Over the past several years, companies conducting public offerings have increasingly been subject to parallel shareholder class actions under Section 11 of the Securities Act of 1933 brought in both federal and state courts. The U.S. Supreme Court’s 2018 decision in Cyan—holding that Section 11 claims brought in state court are not removable to federal court–accelerated that trend. In response, several companies adopted federal-forum selection charter provisions (“FFPs”), requiring that shareholders bring Securities Act claims in federal court.
Before conducting IPOs in 2017, three Delaware corporations – Blue Apron Holdings, Inc., Roku, Inc., and Stitch Fix, Inc.—adopted FFPs. After buying shares in each company, Matthew Sciabacucchi brought a declaratory judgment action in the Delaware Court of Chancery seeking to invalidate these FFPs under Delaware law. The Delaware Court of Chancery agreed with Sciabacucchi that FFPs are facially invalid under Delaware corporate law 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.”
In a unanimous opinion authored by Justice Karen Valihura, the Delaware Supreme Court disagreed with the Chancery Court and reversed, holding that FFPs could withstand a facial challenge under Delaware law.
Following the Cyan decision, state courts saw a notable uptick in 1933 Act cases. Not only did the percentage of filings in state courts increase, but there was an overall increase in 1933 Act filings in both state courts and federal courts, with approximately 75 percent of all such filings either in state court or with parallel filings in different jurisdictions in 2019. Given the lack of a procedural mechanism to consolidate or coordinate parallel state and federal actions, companies conducting public securities offerings faced increased litigation costs and risked disparate outcomes. Companies adopted FFPs to minimize these risks.
1. The Plain Language of DGCL Section 102(b)(1) Permits FFPs.
The Delaware Supreme Court concluded that FFPs are facially valid because they “could easily fall within either” of two broad categories of permissible charter provisions outlined by DGCL Section 102(b)(1): (1) “any provision for the management of the business and for the conduct of the affairs of the corporation” and (2) “any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, . . . if such provisions are not contrary to the laws of this State.” The Court explained that 1933 Act claims arise out of the directors’ “management of its business and affairs and of its relationship with its stockholders.” Bylaws that “regulate the forum in which such ‘intra-corporate’ litigation can occur” are facially valid under Section 102(b)(1) because they are tied to the “‘management of the business’ and the ‘conduct of the affairs of the corporation.’”
By allowing FFPs to remain intact, the Delaware Supreme Court recognized the need for companies to minimize the attendant risks of parallel litigation and the potential for inconsistent judgments and increased litigation costs.
2. FFPs Do Not Conflict With Delaware Public Policy.
The Delaware Supreme Court also concluded that FFPs are not contrary to the policies or laws of Delaware. In reliance on Delaware’s strong policy favoring the “will of stockholders,” including their approval of FFPs in charter amendments, the Delaware Supreme Court explained that such stockholder-approved amendments “should be respected as a matter of policy” and “should not be deemed violative of Delaware’s public policy.” The Delaware Supreme Court also reminded litigants and corporations of the flexibility embodied in Delaware’s corporate law, which provides “immense freedom for businesses to adopt the most appropriate terms” to govern themselves.
3. FPs Relate to Intra-Corporate Claims.
The Delaware Supreme Court rejected the lower court’s attempt to limit forum selection clauses to matters that are only “internal” or “intra-corporate” (e.g., breach of fiduciary duty claims). In reaching its conclusion, the Delaware Supreme Court explained that not only are 1933 Act claims “internal” insofar as “they arise from internal corporate conduct,” the Delaware Court of Chancery improperly attempted to limit the internal affairs doctrine contrary to the plain meaning of DGCL Section 102(b)(1), and it also ran afoul of both U.S. Supreme Court and Delaware Supreme Court precedent.
In overturning the Delaware Court of Chancery’s decision, the Delaware Supreme Court reaffirmed both the flexibility and breadth of Delaware’s corporate code. But the Delaware Supreme Court also recognized potential “down the road” questions concerning enforceability of FFPs by “sister states,” noting that “[t]he question of enforceability is a separate, subsequent analysis that should not drive the initial facial validity inquiry.” As a practical matter, the key question in determining the efficacy of FFPs will be whether state courts outside of Delaware—particularly state courts in California, where the majority of state court Section 11 claims are brought—will enforce the provisions.
Companies that may engage in public offerings (in capital raising, acquisition, or other contexts) may wish to implement an FFP in their own bylaws or charter, along with the forum selection provision addressing fiduciary and certain other claims that was previously approved by the Delaware Court of Chancery and has been implemented by many companies.