In a recent post about the latest U.S. Supreme Court decision supporting arbitration, I speculated that the next step might be arbitration clauses in corporate bylaws, requiring shareholders to arbitrate shareholder claims. In response to my post, several readers alerted me that these issues had already been raised in a case involving CommonWealth REIT, though I had not been able to track the case down. Fortunately a recent law firm memo details the case and discusses its implications. Though it only involves a trial court decision in Maryland state court, the CommonWealth REIT decision could have important implications for those interested in pursuing the notion of arbitration clauses in corporate by-laws.
In a July 8. 2013 Law 360 article entitled “A Template for Tamping Down Corporate Activism” (here, subscription required), Andrew Stern, Alex J. Kaplan and Jon W. Muenz of the Sidley Austin law firm discuss the May 8, 2013 Maryland Circuit Court decision in the case involving CommonWealth REIT. According to the authors, the case is the first to squarely address the issue whether a company can enforce a by-law clause requiring shareholders to arbitrate their claims. As discussed in the memo, the Maryland court ruled that the company could enforce the clause.
Commonweath REIT is a publicly traded real estate investment trust organized under the laws of Maryland. Two investment funds acquired nearly 10% of Commonwealth shares and then launched a lawsuit against the company and its trustees seeking declaratory and injunctive relief to prevent alleged “value-destroying” and “self-interested” conduct by the defendants.
The company immediately initiated arbitration proceedings, in reliance on a provision in the company’s bylaws requiring that “any disputes, claims or controversies brought by or on behalf of any shareholder … be resolved through binding and final arbitration.” The plaintiff funds sought to stay the arbitration, arguing that they had never “assented” to the arbitration clause (which they said had been “unilaterally foisted upon them”) and that no consideration had been exchanged and therefore no binding arbitration agreement had been formed.
The Maryland court rejected the funds’ objections and held the bylaw arbitration clause to be enforceable. In finding that the funds had assented to the clause, the court noted that each share certificate of CommonWealth stock bore a legend stating that “the holder of this certificate…agrees to be bound by all of the provisions of the …Bylaws.” Based on this legend, the court concluded that the funds had “constructive knowledge” of the arbitration provision and that it was “enough to constitute mutual assent of the parties to the arbitration provision.” The court also noted that the funds were “sophisticated parties” who had “actual knowledge” of the arbitration clause as they had “investigated” the company’s bylaws prior to purchasing Commonwealth stock.
The court also found that there had been sufficient consideration for the arbitration clause to be binding. The court found that the arbitration clause could be enforced by either party which the court found to constitute adequate consideration.
The article notes that the funds had filed a notice of appeal of the lower court’s ruling, but that the funds then dismissed their appeal to pursue arbitration.
The article’s authors comment that though it remains to be seen how other courts will address the question of the enforceability of arbitration clauses in corporate bylaws, the Maryland decision “should be seen as, at the very least, a significant incremental victory for boards and trustees who view arbitration as an effective means to manage the typically highly public nature of corporate activism.” At a minimum, the authors note, the decision could be seen – at least for Maryland companies -- as “a green light for boards … to include broad arbitration clauses in their bylaws without seeking shareholder approval.”
Among other issues that other courts may interpret differently than the Maryland court is the question of whether or not shareholders can, like the plaintiffs in the Maryland case, be said to have “constructive knowledge” of the bylaw provisions or to have “assented” to the provisions. The article’s authors noted that the Maryland court did not discuss Delaware court decisions on which the funds sought to rely in arguing that Delaware’s courts have rejected the principle that “stockholders somehow assent to provisions contained in company bylaws simply by virtue of being stockholders.”
I find this entire topic very interesting. After I published my prior post about arbitration clauses in corporate by laws, I had several discussions with various lawyers about whether or not courts would ever enforce such a clause against shareholders, particularly where the clause was adopted without shareholder consent. Several plaintiffs’ lawyers scoffed at the notion that courts would ever enforce such a clause. Nevertheless, here is one case where the court enforced the clause.
To be sure, this is only the decision of a trial level state court. It has no precedential value and may or may not be followed by other courts. Other courts may be less willing to conclude as the court did here that the plaintiffs have “constructive knowledge” of the bylaw clauses or have assented to the provisions. Other courts may be less willing to conclude that there was adequate consideration to support enforcement of the clauses. Nevertheless, at least this one court did enforce the arbitration clause. As the law firm memo’s authors state, this decision does represent an “incremental victory” for those who advocate for the inclusion of these types of provisions in corporate bylaws as a way to forestall costly and burdensome shareholder litigation.
With the U.S. Supreme Court’s willingness to enforce arbitration agreements in commercial and consumer contracts, and with case law developments like the one in Maryland, more companies may be encouraged to attempt to use their bylaws as a way to control shareholder litigation. I suspect we will see more – both from companies and from the courts – on the arbitration clauses in corporate bylaws.
Alison Frankel has an interesting column on this topic on her On the Case blog (here).
Time to Nominate Blogs for the American Bar Association Blawg 100: Each year, the American Bar Association publishes its list of the top 100 legal blogs. The ABA calls its list the Blawg 100. The ABA is calling for nominations for this year’s list. The group would like to know about blogs that you read regularly and that you think other lawyers should know about. They ask that you send a separate nomination for each blog that you would like the group to consider. The group may include some of the best comments from the nominations in their Blawg 100 coverage. Nomination must be submitted no later than 7 p.m. on Friday, August 9, 2013. Nominations can be submitted here.
Quarterly D&O Claims Trends Webinar: On Tuesday, July 16, 2013 at 11 am EDT, I will be participating in a webinar sponsored by Advisen to discuss Quarterly D&O Claims Trends. This hour-long webinar is free. The other particpants in the call will include Kieran Hughes of AIG and Carl Metzger of the Goodwin Proctor law firm. For further information about the seminar and to register, refer here.