Delaware Supreme Court Endorses Exclusive Federal Forum Charter Provisions for Federal Securities Act Claims
March 23, 2020
On March 17, 2020, the Delaware Supreme Court ruled that federal forum selection clauses in corporate charters and by-laws for claims under the Securities Act of 1933 are not facially invalid. The decision, Salzburg v. Sciabacucchi,1 is a significant victory for the securities defense bar and its clients. It provides a potential solution to the prospect of state court litigation arising from public securities offerings in the wake of the US Supreme Court’s 2018 holding in Cyan, Inc. v. Beaver County Employees’ Retirement Fund that state and federal courts have concurrent subject-matter jurisdiction over complaints asserting solely ’33 Act claims.2 Courts should now enforce provisions in Delaware corporations’ by-law and corporate charter provisions that designate federal courts as the sole venue for Securities Act claims against them.
The case arose from multiple Delaware corporations’ adoption of provisions in their certificates of incorporation, in anticipation of their initial public offerings, that make federal courts the exclusive forum for Securities Act claims:
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 Company] shall be deemed to have notice of and consented to [this provision].3
The plaintiff purchased shares of each of the defendant companies shortly after their offerings and then sued for a declaratory judgment that the exclusive federal forum provisions are invalid under Delaware law.4 The Court of Chancery struck down the by-law amendments, holding that corporate constitutive documents can govern only claims involving “rights or relationships that were established by or under Delaware’s corporate law.”5 The Delaware Supreme Court reversed.
Federal Forum Selection Provisions for Securities Act Claims Govern Intra-Corporate Claims Within Section 102(b)(1) and Do Not Violate Delaware or Federal Policy
Because the plaintiff was pursuing a facial challenge to the federal forum provisions, he had to clear a high bar—showing that the provisions “cannot operate lawfully or equitably under any circumstances” and “can never operate consistently with the law.”6 The Court viewed the issue as a simple exercise of statutory construction of Delaware General Corporation Law Section 102, which governs matters appropriate for inclusion in a company’s certificate of incorporation.7 Section 102(b)(1) provides that a certificate of incorporation “may” include:
[a]ny provision for the management of theyby 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, or the governing body, members, or any class or group of members of a nonstock corporation.8
The Court read Section 102(b)(1) as authorizing two different types of provisions: (i) “any provision for the management of the business” or “conduct of” the corporation’s “affairs” and (ii) provisions “creating, defining, limiting, and regulating” the powers of the corporation, its stockholders, or its directors.9 The Court found that exclusive federal forum provisions “easily fall within either of” Section 102(b)(1)’s “broad categories” because the conduct regulated under the Securities Act of 1933—preparing and disseminating registration statements and other disclosures for public offerings—implicate “an important aspect of a corporation’s management of its business and affairs and of its relationship with its stockholders.”10 Federal forum provisions “classically fit the definition of a provision ‘for the management of the business and for the conduct of the affairs of the corporation’” because they serve the important corporate purpose of avoiding the “obvious” costs and inefficiencies of parallel state and federal litigation.11 They also fit within Section 102(b)(1)’s second category because they define, limit, and regulate the shareholders’ power to sue the corporation, its directors, and officers.12
The Court concluded that the Court of Chancery erred in determining that Securities Act claims are “external” and therefore not subject to Section 102(b)(1). That lower court ruling unduly limited the statute to “state law fiduciary duty claims,”13 a reading even narrower than claims concerning a corporation’s “internal affairs,” i.e., claims “peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.”14 The class of claims covered by Section 102(b)(1) is broader still because the Delaware General Corporation Law can affect the rights of those who have not yet become shareholders in a Delaware corporation.15 Securities Act claims fall within what the Court termed the “outer band”—claims that are not “internal claims” within the meaning of Delaware General Corporation Law Section 115, but that nevertheless concern “intra-corporate affairs” defined by Section 102(b)(1).16
The Court also found that federal forum provisions are not contrary to Delaware statutory law or public policy, noting the “great respect” Delaware law affords shareholder-approved charter amendments.17 Federal forum provisions likewise do not violate federal policy.18
Practical Consequences
It remains an open question whether state courts outside Delaware will enforce federal forum provisions in Delaware corporations’ constitutive documents (or even whether those provisions will be enforceable in Delaware courts in every instance).19 As the Court acknowledged, federal forum provisions are essentially a specialized forum selection clause that may not bind a court in every instance. But as the Court hastened to add, (i) federal forum provisions should be entitled to at least the same deference as any contractual choice of forum provision, (ii) because Securities Act claims are closely linked to fiduciary-breach claims, the same principles undergirding the internal affairs doctrine also support enforcing federal forum provisions, and (iii) federal forum provisions are “procedural” in nature and should be given extra-territorial effect.20
The Court’s decision in Salzberg nevertheless gives issuers a potent weapon to implement on a corporation-by-corporation basis Congress’s intent to limit litigation of Securities Act claims to federal courts, an intent that the US Supreme Court found that Congress failed to implement in the Securities Litigation Standards Act of 1998.21 Any corporation contemplating a securities offering should consider adopting an exclusive federal forum provision, either as a stockholder-approved charter or by-law amendment or a by-law amendment adopted unilaterally by the board of directors. Corporations going public and already-public corporations that are contemplating a future securities offering should consider adopting an exclusive federal forum provision. Similarly, any issuer who has made an offering in the past three years (the statute-of-repose period) and therefore could still be subject to Securities Act claims concerning that offering should also consider adopting such a provision. Corporations considering adopting such provisions, whether as a stockholder-approved charter or bylaw amendment or a bylaw amendment adopted unilaterally by the board of directors, should be mindful of institutional investor voting policies and those of Institutional Shareholder Services (ISS) and Glass Lewis & Co.
1 C.A. No. 2017-0931, slip op. (Del. Sup. Mar. 17, 2020) (“Salzberg”).
2 138 S. Ct. 1061, 1066 (2018).
3 Salzberg, slip op. at 3.
4 Id.
5 Id. at 4.
6 Id. at 9.
7 Id. at 10.
8 8 Del. C. § 102.
9 Salzberg, slip op. at 10–11.
10 Id. at 11.
11 Id. at 13–14.
12 Id.
13 Id. at 28.
14 Id. at 35 (quoting McDermott v. Lewis, 531 A.2d 296 (Del. Supr. 1987).
15 Id. at 38-39 (citing the example of Section 202, which allows transfer restrictions in stock certificates to be enforced against subsequent transferees).
16 Id. at 41–42.
17 Salzberg at 15.
18 Id. at 46.
19 Id.
20Id. at 48–50.
21 See Cyan, 138 S. Ct. at 1072 (acknowledging legislative history stating “that SLUSA's purpose was ‘to prevent plaintiffs from seeking to evade the protections that Federal law provides against abusive litigation by filing suit in State, rather than in Federal, court,’” yet holding that concurrent jurisdiction survived SLUSA’s enactment).
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