by Marie Bafus
Federal courts may adjudicate more claims under the Securities Act of 1933 (“Securities Act”) following a recent Delaware Supreme Court decision. Earlier this year, the Delaware Supreme Court ruled that corporations may require stockholders to litigate claims under the Securities Act in federal court, holding that such forum provisions in corporate charter documents and bylaws are facially valid. The Court’s decision in Salzberg v. Sciabacucchi, — A.3d —, 2020 WL 1280785 (Del. Mar. 18, 2020), reversed an earlier ruling of the Delaware Court of Chancery and opened the door for Delaware corporations to require plaintiffs to bring Securities Act claims in federal court. From the perspective of the defense bar, the decision allows Delaware corporations to mitigate the costs, inefficiencies, and burdens imposed when such claims are filed and litigated in state court.
Background
Over the past several years, the plaintiffs’ bar has increasingly filed Securities Act claims in state rather than federal court. Plaintiffs’ lawyers view state court as a more favorable forum for such cases because many of the key provisions of the Private Securities Litigation Reform Act (“PSLRA”) – including more stringent pleading standards, an automatic stay of discovery pending motions to dismiss, and a statutory process for appointing lead plaintiffs – often have been held inapplicable in state court proceedings. To address that trend and minimize the prospect of multiple Securities Act cases proceeding simultaneously in different courts, many corporations included provisions in their charter documents or bylaws requiring Securities Act claims to be brought exclusively in federal court. The enforceability of those clauses assumed greater importance after the U.S. Supreme Court’s March 2018 decision in Cyan, Inc. v. Beaver County Employees’ Retirement Fund, which confirmed that plaintiffs may file Securities Act claims in either state or federal court.
Delaware law expressly permits corporations to use their charter documents and bylaws to require internal corporate claims – e.g., derivative suits and claims involving alleged breaches of fiduciary duty, the rights of stockholders, or application of the Delaware General Corporation Law – to be brought exclusively in the Court of Chancery. But in December 2018, Vice Chancellor J. Travis Laster of the Court of Chancery found that federal forum provisions (FFPs) – those requiring Securities Act claims to be brought in federal court – are unenforceable under Delaware law. In Sciabacucchi v. Salzberg, V.C. Laster held that while charter documents and bylaws may properly specify that claims involving the “internal affairs” of Delaware corporations be litigated in Delaware, they may not regulate matters involving federal law or other “external issues.”
The Delaware Supreme Court Decision
Reversing V.C. Laster’s decision, the Delaware Supreme Court held that FFPs: (1) are, on their face, within the permissible scope of bylaws and charter provisions because (in the words of the relevant statute) they address “the management of the business” and “conduct of the affairs of the corporation”; (2) provide corporations with “efficiencies in managing the procedural aspects of securities litigation” post-Cyan; and (3) do not violate Delaware law or policy. The Delaware Supreme Court rejected the lower court’s finding that, as a matter of Delaware law, mandatory forum provisions are applicable only to matters involving a corporation’s “internal affairs”; instead, the scope of the relevant statute is broad enough to extend to certain other matters, including Securities Act claims. The decision stressed that provisions designed to regulate where stockholders may bring claims based on their purchase of shares in a company (such as Securities Act claims) fall within an area of “intra-corporate” matters, and thus are not purely “external” matters (such as tort or commercial contract claims). Finally, the decision concluded that FFPs do not violate federal policy or principles of “horizontal sovereignty” vis-à-vis other states.
What this Means for Federal Courts and the Plaintiffs’ Bar
As more Delaware corporations adopt FFPs, federal courts can expect to adjudicate more Securities Act claims than they have in the recent past. And, as more Securities Act claims end up in federal court, plaintiffs will face the additional hurdles imposed on such litigation by the PSLRA.
To the extent plaintiffs determine to bring a Securities Act claim in state court despite an FFP, the Delaware Supreme Court left open the possibility that – although such provisions are facially valid – they may be invalid “as applied” – in other words, plaintiffs can argue that a particular FFP is not enforceable in a particular set of circumstances.
What Companies Can Do
- Delaware corporations without FFPs should consider adopting such a provision promptly. The easiest way to do so is by means of a bylaw amendment, which may be accomplished via board action and does not require a stockholder vote. And, although the Delaware Supreme Court’s decision is based on – and limited to – Delaware law, it may provide persuasive authority for companies incorporated in other states that may want to adopt FFPs.
- Delaware corporations that adopted FFPs before the Court of Chancery’s decision in Sciabacucchi but determined not to enforce them pending appellate review in that case, should view the Delaware Supreme Court’s decision as a “green light” to seek enforcement of FFPs going forward. To the extent such companies included risk factors or other disclosures (including on Form 8-K) regarding the non-enforcement of FFPs, such risk factors and disclosures may need to be updated.
- For companies currently defending Securities Act claims in state court, if they had pre-existing FFPs but deferred enforcing them in the wake of Sciabacucchi, they may want to consider whether to seek enforcement now. The success of that strategy will depend on various factors, including the law of the state where the action is pending, the stage of litigation, and whether there are parallel actions in federal court. The ability of a corporation to enact a provision now that would apply retroactively to a pending suit is not yet clear.
Marie Bafus is a senior securities litigation associate at Fenwick & West LLP where she represents companies, officers, and directors in shareholder class actions and derivative litigation.