David H. Kistenbroker
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In a landmark decision critically important to companies preparing registration statements in connection with their initial public offerings, as well as to investment companies (e.g., mutual funds) or other corporations that routinely issue prospectuses, on March 18, 2020, the Delaware Supreme Court ruled in Salzberg, et al. and Blue Apron Holdings, Inc., et al. v. Sciabacucchi, Case No. 346, 2019, 2020 WL 1280785 (Del. Mar. 18, 2020), that Delaware corporations can adopt charter provisions requiring actions arising under the Securities Act to be filed exclusively in federal court. In reversing the Delaware Court of Chancery’s 2018 decision, the Delaware Supreme Court confirmed that Delaware corporations and their directors are granted significant leeway to govern the manner by which their shareholders can bring claims against them.The decision in Blue Apron touches on the interaction between state corporate law and federal securities law. The Securities Act of 1933 (“Securities Act”) not only permits plaintiffs to file claims challenging registration statements in both state and federal courts, but also prohibits the removal of state-court actions to federal court. Increasingly over the past several years, plaintiffs’ counsel have filed more Securities Act claims in state court—where discovery rules can be more lenient and pleading standards less rigorous than in federal courts—often resulting in parallel state and federal court proceedings. In response to this inefficiency and perceived tactical disadvantage, a number of Delaware corporations amended their charters to include federal-forum provisions that require Securities Act claims to be filed exclusively in federal court. In its highly anticipated opinion issued yesterday, the Delaware Supreme Court authorized this tactic, ruling that federal-forum provisions are valid under Delaware law.
Unlike other securities fraud claims (e.g., claims under Section 10(b) of the Securities Exchange Act of 1934), the Securities Act permits plaintiffs to file claims either in state or federal court, including claims under Section 11, which challenge statements or omissions in registration statements; claims under Section 12, which challenge statements or omissions in prospectuses or oral communications; and claims under Section 15, which are asserted against those who “control” any person liable under Sections 11 or 12. Moreover, the Securities Act forbids defendants from removing state court actions to federal court.
Critically, the number of Securities Act claims filed in state court has dramatically increased over the past two years following the U.S. Supreme Court’s March 2018 decision in Cyan, Inc. v. Beaver Cty. Employees Ret. Fund, 138 S. Ct. 1061 (2018), which confirmed not only that state and federal courts exercise concurrent jurisdiction over Securities Act claims, but also that claims filed in state court are not removable to federal court. Following that ruling, plaintiffs’ counsel filed a flurry of claims in state court. In fact, as acknowledged by the Delaware Supreme Court, the number of Securities Act claims filed in state court in 2019 is “historically unprecedented,” jumping from only a handful of state court filings before 2015 to 65 filings in 2019.
As a result, securities issuers and sellers subject to Section 11 and/or 12 have faced an increasing number of state court Securities Act lawsuits—including a number of instances in which identical Securities Act claims have been filed in both state and federal court simultaneously, with no mechanism to consolidate these duplicative actions—a costly and wasteful endeavor which could potentially result in inconsistent decisions. To avoid this risk, many Delaware corporations have adopted “federal-forum provisions” in their charters, requiring plaintiffs to file any action arising under the Securities Act exclusively in federal courts.
In Sciabacucchi v. Salzberg, the plaintiffs challenged the validly of federal-forum provisions, claiming they were invalid on their face. In December 2018, Vice Chancellor Laster of the Delaware Court of Chancery granted summary judgment in favor of the plaintiffs, ruling that the federal-forum provisions were “ineffective and invalid” (No. CV 2017-0931-JTL, 2018 WL 6719718, at *3 (Del. Ch. Dec. 19, 2018)). In reaching his conclusion, the Court of Chancery relied in large part on its decision in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), later codified in Section 115 of the Delaware General Corporation Law (“DGCL”), which held that the statute permits corporations to adopt forum selection provisions for “internal-affairs” claims but not “external” claims, such as for example, claims in tort or contract.
