Thursday, June 11, 2020
So, this week we’re back to litigation-limiting corporate constitutive documents.
Where we last left things, the Delaware Supreme Court held in Salzberg v. Sciabacucchi, 2020 WL 1280785 (Del. Mar. 18, 2020), that Delaware law permits corporations to adopt charter provisions that would require plaintiffs bring Securities Act claims in a federal, rather than state, forum. I posted about that decision here, and argued that it left a number of unanswered questions about its application.
This week, we’re beginning to see the fallout.
In Seafarers Pension Plan v. Bradway, the plaintiff brought a derivative Section 14(a) action against the Boeing Company in the Northern District of Illinois. Plaintiff alleged that the company proxy statements contained false statements pertaining to the development of the 737 Max, and via these false proxy statements, defendants solicited shareholder votes in favor of their own reelection and compensation.
Boeing moved to dismiss on the ground that its bylaws provided that Delaware Chancery Court would be “the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation,” as well as the sole forum for “any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of the Corporation to the Corporation.”
Significantly, because Section 14(a) claims cannot be brought in Delaware Chancery – federal courts have exclusive jurisdiction – Boeing’s argument meant that the plaintiff would not be able to maintain its suit at all. As a result, the plaintiff argued that application of the bylaw to this lawsuit necessarily ran afoul of 15 U.S.C. § 78cc, which prohibits prospective waivers of 1934 Act obligations.
A parallel case, Chopp v. Bradway, 20-cv-00326-MN, involving derivative claims under Section 10(b), was filed in the District of Delaware. Boeing made the same arguments in favor of dismissal in that case as well. (Section 10(b) claims, like Section 14(a) claims, can only be brought in federal court). The plaintiff voluntarily dismissed that action before a decision could be reached, leaving only Seafarers.
On June 8, the Seafarers court agreed with Boeing and dismissed the derivative Section 14(a) claims. See Seafarers’ Pension Plan v. Bradway, No. 27, 19-cv-08095 (N.D. Ill. June 8, 2020). The decision is not currently available on Lexis or Westlaw though I assume it will turn up eventually.
[More under the jump]
We might first ask, why derivative actions? And the answer to that is, direct claims have already been filed against Boeing, and are pending in the Northern District of Illinois, before a different judge. The PSLRA requires that direct securities claims be consolidated in a single case, but not derivative ones, so when a big case comes up, it isn’t uncommon to see firms who miss out on a class lead counsel appointment to file derivative actions instead. That’s not an ideal situation and it’s worth discussing but – as you can tell from my thoughts below – I do not believe bylaws such as Boeing’s are the solution.
In any event, in Seafarers, the court began by recognizing that neither Salzberg, nor Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del Ch. 2013), addressed this exact situation. Salzberg also limited plaintiffs to a single court (federal) but it involved Securities Act claims, which can be brought either in federal or state court. The bylaws in Boilermakers, while covering all derivative claims, explicitly permitted complaints to be filed in any Delaware court (including federal court). So this case presented a novel situation, in that application of the bylaw would bar the plaintiff’s claims entirely.
Given that, the court treated the bylaw as the equivalent of a contractual forum selection provision. And what’s the law on that?
Well, this requires a little bit of delving into history, and it starts by remembering that before the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), federal courts employed a rather complicated test involving an analysis of defendants’ conduct, and the effects of that conduct, to determine whether transnational securities sales were subject to American law. That meant that, ex ante, there was considerable uncertainty as to whether a particular transaction would be governed by the federal securities laws at all.
Given that, federal courts became rather permissive about allowing parties to contract to choose a particular jurisdiction’s law, and a particular forum to resolve claims, in order to allow them to eliminate these uncertainties.
For example, there was a series of cases involving Americans who contracted to become part of underwriting syndicates with Lloyd’s of London. The signatories to these contracts were known as “Names” and, as a group, would be responsible for underwriting a book of insurance business. The contracts were signed in London and required each Name to provide a letter of credit to Lloyd’s from a Lloyd’s-approved bank.
In other words, these contracts were overwhelmingly British. They were Paddington-Bear-in-a-Union-Jack British. They were approximately 30% more British than eating bangers and mash while petting a hedgehog with EastEnders playing on the telly in the shadow of Big Ben. They were only slightly less British than the image you get when you Google “most British picture ever”:
So it wasn’t terribly surprising that when the Americans sued, claiming that the contracts violated the Securities Act of 1933 and the Exchange Act of 1934, a series of federal courts enforced the contractual provisions selecting British law as the rule of decision, and British forums to resolve disputes. The courts considered, and rejected, the argument that these provisions acted as prohibited ex ante waivers of Lloyds’ obligations under the federal securities laws, because British law provided reasonably comparable remedies. In so doing, the courts stressed the importance of allowing the parties to resolve any uncertainty about the law that would govern their relationships. See, e.g., Bonny v. Society of Lloyd’s, 3 F.3d 156 (7th Cir. 1993); Roby v. Corp. of Lloyd’s, 996 F.2d 1353 (2d Cir. 1993); Allen v. Lloyd’s of London, 94 F.3d 923 (4th Cir. 1996); Richards v. Lloyd’s of London, 135 F.3d 1289 (1998); Lipcon v. Underwriters at Lloyd’s, London, 148 F.3d 1285 (11th Cir. 1998).
