Delaware Court of Chancery Upholds Validity of Forum Selection Bylaws

by Reed Smith
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On June 25, 2013, in a judicial development that should ease the burden of multi-jurisdiction litigation, Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery held that forum selection bylaws adopted by the respective board of directors for Chevron and FedEx are statutorily and contractually valid. The companies’ respective bylaws designated Delaware state and federal courts as the sole and exclusive forum for lawsuits involving derivative claims, breach of fiduciary duty claims, claims arising out of the Delaware General Corporation Law and those companies’ “internal affairs,” unless the corporation consents to an alternative forum in writing.

Chancellor Strine observed that in the last three years, the boards of more than 250 publicly traded companies, including Chevron and FedEx, have adopted similar forum selection bylaws. These bylaws operate to designate Delaware courts as the exclusive forum for derivative litigation, breach of fiduciary duty litigation, disputes under the Delaware General Corporation Law (DGCL), and disputes involving the companies’ internal affairs, although they include a provision whereby the board of directors can assent to litigation in other forums. Chancellor Strine recites in his opinion that Chevron’s board adopted the bylaws due to concerns about “the inefficient costs of defending the same claim in multiple jurisdictions” and in order to “minimize or eliminate the risk of what they view as wasteful duplicative litigation.”

In February 2012, institutional plaintiffs, all represented by the same law firm, filed a total of 12 separate lawsuits challenging the defendant companies' adoption of an exclusive forum selection bylaw. Ten of the companies dropped their bylaws and the plaintiffs dropped their suits against those companies. However, Chevron and FedEx declined to drop the bylaws, and the cases against the two companies went forward.

The defendant companies moved for judgment on the pleadings as to the plaintiffs’ claims that the bylaws are per se beyond the board’s authority and contractually invalid, and therefore cannot be enforced like other contractual forum selection clauses because they were unilaterally adopted by the companies’ boards. In his opinion, Chancellor Strine granted the defendants’ motion.

First, Chancellor Strine ruled that the bylaws are valid under Delaware statutory law, specifying that bylaws may contain any provision 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 and employees.” The Chancellor noted that the bylaws related only to suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine. He found that the bylaws are “not facially invalid as a matter of statutory law.”

Second, Chancellor Strine held that the bylaws are valid and enforceable contractual forum selection clauses. The Chancellor said that the DGCL allows directors to adopt and amend bylaws unilaterally. Thus, “when investors bought stock in Chevron and FedEx, they knew…the certificates of incorporation gave the board the power to adopt and amend bylaws unilaterally.” Chancellor Strine rejected the argument that the bylaws were not enforceable because they had not been adopted by shareholders. Chancellor Strine went on to hold that “a forum selection clause adopted by a board with the authority to adopt bylaws is valid and enforceable under Delaware law to the same extent as other contractual forum selection clauses.”

As Chancellor Strine discussed, if a future plaintiff decides to disregard the bylaw and file a lawsuit in another jurisdiction, the defendant company will have to decide whether to invoke the bylaw and to seek to have the case dismissed because the suit was filed in the wrong court. Such future challenges will be subject to scrutiny under the principles of the U.S. Supreme Court’s decision in Bremen v. Zapata Off-Shore Co., which held that forum selection clauses are valid provided that they are “unaffected by fraud, undue influence or overweening bargaining power.” The forum selection clause should be enforced unless enforcement is shown by the resisting party to be “unreasonable.” In other words, the exclusive forum selection bylaws will be “presumptively, but not necessarily, situationally enforceable.”

It remains to be seen whether other jurisdictions will adopt the stance taken by the Delaware Chancery Court. In 2011, the United States District Court for the Northern District of California, in Galaviz v. Berg, refused to enforce the forum selection clause of a corporation which, like Chevron, was incorporated in Delaware with principal executive offices in California. However, the court indicated it was influenced by the fact that “the bylaw was adopted by the very individuals who [were] named as defendants…after the alleged wrongdoing took place.” Additionally, the Northern District of California declined to honor the forum selection bylaw on a motion to dismiss based on apparent invalidity under federal law and corporate law principles rather than state and contract law principles, upon which the Delaware Chancery Court relied. In fact, the California court acknowledged that it is “clear that a contractual venue clause may be enforceable even where it has not been expressly negotiated and there is an imbalance in bargaining power.” Similarly, in 2013, the United States District Court for the Southern District of New York declined to honor such bylaws in In re Facebook. There, the court held forum selection bylaws that became effective four days after Facebook’s IPO were not binding on claims arising out of the day of the IPO.

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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