Investors have a number of rights under federal and state law which they can enforce through litigation, including for example the right to file individual or class actions for damages. But can investors be required to submit these kinds of claims to binding arbitration in lieu of litigation? That is the question posed by a two different initiatives corporate reformers are currently pursuing.


One of the basic features of our system of corporate laws is that aggrieved shareholder can enforce their rights or seek damages by filing a lawsuit. But at the same time, our litigation system is costly and court processes can be both time-consuming and burdensome. For that reason, there have been many proposals over the years to provide for the arbitration of shareholder disputes. For example, in its November 2006 report (here), the Committee on Capital Markets recommended that public companies be allowed to have shareholder votes on the use of arbitration to resolve shareholder claims.


A couple of different developments are bringing these issues to the forefront now. First, on January 10, 2012, the Carlyle Group, an investment partnership preparing to conduct a public offering, submitted to the SEC an amended filing on Form S-1 that, among other things, specifies that its partnership agreement will provide that all limited partners must submit any claims to binding arbitration.


 A January 18, 2012 Bloomberg article by Miles Weiss entitled “Carlyle Seeks to Ban Shareholder Lawsuits Before IPO” (here) discusses the mandatory arbitration provisions described in Carlyle’s filing. Susan Beck’s January 18, 2012 Am Law Litigation Daily article about the Carlyle filing can be found here.


The Carlyle offering is a little unusual, because the firm does business as a limited partnership and the securities in the planned offering will consist of limited partnership units. The rights acquired with the units are defined by a limited partnership agreement. According to the company’s filing, the partnership agreement will provide that every limited partner “irrevocably agrees” that “any claims, suits, actions or proceedings arising out of or relating in any way to the partnership agreement or any interest in the partnership…shall be finally settled arbitration.” The filings explain that the kinds of actions to which this dispute resolution provision apply include without limitation disputes under the Delaware Limited Partnership Act and the federal securities laws. The filing also explains that the dispute resolution provisions specify that the each limited partner “irrevocably waives” any objection he or she may have to arbitration. (The filing’s disclosures relating to the partnership agreement’s dispute resolution provisions can be found here.)


The arbitration requirements reported in the filing are quite detailed. The dispute resolution provisions specify that the arbitration must take place in Wilmington, Delaware. The arbitration proceedings must be confidential and the amount of any award will not be disclosed. The provisions further specify that the person bringing the claim may only pursue arbitration in an individual capacity “and not as a plaintiff, class representative or class member,” and the arbitrators may not consolidate more than one person’s claim.


UPDATE: As discussed in Victor Li’s February 3, 2012 Am Law Litigation Daily article (here), Carlyle Group has announced that in response to pressure from the SEC and others, it as decided to withdraw its proposed provision requireing investors to arbitrate claims.


A separate unrelated development involves the efforts of certain investors to put a proposal on 2012 proxy ballots to require shareholder claims to be arbitrated. According to information provided to me by University of Michigan Law Professor Adam Pritchard, shareholders at Pfizer and Gannett are currently seeking to have proposals included on upcoming proxy ballots that would amend the companies’ corporate charters to require the arbitration of shareholder disputes.


The companies are seeking SEC authorization to omit the shareholder arbitration proposals from their proxy ballots, arguing that the arbitration requirement would violate both state and federal law. The companies contend that the arbitration requirement would violate Delaware law, which they contend provides shareholders with the right to litigate claims in the Delaware Court of Chancery absent a clearly expressed intent to arbitrate. The companies also argue that the arbitration requirement would violate Section 29 of the ’34 Act, which voids any contractual provision that would seek to waive any right under the statute. Finally, the companies contend that the SEC itself historically has taken the position that a mandatory arbitration charter provision would be against public policy.


Advocates for the shareholders seeking to introduce the shareholder proposals argue that there is liberal federal policy favoring arbitration agreements and that there is no support for the argument that an arbitration requirement would violate state law. They contend that Delaware law allows the use of corporate charters to embody agreements between a corporation and its shareholders.


They also argue that the Supreme Court has dealt with anti-waiver clauses in federal statutes and has consistently supported arbitration. In its January 10, 2012 opinion in CompuCredit v. Greenwood, the Court held that a right to sue provision in the federal consumer credit statute does not prohibit the enforcement of an arbitration agreement. The advocates for the shareholders argue the antiwaiver clause in Section 29 prohibits the waiver only of substantive rights, not procedural rights and is not a barrier to the enforcement of an arbitration requirement. The advocates (who include Professor Pritchard) contend that arbitration would not undermine the remedial and deterrent purposes of the federal securities law, arguing in further reliance on the CompuCredit case that the Supreme Court has said that arbitration is the equivalent of litigation.


