Delaware Supreme Court Holds Federal Forum Selection Provisions for Claims Arising Under the Securities Act of 1933 Are Facially Valid
On March 18, 2020, the Delaware Supreme Court issued an important opinion holding that federal forum selection provisions adopted by Delaware corporations requiring that stockholders file actions arising under the Securities Act of 1933 (“1933 Act”) in federal court—and not state court—are facially valid. In so doing, the Delaware Supreme Court reversed the Court of Chancery’s decision in Sciabacucchi v. Salzberg and paved the way for other Delaware corporations to adopt similar federal forum selection provisions. Such provisions may prove useful to Delaware corporations seeking to avoid parallel litigation in state court under the 1933 Act—which actions are not removable to federal court under the U.S. Supreme Court’s decision in Cyan Inc. v. Beaver County Employees Retirement Fund.
In reversing the trial court’s summary judgment decision, the Delaware Supreme Court concluded that the authority conferred by Section 102(b)(1) of the Delaware General Corporation Law (“DGCL”) authorizes Delaware corporations to adopt forum selection provisions requiring that stockholders bring claims arising under the 1933 Act only in federal court. The Delaware Supreme Court held that such a federal forum selection provision “addresses the management of the business and the conduct of the affairs of the corporation, and is, thus, facially valid under Section 102(b)(1).” The Supreme Court also disagreed with the trial court’s conclusion that the authority conferred by Section 102(b)(1) was limited to the internal affairs of a corporation. Instead, the Supreme Court held that “Section 102(b)(1)’s plain language encompasses ‘intra-corporate’ matters that are not necessarily limited to ‘internal affairs.’” In so holding, the Supreme Court reaffirmed that “Section 102(b)(1)’s scope is broadly enabling” and that “the DGCL allows immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise.” Section 102(b)(1), however, is not without limits. For example, “there are purely ‘external’ claims, e.g., tort and commercial contract claims, which are clearly outside the bounds of Section 102(b)(1).” The Supreme Court explained that provisions regulating the forum for 1933 Act claims exist “in what might be called Section 102(b)(1)’s ‘Outer Band’” and included at Figure 1 of its opinion a diagram depicting the relationship among internal affairs, the outer band of intra-corporate affairs, and external affairs. Federal forum selection provisions exist within the “Outer Band” and “are facially valid under Delaware law because they are within the statutory scope of Section 102(b)(1).”
Continuing the evolution in the use of forum selection provisions, which many corporations first adopted in response to the ills associated with multi-forum stockholder challenges to disclosures in public company transactions, the Delaware Supreme Court suggested that federal forum selection provisions served a salutary policy purpose by providing corporations “with certain efficiencies in managing the procedural aspects of securities litigation” by avoiding the “costs and inefficiencies of multiple cases being litigated simultaneously in both state and federal courts.” Providing empirical support for its suggestion, the Delaware Supreme Court pointed to the Cornerstone 2019 Year in Review Report, which observed that “[t]he number of state 1933 Act filings in 2019 increased by 40 percent from 2018,” and that “[a]bout 45 percent of all state 1933 Act filings in 2019 had a parallel action in federal court.”
Although the issue before the Supreme Court involved the facial validity of federal forum selection provisions included in pre-IPO Delaware corporations’ charters, such that the public stockholders all acquired shares with actual or constructive knowledge of the provisions, the Supreme Court suggested that existing case law supported the view that such provisions “in stockholder-approved charter amendments should be respected as a matter of policy.” Facial validity, however, does not immunize a federal forum provision from challenge. Rather, the “question of enforceability is a separate, subsequent analysis that ... depends on the manner in which it was adopted and the circumstances under which it [is] invoked.” Such provisions might be invalidated if they were deemed the product of fraud or overreaching, if enforcement would be unreasonable and unjust, or if they contravened strong public policy of the forum.
Beyond the Supreme Court’s ruling, corporations and practitioners will necessarily want to consider the scope of what—in addition to claims under the 1933 Act—may be swept within a forum selection provision as part of the broader “intra-corporate affairs” of Delaware corporations under Section 102(b)(1) of the DGCL. Although some claims are clearly external matters, the Court observed that the DGCL addresses numerous situations involving the “purchase or transfer of shares” which may fall within the outer band of matters that may be the subjects of facially valid forum provisions. The contours of that band require careful analysis, and will certainly be the subject of further litigation.
Should you have any questions or need advice regarding the potential adoption of a forum selection provision, please contact S. Mark Hurd.
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