Delaware Supreme Court holds federal forum provisions valid and enforceable

On March 20, 2018, the U.S. Supreme Court in Cyan, Inc. v. Beaver County Employment Retirement Fund (“Cyan”) held that class actions under the Securities Act of 1933 (the “1933 Act”) may be brought in state court, and are not removable to federal court. What this means is that plaintiffs can and have been bringing class actions under Section 11 of the 1933 Act in both state and federal court.  This has resulted in procedural headaches and an increase in defense costs that have frustrated both policyholders and D&O insurers alike.

In a March 18, 2020 decision in Salzberg v. Sciabacucchi, No. 346 (2019), the Delaware Supreme Court took the first step in giving companies an option to limit Section 11 class actions to federal court. The Delaware Supreme Court ruled that forum selection clauses are facially valid and enforceable under Delaware law. The decision marks a reversal of the December 2018 Delaware Chancery Court ruling where the Chancery Court held that, under Delaware law, federal forum provisions were invalid and ineffective.

The Delaware Supreme Court ruling provides much welcomed clarity for corporations and insurers looking for tools to combat the post-Cyan uptick of 1933 Act filings in state courts.

Background – Underlying Derivative Action and Appeal

The underlying derivative action was filed against several directors who signed registration statements on behalf of three Delaware corporations (Blue Apron Holdings Inc.; Stitch Fix Inc.; and Roku Inc.), which each included federal forum selection provisions for litigation under the 1933 Act within their charters. 

Such federal forum provisions have been widely adopted by companies going public in response to the U.S. Supreme Court’s ruling in Cyan, which held (i) plaintiffs may pursue class actions under the 1933 Act in state courts, and (ii) defendants cannot remove class actions alleging only 1933 Act claims from state to federal court.

The derivative complaint specifically targeted the validity and enforceability of the federal forum provisions. Relying on Chancery Court precedent established in Boilermakers Local 154 Ret. Fund v. Chevron Corp.,[1] which held that federal forum provisions may be adopted for internal corporate claims, plaintiff sought a declaratory judgment that the defendant corporations’ federal forum provisions were invalid, as the 1933 Act claims were not internal corporate claims.

The Chancery Court ruled in plaintiff’s favor, holding that federal forum provisions attempting to regulate the filing of 1933 Act claims are invalid because 1933 Act claims are external claims outside the scope of corporate contracts. An appeal followed.

Legal Reasoning – Delaware Supreme Court Opinion

The Delaware Supreme Court reversed the Chancery Court ruling and entered a unanimous opinion, holding that federal forum provisions are facially valid under Delaware law. The Delaware Supreme Court’s analysis explains that a facial challenge of a charter provision must demonstrate that such charter provision can never operate consistently with Delaware law. 

The Delaware Supreme Court opinion held that federal forum provisions fall within the broad enabling text of DGCL §102, which governs a corporation’s certificate of incorporation, and specifically DGCL §102(b)(1), which authorizes broad types of provisions within certificates of incorporation. 

Such provisions include “any provision for the management of the business and for the conduct of the affairs of the corporation” and “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.” Accordingly, the Delaware Supreme Court reasoned the federal forum provisions were facially valid, as they “could easily fall within either of these broad categories[.]”

The Delaware Supreme Court found that the Chancery Court’s narrow definition of “internal affairs” was incompatible with established Delaware precedent and improperly restricted the scope of DGCL §102(b)(1). The Delaware Supreme Court opinion reasoned that the Chancery Court’s binary analysis of internal affairs claims versus external claims ignores the reality that corporate claims operate on a spectrum.  Thus, the Delaware Supreme Court found that certain 1933 Act claims may fall on the continuum where they are within the outer band of DGCL §102(b)(1) and therefore permissibly subject to federal forum provisions.

Interestingly, the Delaware Supreme Court added that federal forum provisions survive a facial challenge as a policy matter. Citing to the U.S. Supreme Court opinion in Rodriquez de Quijas v. Shearson/American Express, Inc., where the U.S. Supreme Court held that provisions precluding state litigation of Securities Act claims are permissible under federal law, the Delaware Supreme Court emphasized that forum selection clauses are presumptively valid and enforceable under federal law and Delaware law.  Further on this point, the Delaware Supreme Court acknowledged that Cyan permitted the filing of 1933 Act claims in state court, but notes that Cyan in no way prohibited corporations from designating federal court as the venue for 1933 Act claims by way of federal forum provisions.

Comment – Effective Tool to Combat Parallel State and Federal Litigation

In the wake of Cyan, many companies have grappled with ways to limit or avoid having to litigate securities class action claims in state courts. The Delaware Supreme Court’s decision here is a robust endorsement of the federal forum provisions that many Delaware corporations have adopted as a measure to ensure they will only face such claims in federal courts.

The corporations and insurers who have been forced to deal with post-Cyan jurisdictional complexities (or the prospect of such convoluted litigation) will surely be pleased that the Delaware Supreme Court dedicated an entire section of its opinion highlighting how federal forum provisions are classic tools to avoid parallel state and federal litigation.

The Delaware Supreme Court specifically cited to statistics compiled by Cornerstone Research, which reflect that Cyan precipitated a drastic and unprecedented spike in state and parallel filings of securities class actions. Of particular concern to corporations and insurers are the parallel actions where there is no current procedural means to consolidate or coordinate the various lawsuits, which only leads to greater costs, confusion, and potential for inconsistent judgments.

Where tools, such as federal forum provisions, are available to streamline litigation, the goals of judicial economy and consistency are furthered by their implementation. The Delaware Supreme Court decision here recognizes the value of such provisions and is a helpful step toward a more manageable post-Cyan litigation landscape, including for D&O insurers.

Read others items in London Market Brief - April 2020

 

[1]The Boilermakers holding was codified by Delaware’s legislature by DGCL §115, permitting the use of federal forum provisions for internal corporate claims.  DGCL §115 defines an internal corporate claim as: “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.”