EXCLUSIVE FORUM BYLAWS Delaware Court of Chancery Approves - - PDF document

Volume 21, Number 5 25 The Corporate Governance Advisor

EXCLUSIVE FORUM BYLAWS

In a highly anticipated decision, the Delaware Court of Chancery upheld the validity of board-adopted forum selection bylaws. In June 2013, Chancellor Strine affirmed that a board

• f directors has the statutory authority to

unilaterally adopt forum selection bylaws if the corporation’s certificate of incorporation permits the board to amend its bylaws.

1 If

upheld on appeal, the court’s decision means that boards of Delaware corporations can reduce the threat of multiforum litigation by amending their bylaws to designate Delaware as the exclusive forum for litigation relat- ing to the corporation’s internal affairs. This will enable corporations to litigate certain shareholder disputes more efficiently and with greater predictability.

Proliferation of Multiforum Litigation

In recent years, shareholder litigation invari- ably has followed nearly every announcement of a merger, regardless of size. Ninety-six percent

• f public-company merger announcements val-

ued at $1 billion or more are met with litigation, with an average of over six shareholder lawsuits per transaction.

2 Relatively small transactions

are not immune. For example, 18 lawsuits were filed in connection with the acquisition

• f Conexant Systems, which was valued at

$280 million.

3 Though much of the data pub-

lished on duplicative litigation focuses on the proliferation of litigation relating to mergers and acquisitions, shareholder litigation often follows the announcement of adverse corporate developments as well. In these instances, duplicative lawsuits com- monly are filed in multiple state and federal courts, forcing companies to defend litiga- tion in multiple fora.

4 Shareholder lawsuits

may be filed both where a defendant corpo- ration is incorporated and also where it is headquartered, which, for the vast majority

• f Delaware corporations, is somewhere other

than Delaware.

5

There are no benefits to litigating the same claim in multiple courts, but the problems are myriad. For example, multiforum litiga- tion imposes significant costs on corporations and their shareholders, who ultimately bear the costs of litigation and settlement. It also need- lessly burdens the judicial system and wastes judicial resources, as judges in multiple jurisdic- tions review the same pleadings and often are asked to decide identical motions. That creates a real and significant risk that a corporation could be subject to inconsistent judgments. Conflicting judicial mandates also would leave the law in a confused state.

6

The Exclusive Forum Solution

The adoption by corporations of forum selection provisions is a direct response to the phenomenon of multiforum litigation. These provisions impose order before liti- gation begins by designating an exclusive forum for intracorporate disputes, includ- ing derivative actions, fiduciary-duty actions, actions arising out of the Delaware General Corporation Law, and actions concerning the internal affairs of a corporation. Forum selec- tion provisions do not regulate “external” dis- putes, such as tort or contract claims, that are unconnected to a plaintiff’s status as a share-

• holder. Instead, the provisions relate only to

those actions that are unique to shareholders as shareholders.

Delaware Court of Chancery Approves Board-Adopted Forum Selection Bylaws

By Philip Stamatakos and Marjorie Duffy

Philip Stamatakos is a partner and Marjorie Duffy is an associate with Jones Day. The opinions expressed in this article are those of the authors and not necessarily those of Jones Day or any of its clients.

The Corporate Governance Advisor 26 September/October 2013

Until early 2010, only a handful of publicly traded Delaware corporations had adopted forum selection provisions.

7 Then, in March

2010, Vice Chancellor Laster suggested in an

• pinion that corporations concerned about

multiforum litigation relating to intracorpo- rate disputes could adopt such provisions in their charters.

8 After that opinion, the num-

ber of corporations that adopted forum selec- tion provisions skyrocketed and, by September 2012, over 250 corporations had adopted such provisions.

9

It has become increasingly common for corpo- rate boards to unilaterally adopt forum selection provisions in bylaws or in circumstances that do not require shareholder approval. Forum selec- tion bylaw provisions may be adopted by boards

• f Delaware corporations under the author-

ity of 8 Del. C. § 109(a), which provides that a corporation’s certificate of incorporation may confer the power to adopt and amend bylaws on its board of directors, provided that the bylaw provisions are not inconsistent with Delaware law or the certificate of incorporation. Delaware public companies’ certificates of incorporation commonly confer such power on boards and this has permitted their boards to unilaterally adopt forum selection provisions without the need to put the matter to a shareholder vote. By contrast, a Delaware corporation that adopts forum selection provisions in its certifi- cate of incorporation does so under the author- ity of 8 Del. C. § 102(b)(1), which provides that a certificate of incorporation may contain any provision for the conduct of the corporation’s affairs and any provision that limits or regu- lates the powers of its shareholders provided that such provisions are not contrary to law. Companies that are already public may adopt forum selection provisions in their charters only with shareholder consent. In addition, com- panies that are going public, being spun-off, emerging from bankruptcy, or reincorporat- ing often adopt charter provisions because, in those circumstances, adoption can be accom- plished with no public shareholder vote or with minimal shareholder resistance because of sur- rounding circumstances. It is the first method of adopting forum selec- tion provisions—the board-approved bylaw provision without a shareholder vote—that was the subject of the recent Chancery Court litiga- tion.

