In light of Delaware case law developments over the past year, exclusive forum provisions are being increasingly adopted by public companies. What should you know about this complex but important area of corporate governance?
1. What are these provisions?
Exclusive venue provisions limit a stockholder’s ability to bring suit generally for claims of breach of fiduciary duty, derivative suits and similar violations of corporate law. The vast majority of public companies are incorporated in Delaware; for them, the relevant corporate law is the Delaware General Corporation Code (DGCL). Exclusive venue provisions thus would dictate that essentially any state law corporate governance claim will be heard directly by the Delaware Court of Chancery under the DGCL, absent removal to federal court.
Federal courts may well stay any federal litigation during the pendency of the Delaware proceeding so long as no exclusively federal claims are asserted – exclusively federal claims, however, do include commonly used assertions of inadequate proxy statement disclosure in the acquisitions context.
2. What is driving the adoption of these provisions?
Efficiency: In suing corporations and their boards, there is frequently robust jockeying between plaintiff law firms to become the lead law firm and thus capture the largest share of fees. Historically, many courts have adopted the “first to file” principle, which plainly means the quicker the suit is filed, the higher the likelihood to be certified as lead plaintiff and thus lead counsel. In order to multiply opportunities for recovery, whether ultimately on a contingent fee basis or commonly as part of a fee settlement agreement with the defendant corporation/insurer, plaintiff firms also file in more than one court – in many cases, one plaintiff firm will file in the state where a corporation is incorporated (e.g. Delaware), while a different plaintiff firm will file in the state where the company has its headquarters (e.g. California or New York), each seeking fee recovery. They may also each simultaneously assert federal securities claims, for example often centered on the purported inadequacy of proxy statement disclosure in acquisitions, in order to be able to concurrently file similar cases in federal courts.
The result is a hodgepodge of disorganized litigation with no central legal referee – even though the lawsuits generally are all centered on similar if not identical allegations and underlying set of facts. Not only must companies expend additional G&A expense on multiple legal teams as well as suffer magnified management and board distraction, but different courts may come to entirely different results concurrently.
Substance: Indeed, it is this point that contorts the process further. When a plaintiff firm files a derivative (on “behalf” of a company against a third party such as an officer or director) or other governance claim where the company is incorporated in Delaware but the suit is filed in the company’s state of domicile/headquarters - say, California – the California courts do not apply California law in evaluating such claims. Rather, California courts interpret Delaware law – and use Delaware case law. In its worst form, this means a California judge who may spend one day doing insurance litigation from a fire may then pivot and spend the next day evaluating the legal intricacies in a state nearly 3,000 miles away. In its least harmful light but with greater infrequency, a local court may have a business-exclusive judge/chamber. That judge, however, simply is unlikely to be as versed in the nuances of Delaware law as, say, an actual Delaware judge.
Advocates of exclusive bylaws provisions posit that the provisions both reduce the potential of a three-ring litigation geographic circus (at least down to two rings – Delaware state court and one or more federal courts whenever federal claims are asserted and this cannot be avoided in any event) while increasing the potential quality of jurisprudence by centering state law claims in the Delaware Chancery Court.
3. What are the mechanics of adopting an exclusive jurisdiction provision?
Public corporations are governed by two documents: (1) the charter (akin to a constitution) which in general governs the rights of various classes of stock, and (2) the bylaws, which govern practical considerations such as election of the board and meeting rules. Amending the charter is more difficult because it requires stockholder approval, while amending the bylaws almost always only requires a majority vote of the board of directors.
Most established public companies adopt exclusive venue provisions by inserting them in the bylaws through a board vote. The board may then elect to put this decision to a subsequent stockholder vote for corporate governance reasons, but the language is already operative. The board could recommend that the language be inserted into the charter, which increases the probability that the provision will not repealed in a single election as the threshold for amending a charter makes it an exercise to do so. The question of whether to do so in the charter or the bylaws remains in flux and dependent heavily on individual corporate facts and preferences.
4. Given that discussion of these provisions has been around for a couple of years, why has interest apparently increased in recent months?
In early 2012, 12 companies were sued for having adopted exclusive venue bylaws; except FedEx and Chevron, all of them reversed course and repealed the provision. Ironically for a case centered on the question of limiting multi-forum jurisdiction, Chevron had to embark on, to no great surprise…. multi-forum litigation, as it was sued in both California and Delaware on similar claims. In summer 2013, Delaware’s Chancery Court upheld the validity of these provisions, but the plaintiffs appealed. However, as it became glaringly obvious that discovering life on Mars was more likely than the appeal succeeding before the Delaware Supreme Court, the plaintiffs withdrew. Accordingly, under Delaware law, exclusive venue provisions are explicitly permitted – although some Delaware judges may still have reservations about extreme cases. Critics of exclusive venue provisions would cynically point out that the Delaware Bar is inherently conflicted: upholding the provisions further bolsters Delaware’s economic advantage as the preeminent state for corporate adjudication.
