Wednesday, December 19, 2018

Litigation limits, corporate governance, and securities law - a new hope


If you read this blog regularly, you know that one of my pet issues has been litigation limits in corporate charters and bylaws (examples here, here, and here).

The holy grail, for those who are in favor of these things, has been to insert clauses in corporate governance documents that would require all securities claims to be arbitrated on an individualized basis.  The expectation has been that, given the Supreme Court’s recent jurisprudence, such provisions would pass muster under federal law.

In 2015, Delaware amended the DGCL to prohibit the insertion of arbitration clauses in corporate governance documents.  But that statute explicitly applies only to “internal corporate claims,” Del. Code tit. 8, § 115, leaving open the possibility that it would not prohibit arbitration clauses that only govern federal securities claims.

One of the main stumbling blocks to that maneuver has been the SEC’s resistance – a resistance that recently has been crumbling.

The other stumbling block has been the possibility – which I’ve discussed repeatedly in blog posts, a law review article, and a book chapter (abstract only on SSRN; you have to buy the book for the rest!) – is that charters and bylaws can only govern internal affairs claims, and not external claims, including claims created by federal law.

The latter argument was finally tested in Delaware Chancery, but not in the context of arbitration.  Rather, several companies went public with charter or bylaw provisions requiring that all Section 11 claims be litigated in a federal forum.  That’s not arbitration, naturally, but it raises the same question whether charters and bylaws can govern federal securities claims.

The answer, according to Vice Chancellor Laster, is no.

I won’t quote the whole decision here, but I’ll just say, he has a lot of the same reasoning that I’ve previously laid out (and yes, he cited me, so, you know, yay! And it’s possible when the decision came down the first thing I did was a word search for my name LIKE YOU WOULDN’T DON’T JUDGE).

He also inferred – citing a blog post by Lawrence A. Hamermesh and Norman M. Monhait – that when Delaware enacted Section 115, the reason it limited the statute to “internal corporate claims” was because no one thought charters and bylaws could possibly extend any further.

I am assuming there will be an appeal (Laster also seemed to assume so at oral argument), but if his decision is affirmed, what next?

I’ve been thinking a lot about what a determined corporate advocate would do, and it seems to me there are two possibilities.

First, I could see an effort to persuade other states – Nevada being the most obvious candidate – that corporations organized in that state may limit federal securities claims in their governance documents.  My perspective, however, is that states can’t; any effort to do so would extend beyond the boundaries of internal affairs and the authority of chartering states.  Now, as many readers may be aware, California is already testing the boundaries of the internal affairs doctrine with its new statute requiring public companies with their principal place of business in that state to include women on their boards; it would be the height of irony if the constitutional limits of the internal affairs doctrine were tested not in that context, but in the context of litigation limits on federal securities claims.

Second, I can imagine an effort to bypass charters and bylaws entirely, and simply to insert into a registration statement some kind of declaration to the effect that “all purchasers agree that federal securities claims/Section 11 claims are subject to such-and-such limits.”  But that, of course, might be a bridge too far for the SEC, and even if it isn’t, I personally am unaware of any precedent for treating the registration statement as a “contract,” and thus there would be serious questions about whether purchasers could be bound in this manner.

Anything else I’m not thinking of?  Feel free to speculate in the comments.

In any event, this is clearly my beat, so stay tuned for further developments.

Ann Lipton | Permalink


One possibility: What about including an arbitration provision in a separate shareholder agreement that purports to bind anyone who acquires shares? This is how partnership agreements work in the context of MLPs (although I am not aware of an MLP agreement that includes a mandatory arbitration clause--largely because of the SEC issue you've noted). As a contractual agreement, a shareholder agreement would not be subject to the same internal affairs limit that is placed on corporate charters and bylaws.

Posted by: Mohsen Manesh | Dec 19, 2018 1:11:42 PM

Yes, I totally agree a shareholder agreement would do it - as an ordinary contract. The issue is, can you do that for secondary purchasers? Initial purchasers in the IPO are an easy get, but once they flip their shares, it would be hard to argue that downstream purchasers are still bound. (It would require blurring of the lines between property and contract law which - so far - we don't ordinarily do).

Posted by: Ann Lipton | Dec 19, 2018 1:17:43 PM

In the MLP context though, the Delaware courts routinely assume that the downstream purchasers of MLP units are bound to the terms of the MLP's partnership agreement. I agree that that result stretches the meaning of contract, but shouldn't the same principle apply to downstream purchasers of corporate shares?

Posted by: Mohsen Manesh | Dec 19, 2018 1:37:34 PM

It's a good argument, and it's one I sidestepped in my paper by limiting my discussion to corporations.

My theory is that limited partnerships - like bonds, where the agreement governs downstream purchasers - are different than corporations; they are inherently more contractual. There are many more limits on corporations specifically, which is why Laster made the state's role in constructing corporations so visible in his opinion.

Meanwhile, outside of bonds/preferred shares/LPs, we don't really have a model for transferring contractual rights to subsequent purchasers without that purchaser's agreement, which is why an ordinary purchase agreement in conjunction with the stock purchase shouldn't limit downstream buyers.

It is for me an open question whether a bond indenture could include an arbitration clause that governs federal claims, though.

Posted by: Ann Lipton | Dec 19, 2018 1:39:47 PM

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