Delaware Court Rules That Forum Selection Bylaws Are Not Per Se Invalid

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May the board of directors of a Delaware corporation adopt a bylaw that binds stockholders to bring particular types of causes of action against the corporation or its directors in Delaware? In contrast to caselaw elsewhere ruling that a board-adopted forum selection clause was unenforceable, the Court of Chancery has answered this question in the affirmative. In Boilermakers Local 154 Retirement Fund v. Chevron Corporation, C.A. Nos. 7220-CS and 7238-CS (Del. Ch. June 25, 2013), the court held that such forum selection bylaws “easily meet” the requirements of Section 109(b) of the Delaware General Corporation Law (DGCL). A copy of the decision may be found here.

A forum selection bylaw is a provision in a corporation’s bylaws that designates a forum as the exclusive venue for certain stockholder suits against the corporation, either as an actual or nominal defendant, and its directors and employees. As discussed in an earlier Pepper Hamilton Client Alert, several purported class action lawsuits filed in 2012 challenged the validity of forum selection bylaws adopted by the boards of directors of several Delaware corporations. Those bylaws purported to require certain types of corporate law claims be brought and resolved in Delaware. Forum selection bylaws have been advanced as a way to reduce costly, and arguably wasteful, multijurisdictional litigation, an issue with respect to which the Delaware Supreme Court (and others) have recently expressed concern.

While many of the defendant corporations mooted the challenge to their forum selection bylaws by repealing them, a few defendants answered and proceeded to litigate the challenge in the Delaware Court of Chancery. After discovery began and litigation costs rose, the court permitted the defendants to file a motion for judgment on the pleadings focusing on the question of the facial validity of the bylaws. It was hoped that a ruling on the bylaws’ facial validity under statutory and contractual principles might, as a practical matter, avoid unnecessary additional litigation expense and resolve an important legal question. The Court of Chancery noted that more than 250 publicly traded corporations have adopted such provisions in the last three years.

After extensive briefing and argument, the court determined that the forum selection bylaws are not facially invalid under the Delaware corporate statute:

The bylaws regulate the forum in which stockholders may bring suit, either directly or on behalf of the corporation in a derivative suit, to obtain redress for breaches of fiduciary duty by the board of directors and officers. The bylaws also regulate the forum in which stockholders may bring claims arising under the DGCL or other internal affairs claims. In other words, the bylaws only regulate suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine. ... Thus, the bylaws, by establishing these procedural rules for the operation of the corporation, plainly relate to the “business of the corporation[s],” the “conduct of [their] affairs,” and regulate the “rights or powers of [their] stockholders.” Because Delaware law, like federal law, respects and enforces forum selection clauses, the forum selection bylaws are also not inconsistent with the law. For these reasons, the forum selection bylaws are not facially invalid as a matter of statutory law.

In addition, the court ruled that the bylaws are not facially invalid under contractual principles. The court rejected the notion that a stockholder’s ability to choose a venue for litigation, unhindered by a forum selection bylaw, is a vested right. Rather, stockholders are on notice that, as to those subjects that may be regulated by bylaw under 8 Del. C. § 109(b), the board may act unilaterally:

[T]he bylaws of a Delaware corporation constitute part of a binding broader contract among the directors, officers, and stockholders formed within the statutory framework of the DGCL. This contract is, by design, flexible and subject to change in the manner that the DGCL spells out and that investors know about when they purchase stock in a Delaware corporation. The DGCL allows the corporation, through the certificate of incorporation, to grant the directors the power to adopt and amend the bylaws unilaterally. The certificates of incorporation … authorize their boards to amend the bylaws. Thus, when investors bought stock …, they knew (i) that consistent with 8 Del. C. § 109(a), the certificates of incorporation gave the boards the power to adopt and amend bylaws unilaterally; (ii) that 8 Del. C. § 109(b) allows bylaws to regulate the business of the corporation, the conduct of its affairs, and the rights or powers of its stockholders; and (iii) that board-adopted bylaws are binding on the stockholders. In other words, an essential part of the contract stockholders assent to when they buy stock … is one that presupposes the board’s authority to adopt binding bylaws consistent with 8 Del. C. § 109. For that reason, our Supreme Court has long noted that bylaws, together with the certificate of incorporation and the broader DGCL, form part of a flexible contract between corporations and stockholders, in the sense that the certificate of incorporation may authorize the board to amend the bylaws’ terms and that stockholders who invest in such corporations assent to be bound by board-adopted bylaws when they buy stock in those corporations.

The Court of Chancery emphasized that stockholders are free to change or eliminate board-enacted forum selection bylaws by using the ballot box; for instance, repeal can be accomplished directly by majority vote of stockholders, or indirectly through electoral discipline of directors. The Court of Chancery expressly declined to address hypothetical situations in which forum selection bylaws might be found to operate unreasonably, leaving open the possibility of a successful “as-applied” challenge to their enforceability. The Court of Chancery’s decision remains subject to appeal to the Delaware Supreme Court.

Topics:  Board of Directors, Bylaws, Corporate Governance, Forum Selection Clause

Published In: Business Organization Updates, Civil Procedure Updates, General Business Updates

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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