10 After those lawsuits were filed in early

2012, the rate of bylaw amendment adoption ground to a halt, as companies waited to see whether the bylaws would withstand challenges to their validity.

11

Shareholders Challenge the Chevron and FedEx Bylaws

In 2010 and 2011, the boards of Chevron and FedEx adopted identical bylaw provisions selecting the Delaware Court of Chancery as the exclusive forum for intracorporate disputes relating to internal corporate affairs (except in cases in which the corporations consent to another forum). Each board adopted the bylaw pursuant to powers granted to it in the com- pany’s certificate of incorporation; the matter was not put to a shareholder vote. Beginning in February 2012, shareholders filed identical complaints in the Delaware Court

• f Chancery attacking the board-adopted

bylaws of a dozen companies, including Chevron and FedEx. The complaints chal- lenged the statutory and contractual validity

• f the forum selection bylaws. In response, ten
• f the sued corporations repealed their forum

bylaws. In March 2013, Chevron amended its bylaw to address potential concerns about subject- matter jurisdiction for exclusively federal claims and personal jurisdiction over certain defen-

• dants. As revised, Chevron’s bylaw provided, in

part, that: Unless the Corporation consents in writing to the selection of an alternative forum, the sole and exclusive forum for … [intracor- porate disputes] shall be a state or federal court located within the state of Delaware, in all cases subject to the court’s having personal jurisdiction over the indispensible parties named as defendants.

Volume 21, Number 5 27 The Corporate Governance Advisor

FedEx did not amend its bylaw, which desig- nated only the Court of Chancery. Both com- panies then sought a ruling from the Court of Chancery as to the validity of their bylaws.

Board-Adopted Forum Selection Bylaws Are Valid

In June 2013, Chancellor Strine issued a single ruling in the cases against Chevron and FedEx and held that board-adopted forum selection bylaws are statutorily valid because they con- cern where a shareholder may sue a corporation (not whether a shareholder may sue or the type

• f remedy a shareholder may recover), which

is a process-oriented matter concerning the rights of shareholders that bylaws properly may address under 8 Del. C. § 109(b).

12

The court also rejected the plaintiffs’ argu- ment that the bylaw amendments are not con- tractually binding on shareholders because they were unilaterally adopted by the boards without shareholder consent. The court reiterated that bylaws constitute a binding contract between a Delaware corporation and its shareholders, and in instances in which a Delaware corpora- tion’s certificate of incorporation empowers its board to unilaterally amend its bylaws, share- holders are on notice when they purchase stock that they are party to an inherently flexible contract.

13 In such instances, a board can amend

bylaws without a shareholder vote, as long as those provisions are otherwise consistent with a corporation’s certificate of incorporation and Delaware law.

14

The court noted that even valid forum selec- tion provisions may not always be enforceable because there may be limited circumstances in which requiring a shareholder-plaintiff to litigate in the company-selected forum could be unreasonable.

15 Those circumstances, however,

must be addressed on a case-by-case basis.

16

Simply because the bylaws may be subject to a challenge at some point in the future because

• f the manner in which they would be applied

at that time does not render them facially invalid.

17

The court observed that despite a board’s powers to adopt forum selection bylaws, share- holders ultimately retain significant voice over the adoption of such bylaw provisions because they can vote to amend or repeal the bylaws to remove an offensive forum selection provision, vote to remove directors who voted in favor of such provisions, request that the board waive enforcement of a forum selection provision in a particular instance pursuant to the provision’s

• wn terms, and challenge the application of the

provision in a particular instance.

18

The plaintiffs are positioned to appeal Chancellor Strine’s decision, and the Delaware Supreme Court is expected to have an opportu- nity to consider the validity of Chevron’s and FedEx’s board-adopted forum selection bylaw provisions.

Practice Pointers for Delaware Corporations

In Chevron/FedEx, the Delaware Court of Chancery upheld the validity of board-adopted forum selection bylaws if a corporation’s cer- tificate of incorporation authorizes the board to unilaterally amend its bylaws. Though the Court of Chancery’s decision seems very likely to be upheld, there remains the potential that it could be reversed, which would require the repeal of recently adopted forum selection

• provisions. Consequently, we recommend that

companies await the outcome of any appeal of the Chevron/FedEx case before adopting forum selection bylaws. Moreover, adoption of such provisions may engender hostility from share- holders who submit proposals to dismantle them. If a company’s board decides to adopt a forum selection provision, the company should gauge the likely reaction of its shareholders and consider whether shareholder engagement on the issue is appropriate. Although Institutional Shareholder Services (ISS) did not include a board’s adoption of a forum selection provision in its 2013 governance ratings, Glass Lewis & Co., Inc.’s 2013 voting policies recommend

The Corporate Governance Advisor 28 September/October 2013

a vote against the chair of the governance committee of a company that has adopted a forum selection provision without shareholder approval during the previous year. Further, a board that unilaterally adopts a forum selection provision could receive a shareholder proposal seeking its repeal. Instead of a board adopting a forum selec- tion provision, the board may decide to submit the adoption of a forum selection pro- vision to a shareholder vote. ISS’ 2013 Socially Responsible Investment (SRI) proxy voting guidelines, which offer recommendations to investors who require companies to conduct their business in a socially and environmen- tally responsible manner, provided for a case- by-case review of exclusive forum provisions, taking into account whether a company has been materially harmed in the past by multi- forum litigation and whether the company has certain governance features, such as an annu- ally elected board, a majority vote standard in uncontested director elections, and the absence

• f a non-shareholder approved poison pill.

