The Delaware Supreme Court unanimously held that corporate charter provisions requiring claims under the Securities Act of 1933 to be litigated in federal court are facially valid. These kinds of provisions were proposed after the U.S. Supreme Court’s March 2018 decision in Cyan affirming that state court’s retain concurrent jurisdiction for ’33 Act liability actions. However, in December 2018, the Delaware Chancery Court ruled that federal forum provisions are invalid and unenforceable. In its March 18, 2020 decision (here), the Delaware Supreme Court reversed the Chancery Court, holding that federal forum provisions are a valid form of “private ordering.” The ruling has important implications, which are discussed below. And as also discussed below, there is a very interesting backstory – involving key D&O insurance industry players – to this successful appeal.
Following the U.S. Supreme Court’s Cyan decision, a number of proposals circulated of ways for companies to avoid having to face multiplied or duplicative federal and state court ’33 Act claims. Prominent among these proposed remedial measures was a suggestion that IPO companies should adopt 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 adopted these kinds of provisions, including, for example, Snap, Inc.
Matthew Sciabacucchi purchased shares of three companies – Blue Apron, Stitch Fix, and Roku – either in the companies’ 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 a 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.
As discussed in detail here, in a 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.
Vice Chancellor Laster reasoned that because Federal law defined the underlying claim, it was external to the corporation. Delaware Corporate law can only reach matters that are internal to the corporation. 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.”
The companies appealed the Chancery Court ruling to the Delaware Supreme Court.
The March 18, 2020 Opinion
In an opinion written by Justice Karen Valihura for a unanimous court, the Delaware Supreme Court reversed the Chancery Court’s ruling and held that Federal Forum Provisions (FFP) are facially valid under the Delaware General Corporation Law and that they survive a facial challenge as a policy matter as well.
In holding that FFP are facially valid, the Court noted that FFPs “involve a type of securities claim related to the management of litigation arising out of the Board’s disclosures to current and prospective stockholders in connection with an IPO or secondary offering.” The creation of registration statements is “an important aspect of a corporation’s management of its business affairs and of its relationship with its stockholders.” Accordingly, the court said, a “bylaw that seeks to regulate the forum in which such ‘intra-corporate’ litigation can occur is a provision that addresses the ‘management of the business’ and the ‘conduct of the affairs of the corporation,’ and is thus, facially valid under Section 102(b)(1).” The Court noted further that FFP are not otherwise contrary to the laws of the state.
In a section of the opinion that may be of particular interest to readers of this blog, the Court noted statistical information provided by Cornerstone Research showing the dramatic uptick in state court securities lawsuits following Cyan, including the number of cases involving parallel federal and state litigation. The Court expressly noted the absence of procedural mechanisms to coordinate the state and federal litigation, and the “inefficiencies” that could thereby result.
The Court observed that “by directing 1933 Act claims to federal courts when coordination and consolidation are possible, FFPs classically fit the definition of a provision ‘for the management of the business and conduct of the affairs of the corporation” within the meaning of Section 102.
The Court also addressed the Chancery Court’s concerns about the distinction between the internal and external affairs of a Delaware Corporation. The Supreme Court said the Chancery Court had erred in concluding that “everything other than an ‘internal affairs’ claim was ‘external’ and therefore not the proper subject of a bylaw or charter provision.” By creating this “binary world,” the Chancery Court “superimposed” the “internal affairs doctrine onto and narrowed the scope of Section 102(b)(1) – contrary to its plain language.” Rather than this “binary” division, there is, the Supreme Court said, a “continuum” between “internal affairs” and purely “external” claims.
Going on with this “continuum” logic, the Supreme Court said that FFPs regulating the forum for a Section 11 claims “are neither ‘external’ nor ‘internal affairs’ claims. Rather, they are in-between in what might be called Section 102(b)(1)’s ‘Outer Band.’” (This latter point is illustrated with a rather elaborate graphic depicting this “outer band.”) As being within this “Outer Band,” FFPs are facially valid.
FFPs are also facially valid as a policy matter, the Court said. FFPs do not “offend federal law and policy, nor do they offend principles of horizontal sovereignty” – that is, principles that respect the rights of states to regulate their affairs within their jurisdiction and not beyond.
The opinion concludes with a number of short paragraphs in which the Court affirms that “our law strives to enhance flexibility in order to engage in private ordering and to defer to case-by-case law development,” adding that Delaware’s courts aim “to achieve judicial economy and avoid duplicative efforts among courts in resolving disputes” and that FFPs “advance these goals.”
Delaware’s courts have long recognized the needs to balance the interests of all stakeholders, and FFPs “do not violate that sense of balance as they allow for litigation of federal Securities Act claims in a federal court of plaintiff’s choosing, but allow for consolidation and coordination of such claims to avoid inefficiencies and unnecessary costs.”
The Court ended its opinion by noting that the DGCL was “intended to provide directors and stockholders with flexibility and wide discretion for private ordering and adaptation to new situations.”
The Court’s reversal of the Chancery Court and its conclusion that FFPs are facially valid is a huge win for those who sought to advance this approach as a way to try to mitigate the problems that the Cyan decision has caused. This is also a huge win for the D&O Insurance industry. The insurers have been struggling to deal with Cyan, at a time when the industry is facing a host of other issues. The outcome of this case gives the insurers and their policyholders a way to try to address the Cyan problem without having to depend on congressional action, at least with respect to Delaware corporations. (Assuming here for the sake of discussion that there will again some day be IPOs again…) However, as great as this decision is, it doesn’t solve every problem, and there are going to have to be some other questions answered as well.
