The Delaware Supreme Court held on March 18 in Salzberg, et al. v. Sciabacucchi that the exclusive federal-forum provisions in certificates of incorporation for three Delaware corporations were not facially invalid. The decision will provide many Delaware corporations sued in state court for violations of the Securities Act of 1933 with grounds for dismissal, likely counteracting the jurisdictional implications of the US Supreme Court’s decision in Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund, 138 S. Ct. 1061 (2018).
In 2018, the US Supreme Court held in Cyan that both state and federal courts have concurrent jurisdiction over claims brought under the Securities Act of 1933 (1933 Act). Specifically, the Supreme Court held that the amendments to the 1933 Act in the Securities Litigation Uniform Standards Act of 1998 (SLUSA) did not bar state court jurisdiction over class actions alleging only 1933 Act violations, nor did it authorize the removal of such suits from state to federal court.
The Cyan decision prompted a significant shift in the securities litigation landscape, as plaintiffs increasingly filed 1933 Act claims in state court, in part to evade the procedural protections of the Private Securities Litigation Reform Act in 1995 (PSLRA).[1] As Salzberg recognized, in 2018 there were 55% more state-only 1933 Act filings than there were federal-only 1933 Act filings.[2] And in 2019, “[t]he number of state 1933 Act filings in 2019 increased by 40% from 2018,” and “[a]bout 45 percent of all state 1933 Act filings in 2019 had a parallel action in federal court.”[3] Since Cyan, there have been at least 43 parallel class actions filed in multiple jurisdictions.[4]
Corporations responded to Cyan in part by including federal-forum provisions (FFPs) in their certificates of incorporation. The FFPs designate that the federal courts are the exclusive forum for any claims brought under the 1933 Act.
In late 2017, a shareholder of three Delaware corporations with FFPs—Blue Apron Holdings, Inc., Stitch Fix, Inc., and Roku, Inc.—sought a declaratory judgment that those corporations’ FFPs are invalid under Delaware law.[5] The Delaware Court of Chancery held that the “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”[6] Because “the [FFPs] attempt to accomplish that feat,” the court found that the FFPs were “ineffective and invalid.”[7] Defendants appealed.
On appeal, the Delaware Supreme Court reversed the decision of the Chancery Court, holding that FFPs are valid under Delaware corporate law.
The Delaware Supreme Court started its analysis with the plain text of Section 102(b)(1) of the Delaware General Corporation Law (DGCL). Section 102 governs the matters contained in a corporation’s certificate of incorporation and authorizes two types of provisions in the certificate: 1) “any provision for the management of the business and for the conduct of the affairs of the corporation,” or 2) “any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, . . . if such provisions are not contrary to the laws of this State.”[8] Because these categories are quite broad, the court held that an FFP “could easily fall within either” of the categories, “and thus, is facially valid.”[9] Specifically, because an FFP directs 1933 Act claims to federal court, the provisions “classically fit” within the definition of a provision “for the management of the business and for the conduct of the affairs of the corporation” under the first prong of Section 102.[10] Since an FFP dictates where current and former shareholders can bring 1933 Act claims against the corporation, an FFP also “define[s], limit[s] and regulat[es] the powers of the corporation, the directors and the stockholders.”[11] FFPs therefore fall within the second prong of Section 102.
The court expounded some of its prior decisions to find that FFPs “do not violate the policies or laws” of Delaware. In Sterling v. Mayflower Hotel Corp., the court held that “the stockholders of a Delaware corporation may by contract embody in the [certificate of incorporation] a provision departing from the rules of the common law, provided that it does not transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself.”[12] And the Court’s decision in Williams v. Geier[13] “supports the view that FFPs in stockholder-approved charter amendments should be respected as a matter of policy.”[14]
The court emphasized the need for resolution of “the post-Cyan difficulties presented by multi-forum litigation of Securities Act claims.”[15] Highlighting the inefficiencies and burdens resulting from Cyan, the court observed: “When parallel state and federal actions are filed, no procedural mechanism is available to consolidate or coordinate multiple suits in state and federal court. The costs and inefficiencies of multiple cases being litigated simultaneously in both state and federal courts are obvious.”[16]
FFPs also do not violate federal law or policy. The US Supreme Court has upheld numerous types of forum selection clauses,[17] has held that “federal law has no objection to provisions that preclude state litigation of Securities Act claims,”[18] and has found that Delaware courts can settle claims subject to exclusive federal jurisdiction without violating federal law or policy.[19] Further, nothing in Cyan prohibits FFPs.[20]
Addressing what the court said was “[p]erhaps the most difficult aspect of this dispute”—the “down the road” issue of whether FFPs will be respected and enforced by other states—the court concluded that because FFPs are procedural mechanisms rather than substantive measures, they therefore “do not violate principles of horizontal sovereignty.”[21]
Finally, the court concluded that FFPs are consistent with a central purpose of the DGCL – to provide “immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise.” [22] Because the DGCL was “intended to provide directors and stockholders with flexibility and wide discretion for private ordering and adaptation to new situations,” a board’s decision to utilize a new use of “plain statutory authority” does not make such an action invalid under Delaware law.[23]
While the extent to which other state courts will follow Salzberg remains to be seen, the decision provides Delaware-incorporated defendants that have adopted FFPs with grounds to seek dismissal of 1933 Act cases filed in state court. In light of Salzberg, Delaware corporations preparing for an IPO or secondary public offering should consider including an FFP in their certificates of incorporation and/or offering materials.
Beyond the FFPs at issue in Salzberg, the Delaware Supreme Court’s decision has potentially far-reaching implications for the scope of matters subject to private ordering for Delaware corporations. The decision will likely be the subject of judicial and academic discourse for a long time to come.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Boston
Michael D. Blanchard
Philadelphia
Laura Hughes McNally
[1] See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 (2006)
[2] Salzberg v Sciabacucchi, No. 346, 2019, slip op. at 12 (Del. 2020) (citing Stanford Law Sch. Secs. Class Action Clearinghouse & Cornerstone Research, Securities Class Action Filings 2018 Year in Review 22 (2019))
[3] Id. (citing Stanford Law Sch. Secs. Class Action Clearinghouse & Cornerstone Research, Securities Class Action Filings 2019 Year in Review 4 (2020))
[4] Id. at 24.
[5] Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018)
[6] Id. at *3.
[7] Id.
[8] 8 Del. C. § 102(b)(1).
[9] Sciabacucchi, slip op. at 11.
[10] Id. at 13-14.
[11] Id. at 14.
[12] 93 A.2d 1018 (Del. 1952).
[13] 671 A.2d 1368 (Del. 1996).
[14] Sciabacucchi, slip op. at 15.
[15] Id. at 52.
[16] Id. at 13.
[17] Id. at 44 (citing M/S Bremen v. Zapata Off-Shore Co., 107 U.S. 1 (1972) and Carnival Cruise Lines, Inc. v. Shute, 499 U.S. 585 (1991)).
[18] Id. at 43 (citing Rodriquez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989)).
[19] Id. at 45 (citing Matsushita Electric Industrial Co. v. Epstein, 516 U.S. 367, 377, 382 (1996)).
[20] Id. at 44.
[21] Id. at 52.
[22] Id. at 13.
[23] Id. at 53 (citing Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934, 953 (Del. Ch. 2013) (“[O]ur corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs. Merely because the [DGCL] is silent as to a specific matter does not mean that it is prohibited.”)).