In the wake of the U.S. Supreme Court’s Cyan decision, corporate defendants faced the risk of wasteful and duplicative federal and state court securities litigation. In order to address this concern, corporate reformers suggested that companies should adopt provisions in their corporate charters designating an exclusive federal forum for securities litigation. The Delaware Supreme Court upheld the facial validity under Delaware law of federal forum provisions in the Sciabacucchi decision, but the question remained whether the courts in other jurisdictions would enforce the provisions. A number of courts in California and New York did subsequently uphold the provisions, but these were all trial court rulings.
Now, in an important legal development, a California intermediate appellate court has upheld the enforcement of the provisions, the first appellate decision on the issue outside Delaware. The California appellate court’s ruling in the Restoration Robotics case could represent a significant milestone in the development of post-Cyan litigation. A copy of the California appellate court’s April 28, 2022 decision can be found here. An April 29, 2022 memo from the Latham & Watkins law firm about the appellate court’s decision can be found here.
In March 2018, the United States 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 Cyan, there was a proliferation of state court securities suits, often parallel to and duplicative of federal court lawsuits based on the same essential allegations. There are no procedures to consolidate these parallel state court and federal court lawsuits. As a result, companies conducting IPOs and follow-on securities offerings face the possibility of having to fight a multi-front war in the event of securities litigation relating to their securities offerings.
In response to these concerns, 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 Salzburg v. Sciabacucchi that federal forum provisions are facially 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 separate rulings during the second half of 2020, three different California courts held that FFP in the charters of three state court securities lawsuit defendants were valid and enforceable. First, 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. Second, as discussed here, in November 2020, a California Court in the Uber case also held an FFP in the company’s corporate charter to be valid and enforceable and granted the defendants’ motion to dismiss. In December 2020, as discussed here, a California state court judge held the FFP in Dropbox’s corporate bylaws to be valid and enforceable and dismissed the state court action.
(Although little noted, there was actually a fourth California ruling in December 2020; days after the Dropbox ruling, the same judge who granted the motion to dismiss in Dropbox separately granted the motion to dismiss in the separate securities class action lawsuit 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.)
In addition to these California state court rulings, a New York state court, applying New York law, ruled on August 31, 2021 in the Casa Systems case that the defendant company’s FFP in its corporate charter was valid and enforceable, as discussed here. The court dismissed the plaintiff’s New York state court securities class action lawsuit on the basis of the federal forum provision.
While these courts have all uniformly held that FFP are valid and enforceable, all of these decisions represent only the rulings of state court trial decisions. Until now, there have been no state appellate court rulings outside of Delaware addressing the question of the validity and enforceability of the FFP. Now, in the Restoration Robotics case (mentioned above as one of the California state court cases upholding FFP) has addressed these issues under California law.
The Restoration Robotics Case
Restoration Robotics completed its IPO in October 2017. As part of its IPO process, the company amended its certificate of incorporation to include a provision specifying the federal district courts of the United States as the exclusive forum for the resolution of any complaint under the Securities Act of 1933. In early 2018, the company was sued in a number of securities class action lawsuits in both state and federal courts. The suits filed in federal court were consolidated and ultimately settled. The state court lawsuit went forward. The defendants moved to dismiss the separate state court lawsuit.
In a September 1, 2020 decision (here), San Mateo County Judge Marie Weiner agreed with the defendants that the company’s FFP barred the defendants’ lawsuit and granted the defendants’ motion to dismiss. The plaintiff appealed.
The Appellate Court Ruling
In a April 28, 2022 opinion written by Judge Marla J. Miller for a unanimous three-judge panel the Court of Appeal for the First Appellate District affirmed the Superior Court’s dismissal of the action.
In affirming the lower court, the appellate court rejected each of the arguments the plaintiff had raised. First, the court rejected the plaintiff’s argument that the FFP violated the “anti-removal” provision of the jurisdictional provision of ’33 Act. The appellate court said that because Restoration Robotics did not seek to remove the state court action to federal court, but instead only sought to enforce the FFP, “the removal bar has no apparent application to the FFP.”
