The number of companies embracing such clauses in some form has doubled within a year.
In litigation, the first big strategic decision is where to sue. Different courts and states’ laws are perceived as leaning toward plaintiffs or defendants – indeed, the US Chamber of Commerce annually ranks the ‘lawsuit climate’ in every state. Delaware perennially tops the Chamber’s list, so people might expect the plaintiffs’ bar to shun the state. Despite being perceived as pro-management, however, for decades plaintiffs’ attorneys overwhelmingly filed shareholder lawsuits in Delaware. As a result, so many major cases were decided in Delaware that it became known as the ‘mother court for corporate law.’
Over the past 15 years or so, however, the plaintiffs’ bar has indeed turned its back on Delaware. Now multiple shareholder lawsuits against Delaware corporations alleging different claims from essentially the same facts are simultaneously being filed in multiple states and in federal courts – and sometimes Delaware courts are being bypassed entirely. That’s not to say Delaware is seeing fewer cases, just proportionately fewer, even as the overall case volume rises. This trend is generally expensive for corporations, who face increased litigation costs and risks.
Clause and effect
Now a new corporate defense-side strategy is emerging: Delaware forum selection clauses. These provisions, which can be added to bylaws by director action, added to charters through shareholder-approved amendments or built into charters at the time of going public or emerging from bankruptcy, dictate that virtually all corporate claims be filed in Delaware. The trend was first quantified by Claudia Allen, chair of the corporate governance practice group at Neal Gerber & Eisenberg. Allen recently updated her groundbreaking Study of Delaware forum selection in charters and bylaws and found that as of December 31, 2011, the number of firms embracing such clauses in any form had doubled to 195 from 82 in April 2011.
‘In my experience, boards and shareholders generally want predictability, an experienced judiciary and prompt resolution of disputes,’ Allen notes. As a result, Delaware forum selection clauses make sense because the highly regarded Court of Chancery ‘is often able to resolve disputes on an expedited basis due to its streamlined procedures and processes.’
Allen acknowledges that some see the clauses as anti-shareholder, including proxy advisory group Glass Lewis. Nonetheless, she notes, ‘shareholders are not a homogenous group, and can have disparate interests and investment objectives.’
Reflecting the concerns of at least some shareholders about the provisions, venerable Delaware law firm Prickett Jones & Elliott sued 12 large-cap companies whose boards added the provisions into their bylaws. The suits sought to have the provisions invalidated, enforcement of them blocked, and other relief. Ten of the companies repealed the challenged bylaws; Chevron and FedEx, however, chose to litigate and answered the complaints. As a result, Delaware courts will have the chance to rule on the enforceability of these bylaws.
At least two companies were trying to add Delaware forum selection clauses to their charters by majority shareholder vote at their annual meetings in early May. In April, Prickett Jones sued to enjoin those votes. How the companies respond to these suits will dictate whether and how Delaware courts assess these clauses in the charter amendment context. Currently, there are no lawsuits challenging the Delaware forum selection clauses adopted in a company’s charter documents at IPO.
Nancy Wojtas, a partner with Cooley Godward Kronish, notes that if the provisions are upheld, new issues will arise. ‘Will companies start selecting other states that are perceived as defendant-friendly, or conceivably plaintiff-friendly?’ she asks. ‘Nevada is perceived as fairly management-friendly; assuming jurisdiction exists, will companies start choosing Nevada courts?’
Given Delaware’s long-standing reputation for being management-friendly, the decades-long tradition of suing in the state seems surprising. But according to a 2011 University of Cambridge Faculty of Law research paper written by John Armour, Bernard Black and Brian Cheffins, titled Delaware’s balancing act, Delaware has also had an even stronger reputation for being litigation-friendly.
The report found that lawsuits were easy to file, and settlements and plaintiff firm fee requests were easy to get approved. The report argues, based on court filings and interviews with practitioners, that those factors have shifted and are likely driving the current situation. Perhaps most importantly, Delaware judges have become very critical of some commonly filed shareholder lawsuits, and are much less likely to blindly approve plaintiff firm fee requests, even when the defense side has agreed to them.
The authors cite cases in which Delaware judges slashed fees by as much as 75 percent.
