You probably remember the 2020 major cyberattack—reportedly perpetrated by a foreign government—of SolarWinds, a Delaware public company that “provides software products used to monitor the health and performance of information-technology networks.” The hack of the company’s software systems affected thousands of clients, including several government agencies. After the company disclosed the cyberattack, its stock price plummeted. Litigation ensued.  One of the cases, Sobel v. Thompson, brought in a Texas federal district court, was a derivative lawsuit in which the plaintiff stockholder claimed, on behalf of the company, that the company’s officers and directors failed to disclose known cybersecurity deficiencies in the company’s periodic and other reporting prior to the cyberattack—a case under Exchange Act Section 10(b).  The defendants moved to dismiss the case on the basis of forum non conveniens.  Why? Because the company’s charter included a forum-selection provision making the Delaware Chancery Court the exclusive forum for derivative litigation. The Court dismissed the case, notwithstanding the plaintiff’s contention that, in light of the federal courts’ exclusive jurisdiction over Exchange Act claims, enforcement of the charter provision would effectively preclude him from bringing his derivative Exchange Act claims in any forum.  We have previously seen cases addressing enforcement of Delaware forum-selection clauses in the context of claims regarding allegedly false or misleading proxy statement disclosures under section 14(a), and there, the circuits are split.  Per Alison Frankel’s piece in Reuters, this case may be novel in that it addresses the application of a forum-selection provision in the context of claims under Section 10(b). Will this case—and, should it be widely followed, others like it—effectively put the kibosh on derivative Section 10(b) claims?

In his complaint, the plaintiff asserted four derivative claims: “(1) breach of fiduciary duty; (2) violation of Section 14(a) of the [Exchange Act]; (3) violation of Section 10(b) and Section 21(D) of the Exchange Act; and (4) misappropriation of material, nonpublic information of the Company.”  Because all of the claims were derivative, the defendants moved to dismiss the complaint on the basis of the forum-selection provision contained in the company’s restated certificate of incorporation, which provided that, absent company consent, the Delaware Court of Chancery “shall be the sole and exclusive forum” for “any derivative action or proceeding brought on behalf of the Corporation.”

The plaintiff contended first that the company waived its right to invoke the exclusive-forum provision by consenting to litigate his derivative claims in federal district. After a fact-driven analysis of whether the defendants did or didn’t waive, the Court found no waiver had occurred.

The plaintiff’s key argument for this purpose, however, was that “the Court should decline to enforce the COI’s venue provision because it would effectively preclude him from bringing his derivative Exchange Act claims in any forum, which Plaintiff contends violates federal public policy and Delaware law.” The Court concluded that “neither argument provides a sufficient basis to disregard the COI’s venue provision.” According to the Court, all “parties agree that enforcing the COI’s venue provision will effectively preclude Plaintiff from asserting his derivative Exchange Act claims in any forum.” However, the plaintiff cited “no binding authority holding that the federal courts’ exclusive jurisdiction over Exchange Act claims supplies an independent basis, let alone the required strong public policy, to preclude enforcement of a valid forum-selection clause. To the contrary, the Supreme Court has recognized the strong federal policy in favor of enforcing such clauses in closely similar contexts.” The Court expressly declined to accept the Seventh Circuit’s reasoning in Seafarers, reasoning that, although enforcing the forum-selection provision

“would foreclose Plaintiff’s derivative Exchange Act claims, there is no indication that it would deprive him of all substantive rights under the statute. First, as Defendants observe—and Plaintiff does not dispute—Delaware law recognizes derivative state-law claims with available remedies that are commensurate to those available under Plaintiff’s federal derivative claims…. Moreover, Plaintiff does not dispute that the COI’s venue provision only applies to derivative claims—it does not prevent him from directly pursuing Exchange Act claims in any federal court. In the face of a valid forum-selection clause, differences in the availability of specific causes of action is only relevant where ‘the remedy provided by the alternative forum is so clearly inadequate or unsatisfactory that it is no remedy at all.’”

 (And indeed, Frankel reports that the company is “already facing a shareholder class action asserting direct Exchange Act claims arising from the 2020 hack.”)

The plaintiff also argued that enforcing the forum-selection provision would violate Delaware law. The Court again disagreed. The plaintiff had not shown that “enforcing the COI’s venue provision would contravene ‘applicable jurisdictional requirements’ in the Exchange Act.”  In addition, the Court said, the plaintiff had misconstrued Sciabacucchi, which addressed “internal corporate claims” under Delaware Section 115. Because Exchange Act claims are not “internal corporate claims,” Sciabacucchi, the Court reasoned, suggested that the Section 115 was not applicable to plaintiff’s claims here.

In her column, Frankel gives us a taste of the academic debate over this issue.  Tulane Professor Ann Lipton, who characterized the decision as “break[ing] new ground…because it extends forum selection enforcement to derivative 10(b) claims,” said the decision reflects “a gradual ability of corporations to opt out of the securities laws….In Lipton’s view, derivative 10(b) claims are quite distinct from direct Exchange Act fraud allegations, because derivative suits assert that the corporation itself—rather than any outside investor—was harmed as a buyer and seller of the company’s shares.” Stanford Professor Joe Grundfest expressed a contrary view, supporting the decision: “Theoretically, he said, there’s a difference between direct and derivative 10(b) claims. But in reality, Grundfest said, there is no remedy shareholders can obtain from derivative Exchange Act suits that they can’t get from Delaware breach-of-duty suits and direct Exchange Act class actions.”

For more information about securities litigation, see the Cooley Securities Litigation + Enforcement blog.

Posted by Cydney Posner