(Reuters) - The debate over corporations imposing arbitration on shareholders through corporate charters and bylaws is still mostly in the realm of theory and academic furor. The Securities and Exchange Commission, as you know, is contemplating the issue, though SEC Chair Jay Clayton has said he’s in no rush to decide whether the commission will end its longtime policy of squelching proposed mandatory arbitration provisions for companies going public.
Shareholder rights activists, meantime, are preemptively arguing that mandatory shareholder arbitration is illegal. The consumer advocacy group Secure Our Savings, for instance, has just released a white paper in which 21 of the most eminent securities law professors in the country contend that Delaware law does not allow corporations to frog-march shareholders into arbitration of their claims under federal securities law.
I’m going to explain the law profs’ reasoning. But I’m also going to tell you why the issue in the white paper is not just academic: There’s a case under way in Delaware that could turn out to be a crucial precursor to litigation over mandatory arbitration clauses. And the profs’ white paper is already a matter of dispute in that case.
In the new paper, the securities law professors – including, among other luminaries, John Coffee of Columbia, Lucian Bebchuk and John Coates of Harvard, Ann Lipton of Tulane, James Cox of Duke and Donald Langevoort of Georgetown - contend that federal securities claims are outside the scope of corporate charters and bylaws governed by Delaware law. Corporations can’t impose mandatory arbitration of federal securities claims through charters and bylaws, according to the profs’ argument, because compacts between corporations and shareholders are limited to state law governance issues, not disputes under federal securities law.
The professors’ white paper acknowledged that then-Chancellor Leo Strine of Delaware Chancery Court, who is now Chief Justice of Delaware Supreme Court, ruled in 2013’s Boilermakers Local 154 Retirement Fund v. Chevron (73 A.3d 934) that corporations can adopt bylaws steering litigation “relating to the internal affairs of the corporation” to their chosen venue. Corporations also got a green light from the Delaware Supreme Court in 2014’s ATP Tour v. Deutscher Tennis Bund (91 A.3d 554) to impose fee-shifting on shareholders via a corporate charter. The Chevron and ATP rulings, as the white paper concedes, stand for the proposition that Delaware regards corporate charters and bylaws as a wide-ranging “flexible contract” between businesses and their shareholders, although Delaware legislators acted in 2015 to limit corporate flexibility by prohibiting cost-shifting provisions and barring mandatory arbitration for corporate governance claims.
But even Delaware law isn’t sufficiently flexible to erase the right to sue under federal securities statutes, according to the profs’ paper. When Strine described the “flexible contract” concept in his Chevron opinion, he made clear that his reasoning was limited to shareholder suits “in cases governed by the internal affairs doctrine.” The ATP decision, according to the white paper, involved both antitrust and breach-of-duty claims, but nothing in the ruling indicated the Delaware Supreme Court meant to allow corporations to restrict litigation beyond corporate governance issues.
“Corporate charters and bylaws were never intended to govern anything beyond the law of the state of incorporation,” said Tulane’s Lipton, who wrote a 2016 Georgetown Law Journal article, “Manufactured Consent,” on whether corporations can curtail shareholder litigation through charter and bylaw provisions. Her reasoning, in a nutshell from the Georgetown paper: “Securities regulation differs from state corporate governance regulation in a crucial respect — namely, that securities regulation treats shareholders as external to the corporation,” Lipton wrote. “Corporate governance, by contrast, treats investors as a part of the corporation itself, a constituency to whom duties are owed and who possess certain rights of control. Corporate constitutive documents do not bind stockholders in any capacity except as internal corporate constituents; therefore, litigation limiting clauses contained in such documents can only apply to state law governance claims.”
In a phone interview, Lipton drew an analogy between a shareholder who slipped and fell on her way into a corporation’s annual meeting and a shareholder claiming securities fraud. No one would reasonably argue that the corporation could require the slip-and-fall shareholder to arbitrate her claim because of a mandatory arbitration provision in a corporate charter. Lipton said the same reasoning applies to shareholders suing under federal securities law: Those claims fall outside of the compact shareholders make under Delaware law.