Reinforcing this point, Allen says: ‘Forum selection clauses can be viewed as a threat to the business model of certain plaintiffs’ firms which prefer to file cases against Delaware companies outside Delaware because Delaware has a reputation of being tough on frivolous suits and carefully scrutinizing fee applications.’ R. J. Skaggs, of Delaware law firm Morris Nichols Arsht & Tunnell, puts it slightly differently: ‘What our courts have said is that they don’t want bad cases that reach quick settlements and seek high fees, which of course makes sense from any reasonable public policy perspective.’
But plaintiff firm economics aren’t the only driver of the trend to sue outside Delaware, according to the Cambridge report. Another factor is a federal law that reforms securities litigation. Because the law requires complaints to be detailed factually but limits discovery until after surviving a motion to dismiss, suits are much harder to bring. The consequences of this are apparently two-fold. First, many firms that used to file securities claims now file corporate cases, and these newcomers are not invested in the traditional pattern. Second, the report claims plaintiffs are filing ‘tagalong’ corporate claims in state court that facilitate speedy discovery – but it also asserts that Delaware’s rules don’t confer that advantage, so the federal law did not drive an uptick in Delaware lawsuits.
The Cambridge report makes yet another claim that recent news supports: despite companies’ protests that multi-jurisdiction litigation is too hard on them, they can use the competing cases to their advantage by playing plaintiffs off against each other. For example, the New York Times has reported that Bank of America (BofA) is facing litigation in both Delaware and New York over its acquisition of Merrill Lynch. After settlement talks failed with the Delaware plaintiffs, BofA cut a deal with the New York plaintiffs for $20 million. If the New York judge approves the deal, the Delaware case goes away too. However, the Delaware plaintiffs have objected to the deal, saying the $20 million is radically low given that BofA paid $150 million to the SEC for the same conduct, and the fact that BofA’s insurance would cover all of it. Indeed, the Delaware plaintiffs have done much more discovery than New York, according to the Times, and the case raises important issues of Delaware law. Despite the factors driving companies to consider exclusive forum selection clauses, cases like these suggest companies can exploit multiple jurisdiction litigation to their advantage as well.
A matter of law
Against this complex backdrop of strategic forum selection, Holly Gregory, a corporate partner with Weil Gotshal & Manges explains the rationale for exclusive Delaware forum clauses. ‘As a matter of law, in a lawsuit for breach of fiduciary duty against directors of a Delaware corporation, Delaware law must apply,’ she says. ‘And what better court to apply Delaware law than a Delaware court?
‘The say-on-pay litigation is a perfect example,’ she continues. ‘A breach of fiduciary duty claim based on a failed say-on-pay vote was brought against Cincinnati Bell in Ohio. That case was a state law claim brought in federal court under diversity jurisdiction applying Delaware law. Many commentators have noted that a Delaware court would likely have granted the motion to dismiss that the Ohio federal court denied. That’s important because once a motion to dismiss is rejected, the costs of litigation shoot up, changing the settlement dynamics.’
Gregory and Allen agree that shareholders and plaintiffs’ attorneys with good cases shouldn’t fear the Delaware courts. Allen notes that ‘in the Southern Peru Copper shareholder derivative litigation, the Court of Chancery entered a $1.3 billion judgment and awarded $285 million in attorneys’ fees. The Delaware courts will not ignore breaches of fiduciary duty.’
Skaggs disputes the pro-management culture. ‘It’s in the interest of Delaware to have a flexible and fair corporate system that protects fundamental shareholder rights,’ he says. ‘If you are too management-friendly, no one will want to invest in corporations governed by your law. If you are too shareholder-oriented, you will inhibit economically efficient innovation by management. If you become unbalanced in either direction, no one will want to use your system of corporate law and courts.’
Will the trend of adopting these clauses continue? Allen believes so, at least in the IPO context, though the answer will hinge on the outcomes of the pending Chevron and FedEx cases.
Circumstances of adoption of Delaware forum provisions
With other bylaw amendments 23.6%
Standalone bylaw amendments 8.2%
Reincorporating in Delaware 5.1%
Shareholder-approved charter provision 2.6%
Emerging from bankruptcy 2.6%
Note: Companies that fall within more than one category are included in each such category; thus, percentages total more than 100 percent.
Source: Study of Delaware forum selection in charters and bylaws by Claudia Allen, 2012.