One idea that resurfaces from time to time is the suggestion that companies ought to adopt bylaw or charter provisions mandating the arbitration of shareholder claims, including claims under the federal securities laws. The current SEC Chair, Jay Clayton, has said that he does not consider the issue to be a top priority, seemingly shelving the idea for the time being. But various contending parties have continued to agitate on the issue.
In a recent white paper issued by a consumer advocacy group and signed by a number of prominent securities law professors, the professors state their view that Delaware law does not permit federal securities law claims to be resolved in arbitration or in any specific forum. The white paper is sure to stir the pot. As discussed below, it could also have an impact on a case currently pending in Delaware state court that could dictate whether or not Delaware companies may designate a federal court forum for the resolution of claims under the federal securities laws.
A November 19, 2018 press release from the consumer advocacy group Secure Our Savings about the white paper can be found here. The white paper itself can be found here. Alison Frankel’s November 26, 2018 post about the white paper on her On the Case blog can be found here.
As readers will recall, in 2013, then-Chancellor Leo Strine Jr. held (as discussed here) in the Chevron case that corporations can adopt bylaws designating a preferred forum for litigation “relating to the internal affairs of the corporation.” A 2014 Delaware Supreme Court decision in the ATP Tour case (discussed here) also upheld the validity of a bylaw provision shifting fees to an unsuccessful litigant in a shareholder claim. However, in 2015, the Delaware legislature enacted a provision barring fee-shifting bylaws, while codifying the right of Delaware corporations to designate Delaware as the preferred forum for shareholder disputes.
These various developments provide the backdrop for the latest developments in the ongoing debate about the permissibility of bylaws requiring shareholders to arbitrate their claims under the federal securities laws. Advocates of these kinds of provisions contend that the proposed bylaw provisions represent just another form of the litigation management bylaws that Delaware’s courts have recognized, relying in particular on Chancellor Strine’s statements in the Chevron decision that under Delaware law, charter and bylaw provisions constitute a “flexible contract” to which stockholders are a party.
In their white paper, the law professors contend that despite the breadth of flexibility under Delaware law with respect to bylaw provisions, Delaware’s laws do not authorize provisions regulating litigation under the federal securities laws. The professors emphasize that Chevron recognized the legitimacy of provision designating a preferred forum for the litigation of claims “governed by the internal affairs doctrine.” Chancellor Strine went out of his way in the opinion to differentiate these kinds of claims from tort claims or other claims a stockholder might assert in his or her right as a shareholder.
The professors also rely on a statement in Vice-Chancellor Laster’s 2015 opinion in the In re Activision Blizzard Stockholder litigation, in which the Vice-Chancellor said that fraud claims do not arise from the contractual relationship between the shareholder and the corporation but from the corporation’s allegedly false statement. Laster wrote that “A Rule 10b-5 claim under the federal securities laws is a personal claim akin to tor claim for fraud.”
Based on these various holdings, the professors assert that because the flexibility for bylaws under the relevant Delaware statutory provision does not extend “so far as to permit the charter or bylaws to create a power to bind stockholders in regard to the venue for federal securities class actions,” Delaware law “does not permit bylaws to restrict the forum for federal securities actions.” The right to bring such actions is not a property right associated with shares of corporate stock and it thus “falls outside the scope of what Delaware law permits the corporate bylaws to regulate.”
The professors’ white paper is interesting in and of itself, but it could also have an impact in a case currently pending in court in Delaware. (Hat tip to Alison Frankel for pointing out in her blog post to which I linked above for pointing out the relevance of the white paper to the pending case.)
As I noted at the time, in late 2017, a plaintiff shareholder filed a lawsuit in Delaware Chancery Court against the board members of three companies (Blue Apron, Roku, and Stitch Fix) that adopted bylaws designating federal court as the preferred forum for the resolution of federal securities law claims, 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 plaintiff in the Chancery Court action is arguing in reliance on Vice-Chancellor Laster’s opinion in the Activision case that federal securities laws claims do not pertain to the internal affairs of a company and therefore may not properly be regulated by bylaw or charter provisions. The defendants argue that Laster’s opinion was narrower than plaintiffs contend and did not reach the conclusion that federal securities claims are not related to shareholders’ rights and powers. The plaintiff in the case has submitted the professors’ white paper to the court; the defendants have disparaged the paper as a mere advocacy piece that depends on selection quotations from court precedent.
There are other grounds upon which the plaintiff in the Chancery Court action is challenging the provision. Among other things the plaintiff is relying on the provisions in federal securities laws prohibiting companies from requiring shareholders to waive any rights they have under the securities laws. In her blog post, Frankel quotes one of the professors that signed the paper as saying that these anti-waiver provisions have been “badly eroded” and so the shareholder’s best bet in the Chancery Court case is to argue that corporate charter and bylaw provisions may not extend to disputes under the federal securities laws.
The Chancery Court case relates to federal court forum selection provisions; the bylaws at issue in the case do not contain mandatory arbitration provisions. However, Frankel quotes one commentator as noting, the forum selection provisions at issue are “really a stalking horse for mandatory arbitration provisions.” If the Delaware court concludes that companies can designation in their bylaws a forum for federal securities litigation, then “corporations will undoubtedly use the ruling to argue they’re entitled to compel arbitration, since that’s just another forum.”
The professors’ white paper and the pendency of the Chancery Court case are potentially very significant for a key issue that has been circulating recently.
Readers will recall that earlier this year, the U.S. Supreme Court held in the Cyan case that state courts retain concurrent jurisdiction for liability claims arising in the Securities Act. The Court’s holding means that companies subject to potential Securities Act liability (primarily, although not exclusively, IPO companies) may be subject to litigation in state court – raising the possibility that the companies might be forced to litigate the claims in multiple jurisdictions.
In the face of the threat of litigating in multiple jurisdictions, the idea began to circulate that prospective IPO companies could avoid state court jurisdiction for any later claims by adopting bylaw provisions designating a federal court forum for claims under the federal securities laws. This suggestion is most frequently associated with Stanford Law Professor Joseph Grundfest (who, conspicuously but not surprisingly, was not among the white paper signatories).
Under the professors’ analysis in the white paper, the “internal affairs” logic of the Delaware court provisions relating to litigation management bylaws not only prohibits mandatory arbitration bylaws, but any bylaw or charter provision designating a forum for federal securities litigation. In other words, if the professors are correct, the bylaw provisions at issue in the pending Delaware Chancery Court case are impermissible under Delaware law – and in addition, any mandatory arbitration bylaw for securities claims would also be impermissible.
On the other hand, if the Chancery Court disregards the professors’ analysis and holds that bylaws designating a federal forum for securities claims are permissible under Delaware laws, IPO companies and others will have a means by which to avoid the kind of multi-jurisdiction litigation that Cyan threatens (and has in fact begotten). However, were the Chancery Court to reach that conclusion, companies would, as the commentator noted in Frankel’s blog post, quickly adopt provisions mandating the arbitration of federal securities claims, which potentially represent a massive change in the securities litigation environment.
As I noted in my post at the time when the Delaware Chancery Court case was first filed, there are a number of potential threshold issues that might prevent the court from reaching the substantive issues about the permissibility of the bylaw provisions. The plaintiff’s claim presents both ripeness and standing issues that potentially could present threshold barriers that would defeat the plaintiff’s claims even before the court reached the substantive issues.
The bottom line is that everyone should stay tuned. There could be further developments ahead that could significantly affect all of these issues. The one thing is for sure is that various constituencies will continue to agitate on these issues.