Source: https://blog.hfk.law/
Timestamp: 2019-04-20 16:49:15+00:00

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Delaware corporations can adopt forum-selection bylaws naming Delaware as the exclusive forum for stockholder claims related to the internal affairs of the corporation. However, based on a recent Court of Chancery ruling, Delaware corporations cannot adopt charter provisions that require plaintiffs to go to federal court (rather than state court) to assert any claims made under the federal securities laws.
Forum selection bylaws require stockholder plaintiffs to bring actions for breach of fiduciary duty and other matters related to the internal affairs of a corporation in a specific jurisdiction. In 2013, Chief Justice Leo E. Strine, Jr., then serving on the Court of Chancery, ruled in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), that Delaware forum selection bylaws are valid and enforceable.
On the other hand, federal-forum charter provisions require plaintiffs to bring actions under the federal securities laws in federal court and not in state court. In an opinion issued on December 19, 2018, Sciabacucchi v. Salzberg, Del. Ch. C.A. No. 2017-0931-JTL, Vice Chancellor J. Travis Laster ruled that federal-forum charter provisions are “ineffective and invalid.” The difference is that forum selection bylaws apply only to actions involving the internal affairs of the corporation, while federal forum provisions apply to the external act of buying shares—at which point the buyer is not yet a stockholder of the corporation.
The “internal affairs doctrine” means, for example, that “Delaware corporate law can specify the rights, powers, and privileges of a share of stock, determine who holds a corporate office, and adjudicate the fiduciary relationships that exist within the corporate form.” In other words, internal affairs include ownership of stock, the roles of officers and directors, and fiduciary duties. However, Delaware’s authority over a Delaware corporation does not extend to the corporation’s “external relationships, particularly when the laws of other sovereigns govern those relationships.” Federal law governs the relationships between buyers and sellers of securities. Delaware law governs the relationships between Delaware corporations and their directors, officers, and stockholders.
In Sciabacucchi, three Delaware corporations, Blue Apron Holdings, Inc., Roku, Inc., and Stitch Fix, Inc., launched initial public offerings in 2017. Each of the three corporations adopted a provision in its certificate of incorporation stating that “the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933.” The Securities Act of 1933, or the ’33 Act, requires companies offering securities to the public “to make full and fair disclosure of relevant information” by filing registration statements with the United States Securities and Exchange Commission (SEC). The ’33 Act created private causes of action for investors and provided that those claims could be brought in state or federal court. On March 20, 2018, in Cyan, Inc. v. Beaver County Employees’ Retirement Fund, 138 S. Ct. 1061, the Supreme Court of the United States confirmed that ’33 Act claims can be brought in state or federal court and, if brought in state court, cannot be removed to federal court.
In Sciabacucchi, the plaintiff, who held shares of stock in each of the three corporations, brought an action in the Delaware Court of Chancery challenging the federal forum provisions and seeking a declaration that the provisions were invalid. The parties filed cross-motions for summary judgment. The Court found that the matter was ripe for adjudication because of the likely deterrent effect of the provisions on plaintiffs who would otherwise bring their actions in state court, and the likelihood that similar provisions would be adopted by other corporations.
The Court traced the origin of corporate forum-selection provisions to “an epidemic of stockholder litigation,” including “frequently meritless” actions that were settled for “non-monetary relief and an award of attorneys’ fees.” In 2010, Vice Chancellor Laster suggested in In re Revlon, Inc. Shareholders Litigation, 990 A.2d 940, that the filing of multiple lawsuits in multiple jurisdictions could be mitigated by the adoption of bylaws requiring stockholder litigation to be brought in the jurisdiction of incorporation. In 2013, then-Chancellor Strine held in Boilermakers that those bylaws were valid under Delaware law. By August 2014, 746 publicly traded corporations had adopted such forum-selection bylaws.
In 2015, the Delaware General Assembly codified the holding of Boilermakers by adopting a new Section 115 of the Delaware General Corporation Law (DGCL). Section 115 provides that a Delaware corporation’s charter or bylaws may require “internal corporate claims” to be brought in Delaware courts. The term “internal corporate claims” was defined to include claims of breach of fiduciary duty and claims based on the DGCL. However, the statute said nothing about external claims, including securities law claims—it was understood that corporate documents could not be used to regulate external claims.
The DGCL contains provisions stating the subjects (in short, internal affairs) that may be addressed by bylaws and certificates of incorporation. Compare 8 Del. C. § 102(b)(1) (charters) and 8 Del. C. § 109(b) (bylaws). Based on the similarities between the provisions, Vice Chancellor Laster in Sciabacucchi found that the holding of Boilermakers with respect to bylaws should apply equally to certificates of incorporation.
