Limiting Litigation Through Corporate Governance Documents

There has recently been a surge of interest in “privately ordered” solutions to the problem of frivolous stockholder litigation, in the form of corporate bylaw and charter provisions that limit plaintiffs’ ability to bring claims. The most popular type of provision has been the forum selection clause; other proposed limitations include arbitration requirements, fee-shifting to require that losing plaintiffs pay defendants’ attorneys’ fees, and minimum stake requirements. Proponents argue that these provisions favor shareholders by sparing the corporation the expense of defending against meritless litigation. Drawing on the metaphor of corporation as contract, they argue that litigation limits are common in ordinary commercial contracts, and that bylaws and charter provisions should be interpreted similarly.

I have drafted a chapter for the forthcoming Research Handbook on Representative Stockholder Litigation (Sean Griffith et al., eds) in which I discuss the history of these provisions, the state of the law regarding their enforceability, and policy concerns surrounding their adoption.

Proposals for privately ordered litigation limits have evolved over time. Originally, they concerned arbitration of state law fiduciary claims; eventually, they were expanded to cover federal securities claims; later still, forum selection came into vogue. At first, it was assumed any such provisions would be subject to stockholder approval or added to the charter prior to an initial public offering, but in Boilermakers Local 154 Retirement Fund v. Chevron Corporation, 73 A.3d 934 (Del. Ch. 2013), then-Chancellor Strine held that directors, acting unilaterally, may add forum selection provisions to corporate bylaws. Shortly thereafter, in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 ( 2014), the Delaware Supreme Court reached a similar conclusion with respect to a fee-shifting bylaw that required plaintiffs who did not “substantially” succeed on their claims to reimburse defendants for their attorneys’ fees and expenses.

These decisions contained certain important limitations. First, although Chancellor Strine in Boilermakers described bylaws as part of a contract between stockholders and managers, he conceded that stockholders do not consent to bylaws that are unilaterally imposed; instead, he held that stockholders consent to the overall corporate framework, which includes the power of management to alter the bylaws.

Second, both ATP and Boilermakers recognized that management power to act within the corporate framework is subject to fiduciary duties. Therefore, any litigation limitation must be evaluated for consistency with those obligations.

Third, both decisions suggested that litigation limits could only extend to claims governed by the internal affairs doctrine (an odd move, in the case of ATP, for the dispute arose in the context of federal antitrust litigation). Boilermakers explicitly held that anything else would not regulate stockholders in their capacity as stockholders, and therefore would fall outside the scope of management’s authority.

After that, corporations flocked to adopt forum selection and fee-shifting bylaws, as well as more creative limitations, while commenters advocated for their use for securities claims as well as state-law governance litigation. finally called a halt to at least some of the experimentation by amending its corporation law to prohibit fee shifting entirely, and to prohibit any provision that would bar access to courts—thus preventing corporations from either requiring arbitration, or exclusively selecting a non-Delaware forum. However, the amendments only addressed “internal corporate claims,” leading to speculation that they did not extend to other types of claims.

A number of doctrinal and policy questions continue to be raised by such provisions.

First, we must ask whether litigation limits are subject to the internal affairs doctrine. The Boilermakers court believed they are, so long as they concern internal affairs claims. This conclusion is not without its weaknesses; litigation limits concern the civil procedural rules that are used to maintain an action, not the substance of the claim itself, which is what has been traditionally understood to be the scope of the internal affairs doctrine. Moreover, in ordinary contracts, the enforceability of forum selection clauses is first tested notby reference to the law that governs the contract as a whole, but by reference to the law of the court in which the claim is brought. This is the opposite of how the internal affairs doctrine operates.

That said, even if Boilermakers is correct, we must further inquire whether litigation limits can extend to non-internal affairs claims, like federal securities litigation. Boilermakers and ATP suggest they cannot, for good reason: federal securities law, like other kinds of external regulation, rests on a particular set of federal policies and priorities. By contrast, states—not the federal government—set the ground rules regarding what powers directors may exercise to limit litigation. State officials are not positioned to make the proper policy determinations when the matter involves a regulatory scheme that originates from another jurisdiction.

Next, we must ask whether litigation limitations are an appropriate subject for private ordering at all. Management is inherently conflicted in adopting and enforcing litigation limits—and is certainly acting from a position of informational advantage—creating a high risk of abuse. Forum selection bylaws, for example, may be used to encourage “reverse auctions” amongst plaintiffs’ counsel; directors can choose to adopt them—or not—on the eve of anticipated litigation, and then can selectively enforce them to pick their preferred plaintiff. Arbitration and fee shifting raise even larger concerns, because they make it easy for managers to tilt the playing field against plaintiffs with legitimate claims.

The standard rejoinder is that shareholders may vote out directors who adopt litigation limits of which they disapprove, or enact their own counter-bylaws. Moreover, if shareholders discount the stock prices of companies that adopt disfavored limits on litigation, investors will be compensated for the risk, and can subject the errant directors to the market for corporate control.

Yet the question remains whether shareholders can determine how litigation limits should be priced. Leaving aside the problem that not all stock trades in an efficient market, it may not be possible to predict how these provisions affect future managerial behavior.

Which leads to the final question, namely, whether stockholder litigation should be treated as public or private law. Fiduciary duties are a form of regulation of corporate managers, intended to encourage investment. Securities regulation is intended to facilitate the development of capital markets. If litigation limits weaken enforcement of these laws, the public benefits are weakened as well.

Commenters have argued that, at the very least, litigation limits may require a higher form of stockholder consent than merely their consent to the corporate form. But there remains the more fundamental objection that stockholder litigation serves a public purpose. If so, there may not be a privately ordered solution that accounts for the positive externalities that litigation generates. Thus, if nuisance litigation continues to be a problem after the PSLRA and Rule 23.1 and the business judgment rule and In re Trulia Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016) and exculpation provisions and Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (2015), the solution may lie in the reconsideration of the entire system of private enforcement of corporate law, and perhaps the substitution of a more robust government enforcement regime.

The full chapter can be downloaded here.