Normally corporate bylaws are drafted during the business formation process. However, sometimes corporations amend their bylaws. The question then becomes one of whether amendments to the corporate bylaws can or should be applied retroactively. When these amendments would impair previously accrued claims, both California and Delaware courts agree that the answer to this question is “no.”
California Court Refuses to Apply Bylaws that would Impair an Accrued Claim Retroactively
A California court has refused to apply bylaws that would impair an accrued claim retroactively. The case is Cobb v. Ironwood Country Club. In this case Ironwood’s board of directors adopted a bylaw that required binding arbitration of disputes. Ironwood did not pass this bylaw until four months after past and current members of the country club had already filed a lawsuit dealing with an alleged breach of an agreement by Ironwood. Ironwood then argued that, because the members had agreed to follow the bylaws, including a provision in the bylaws that allowed their amendment, that the members and former members were bound by the new bylaw that mandated the arbitration. The trial court and the Court of Appeal disagreed with Ironwood’s assessment.
In its opinion the Court of Appeal explained that allowing the retroactive application of this sort of amended bylaw would give Ironwood the unlimited right to alter the agreement it had made with its members. This would make the contract illusory and therefore unenforceable. Additionally the Court explained that the implied covenant good faith and fair dealing would prohibit a party from making this sort of unilateral change that would impair the other party’s rights. The members and former members had already accrued their right to sue, so stripping them of that right would be a significant impairment of their rights. Finally, the Court noted that the one-sided nature of the bylaw may also make it unenforceable because it is unconscionable.
Delaware Court Reaches Similar Decision
The Delaware Court of Chancery reached a similar decision in Strougo v. Hollander. In the Delaware case a corporation amended its bylaws to include a non-reciprocal fee-shifting bylaw. Prior to its adopting this new bylaw a former stockholder had filed a lawsuit challenging the fairness of a reverse stock split that had the effect of involuntarily cashing out the plaintiff and other class members. In this case the time line was a little bit different from the California case, but the result was the same. The offended stock split occurred, then the bylaws were amended, then the plaintiffs filed suit. The Court reasoned that the plaintiff was no longer a stockholder as soon as the reverse stock split happened. Because he was no longer a stockholder, the bylaws no longer applied to him. That means that the change in the bylaws that happened after he was no longer a stockholder could not be applied to him.