Corporations Cannot Bar Plaintiffs from Bringing Securities Law Claims in State Court: Delaware Court of Chancery Finds Federal-Forum Charter Provisions “Ineffective and Invalid”

By Jay McMillan

Delaware corporations can adopt forum-selection bylaws naming Delaware as the exclusive forum for stockholder claims related to the internal affairs of the corporation. However, based on a recent Court of Chancery ruling, Delaware corporations cannot adopt charter provisions that require plaintiffs to go to federal court (rather than state court) to assert any claims made under the federal securities laws.

Forum selection bylaws require stockholder plaintiffs to bring actions for breach of fiduciary duty and other matters related to the internal affairs of a corporation in a specific jurisdiction. In 2013, Chief Justice Leo E. Strine, Jr., then serving on the Court of Chancery, ruled in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), that Delaware forum selection bylaws are valid and enforceable.

On the other hand, federal-forum charter provisions require plaintiffs to bring actions under the federal securities laws in federal court and not in state court. In an opinion issued on December 19, 2018, Sciabacucchi v. Salzberg, Del. Ch. C.A. No. 2017-0931-JTL, Vice Chancellor J. Travis Laster ruled that federal-forum charter provisions are “ineffective and invalid.” The difference is that forum selection bylaws apply only to actions involving the internal affairs of the corporation, while federal forum provisions apply to the external act of buying shares—at which point the buyer is not yet a stockholder of the corporation.

The “internal affairs doctrine” means, for example, that “Delaware corporate law can specify the rights, powers, and privileges of a share of stock, determine who holds a corporate office, and adjudicate the fiduciary relationships that exist within the corporate form.” In other words, internal affairs include ownership of stock, the roles of officers and directors, and fiduciary duties. However, Delaware’s authority over a Delaware corporation does not extend to the corporation’s “external relationships, particularly when the laws of other sovereigns govern those relationships.” Federal law governs the relationships between buyers and sellers of securities. Delaware law governs the relationships between Delaware corporations and their directors, officers, and stockholders.

In Sciabacucchi, three Delaware corporations, Blue Apron Holdings, Inc., Roku, Inc., and Stitch Fix, Inc., launched initial public offerings in 2017. Each of the three corporations adopted a provision in its certificate of incorporation stating that “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.” The Securities Act of 1933, or the ’33 Act, requires companies offering securities to the public “to make full and fair disclosure of relevant information” by filing registration statements with the United States Securities and Exchange Commission (SEC). The ’33 Act created private causes of action for investors and provided that those claims could be brought in state or federal court. On March 20, 2018, in Cyan, Inc. v. Beaver County Employees’ Retirement Fund, 138 S. Ct. 1061, the Supreme Court of the United States confirmed that ’33 Act claims can be brought in state or federal court and, if brought in state court, cannot be removed to federal court.

In Sciabacucchi, the plaintiff, who held shares of stock in each of the three corporations, brought an action in the Delaware Court of Chancery challenging the federal forum provisions and seeking a declaration that the provisions were invalid. The parties filed cross-motions for summary judgment. The Court found that the matter was ripe for adjudication because of the likely deterrent effect of the provisions on plaintiffs who would otherwise bring their actions in state court, and the likelihood that similar provisions would be adopted by other corporations.

The Court traced the origin of corporate forum-selection provisions to “an epidemic of stockholder litigation,” including “frequently meritless” actions that were settled for “non-monetary relief and an award of attorneys’ fees.” In 2010, Vice Chancellor Laster suggested in In re Revlon, Inc. Shareholders Litigation, 990 A.2d 940, that the filing of multiple lawsuits in multiple jurisdictions could be mitigated by the adoption of bylaws requiring stockholder litigation to be brought in the jurisdiction of incorporation. In 2013, then-Chancellor Strine held in Boilermakers that those bylaws were valid under Delaware law. By August 2014, 746 publicly traded corporations had adopted such forum-selection bylaws.

In 2015, the Delaware General Assembly codified the holding of Boilermakers by adopting a new Section 115 of the Delaware General Corporation Law (DGCL). Section 115 provides that a Delaware corporation’s charter or bylaws may require “internal corporate claims” to be brought in Delaware courts. The term “internal corporate claims” was defined to include claims of breach of fiduciary duty and claims based on the DGCL. However, the statute said nothing about external claims, including securities law claims—it was understood that corporate documents could not be used to regulate external claims.

The DGCL contains provisions stating the subjects (in short, internal affairs) that may be addressed by bylaws and certificates of incorporation. Compare 8 Del. C. § 102(b)(1) (charters) and 8 Del. C. § 109(b) (bylaws). Based on the similarities between the provisions, Vice Chancellor Laster in Sciabacucchi found that the holding of Boilermakers with respect to bylaws should apply equally to certificates of incorporation.

The Court found that because securities law claims are based on the purchase of securities, as opposed to the ownership of the shares, securities law claims are external to the affairs of the corporation. “The cause of action does not arise out of or relate to the ownership of the share, but rather from the purchase of the share.” Claims are governed by Delaware law where they relate to the stockholder “qua” stockholder. The Court concluded that federal-forum provisions “purport to regulate the forum in which parties external to the corporation (purchasers of securities) can sue under a body of law external to the corporate contract (the 1933 Act). They cannot accomplish that feat, rendering the provisions ineffective.”

Assuming that Sciabacucchi is not reversed on appeal, Delaware law allows Delaware corporations to adopt forum selection bylaws or charter provisions governing actions related to the internal affairs of the corporation, but does not allow Delaware corporations to adopt federal-forum provisions governing federal securities law claims. Delaware corporations can and should adopt bylaws or charter provisions naming Delaware as the exclusive forum for actions related to the internal affairs of the corporation. Those provisions are effective to limit multi-jurisdiction stockholder litigation. Delaware corporations may not, however, adopt bylaws or charter provisions that name the federal courts as the exclusive forum for federal securities law actions. Those actions can still be brought in any state or federal court that has jurisdiction over the defendants.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP.  He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery.  For more information on the firm, visit hfk.law.

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