United States: Delaware Chancery Invalidates Exclusive Federal Forum Provisions

Last Updated: January 2 2019
Article by Cydney Posner

In March 2018, in Cyan Inc. v. Beaver County Employees Retirement Fund, SCOTUS held that state courts continue to have concurrent jurisdiction over class actions alleging only '33 Act violations by private plaintiffs and that defendants cannot remove actions filed in state court to federal court. (See this PubCo post.) Both before and especially after Cyan, to avoid state court litigation of '33 Act claims (and forum shopping by plaintiffs for the most favorable state court forum), many companies adopted "exclusive forum" provisions in their charters or bylaws that designated the federal courts as the exclusive forum for litigation under the '33 Act. Delaware law expressly permits the adoption of charter or bylaw provisions that designate Delaware as the exclusive forum for adjudicating "internal corporate claims," i.e., claims, including derivative claims, that are based on a violation of a duty by a current or former director or officer or stockholder or as to which the corporation law confers jurisdiction on the Court of Chancery. However, federal securities class actions are not expressly included. (See this PubCo post.)

The enforceability of "exclusive federal forum" provisions was then challenged in the Delaware courts in a case seeking a declaratory judgment to invalidate the provisions included in the Delaware Certificates of Incorporation of three companies. And, after Cyan, that Delaware case took on much greater significance. A decision in that case, Sciabacucchi v. Salzberg, has now been rendered by the Delaware Chancery Court. On cross-motions for summary judgment, Vice Chancellor Laster held that all three of the exclusive federal forum provisions at issue in that case were invalid.

Facts of the case. In this case, three Delaware companies adopted exclusive federal forum provisions in their charters prior to their IPOs. The provisions were identical in two cases, stating as follows: "Unless the Company consents in writing to the selection of an alternative forum, 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. Any person or entity purchasing or otherwise acquiring any interest in any security of the Corporation shall be deemed to have notice of and consented to [this provision]." In the other instance, the provision was essentially the same but included a savings clause, specifying exclusive federal jurisdiction but only "to the fullest extent permitted by law."

DGCL. In 2015, the DGCL was amended to expressly permit companies to adopt, in their bylaws and charters, forum-selection provisions applicable to "internal corporate claims," that is, "claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery." Although the DGCL does not explicitly state that the charter or bylaws cannot include forum-selection provisions addressing other types of claims, the Court pointed to commentary by members of the Corporation Law Council suggesting that the corporate charter and bylaws could not be used to regulate external claims and that a securities law claim was not an "internal corporate claim."

Prior case law. In addition, in a case that predated the statutory amendment, Boilermakers Local 154 Ret. Fund v. Chevron Corp., Chief Justice Strine (while still on the Chancery Court) held that a corporation can adopt a forum-selection bylaw for internal-affairs claims, that is, to regulate "internal affairs claims brought by stockholders qua stockholders," but, VC Laster noted, not "to regulate external relationships. The Boilermakers decision noted that a bylaw cannot dictate the forum for tort or contract claims against the company, even if the plaintiff happens to be a stockholder." While the Boilermakers decision concerned bylaws, VC Laster saw no difference with regard to corporate charters. DGCL Section 102(b)(1), which provides general authority for non-mandatory charter provisions is, the Court contended, inherently limited to internal affairs.

According to the Court, Boilermakers is determinative:

"The Boilermakers distinction between internal and external claims answers whether a forum-selection provision can govern claims under the 1933 Act. It cannot, because a 1933 Act claim is external to the corporation. Federal law creates the claim, defines the elements of the claim, and specifies who can be a plaintiff or defendant.... A claim under the 1933 Act does not turn on the rights, powers, or preferences of the shares, language in the corporation's charter or bylaws, a provision in the DGCL, or the equitable relationships that flow from the internal structure of the corporation."

Under Boilermakers, a 1933 Act claim is distinct from "internal affairs claims brought by stockholders qua stockholders." Rather, a "1933 Act claim resembles a tort or contract claim brought by a plaintiff who happens also to be a stockholder, but under circumstances where stockholder status is incidental to the claim. A 1933 Act claim is an external claim that falls outside the scope of the corporate contract."

First Principles. Moreover, reasoning from "first principles," VC Laster here distinguishes the authority of Delaware and its courts to regulate internal affairs with respect to corporations that are entirely creations of Delaware law (under the "internal-affairs doctrine"), as compared with the corporation's external relationships, where Delaware may not have authority and which may be governed by other state's laws (such as antitrust or labor law), even when the party asserting the claim happens to be a stockholder:

"Envision a customer who happens to own stock and who wishes to assert a product liability claim against the corporation. Even though the corporation's relationships with its customers are part of its business and affairs, and even though the customer-stockholder plaintiff would own stock, the shares are incidental to the operative legal relationship. Only a state exercising its territorial authority can regulate the product liability claim. Because the claim exists outside of the corporate contract, it is beyond the power of state corporate law to regulate."

That limitation applies even to shares that may have been stolen or where the stockholder asserts a claim for fraud in connection with the purchase of the shares. In that case,

"the claim for fraud is not an attribute of the shares and does not arise out of the corporate contract. Whether a purchaser of securities may have bought shares in a Delaware corporation is incidental to a claim under the 1933 Act. That happenstance does not provide a sufficient legal connection to enable the constitutive documents of a Delaware corporation to regulate the resulting lawsuit. The claim does not arise out of the corporate contract and does not implicate the internal affairs of the corporation. To the contrary, assuming the securities in question are shares, the claim arises from the investor's purchase of the shares. At the time the predicate act occurs, the purchaser is not yet a stockholder and lacks any relationship with the corporation that is grounded in corporate law.

"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 this case, the Federal Forum Provisions attempt to accomplish that feat. They are therefore ineffective and invalid."

Savings clause. Finally, the Court held that even the forum-selection provision with the savings clause was invalid because there was "no context" in which it could "operate validly"; that is, there was nothing left in the forum-selection provision "for the savings clause to save."

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