover Planning Comm'n, 902 A.2d 1084, 1092 (Del. 2006).
Unlike Delaware, New York's fee-shifting rules applicable to corporate governance actions are rooted in statute: §626(e) of the Business Corporation Law (BCL) governs the award of attorney fees in derivative actions; C.P.L.R. Rule 909 controls the award of fees in class actions. Neither rule explicitly references fee awards in mooted cases nor have mootness fee awards been the subject of much New York case law development. What few decisions that have been reported, however, suggest that New York's rules will be as stringent as those Delaware applies, if not tougher.
Awards in Derivative Actions
Less than a handful of reported decisions by New York courts have considered a mootness fee award in a derivative action under BCL §626(e) and none have approved such an award. From these decisions, two rules governing potential mootness fee awards can be gleaned, both of which are similar to the standard Delaware employs. What New York might say about the other elements of Delaware's rule remains the open question.
Turning first to the overlapping elements, under New York law, a plaintiff must establish that his pleadings properly alleged that he had standing to assert a derivative claim consistent with the substantive law of the state in which the corporation was organized. Blankfein, 111 A.D.3d at 45-46. Delaware imposes the same requirement. See Grimes v. Donald, 791 A.2d 818, 822-23 (Del. Ch. 2000), aff'd, 784 A.2d 1080 (Del. 2001).
Second, as with all fee awards under BCL §626(e), the plaintiff must show that he achieved a "substantial benefit," which may include a "common fund" or meaningful "corporate therapeutics." Sardis v. Sardis, 56 Misc. 3d 727, 739-40 (Sup. Ct. 2017); accord Seinfeld v. Robinson, 246 A.D.2d 291, 294-98 (1st Dep't 1998). Again, Delaware law requires the same. Tandycrafts, 562 A.2d at 1164-65.
Turning to the open issues, the first is Delaware's requirement that plaintiff establish that his complaint was "meritorious when filed," meaning that it could withstand a motion to dismiss. Chrysler v. Dann, 223 A.2d 384, 387 (Del. 1966). There is good reason to expect that New York courts would impose a similar requirement. Courts applying BCL §626(e) have refused to approve the award of attorney fees in settlements of derivative actions when the actions lacked merit. See, e.g., Montro v. Bishop, 6 A.D.2d 787, 787 (1st Dep't 1958), Kaplan v. Rand, 192 F.3d 60, 72 (2d Cir. 1999). Moreover, Delaware adopted its "meritorious when filed" requirement as a bulwark to deter "baseless litigation." Allied Artists Pictures v. Baron, 413 A.2d 876, 879 (Del. 1980). New York courts have acknowledged a similar goal of deterring strike suits and recognized that various features of derivative litigation—including the requirements for standing and demonstrating that a "substantial benefit" was achieved as a predicate for a fee award—are intended, at least in part, to achieve that goal. See Bansbach v. Zinn, 1 N.Y.3d 1, 9, 7 (2003) (standing); Freedman v. Braddock, No. 24708/92, 1997 WL 34850128 (N.Y. Sup. Ct. June 27, 1997) (substantial benefit). Accordingly, precedent and policy favor construing BCL §626(e) as imposing a "meritorious when filed" requirement.
A second open issue is the requirement of demonstrating a causal nexus between the plaintiff's litigation and the defendant's action mooting the suit. Under Delaware law, a plaintiff receives a rebuttable presumption that its lawsuit caused the defendant's action, imposing on the defendant the burden of showing that the lawsuit "did not in any way cause their action." Allied Artists, 413 A.2d at 880. Delaware adopted its rule on the pragmatic grounds that the defendant is in the best position to know the reasons for its own actions. Id.
It is far from certain, however, that New York courts would adopt Delaware's burden-shifting rule. For example, whereas Delaware applies its presumption to fee award requests in both the settlement and mootness contexts, id., New York courts, in the settlement context, have not employed a burden-shifting rule but instead require a showing that "plaintiffs achieved a 'substantial benefit.'" Seinfeld, 246 A.D.2d at 294; Seinfeld v. Robinson, No. 22304/90, 2001 WL 36023241 (N.Y. Sup. Ct. March 8, 2001) (burden rests on plaintiff to show entitlement to fees), aff'd, 300 A.D.2d 208 (1st Dep't 2002).
