Delaware Court of Chancery Upheld Enforceability of Bylaws with Forum Selection Clauses Unilaterally Adopted by Board of Directors

by Sheppard Mullin Richter & Hampton LLP
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In Boilermakers Local 154 Retirement Fund v. Chevron Corp., C.A. No. 7220-CD, 2013 WL 3191981 (Del. Ch. June 25, 2013), the Delaware Court of Chancery dismissed facial challenges to the validity of corporate bylaws that restrict the forum where corporate governance litigation may be brought. The court rejected the argument that the bylaws were statutorily invalid because they went beyond the board’s authority under the Delaware General Corporation Law (“DGCL”). The court also rejected the argument that the bylaws were contractually invalid under The Bremen v. Zapata Offshore Co., 407 U.S. 1 (1972), which holds that unreasonable forum selections clauses are unenforceable. This decision undoubtedly will result in the increased promulgation of such bylaws, greatly limiting (if not eliminating) the risk and cost of identical stockholder suits challenging board actions pursued in multiple jurisdictions.

Between 2010 and 2012, the boards of directors of Chevron and FedEx, both Delaware corporations, adopted amendments to their bylaws requiring that all lawsuits involving challenges to corporate governance be brought exclusively in Delaware. The boards did this in an effort to deter burdensome multijurisdiction stockholder litigation.

In this consolidated action, plaintiff stockholders sued the boards challenging the facial statutory and contractual validity of the bylaws. Defendants moved for judgment on the pleadings to dismiss plaintiffs’ facial challenges to the bylaws.

The court held the bylaws statutorily valid under the DGCL. Section 109(b) of the DGCL provides that the bylaws of a corporation “may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers, or employees.” In upholding the validity of the bylaws under Section 109(b), the court reasoned that internal affairs claims relate quintessentially to the corporation’s business and conduct. Also, the bylaws address the “rights” of the stockholders by regulating where stockholders can assert their internal affairs claims. The court further reasoned that the bylaws were not inconsistent with the law because Delaware respects the internal affairs doctrine, which recognizes that the laws of the state of an entity’s incorporation should govern a its internal affairs. Additionally, Delaware corporate bylaws are process oriented, meaning that bylaws typically do not contain substantive mandates but direct how the corporation, the board and its stockholders may take certain actions. The bylaws at issue were process oriented, in that they did not regulate what suits may be brought against the corporation, only where suits may be brought.

The court held the bylaws contractually valid despite being adopted by the board unilaterally. The court explained that a Delaware corporation’s bylaws are part of a flexible but binding contract among the directors, officers and stockholders. The DCGL allows the corporation, through the certificate of incorporation, to grant directors the power to unilaterally adopt and amend the bylaws per Sections 109(a) and (b). The certificates of incorporation of Chevron and FedEx contained a provision conferring this power on the boards. As such, the court held, plaintiffs were on notice that the directors had the power to amend the bylaws unilaterally and assented to this power when they purchased stock in the corporation. The court also noted that its holding is supported by Carnival Cruise Line, Inc. v. Shute, 499 U.S. 585, 588 (1991), which held the forum selection provision printed on a ticket after a customer had purchased the ticket was enforceable.

In its opinion, the court responded to a number of plaintiffs’ arguments. First, the court disagreed with plaintiffs’ argument that stockholders’ rights may not be regulated by board-adopted bylaws. The court reasoned that plaintiffs attempted to revive the outdated “vested rights” doctrine.

Second, the court refused to entertain plaintiffs’ hypotheticals illustrating how the bylaws might operate unreasonably. The court reasoned that it is inappropriate to address hypotheticals in the absence of a genuine controversy with concrete facts, and stressed that the court does not render advisory opinions. The Delaware Supreme Court had previously adopted Bremen in Ingres Corp. v. CA, Inc., 8 A.3d 1143 (Del. 2010), which held forum selection clauses presumptively enforceable and subject to as-applied review in real-world situations.

Third, the court disagreed with plaintiff’s assertion that the bylaws prohibit parties from asserting claims over which federal courts have exclusive subject matter jurisdiction. The court explained that the bylaws do not prohibit parties from bringing claims in federal court, and that plaintiffs even conceded that the majority of claims covered by the bylaws would most likely be state law claims.

The court also noted other mechanisms that stockholders could use to challenge the bylaws. Stockholders can repeal bylaws by majority vote pursuant to Section 109(a). They can influence board of directors elections pursuant to Section 211. Additionally, they can cite Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437, 439 (Del. 1971), in support of an argument that the bylaws serve purposes inconsistent with the directors’ fiduciary duties. When a genuine controversy with concrete facts arises, stockholders also can cite Bremen to support an argument that the bylaws are unreasonable.

This decision is important for several reasons. First, the number of corporations with forum selection bylaws will increase. Second, adoption of forum selection bylaws will curb the rise of duplicative suits brought in multiple courts against the same defendants for the same alleged wrongdoing. This will promote judicial efficiency and reduce the legal costs expended by corporations on redundant multiforum litigation.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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