Attempting to follow the rationale of Boilermakers, the Court of Chancery thus distinguished between “internal” and “external” claims—ruling that the former could be subject to forum-selection provisions but the latter could not. It then determined that a claim is “external” if it does not involve rights or relationships established under Delaware corporate law. Applying this rule, the Court of Chancery concluded that Securities Act claims were “external to the corporation” because they arose under federal law and did not turn on the “rights, powers, or preferences of the shares, language in the company’s charter or bylaws, a provision in the DGCL, or the equitable relationships that flow from the internal structure of the corporation.” See Sciabacucchi v. Salzberg, 2018 WL 6719718, at *1.
On March 18, 2020, the Delaware Supreme Court, sitting en banc, issued a 53-page unanimous opinion, reversing the opinion of the Court of Chancery.
The Court first ruled that provisions regulating the forum of “intra-corporate” litigation fall within the “broad, enabling” scope of Section 102 of the Delaware General Corporation Law, which permits Delaware corporations to include in their certificate of incorporation “any provision for the management of the business and for the conduct of the affairs of the corporation,” and “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.” Nor did any law prohibit federal-forum provisions; to the contrary, Delaware has long-upheld forum selection clauses as valid.
The Court further ruled that Section 115, which allows a Delaware corporation to require “internal corporate claims” to be filed “exclusively . . . in this State,” had no applicability because Securities Act claims are not “internal corporate claims” (a proposition that no party disputed). Although plaintiffs argued that Section 115 somehow “implied” that federal-forum provisions were now invalid under Section 102, the Court disagreed, noting that the General Assembly tellingly did not amend the broad text of Section 102, affirming the long-standing rule that courts should not “impliedly amend” a statute unless such intention was “manifestly clear.”
Section 115, the Court further explained, was simply intended, in part, to codify Boilermakers. As a result, it was only intended to clarify that for certain claims—namely, “internal corporate claims”—corporations may select Delaware courts as the only forum, but Delaware courts cannot be excluded as a forum. For other claims not covered by Section 115, including Securities Act claims, the broad and permissive provisions of Section 102 still apply. In a footnote, the Court further clarified that Section 115 is limited only to claims created under Delaware corporate law, not federal law.
The Court then concluded that the Court of Chancery wrongly embraced a “binary world” consisting of only “internal affairs” claims and “external” claims. Rejecting that binary world, the Court acknowledged a “continuum” of claims: on the one end were “internal affairs” claims (like those at issue in Boilermakers), in the middle were other “intra-corporate” claims, and at the other end were “external” claims. Securities Act claims fall in the middle: they are “intra-corporate” claims because they involve a shareholder’s claim against the company or those who control the company. As a result, the broad text of Section 102 permits corporations to adopt federal-forum provisions requiring Securities Act claims to be filed exclusively in federal court.
The Delaware Supreme Court’s opinion provides necessary clarity to Delaware corporations going forward: federal-forum provisions are valid and enforceable under Delaware law. Moreover, given the plaintiffs’ bar’s increasing desire to pursue Securities Act claims in state courts, including entirely duplicative claims in both state and federal courts, Delaware corporations now have the confirmed ability to adopt federal-forum provisions requiring Securities Act claims to be litigated exclusively in federal court. Such provision could be of increased importance to a Delaware-organized investment company (such as an open-end mutual fund), which faces daily risk of Section 11 claims due to the fact that any shareholder transaction is deemed to be based on the operative prospectus.
The Court also addressed in a footnote the concern that had driven much of the attention on this case, which was that a decision authorizing federal-forum provisions will open the door for Delaware corporations to next adopt mandatory shareholder-arbitration provisions. The Court stated that such provisions would violate Section 115 of the DGCL by virtue of the fact that they would remove corporate claims from the purview of Delaware courts altogether.
Finally, the Court’s ruling today is critically important to Delaware corporations because it confirms once again that Delaware courts will show great respect and due deference to stockholder-approved charter provisions, giving corporations and their investors significant leeway to structure and govern their own relationships.