5. What’s the current level of uncertainty for these provisions?
Chevron remains in litigation in California – and a California court may be less inclined to strip itself of its own jurisdiction. Whether in the pending Chevron claims in California or in a future action, we may well see a case wind its way to another state’s supreme court where it rejects Delaware’s position and throws out exclusive forum provisions. In the case of two states clashing, it would be a classic fact pattern for appeal to the Supreme Court to sort out how to apply the full faith and credit of each state’s potentially conflicting precedent.
6. Are there differences for categories of public companies?
Pre-IPO companies are not subject to the vagaries of proxy advisory firm recommendations for stockholders – their stockholder votes are a private affair, and with technology companies, limited really to venture capital firms and founders. It is no surprise, then, that a a significant number of technology companies going public have adopted these provisions – many in their charter (Facebook and LinkedIn most prominently) thus rendering a possible repeal by stockholders post-IPO both burdensome and unlikely.
7. ISS and Glass Lewis are skeptical of these provisions – does that make asking for a stockholder vote to adopt them an exercise in futility?
Companies that are already public face scrutiny from their current stockholder base. While both ISS and Glass Lewis look askance on these provisions, it is unclear how their objections further the goals of large institutional investors who are their clients.
Glass Lewis is almost dogmatic: if a company does not submit the adoption question to its stockholders, Glass Lewis will recommend a “no” vote for the chairperson of the company’s nominating and governance committee. When a company does put the (unbundled) proposal to a vote, it recommends against the proposal.
ISS will only consider an exclusive forum proposal if the company (a) does not have a classified/staggered board, (b) does not have a stockholder rights plan/poison pill, and (c) has majority voting for directors in uncontested elections. However, even then, ISS insists that the company provide multiple examples to show where it has been harmed from prior multi-forum stockholder litigation, and anecdotal evidence suggests that ISS has set the bar high. That said, it has softened its stance a bit, because it used to require that stockholders have a “meaningful” (i.e. 10 percent threshold) right to call a special meeting before it would consider an exclusive forum proposal.
Interestingly, however, there are a number of examples of companies who have ignored the ISS and Glass Lewis positions and plowed ahead by mounting a proxy campaign in favor of the exclusive forum proposal. This generally involves retaining a proxy solicitor and lobbying individual institutional investors – many of whom do not seem perturbed. Perhaps this is because, unlike with other mechanisms, it is unclear that these provisions even hypothetically impede realization of stockholder value, as opposed to denting the prospects of plaintiff firm legal fees.
As increasing numbers of companies seek adoption of these provisions following Delaware’s court affirmation, it will be interesting to see whether ISS and Glass Lewis may be tempted to change course, particularly when many of their clients appear open to ignoring their current advice on this subject.
8. Why would a corporation not adopt these provisions?
Substance: Commentators have postulated that a “hometown hero,” a corporation whose profile and personalities are both known and respected in the local community, may well believe it is better respected in a local court. It may also believe its business is more substantively understood by a local court – whether in industries such as energy in Texas, manufacturing in Michigan or technology in California. Most exclusive venue provisions, however, are “elective” in that a corporation may elect to opt out of the exclusive provision – but, conversely, a stockholder unilaterally cannot opt out. Thus, as most provisions are currently drafted, a corporation can to a certain extent engage in forum shopping among state courts.
Procedural: As a result, most companies are left with procedural reasons. They may not wish to antagonize their stockholder base – or expend the resources fighting a proxy campaign against the proxy advisory firms, even if they would be likely to succeed. Boards generally are risk adverse in corporate governance – after all, companies are here to produce products and sell services rather than to be known as innovators in corporate law – and so some boards may be most comfortable refraining until absolute clarity emerges on the enforceability of such provisions. However, this thought camp appears to be shrinking in size; many boards believe that Delaware’s approval of these provisions, coupled with the groundswell in adoption, will lead to protection in numbers. The herd of directors may not be stampeding yet, but it certainly seem to be kicking up more dust.
9. What if my company is not headquartered in Delaware – does this matter?
A company that is both incorporated and headquartered in the same state is less susceptible to, but not immune from, multi-forum litigation. Such company’s financial instruments or ties may be to New York – or it may have significant operations – perhaps from historical mergers – in other states. Because this area is new ground even for Delaware to till, other states have yet to see companies rush to adopt analogous provisions.
That said, as the concept has become more settled in Delaware (and if Delaware’s decisions are upheld in other courts), it is likely only a matter of time before companies incorporated in other states will also move towards limiting litigation to their home-state court.