For a time a few years ago, litigation management bylaws were all the rage. Driven by concerns about multi-forum merger-related litigation, commentators proposed company adoption of forum selection bylaws for internal corporate disputes. The debate widened when reformers suggested that companies adopt fee-shifting bylaws. The debate subsided in 2015 when the Delaware legislature adopted legislation authorizing the adopting of bylaws designating Delaware’s courts as the preferred forum for disputes under Delaware, but prohibiting fee-shifting bylaws.
The topic of litigation management bylaws resurfaced in recent months in connection with the debate about plaintiffs lawyers’ resorting to state court (primarily in California) to assert securities class action claims, in reliance on the concurrent jurisdiction provisions under the Section 22 of the Securities Act of 1933. Concerns about this kind of litigation has in turn precipitated various self-help measures companies could adopt to try to avoid getting hauled into state court for these kinds of suits.
Prominent among these proposed remedial measures was a suggestion that companies adopt bylaws designated federal courts as the exclusive forum for the resolution of claims under the ’33 Act. Indeed, a number of high profile IPO companies have adopted these kinds of forum selection provisions, including, for example, Snap, Inc.
On December 29, 2017, a plaintiff shareholder filed a lawsuit in Delaware Chancery Court against the board members of three companies that have adopted these kinds of federal court forum selection provisions, seeking a judicial declaration that these kinds of bylaw provisions are invalid under Delaware law. A copy of the plaintiff’s complaint can be found here.
The complaint purports to be filed as a class action on behalf of the shareholders of three companies that recently completed IPOs: Blue Apron; Stitch Fix; and Roku. The complaint alleges that each of these three companies have adopted “substantially identical Federal Forum Provisions in their organizing documents.”
The complaint specifically refers to then -Chancellor Strine’s 2013 opinion in the Chevron case (about which refer here) in which the Chancellor approved forum selection bylaws the company had adopted. In reaching this decision, Strine had emphasized the fact that the bylaw at issue applied only to internal corporate claims governed by Delaware law, and, the complaint alleges, “did not purport to regulate claims under the federal securities laws,” and noted that the bylaws would be beyond the language of the Delaware statutory provisions regarding corporate bylaws if they did not deal with the rights and powers of stockholders.
The complaint also refers to the statutory provision the Delaware General Assembly adopted in 2015 (about which refer here), codifying the Chevron decisions and authorizing Delaware corporations to adopt bylaw provisions designated Delaware’s courts as the preferred forum for the resolution of “internal corporate claims.”
The federal forum provisions that the three defendant companies have adopted, the complaint alleges, “flaunt these careful compromises,” because a claim under the federal securities laws is not an internal claim but rather is “a personal claim akin to a tort claim for fraud.” Moreover, it is not governed by Delaware law.
The complaint goes on to raise the alarm that if the forum selection bylaw is not limited to internal corporate affairs, “then there is no limiting principle at all.” The federal forum selection provisions could be a “thin edge that wedges open a door to provisions requiring arbitration of federal securities claims or even provisions exculpating fiduciaries from liability for securities violations.”
In contending that the three nominal defendant companies’ federal forum provisions violate Delaware law, the Complaint alleges that the bylaws “purport to regulate a plaintiff’s choice of venue in actions that do not assert internal corporate claims governed by Delaware law.” The complaint further asserts that the federal forum provisions, designating a court other than the courts of Delaware as the preferred forum, are inconsistent with Delaware Corporations Code Section 115, which bars bylaw provisions that “prohibit brining such claims in the court of this State.”
Many readers undoubtedly are aware that a case is pending before the United States Supreme Court that is highly relevant to the general topic of the concurrent jurisdiction provisions in the ’33 Act. In the Cyan case (about which refer here), the Supreme Court will address the question of whether or not Congress’s adoption of the Securities Litigation Uniform Standards Act of 1998 (SLUSA) preempted the ’33 Act’s concurrent jurisdiction provisions.
The complaint asserts that while Cyan will undoubtedly resolve the concurrent jurisdiction issue for class actions, it will not resolve the question of whether or not individuals have the right to file individual actions in state court (because SLUSA applies, if at all, only to “covered class actions”).
The plaintiffs’ lawyers’ practice of asserting federal securities law claims in state court has been viewed as a deeply troublesome practice among defense practitioners, particularly in California (as discussed in a guest post on this blog, here).
Continuing concerns about perceived abuses associated with this state court litigation has led to a number of reform proposals. As discussed here, among these proposals is an idea floated by Stanford Law Professor Joseph Grundfest, that corporations adopt a forum selection bylaw designating federal court as the forum for the resolution of federal securities law claims under the Securities Act of 1933. The complaint in this lawsuit specifically refers to Professor Grundfest’s proposals in that regard.