Assuming that Sciabacucchi is not reversed on appeal, Delaware law allows Delaware corporations to adopt forum selection bylaws or charter provisions governing actions related to the internal affairs of the corporation, but does not allow Delaware corporations to adopt federal-forum provisions governing federal securities law claims. Delaware corporations can and should adopt bylaws or charter provisions naming Delaware as the exclusive forum for actions related to the internal affairs of the corporation. Those provisions are effective to limit multi-jurisdiction stockholder litigation. Delaware corporations may not, however, adopt bylaws or charter provisions that name the federal courts as the exclusive forum for federal securities law actions. Those actions can still be brought in any state or federal court that has jurisdiction over the defendants.
In California State Teachers’ Retirement System v. Alvarez, 2018 Del. LEXIS 41 (Del. Jan. 25, 2018), the Delaware Supreme Court affirmed the Court of Chancery’s dismissal of a derivative suit against the board of directors of Wal-Mart Stores, Inc., finding that the claims were precluded because a similar suit in an Arkansas federal court had been dismissed for the stockholder plaintiffs’ failure to make a demand for action on the board, or to plead that such a demand would be futile. The Court found that the Arkansas plaintiffs’ representation of the corporation’s stockholders was not “grossly deficient” despite their failure to make a demand for inspection of corporate books and records under Section 220 of the Delaware General Corporation Law. The Court also rejected Chancellor Andre G. Bouchard’s recommendation that it adopt a more plaintiff-friendly standard.
The Delaware and Arkansas suits both asserted claims for breach of fiduciary duty against Wal-Mart’s directors for failure to adequately oversee the company’s Mexican unit, Wal-Mart de Mexico (WalMex), whose executives allegedly engaged in a bribery scheme and cover-up. Following an April 2012 report in the New York Times, eight derivative complaints were filed in the United States District Court for the Western District of Arkansas, and seven more were filed in the Delaware Court of Chancery. The Arkansas court initially stayed its proceedings pending the Delaware action. At the urging of then-Chancellor Leo Strine, the Delaware plaintiffs sought Wal-Mart’s books and records under Section 220. However, the “unusually contentious” Section 220 action dragged on for three years.
Meanwhile, in 2013, the Arkansas court’s stay was lifted and, on March 31, 2015, the Arkansas court granted the director defendants’ motion to dismiss with prejudice for the plaintiffs’ failure to make demand or plead demand futility as required by Rule 23.1 of the Federal Rules of Civil Procedure. One month later, on May 1, 2015, the Delaware plaintiffs amended their complaint based on what they had learned from Wal-Mart’s books and records. The director defendants moved to dismiss the amended complaint based on res judicata, or issue preclusion, arguing that the Delaware plaintiffs were precluded by the Arkansas dismissal from pleading that demand was excused as futile.
Chancellor Bouchard granted the motion to dismiss based on res judicata. The stockholder plaintiffs appealed to the Delaware Supreme Court, arguing, among other things, that they were denied their federal right of due process. The Delaware Supreme Court affirmed the dismissal, finding that the issues were the same in both actions and that the plaintiffs in the two actions were “in privity,” or had identical interests, because, under applicable Arkansas law and federal law, the real party in interest in both cases was the corporation.
The Delaware Supreme Court disagreed, finding that all three federal circuit courts of appeal that addressed the issue held that stockholder plaintiffs’ due process rights were protected “when their interests were aligned with and were adequately represented by the prior plaintiffs,” and that “most other cases” granted preclusive effect to prior Rule 23.1 dismissals.
The Delaware Supreme Court found that the Arkansas plaintiffs and the Delaware plaintiffs had an identity of interests, that they were both aware that a judgment in one case could have a preclusive effect on the other case, and that the Arkansas stockholder plaintiffs adequately represented the Delaware stockholder plaintiffs. As to adequacy of representation, the Delaware Supreme Court found that “(i) the quality of their representation was not grossly deficient, and (ii) their economic interests were not antagonistic to other stockholders.” The Court found that the Arkansas plaintiffs decided not to make a Section 220 demand – as urged by then-Chancellor Strine – because they thought that documents in the public domain cited in the New York Times article were sufficient to plead demand futility. Although that turned out to be a “tactical error,” the decision not to make a Section 220 demand “in this instance does not rise to the level of constitutional inadequacy.” (Emphasis in original).
The Delaware Supreme Court thus left open the possibility that failure to make a Section 220 demand could in another instance make a plaintiff an inadequate representative, which would allow a subsequent plaintiff to proceed without preclusion. The Court agreed, however, with the Court of Chancery’s conclusion that “it does not follow that plaintiffs are necessarily inadequate representatives because their counsel chose not to follow a recommended strategy in a different action, even one suggested by a preeminent corporate jurist, particularly when they are litigating in a different jurisdiction before a different judiciary.” The Arkansas plaintiffs were not inadequate representatives merely because they failed to make a Section 220 demand or because they subsequently failed to adequately plead demand futility.

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