An increasingly popular trend in recent years has been the adoption by Delaware public companies of an exclusive forum provision in their bylaws. An exclusive forum provision generally provides for the Delaware Court of Chancery to be the exclusive forum for certain disputes (including derivative actions, breach of fiduciary duty claims, claims arising pursuant to the company’s charter or bylaws and other shareholder litigation) against the company — and prohibiting such suits in other jurisdictions. Expected benefits cited by companies of adopting exclusive forum bylaw provisions include decreased litigation costs, avoiding parallel litigation in multiple jurisdictions and the predictability of Delaware courts.
However, in adopting an exclusive forum bylaw provision, a company faces uncertainty as to whether such provision will ultimately be enforceable, in addition to other possible negative consequences. Until recently, many companies have found that the potential benefits outweigh the uncertainty and risks involved and have adopted these provisions. However, companies currently contemplating this decision will now have to consider that several companies have recently found their exclusive forum bylaw provisions challenged in Delaware courts.
This article will discuss recent developments concerning exclusive forum bylaw provisions and highlight some of the factors a company should consider before deciding to adopt such a provision.
What are Exclusive Forum Provisions?
A typical exclusive forum bylaw provision might state: “With respect to any action arising out of any act or omission occurring after the adoption of this by-law, unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of the Corporation to the Corporation or the Corporation’s shareholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, the Corporation’s Certificate of Incorporation or these By-Laws, or (iv) any action asserting a claim governed by the internal affairs doctrine, in each case subject to the Court of Chancery of the State of Delaware having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise acquiring any interest in shares of capital stock of the Corporation shall be deemed to have notice of and consented to the provisions of this Article.”
Some of the reasons why companies have adopted exclusive forum provisions include:
- such provisions address the increased trend of shareholder litigation being brought outside of Delaware and the increased prevalence of duplicative litigation in multiple jurisdictions, which is costly, inefficient and creates a risk of inconsistent outcomes;
- such provisions can help provide greater certainty with respect to the outcome of disputes as Delaware courts have substantial expertise in matters of corporate law and a well-developed body of caselaw; and
- litigation in Delaware courts is generally viewed as having more efficient and expedited administration of cases than in other forums.
However, a company must also consider the negative effects that could potentially accompany adopting such a in its bylaws. As more fully discussed below, possible negative consequences a company might face include enforceability concerns, negative shareholder reactions (such as the recent rash of shareholder lawsuits challenging such provisions) and possible negative vote recommendations from proxy advisory firms.
Are Exclusive Forum Provisions Enforceable?
There has long been uncertainty surrounding the enforceability of exclusive forum bylaw provisions. The enforceability of exclusive forum provisions contained in a company’s charter was bolstered by In re Revlon, Inc. Shareholders Litigation, 990 A.2d 940 (Del. Ch. 2010), a case decided by the Delaware Court of Chancery. In Revlon, the court noted in dicta that “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.” The court suggested that an exclusive forum provision may be valid under general principles of contract law and analogized to cases where similar exclusive forum provisions in contracts were held enforceable.
However, issues of enforceability are heightened when the exclusive forum provision has been adopted by a company’s board of directors without shareholder approval. Under Delaware law, unlike a charter amendment, which requires shareholder consent, amendments to a company’s bylaws may be adopted unilaterally by a company’s board of directors. It may be difficult to put forward the argument suggested by the court in Revlon that the shareholders and the company have entered into a contract with respect to an exclusive forum provision through a company’s bylaws where such provision has been adopted solely through board action (as opposed to forum selection clauses in contracts that are generally enforceable because all parties consent at the time of its execution).
Another consideration is whether jurisdictions outside of Delaware will give effect to exclusive forum provisions providing for all shareholder litigation to take place in Delaware. This issue has recently been tested in the California district courts. In Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011), a case decided by the U.S. District Court for the Northern District of California, the court held that an exclusive forum selection bylaw was not enforceable under federal law. The court indicated that the argument that the provision was valid would have been stronger had the provision been approved by the company’s shareholders. One fact that may help to distinguish this case, however, is that the defendant directors had adopted the bylaw provision after the alleged wrongdoing took place. Until additional caselaw develops, it is unclear how courts in other states will interpret exclusive forum selection provisions with similar or a different set of facts.
Recent Delaware Litigation
In February 2012, complaints were filed in the Delaware Court of Chancery against twelve companies that had recently adopted exclusive forum bylaw provisions, including Chevron Corporation, FedEx Corporation, Curtiss-Wright Corporation, SPX Corporation, and Air Products and Chemicals Inc. The complaints challenged, among other things, the validity, applicability and enforceability of the exclusive forum bylaw provisions and sought a declaration from the court that such provisions are invalid.
