The Delaware Court of Chancery, in Swipe Acquisition Corp. v. Krauss, No. 2019-0509-PAF, 2021 WL 282642 (Del. Ch. Jan. 28, 2021), recently declined to enforce a choice-of-law provision in a stock purchase agreement that designated Delaware law as the exclusive law, because the court held that California public policy prohibited a purported waiver of a contractual party’s right to assert a claim under the California Securities Act. The Court of Chancery’s decision in Swipe Acquisition demonstrates that Delaware courts will not enforce a choice-of-law provision if it would be contrary to a fundamental policy of the state whose law would apply but for the choice-of-law provision (here, California). Commercial parties and their advisors should carefully consider the potential that Delaware law, which is often selected as the exclusive law in connection with mergers and acquisitions, may not be enforced based on public policy concerns in light of the court’s reasoning in Swipe Acquisition.
The plaintiff, Swipe Acquisition Corporation (Swipe), is a Delaware corporation that was formed to acquire a North Carolina corporation headquartered in Nevada and owned by the defendants, specifically, PLI Holdings, Inc. (PLI). On May 30, 2018, Swipe and the defendants executed a stock purchase agreement (the SPA) under which Swipe acquired 100 percent of PLI. Under the SPA, the defendants agreed to provide indemnification for losses resulting from any breach of PLI’s or the defendants’ representations and warranties under the SPA. The SPA included a choice-of-law provision requiring the application of Delaware law to the SPA and any claims relating to the SPA:
This Agreement, and all claims or causes of action (whether in contract, tort or statute) that may be based upon, arise out of or relate to this Agreement, or the negotiation, execution or performance of this Agreement (including any claim or cause of action based upon, arising out of or related to any representation or warranty made in or in connection with this Agreement or as an inducement to enter into this Agreement), shall be governed by, and enforced in accordance with, the internal laws of the State of Delaware, including its statutes of limitations.
2021 WL 282642, at *3 (emphasis added). In May 2019, Swipe asserted that PLI and the defendants had breached their representations and warranties by concealing the loss of an important customer, and Swipe delivered a notice to the defendants of its claim for indemnification. However, the defendants denied Swipe’s indemnification claim.
On June 28, 2019, Swipe filed a complaint in the Delaware Court of Chancery asserting four causes of action: (1) breach of contract; (2) indemnification for breach of the representation and for fraud; (3) common law fraud; and (4) violation of the California Securities Act. The defendants moved to dismiss and argued, among other things, that the Delaware choice-of-law provision constituted a waiver of Swipe’s right to assert a claim under the California Securities Act. The court, in large part, denied the defendants’ motion as to counts 1, 2, and 3, and requested the parties to submit supplemental briefing regarding the defendants’ argument that Swipe could not permissibly rely on California law due to the SPA’s Delaware choice-of-law provision.
The court’s ruling
The Court of Chancery rejected the defendants’ argument based on the allegations in the complaint, and denied the defendants’ request to dismiss Swipe’s claim under the California Securities Act. The court explained that “[u]pholding freedom of contract is a fundamental policy of [Delaware]” and “Delaware law is ‘generally supportive of choice-of-law provisions.’” (quoting Ascension Ins. Holdings, LLC v. Underwood, 2015 WL 356002, at *4, *2 (Del. Ch. 2015). Citing 6 Del. C. § 2708, the court stated:
“Upholding freedom of contract is a fundamental policy of this state.” That contractual freedom also extends to selecting the law that governs the parties’ relationship, which is codified by statute [under 6 Del. C. § 2708]:
The parties to any contract, agreement or other undertaking...may agree in writing that the contract, agreement or other undertaking shall be governed by or construed under the laws of this State, without regard to principles of conflict of laws, or that the laws of this State shall govern, in whole or in part, any or all of their rights, remedies, liabilities, powers and duties....
6 Del. C. § 2708. “At its core, Section 2708 is intended to provide certainty to parties who are subject to jurisdiction in Delaware that their choice of Delaware law governing the construction and enforceability of their contracts will be respected.”
2015 WL 356002, at *4 (citation omitted). The court held that the Delaware choice-of-law provision in the SPA could “reasonably be construed to waive the right to assert any non-Delaware law claims relating to the SPA, which would include” a claim under the California Securities Act. Id. at *4–5. The court’s analysis favored the defendants’ argument for dismissal.
