One idea circulating since the U.S. Supreme Court held in Cyan that state court Section 11 actions are not removable to federal court is that companies could avoid state court actions by adopting a federal forum bylaw or charter provision. Indeed, a number of companies recently have adopted these provisions prior to going public. Late last year, a shareholder of several IPO companies filed an action in Delaware Chancery Court seeking a judicial declaration that the companies’ Federal Forum Provisions are invalid. On December 19, 2018, Vice Chancellor Travis Laster issued a memorandum opinion agreeing with the plaintiff and holding that under Delaware law, Federal Forum Provisions are invalid and ineffective. A copy of Laster’s opinion can be found here.
Litigation management bylaws have been a hot topic in Delaware over the last several years. 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.
The topic of litigation management bylaws resurfaced in recent months in connection with the debate about plaintiffs lawyers’ resorting to state court to assert liability actions under Section 11 of the Securities Act of 1933, in reliance on the concurrent jurisdiction provisions in the Section 22 of the ’33 Act. The possibility of trying to use these kinds of bylaw or charter provisions took on increased urgency after the U.S. Supreme Court issued its opinion in Cyan in March 2018 confirming that state court Section 11 actions are not removable to federal court. Concerns about the possibility of Section 11 state court actions have in turn precipitated the discussion of various self-help measures companies could adopt to try to avoid getting hauled into state court for Section 11 claims.
Prominent among these proposed remedial measures was a suggestion that IPO companies should adopt bylaws or charter provisions designating federal courts as the exclusive forum for the resolution of claims under the ’33 Act. A number of high profile IPO companies have adopted these kinds of forum selection provisions, including, for example, Snap, Inc.
Matthew Sciabacucchi purchased shares of three companies – Blue Apron, Stitch Fix, and Roku – either in their IPOs or shortly thereafter. In December 2017, Sciabacucchi filed a derivative action in Delaware Chancery Court against the twenty individuals who signed the registration statements for the three companies and who have served as directors of the companies since they went public. Each of these companies has charter provisions designating federal forum “for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933.” In his complaint, Sciabacucchi sought a judicial declaration that the companies’ Federal Forum Provisions are invalid. The parties filed cross-motions for summary judgment.
The December 19, 2018 Opinion
In his December 19, 2018 Opinion, Vice Chancellor Laster granted the plaintiff’s motion for summary judgment, holding under Delaware law that the companies’ Federal Forum Provisions are ineffective and invalid.
In reaching this decision, Laster noted that in the Chevron case (which he refers to as the Boilermakers case), then-Chancellor Strine had held that a Delaware corporation can adopt a forum-selection clause bylaw for “internal affairs” claims. At the same time, Strine also noted that Delaware statutory provision specifying what can be in company by-laws does “does not authorize a Delaware corporation to regulate external relationships.” For example, Strine said, a bylaw cannot dictate the forum for a tort claim or a contract claim against the company, even if the plaintiff happens to be a shareholder of the company.
This distinction between internal and external claims “answers whether a forum-selection provision can govern claims under the 1933 Act.” Laster said “It cannot, because a 1933 Act claim is external to the corporation. Federal law creates the claim, defines the elements of the claim, and specifies who can be a plaintiff or a defendant.”
Laster went on the examine Delaware’s authority to regulate the corporations created under its laws. Delaware has certain authority on internal matters relating to the company’s organization, but that authority “does not extend to its creation’s external relationships.” The state’s authority does not extend, for example to tort claims asserted against the company. The same is true, Laster said, when a plaintiff asserts a claim involving for fraud involving shares. The speaker “may have made fraudulent statements about the shares … but the claim for fraud is not attributable to the shares and does not arise out of the corporate contract.” The shares may have been issued by a Delaware corporation, but this “happenstance does not provide a sufficient legal connection to enable the constitutive documents of a Delaware corporation to regulate the resulting lawsuit.”
A Delaware corporation’s corporate charter “cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s law.” In this case, that, Laster said, is exactly what the Federal Forum Bylaws attempt to do. They are, therefore, “ineffective and invalid.”
This case has been closely watched. There was a great hope that the Delaware court would validate the use of Forum Selection Bylaws, which would provide a way for IPO companies to avoid the risk of having to litigate Section 11 cases in state court – or even worse, to have to litigate cases in state court while parallel cases were also pending in federal court or even in the courts of other states. Laster’s opinion dashes those hopes. Because so many publicly traded companies are organized under the laws of Delaware, including most IPO companies, Laster’s ruling effectively eliminates the possibility of using Federal Forum Provisions for most companies.
The defendant can of course appeal, and the Delaware Supreme Court could modify or overturn Laster’s opinion. Call it a hunch, but I don’t see Laster’s opinion being overturned.
I could of course turn out to be wrong about the appeal. However, one reason I feel reasonably confident that Laster’s opinion will withstand appeal is the important distinction he drew between provisions regulating the internal affairs of a company and provisions regulating the company’s external affairs. In a recent white paper issued by issued by a consumer advocacy group and signed by a number of prominent securities law professors (discussed at length here), the professors stated their view that, because of its distinction between the internal and external affairs of a company, Delaware law does not permit bylaws to restrict the forum for federal securities actions.
Laster’s opinion not only dashes the hopes of those who thought the use of Federal Forum Provisions would eliminate the possibility that IPO companies might have to litigate Section 11 claims in state court, but also dashes the hope that, in a variation of the forum selection idea, corporate bylaws or charter provisions could be used to require shareholders to arbitrate shareholder claims.
The idea of companies adopting mandatory arbitration provisions has been a hot topic for the last few months. Advocates and opponents of this idea were closely watching this Delaware case to see what the court might say about the federal forum selection provisions at issue. Some thought that if the Court were to conclude that companies can designate in their bylaws a federal forum for federal securities litigation, then corporations would try to use the ruling to argue they are entitled to compel arbitration, since arbitration is just another forum. Laster’s opinion holding that the Federal Forum Provisions are invalid and ineffective because they seek to address external affairs would seem to preclude mandatory arbitration provisions as well, at least for Delaware corporations.
If as now appears to be the case companies are precluded from relying on bylaw or charter provisions to try to eliminate the possibility of having to defend Section 11 claims in state court, it looks as if the only thing left is for companies to turn to Congress.
The whole point of SLUSA was that Congress intended that securities class action lawsuits should be litigated in federal court. The Congressional draftsman made a hash of things when it came to modifying the jurisdictional provisions of the ’33 Act, and that is how the U.S. Supreme Court wound up concluding in Cyan that notwithstanding SLUSA state courts retain concurrent jurisdiction for Section 11 claims. Congress is going to have to go back and clean things up.