As a preliminary matter, and before I get into breaking down what the opinion does and does not do, I want to note here that the use of FFPs was a solution proposed and advanced by Stanford Law School Professor Joseph Grundfest, to the point that this idea was referred to by many as the “Grundfest solution.” And not only did Grundfest propose this solution, he was one of its strongest proponents. His critique of the Chancery Court’s opinion (which I discussed at length in a prior post, here) not only detailed the problems with the Chancery Court’s analysis, but laid out the essential lines of analysis that were to form the core of the Supreme Court’s opinion. Many of those lines of analysis appeared only Grundfest’s paper, but not in the parties’ briefs. Consider this blog post effectively a “high five” to Grundfest.
I would be remiss if I did not also mention the lawyers at the Wilson Sonsini law firm, who did an excellent job represented the defendants on this appeal. My congratulations to everyone at Wilson Sonsini who worked on this appeal.
That said, and as important as this decision is, it is also important to consider what it does not do.
First and foremost, this opinion is very much a creature of Delaware law. This is a critically important decision for companies that are organized under Delaware law, as in fact most publicly traded companies are. But not every company is organized under Delaware law. REITs are often organized under Maryland law. Many high tech companies are organized under Nevada law. Many financial services companies are organized under New York law. Foreign companies conducting IPOs or secondary offerings in the U.S. are organized under the laws of their home countries. Notwithstanding this great Delaware decision, these other companies may not be able to rely on FFPs to ensure that any ’33 Act litigation in which they get involved is only in federal court – at least not in reliance on this opinion alone.
Second, the Delaware Supreme Court only says that an FFP is “facially valid.” It does not address questions that might arise when a claimant seeks to contest an FFP “as applied.” The next battleground for sure will be individual disputes in which claimants contend that while there may be nothing facially invalid about an FFP, the FFP as applied is invalid or should not be enforced. Look for those issues next.
Third, companies relying on this opinion may try to push things. This case only addressed FFPs in articles of incorporation under DGCL Section 102. As Professor Grundfest pointed out to me when we discussed this decision, the next question is whether the logic of this case extends beyond articles of incorporation to corporate bylaws under Section 109. While there is seemingly nothing about this opinion that would appear to prohibit companies from putting FFPs in their bylaws rather than in the articles of incorporation, claimants may seek to challenge bylaws as beyond the scope of what the court addressed here.
Fourth, as companies seek to push the limits of this opinion, they may try to drill down even further and provide not only that ’33 Act claims have to be filed in federal court, but have to be filed in a specific federal court. These kind of efforts may also be challenged, and may in fact be beyond the federal policy considerations and considerations of horizontal sovereignty that the court discussed here.
While there are some ongoing questions that may follow after this decision, there are some features of this opinion that may be overlooked but that also are very important.
For example, one of the questions about this case as it advanced was whether a ruling by the Delaware Supreme Court allowing FFPs might be sufficient to allow companies to adopt charter provisions requiring securities cases to be arbitrated. (See Alison Frankel’s September 23, 2019 post on her On the Case blog, here, for a good discussion of these questions).
The Delaware Court addressed this concern on the last page of its opinion, in footnote 169. The Court noted the concern that if the FFP was upheld here the “next move” might be the adoption of charter provisions requiring the arbitration of internal affairs claims. Such a provision, the Court said, would “violate” Section 115, noting that language from the legislature’s report on Section 115 that Section 115 would invalidate a forum selection provision that would designate a forum other than Delaware or “an arbitral forum” if would preclude litigating such claims in Delaware courts.
While there are these questions and concerns and other features of this case to be noted and considered, overall the ruling is a big win for the advocates who proposed this approach as a way to try to avoid the problems that Cyan has created. To be sure, it does not, as noted above, answer every question, but it accomplishes a lot for the benefit of the vast majority of public companies that are Delaware corporations, and it does that without the need for Congressional legislation.
An Important Story that Must be Told About the Appeal in this Case: Litigation is expensive, and there is a great story to be told here about how the defendant companies managed the cost of the appeal to the Delaware Supreme Court of the Chancery Court’s ruling.
There was a particular problem here for the defendant companies, in that there was no underlying litigation, so there was no risk to them after the Chancery Court’s ruling in just walking away. The defendant companies could have saved themselves a lot of time and trouble by simply accepting the Chancery Court’s ruling and moving on. Instead, however, the defendant companies recognized the importance of appealing the Chancery Court opinion. In order to help make that happen, a number of key players in the D&O insurance industry stepped forward.
Several key D&O insurance participants recognized the issues that this situation presented and agreed to help finance this appeal. The funding for this appeal was organized by my good friends Priya Cherian Huskins and Lauri Floresca of Woodruff Sawyer, and paid for by a number of key industry participants, including several insurers and brokers (listed in the next paragraph). It is important to note about the carrier participants that several of them were not on any of the defendant companies’ programs — and even with respect to the defendant companies’ programs, the retentions involved were such that the insurers that were on the programs were unlikely to be contractually at risk. The payments were all voluntary.
Here are the carriers that were involved in financing this effort (in alphabetical order): Allianz; Allied World; Beazley; Chubb; Great American; Hiscox; Old Republic; Swiss Re. The brokers involved were Woodruff Sawyer and Arthur J. Gallagher.
My congratulations to all of these participants for their willingness to help support this effort. As Priya said to me about this effort, “I’m so proud to be part of this kind of business community.” My congratulations to Priya and Lauri for pulling this group together, and to everyone for the successful outcome. This is a great example of the business community rallying around an important cause for the sake of the industry, our clients, and the economy.
To all who participated in this effort, I salute you, as should everyone in this industry.