CLIENT ALERT
By: Michael Stanley and Michael Lambert
March 31, 2020
On March 18, 2020, in Salzberg v. Sciabacucchi, No. 346, 2019 (Del. Mar. 18, 2020), the Delaware Supreme Court held that federal forum provisions in corporate charters, requiring claims under the Securities Act of 1933 (the “1933 Act”) to be litigated in federal court, are facially valid This decision will enable Delaware corporations to adopt federal forum provisions and to avoid state court 1933 Act claims and consolidate 1933 Act claims in a single forum. However, questions remain as to whether other states will endorse this holding or void federal forum provisions on public policy grounds.
A Bit of Background
The federal courts are viewed as a safe harbor for companies defending claims brought under the Securities Act of 1933 (the “1933 Act”). This is due in large part to the requirement that claims under the 1933 Act litigated in federal court are subject to the Private Securities Litigation Reform Act of 1995 (“PSLRA”). The PSLRA requires a plaintiff to plead fraud with scienter, automatically stays discovery during the pendency of a motion to dismiss, and caps damages and recoverable attorneys’ fees.
In 2018, the Supreme Court neutered the defendant-friendly requirements of the PLSRA in Cyan, Inc. v. Beaver Cty. Employees Ret. Fund, 138 S. Ct. 1061 (2018). In Cyan, the Court held that under Securities Litigation Uniform Standards Act of 1998, state and federal courts have concurrent jurisdiction over 1933 Act claims and 1933 Act claims are not removable on their own. As a result, the rate of state court 1933 Act claims increased dramatically, allowing plaintiffs to avoid the PLSRA’s procedural protections. Additionally, because 1933 Act cases could not be removed and consolidated in the federal system, corporations were forced to defend duplicative lawsuits on multiple fronts. Corporations responded by adopting federal forum provisions in articles of incorporation or corporate by-laws requiring stockholders to bring 1933 Act claim in federal court. Salzberg involved the validity of these provisions
In Salzberg, the plaintiffs sought a declaration that the federal forum provisions in the articles of incorporation of Roku, Inc., Stitch Fix, Inc. and Blue April Holdings, Inc.—each a Delaware corporation—were facially invalid. The Delaware Chancery Court agreed with the plaintiffs and found that because a 1933 Act claim does not involve rights established by Delaware, the federal forum selection clauses in corporate documents were not binding. The companies appealed to the Delaware Supreme Court.
The Delaware Supreme Court’s Decision
The Delaware Supreme Court reversed, citing both statutory and policy reasons to hold federal forum provisions valid. As a statutory basis, the Court held that Delaware General Corporation Law, § 102(b)(1) controlled. This provision grants a corporation the power to adopt charter provisions that govern the conduct of the business and affairs of the corporation and regulate its relationship with its shareholders. The federal forum provision accomplished this goal by allowing companies to manage post-Cyan securities litigation in an efficient manner through federally administered consolidating and coordinating procedures. As the Delaware Supreme Court put it, “[b]y directing 1933 Act claims to federal courts when coordination and consolidation are possible” 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.” Additionally, the Delaware Supreme Court rejected that 1933 Act claim represent intra-corporate affairs that must be brought in Delaware under Delaware General Corporation Law, § 115.
As for the policy basis, the Court review both federal and state public public policy. First, the Delaware Supreme Court concluded that federal forum provisions are not an end-run around Cyan’s non-removability holding. Instead, the court embraced traditional forum selection clause concepts to allow parties to a corporate charter, i.e. a contract among shareholders, the choice of where to litigate disputes. This makes sense. While Cyan did hold that 1933 Act claims are not removable, it also held that 1933 Act claims have concurrent jurisdictional in both state and federal courts. The federal forum provision simply selects one of the two forums available under Cyan.
Second, the Court reviewed inter-state public policy and federal forum provisions. The Delaware Supreme Court acknowledged that this is the thorniest issue it faced and questioned whether other states would enforce the federal forum provision. Despite this acknowledgment, the Court stated that were “persuasive arguments that could be made to our sister states” that a federal forum provision “does not offend principles of horizontal sovereignty–just as it does not offend federal policy.” In reaching this conclusion, the Court focused on, potential “as applied”, as opposed to facial, challenges to federal forum provision and noted that they serve as an important safety valve. Additionally, the Court noted that forum selection clauses are procedural, not substantive. Thus, other states should apply its holding to suits involving Delaware corporation in their state because Salzberg would not interfere with the substantive rights of its citizens.
Salzberg’s Upshot
There are two main takeaways from Salzberg. First, under Delaware law, corporations possess “immense freedom” to decide how to order their affairs and contractual relationship with their shareholders. Because of this freedom, corporations may select the federal courts as the appropriate forum to adjudicate securities disputes under the 1933 Act, thereby avoiding duplicative actions. To reap this benefit, Delaware corporations should draft or amend their articles of incorporation with a federal forum provision.
Second, it remains to be seen whether other states will apply Salzberg’s rationale to cases involving Delaware defendants. Will the Salzberg court’s “legitimate concerns” that its opinion was an “out-of-our-lane power grab”, and a “federalization of [its] corporate law” give other states pause to enforce a federal forum provision in a Delaware company’s charter? Or will the procedural safe guards of an “as applied “ challenge to the forum selection clause be sufficient to calm other states? Time will tell.