A third California state court has ruled that a provision specifying that federal courts are the exclusive forum for the resolution of ‘33 act liability actions is valid and enforceable. This latest decision — in a state court securities class action lawsuit pending against Dropbox — suggests that a broad consensus is emerging in California court to enforce federal forum provisions. But while the Dropbox decision is largely consistent with the prior California state court decisions enforcing FFP, there are certain features of the Dropbox decision that make it noteworthy and interesting in its own right. A copy of the December 4, 2020 decision in the Dropbox case can be found here. A December 8, 2020 memo from the Seyfarth Shaw law firm about the ruling can be found here.
Background Regarding Federal Forum Provisions
In March 2018, the U.S. Supreme Court held in Cyan, Inc. v. Beaver County Employees Retirement Fund that state courts retain concurrent jurisdiction for liability actions under the Securities Act of 1933. Following this ruling, state court Section 11 actions have proliferated. In response to these developments, and out of concern that they could be subject to parallel state court and federal court litigation, a number of companies adopted charter provisions specifying that ’33 Act liability actions against the company must be brought in federal court. In March 2020, the Delaware Supreme Court held in Sciabacucchi v. Salzburg that federal forum provisions are valid under Delaware law. Even after the Sciabacucchi decision, the question remained whether the courts of other states would find FFP to be valid and enforceable.
In September 2020, a California court in the Restoration Robotics case held an FFP to be valid and enforceable and granted the motion of the defendants to dismiss the state court action. As discussed here, in November 2020, a separate California state court in the Uber securities class action lawsuit also held the FFP in the company’s charter to be valid and enforceable and granted the defendants’ motion to dismiss.
Background Regarding the Dropbox Lawsuit
Among the companies that adopted a federal forum provision is Dropbox, a Delaware corporation based in California 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. (Ultimately, four state court lawsuits were filed and later consolidated in San Mateo County Superior Court.) 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 and its directors and officers filed a motion to dismiss the consolidated state court action on the grounds of forum non conveniens, arguing in reliance on the Sciabacucchi decision that the federal forum provision in its corporate bylaws is valid on its face and therefore that the state court lawsuit must be dismissed. The Underwriter defendants joined the Dropbox Defendants’ dismissal motion. Interestingly, and as noted in detail here, six former Delaware Chancery Court and Supreme Court judges joined together to submit to the California state court an amicus brief in support of the defendants’ motion to dismiss in which they defend Delaware’s authority to determine the validity of the federal forum provisions. The court in the Dropbox action also accepted supplemental briefing after the September 1, 2020 ruling in the Restoration Robotics case.
The December 4, 2020 Decision
In a December 4, 2020 Opinion, California (San Mateo County) Superior Court Judge Nancy L. Fineman granted the Dropbox defendants’ motion to dismiss. Judge Fineman granted the motion in reliance on both California and United States authority.
In granting the Dropbox defendants’ motion, Judge Fineman made a number of determinations: that plaintiffs may waive their right to have their Securities Act cases adjudicated in federal court; that the plaintiffs have not met their burden of showing that the FFP is unfair or unreasonable; that by purchasing Dropbox stock, the plaintiffs agreed to the FFP in the Dropbox bylaws; that the FFP is not unlawful or unconscionable under California law; that enforcement of the FFP is not unconscionable; and that the plaintiffs failed to prove that the FFP violates the Commerce Clause or the Supremacy Clause of the U.S. constitution.
In making these various determinations, Judge Fineman rejected the plaintiffs’ argument that the FFP is unreasonable because it was not separately negotiated, and emphasized that “when Plaintiffs acquired their shares, their purchases were subject to Dropbox Bylaws and the assented to the FFP.” Judge Fineman also noted that even under the FFP, the plaintiffs have a full and fair opportunity to have their claims heard in federal court, while also noting that Dropbox provided a “legitimate business need” for the FFP, which is to try to “avoid the unnecessary costs and burdens of defending multiple cases simultaneously in both state and federal courts and the possibility of inconsistent judgments and rulings.”
As I noted above, the ruling the Dropbox case is the third California state court decision upholding the validity and enforceability of a federal forum provision. Interestingly, in her ruling in the Dropbox case, Judge Fineman specifically referenced (but also explicitly did not rely on) San Mateo County Judge Marie Weiner’s September 2020 decision in the Restoration Robotics case. Judge Fineman did not reference the November 2020 decision in the Uber case.
But while the Dropbox decision is the third decision to uphold the enforceability of FFP, there are some features of the Dropbox decision that make it noteworthy even in the context of the prior two decisions.