Each of these initiatives is poised to be addressed shortly. The SEC will be called upon to respond to the Carlyle Group’s offering document and decide whether the offering may go forward with the dispute resolution requirement unchanged. Among other things, the SEC will have to determine whether or not Carlyle’s partnership ownership structure is a differentiating consideration. According to the Bloomberg article linked above, in 1990 the SEC refused to allow the offering of a savings and loan to go forward until the firm removed the arbitration clause from its corporate charter.


The SEC will also have to determine whether or not Pfizer and Gannett can omit the shareholder proposals from their proxy ballots. With deadlines for proxy mailings approaching, the SEC will have to reach a decision in time to allow the companies to prepare their proxy ballots. Of course even if the shareholder initiatives are included on the proxy ballots, a majority of shareholders would have to vote in favor of the proposals in order for them arbitration requirements to come into force.



The motivations behind these efforts to require shareholder disputes to be arbitrated rather than litigated are perfectly understandable. Anyone who has ever been involved in any way in a material shareholder lawsuit knows that they are terribly costly and that they impose enormous burdens on all of the litigants. Taken collectively, shareholder litigation imposes an enormous cost on corporations in our country.  Reducing these costs is a highly desirable objective.


On the other hand, requiring shareholders to arbitrate their corporate claims would represent a massive change in the way that investor rights are addressed. Even if the U.S. Supreme Court thinks arbitration is equivalent to litigation, the fact is that in arbitration certain procedures are unavailable – like, for example, the ability to appeal.  And there are features of the Carlyle requirements that are clearly designed to ensure that arbitration would not be equivalent to litigation (for example, the prohibition against claimants proceeding collectively).


A change of this magnitude that has at least been approved by a shareholder vote has more of a sympathetic appeal. But even if the Carlyle offering is allowed to go forward with its offering with the dispute resolution procedures in its partnership agreement, or if Pfizer or Gannett have a mandatory arbitration shareholder proposal on this year’s proxy ballot, it would remain to be seen what would happen and how the arbitration provisions would be enforced when claims arise later. Court would then have to determine whether or not the provisions were valid and enforceable.


If any of these initiatives are permitted to go forward, it will be interesting to see what happens next. If Carlyle were able to include the mandatory arbitration provision in its charter (and if the reason Carlyle is permitted to do so is not linked to the fact that it is a partnership), it would seem likely that other companies would seek to implement similar provisions in the charters prior to their initial public offerings. And if the activist shareholders are successful in getting the mandatory arbitration issue on the Pfizer or Gannett proxy ballots, it seems likely that shareholders at other companies would pursue these same initiatives.


Though I could see these kinds of initiatives quickly spreading to other companies, these initiatives may not be popular with all shareholders. Indeed, I could easily imagine many shareholders actively opposing these types of efforts, taking the view that the opportunity to resort to the courts to seek redress of grievances is a basic and important right and an important tool to ensure that corporate officials abide by their legal duties.  The plaintiffs’ securities bar undoubtedly would become actively involved in resisting efforts to introduce these kinds of changes elsewhere.


Thus even of these current initiatives succeed, we would still be a very long way from the elimination of our current system of shareholder litigation. Nevertheless, it will be very interested to see where these current initiatives lead. The possibility for the adoption of a requirement for the mandatory arbitration of shareholder claims presents at least the theoretical chance for a radial revision on our current system of shareholder litigation.


One final note. The arbitration provision in the Carlyle partnership provision is far from the only restrictive aspect of the Carlyle structure. As Ohio State Law Professor Steven Davidoff notes in a January 18, 2012 post on the Dealbook blog (here), Carlyle "is propsing the most shareholder-unfriendly corporate goverance structure in modern history."  He notes that under the Carlyle structure shareholders have no right to elect directors and the company will not hold annual meetings of shareholders. In light of thse constraints and the arbitration provision, "the real question is whether prospective shareholders protest and refuse to participate in Carlyle’s IPO because of the governance issues."


Thanks to the several readers who sent me links to the Bloomberg article and very special thanks to Professor Pritchard for sending me the information about the Pfizer and Gannett shareholder proposals.


Jobs Link: One of the great blogs that I follow closely is The FCPA Professor blog, which is written by Butler University Law Professor Mike Koehler. Professor Koehler’s posts are always interesting and well written. Now there is another reason to visit the site. Professor Koehler has added a Jobs link to his site (here), in which he will post job openings in his field. Great to see a fellow blogger expanding the universe of blogging possibilities.


The M&A Litigation Problem: In the latest issue of InSights, entitled “Why Mergers and Acquisitions Related Litigation is Such a Serious Problem” (here), I take a look at the issues arising from the growing levels of litigation surrounding M&A transactions.  These kinds of cases are becoming increasingly common and increasingly costly, both of which pose significant problems for companies and for D&O insurers.