By Gerald P. Burleson and Charles R. Ronan, members of the California Bar
© 2013 by Gerald P. Burleson, all rights reserved.
In recent years, several Delaware corporations have either adopted or proposed exclusive forum selection bylaw provisions. These provisions generally require that stockholder suits relating to the internal affairs of a corporation be brought exclusively in the company’s state of incorporation, Delaware. However, a minority shareholder in California might prefer to bring suit here, for convenience and to take advantage of a forum that may seem more plaintiff-friendly than the other alternatives. And, California has an interest in protecting resident stockholders. Exclusive forum selection bylaws unilaterally adopted by boards of directors are under scrutiny and have been the subject of legal challenges.
On June 25, 2013, in a closely watched case, the Delaware Chancery Court rejected statutory and contractual challenges to forum-selection bylaws adopted unilaterally by the boards of directors of Chevron Corporation and FedEx Corporation. The court determined that a board of directors, if granted authority to adopt bylaws by the certificate of incorporation, has the power under the Delaware General Corporation Law (DGCL) to adopt a bylaw requiring litigation relating to the corporation’s internal affairs to be conducted exclusively in the Delaware courts. Boilermakers Local 154 Retirement Fund v. Chevron Corp. (Del. Ch. 2013) 73 A.3d 934, 958. The court also rejected the plaintiffs’ arguments that the bylaws are contractually invalid because the corporations’ boards of directors unilaterally adopted them without stockholder approval. In the opinion, the court explained that bylaws, along with the certificate of incorporation and the DGCL, are considered “part of a flexible contract between corporations and stockholders,” and that “stockholders who invest in such corporations assent to be bound by board-adopted bylaws when they buy stock in those corporations.” Id. at 940.
The court recognized that while forum selection provisions are valid as a matter of Delaware corporate law, they are still subject to challenge. The court reasoned that shareholder plaintiffs could always sue in their chosen forum and then respond to a defense motion to dismiss for improper venue by arguing, based on actual facts, that the forum selection provision in the corporation’s bylaws should not be recognized because enforcement would be unreasonable or that the provision was being used for improper purposes inconsistent with the directors’ fiduciary duties. Id. at 963. The court noted that a forum selection provision does not restrict the plaintiffs’ ability to sue in a forum they select outside of Delaware for claims that do not fall within the scope of the forum selection provision, such as claims based on violations of federal securities law or tort claims. Id. at 952.
However, California courts could reach a different conclusion on a forum selection provision incorporated in the bylaws of a foreign corporation with a California nexus sufficient to support the application of section 2115 of the Corporations Code (see blog article posted 11/12/2013 at this website, “California Law May Govern Critical Corporate Governance Issues Even Though it’s a Delaware, Nevada or Texas Corporation”). California courts may refuse to enforce such a forum selection provision where enforcement would circumvent the legislature’s intention embodied in section 2115 that California law governs the dispute. California’s legislature has an established interest in protecting resident stockholders and if certain conditions are satisfied, California law, and not the law of the chartering jurisdiction, will govern a range of fundamental corporate governance issues, including the directors’ standard of care. California courts have clarified that the policy is, at least in part, driven by a belief that California has the largest concern in protecting its resident shareholders and this interest is superior to the incorporating state’s right to regulate corporate governance issues. Sara Lewis, Transforming the “Anywhere but Chancery” Problem into the “Nowhere but Chancery” Solution (2008) 14 Stan. J.L. Bus. & Fin. 199, 217. However, the issue is far from settled.
In 2011, a California federal court refused to enforce an exclusive forum provision. In Galaviz v. Berg, the court stated that the defendant corporation, Oracle, did not show federal law required or even permitted the federal courts to defer to any provision of state corporate law that might purport to give a corporation’s directors the power to control venue. See Galaviz v. Berg (N.D. Cal. 2011) 763 F.Supp.2d 1170, 1175. The court reasoned that it would be inequitable to apply the forum clause to the plaintiffs, who had purchased their shares before the bylaw was adopted and therefore had no notice. However, not only did the shareholders not consent to the provision, the court also noted that all of the defendants had approved the provision after their alleged wrongdoing, which made the bylaws appear as a shield to their own liability. The Court also suggested that the result may have been different if the clause had been adopted in the company’s certificate of incorporation after a shareholder vote. Id. at 1174. After Galaviz, many Delaware corporations elected to wait for shareholder approval before adopting such exclusive-forum provisions.
The validity of forum-selection clauses unilaterally inserted into a corporation’s bylaws through director adoption still faces considerable debate and likely litigation. The effectiveness, enforceability and desirability of exclusive forum provisions are far from settled. However, California courts are generally protective of minority shareholders’ rights when a change in the by-laws of a corporation, without consent, unreasonably deprives the shareholder of pre-existing rights. In re Flashcom, Inc. (Bankr. C.D. Cal. 2004) 308 B.R. 485, 490.