Prior to this decision, which reversed the Delaware Court of Chancery’s ruling, many Securities Act claims were brought in state courts across the country, which led to not only inconsistent and unpredictable rulings, but also increased premiums for D&O insurance policies. The Delaware Supreme Court’s decision in Salzberg, however, makes clear that Delaware corporations, through federal forum selection provisions, can mitigate the problems presented by duplicative state court and multi-forum litigations of Securities Act claims — many of which arise from public securities offerings.
Background
Plaintiff-below, appellee Matthew Sciabacucchi filed a complaint in the Delaware Court of Chancery against three companies that had adopted federal forum selection provisions for Securities Act claims. The plaintiff sought a declaratory judgment that the federal forum selection clauses are facially invalid under Section 102(b)(1) of the Delaware General Corporation Law (DGCL), 8 Del. C. section 102(b)(1), which statute governs matters contained in a corporation’s charter. On a motion for summary judgment, the Court of Chancery held that federal forum selection provisions “are ineffective and invalid” because the “constitutive documents of a Delaware corporation 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 corporate law.” Defendants appealed to the Delaware Supreme Court.
Holding and Analysis
As the Delaware Supreme Court explained, federal forum selection provisions were broadly implemented in response to the United States Supreme Court’s decision in Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund, 138 S. Ct. 1061 (2018), which allowed state courts to retain concurrent jurisdiction for Securities Act claims. As a result of the decision in , plaintiffs and their counsel increasingly filed Securities Act claims in state courts to avoid defendant-friendly provisions in the Private Securities Litigation Reform Act (PSLRA) that only apply in federal court. Corporations sought to prohibit this practice with federal forum selection provisions. Corporations often find federal courts more favorable than state courts for securities claims because a motion to dismiss in federal court triggers an automatic stay of discovery under the PSLRA, which reduces litigation costs. In addition, dismissals are higher in federal court, with studies showing that between 2011 and 2018, 42% of Securities Act claims filed in federal court were dismissed, compared to 19% in state courts.
There were several notable aspects of the Delaware Supreme Court’s decision. First, the Delaware Supreme Court’s analysis started with a textual analysis of Section 102(b)(1) of the DGCL. The Court held that the plain language of Section 102(b)(1) broadly allows corporate charters to include any provisions “for the management of the business and for the conduct of the affairs of the corporation” and any provision “creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of stockholders, … if such provisions are not contrary to” Delaware law. The Court reasoned that federal forum selection provisions could fall within either of these categories because Securities Act claims are related to the management of litigation arising from public securities offerings, and because the drafting, reviewing, and filing of securities registration statements with the Securities and Exchange Commission are part of the corporation’s management and its relationship with stockholders.
Second, the Delaware Supreme Court rejected the Court of Chancery’s reasoning that Securities Act claims are inherently “external” to the corporation. The Court held that Securities Act claims “are ‘internal’ in the sense that they arise from internal corporate conduct on the part of the Board and, therefore, fall within Section 102(b)(1)” of the DGCL. The Court explained that “Section 102(b)(1)’s plain language encompasses ‘intra-corporate’ matters that are not necessarily limited to ‘internal affairs.’” Because it was possible that the federal forum selection provisions “could apply to [such] an intra-corporate claim,” the Court reasoned the Court of Chancery had “narrowed the broad enabling scope of Section 102(b)(1) in a way that is inconsistent with decisions by this Court and with the overall statutory scheme” of the DGCL. The Court reiterated that “the DGCL allows immense freedom for business to adopt the most appropriate terms for the organization, finance, and governance of their enterprise” and “was intended to provide directors and stockholders with flexibility and wide discretion for private ordering and adaptation to new situations.”
It is important to note that, while the Court’s discussions focused on claims under Sections 11 and 12 of the Securities Act (the typical claims filed by plaintiffs), it is likely that claims under other sections of the Securities Act would be considered “intra-corporate” and fit under the Court’s analysis of Section 102(b)(1). The purview of Section 102(b)(1), however, has limits. For example, the Court explained that “there are purely ‘external’ claims, e.g., tort and commercial contract claims, which are clearly outside the bounds of Section 102(b)(1).”
Third, the Delaware Supreme Court addressed whether federal forum selection provisions violate federal law or policy, and the Court held that they do not. In reaching this holding, the Court cited two decisions from the United States Supreme Court, Rodriquez de Ouijas v. Shearson, which held that Securities Act claims may be subject to binding arbitration, and M/S Bermen v. Zapata Off-Shore Co., which required courts to enforce forum selection clauses unless necessary to avoid a result contrary to positive law or a fundamentally inequitable result.
Fourth, the Delaware Supreme Court addressed whether its holding would inappropriately limit the jurisdiction of other states to adjudicate Securities Act claims. The Court found that federal forum selection provisions do not offend the sovereignty of other states, citing, among other things, the deference accorded by other states to contractual forum-selection provisions.
Finally, the Delaware Supreme Court noted in a footnote that much of the concern over the federal forum selection provisions related to the “next move” of corporations requiring “arbitration of internal corporate claims.” The Court stated, however, in dicta, that such provisions “would violate Section 115” of the DGCL, 8 Del. C. section 115.
Takeaways
The case could affect public companies that already have federal forum selection provisions in their charters or bylaws, as well as other companies that are considering such provisions. The implications of this decision essentially allows a Delaware corporation to undo Cyan and force plaintiffs to litigate Securities Act claims in federal court. Again, this helps avoid multi-forum litigation and the inherent uncertainties with litigating Securities Act claims in state court, as well as ensuring that all provisions of the PSLRA are enforced. Insurance carriers also may view federal forum selection provisions as reducing litigation risks and costs associated with public offerings and reduce premiums accordingly.
It is still uncertain how other state courts will react. Will other states follow the reasoning of the Delaware Supreme Court, and will courts permit companies incorporated outside Delaware to enact federal forum selection provisions? In the meantime, corporations that do not have such federal forum selection provisions in their charters or bylaws, including public corporations and corporations considering initial public offerings, should evaluate with counsel whether such provisions should be added to charters or bylaws, including in advance of a public offering, to ensure the corporation is best positioned to manage claims for Securities Act liability.
Client Alert 2020-153
