After the Delaware Supreme Court’s March 2020 decision in Salzberg v. Sciabacucchi upholding the facial validity of corporate charter provisions designating federal court as the forum for Securities Act liability claims, several questions remained. Among the questions is whether others’ states courts will recognize and enforce federal forum provisions in Delaware corporations’ charters. This issue has been teed up for decision in a Section 11 lawsuit pending in San Mateo County court in California, in a case involving Dropbox. Dropbox has filed a motion urging the California state court to dismiss the action, in reliance on the federal forum provision in its corporate charter.
As discussed Alison Frankel’s July 13 post on her On the Case blog (here), a group of six ex-judges from Delaware has now entered an amicus brief on the issue in the case, urging the California court to recognize Delaware legal authority and enforce the federal forum provision in Dropbox’s charter. The Dropbox case, according to Frankel, is “shaping up as an early test of the application of the [Sciabacucchi decision] that forum selection clauses requiring shareholders to litigate Securities Act claims in federal court are facially valid because they concern the corporation’s internal affairs.”
Background
As readers will recall, in March 2018, the U.S. Supreme Court held in Cyan v. Beaver County Employees’ Retirement Fund that state courts retain concurrent jurisdiction for securities class action lawsuits based on alleged liability under the Securities Act of 1933. Following this ruling, state court Section 11 actions have proliferated. The rise in state court securities suits has meant that defendant companies face the risk of multiple or duplicate lawsuits filed over the same set of allegations.
As protection against this possibility of duplicative litigation, some observers (most notably Stanford Law Professor Joseph Grundfest) suggested companies could adopt charter provisions designating a federal forum for Securities Act liability actions involving the company.
Plaintiffs’ lawyers and investor activists challenged the adoption by Blue Apron and two other companies of federal forum provisions, leading to the Sciabacucchi ruling upholding the validity of this type of provision. Since that time, many companies have adopted federal forum provisions in their charters.
The Dropbox Lawsuit
Among the companies that adopted a federal forum provision is Dropbox, a Delaware corporation that completed its IPO in 2018. In August 2019, Dropbox was sued in a Section 11 class action lawsuit in San Mateo County Superior Court in California. Dropbox has also been sued in a separate Section 11 lawsuit in the United States District Court for the Northern District of California.
In May 2020, Dropbox, represented by the Wilson Sonsini law firm, filed a motion to dismiss the state court action, arguing in reliance on the Sciabacucchi decision that the federal forum provision in its corporate charter is valid on its face and therefore that the state court lawsuit must be dismissed because the provision does not “diminish the rights of California residents in a way that violates a statute or public policy of the state.”
The plaintiff shareholder in the state court suit, represented by the Robbins Geller law firm, has filed a brief in opposition to dismissal in which the plaintiff argues that the Dropbox’s charter provision and Delaware’s approval of federal forum provisions are both contrary to the U.S. Constitution (in that the clause, according to the plaintiff, violates both the Commerce Clause and the Supremacy Clause), federal securities law, and California contract law. The plaintiff argues that “allowing a Delaware statute to regulate whether a California court may exercise jurisdiction expressly given to it by Congress over a claim arising under federal law is invalid.” The plaintiff also argued that investors did not knowingly consent to the forum selection provision simply by buying the company’s shares.
Dropbox filed a brief in reply to the plaintiff’s opposition, arguing that the plaintiff’s constitutional arguments are groundless because the Sciabaccuchi decision addressed provisions adopted by private companies, not a Delaware law interfering on the rights of other states.
The Amicus Brief
Now, six former Delaware Chancery Court and Supreme Court judges have joined together to submit to the California state court an amicus brief in which they defend Delaware’s authority to determine the validity of the federal forum provisions. The brief was signed by Grover Brown, Jack Jacobs, Stephen Lamb, Henry DuPont Ridgely, Myron Steele and Norman Veasey. Professor Grundfest also signed the brief. According to Frankel, the group effort was organized by Grundfest and former Chancellor William Chandler, who is now at the Wilson Sonsini law firm, which is representing Dropbox in the state court litigation. The six judges joined only the portion of the brief relating to Delaware law; all other parts of the brief reflect only the views of Professor Grundfest.
