(Reuters) - There has been a significant escalation in the fight over whether corporations can require shareholders to arbitrate claims against the company.
A Johnson & Johnson shareholder pushing for mandatory arbitration moved Tuesday to enjoin J&J’s April 25 annual meeting, arguing that the company must allow investors to vote on a proposal that would require them to arbitrate their disputes with J&J. The preliminary injunction motion, filed in federal court in Trenton, New Jersey, will be, to the best of my knowledge, the first courtroom test of the legality of mandatory shareholder arbitration.
The injunction motion, which follows a March 1 lawsuit against the company, was filed by the Doris Behr 2012 Irrevocable Trust. The trust, which is advised by Harvard law professor emeritus (and arbitration proponent) Hal Scott, wants the court to compel J&J to allow shareholders to vote on a proposed bylaw precluding securities class actions and directing investors to resolve claims in individual proceedings before the American Arbitration Association. (Yes, that’s right: The trust, a shareholder, wants a bylaw that would end shareholder class actions.)
J&J, as I’ll explain, opposes the bylaw. Its lawyers at Skadden Arps Slate Meagher & Flom didn’t respond to my request for comment on the trust’s preliminary injunction motion but said in a letter Wednesday to the judge overseeing the case that there’s no need for urgency and that the trust’s arguments are contrary to the weight of authority.
Scott and the trust first proposed a shareholder vote on mandatory arbitration last November. That proposal, as you may recall, led to a blowup at the Securities and Exchange Commission. Johnson & Johnson’s Skadden lawyers informed the SEC in December that the company considered the proposal a violation of federal securities law. J&J, they said, intended to exclude the Behr trust’s proposal from proxy materials and from a shareholder vote. The company asked the SEC’s corporate finance division for reassurance that the commission would not bring an enforcement action against the company for blocking the proposed resolution.
In the past, the SEC has pushed back hard against shareholder arbitration, including 2012 proposals by shareholders at Gannett and Pfizer that presaged the Behr trust’s J&J proposal. But some SEC commissioners have lately announced support for mandatory shareholder arbitration provisions and SEC chairman Jay Clayton has been notably non-committal on the issue. Arbitration opponents saw the trust’s J&J proposal as a threat - and mobilized opposition.
The SEC ended up agreeing that J&J could block the proposal, relying mostly on a last-minute opinion from New Jersey’s attorney general that said mandatory arbitration was illegal under state law. Notably, however, the SEC seemed to back away from its previous position that requiring shareholders to arbitrate would violate federal law – possibly in recognition of pro-arbitration rulings by the U.S. Supreme Court in 2013’s American Express v. Italian Colors (133 S.Ct. 2304) and 2018’s Epic Systems v. Lewis (138 S.Ct. 1612).
That shift by the SEC, Scott told me Wednesday, was critical to the trust’s decision to go to court to demand J&J put its arbitration proposal to a shareholder vote. By basing its decision on the New Jersey AG’s view of New Jersey law, Scott said, the SEC left open the question of whether the AG’s interpretation is correct – and failed entirely to address the trust’s arguments that the Federal Arbitration Act preempts state law no matter what New Jersey has to say about mandatory shareholder arbitration.
The trust, which is represented in the new litigation against Johnson & Johnson by Jonathan Mitchell of Mitchell Law, lays out its case comprehensively in Tuesday’s preliminary injunction brief, which seeks a declaration that J&J violated federal securities laws by excluding the trust’s proposal and an injunction requiring J&J to announce in a supplemental proxy statement that mandatory shareholder arbitration is legal under state and federal law. J&J has already sent out proxy materials for the scheduled April 25 meeting, omitting mention of the Behr trust’s proposal.
According to the trust’s injunction brief, J&J bears the burden of proving its proposal is illegal and the company has been unable to identify any federal statute or New Jersey law or legal precedent that precludes mandatory shareholder arbitration. The trust argues that after the Supreme Court’s decisions in Epic and Italian Colors, such provisions are permissible under federal law because nothing in the Securities and Exchange Act implies a partial repeal of the Federal Arbitration Act. (I’m condensing a nuanced, multi-pronged argument but that’s the gist.) The trust contends that the New Jersey AG erroneously based his conclusion about the state-law legality of mandatory arbitration on a recent Delaware ruling on forum selection in corporate charters – and even if the AG were correct in his interpretation, the FAA trumps state law.
“There is no need for this court to explore the contours of New Jersey law or engage in … guesses about what the New Jersey courts might do,” the brief said. “If the law of New Jersey purports to prohibit a corporation and its shareholders from agreeing to arbitrate their disputes, then that law is preempted by the FAA.”
In a letter filed Wednesday with U.S. District Judge Michael Shipp of Trenton, J&J counsel Andrew Muscato of Skadden said the trust has manufactured urgency after waiting weeks to file a complaint and injunction motion. “Conspicuously absent from the application is any attempt to demonstrate emergency circumstances,” the letter said. “Plaintiff did not file suit until March 21 — more than four and a half months after it knew Johnson & Johnson intended to exclude the proposal, almost six weeks after the SEC issued its no-action letter and eight days after the company filed (and mailed and/or made available electronically) its proxy materials.”
J&J also previewed the merits of its argument against mandatory shareholder arbitration. “(The trust’s) theory is built upon the notion that everyone else got it wrong,” the company’s letter said. “In actuality, (the trust) has no likelihood of success, as evidenced by the numerous authorities it dismisses as wrong, including the State of New Jersey’s chief legal officer.”
Muscato didn’t respond to my email request for comment. Plaintiffs’ advocacy groups will probably also want a say in this case. After the trust sued, the American Association of Justice and the Secure Our Savings coalition, which is led by Public Justice and the Consumer Federation of America, issued statements warning that the mandatory arbitration provisions the Behr trust is advocating will make it easier for corporations to defraud investors. “We will continue to oppose this effort and any others that aim to shield unscrupulous corporations from accountability by hiding behind forced arbitration clauses,” the AAJ statement said.
Trust lawyer Scott told me he just wants to give J&J shareholders a chance to vote on mandatory arbitration. “I believe it’s they who should make the decision,” he said. “I want to give them a choice.”