Restricting Shareholders’ Ability to Challenge Corporations: Delaware Chancery Court Upholds Companies’ Right to Select Forum for Suits Against Them

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The U.S. state of Delaware’s courts, particularly the Court of Chancery, are usually thought of as doughty protectors of shareholder rights. But some recent decisions have, in fact, narrowed such rights. Following close upon the heels of the recent Delaware Supreme Court decision limiting the ability of a corporation’s shareholders to file multiple shareholder derivative actions in multiple forums,1 another Delaware court has held that corporate bylaws providing that the corporation’s shareholders can file suit against it only in Delaware valid and enforceable. In a June 25, 2013 decision on a pair of consolidated actions, Chancellor Strine rejected shareholder challenges to forum selection bylaws enacted by their corporations’ boards of directors.2 Under the challenged bylaws,3 shareholders who sue Delaware corporations in connection with “intra-corporate” disputes can do so only in Delaware courts.

These forum selection bylaws have become increasingly popular; according to Chancellor Strine, more than 250 publicly traded corporations have adopted such provisions in the last three years. As the defendant corporations explained in their briefs, the purpose behind these provisions is to avoid the expense of defending “duplicative litigation.”4 Frequently, shareholders will seek to challenge corporate actions—such as a merger or acquisition—by suing the corporation or its officers and directors. These suits can be filed by any shareholder and can usually be brought in a variety of state and federal courts, and as a result, a single corporate action often ends up being the subject of multiple lawsuits in multiple courts. Such “multiforum litigation,” defendants argued, “imposes high costs on the corporations and hurts investors by causing needless costs that are ultimately born by stockholders.”

Plaintiffs’ argument against the bylaws was two-fold: (1) the bylaws were invalid under Delaware General Corporation Law (“DGCL”) because they exceeded the defendant boards’ statutory authority, and, (2) under general contract law, the provisions were invalid because they were passed unilaterally by the boards.

In upholding the validity of the forum selection bylaws under Delaware law, Chancellor Strine noted that under the DGCL,5 the board of directors may enact bylaws containing any provision related to the corporation’s internal affairs, so long as the provision is legal and consistent with the corporation’s certificate of incorporation. Chancellor Strine held that the forum selection bylaws enacted by the defendant corporations fit those criteria.

Plaintiffs argued that under general contract law, a board of directors may not enact bylaws that regulate shareholders’ rights without shareholders’ approval. In rejecting this argument, Chancellor Strine explained that a board can indeed pass such provisions, because the bylaws of a Delaware corporation are part of a “contractual framework” between directors, officers, and shareholders, which is “flexible and subject to change.” This flexibility allows a board to amend bylaws unilaterally, as long as the corporation’s articles of incorporation allow it—as most do. Chancellor Strine stated that investors are aware of these conditions when they purchase stock of Delaware corporations, and agree to be bound by bylaws passed in that way. So, with certain limited exceptions, forum selection clauses are just like other contract clauses and are generally valid.

Finally, Chancellor Strine rejected plaintiffs’ attempt to demonstrate that the bylaws were invalid in their entirety by presenting a series of hypothetical situations in which the application of the bylaws might be unfair. In so doing, Chancellor Strine warned that if the forum selection bylaw is unfair to a specific shareholder bringing a lawsuit, he or she may challenge it as unfair at that time. Additionally, he noted, shareholders may repeal the bylaws by a majority vote, and, if necessary, can vote out directors who voted to include such provisions.

While this decision has far-reaching implications, it also has certain limitations. First, it applies only to Delaware corporations, and only those that allow their boards to unilaterally enact bylaws. Second, it covers only actions filed by shareholders in connection with a corporation’s “internal affairs.” This may include derivative lawsuits, in which investors bring a lawsuit on behalf of the company itself; fiduciary duty suits brought against directors and officers of the company; suits brought under Delaware corporate law; and other “internal affairs” suits, which turn on the relationship between the company, its shareholders, directors, and officers.6

Practically speaking, when a board considers enacting forum selection bylaws, it should be aware that many proxy advisory firms have indicated that they have a negative view of these types of bylaws, at least those enacted without explicit shareholder approval. The board should also be sure that being sued in Delaware is in the corporation’s best interests, and if not, it should consider which state’s courts would be better suited to its needs.

Following this decision, it is likely that many Delaware corporations will adopt similar provisions, but many major questions remain unanswered. It is unclear whether plaintiffs in these cases will file an appeal, and if so, whether Chancellor Strine’s decision will be upheld. Equally important and unclear is what effect other states’ courts will give this decision. Because this decision is the definitive pronouncement of Delaware on this subject, courts in other jurisdictions considering similar bylaws enacted by Delaware corporations should apply the holding of this case and dismiss actions brought before them. Thus, theoretically, this decision has potential broad application. However, before Chancellor Strine authored this opinion, at least one judge in the Northern District of California reached a contrary conclusion, and rejected arguments similar to those adopted here.7 But another judge in the same district hearing a substantially similar case decided to wait to see how Chancellor Strine decided these cases.8 It is therefore likely that these provisions will be challenged in various jurisdictions, with results that could vary substantially from those reached by Chancellor Strine.

Footnotes

1 Pyott v. Louisiana Municipal Police Employees’ Retirement System, discussed here.

2 Boilermakers Local 154 Retirement Fund et al. v. Chevron Corp. et al., case No. 7220, and ICLUB Investment Partnership v. FedEx Corp. et al., case No. 7238 (Del. Ch. 2013).

3 Both defendant corporations enacted substantively similar bylaws, providing:

Unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of the Corporation to the Corporation or the Corporation’s stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of capital stock of the Corporation shall be deemed to have notice of and consented to the provisions of this [bylaw].

4 Not mentioned in Strine’s decision is the well-developed and sophisticated nature of Delaware corporate jurisprudence. By requiring cases to be filed there, litigants may be able to obtain more predictable results.

5 8 Del. C. § 109(a).

6 The decision does not address whether a bylaw could be enacted for other types of suits. For example, the decision does not cover suits brought against a corporation when a shareholder is allegedly injured by the corporation as a result of personal injury, securities fraud, or breach of contract.

7 Galaviz v. Berg, 763 F. Supp. 2d 1170, 1174 (N.D. Cal. 2011) (Seaborg, J.).

8 Bushansky v. Armacost, C 12-01597 WHA, 2012 WL 3276937 (N.D. Cal. Aug. 9, 2012) (Alsup, J.)

 

Topics:  Forum, Forum Selection Clause, Forum Shopping, Shareholder Litigation, Shareholder Rights, Shareholders

Published In: Business Organization Updates, Business Torts 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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