First, the FFP at issue in the Dropbox case was in the company’s bylaws, rather than in the company’s corporate charter. In both the Restoration Robotics and Uber cases, the FFP at issue had been in the corporate charter. In a footnote in her opinion, Judge Fineman specifically noted that in her opinion the “same law applies to a charter as to a bylaw.” This aspect of Judge Fineman’s ruling does address one question that had been asked about FFP, which is whether the FFP needed to be in the corporate charter in order to be effective. Judge Fineman’s opinion suggests that it is sufficient if the FFP is in the bylaws of the company seeking to enforce it.
Second, in both the Restoration Robotics and Uber decisions, the courts respectively declined to reach the plaintiffs’ arguments that the enforcement of an FFP would violate the Commerce Clause and Supremacy Clause of the U.S. Constitution. In the Dropbox case, Judge Fineman did not decline to reach these issues but instead ruled that the plaintiff had failed to prove a constitutional violation. Judge Fineman’s analysis of these issues is rather cursory. However, even if only briefly considered, she did reject one of the significant arguments for plaintiffs to try to rely in order to continue to try to challenge the enforceability of FFP. Judge Fineman’s ruling does suggest that the arguments of constitutional violation will not be a productive argument for plaintiffs seeking to oppose the enforcement of FFP provisions.
Third, in the Dropbox case, Judge Fineman extended her dismissal ruling to the underwriter defendants. In the Restoration Robotics case, Judge Weiner had expressly declined to extend her dismissal ruling to the Underwriter Defendants in that case, as the Underwriter Defendants were not parties to the enforceable rights in the company’s corporate charter. Judge Fineman extended her dismissal grant to the underwriter defendants in the Dropbox case, saying that she did so “on the grounds of economy and efficiency.”
In thinking about the Dropbox case, it is important to note that the case involved the very circumstances that motivated advocates of the FFP provisions. That is, Dropbox not only faced the state court securities lawsuits pending in San Mateo County Superior Court, but it also faced parallel federal court litigation involving the same allegations, with no procedural mechanism to consolidate the cases notwithstanding the risk of inconsistent rulings and judgments.
The fact that there are now three California state court decisions upholding the validity and enforcement of federal forum provisions does suggest that Delaware corporations doing business in California and sued in California state court can rely on FFP as a way to avoid the risk of facing parallel state and federal court litigation under the ’33 Act. However, while these decisions represent important milestones, they unfortunately do not mean that the Cyan problem has been put to rest.
For companies that are incorporated under the laws of states other than Delaware, the question of the validity and enforceability of FFP remains. While most U.S. public companies are incorporated in Delaware, many are not. Many tech companies are incorporated in Nevada; most REITs are incorporated in Maryland; many financial services companies are incorporated under the laws of New York. For these companies and the many others organized under the laws of states other than Delaware, the validity and enforceability of FFP in their corporate documents remains uncertain.
By the same token, even with respect to Delaware corporations, while there is an emerging consensus among California courts that FFP are enforceable under California law, it is not yet clear whether the courts of other jurisdictions will find FFP to be valid and enforceable under their respective law. Indeed, even saying there is a consensus in California might be overstating the matter, since all three of the decisions so far are only trial court rulings, lacking any precedential authority.
Eventually all of these remaining concerns and issues might be addressed, but even then it will only be as a result of a pain-staking, time-consuming piecemeal process. Given all of these concerns, the preferred solution to address the Cyan problem – even after the three California state court rulings — is Congressional action. It would be a very simple matter for Congress to amend Section 22 of the ’33 Act to eliminate concurrent jurisdiction and to put an end to wasteful, inefficient parallel litigation. However, given how the current division and distraction within Congress, not to mention the upcoming change in administration, Congressional action on this seems unlikely anytime soon. For that reason all companies but particularly companies contemplating an IPO would be well-advised to adopt a federal forum provision.
Boris Feldman of the Freshfields law firm has an interesting take on the three California decisions in a December 10, 2020 post on the Harvard Law School Forum on Corporate Governance, here.
Special thanks to a loyal reader for providing me with a copy of the Dropbox ruling.
UPDATE: In an additional December 7, 2020 order (here), Judge Fineman granted the defendants’ motion to dismiss on the ground of forum non conveniens in the separate securities class action lawsuit pending in her court against Sonim Technologies, Inc. Her order in the Sonim Technologies was entered in reliance upon and incorporated by reference her prior opinion in the Dropbox case. Sonim Technologies