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Litigation News

Litigation News | 2021

Federal Forum Provision in Incorporation Document Is Upheld

Ashlee Hamilton


  • State court dismisses 1933 Securities Act claims brought by shareholders due to federal forum provision buried in company’s amended incorporation documents.
  • Analogizing the provision to a forum selection clause, the court declined to exercise jurisdiction over a shareholder derivative suit. 
Federal Forum Provision in Incorporation Document Is Upheld
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In a case of first impression, one state court addressed the enforceability of a federal forum selection provision in a company’s certificate of incorporation. Businesses began using such provisions to avoid state courts after the U.S. Supreme Court upheld the anti-removal provision of the Securities Act of 1933 (the Act) in Cyan Inc. v. Beaver County Employees Retirement Fund. Analogizing the provision to a forum selection clause, the court declined to exercise jurisdiction over a shareholder derivative suit. However, ABA Litigation Section leaders warn that putting a federal forum provision in corporate documents does not guarantee a federal forum for securities claims.

Engineering an Escape Hatch from State Court

In Wong v. Restoration Robotics, Inc., a shareholder filed a class action in California state court alleging the defendant, a Delaware corporation, and its officers and directors violated the Act. The company moved to dismiss, asserting that a provision in its certificate of incorporation specifically designated the federal courts as the forum for any claims arising under the Act and bound all stockholders. Notably, the shareholders voted on the amendment to the certificate of incorporation that included the federal forum provision (FFP). In arguing for dismissal, the company relied upon the Delaware Supreme Court’s ruling in Salzberg v. Sciabacucchi, which held that FFPs are not contrary to Delaware law and that FFPs “do not offend federal law and policy.”

The trial court explained that Salzberg only addressed a facial challenge as to whether an FFP could be included in an article of incorporation under Delaware corporate law and not its substantive application. Because Delaware corporate law only extends to a company’s “internal affairs,” and a shareholder derivative suit against a company and its officers and directors was not an “internal affair,” the trial court concluded that Delaware law did not apply. It also rejected Salzberg’s conclusion that FFPs did not contravene federal law and policy as conclusory and noted that Salzberg did not bind other states considering whether an FFP might be enforceable under the laws of their jurisdictions. Accordingly, the court concluded that Salzberg was “irrelevant” to determining whether the FFP was enforceable.

Enforceability Determined Under California Law on Forum Selection Clauses

Nevertheless, in the absence of any case on point, the trial court considered Salzberg’s suggestion to evaluate an FFP’s enforceability under existing standards for (1) forum selection clauses, (2) mandatory arbitration provisions, and (3) settlement releases—but under California law. The court first reasoned that a settlement release is not comparable to a “[p]rovision unilaterally imposed, buried in a multi-pages SEC filing,” observing that public policy favors settlements but not involuntary waivers of rights.

Next, the court found that the FFP was unlike a mandatory arbitration provision but suggested that the FFP would be enforceable under such an analysis. In California, a party opposing enforcement of an arbitration provision must establish both procedural unconscionability, which “focuses on oppression or surprise due to unequal bargaining power,” and substantive unconscionability, which “focuses on overly harsh or one-sided results.” Noting that the company unilaterally drafted the FFP and then obscured it within the small print of lengthy forms, the court concluded that procedural unconscionability was present. However, it found no substantive unconscionability, because while the FFP deprived shareholders of “the different procedural advantages of a state court forum,” it left the Act’s substantive protections intact, including the right to a jury trial.

Rather, the court found the FFP most like a contractual forum selection clause, observing that the shareholders had voted on the amended certificate of incorporation that included the FFP. The court explained that a forum selection clause is generally enforceable unless its application would be unfair or unreasonable, and a trial court retains discretion whether to enforce the clause. In holding that the FFP was enforceable, the court relied on Drulias v. First Century Bancshares, Inc. There, a California appellate court upheld a forum selection clause embedded in corporate bylaws that were adopted without shareholder approval, stating that “[a] forum selection clause need not be subject to negotiation to be enforceable.”

Noting the circumstances in Drulias were “more ‘unfair’”, the court determined that the plaintiffs failed to demonstrate the FFP was unfair or unreasonable. Because the shareholders retained their due process and substantive rights under the Act and did not establish that the FFP either violated California law or public policy, or that it was unconstitutional or illegal under federal law, the court declined to exercise jurisdiction and dismissed the case. According to the court, “[t]he real culprit of Plaintiffs’ dismay [wa]s the broad scope of Section 102 of the Delaware General Corporation Law, which the Delaware Supreme Court has held goes beyond the regulation of internal affairs of a corporation or of intrastate commerce.”

The Rise of Federal Forum Provisions in Corporate Documents?

Drafters may begin regularly including FFPs in by-laws and incorporation documents, according to Litigation Section leaders. “If you want a chance to avoid litigating a 1933 Act claim in state court, it is worth taking a crack at including a provision like this in the by-laws. There is no guarantee that the law will be interpreted the same in every state and by every judge, so it is not a bullet-proof means of avoiding state court,” warns Sean O’D. Bosack, Milwaukee, WI, cochair of the Section’s Corporate Counsel Committee.

Other Section leaders agree. “Without having a good handle on the law of every state, it is tough to say. It tends to make sense if you are incorporating in Delaware. Probably in California as well,” advises Joseph S. Simms, Cleveland, OH, cochair of the Section’s Securities Litigation Committee.

Some corporations may already be heeding that advice. Since the ruling in Wong, California courts have upheld FFPs in two additional cases: In re Uber Technologies Securities, Litigation and In re Dropbox, Inc. Securities Litigation [login required].