(Reuters) - In a boon to companies contemplating IPOs, the Delaware Supreme Court held Wednesday in Salzberg v. Sciabacucchi that corporations can require investors to file securities fraud claims arising from their IPOs or secondary offerings in federal court. The state justices’ hotly anticipated ruling, which overturned a 2018 Chancery Court decision (2018 WL 6719718), said that forum selection clauses in the corporate charters of Blue Apron, Roku and Stitch Fix were permissible because Delaware corporate law give companies broad latitude to manage internal affairs, including the disclosure decisions underlying Section 11 claims.
“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,’ and is, thus, facially valid,” wrote Justice Karen Valihura for the unanimous Supreme Court, quoting Delaware’s corporate code.
The court also concluded that the forum selection clauses are compatible with federal law and policy, citing the U.S. Supreme Court’s decision in 1989’s Rodriquez de Quijas v. Shearson (109 S.Ct. 1917). In that case, the U.S. justices upheld an agreement requiring a brokerage customer to arbitrate Securities Act claims instead of suing in state court. And in what the court described as “perhaps the most difficult aspect of this dispute,” the Delaware justices concluded that because forum selection provisions are procedural, not substantive, other states are not likely to think Delaware is stepping on their toes by allowing corporations to bar shareholders from filing state-court Securities Act claims.
Blue Apron and the other companies in the Sciabacucchi case included forum selection provisions in their charters in response to the U.S. Supreme Court’s 2018 holding in Cyan v. Beaver County Employees’ Retirement Fund (138 S.Ct. 1061), which confirmed that investors can file Securities Act claims in either state or federal court. That decision led to a boom in Section 11 class action filings in state court, where the stringent federal rules for securities class actions do not apply. It’s become quite common for companies to be faced with parallel shareholder class actions in state and federal court, which leads to increased defense costs and in some cases, to inconsistent rulings.
The new Delaware Supreme Court ruling will help businesses contemplating IPOs avert that prospect, said Roku and Stitch Fix counsel William Chandler of Wilson Sonsini Goodrich & Rosati, who argued the Sciabacucchi case to the state justices. (Blue Apron had counsel from Wilmer Cutler Pickering Hale & Dorr.) Insurance costs for directors and officers of companies going public had skyrocketed alongside state-court securities filings, Chandler said in an interview. The Delaware decision should bring those costs down. “This is a significant tool for our pre-IPO clients,” Chandler said.
Shareholder lawyer Joel Fleming of Block & Leviton, who argued at the Delaware Supreme Court for lead plaintiff Matthew Sciabacucchi, declined to comment on the decision.
Chandler, who served as Chancellor of Delaware Chancery Court from 1997 to 2011, also said the Supreme Court’s ruling is a powerful reminder of the state’s “broad, enabling view” of corporate compacts with shareholders. “I personally believe this will strengthen Delaware’s position as the leading jurisdiction in the corporate chartering market,” he said in an email following up on our interview. “It reaffirms and underscores the central tenet of Delaware corporate law, which is that we believe in private ordering and the ability of stockholders and managers to innovate in corporate governance in ways designed to address novel or emerging issues.”
Plaintiffs’ lawyers had been awarded $3 million by Vice-Chancellor Travis Laster for successfully invalidating the Roku, Stitch Fix and Blue Apron charter provisions in Chancery Court. The Supreme Court reversed the fee award in Wednesday’s decision.
That’s the straightforward takeaway from Wednesday’s landmark decision. But a murkier question looms over the ruling: Is forum selection for Securities Act class actions the first step on a path that leads to mandatory arbitration of all shareholder fraud claims?
Opponents of securities class actions, as you’re probably aware, have been pushing harder than ever for companies to adopt bylaws requiring investors to arbitrate securities claims. Leading the effort is retired Harvard law professor Hal Scott, who is the trustee of a trust that has called for shareholder votes on a mandatory arbitration clause at both Johnson & Johnson and Intuit. Intuit shareholders resoundingly rejected the proposal in a vote in January 2020. Johnson & Johnson obtained the blessing of the Securities and Exchange Commission to exclude Scott’s proposal from its 2019 annual meeting, but Scott subsequently sued J&J in federal court in Trenton, New Jersey, seeking a declaration that mandatory shareholder arbitration comports with federal law.
That case has been on hold, awaiting the Delaware Supreme Court’s ruling in Sciabacucchi. But now that the Delaware justices have issued their decision, I expect the J&J litigation to fire up again.
The new ruling directly addresses the prospect of mandatory shareholder arbitration only in a footnote on its final page. “Much of the opposition to (forum selection provisions) seems to be based upon a concern that if upheld, the ‘next move’ might be forum provisions that require arbitration of internal corporate claims,” the Delaware Supreme Court said. “Such provisions, at least from our state law perspective, would violate” a 2015 amendment to Delaware’s corporate code that says Delaware corporations may not bar shareholders from bringing internal corporate claims in Delaware courts.
Wilson Sonsini’s Chandler told me that the footnote should help alleviate the “irrational fear” that forum selection provisions for Securities Act claims will lead to mandatory shareholder arbitration clauses. The SEC has never allowed a public company to adopt mandatory arbitration, he said, and now the Delaware justices have said state law doesn’t allow it. Moreover, Chandler said, “I don’t think any board of directors has the stomach for it because they know they’d be voted out.”
But Hal Scott, the law professor pushing for shareholder arbitration, told me in an email that he thinks the Delaware Supreme Court ruling is going to help his cause. The court’s footnote, he pointed out, refers to an amendment that addresses only “internal corporate claims” – not shareholder fraud claims under the Securities and Exchange Act of 1934. Most of the biggest shareholder class action settlements have been based on Exchange Act fraud claims.
Essentially, the Delaware Supreme Court seems to have waved away the wrong bogeyman: Concerns about the next step beyond forum selection for ‘33 Act claims were not centered on mandatory arbitration of, say, breach of duty suits arising from M&A deals. Shareholder advocates are worried about corporations eradicating securities fraud class actions by mandating arbitration. The Delaware Supreme Court did not squarely address whether Delaware law will allow them to use corporate charters or bylaws to do that.