There is even less reason to apply a burden-shifting rule in mootness fee cases. As courts have observed, in contrast to settlements, fee awards in mootness cases can present a "particularly nettlesome task" of identifying the benefit obtained and its relation to the litigation. See In re First Interstate Bancorp Consol. S'holder Litig., 756 A.2d 353, 357 (Del. Ch. 1999), aff'd, 755 A.2d 388 (Del. 2000); cf. Blankfein, 111 A.D.2d at 49 (describing "causation of a substantial benefit" as a "complex issue" that is "likely to lead to protracted litigation"). Allowing a plaintiff to streamline that inquiry by presuming that chronology is equivalent to causation enshrines in doctrine what would otherwise be rejected as the logical fallacy post hoc ergo propter hoc. While Delaware has adopted such a rebuttable presumption on pragmatic grounds, its use comes at the price of enabling plaintiff to more easily claim an entitlement to fees. It thus undermines New York's policy of deterring "unwarranted litigation" by imposing on plaintiff the burden of "demonstrating that the action has caused a substantial benefit." Blankfein, 111 A.D.3d at 49 (in a mootness fee case, observing, in dicta, that plaintiff must demonstrate causation). New York courts may find Delaware's rebuttable presumption too steep a price to pay to simplify the fee award process, just as other courts have concluded. See, e.g., Lansky v. NWA, 471 N.W.2d 713, 714 (Minn. Ct. App. 1991) (rejecting presumption because it could encourage strike suits by failing to consider the facts of each case).
Awards in Class Actions
There is reason to believe that New York courts would assess mootness fee applications in class actions far differently than they might in derivative actions. Indeed, such fee awards may be unavailable in class actions.
That potentially differing treatment is due to the difference in the applicable statutory terms. Whereas BCL §626(e) permits a fee award if a derivative action "was successful, in whole or part," C.P.L.R. Rule 909 conditions the award of fees on a "judgment" having been "rendered in favor of the class." Accordingly, while a mooted derivative suit might be considered "successful" if it achieved a "substantial benefit," a mooted class action would not result in a "judgment" favorable to the class—even if, as consequence of the action having been filed, a "substantial benefit" was achieved. Thus, a strict construction of the statute might preclude the award of a mootness fee.
There does not appear to be any reported New York court decision directly addressing a mootness fee award in the class action context. Insight into the possible treatment of such an application, however, can be gleaned from the decision in La. Mun. Emps.' Ret. Sys. v. Cablevision Sys., 74 A.D.3d 1291 (2d Dep't 2010). That case arose from purported class actions brought on behalf of minority shareholders of Cablevision Systems, challenging a proposed stockholder buy-out by the controlling stockholders. The litigation settled once the offering price was increased, but the settlement was aborted because the acquisition never closed. At that point, the class actions essentially were moot. Despite the settlement's termination, class plaintiffs sought an award of counsel fees, which the trial court granted after finding that plaintiffs' efforts had yielded a substantial benefit. The Second Department reversed the fee award based on its finding that "the plaintiffs clearly did not obtain a judgment in favor of the class within the meaning of CPLR 909." Id. at 1293.
Although one decision does not necessarily sound the death knell on mootness fee awards in class actions, it illustrates New York courts' strict adherence to the American Rule in the absence of a recognized exception. See generally Flemming v. Barnwell Nursing Home and Health Facilities, 15 N.Y.3d 375, 379-80 (2010) (narrowly construing prior version of C.P.L.R. Rule 909).
When forum shopping, plaintiffs must consider not only whether the forum will be hospitable to the merits of their claims, but also to their counsel's fee requests. In corporate governance actions, plaintiffs should expect that New York's courts will evaluate mootness fee applications in derivative actions under standards at least as stringent as those in Delaware and may deny such applications entirely in class actions. Applying such standards should help prevent New York from becoming a second home for strike suits fleeing Delaware.
David F. Wertheimer is a partner at Hogan Lovells in New York. His practice includes private federal securities class actions and corporate governance litigation. Justin S. Brenner is a senior associate at the firm.