Delaware’s highest court will hear arguments this week about whether corporations based in the state can use their bylaws to force shareholders to file securities suits in federal court.
A group of technology companies—Blue Apron Holdings Inc., Roku Inc, and Stitch Fix Inc.—will argue Jan. 8 to overturn a December 2018 Chancery Court decision that found such provisions in corporate bylaws violated Delaware law.
The case could affect more than a hundred public companies that have written federal forum selection provisions into their corporate bylaws or company charters. And other companies that are considering such provisions are waiting to see what Delaware will do before they proceed.
If the decision is upheld, those provisions would become invalid and secure plaintiffs’ choice to find forums that they deem friendlier. A reversal could free up Delaware corporations to write other restrictive covenants into corporate bylaws or charters, such as mandatory arbitration clauses.
“This is what the Delaware Supreme Court is going to be asking: How much can a corporation bind people just because they happen to own shares of the corporate stock?” Ann M. Lipton, an associate professor in business law and entrepreneurship at Tulane University School of Law and co-signer of an amicus brief calling to uphold the decision, said. “If this is OK, then why not an arbitration clause for any employee that happens to own stock?”
Corporations find federal courts favorable to state courts for securities claims because a motion to dismiss triggers an automatic stay of discovery, cutting down on litigation costs. Also, dismissals are higher in federal court. One study showed that between 2011 and 2018, 42% of Securities Act claims filed in federal court were dismissed, compared to just 19% in state courts.
The case will decide the fate of a trend that started in 2017, when Snapchat owner Snap Inc. sold shares in an initial public offering. The company included a provision in its certificate of incorporation that deemed federal courts “the exclusive forum” for any complaint filed under the Securities Act of 1933.
Before their IPOs in 2017, Blue Apron, Roku, and Stitch Fix also wrote similar federal courts-only provisions into their bylaws. Shareholders often sue newly IPO-ed companies for Securities Act claims, such as omissions or misstatements in securities registration statements. The Securities Act allows investors to file either in federal or state court.
Investor Matthew Sciabacucchi sued the three companies in a lawsuit, arguing that such provisions violated the Delaware General Corporation Law.
The court’s Vice Chancellor J. Travis Laster agreed in an opinion issued Dec. 19, 2018. He found that Delaware corporations may require shareholders to litigate internal company disputes in the state. Delaware law does not give companies the right to mandate a forum selection for Securities Act claims, he said.
A Delaware corporation “cannot use its charter or bylaws to regulate the forum in which parties bring external claims, such as federal securities law claims,” Laster wrote in his opinion. “Delaware can regulate the internal affairs of its corporate creations, regardless of their location, but only their internal affairs.”
A Delaware Supreme Court reversal of Laster’s decision could likely make the exclusive federal forum provision a “standard” bylaw provision for the companies in the state, Caroline H. Bullerjahn, a partner in Goodwin Procter LLP’s securities litigation and white collar defense group, said.
Such provisions are a response to an increase in securities lawsuits filed in state courts, sometimes in multiple jurisdictions.
The U.S. Supreme Court ruled in March 2018 in Cyan v. Beaver County Employees Retirement Fund that securities class actions filed in state court could not be removed to federal court. State filings increased after the ruling, as did liability insurance premiums for directors and officers.
“There’s been an explosion of these kinds of claims brought in state court,” says Roger A. Cooper, a partner at Cleary Gottlieb Steen & Hamilton LLP who focuses on shareholder litigation.
Three quarters of new Securities Act cases filed in the first half of 2019 were filed in state courts, Blue Apron, Roku and Stitch Fix said in their opening brief.
The costs of state court litigation of Securities Act claims have nearly doubled from $13.92 billion annually between 2010 and 2017 to $24.93 billion in 2018, according to the brief.
If the trend isn’t curbed, conducting IPOs, raising capital, and operating as public companies will become more expensive, they said. Stockholders and companies will bear the ultimate costs, they said.
Investor advocates and some academics say overturning the Chancery Court’s decision would erode individual shareholders’ rights.
“Simply put, charter and bylaw provisions that limit the forums available to vindicate stockholder rights decrease the efficacy of a critical tool for promoting good corporate governance and ensuring accountability to investors,” the Council of Institutional Investors, a nonprofit association that advocates for shareholders, wrote in an amicus brief. “They should not be adopted, much less judicially validated.”
Federal securities claims by definition fall outside the “corporate contract,” so dictating where investors can pursue those claims is not a proper subject for charter or bylaw provisions, a group of 19 law professors, including Lipton, wrote in an amicus brief in the case.
“Reversing the Court of Chancery’s decision would constitute a substantial extension of the corporate contract and would infringe upon the will of Congress,” they wrote. “Delaware law is entitled to and should not hesitate to regulate the internal affairs of its corporations, but should be careful not to overstep its ‘lane.’”
The companies are also appealing Laster’s July 8 decision to award the plaintiff’s $3 million in attorneys’ fees.
The case is Salzberg v. Sciabacucchi, Del. en banc, No. 346,2019 D, Oral arguments 1/8/20.