Delaware court upholds validity of forum selection clauses in bylaws

Ruling empowers companies to reduce risk of shareholder lawsuits filed in multiple jurisdictions.

Winning the fight over where a suit is filed—state court versus federal court, one state’s courts versus another’s—can have a profound impact on how a case is adjudicated. As a result, contracts routinely have ‘forum selection’ clauses requiring that suits related to the contract are handled only in the preferred court.

But what about forum selection clauses in a corporation’s bylaws that purport to require that all lawsuits regarding a corporation’s ‘internal affairs’ be brought in Delaware?

Companies may want these clauses because of a rise in shareholder claims relating to internal affairs filed outside of Delaware, even though the companies involved are Delaware companies and the substantive law at issue is Delaware law. Indeed, multiple claims arising from essentially the same facts can be filed virtually simultaneously in multiple jurisdictions. This multi-jurisdictional litigation can be very expensive and duplicative.

Last year Corporate Secretary reported on a trend of companies responding to such litigation by including such exclusive forum provisions in bylaws and certificates of incorporation. At that time, the legality of including such clauses in bylaws was uncertain and was being litigated in cases brought against Chevron and FedEx. Now Delaware’s Court of Chancery has spoken: bylaw provisions requiring Delaware to be the exclusive forum for shareholder litigation are enforceable, even if unilaterally adopted by the board, so long as the company’s certificate of incorporation allows for unilateral adoption of bylaws.

Holding that a forum selection clause adopted by a board with authority to adopt bylaws is valid and enforceable under Delaware law to the same extent as other contractual forum selection clauses, the Court said it will enforce such bylaws following principles set down by the US Supreme Court in Bremen and adopted explicitly in Ingres Corp. v. CA, Inc.

Since the decision addressed only a challenge seeking to invalidate the forum selection bylaws as written and left room for plaintiffs to continue to challenge them on an ‘as applied’ basis, it doesn’t eliminate the risk of multi-jurisdictional litigation of covered claims arising from essentially the same facts. But it should empower companies to dramatically reduce such risk.

Given that Delaware courts are ‘corporation friendly,’ the benefits of the decision aren’t limited to curtailing multi-jurisdictional litigation, the law firm Cahill Gordon said in a client alert.

‘Because of the well-developed precedent in Delaware on many corporate law issues, the certainty of a Delaware venue for the resolution of disputes will likely increase the predictability of outcomes, [and] lead to further consistency in the law in these relevant areas,’ the alert said.

Although companies will appreciate all these benefits, they should note that forum selection clauses adopted in bylaws cannot apply to all possible claims, just those that relate to a company’s internal affairs. That means claims such as derivative suits and claims of breaches of fiduciary duty are covered, but not federal security law disclosure claims, tort claims, or general commercial litigation.

In its analysis of the bylaw’s legality, the Court found it significant that the Board could waive the forum selection clauses ‘in order to meet their obligation to use their power only for proper corporate purposes.’ Companies that don’t reserve the right to make exceptions might be more vulnerable to arguments against the enforcement of forum selection provisions, as the law firm Gibson Dunn noted in its client alert.

Nonetheless, it’s not a given that companies will overwhelmingly rush to adopt these provisions, particularly since signs of shareholder opposition abound. The AFL/CIO proxy voting guide recommends voting against all exclusive forum clauses, and proxy services ISS and Glass Lewis are skeptical of them. In 2011, the Council of Institutional Investors adopted a policy advising against adopting these provisions.

‘Companies should think twice about asking their shareowners to vote on exclusive forum provisions in bylaws,' warned Amy Borrus, the Council’s deputy director. ‘While a single forum may make the claims process more predictable, shareowners regard these provisions as a broad transfer of leverage from capital providers to the managers who work for them.’

Now that the bylaw approach has been validated by the Court, more companies are likely to seek to include these clauses, and the strength of shareholder opposition will become more clear. To date the opposition hasn’t been particularly strong: both Chevron and FedEx, the plaintiffs in the case the Court decided, handily won shareholder proposals seeking to repeal the forum selection bylaws.

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