Forum selection provisions in companies’ certificates of incorporation that require claims under the Securities Act of 1933 to be litigated in federal court are facially valid, a state supreme court held. Federal forum provisions provide efficiency and consistency to unintended problems created by federal securities laws, the Supreme Court of Delaware reasoned. ABA Section of Litigation leaders expect more widespread use of forum selection provisions for securities claims in corporate charters or bylaws following this decision.
November 19, 2020 Top Story
Companies May Select Forum Through Charter Provision
Federal-forum clause for securities claims in articles of incorporation upheld
By Laura W. Givens
Reforms Prompt Companies to Use Forum Selection Clauses
The Securities Act of 1933 provides that private plaintiffs may bring their claims under the act in either federal or state courts. If a plaintiff chooses to bring an action under the act in state court, a defendant cannot change the forum. The act requires persons offering securities for sale to the public to file a registration statement that makes full and fair disclosure of relevant information.
Concerns over perceived abuses of the class action vehicle in litigation involving nationally traded securities prompted Congress in 1995 to adopt the Private Securities Litigation Reform Act (PSLRA). PSLRA limits recoverable damages and attorney fees and provides other restrictions on litigation. PSLRA had the unintended consequence of plaintiffs bringing class actions in state court under state law rather than face the PSLRA obstacles in federal court. That prompted companies, like the defendants in Salzberg v. Sciabacucchi, to include federal forum selection provisions in their certificates of incorporation.
Stock Purchasers Challenge Forum Selection Clause
The Salzberg defendants were all Delaware corporations that launched a 2017 initial public offering. Before filing their registration statements with the U.S. Securities and Exchange Commission, each company designated the federal courts as the exclusive forum for the resolution of claims under the ’33 Act in their respective certificates of incorporation.
Shareholders of the companies’ common stock sought a declaratory judgment that the federal-forum provisions were invalid under Delaware law and filed a putative class action in the Delaware Court of Chancery against the companies and their directors. The chancery court agreed with plaintiffs and granted their motion for summary judgment. In holding that the federal-forum provisions were ineffective and invalid, the court reasoned that constitutive documents of a Delaware corporation could not bind a plaintiff to a particular forum where the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.
Federal-Forum Provisions Held Valid under Delaware Law
The Supreme Court of Delaware reversed. At the outset, the appellate court explained that “[t]he plaintiff must show that the federal-forum provisions do not address a proper subject matter of charter provisions under” Section 102(b)(1) of Delaware’s General Corporation Law, and that the charter provisions “cannot operate lawfully or equitably under any circumstances.” The court concluded that the federal-forum provisions were facially valid because it could fall within either of the two categories authorized by Section 102(b)(1), which authorized (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 this State.” It reasoned that “a bylaw that seeks to regulate the forum in which such “intra-corporate” litigation can occur is a provision that addresses the ‘management of the business’ and the ‘conduct of the affairs of the corporation,’ and is, thus, facially valid under Section 102(b)(1).”
The court further observed that when parallel state and federal actions are filed, no procedural mechanism is available to consolidate or coordinate the suits, and there is the possibility of inconsistent judgments. By directing claims to federal court, a federal-forum provision provides for management of the business and for the conduct and affairs of the corporation.
Expect Changes After Salzburg
“Before Salzberg, many Delaware corporate law practitioners believed that forum selection provisions under Section 102(b)(1) were limited to binding a plaintiff to a particular forum when the claim involved rights that were established by Delaware corporate law or affecting a corporation’s internal affairs,” explains Albert H. Manwaring, IV, Wilmington, DE, cochair of the M&A/Proxy Subcommittee of the Securities Litigation Committee of the Section of Litigation.
“While the scope of Intra-Corporate Affairs claims under Salzberg is not yet clear, I suspect corporate attorneys will seek to include forum selection provisions in corporate charters or bylaws for ’33 Act claims and other claims seeking to channel class actions implicating ‘Intra-Corporate Affairs’ to a particular forum,” he concludes.
“It is also important to note that the decision only considered a facial attack on a forum provision in a charter, not a bylaw,” observes John E. Clabby, Tampa, FL, chair of the Class Actions Subcommittee of the Section’s Securities Litigation Committee. “Attorneys who represent investors in newly issued shares of public companies should be expected to plead their actions creatively after Salzberg to attempt to avoid claims under the 1933 Act, if they wish to stay in state court. For example, we may see state-court disclosure actions pleaded as conversion or fraud claims,” predicts Clabby.
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Related Resources
- Omnicare, Inc., v. Laborers Dist. Counsel Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015).
- Cyan, Inc., v. Beaver Cty. Emps. Ret Fund, 138 S. Ct. 1061, 1066 (2018).
- Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 126 S. Ct. 1503 (2006).
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