The Delaware Supreme Court upheld the validity of exclusive federal forum provisions included in Delaware certificates of incorporation requiring actions arising under the Securities Act of 1933 to be filed in federal court instead of state court.
On March 18, 2020, the Delaware Supreme Court upheld the validity of exclusive federal forum provisions (FFPs) included in a Delaware company’s certificate of incorporation requiring actions arising under the Securities Act of 1933 (the Securities Act) to be filed in federal court instead of state court in the case of Salzberg v. Sciabacucchi.1 This is particularly significant because, while federal and state courts have concurrent jurisdiction over Securities Act claims,2 in 2018 the U.S. Supreme Court held in Cyan, Inc. v. Beaver County Employees Retirement Fund3 that Securities Act claims filed in state court cannot be removed to federal court.
As a result of the Cyan decision, plaintiffs changed their strategy and the number of state court filings immediately escalated.4 Plaintiffs were strategically filing Securities Act claims in state courts to avoid the heightened pleading standards of the Private Securities Litigation Reform Act (the PSLRA) that Congress adopted in 1995 in an effort to reduce abusive litigation.5 Notably, the PSLRA only applies in federal courts, not state courts. The combination of the PSLRA and the Cyan decision motivated strategic plaintiffs to file Securities Act claims in state courts in order to receive the simultaneous benefit of evading the heightened pleading standards of the PSLRA while also leaving defendant corporations without a means of changing the forum to a federal court.
Overview and Results of the Salzberg Case
In response to the increased Securities Act claims being filed in state courts, corporations began adopting federal forum selection provisions in their charters requiring that such claims must be brought in federal courts.
The defendant corporations in Salzberg are all Delaware corporations that, prior to their initial public offerings (IPOs), adopted FFPs in their respective certificates of incorporation, designating federal courts as the exclusive forum for claims under the Securities Act.6 Sciabacucchi, the plaintiff in the case, bought shares of common stock of each of these companies either during or shortly after their IPOs and then brought a declaratory judgment in the Chancery Court that such FFPs are facially invalid under Delaware law.7 The Chancery Court held that FFPs were invalid because 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.”8
However, the Delaware Supreme Court reversed the Chancery Court and concluded that (1) FFPs fall within the broad enabling text of Section 102(b)(1) of the Delaware General Corporation Law (DGCL), which governs the contents of the certificate of incorporation,9 and (2) while the Delaware Supreme Court agreed with the Chancery Court that claims under the Securities Act are not “internal corporate claims” within the meaning of Section 115 of the DGCL (which governs forum selection provisions), Section 102(b)(1) is not limited by such definition, and FFPs are therefore valid under Delaware law.10 Although the Delaware Supreme Court affirmed the facial validity of FFPs, it also cautioned that “[c]harter and bylaw provisions that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose.”11 The court went on to list various bases upon which forum-selection provisions may be invalidated on an “as applied” basis.12
In its concluding statement, the Delaware Supreme Court noted that FFPs are a relatively recent trend “designed to address the post-Cyan difficulties presented by multi-forum litigation of Securities Act claims.”13 Moreover, the validity of FFPs advance Delaware’s goals of “achiev[ing] judicial economy and avoid[ing] duplicative efforts among courts in resolving disputes” and is also compatible with Delaware law’s efforts to enhance flexibility and deference to case law development.14 Finally, it is important to note that the Salzberg decision does not overturn Cyan, but merely affirms the facial validity of FFPs in Delaware certificates of incorporation, and corporations should consider whether adopting an FFP is right for them.
Practical Implications of the Salzberg Case
- Certificates of Incorporation: Boards of Delaware public companies should consider adopting FFPs, if possible, in order to prevent duplicative litigation in federal and state courts (e.g., claims brought under the Securities Exchange Act of 1934 in federal courts and claims brought under the Securities Act of 1933 in state courts) and to invoke the higher pleading standard and other benefits of the PSLRA. This may only be practical for corporations that are pre-IPO depending on the corporation’s stockholder base and potential proxy adviser impact.
- FFPs in Bylaws: While the Salzberg case involved FFPs in Delaware certificates of incorporation, the Delaware Supreme Court extensively discussed Boilermakers Local 154 Retirement Fund v. Chevron Corp.,15 a case that approved a forum-selection clause adopted into the defendant companies’ bylaws, in its opinion. In the court’s discussion, it did not say anything suggesting that adopting an FFP in a company’s bylaws rather than its certificate of incorporation would make a difference, indicating the court’s holding may not be limited to certificates of incorporation. But, for ease of doubt, we would suggest making any FFP adoption into the company’s certificate of incorporation (if possible).
- Company Bonds: Bondholders are not subject to corporate charters. However, corporate debt may still be registered with the Securities and Exchange Commission (SEC) and therefore subject to, and therefore liable for, claims filed under the Securities Act. Companies may want to explore including FFPs in bond indentures.
- Proxy Adviser Considerations and FFPs: Glass Lewis has a negative view on forum selection clauses, generally recommending a vote against the governance committee chair where the board adopts a forum selection clause without shareholder approval (or seeks shareholder approval of a forum selection clause pursuant to a bundled bylaw amendment, rather than as an individual proposal).16 However, Glass Lewis provided the caveat that it will “evaluate the circumstances surrounding the adoption of any forum selection clauses” and “[w]here it can be reasonably determined that a forum selection clause is narrowly crafted to suit the particular circumstances facing the company and/or a reasonable sunset provision is included, [Glass Lewis] may make an exception to this policy.”17 Institutional Shareholder Services (ISS) has a more liberal approach on forum selection clauses and states that it will vote on a case-by-case basis taking into account the following factors: (1) the company’s stated rationale for adopting such provision, (2) disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the jurisdiction of incorporation, (3) the breadth of application of the bylaw, including the types of lawsuits to which it would apply and the definition of key terms, and (4) governance features such as shareholders’ ability to repeal the provision at a later date (including the vote standard applied when shareholders attempt to amend the bylaws) and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.18
- 2020 WL 1280785 (Del. Mar. 18, 2020).
- Section 22 of the Securities Act (15 U.S.C. §77v(a).
- 138 S. Ct. 1061 (2018).
- Salzberg, 2020 WL 1280785 at *5 (citing Stanford Law Sch. Secs. Class Action Clearinghouse & Cornerstone Research, Securities Class Action Filings 2018 Year in Review 22 (2019)).
- Id. at *2 (citing Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82).
- Id. at *1 and *3.
- Id. at *1.
- Id. at *1; see also Sciabacucchi v. Salzberg, 2018 WL 6719718 at *6 (Del. Ch. Dec. 19, 2018).
- Specifically, the Delaware Supreme Court noted that Section 102(b)(1) authorizes two broad types of provisions: (1) “any provision for the management of the business and for the conduct of the affairs of the corporation” and (2) “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 [Delaware].” Salzberg, 2020 WL 128078 at *4.
- Id. at *16.
- Id. at *21.
- Id. (citing Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 15 (1972) for the three bases).
- Id. at *23.
- 73 A.3d 934 (Del. Ch. 2013).
- Glass Lewis, 2020 Proxy Paper Guidelines: An Overview of the Glass Lewis Approach to Proxy Advice United States 15, https://www.glasslewis.com/wp-content/uploads/2016/11/Guidelines_US.pdf.
- ISS, United States: Proxy Voting Guidelines, Benchmark Policy Recommendations 24, https://www.issgovernance.com/file/policy/active/americas/US-Voting-Guidelines.pdf.