Delaware Supreme Court Affirms Validity of Corporate Charter Provisions Requiring U.S. Securities Act Claims to be Brought in Federal Court

In a highly anticipated decision, the Delaware Supreme Court issued an opinion yesterday in Salzberg v. Sciabacucchi, upholding the validity of “federal forum provisions” (“FFPs”) in corporate charters that require any claims brought under the federal Securities Act of 1933 (the “Securities Act”) to be pursued in federal court.[1]  Businesses incorporated in Delaware have increasingly adopted FFPs in their charters, particularly in response to the U.S. Supreme Court’s 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, which held that federal and state courts have concurrent jurisdiction over class action claims brought under the Securities Act, and that such claims are not removable to federal court.[2] Cyan had an immediate and significant impact, with state Securities Act filings increasing by 40% in 2019, and actually exceeding the number of federal-only court filings.[3]  The Salzberg decision has the potential to reverse that trend. In light of the Delaware Supreme Court’s decision, and the significant benefits that often come from litigating Securities Act claims in federal court, companies without an FFP in their corporate charter should strongly consider adopting one.

Background

Under the Securities Act, any person offering securities for sale to the public must file a registration statement with the U.S. Securities and Exchange Commission that makes “full and fair disclosure” of information relevant to the public offering.  To ensure issuers comply with their obligations and to protect investors, the Securities Act creates a private right of action for purchasers of such securities.  Under the statute, and as recently affirmed by the U.S. Supreme Court in Cyan, private plaintiffs are permitted to bring Securities Act claims in both federal and state courts.  And if an action is initiated in state court, defendants are precluded from removing it to federal court.

Generally, defendants in Securities Act cases will prefer to be in federal court, where the judges are more familiar with interpreting and applying the federal securities laws and in which out-of-state or foreign defendants have less concern (founded or not) that they will be treated unfairly.  Accordingly, and especially in light of the U.S. Supreme Court’s Cyan decision, many Delaware corporations have adopted FFPs in their charters, which generally provide that the federal district courts “shall be the exclusive forum” for hearing claims under the Securities Act. 

In Sciabacucchi v. Salzberg, the plaintiff purchased shares in several Delaware corporations with FFPs in their charters, including Blue Apron Holdings, Inc., Roku, Inc., and Stitch Fix, Inc.  Plaintiff then brought a declaratory judgment action in Delaware Chancery Court, alleging the FFPs violated Delaware law.  The Chancery Court agreed, holding that 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.”[4]  The defendants appealed, and the Delaware Supreme Court has now reversed. 

Discussion

Under Section 102(b)(1) of the Delaware General Corporation Law (“DGCL”), a provision in a corporate charter is valid so long as it is (a) either (i) a provision “for the management of the business and for the conduct of the affairs of the corporation,” or (ii) a provision “creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders;” and (b) the provision is “not contrary to the laws of” Delaware.  Thus, a plaintiff challenging a charter provision must show that the provision in question “cannot operate lawfully or equitably under any circumstances.” 

In Salzberg, the Delaware Supreme Court held that FFPs are facially valid under Section 102(b)(1).  First, FFPs “involve a type of securities claim related to the management of litigation arising out of the Board’s disclosures to current and prospective stockholders in connection with an IPO or secondary offering.”  Because a bylaw that seeks to regulate the forum in which such “intra-corporate” litigation can occur is a provision that addresses the “management of the business” and the “conduct of the affairs of the corporation,” it is facially valid under the first category delineated in Section 102(b)(1).  Second, because FFPs prescribe where current and former stockholders can bring Securities Act claims against the corporation its and directors and officers, an FFP is also a provision “defining, limiting and regulating the powers of the corporation, the directors and the stockholders,” and thus facially valid under the second category delineated in Section 102(b)(1).

The Delaware Supreme Court further held that FFPs are not “contrary to the laws of” Delaware, because (i) Delaware public policy affords great deference to stockholder-approved charter amendments as contracts among a corporation’s stockholders, and (ii) the DGCL allows immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise. 