Each of the complaints was filed by the same two law firms and contained substantially similar arguments, including:
- the exclusive forum bylaw provision is overreaching as, under the provision, disputes must be brought in the Delaware Court of Chancery regardless of whether such court has personal jurisdiction over the defendants or subject matter jurisdiction of the claims1;
- the exclusive forum bylaw provision is not a valid and binding forum selection clause under general contract law since there was no mutual consent by the shareholders; and
- the exclusive forum bylaw provision is invalid as it conflicts with federal law and encroaches on federal jurisdiction, such as the Securities Litigation Uniform Standards Act of 1998, which designates the federal courts as the exclusive venue for nearly all private securities class actions.
The litigation potentially presents an opportunity for Delaware courts to finally provide definitive guidance as to the enforceability of exclusive forum bylaw provisions (at least in Delaware). However, we may not ultimately see how the Delaware courts will interpret these provisions in these cases as, within a short period after the complaints were filed, ten of the twelve companies subject to suit amended their bylaws to remove the exclusive forum provision in its entirety. Of the remaining companies, Chevron Corporation amended its bylaws to modify the exclusive forum provision to address some of the arguments raised in the complaint. In the amendment to its exclusive forum provision, Chevron, among other things, provided that the forum for litigation includes any state or federal court located within the State of Delaware (and not just the Delaware Court of Chancery), which Chevron believes should “ensure the effectiveness of the by-law in light of the Court of Chancery’s jurisdictional limitations.” It does not appear that the amendments to the exclusive forum provision were enough to obtain a dismissal, as the lawsuit against Chevron is proceeding. Only FedEx Corporation did not make any subsequent amendments to its bylaws (as of the date of this article). As the remaining lawsuits are still in the early stages, it is still possible that one or both of the companies may amend (or further amend) their bylaws or that the lawsuits will not progress to a court decision.
Even if the Delaware courts do not ultimately decide the issue at this time, the complaints and the responses of the defendant companies nevertheless provide helpful guidance to companies that are considering adopting exclusive forum bylaw provisions. In each of the twelve cases, the bylaws had been amended to include the exclusive forum provision upon a vote by the board of directors without shareholder approval. Thus, for companies that have obtained shareholder approval of their exclusive forum provision, there is reason to believe that such provision is less likely to be challenged in court. In addition, the fact that so many of the companies quickly yielded from the challenge to their exclusive forum bylaw provisions by eliminating the provisions may provide an indication of the level of confidence those companies had in the validity of the provisions as adopted.
Proxy Advisory Firms
An additional factor that companies should consider in deciding whether to adopt or to put to a vote of its shareholders the adoption of an exclusive forum provision is the risk of receiving negative vote recommendations from proxy advisory firms. In its 2012 U.S. Proxy Voting Guidelines, ISS indicated that it will recommend votes on exclusive venue proposals on a case-by-case basis, “taking into account whether the company has been materially harmed by shareholder litigation outside its jurisdiction of incorporation, based on disclosure in the company’s proxy statement; and whether the company has the following good governance features: (1) an annually elected board; (2) a majority vote standard in uncontested director elections; and (3) the absence of a poison pill, unless the pill was approved by shareholders.” Thus, a company that has not adopted these governance practices will risk a negative vote recommendation from ISS.
In its 2012 Proxy Season U.S. Proxy Paper Policy Guidelines, Glass Lewis states that “any charter or bylaw provision limiting a shareholder’s choice of legal venue is not in the best interests of shareholders.” The guidelines note that such provisions may increase the costs of and effectively discourage shareholder derivative claims and that Glass Lewis will recommend a negative vote against any charter or bylaw amendment that seeks to adopt an exclusive forum provision. In addition, where an exclusive forum provision is adopted by the board without shareholder approval or pursuant to a bundled bylaw amendment rather than as a separate proposal, Glass Lewis has indicated that it will recommend a vote against the election of the chairman of the governance committee.
Finally, in the Corporate Governance Policies issued by the Council of Institutional Investors in December 2011, the council recommended that “U.S. companies should not attempt to restrict the venue for shareowner claims by adopting charter or bylaw provisions that seek to establish an exclusive forum.” It is thus clear at this point that the proxy advisory firms do not consider exclusive forum provisions to be “best practices” for what they consider to be good corporate governance.
Until further guidance is provided by the courts, a company will need to decide whether the benefits of an exclusive forum bylaw provision outweigh the uncertainty and potential negative consequences outlined above. Further, if a company decides to proceed, the company will also need to consider whether to seek to obtain shareholder approval of the provision, rather than adopting the provision solely by board action.