As I noted at the time (here), on December 19, 2018, Delaware Vice Chancellor Later held that under Delaware law, a corporate charter provision specifying that liability actions under Section 11 of the Securities Act of 1934 must be brought in federal court are invalid and ineffective. A copy of Laster’s opinion in Sciabacucchi v. Salzburg (referred to below as the Blue Apron decision) can be found here. In the following guest post, Paul Ferrillo, Robert Horowitz, and Steven Margolin of the Greenberg Traurig law firm take a look at the Blue Apron decision and examine whether or not Congress will act to eliminate concurrent state court jurisdiction for state court claims. The authors also examine the steps companies should take now in light of the possibility of facing litigation in both state and federal court. I would like to thank the authors for their willingness to allow me to publish their article as a guest post. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit an article. Here is the authors’ article.
Given that historical federal securities outcomes in state courts outside of Delaware often created outcomes that were not only more uncertain but more costly as well, there was some hope that Vice Chancellor Travis Laster (“VC Laster”), in the Blue Apron decision, might find that bylaws designating a federal forum for Section 11 lawsuits (brought under Section 11 of the Securities Act of 1933 (the “’33 Act”)) would stand the test of Delaware’s “internal affairs” doctrine, which relates to the Delaware Court’s traditional jurisdiction over internal matters relating to the relationships among or between a corporation and its officers, directors, and shareholders. That was not the case, however, as VC Laster ruled that a claim under the ’33 Act is “external” to the corporation because “[f]ederal law creates the claim, defines the elements of the claim, and specifies who can be a plaintiff or a defendant.” VC Laster thus denied the Company’s attempt to create exclusive federal jurisdiction via its bylaws.
This decision, though understandable as a matter of Delaware law, leaves two questions hanging:
(1) Will Congress act to create exclusive federal jurisdiction for class actions alleging only Section 11 claims?
(2) What are companies to do now, with the prospect of litigating IPO-related claims in both federal and state courts, at the same time and perhaps in different places?
We explore both questions more below and, in doing so, briefly summarize the somewhat complex set of circumstances that have led us here.
At least in part, the Blue Apron decision flows from two guiding principles. First, by enacting Section 11 of the ’33 Act, Congress created concurrent jurisdiction in both federal and state courts. This contrasts with the provisions of the Securities Exchange Act of 1934 (the “’34 Act”), which gave the federal courts exclusive jurisdiction over open-market, “securities fraud” claims brought by shareholders under Section 10b of the 34 Act. Many times this jurisdictional difference worked itself out because plaintiffs often brought both Section 11 and Section 10(b)-5 claims in the same federal court complaint. But not always.
Second, Congress had a chance in 1998 to fix federal court jurisdiction for all federal securities claims when it passed the Securities Litigation Uniform Standards Act (SLUSA), which provided that:
No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging—
(1) an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or
(2) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.
As noted by VC Laster in Blue Apron, “The Federal Jurisdiction Statute (of SLUSA) forces plaintiffs to sue in federal court if they wish to pursue class-wide relief involving publicly traded securities on a fraud-based theory, regardless of whether the cause of action invokes federal or state law. To make sure that plaintiffs cannot bypass the Federal Jurisdiction Statute by ignoring it and filing in state court, SLUSA permits the removal of certain class actions to federal court.” Blue Apron, at 10-11.
But what exactly did SLUSA do? Did it mandate that all federal securities claims brought as class-actions, whether under Section 11 of the ‘33 Act or Section 10(b) of the 34 Act, be brought in federal court? Or did it leave the ’33 Act’s state court jurisdictional provisions alone, intending SLUSA to apply to class actions alleging only state statutory or common law claims? This question was left unanswered for a very long time, until the United States Supreme Court (the “Supreme Court”) resolved it in Cyan, Inc. v. Beaver County Employees Retirement Fund (“Cyan”), ruling unanimously that, class actions under the ’33 Act (1) may be brought in state court pursuant to SLUSA, and (2) are not removable to federal court.
The Blue Apron Decision
The Blue Apron case was filed as a class action in Delaware state court before the Supreme Court’s Cyan decision, and was brought by a plaintiff who purchased shares in three companies that had (in their bylaws or charters) designated federal courts as the exclusive forum for ’33 Act claims: Blue Apron, Stitch and Roku. The plaintiff alleged Section 11 claims under the ’33 Act arising from the IPO of each company, whose registration statements each included a forum selection clause which generally stated:
Unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933. Any person or entity purchasing or otherwise acquiring any interest in any security of the Corporation shall be deemed to have notice of and consented to [this provision]
Thus, it was clear that the companies intended to require any plaintiff suing under Section 11 of the ’33 Act to litigate in federal court.
VC Laster’s decision in Blue Apron held that limitation was invalid as a matter of Delaware law, but the decision was not written on a blank slate; then-Chancellor Stine’s decision in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013) ( “Chevron””) had helped pave the road several years earlier. The Chancellor (who now sits as Chief Justice of the Delaware Supreme Court) found that certain forum selection provisions found in Chevron’s bylaw addressed only internal affairs claims, holding that:
a matter of easy linguistics, the forum selection bylaws address the “rights” of the stockholders, because they regulate where stockholders can exercise their right to bring certain internal affairs claims against the corporation and its directors and officers. They also plainly relate to the conduct of the corporation by channeling internal affairs cases into the courts of the state of incorporation, providing for the opportunity to have internal affairs cases resolved authoritatively by our Supreme Court if any party wishes to take an appeal. That is, because the forum selection bylaws address internal affairs claims, the subject matter of the actions the bylaws govern relates quintessentially to “the corporation’s business, the conduct of its affairs, and the rights of its stockholders [qua stockholders].
