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Delaware Supreme Court: Corporations May Use Bylaws to Require Investors to Sue in Federal Court for Securities Act Claims

AOL - Shareholder Lit and Enforcement

In Sciabacucchi v. Salzberg, No. 346, 2019 (March 18, 2020 Del. Sup. Ct), the Delaware Supreme Court has strengthened the use of forum selection clauses in bylaws and other governance documents by holding that corporations may enact provisions that require federal Securities Act claims be brought in federal court. The ruling will allow corporations to consolidate federal securities claims more easily, providing for more efficient and timely resolution.

  • The Supreme Court’s ruling reverses a Chancery decision, which had ruled that though corporations could use bylaws to require fiduciary claims be brought in Delaware courts, the ruling did not extend to provisions requiring federal Securities Act claims be brought in federal court.
  • The ruling is particularly helpful after the United States Supreme Court’s 2018 ruling in Cyan v. Beaver County Employees Retirement Fund. That case held that plaintiffs could bring Securities Act claims in state court and, so long as those were the only claims, defendants were powerless to remove to federal court. Now, corporations can require that such claims be brought in federal court, which will allow them to be consolidated through transfer motions or multi-district litigation proceedings.
  • The Delaware Supreme Court suggested that other states have the authority to decline to enforce such provisions. But it provided a roadmap of powerful arguments for why other states should enforce them.
  • Though the opinion does not address other corporate forms, like publicly traded partnerships or limited liability companies, it provides powerful footing for all companies to adopt federal-forum provisions.
  • The opinion also does not address whether forum-selection clauses can apply to claims brought under the Securities Exchange Act, which includes the popular Section 10(b) cause of action. But its reasoning arguably extends to such claims.

Summary of Opinion

The Delaware Supreme Court has strengthened the use of forum selection clauses in bylaws and other governance documents. Three companies — Blue Apron, Roku, and Stitch Fix — each launched IPOs in 2017. Before going public, the companies adopted federal-forum provisions (“FFP”) requiring investors to bring any claims under the Securities Act of 1933. An individual who owned shares in all three companies requested a declaratory judgment that the FFPs were facially invalid. The Court of Chancery agreed and granted a declaratory judgment.

On appeal, the Delaware Supreme Court reversed. It concluded that such provisions can be included in certificates of incorporation and bylaws under Delaware General Corporation Law § 102(b)(1). Section 102(b)(1) authorizes corporate provisions that relate to the “management of the business” or “limiting and regulating the powers of the corporation … or any class of shareholders,” so long as they “are not contrary to the law of this State.”

The Court concluded FFPs “easily” fell within the authorization in § 102(b)(1). Because FFPs allowed corporations to maintain efficiency in litigation, they served the management of the businesses; and they dictated where shareholders could file suit, so they limited the powers of shareholders. The Court also determined FFPs were not contrary to the laws of Delaware because corporations have broad power to authorize bylaws absent a settled public policy prohibiting them.

The Court rejected the shareholder’s argument that a recent legislative amendment prohibited FFPs. Delaware General Corporate Law § 115 was enacted in 2015. It codified a previous ruling that corporations could enact corporate provisions selecting Delaware as the forum for any “internal corporate claims.” It also prohibited corporate provisions that forbid shareholders from bringing suit in Delaware. The shareholder in Sciabacucchi argued that § 115 impliedly amended § 102(b)(1), but the Court rejected that argument as contrary to traditional rules of statutory construction, such as the rule that statutes are not “altered by implication unless there is an irreconcilable conflict.” Instead, § 115 and § 102(b)(1) each had unambiguous language that applied in different situations.

The Court also rejected the Chancery Court’s conclusion that § 102(b)(1) authorized only bylaws relating to internal corporate claims. Previous Delaware Supreme Court precedent held that § 102(b)(1) extended to “intra-corporate litigation.” The Court of Chancery read that term to be limited to state law fiduciary claims, which the Delaware Supreme Court concluded unduly narrowed the term. Relying on both Delaware and United States Supreme Court precedent, the Delaware Supreme Court held that § 102(b)(1) was broader than the definition of “internal corporate claims” given in § 115.

Finally, the Delaware Supreme Court addressed concerns that its ruling could conflict with federal policy or pose issues of horizontal comity. Using established federal precedents, it concluded that Delaware could permit its corporations to impose FFPs. It then acknowledged that “[p]erhaps the most difficult aspect” of FFPs was the “question of whether they will be respected and enforced by our sister states.” Since FFPs did not apply to only “internal affairs” as that term had been defined under federal law, the Court acknowledged that they might not be “fully encompass[ed]” by the federal precedents. It then identified “persuasive arguments that could be made to our sister states” that FFPs should be enforced. Those arguments included that corporate charters are contractual in nature, shifting the burden of non-enforceability to plaintiffs; that Securities Act claims closely parallel state fiduciary claims which clearly are “internal affairs”; and that other states had permitted forum-selection clauses for fiduciary claims, and those clauses are arguably more restrictive than the FFPs at issue.

Recommendation

Companies should consider adopting bylaws that have FFPs and other similar forum selection clauses. Such bylaws will promote predictability and efficiency should companies be sued for federal securities violations or traditional fiduciary breach claims. Sciabacucchi v. Salzberg’s holding provides a powerful foundation on which to defend such bylaws.

Visit our website to learn more about V&E’s Shareholder Litigation & Enforcement practice. For more information, please contact Vinson & Elkins lawyers Michael Holmes, Craig Zieminski, or Bryan Gividen.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.