Yesterday, the Delaware Supreme Court heard the appeal in Sciabacucchi v. Salzberg (pronounced Shabacookie!) in which the Chancery Court held invalid exclusive federal forum provisions for ’33 Act litigation in the charters of three Delaware companies. Few of the justices revealed their inclinations, so it’s difficult to predict the outcome. We’ll have to wait for the Court’s final decision.
You might recall that this case took on a heightened significance when, in March 2018, SCOTUS held, in Cyan Inc. v. Beaver County Employees Retirement Fund, that state courts continue to have concurrent jurisdiction over class actions alleging only ’33 Act violations and that defendants cannot remove these actions filed in state court to federal court. (See this PubCo post.) Both before and especially after Cyan, to avoid state court litigation of ’33 Act claims (and forum shopping by plaintiffs for the most favorable state court forum), many companies adopted “exclusive federal forum” provisions in their charters or bylaws that designated the federal courts as the exclusive forum for litigation under the ’33 Act (FFPs). Delaware law expressly permits the adoption of charter or bylaw provisions that designate Delaware as the exclusive forum for adjudicating “internal corporate claims,” defined as claims, including derivative claims, that are based on a violation of a duty by a current or former director or officer or stockholder or as to which the corporation law confers jurisdiction on the Court of Chancery. However, federal securities class actions are not expressly included. (See this PubCo post.)
In Chancery Court
Shortly before Cyan was decided, the enforceability of FFPs was challenged in the Delaware courts in a case seeking a declaratory judgment to invalidate the provisions included in the Delaware Certificates of Incorporation of three companies. The provisions in the charters of two of the companies were identical, stating as follows: “Unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933. Any person or entity purchasing or otherwise acquiring any interest in any security of the Corporation shall be deemed to have notice of and consented to [this provision].” In the other instance, the provision was essentially the same but included a savings clause, specifying exclusive federal jurisdiction but only “to the fullest extent permitted by law.” On cross-motions for summary judgment, Vice Chancellor Laster held that all three of the exclusive federal forum provisions at issue were invalid.
In invalidating the FFPs in Sciabacucchi, VC Laster viewed Boilermakers Local 154 Ret. Fund v. Chevron Corp. (opinion by former Chief Justice Strine while still on the Chancery Court) to be determinative. That case, VC Laster wrote, held that a corporation could adopt a forum selection bylaw to regulate “internal affairs claims brought by stockholders qua stockholders,” but not “to regulate external relationships.” He went on to say that the “Boilermakers decision noted that a bylaw cannot dictate the forum for tort or contract claims against the company, even if the plaintiff happens to be a stockholder.” Under Boilermakers, he wrote, a ’33 Act claim is distinct from “internal affairs claims brought by stockholders qua stockholders.” Rather, he contended, a ’33 Act claim “resembles a tort or contract claim brought by a plaintiff who happens also to be a stockholder, but under circumstances where stockholder status is incidental to the claim. A 1933 Act claim is an external claim that falls outside the scope of the corporate contract.”
In addition, VC Laster distinguished the authority of Delaware and its courts to regulate the internal affairs of corporations, which are entirely creations of Delaware law, under the “internal affairs doctrine,” as compared with the corporation’s external relationships. Delaware may not have the authority to regulate external relationships, which may be governed by other states’ laws (such as antitrust or labor law), even when the party asserting the claim happens to be a stockholder. “The constitutive documents of a Delaware corporation,” wrote VC Laster, “cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”
As a result, VC Laster viewed DGCL Section 102(b)(1), which provides general authority for non-mandatory charter provisions, to be inherently limited to internal affairs. In addition, in 2015, following the Boilermakers decision, the DGCL was amended to add Section 115 to expressly permit companies to adopt, in their bylaws and charters, forum selection provisions applicable to “internal corporate claims,” defined as “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.” Although Section 115 did not explicitly state that the charter or bylaws cannot include forum selection provisions addressing other types of claims, VC Laster pointed to commentary by members of the Corporation Law Council suggesting that the corporate charter and bylaws could not be used to regulate external claims and that a securities law claim was not an “internal corporate claim.” (See this PubCo post.)