The amicus brief argues that the question of the validity of a federal forum provision is a matter of the internal affairs doctrine, which holds that only the state of incorporation can regulate the internal affairs of the company. The amici argue that the plaintiff’s Securities Act claims derive from the activities of the company’s corporate officers in signing the company’s offering documents; “as such, the complaints arise from ‘internal’ corporate conduct on the part of Dropbox’s directors and officers and the plaintiffs’ status as stockholders.”
Because these matters are all internal, the question of the state law that governs these affairs is equally internal – meaning that in this case Delaware law should govern the question of the validity and enforceability of the federal forum provisions. Sciabacucchi, the amici contend, does not “reach out beyond the purview of that state’s law.” Rather, the decision “gives Delaware corporations a tool, authorized under Delaware law, for ensuring that claims fundamentally based on a plaintiff’s status as an owner of company stock are litigated in a single, efficient forum.”
In a separate section of the brief that the six Delaware jurists did not join, Grundfest argues further that the SEC has reviewed and allowed dozens of registration statements for companies that disclose the companies’ adoption of federal forum provisions. If the provisions were unconstitutional or contrary to federal securities laws, the SEC would not have allowed companies to proceed with their IPOs.
In her blog post about the amicus brief, Frankel quotes Grundfest as saying that “In order for plaintiffs to prevail here, they have to persuade the court to ignore U.S. Supreme Court precedent, persuade the court to misread Sciabacucchi, and argue that every corporation in America is ungovernable and that the SEC does not know federal securities law.”
Frankel’s article quotes Darren Robbins of the Robbins Geller law firm as saying that Grundfest and Wilson Sonsini are continuing to fight the battle they already lost in the Supreme Court’s Cyan ruling. They have “an undue fixation on impinging on shareholders’ desire to vindicate their rights in state court.” As for the amicus brief, Robbins is quoted as saying that he is not concerned by Dropbox’s effort to “go corral and induce jurists now in private practice to tell a California court what the law means.”
According to Frankel, Dropbox has proposed a July 31, 2020 hearing for its dismissal motion.
Discussion
It is going to be very interesting to see what the California court does with Dropbox’s motion to dismiss. If as the plaintiff urges the court declines to enforce Dropbox’s federal forum provision, the value of such provisions and of the Sciabacucchi decision will be substantially diminished. If other states’ courts cannot be counted on to dismiss Section 11 cases that are filed in state court, the provisions will have little value outside Delaware, and the plaintiffs’ lawyers will be able to circumvent the provisions simply by filing in state courts other than Delaware’s.
Those of us who value the efficiency of the legal system are keenly rooting for Dropbox to prevail here. The fact is that the Cyan decision has created an ugly mess. The Dropbox case itself illustrates the problem. There is absolutely no reason for the state court lawsuit to exist. The interests of the plaintiff class are fully represented in the parallel federal court lawsuit. One could suspect that the plaintiffs’ lawyers are pursuing the duplicative lawsuit because the San Mateo court has a well-earned reputation as being plaintiff-friendly and as a being a court in which it is much more difficult for defendants to get cases dismissed than in federal court.
It is extremely unfortunate the because of the Cyan decision we are in a situation in which companies can be subject to wasteful, duplicative litigation. In a functional world, Congress would act to address this problem. It would be a relatively simple task for Congress to amend Section 22 of the ’33 Act to eliminate concurrent state court jurisdiction for Section 11 claims (as Congress attempted but failed to do in 1998 in SLUSA). However, the current divided and distracted Congress seems unlikely to address this obvious problem.
In the absence of Congressional action, companies need to be able to do what they can to try to protect themselves against the possibility of wasteful and duplicative litigation. The practical effect of a refusal by other state courts to recognize and enforce federal forum provisions in Delaware corporations’ charters will be that companies’ efforts to protect themselves will be hamstrung.
Congress may have intended that companies can be sued for alleged Securities Act violations in either federal or state court, but it clearly could not have intended that companies can be sued in both federal and state court. Because this is a result that Congress could not have intended and nobody on the entire planet wants other than a small number of plaintiffs’ lawyers, the California court should recognize the validity and enforceability of Dropbox’s federal forum provision.