As this complaint makes clear, a number of companies, perhaps following Professor Grundfest’s suggestion, have indeed adopted these kinds of forum selection provisions in connection with or in anticipation of their IPOs. In addition to the three nominal defendant companies, the complaint refers to Tintri and Snap as companies that have adopted these kinds of bylaw provisions.
In seeking a judicial declaration as to whether the three nominal defendant companies’ bylaws violated Delaware law, the plaintiff asserts that the companies’ federal forum provisions “are and will continue to act [as] a significant deterrent to investors who might wish to bring such a claim in state court.”
The plaintiff’s Chancery Court complaint is made in reliance on Delaware law, which makes sense given the forum. This reliance on Delaware law may be somewhat ironic, as (in my view, anyway) what arguably may be the plaintiffs’ strongest argument is actually under the ’33 Act itself. Section 14 of the ’33 Act specifically provides that “Any condition, stipulation or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of the Commission shall be void.” There would appear to be at least an argument that the forum selection by law provision required shareholders to waive the concurrent jurisdiction provisions under Section 22.
It remains to be seen whether or not the Delaware Court will regard this dispute as sufficiently ripe for judicial consideration. Under Delaware law, as under federal law, there is a prerequisite in order for a Court to have the authority to render a declaratory judgment that the declaratory judgment arise out of an actual case or controversy. The defendants in this case undoubtedly will argue that this case does not involve an actual case or controversy, and therefore the request for declaratory relief is not ripe for judicial determination.
Indeed, there could be an argument as well that the shareholder claimant in this action lacks standing to bring this claim, as he can assert no injury on his own behalf, nor threat of imminent injury, other than the conjectural future injury to which any shareholder may or may not be subject in the event they may or may not want to file a state court lawsuit sometime in the future.
Both the ripeness and standing issues, if relevant here, would be analytically prior to and potentially preclusive of consideration of the substantive legal arguments on which the shareholder plaintiff seeks to rely. So it remains to be seen whether or not the Chancery court will actually reach the substantive legal argument the plaintiff’s declaratory judgment seeks to raise.
All of that said, there may be something to the plaintiff’s “parade of horribles” argument that the federal forum selection provisions represent the “thin edge that wedges open a door to provisions requiring arbitration of federal securities claims.” Readers of this blog well know that there are proposals circulating, including even by an SEC commissioner, that companies ought to consider provisions mandating arbitration of federal securities claims.
But whether or not this concern is legitimate, this particular declaratory judgment action, as arguably creative as it is, may not be the vehicle by which the federal form provisions are validated, much less the vehicle that leads to the introduction of mandatory arbitration provisions.
In any event, it is clear that even if this case does not proceed to the merits, we are in for a further round of controversy surrounding litigation management bylaws. I suspect that this topic will remain on the agenda in the months and even years ahead.
Special thanks to a loyal reader for sending me a copy of the Delaware Chancery Court DJ Action complaint.
N.J. Adopts Law Authorizing Forum Selection Bylaws: As if to prove my point that litigation management bylaws could prove to be a hot topic in 2018, it turns out that on Friday January 5, 2018, the New Jersey Senate passed a statute authorizing New Jersey corporations to adopt bylaws designating federal and state court in New Jersey as the exclusive forum for certain shareholder actions. The legislation, which passed the state Assembly last month, now head to Governor Christie’s desk for his signature.
As discussed in a January 5, 2018 Law 360 article (here, subscription required), the bylaw would apply to “any derivative action or proceeding brought on behalf of the corporation” and certain actions brought by one or more shareholders. These other shareholder actions include matters asserting a breach of fiduciary duty owed by a current or former director or officer; a breach of the certificate of incorporation or by-laws; or a claim under the New Jersey Business Corporation Act. A forum selection clause could also apply to a shareholder class action alleging a breach of a duty to disclose or a related claim against the corporation or its current or former directors or officers.
According to the Law 360 article, the legislation states that bylaws may provide that one or more shareholders who file an action in violation of a forum selection clause “shall be liable for all reasonable costs incurred in enforcing the requirement, including, without limitation, reasonable attorney’s fees of the defendants.”
The new NJ statute is interesting and broader than Delaware’s equivalent statute, in that it authorizes corporations organized under the state’s law to adopt a bylaw designated both NJ federal as well as NJ state courts as the preferred forum. It also allows the forum designation to apply to a broader range of types of actions.
PLUS Webinar: Readers who may have missed the opportunity to listen in on the January 4, 2018 PLUS Webinar concerning current D&O claims and liability trends will want to know that until January 12, 2018, the webinar is available to be accessed for free on the PLUS Blog, here. Readers will also want to note that January 12 is the last date for which the early bird discounted registration fee is available for the upcoming PLUS D&O Symposium in New York on January 31 and February 1, 2018.