Another Tool in the Toolbox – Delaware Approves “Federal Forum Provisions” For Stockholder Securities Claims
In a closely-watched case, Salzberg v. Sciabacucchi, No. 346, 2019 (Del. Mar. 18, 2020), the Delaware Supreme Court upheld the facial validity of charter provisions requiring that stockholders bring claims arising under the Securities Act of 1933, as amended (the “1933 Act”), exclusively in federal court. Such provisions, known as “Federal Forum Provisions,” are a powerful tool for corporations that desire to minimize the burdens of multi-jurisdictional litigation and provide for the cost-efficient management and resolution of 1933 Act claims. Delaware companies that have not previously adopted Federal Forum Provisions, as well as companies incorporated in other states with similarly broad corporate statutes, will want to carefully review the Salzberg decision and consider implementing these important protections.
The 1933 Act allows purchasers of a registered security to sue when false or misleading information is included in a registration statement or where securities are sold using prospectuses or oral communications that contain material misstatements or omissions. A plaintiff “need only show a material misstatement or omission to establish its prima facie case”; the plaintiff generally need not show that the issuer was acting with any intent to deceive. In addition to the issuer, other defendants, including the corporation’s directors, are also potentially liable under the registration statement provisions of the 1933 Act.
The United States Supreme Court has held that federal and state courts have concurrent jurisdiction (i.e., claims can be brought in either court) over class actions based on the 1933 Act and that such claims are not removable to federal court. In recent years, an increasing number of such cases have been filed in state court in order to avoid various procedural rules and restrictions that apply to federal securities actions brought in federal court and that are perceived by some plaintiffs as more onerous than the procedures that apply under state law.
In response to these developments, some corporations began adopting forum-selection provisions that specified the federal courts as the exclusive forum for 1933 Act claims. By requiring all such claims to be brought in federal court, the corporation is able to seek consolidation or coordination of related cases and potentially avoid litigating simultaneously in several different jurisdictions or defending, on a piecemeal basis, claims that might otherwise be brought both in state and federal court with potentially different and inconsistent outcomes. The corporation is also able to take advantage of the procedural protections provided in federal court in connection with securities lawsuits.
Each of the companies involved in the Salzberg case is a Delaware corporation that launched a 2017 initial public offering. Before filing its registration statement with the SEC, each company adopted a Federal Forum Provision in its certificate of incorporation. The plaintiff in Salzberg was a stockholder who challenged the validity of such provisions under Delaware law. The Delaware Chancery Court struck down the provisions as invalid, concluding that the “constitutive documents of a Delaware corporation 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.” The Delaware Supreme Court disagreed and reversed on appeal, finding that such provisions were permitted under Delaware’s General Corporation Law (“DGCL”), including Section 102(b)(1) of the DGCL.
More specifically, the Delaware Supreme Court found that Section 102(b)(1) authorizes two broad types of provisions: “any provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, . . . if such provisions are not contrary to the laws of this State.” The Court concluded that Federal Forum Provisions “could easily fall within either of these broad categories,” and thus were facially valid.[1]
In upholding the Federal Forum Provisions in the defendants’ certificates of incorporation, the Court characterized securities claims under the 1933 Act as “intra-corporate” disputes within the scope of Section 102(b)(1), distinguishing such claims from the narrower subset of “internal corporate claims” that are the subject of Section 115 of the DGCL, which allows a corporation to require stockholders to bring such claims exclusively in the state courts of Delaware. The Court found no inconsistency between the two provisions and rejected arguments that Federal Forum Provisions were against public policy or inconsistent with federal law, noting that corporate charters are contracts among a corporation’s stockholders that are given great respect under Delaware law.
The Court’s decision in Salzberg gives a green light to Delaware corporations to adopt Federal Forum Provisions addressing stockholder claims under the 1933 Act. The provisions in Salzberg were included in the defendants’ certificates of incorporation, and were discussed by the Court in that context, but much of the reasoning in Salzberg would be equally applicable to a Federal Forum Provision in a company’s bylaws. For example, the opinion relies in part on Section 115 of the DGCL, which authorizes a corporation to enact forum selection provisions through either the certificate of incorporation or the bylaws. Decisions of the Delaware Supreme Court prior to the enactment of Section 115 similarly have upheld provisions affecting the rights of stockholders, including forum selection provisions that were implemented solely through a bylaw. Accordingly, boards of directors of corporations that already are publicly traded may wish to consider adopting Federal Forum Provisions through amendments to the bylaws.
Finally, the Federal Forum Provisions at issue in Salzberg required litigation of 1933 Act claims in the federal courts generally, without specifying the federal courts of a particular state. The Court called out that fact as further supporting its conclusion that the provisions did not implicate any Delaware public policy, noting that the provisions were more favorable than forum selection provisions permitted under Section 115 of the DGCL, which allow corporations to require stockholders to litigate certain types of claims exclusively in the courts of a single state (Delaware). The Court’s discussion leaves unanswered, for now, whether a corporation might similarly be able to specify the federal courts of Delaware (or another state with which the corporation has a logical connection, such as the state where it has its principal place of business) as the exclusive forum for 1933 Act claims.
North Carolina, like Delaware, has broadly permissive corporate laws that allow corporations to enact articles and bylaws affecting their governance and operation. The North Carolina Business Corporation Act allows companies to include in their articles of incorporation any provision not inconsistent with law regarding “managing the business and regulating the affairs of the corporation” and “defining, limiting and regulating the powers of the corporation, its board of directors, and shareholders,” which is very similar to the Delaware statutory language relied upon by the court in Salzberg. (N.C. Gen. Stat. § 55-2-02(b)(2).) While no North Carolina court has addressed the issue, our courts frequently consider Delaware decisions and, if called upon to address the validity of a Federal Forum Provision adopted by a company incorporated in North Carolina, likely would give significant weight to the Delaware Supreme Court’s decision in Salzberg. Accordingly, companies incorporated in North Carolina may also wish to take this opportunity to adopt Federal Forum Provisions in their articles of incorporation or bylaws similar to those approved in Salzberg.
[1] As with other types of forum selection clauses permitted under the DGCL, the Court left open the possibility that such clauses could be challenged on an “as applied” basis, which might allow a court to refuse to enforce a forum selection provision in particular circumstances, for example in cases of fraud, or where doing so would be “unreasonable and unjust” or would violate a strong public policy of the forum in which suit is brought.
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