Delaware Supreme Court Allows Companies to Restrict 1933 Act Claims to Federal Court – Shareholder Advocate Summer 2020

July 28, 2020

By Carol V. Gilden

It has been quite a year on the forum selection front as many on both sides of the “v” waited for the Delaware Supreme Court to rule on a stockholder’s challenge to the validity of corporate provisions restricting claims under the Securities Act of 1933 to federal court, even though the 1933 Act also allows investors to bring those claims in state court. Instead of providing clarity, however, the Delaware Supreme Court introduced more uncertainty when, in Salzberg v. Sciabacucchi, 227 A.3d 102 (2020), it reversed the Chancery Court’s ruling invalidating the provisions and found them a permissible exercise of corporate power. While the decision on its face deals with a narrow issue, it may open the door to further efforts to eviscerate the rights of stockholders.

At issue in Salzberg were federal forum provisions that three companies, Stitch Fix, Roku and Blue Apron, had included in their articles of incorporation, sometimes referred to as a corporate charter, before they went public. While the language differed slightly in the forum provisions, all required that any claims under the 1933 Act be litigated in federal court, despite concurrent state and federal jurisdiction.1 Matthew Sciabacucchi, who purchased shares in all three companies through the IPOs, or shortly thereafter, filed a class action in Delaware Chancery Court seeking to have the provisions declared invalid under Delaware law. The Chancery Court agreed, invalidating the provisions on a facial basis. Drawing a line between internal claims, which it said can be regulated by a company’s charter or bylaws, and external claims involving a company, which cannot, the Chancery Court concluded that the 1933 Act claims were external to the company. The Chancery Court reasoned that “[f]ederal law creates the claim, defines the elements of the claims, and specifies who can be a plaintiff or defendant.” Accordingly, the Chancery Court held that the provisions were invalid because 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.” Then, the Delaware Supreme Court reversed.

The Delaware Supreme Court held that the federal forum provisions did not violate Delaware law and were in fact facially valid under Section 102(b)(1) of the Delaware General Corporation Law. Section 102(b)(1) provides that articles of incorporation may contain “[a]ny 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 …, if such provisions are not contrary to the laws of this State.” The Court explained that, in making a facial challenge, the plaintiff had to demonstrate that the “charter provisions ‘do not address proper subject matters’ as defined by statute, ‘and can never operate consistently with the law.’” The Court reasoned that federal forum provisions fall within the categories of Section 102(b)(1) since the preparation and filing of a registration statement is an aspect of a “corporation’s management of its business and affairs and of its relationship with its stockholders,” and that “a bylaw that seeks to regulate the forum in which ‘such intra-corporate’ litigation can occur is a provision that addresses the ‘management of the business’ and ‘conduct of the affairs of the corporation.’”

The Delaware Supreme Court rejected the Chancery Court’s binary approach of internal versus external claims as well as its characterization of 1933 Act claims as external claims. Instead, the Court interjected a third category of claims into this analysis, “intra-corporate litigation,” which falls somewhere on the continuum between internal (affairs) claims and external claims. Building on this framework, the Court concluded that federal forum provisions are “intra-corporate” and, like internal claims, are within the statutory scope of Section 102(b)(1)—and, as such, are facially valid under Section 102(b)(1). Importantly, the Delaware Supreme Court also pointed out that federal forum provisions serve as a procedural mechanism and are not substantive, noting they “’regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation.’”

Putting aside that the forum provisions at issue appeared in a charter and not a bylaw, Salzberg leaves open several questions about just how far such provisions can go. As commentators have noted, the decision has opened the door to uncertainties, including issues relating to federalism, mandatory arbitration, and the interests of other states in seeing their law apply to companies that are headquartered in their state but incorporated in Delaware.2 Regarding the latter, in In re Dropbox Securities Litigation, the plaintiffs in a California state class action asserting Section 11 claims against a California company incorporated in Delaware are currently litigating a motion to dismiss based on a federal forum provision similar to those at issue in Salzberg.

Further, the use of forum provisions to preclude litigation of federal derivative claims is also in play. Cohen Milstein is currently challenging The Boeing Company Board of Directors’ use of a forum selection bylaw to strip stockholders of their substantive right to bring derivative claims under the Securities Exchange Act of 1934. Boeing’s bylaw requires all derivative cases to be litigated in Delaware Chancery Court, which lacks jurisdiction over 1934 Act claims. In addition to appealing the federal district court’s dismissal of the derivative case based on the forum selection bylaw, Cohen Milstein has filed a declaratory class action in Delaware Chancery Court challenging the validity and enforceability of the bylaw because it eliminates stockholders’ rights to assert exclusively federal claims in a derivative action. This may be just the start. Other attempts to push the boundaries of corporate charters and bylaws may follow as the battle over forum selection provisions designed to curtail the rights of stockholders continues.

  1. Importantly, under the 1933 Act, Congress provided for both federal and state court jurisdiction over investors’ claims and a statutory right of non-removal from state to federal court. See 15 U.S.C. §77v(a); see also Cyan, Inc v. Beaver Cnty. Emps. Ret. Fund, 138 S. Ct. 1061, 1078 (2018) (holding that SLUSA did not strip state courts of jurisdiction to adjudicate class actions alleging 1933 Act claims, nor could such cases be removed to federal court.)
  2. See “Del. Federal Forum Ruling Could Open Door To Mischief,” Law360 (March 19, 2020); “So the Salzberg v. Sciabacucchi Decision is In!,” Ann Lipton,… (March 21, 2020). See also Shareholder Advocate, Winter 2019, quoting James D. Cox, a Duke Law School professor “… the Constitution’s Supremacy Clause does not permit state law to eviscerate protections provided investors by the federal securities laws.”