Later, two district courts applied the same analysis to domestic contracts, enforcing state forum selection clauses even when doing so would preclude federal securities claims. See Spenta Enterprises, Ltd. v. Coleman, 574 F. Supp. 2d 851 (N.D. Ill. 2008); Vernon v. Stabach, 2014 WL 1806861 (S.D. Fla. May 7, 2014). I am unaware of any other decisions that apply a forum selection clause to force dismissal of a federal securities claim for a wholly domestic transaction.
And in 2010, the Supreme Court decided Morrison, which created a bright-line rule providing that American law applies only to securities transactions where the purchase or sale occurs in the U.S.
Anyhoo, relying on Spenta, the Seafarers court concluded that Delaware can provide similar remedies to Section 14(a). Therefore, the forum selection clause would not force the plaintiff to abandon the substance of its Section 14(a) claims, and the clause was enforceable in the same manner as any other contractual forum selection provision. Case dismissed.
So, what do we make of all this?
First, taking the forum selection analysis at face value, and assuming that bylaws are the same as contracts etc etc, I have serious doubts about the correctness of applying Bonny and its ilk to domestic transactions. As I said, the original caselaw was developed in the international context at a time when the applicable law was very uncertain. That’s no longer true after Morrison; these days, it’s far easier for parties to know in advance which law applies, which significantly weakens the Bonny et al. policy rationale. And there’s simply no reason to take those cases and apply them domestically, when we know that the company is subject to both state and federal law, and has no right to opt out of its federal obligations.
Second, we have the derivative posture. When I wrote about litigation-limiting bylaws and charters in Manufactured Consent, I, ahem, intentionally dodged the issue of derivative claims brought to enforce non-internal affairs obligations (see footnote 292), because I think they present a complex case. Typically, you’d apply the law of the state of incorporation to determine if demand is excused before getting to the merits of the claim, so they’re kind of a hybrid action. Here, because the company can still bring the substantive claim directly, you can argue (and Boeing did argue) that application of its bylaw results in no waiver at all; even if this plaintiff is out of court, Boeing itself can still bring a Section 14(a) claim as the real party in interest.
Point being, these types of cases fit uneasily into the question presented in Salzberg, namely, the extent to which corporate constitutive documents can cover federal claims.
Third, is DGCL 115 implicated? That provision authorizes Delaware corporations to require certain claims to be brought exclusively in Delaware courts, which might – depending on your interpretation – mean any Delaware court, including federal courts, which would require Boeing to give plaintiffs access to at least one federal forum. But Salzberg held that DGCL 115 only applies to “claims requiring the application of Delaware corporate law as opposed to federal law.” Do federal derivative claims fall into that category by dint of the fact that Delaware standards determine demand futility?
Also, Salzberg notes that DGCL 115’s legislative history says it is not “intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction.” Does that mean that DGCL 115 should be read to prohibit such a provision – which would invalidate the application of Boeing’s bylaw to Section 14(a) – or is it simply irrelevant?
Fourth, we have the question whether bylaws and charters should be distinguished. Are federal forum selection provisions effective if they are included only in the bylaws? As I discussed in my post about Salzberg, I don’t think the Delaware Supreme Court was clear on this point.
Fifth, also in that post, I said that it’s not clear how far Salzberg extends beyond Section 11. The Court emphasized that Section 11 claims necessarily involve directors, which made them internal-affairs adjacent; that’s also true of Section 14, but not true of Section 10(b) or Section 12.
Sixth, we have what has always been my problem with applying these things to federal claims, and that’s that Delaware requires that directors comport with fiduciary obligations both when they pass the bylaw initially, and when they choose to enforce it in a particular case. The Seafarers court made no attempt to answer those questions. Seafarers’ analysis on this point was particularly sloppy because it held that such bylaws would be justified, inter alia, to avoid “inconsistent verdicts.” But in a derivative action, there’s little risk of inconsistent verdicts; the first-decided case would be preclusive of later ones. (Yes, yes, there are the overlapping direct claims, but those are not covered by Boeing’s bylaw and in any event are ongoing in the same court. The issue required more thought, is my point).
Significantly, in Boilermakers, then-Chancellor Strine suggested that if a bylaw operated to force a waiver of a federal claim, the bylaw might be invalid contractually and/or directors might violate their fiduciary obligations by insisting on its application. See Boilermakers, 73 A.3d at 959, 963.
Seventh, if Seafarers was correct to apply the waiver standards imported from the international cases, that means going forward, courts will constantly have to determine if Delaware law is equivalent to/provides similar protections to federal law. Federal courts will have to construe and reconstrue the contours of Delaware law and its similarity to federal law – and Delaware law is known for shifting and altering its precedent – and possibly may involve Delaware courts in interpreting federal law. It’s precisely the kind of entanglement that I warned about when I posted about the Salzberg decision. Determining the enforceability of these provisions will require federal intrusion into the Delaware space in a manner that Delaware will, I believe, come to regret.
But eighth and finally, the important thing to remember is that this is a federal question. It’s a federal question whether corporate charters and bylaws – whose content is determined by state law, that are subject to state fiduciary obligations, and that are alterable only according to state standards – are the equivalent of “contractual” provisions that can alter federal rights and obligations accordingly. That Delaware calls them “contracts” does not make it so for federal purposes, and, Seafarers notwithstanding, that dispute continues.