Chief Justice Strine thus distinguished those claims that were internal to the Corporation (like derivative and breach of fiduciary duty lawsuits), where jurisdiction of the Delaware Chancery Court could be mandated, from those types of claims that were external to the corporation (like securities fraud claims brought by shareholders).
Two years after Chevron, the current version of Section 115 of the Delaware General Corporation Law (“DGCL”) was adopted and legislatively confirmed the ability of Delaware corporations to include forum-selection provisions in their charters and bylaws. It states:
The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.
“Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.”
Thus, the General Assembly codified Chevron’s holding that a Delaware corporation can mandate exclusive jurisdiction in Delaware over “internal corporate claims,” defined to encompass claims covered by the internal-affairs doctrine.” There statute made no mention of securities claims arising out of Section 11 of the ’33 Act.
Relying primarily on Chevron and Section 115 of the DGCL, VC Laster found that Section 11 claims clearly are external to the corporation and do not relate to its internal affairs. Thus, the defendant corporation’s attempts to mandate federal jurisdiction for Section 11 claims were held to be invalid, and plaintiff’s motion for summary judgement was granted.
How To Deal with State Court Jurisdiction over Section 11 claims?
There is an obvious solution when considering how to deal with the situation going forward: Congress can solve the situation by amending SLUSA to provide for exclusive federal jurisdiction over Section 11 class actions. But will it do so? Is there enough “pro-corporate” sentiment in D.C. to support such a move? And even assuming there is, will this Congress consider such a provision when there are so many other things on its plate? These are not questions that can be answered here, and only time will tell if such an amendment surfaces.
Meanwhile, the resulting risk-allocation decisions are seemingly left in the hands of the corporate issuers themselves (and, to a large extent, their boards of directors or private equity sponsors (where applicable)). Will they decide to accept the balance sheet risk of potentially facing class actions in both state and federal courts, with similar or overlapping allegations of IPO-related securities violations being litigated in multiple venues? And how will the issuers deal with the related risk that their underwriters might be sued as well, implicating the issuer’s general indemnification obligations in connection with the IPO?
These questions are addressed more readily than the Congressional ones because the answer is suggested by historical practice: corporate issuers have tended to deal with such risks by purchasing D&O insurance that covers both the entity and the affected individuals (on a primary basis and an excess Side A basis, the latter of which covers losses that a company is either unable to indemnify or not permitted to indemnify under its certificate of incorporation or bylaws).
There are several considerations with that approach, including:
- Shareholder lawsuits have become much more expensive to settle over the past few years, especially including Section 11 claims. Are corporations buying enough coverage in a tower of insurance to address all potential liabilities arising out of an IPO (including underwriter liability if that coverage is sought within the company’s D&O coverage)?
- D&O premiums have gone up over the past two years in response to this trend of increasing settlement amounts. Will D&O rates continue to rise, placing even more pressure on corporate expenses.
- Pending a SLUSA amendment that provides an exclusive federal forum for Section 11 claims, will D&O carriers be willing to provide greater limits of liability for IPOs — or even any limits of liability at all– knowing that costs and settlement amounts are likely to keep increasing over time?
This is certainly a conundrum, and it presents a unique problem for corporations and their private equity sponsors who are seeking to go public or to issue shares in a secondary offering. While we cannot predict how/whether those involved will exercise their business judgment in making these decisions, it seems clear that the affected directors and officers will want more protection through increased D&O insurance, balance sheet coverage, or both. Indeed, our decades of experience representing directors and officers suggests that the only real questions are how much IPO-related coverage will cost and how much the corporations will be willing to pay for that protection.
In our minds, at least, there is no doubt that the directors who sign registration statements will continue to ask, “Am I covered?” And they should. It is never certain how an IPO will perform, the economy tends to be more uncertain than not, and it is no fun to be a defendant in a securities fraud-related action (or any securities action) – especially if the issuing company goes bankrupt and/or the balance sheet is otherwise unavailable for indemnification obligations.
Ultimately the answer may be that issuers and private equity sponsors are going to need to pay higher premiums to buy the necessary coverage for potential IPO- related liabilities. And that answer leads to a related question: will carriers want to provide the coverage limits requested for IPOs? The market right now is very tight, and even before the Blue Apron decision many D&O carriers have indicated that they just don’t want to play in the IPO space.
We have seen this dynamic before, including during the Financial Crisis when the market for financial services companies was tight to “very tight” given the losses during that period. These things have a way of working themselves out in the market, which can reflect a cause-and-effect relationship. If corporations need (or must have) the coverage because their directors are requiring it, then they will likely accept higher premiums. And those higher premiums may in turn draw more carriers into the market if they are convinced that they can write that business profitable given the increasing settlement amounts.
As they old adage goes, it is not over until “the fat lady sings.” We will see what tune directors and officers sing going forward, how the carriers respond, and whether Congress can be convinced to act following the Blue Apron decision.
Paul Ferrillo is a shareholder in Greenberg Traurig’s Cybersecurity, Privacy, and Crisis Management Practice. He focuses his practice on cybersecurity corporate governance issues, complex securities and business litigation, and internal investigations. He assists clients with governance, disclosure, and regulatory matters relating to their cybersecurity postures and the regulatory requirements which govern them.
Bob Horowitz is a shareholder and co-chair of the firm’s D&O Securities Litigation Practice. His securities practice involves the defense of underwriters, issuers, directors, and officers in securities class actions and in SEC investigations and enforcement actions.
Steven Margolin is a shareholder in the firm’s Litigation Practice. He focuses his practice on corporate and commercial litigation, representing business entities, officers, directors and investors in Delaware’s Court of Chancery as well as the U.S. District Court for the District of Delaware and the U.S. Bankruptcy Court for the District of Delaware.