Saturday, March 14, 2015
The Delaware Legislature is set to consider new legislation concerning litigation-limiting bylaws and charter provisions.
As discussed here, the new legislation would, among other things:
(1) Explicitly authorize corporations to include in their charter or bylaws forum selection clauses that designate Delaware courts as the exclusive forum for shareholder litigation;
(2) Explicitly forbid corporations from including in their charters or bylaws forum selection or arbitration clauses that prohibit bringing claims in Delaware courts; and
(3) Prohibit fee-shifting bylaws and charter provisions.
[More under the cut]The first thing to note about this proposed legislation is that it is limited to corporate governance/internal affairs claims. This is important, because many companies have adopted fee-shifting/arbitration/forum selection provisions with the intent of applying them to securities claims, as well as internal affairs claims. I’ve previously argued that this is improper; to the extent charters and bylaws are contracts at all, they are contracts concerning the internal economy of the corporation, and securities claims fall outside their scope.
I believe the new legislative proposals support my argument. If they are adopted, it will demonstrate that Delaware recognizes that corporate constitutive documents concern only matters that fall under the internal affairs rubric. This is only to be expected, because unlike internal affairs claims (which concern obligations imposed by Delaware law), Delaware is not positioned to make policy judgments regarding the propriety of allowing corporations to limit how securities claims (which are not brought under Delaware law and do not concern Delaware-imposed duties) will be pursued. Notably, nowhere in the proposals, the accompanying memo, or the FAQ, is there any mention that the Delaware Corporation Law Council even considered whether these proposals should apply to securities claims - which I interpret to mean that they understood that securities claims are outside of Delaware's bailiwick.
The second thing to note is that the forum selection provisions – unsurprisingly – are geared toward protecting Delaware’s dominance in the field of corporate law. When Delaware courts first approved forum-selection clauses, they likely did so in the expectation that those clauses would be used to funnel litigation into Delaware. But in City of Providence v. First Citizens Bancshares, Inc., 99 A.3d 229 (Del. Ch. 2014), a Delaware corporation adopted a forum selection clause that specified North Carolina as the forum for all shareholder litigation – something that Delaware likely did not expect. This proposed legislation would ban clauses like the one in First Citizens.
The proposed legislation also (attempts to) eliminate the threat of Delaware’s courts being displaced by arbitration. Courts recently enforced an arbitration clause contained in the bylaws of a publicly-traded Maryland REIT; if that kind of thing becomes popular, once again, it would undermine Delaware’s dominance, so it’s unsurprising that the proposed legislation attempts to nip that trend in the bud.
On that point, however, there’s a wrinkle, in the form of the Federal Arbitration Act. That Act requires that states honor “contractual” arbitration clauses, and Delaware has – for better or worse – taken to describing litigation-limiting bylaws as “contracts” that bind all shareholders. If the FAA applies to corporate charters and bylaws (as the courts held in the case of the Maryland REIT), it could actually preempt this legislation. That’s the topic I address in my forthcoming article, Manufactured Consent. I will eventually post a more detailed summary, but the bottom line is, I conclude that charters and bylaws are not FAA contracts (and that they do not, in any event, extend to securities claims).
Finally, the fee-shifting prohibition also may be seen as an effort to protect Delaware’s dominance in the field of corporate law. Fee-shifting represents an existential threat to Delaware’s control, because most corporate law is generated through shareholder lawsuits, and fee-shifting is an extremely strong deterrent to bringing them. Now, I suspect that the Delaware Supreme Court may have originally approved of fee-shifting with the expectation that it could limit its use (by allowing it to be used as an antitakeover device, but not as a device to deter ordinary shareholder litigation). But, even if that was the court's intention, the issue exploded more quickly than it likely anticipated, making this legislation somewhat inevitable.
There are strong forces lobbying against this legislation, often in the form of warnings that if the legislation passes (particularly the ban on fee shifting), public corporations will take their business elsewhere, and Delaware will, ahem, have to actually work for a living. Even if one believes that assertion, my money's on the legislation passing, because Delaware's damned either way. Delaware's dominance in the field of corporate law is traceable to its courts; it simply can't afford to allow corporations to adopt measures that would functionally close them to shareholder litigation. So Delaware's kind of stuck with the devil it knows, particularly since the idea that other states will rush to compete for corporate charters by allowing fee shifting is deeply speculative (Oklahoma notwithstanding), and depends on, among other things, the SEC and the NYSE sitting idly by.