The appellate court also rejected the plaintiff’s argument that the FFP violated the “anti-waiver” provision of the ’33 Act (which voids any condition or stipulation seeking to waive compliance with the requirements of the ’33 Act). The Court said that the FFP does not amount to a waiver of compliance, reasoning that the concurrent jurisdiction provision in the ’33 Act “does not impose any duty” requiring compliance, and there for “can be overridden by a forum selection agreement without violating the 1933 Act’s anti-waive provision.”
The appellate court next rejected the plaintiff’s argument that the FFP violated the dormant Commerce Clause in the constitution. The appellate court said that, as a threshold matter, the FFP did not involve any “state action,” a necessary element of any dormant Commerce Clause claim. The appellate court said further that the plaintiff’s dormant Commerce Clause claim failed on the merits, noting that FFP benefit both shareholders and corporations alike by advancing judicial efficiency, and therefore “any burden on interstate commerce here is slight compared to the benefit.”
Similarly, the appellate court rejected the plaintiff’s argument that the FFP violated the Supremacy Clause in the U.S. constitution. The plaintiff had argued that the Delaware was unconstitutionally discriminating against federal law; the appellate court disagreed, noting that Delaware itself was not purporting to shut its doors to a federal claim based on a policy disagreement.
Finally, the appellate court held that Delaware law, rather than California law, controlled the question of the validity of the FFP, a question that Delaware had answered in the Sciabacucchi decision. The question of the enforceability of the FFP was, however, a question of California law. The appellate court said that because the FFP was neither outside the reasonable expectations of shareholders nor was it unconscionable, it was enforceable under California law.
The California Appellate Court’s decision is a big win for anyone who wants to see a stake driven into the heart of the pernicious possibility for wasteful, duplicative parallel state and federal court securities litigation. The appellate court’s opinion is detailed, thorough, and well-reasoned. To be sure, the plaintiff could seek to appeal the decision to the California Supreme Court, but honestly further appeals would just be good money after bad.
Even if the plaintiff’s counsel were to reason that further appeal would be worth the gamble, I have to say it would be a long-shot gamble. As the Latham & Watkins law firm notes in the memo to which I linked above, there is now a “broad consensus” that FFP are valid and enforceable. Not a single court has rejected the validity or enforceability of the provision; courts applying the laws of three states (Delaware, California, and New York) have upheld the provisions.
I want to emphasize here that the appellate court’s ruling upholding the FFP is a win for both corporations and for shareholders. There may be a very small handful of plaintiffs’ lawyers out there who want to try to continue to make money through parallel state and federal court litigation, but otherwise the continued possibility for further parallel litigation is bad for everyone else on the planet. The existence of parallel litigation needlessly and irrationally drives up litigation costs for companies, harming shareholders’ investment interests. The possibility of wasteful parallel litigation has contributed to the huge increase in D&O Insurance costs in recent years (and the imposition for IPO companies of self-insured retentions of as much as $10 million or more), which harms companies financially and again harms the investment interests of shareholders.
There is one further thing I have to say about the developing case law on FFP, and that is, in the wake of Sciabucucchi and the other court decisions upholding FFP, fewer securities lawsuits are being filed in state court. The fact is that these days almost all IPO companies and many well-established companies have adopted FFPs. With the proliferation of FFP, fewer state court securities class action lawsuit are being filed.
In a perfect world, Congress would long ago have acted to eliminate the possibility for parallel state and federal litigation on the same cause of action. The failure of Congress to act and address and obvious problem (and an unintended consequence of a drafting error or oversight in its enactment of SLUSA) is a reflection of the distracted and divided times in which we live.
In the absence of Congressional action, self-help, in the form of FFP, is the only solution. If the plaintiff in this case seeks to appeal this appellate decision, every right-thinking person everywhere should rise up and oppose the effort, which would literally serve no purpose other than to try to preserve the unintended right of a very small number of plaintiffs’ securities class action attorney to extract an economic benefit for themselves alone through wasteful, duplicative litigation.