For many years, business groups and corporate representatives have tried to reform shareholder litigation through legislation and case law development, with mixed success. However, in more recent years an interesting new initiative has emerged – the attempt to achieve litigation reform through amendments to corporate bylaws. This effort received a significant boost last year when the Delaware Chancery Court upheld the validity of a forum selection bylaw, designating the preferred forum for shareholder litigation.
The initiative was even further advanced earlier this year when the Delaware Supreme Court upheld the validity of a fee-shifting bylaw, which requires an unsuccessful litigant in shareholder litigation to pay their adversaries legal expenses. The future prospects for this type of bylaw are uncertain at the moment as the Delaware legislature considers whether or not to prohibit Delaware stock corporations from using this type of bylaw.
Along with these other litigation reform bylaws initiatives, the most interesting and arguably most controversial proposal is the use of bylaws requiring shareholder disputes and claims to be resolved through binding arbitration. As discussed here, several courts have now upheld the validity of these types of bylaws, which may encourage other companies to consider adopting bylaws requiring shareholder disputes to be arbitrated.
In the following guest post, Claudia Allen of the Katten Muchin law firm describes her recent article in which she reviews the legal, policy and practical issues that these kinds of mandatory arbitration bylaws present. She also reviews the obstacles that companies attempting to adopt these kinds of bylaws might face, as well as the kinds of issues that companies considering adopting these kinds of bylaws might want to take into account.
I would like to thank Claudia for her willingness to publish her guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you are interested in submitting a post. Here is Claudia’s guest post:
Bylaws Mandating Arbitration of Stockholder Disputes? (forthcoming Delaware Journal of Corporate Law, available at http://ssrn.com/abstract=2444771) examines the legal, policy and practical issues raised by bylaws that would mandate arbitration of stockholder disputes and eliminate the right to pursue such claims on a class action basis. The article also analyzes the limited number of arbitration bylaws that have been adopted or proposed and related case law concerning the validity and enforceability of these provisions.
Bylaws was prompted by late June 2013 decisions from the United States Supreme Court and the Delaware Court of Chancery, which, when read together, suggested that such bylaws should be enforceable. In American Express Co. v. Italian Colors Restaurant, the United States Supreme Court, interpreting the Federal Arbitration Act, upheld a mandatory arbitration provision, including a class action waiver, in a commercial contract. The decision focused upon the arbitration provision as a contract subject to the FAA. Next, the Delaware Court of Chancery rendered its opinion in Boilermakers Local 154 Retirement Fund v. Chevron Corp. The decision, which emphasized that bylaws are contracts between a corporation and its stockholders, upheld bylaws adopted by the boards of Chevron Corporation and FedEx Corporation requiring that intra-corporate disputes be litigated exclusively in Delaware courts.
Subsequent United States Supreme Court and Delaware Supreme Court decisions addressing forum selection and a board’s unilateral power to adopt bylaws have only strengthened the argument for enforceability. For example, the United States Supreme Court views an arbitration clause as a specialized kind of forum selection clause, and in December 2013 reiterated the strong presumption in favor of the validity of arbitration provisions in Atlantic Marine Construction Company, Inc. v. United States District Court for the Western District of Texas. While Boilermakers was a Delaware trial court decision, and thus not a definitive statement of Delaware law, the Delaware Supreme Court effectively endorsed Boilermakers and the validity of board-adopted bylaws that may deter litigation in its May 2014 ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation). That opinion upheld the validity of “loser pays” bylaws.
In addition to complementing each other, both American Express and Boilermakers address a similar issue, namely, the explosion in class action and derivative litigation that settles primarily for attorneys’ fees, most commonly in the context of mergers and acquisitions. Stockholders ultimately bear the costs of such litigation. Class actions and derivative lawsuits are forms of representative litigation, in which named plaintiffs seek to act on behalf of a class of stockholders or the corporation itself. The plaintiffs are customarily represented by attorneys on a contingent fee basis, making the lawyer the “real party in interest in these cases.” If mandatory arbitration bylaws barring class actions were enforceable, the logical outcome would be a marked decline in class actions, since the alleged existence of a class is a principal driver of attorneys’ fees.
Bylaws analyzes potential obstacles to adopting arbitration bylaws, including the policy of the Securities and Exchange Commission staff against allowing companies with arbitration provisions in their organizing documents to go public. This policy, which does not apply to companies that are already public, is based upon the notion that stockholders would be forced to waive rights under the securities laws, thus violating the “anti-waiver” provisions in such laws. Yet, the Staff’s position is at odds with Supreme Court precedent finding that agreements to arbitrate are not waivers of substantive rights. Corporations could, however, overcome this issue by excluding securities claims from the scope of an arbitration clause.
Mandatory arbitration bylaws are also likely to attract significant negative stockholder sentiment, at least initially, particularly if they include a class action waiver. This would be consistent with the reaction of consumer advocates to the Supreme Court’s decisions upholding arbitration in commercial agreement, and the initial reaction of stockholder advocates to exclusive forum and fee-shifting provisions in certificates of incorporation and bylaws. Bylaws examines potential avenues for stockholders to express opposition, including seeking repeal.
Perhaps a more fundamental question is whether public companies will support arbitration. While arbitration is often viewed by opponents as favoring corporations, and is widely used in the financial services industry, corporations have a range of viewpoints on arbitrating. Arbitration theoretically offers speed, lower costs, confidentiality and the ability to influence the selection of the arbitrator. However, since arbitration is final and non-appealable, except in extremely limited circumstances, it is also less predictable. Predictability may be of less concern when the amounts in controversy are relatively small, but, in connection with securities class actions and derivative claims, the stakes can be high, making arbitration of such claims less attractive.
Since arbitration is fundamentally a creature of contract, Bylaws argues that there are opportunities for corporations to craft arbitration bylaws that take into account company-specific concerns, while responding to many likely criticisms. For example, carving out claims in excess of a specified high dollar threshold, and providing that such claims would be litigated, would address company concerns about unpredictability. Providing that arbitrators’ decisions (perhaps including brief findings of fact and conclusions of law) will be made public could, for those corporations interested in making the arbitration process more transparent, answer critics who believe that arbitration occurs in a black box and automatically disadvantages individuals. However, the inherent bias of some stockholders and corporations against arbitration is likely to make experimentation in this area slow and difficult.