The Delaware Supreme Court also examined whether FFPs violate Section 115 of the DGCL, which provides that no provision of a corporate charter may prohibit “internal corporate claims” from being brought “in the courts of this State.”  However, the Court held that Section 115 does not render FFPs invalid because claims under the Securities Act are not “internal corporate claims” since they are not governed by substantive Delaware law, and that “Section 115 likely was intended to address claims requiring the application of Delaware corporate law as opposed to federal law.”[5]  Instead, the Delaware Supreme Court described FFPs as “outer band” matters that govern neither purely “internal affairs” nor “external affairs.” Rather, they are “intra-corporate” matters that fall just outside the ambit of Section 115, but nevertheless within the scope of Section 102(b)(1) as valid corporate charter provisions.  The Court also considered whether its holding was in conflict with federal law (and therefore potentially preempted), but found that it was consistent with the U.S. Supreme Court’s 1989 ruling in Rodriquez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989), which upheld an arbitration provision in a brokerage agreement that precluded state court litigation of Securities Act cases.

The Delaware Supreme Court’s Salzberg opinion provides another marker on Delaware’s road to maintaining its state-of-the-art corporation law and market appeal that makes it the preferred U.S. state for incorporation. The DGCL section authorizing forum selection (Section 115[6]), as added in 2015 by the Delaware legislature and mentioned by the Court (as discussed above), could be viewed as helping in part to allow for the continued development of Delaware case law even while Delaware has put limits on the ability of corporations to adopt measures deemed too one-sided (such as the 2015 provision barring the use of a fee-shifting bylaw[7]). Notably, in reversing the Chancery Court, the Delaware Supreme Court highlighted the focus of Delaware law on “enhanc[ing] flexibility in order to engage in private ordering” for Delaware corporations’ directors and stockholders. 

Conclusion

Now that the Delaware Supreme Court has affirmed the validity of FFPs that require Securities Act claims to be brought in federal court, companies should strongly consider adopting such a provision in their corporate charter if they do not already have one. Although companies incorporated outside Delaware may face legal challenges with respect to such FFPs, the Delaware Supreme Court’s Salzberg decision encourages its “sister states” to uphold such provisions.  Indeed, the Court’s opinion underscores that “FFPs can provide a corporation with certain efficiencies in managing the procedural aspects of securities litigation following the United States Supreme Court’s decision in [Cyan,]” including by avoiding “[t]he costs and inefficiencies of multiple cases being litigated simultaneously in both state and federal courts,” as well as “the risks of litigating in multiple forums simultaneously, with potentially divergent and contradictory outcomes.” Thus, no matter where incorporated, companies should consider the utility of an FFP.



[1]    Salzberg v. Sciabacucchi, 2020 WL 1280785, at *23 (Del. Mar. 18, 2020) (hereinafter, “Salzberg Appeal”).

[2]    138 S. Ct. 1061, 1078 (2018).

[3]    Stanford Law Sch. Sec. Class Action Clearinghouse & Cornerstone Research, Securities Class Action Filings 2019 Year in Review 4, 25 (2020), https://www.cornerstone.com/Publications/Reports/Securities-Class-Action-Filings-2019-Year-in-Review.

[4]    Sciabacucchi v. Salzberg, 2018 WL 6719718, at *3 (Del. Ch. Dec. 19, 2018).  

[5]    Salzberg Appeal at *10 & n.79, *11.  Section 115 expressly defines “internal corporate claims” 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 [the DGCL] confers jurisdiction upon the Court of Chancery.”  8 Del. C. § 115.

[6]    See 8 Del. C. § 115, which confirmed the ability of a corporation’s charter or bylaws to require that such internal corporate claims be brought solely and exclusively in any or all of the courts of the State of Delaware.

[7]    See 8 Del. C. § 102(f) and 8 Del. C. § 109(b), which invalidate any provision in the charter or bylaws of a stock corporation that shifts attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim to a stockholder.