The companies appealed.
Oral Argument before the Delaware Supreme Court
[Based on my notes, so standard caveats apply.)
In the oral argument, counsel for the appellant companies opened by stating that the role of the Court in the context of a facial challenge to the FFPs is just to apply and interpret the text of the statute. In that regard, he maintained, Section 102(b)(1) is broad and enabling, allowing corporations to add to their charters any provision “for the management of the business” or “for the conduct of the affairs of the corporation.” That language, which does not limit “affairs” to “internal affairs,” certainly permits the inclusion of FFPs, which provide for the management of the risks and costs of securities litigation in multiple forums by channeling it into federal courts.
When asked whether Section 115 provides a limiting gloss on Section 102, counsel maintained that Section 115 was simply a codification of the Boilermakers decision and applied only in that context. Section 115, he contended, does not address or preclude any other forum selection provisions; it simply says that an internal corporate claim must be brought in the Delaware courts. Quoting Justice Kagan in Cyan, he observed that the statute says what it says and it doesn’t say what it doesn’t say. What’s more, again quoting Justice Kagan, you don’t hide elephants in mouse holes: the Delaware legislature has always been very deliberate in crafting statutory language, and if it intended to limit or expand Section 102, it would have done so expressly and clearly. Moreover, he argued, in a “fatal flaw,” the Chancery Court misapplied the concept of the internal affairs doctrine: although the doctrine has a constitutional basis and is part of Delaware common law, it is intended as a principle of choice of law to determine whether Delaware law should be applied to cases in other jurisdictions, not in this context or across the Code.
The core of counsel’s argument was that Section 11 claims are not “external” as the lower court opinion contended. But, he argued, neither do they fit within the definition of “internal affairs.” Rather, he contended that securities claims under Section 11 are “intra-corporate” claims—i.e., they are just like fiduciary duty claims (which are clearly within the definition of internal affairs) because they arise out of the nexus of the internal relationships among stockholders, directors and the company; the only difference is that Section 11 claims are brought under federal law, not Delaware law. That nexus is what brings Section 11 FFPs within Section 102(b)(1). Similarly, Section 11 claims involve the same “core conduct” as that covered by Section 115 (and could even be brought in Delaware as fiduciary duty claims): the board is presumed to have reviewed the disclosures in the registration statement and authorized its filing and is alleged to have breached its duty to stockholders and prospective stockholders by making material misstatements or omissions. But, he noted, the scope of forum selection provisions that may be added is cabined. For example, tort claims are external and not within Section 102(b)(1). Thus, if a stockholder slips and falls at a property owned by a publicly held chain store and sues the company, then the stockholder is not suing in his or her capacity as a stockholder, but rather as a customer. In that context, the claim relates to company operations and does not involve the internal relationships among stockholders, directors and the company. To fall under 102(b)(1), the matter must involve that nexus of internal relationships, counsel contended. Section 11 claims do just that, and the fact that the cause of action is under federal law does not turn an intra-corporate claim into an external matter.
He also argued against the notion that Boilermakers or the legislature intended to create a bright line rule as the lower court and the appellee contended. That’s because Delaware recognizes that it’s not possible to have “doctrinal exactitude” in some of these cases. Delaware’s approach is broader: the laws provide for a presumption of validity of the provisions of the certificate, the application of which a court of equity polices on a case-by-case basis based on the concrete facts of each case (for example, if the provision involved improper motives). A bright line would inhibit companies’ ability to innovate and evolve in response to changing circumstances. Delaware’s courts have been open to novel approaches (that are not otherwise precluded), and this ability to evolve has historically been a hallmark of Delaware law. Consider for example, the development of poison pills, which are not expressly provided for in the statute and were viewed by numerous academics as impermissible, but have been permitted by Delaware courts and policed on a case-by-case basis.