ISS may decide to recommend the case-by- case review in future guidelines applicable to all investors. Glass Lewis, on the other hand, has taken a more hostile view toward forum selection provisions and generally recommends voting against a forum selection provision unless the company presents a “nuanced argu- ment” demonstrating that the provision would directly benefit shareholders, and then only if the company maintains what Glass Lewis regards as an “undisputable record” of good corporate governance practices. As to shareholder proposals, which include proposals to repeal forum selection bylaws unilaterally adopted by a board, both ISS and Glass Lewis purport to consider those propos- als on a case-by-case basis. In 2012, Chevron received a nonbinding shareholder proposal to repeal its forum selection bylaw. Chevron put that proposal to a vote of its shareholders and, despite recommendations from both ISS and Glass Lewis to repeal the bylaw, the repeal proposal was defeated by a 2-to-1 margin. Shareholders of United Rentals—which, like Chevron, has a strong record of good corpo- rate governance—rejected a similar nonbinding repeal proposal despite support for the proposal from both ISS and Glass Lewis. Finally, if a corporation decides to adopt a forum selection provision, it should con- sider adopting a provision that identifies the Delaware Court of Chancery as the exclusive forum for derivative actions, fiduciary-duty lawsuits, claims under the Delaware General Corporation Law, and any other claims related to the corporation’s internal affairs. Companies may wish to further consider adopting a bylaw modeled after the amended Chevron bylaw. Though Chancellor Strine upheld the validity

• f both the FedEx and the amended Chevron

bylaws, the Chevron amended bylaw (unlike the FedEx bylaw) takes into account the jurisdic- tional limits of the Court of Chancery by des- ignating a federal court for federal-law claims and addresses circumstances in which personal jurisdiction may be lacking.

Conclusion

If upheld on appeal, as we predict it will be, the Chevron/FedEx decision means that boards

• f Delaware corporations have a reliable means

to combat ever-expanding multiforum litiga- tion and reduce its attendant costs and risks. Corporate boards will then need to assess the benefits of adopting forum selection provisions and consider whether adoption of the provi- sions is in their corporations’ best interests.

Notes

• 1. Boilermakers Local 154 Ret. Fund v. Chevron Corp.,

C.A. Nos. 7220-CS, 7238-CS, 2013 BL 167755 (Del. Ch. June 25, 2013).

• 2. Robert M. Daines & Olga Koumrian, “Recent

Developments in Shareholder Litigation Involving Mergers and Acquisitions,” at 3 (Mar. 2012), http://www.cornerstone. com/files/News/d7e418ea-eb2c-4a17-8eae-de2510d9d1ba/ Presentation/NewsAttachment/8b664075-ebfb-4cce-aa76- 8a050befad03/Cornerstone_Research_Shareholder_MandA_ Litigation.pdf .

• 3. Id.

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• 4. Matthew D. Cain & Steven M. Davidoff, “A

Great Game: The Dynamics of State Competition and Litigation”, at 15 (Jan. 2013), http://ssrn.com/ abstract=1984758 (“Multi-state litigation has increased along with litigation rates generally.”).

• 5. Joseph A. Grundfest & Kristen A. Savelle, “The

Brouhaha Over Intra-Corporate Forum Selection Provision: A Legal, Economic and Political Analysis,” 68 Bus. Law. 325, 335 (Feb. 2013) (72 percent of transac- tions involving Delaware corporations were challenged in Delaware and another state or federal forum).

• 6. In re Allion Healthcare Inc. S’holders Litig., C.A. No.

5022-CC, 2011 BL 83642, at *5 n.11 (Del. Ch. Mar. 29, 2011).

• 7. Grundfest & Savelle,

supra note 5 at 362.

• 8. In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 960

(Del. Ch. 2010).

• 9. Grundfest & Savelle,

supra note 5 at 362.

• 10. To date, there do not appear to be any challenges to

the validity of forum selection provisions in certificates

• f incorporation or those in bylaws adopted with the

approval of shareholders.

• 11. Grundfest & Savelle,

supra note 5, at 362. 12. Chevron , 2013 BL 167755, at *25-26. 13.

• Id. at *33.

14. See id. at *34 (“the stockholders assent to not having to assent to board-adopted bylaws”). 15. See id. at *46 (“the key is that forum selection bylaws, like other forum selection clauses, are not facially invalid because they might operate in a problematic way in some future situation”). 16. See id. at *40 (“the time for a plaintiff to make an as- applied challenge to the forum selection clauses is when the plaintiff wishes to, and does, file a lawsuit outside the chosen forum”). 17. Id . 18.

• Id. at *30, 35, 38, 46.