However, the Court of Chancery went on to explain that Delaware recognizes a “narrow exception” to the enforceability of choice-of-law provisions. Specifically, Delaware courts will refuse to enforce a choice-of-law provision if enforcement would be contrary to a fundamental policy of the state whose law would apply absent the choice-of-law provision. The court discussed application of Delaware choice-of-law clauses under circumstances that would constitute contracting around the public policy of another state, in which Delaware law may apply an exception to their enforceability under section 187(2)(b) of the Restatement (Second) of Conflict of Laws:
Sometimes…the state law that would apply in the absence of a choice-of-law provision enshrines a particularly strong public policy interest, to the point that the state has determined that “contract[ing] around that public policy would be an unwholesome exercise of freedom of contract.” Under those circumstances, Delaware law recognizes a narrow exception to the enforceability of choice-of-law provisions [under the Restatement (Second) of Conflict of Laws § 187].
A choice-of-law provision is unenforceable if its enforcement would be “contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which...would be the state of the applicable law in the absence of an effective choice of law by the parties.” ...Section 187(2)(b) of the Restatement (Second) of Conflict of Laws states: “The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless....(b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.”
2015 WL 356002, at *5. The Court of Chancery held that Swipe adequately pleaded a claim under the California Securities Act, and then proceeded to analyze whether waiver of the claim would be contrary to California’s public policy. The court explained that California law prohibits contractual waivers of the California Securities Act unless the party seeking to enforce the waiver can show that it will not diminish the plaintiff’s statutory rights under California law. The court explained that “the foreign forum [here, Delaware, must] provide the same or greater rights than California.” Accordingly, the court analyzed whether enforcing the choice-of-law provision would diminish Swipe’s California statutory rights.
The Court of Chancery rejected the defendants’ argument that Swipe’s statutory rights would not be diminished because, according to the defendants, the Delaware and California Securities Acts are substantively identical. The court held that, regardless of whether the Delaware and California Acts are substantively identical, the record demonstrated that Swipe could not assert a claim under the Delaware Securities Act because, under the facts alleged, there was not “a sufficient nexus” between Delaware and the merger transaction at issue to permit application of the Delaware Securities Act. Thus, the court concluded that, because none of Swipe’s other claims would provide rights that were the same as or greater than its California Securities Act claim, enforcing the choice-of-law provision in the SPA would be contrary to California’s public policy:
Defendants argue that, even if Plaintiff cannot advance a Delaware Securities Act claim, “California public policy would only be violated...where the plaintiff would be left without any remedy.” This same argument was rejected in [Rachel Verdugo v. Alliantgroup, LP, No. G049139, opinion (Cal. App. May 28, 2015)]:“[T]he question is whether enforcing the forum selection clause would diminish Verdugo’s unwaivable rights under the [California statute], not whether [the foreign state’s] law provides ‘adequate’ remedies.” Defendants’ argument also ignores that Plaintiff’s ability to prevail on its California Securities Act claim would require different elements of proof than Plaintiff’s indemnification, breach of contract, and common law fraud claims. Indeed, the purpose of the California Securities Act is to provide an avenue to obtain damages where reliance cannot be proved. Barring Plaintiff’s California Securities Act claim would thus impermissibly “diminish” Plaintiff's rights, especially in the event that it could prevail on its California Securities Act claim but cannot prevail on its common law fraud claim. Defendants’ argument is also illogical: it would render the rule articulated in Verdugo moot, because damages available under the California Securities Act would always be – at least in part – duplicative of damages available at common law, and so enforcement of a choice-of-law provision would never “diminish” a plaintiff's rights under California law. Therefore, I am not persuaded that precluding Plaintiff’s California Securities Act claim would not “diminish [Plaintiff’s] unwaivable statutory rights” under California law.
For the foregoing reasons, because California has a materially greater interest in the application of the California Securities Act than Delaware and because its law would apply to part of Plaintiff’s allegations of fraud, any waiver by Plaintiff of its right to assert a claim under the California Securities Act would be contrary to California’s public policies.
Swipe Acquisition, 2021 WL 282642, at 19–21 (citations and footnotes omitted).
- Swipe Acquisition is an example of Delaware law and Delaware courts balancing, on the one hand, Delaware’s strong policy in favor of parties’ freedom of contract and, on the other hand, promoting the public policies of other jurisdictions under non-Delaware law.
- Parties should be cognizant when including a Delaware choice-of-law provision that doing so will not bar securities law claims under non-Delaware law, unless the party seeking to enforce the choice-of-law provision can show that enforcement will not diminish the plaintiff’s statutory rights under the applicable non-Delaware law.
- Enforcement of a Delaware choice-of-law provision to preclude a claim under the California Securities Act would be contrary to California’s public policy if the plaintiff could not assert at least a substantively identical claim under the Delaware Securities Act (due to a lack of nexus with Delaware or otherwise), unless the plaintiff can pursue other claims that would provide rights that are the same as or greater than its California Securities Act claim.