Delaware Court to Rule on Exclusive-Forum Bylaws

Thinking about adopting bylaws designating Delaware as the exclusive forum for shareholder litigation? Then get ready for a fight.

In a single week earlier this month, shareholders filed class-action lawsuits in Delaware Chancery Court against 11 companies challenging so-called “exclusive forum bylaws.” The targets include FedEx, Chevron, Priceline.com, Danaher, Navistar, and others. Plaintiff lawyers say more such complaints are on the way.

The complaints argue that the companies' forum selection bylaws aren't binding because they were added without shareholder approval. The lawsuits further claim the bylaws are unilateral in effect because, while shareholders can only bring claims in Delaware, the bylaws provide no forum restrictions on the companies themselves.

The lawsuits ask the court to decide whether the bylaws are enforceable. “We don't think it's appropriate for defendants to be able to forum-shop like this,” says Lee Rudy, a partner with Kessler Topaz, one of the law firms that jointly filed the lawsuits with law firm Prickett, Jones & Elliott. “We thought it was important that the Delaware Chancery Court have an opportunity to weigh in on their legality.”

If the Delaware Chancery Court strikes down the bylaws, that will be a heavy blow against efforts to steer shareholder litigation toward specific venues. The only other case to address the issue directly was Galaviz v. Berg, decided in January 2011, when a U.S. district court judge in northern California refused to enforce Oracle's exclusive forum bylaw, in part because it had not been put to a shareholder vote.

Exclusive forum bylaws have been around for nearly a decade, but gained popularity in 2010, when Delaware Chancery Court Vice Chancellor Travis Laster added a footnote in his decision on a shareholder suit against Revlon supporting the practice.  “If boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes,” he wrote.

Following that opinion, “many companies started adopting exclusive forum provisions in their bylaws,” says Steven Haas, a lawyer with law firm Hunton & Williams.

Did they ever. The number of Delaware corporations that adopted or proposed adopting forum-selection provisions in charters and bylaws more than doubled from 82 in April 2011 to 195 by the end of last year, according to a study conducted by Claudia Allen, partner and chair of the corporate governance group of law firm Neil Gerber and Eisenberg. Nearly all (97 percent) of those provisions were proposed or adopted following the Revlon decision.

Companies generally view forum-selection provisions as a means to reduce the cost and uncertainty of litigating outside of Delaware, which is widely recognized as the preeminent forum for resolving corporate governance disputes. Companies also choose to adopt exclusive-forum bylaws to prevent shareholders from challenging the same action in different jurisdictions simultaneously, which happens regularly in mergers and acquisitions. “There clearly is a rational basis to conclude that an exclusive-forum provision is in the best interest of all shareholders,” Allen says.

Rudy says forum selection bylaws would be better off in corporate charters, subject to a shareholder vote. “I'm not saying that if they did it in a corporate charter amendment with a vote that it would necessarily be proper, but that would be an important protection for shareholders,” he says. According to Allen's study, 56 percent of the bylaws analyzed are in corporate charters.

Widespread Ramifications

If the Chancery Court upholds the legitimacy of the bylaws, companies will probably rush to enact them. “A ruling that upholds exclusive-forum bylaws could be one of the most significant events in reforming class-action litigation since Congress passed the Private Securities Litigation Reform Act in 1995,” Haas says. “Numerous other companies can be expected to adopt them almost immediately.”

“There clearly is a rational basis to conclude that an exclusive forum provision is in the best interest of all shareholders.”

—Claudia Allen,

Partner,

Neil Gerber and Eisenberg

That fact puts the Delaware court in a delicate position; it is reviewing a bylaw that could potentially drive up the court's “market share” of litigation, since almost all the exclusive-forum bylaws designate Delaware as the favored jurisdiction.

Aside from upholding forum bylaws, the court could also decide either to invalidate them, or uphold them but require that they be approved by a shareholder vote. “Even if the court decided to hear such a case, we don't know if the answer will be black and white” or “more nuanced,” Allen says. “There are a lot of open questions.”

The legal challenges to the practice raise several questions, including:

Is stockholder litigation a matter of internal corporate governance, subject to regulation in the bylaws?

Even if Delaware strikes down board-adopted bylaws, can forum-selection bylaws adopted by shareholders be enforced?

Assuming Delaware enforces such bylaws, can they bind former stockholders?

Can an exclusive-forum provision require an entire action be brought in a Delaware court, even if only one of many claims in that action falls within the scope of that provision?

Can the bylaw dictate forums for lawsuits that challenge actions pre-dating its adoption?

FORUM PROVISIONS

Below are two charts from the “Study of Delaware Forum Selection in Charters and Bylaws.” The first chart shows the circumstances of forum provision adoption; the second shows location of the provisons.

Source: Study of Delaware Forum Selection in Charters and Bylaws.

Shareholders have also filed several proxy proposals requesting that exclusive-forum bylaws be repealed. Votes this proxy season will give companies a better sense of where shareholders stand on the issue. “You shouldn't assume automatically that shareholders oppose these provisions,” Allen says.

Proxy advisory firms Institutional Shareholder Services and Glass Lewis have both clarified how they intend to advise clients on forum-selection proposals for the 2012 proxy season. ISS said it will review them on a case-by-case basis, considering whether the company has been materially harmed by shareholder litigation outside its jurisdiction, and whether the company adopted certain shareholder-friendly governance practices.

Glass Lewis said it opposes exclusive-forum bylaws and will recommend voting against governance committee chairs at companies that adopt such provisions without shareholder approval. In the event a board does seek shareholder approval, Glass Lewis said it will “weigh the benefits” of the company's other bundled bylaws or charter amendments when determining its ultimate voting recommendation.

Kurt Glaubitz, a spokesman for Chevron, says the company has received a shareholder proposal on the topic and will make its position available in proxy materials to be filed April 16. He would not comment further on the pending litigation. A spokesperson for Navistar also declined to comment.

Whether these lawsuits will discourage companies from adopting such bylaws is too soon to tell, Allen says. “Some may be waiting to see how the litigation is resolved.”