So Long, Cyan?—Delaware Supreme Court Endorses Federal Forum-selection Provisions for Securities Act Claims

As discussed in our prior post on the Court of Chancery’s decision, the case involved three corporations that adopted federal forum-selection provisions for Securities Act claims in their respective certificates of incorporation prior to their initial public offerings. Plaintiff had purchased shares of common stock in the initial public offerings (or shortly thereafter) and challenged the forum-selection provisions in a declaratory judgment suit. By way of background, Section 102(b)(1) of the Delaware General Corporation Law (“DGCL”) sets out what provisions can be included in a Delaware corporation’s charter, and Section 115 of the DGCL (adopted in 2015) expressly permits the implementation of a forum-selection provision in favor of Delaware courts for “internal corporate claims.” Reading these statutes together, and drawing on other principles of Delaware law, the Court of Chancery held that the forum selection provisions were invalid because they did not implicate claims involving rights or relationships established by Delaware law, i.e., claims arising from the “internal” operations of the companies.

In reversing, the Delaware Supreme Court held, in a careful statutory analysis, that the Court of Chancery had read Section 102(b)(1) too narrowly and that federal forum-selection provisions fall within the broad scope of what is permitted by Section 102(b)(1). The Supreme Court also held that federal forum-selection provisions regulating the fora for Section 11 claims involving existing stockholders are neither “external” nor “internal affairs” claims, but instead are an “in-between in what might be called Section 102(b)(1)’s ‘Outer Band[.]’” The federal forum-selection provisions also were held not to violate Delaware public policy as they “do not violate th[e] sense of balance as they allow for litigation of federal Securities Act claims in a federal court of plaintiff’s choosing, but also allow for consolidation and coordination of such claims to avoid inefficiencies and unnecessary costs.”

The implications of today’s decision are potentially far-reaching. If it were broadly followed, the decision essentially provides Delaware companies with the ability to “opt out” of Cyan by requiring that Securities Act claims be filed in federal court. Corporations—wherever they are incorporated, but especially in Delaware—that are contemplating engaging in public offerings should consider whether federal forum-selection provisions should be added to their charters.

A key question, however, is how consistently the decision will be followed by courts in other jurisdictions, as we believe it should be. The Delaware Supreme Court recognized that “[p]erhaps the most difficult aspect of this dispute is not with the facial validity of [federal forum-selection provisions], but rather, with the ‘down the road’ question of whether they will be respected and enforced by our sister states.” As noted above, the Court acknowledged that federal forum-selection provisions, at least arguably, are not squarely internal corporate matters—for which the “internal affairs” doctrine states that the law of the company’s state of incorporation applies. The Court offered a number of reasons, however, that would support applying the “internal affairs” rule to federal forum-selection provisions regardless of such doctrinal detail. First, the Court observed that the rules for determining the validity of forum-selection provisions in the contractual context were informative here—because corporate charters are essentially contracts among the corporation’s stockholders—and that, in the contractual context, the Court had previously held that forum-selection provisions are “presumptively valid.” Second, the Court also noted that, because “many Section 11 claims closely parallel state law breach of fiduciary duty claims, many of the same reasons requiring application of the internal affairs doctrine would support the enforcement of [forum-selection provisions].” For example, like officers’ and directors’ due process rights to know what law will be applied to their actions, the need for uniformity and predictability that forum-selection provisions address argues in favor of their being enforced. Third, the Court emphasized that forum-selection provisions are procedural, not substantive, and thus do not violate constitutional principles against one state asserting extraterritorial jurisdiction over another state’s persons or property. Fourth, the Court also noted that forum-selection provisions are less restrictive than Delaware-forum provisions which have been respected in other jurisdictions. Thus, the Court concluded that forum-selection provisions, as a facial matter, do not violate principles of state sovereignty and should be enforced by other state courts.

Another issue is whether plaintiffs may attempt to raise federalism challenges to enforce a forum-selection provision that, at least arguably, would render nugatory the Securities Act’s concurrent grant of jurisdiction to state courts. In today’s decision, the Court convincingly held that federal forum-selection provisions do not violate federal law or policy for several reasons. Among other things, the Court pointed in particular to the United States Supreme Court’s decision in Rodriquez de Quijas v. Shearson/American Express, Inc. 490 U.S. 477 (1989). That decision specifically held that an agreement to arbitrate claims under the Securities Act was enforceable—and, the Delaware Court emphasized, showed that under the Supreme Court’s jurisprudence “federal law has no objection to provisions that preclude state litigation of Securities Act claims.” The Delaware Supreme Court also noted that “nothing in Cyan prohibits a forum-selection provision from designating federal court as the venue for litigating Securities Act claims,” and cited additional Supreme Court and other cases in support. Although the Delaware Supreme Court’s views on this specific question may be argued not to be binding on courts in other jurisdictions, a plaintiff would likely face a significant challenge in asking a court to refuse to enforce a federal forum-selection clause on federalism grounds, particularly given the rich decisional history rejecting such arguments in other contexts.

Further, another unanswered question is whether Delaware (and other) companies that are already facing Securities Act litigation in state courts can enact charter amendments that would defeat state court jurisdiction in such actions. Today’s decision did not address whether such an amendment could be invoked in an ongoing litigation that began prior to the change or that includes former stockholders who purchased shares before the amendment. Whether a court would enforce a newly adopted federal forum-selection provision to an ongoing litigation will need to be considered closely in the relevant jurisdiction.

Finally, principles of Delaware corporate law aside, it bears mention that today’s decision was a victory in the direction of common sense. SLUSA was intended to channel securities class action litigation to federal law and federal court. Thanks to inartful statutory drafting (one Supreme Court Justice famously called it “gibberish”), the U.S. Supreme Court in Cyan found that SLUSA failed to achieve its aim, leaving a loophole for exclusively federal securities litigation to be filed in state court without a right of removal to federal court. The result has been a proliferation of state court actions, often in parallel to federal court actions alleging the exact same claims with respect to the exact same issuer. This phenomenon has driven up insurance costs and spawned excess litigation with less consistent results. Today’s decision says that Delaware corporations, and their shareholders, can do something about that.