In light of the Delaware Supreme Court’s March 18, 2020 decision in Sciabacucci v. Salzberg, companies incorporated in Delaware should consider including a federal-forum provision (“FFP”) in their organizational documents. Noting that Delaware corporations have “the broadest grant of power in the English-speaking world to establish the most appropriate internal organization and structure for the enterprise,” the court overruled the trial court’s decision in this closely-watched lawsuit.
The per curiam opinion by the court sitting en banc rejected the Vice Chancellor’s holding that FFPs—that is, provisions mandating that actions arising under the Securities Act of 1933 (the "Securities Act") be filed in a federal court—are invalid under Delaware law because the “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”
The court held instead that FPPs can be valid under Delaware law. Given the explosion of Securities Act suits filed in state courts in recent years by plaintiffs who believed the state court forum to be advantageous, the ability for Delaware corporations to mandate that such suits be brought in federal court could have a significant effect on Securities Act litigation in the years to come.
The Securities Act requires companies offering securities for sale to the public to file a registration statement that discloses financial and other information concerning the business and the securities being offered for sale. Through Section 11 of the Securities Act, the purchasers of those securities have a narrow but strong private right of action that provides for strict liability against issuers, signatories, and underwriters—subject only to certain affirmative defenses—if the registration statement contains any material misstatements or omissions. (Purchasers also may sue sellers and control parties under Sections 12 and 15 of the Securities Act.) Damages are statutorily presumed to be the full amount of each purchaser’s stock price loss up to the time the lawsuit is filed, unless defendants meet their burden to show otherwise.
For many years, the federal circuits were split as to whether Securities Act cases could be brought in state court. In 2018, the United States Supreme Court in Cyan Inc. v. Beaver County Employees Retirement Fund resolved the issue and held that plaintiffs can bring Securities Act claims in state court and that those actions are not removable to federal court. Some securities plaintiffs believe state court venues to be advantageous, due to a perceived quicker path to discovery and ultimately trial and as a means to avoid certain provisions of the federal Private Securities Litigation Reform Act (the “PSLRA”). The PSLRA, enacted by Congress in 1995 in a bid to reduce frivolous private securities lawsuits, limits recoverable damages and attorney’s fees, provides a “safe harbor” for forward-looking statements, imposes restrictions on the selection of lead plaintiffs, and requires a stay of discovery pending resolution of any motion to dismiss. Following Cyan, the filing of Securities Act cases in state courts has escalated. According to Cornerstone Research, before Cyan, plaintiffs filed an average of only five state court-only Securities Act cases each year. In 2018, the year Cyan was decided, the number more than tripled, to 16. This past year, the number nearly doubled again, with 27 state court-only Securities Act suits filed (and another 22 filed in parallel with other federal court claims).
Preferring federal court to state court, some corporations have adopted FFPs designating federal courts as the exclusive forum for claims arising under the Securities Act. In the Sciabacucchi case, each of the companies named as nominal defendants adopted an FFP in its certificate of incorporation before filing its registration statement with the SEC and proceeding with its initial public offering. The plaintiff bought shares of common stock of each company, filed a putative class-action complaint under the Securities Act, and sought a declaratory judgment that the FFPs are invalid under Delaware law. The Court of Chancery granted a motion for summary judgment in plaintiff’s favor, determining that the FFPs were ineffective and invalid because corporate organizational documents can regulate only “internal affairs claims brought by stockholders qua stockholders,” not external claims arising under the federal securities laws.
The Delaware Supreme Court dismantled the binary approach adopted by the trial court, opting instead to describe Securities Act claims as neither “external” nor “internal.” Rather, according to the court, they are “in-between,” “intra-corporate,” or the “Outer Band” of Section 102(b)(1) of the Delaware General Corporation Law (the “DGCL”), which governs the matters contained in a corporation’s certificate of incorporation. The court held that Securities Act claims arise from internal corporate conduct on the part of the board of directors and therefore fall within Section 102(b)(1). Based on that reasoning, FFPs are facially valid.
The United States Supreme Court is unlikely to have occasion to review the decision as the parties in their briefing acknowledged that the dispositive question is limited to whether Delaware law authorizes FFPs.
The Sciabacucchi opinion confirms the view that FFPs advance the goals of Delaware corporate law: certainty and predictability, uniformity, and prompt judicial resolution to corporate disputes. In the short term, those defendants facing pending Securities Act claims who preserved grounds for removal or dismissal due to an FFP may consider a second effort. In addition, the perception that state courts are more plaintiff-friendly has resulted in higher costs for directors and officers liability insurance. The Sciabacucchi decision may ease at least one pressure point at a time of macroeconomic uncertainty.
But the import of the Sciabacucchi opinion is as much about the issues it did not reach as the issue it did. First, the opinion takes up the legitimacy of the FFPs on a facial challenge but pointedly states that “[t]he question of enforceability is a separate, subsequent analysis that should not drive the initial facial validity inquiry.” In other words, although the DGCL permits the inclusion of FFPs, specific FFPs still could be held to be unreasonable and invalid on a factual challenge. As the court noted, “as applied challenges are an important safety valve in the enforcement context . . . . [W]hether the specific charter provision is enforceable ‘depends on the manner in which it was adopted and the circumstances under which it [is] invoked.’” For example, the court did not address whether a corporation could amend its charter or bylaws to adopt an FFP with retroactive effect. There are legal and policy reasons why this may be permitted—as the court noted, “stockholder-approved charter amendments should be respected as a matter of policy.” But Sciabacucchi does not explicitly decide the issue, which would likely need to be addressed on a case-by-case basis.
Second, the court noted that the “most difficult aspect of this dispute is not with the facial validity of FFPs, but rather, with the ‘down the road’ question of whether they will be respected and enforced by our sister states.” As the opinion observes, other states might react negatively “to what could be viewed as an out-of-our lane power grab,” which in turn could invite greater scrutiny of the internal affairs doctrine, or a move towards federalization of corporate law. If other states’ courts will not enforce Delaware corporations’ FFPs, then the Sciabacucchi opinion would be a hollow victory for those corporations’ attempts to litigate their Securities Act claims in federal court only. For its part, the Delaware Supreme Court believes that other states’ courts will follow Sciabacucchi and respect the facial validity of Delaware corporations’ FFPs. As the court reasoned, constitutional protections such as the Due Process Clause and Full Faith and Credit Clause and "[t]he need for uniformity and predictability that FFPs address... argue in favor of deference being given to them."
While many states respect Delaware corporate law, it may turn out that the Sciabacucchi opinion is harder precedent to follow than the Delaware Supreme Court’s 2013 decision in Boilermaker Local 154 Retirement Fund v. Chevron Corporation, which held that disputes over the internal affairs of Delaware corporations could be restricted to Delaware courts. To the extent that the Sciabacucchi decision is viewed as the logical next step in that line of cases, the court took pains to try to preempt one additional prospective development: mandatory arbitration of internal corporate claims, noting that such provisions would violate Delaware state law. Even with “the broadest grant of power in the English-speaking world,” in Delaware, it appears some restrictions may apply.
Or maybe not. While the Delaware Supreme Court may believe such clauses would violate Delaware law, their legality under Delaware law may be irrelevant. The Federal Arbitration Act provides that written agreements to arbitrate “shall be valid, irrevocable, and enforceable,” and the United States Supreme Court has held that this provision preempts contrary state laws. Now that the Delaware Supreme Court has recognized the validity of charter provisions such as FFPs, mandatory arbitration provisions may indeed be the next step. It is certainly one for which some Delaware corporations may attempt to advocate.
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