In addition, counsel did not see any conflict with federal law or specifically, Cyan, which he characterized as a case involving “removal” to federal court. Cyan did not involve forum selection provisions, which, he argued were upheld (and even favored as a policy matter) by SCOTUS in Rodriguez de Quijas v. Shearson/Am. Express, Inc. Even if the same topics were addressed under federal and Delaware law, that would not necessarily result in conflict: there are numerous areas where Delaware law is complementary to federal law and comfortably coexists, such as in connection with hostile tender offers (poison pills), proxy access, and annual meetings and the proxy process. Moreover, to date, FFPs have been described in dozens of registration statements, but the SEC has never challenged the validity of these provisions or raised the question to the Delaware courts for determination. The SEC, he said, “knows its way to Dover” to certify questions to the Delaware courts when there is an open issue under Delaware law, and they have done so many times before.
Counsel for the appellee argued that the lower court was correct in concluding that the FFPs at issue are not authorized by statute because they relate to an external matter. What’s more, Section 115 must be read to infuse Section 102(b)(1): in his view, the dividing line created by the internal affairs doctrine is basic to federalism and a fundamental tenet of Delaware corporate law. In particular, he saw the reference in Section 102(b)(1) to “affairs of the corporation” as a historic reference to the internal affairs doctrine and pointed to an old New Jersey case to that effect. Why would the legislature have included the definition of “internal corporate claims” in Section 115 if it viewed other forum selection provisions as appropriate?
He distinguished Section 11 claims as “external” because they are claims under federal law, not Delaware corporate law, that arise out of a security holder’s status as a “purchaser” “or “seller” of securities, not as a stockholder qua stockholder, or necessarily even as a “stockholder” at all. In addition, Section 11 claims do not “travel” with the shares, as do direct fiduciary duty claims. To prevail, he said, appellants must show either that “internal” means something much broader than “internal affairs” or that Section 11 claims fall within the meaning of “internal affairs”: he did not think that they had shown precedential or other support for either concept. Moreover, he contended, precedent supports his argument. In a case regarding a Delaware statute that was modeled on the ’33 Act, the Delaware Supreme Court has held that claims regarding misstatements in connection with the sale of securities are not internal affairs claims. By comparison, Boilermakers relied on the internal affairs doctrine in channeling matters involving internal affairs that will be governed by Delaware law into the Delaware courts.
In addition, he argued, because the corporation is a creature of statute, the power to include forum selection provisions must be expressly authorized, as in Section 115. While federal policy may favor the adoption of forum selection provisions, he differentiated those based in contract from those imposed in corporate charters or bylaws, the latter being subject to the confines of the internal affairs doctrine. By analogy, he observed that Section 102(b)(7), which expressly authorizes corporations to include charter provisions that limit the personal liability of directors for certain breaches of fiduciary duty, is silent with regard to officers and aiders and abettors. Under the appellants’ analysis, why couldn’t Section 102(b)(7) just be extended to allow the same type of charter provision to apply to officers and to aiders and abettors? But, he said, the Court, looking at the text of the statute, has not allowed those extensions.
Counsel also contended that validating the FFP would be contrary to public policy in that it could conflict with the laws of other jurisdictions, both federal and state. In particular, it would conflict with Cyan, which he said affirmed that ’33 Act claims could be filed in federal or state court. He also argued that Delaware’s strict adherence to staying in its “own lane” is a policy intended to discourage the risk of federalization. In the event conflicts do arise, they could ultimately affect due process. For example, if, as a result of a conflict, it becomes unclear which law applies, the result would be a lack of predictability and consistency. That, he contended, is what the internal affairs doctrine is intended to prevent.
Full disclosure: Cooley represented a group of companies that filed an amicus brief in support of the appellants’ position that, under Delaware law, FFPs may be included in Delaware organizational documents.