Vice-Chancellor Travis Laster said as much in 2015’s In re Activision Blizzard Stockholder Litigation (124 A.3d 1025), which is cited in the law professors’ new white paper. Discussing the distinction between fraud and Delaware corporate law claims, the vice-chancellor said fraud claims do not arise from the contractual relationship between the shareholder and the corporation but from the corporation’s allegedly false statement. “A Rule 10b–5 claim under the federal securities laws is a personal claim akin to a tort claim for fraud,” he wrote.
That brings me to the Delaware case I mentioned above. Three companies that went public in 2017 – Blue Apron, Roku and Stitch Fix – included provisions in their corporate charters that require shareholders to litigate federal securities claims in federal court. Shareholders sued in Delaware Chancery Court to invalidate the forum selection provisions. Vice-Chancellor Laster heard summary judgment arguments in September in consolidated litigation over the provision.
Plaintiffs’ lawyers at Block & Leviton relied on the vice-chancellor’s Activision decision in their summary judgment brief, arguing that the opinion shows federal securities fraud claims are not internal claims so Delaware law does not enable corporations to curtail them through corporate charters. The defendants, represented by Wilson Sonsini Goodrich & Rosati (for Roku and Stitch Fix) and Wilmer Cutler Pickering Hale & Dorr (for Blue Apron) countered that Laster’s Activision decision is narrower than the plaintiffs portray it to be. The ruling considered whether fraud claims travel with shares when they are sold, according to the defendants, and did not, in fact, reach the broad conclusion that federal securities claims are unrelated to shareholders’ rights and powers.
Tulane’s Lipton has been writing since the inception of the Blue Apron case that the forum selection provisions at issue in the litigation are really a stalking horse for mandatory arbitration provisions. (Hat tip to the invaluable and exhaustive Chancery Daily, which highlighted Professor Lipton’s previous writing on the Blue Apron case in a post last week.) If Vice-Chancellor Laster or the Delaware Supreme Court ends up deciding that companies can choose a forum for federal securities litigation via their corporate charters, Lipton told me, corporations will undoubtedly use the ruling to argue they’re entitled to compel arbitration, since that’s just another forum.
Lawyers in the Blue Apron case implicitly acknowledged the litigation’s relevance in the mandatory arbitration debate last week. Shareholders’ lawyers notified Vice-Chancellor Laster about the law professors’ new white paper, which they submitted without additional comment “for your honor’s consideration.” Wilson Sonsini responded that the white paper, which is basically “an advocacy piece that selectively cites this court’s precedent,” is effectively an untimely amicus brief that the vice-chancellor should disregard.
Lipton told me Delaware’s ultimate ruling on whether corporations can use charters and bylaws to require arbitration of federal securities claims will likely be dispositive. Shareholder arbitration opponents argue that federal securities laws contain anti-waiver provisions that preclude arbitration but Lipton said U.S. Supreme Court precedent has badly eroded those arguments. It’s not likely, she said, that federal courts will uphold shareholders’ right to sue in a showdown between securities laws and the Federal Arbitration Act. She said she believes shareholders’ best chance to kill mandatory arbitration will be in state court holdings that corporate charters and bylaws don’t extend to federal securities laws.
I asked Wilson Sonsini’s William Chandler, a former Delaware chancellor, to respond to the law professors’ white paper, since he offered in the defendants’ letter to Vice-Chancellor Laster to provide a substantive analysis. He declined, citing the ongoing litigation. I also contacted securities law professor Adam Pritchard of the University of Michigan, a proponent of mandatory shareholder arbitration. In an email, Pritchard said he disagrees with the linchpin argument that federal securities fraud claims do not arise from shareholders’ charter and bylaw agreements.
“I find the argument that a Rule 10b-5 claim is not a claim brought as a stockholder to be bizarre,” he wrote. “If a Delaware corporate claim brought as a shareholder would be subject to an arbitration clause, I don’t think Delaware can discriminate against federal claims brought as a stockholder under the FAA.”