Delaware Corporations Seek to Counter Forum Shopping

In response to concerns that the plaintiffs’ bar is rushing [1] to sue Delaware corporations “anywhere but Delaware,” to avoid the predictability and speed of Delaware courts and potentially to obtain larger settlements, 195 Delaware corporations (including Chevron, DIRECTV, Life Technologies and 24 other members of the S&P 500) have adopted or proposed adopting charter or bylaw provisions requiring that derivative actions, fiduciary duty claims and other intra-corporate disputes be litigated exclusively in the Delaware Court of Chancery. Among other things, these provisions seek to address the phenomenon of Delaware corporations facing parallel, competing litigation in Delaware and another state or in federal court, [2] often in connection with M & A activity. The January 2012 edition of my Study of Delaware Forum Selection in Charters and Bylaws analyzes these provisions and the trends they reveal.

The number of Delaware corporations that adopted or proposed adopting forum selection provisions in charters and bylaws more than doubled from 82 in April 2011 (when the prior edition of the Study was published) to 195 as of December 31, 2011. 96.9% of these provisions were proposed or adopted following Vice Chancellor Laster’s March 2010 suggestion in re Revlon Inc. Shareholders Litig.: “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.” [3]

The sheer increase in numbers does not, however, tell the whole story. The increase has occurred in an environment where questions linger as to the enforceability of forum selection provisions, particularly bylaws, and shareholder activists are beginning to express their opposition to exclusive forum clauses.

Charter vs. Bylaw. Whether a company adopts a charter provision or a bylaw provision remains closely tied to whether a company is going public or is already public. Over 95% of the 109 charter provisions analyzed were adopted or proposed in connection with initial public offerings (“IPOs”), spin-offs or reorganizations in bankruptcy, where shareholder approval is not required. Only a handful of public companies have put a charter amendment to a shareholder vote. Of the six charter amendment proposals included in proxy statements during the 2011 proxy season, five were approved and one failed. However, two of those proposals passed by narrow margins and two passed at companies with significant insider ownership. To date, one company has sought (and obtained) shareholder approval of a forum selection charter amendment in 2012—although it is too early in the proxy season to draw any conclusions. Including forum selection clauses in charters is attractive to corporations since shareholders do not have the unilateral ability to modify charter provisions, and a stronger case can be made for the enforceability of charter provisions than for bylaws unilaterally adopted by the board.

As a practical matter, established companies have generally continued to adopt bylaws. Yet, the extent to which non-Delaware courts will respect such bylaws remains unclear. This issue has continued to receive attention since January 2011, when the Federal District Court for the Northern District of California, in Galaviz v. Berg, refused to dismiss shareholder derivative claims against Oracle Corporation based upon an exclusive forum bylaw. The court based its decision upon federal common law. [4]

Of the provisions in the Study, 55.9% are in charters, up from 51.2% in April 2011. While charter provisions dominated when the Study was originally published in July 2010, the ups and downs in this relative percentage appear to be correlated with the overall health of the IPO market. Forum selection bylaws constitute 35.4% of the provisions in the Study, down from 43.9% in April 2011. It is difficult to determine the extent to which the Galaviz decision may have affected the decrease in the percentage of forum selection bylaws in this edition of the Study, compared to the April 2011 edition. However, the number of forum selection bylaws adopted in the month after the Galaviz decision spiked, and, viewed in absolute terms, 51 companies adopted exclusive forum bylaws in 2011, compared to 18 in 2010. In addition, 5.1% of the companies analyzed included provisions in the trust agreements of statutory trusts and 3.6% included provisions in both their charters and bylaws.

2012 Proxy Season. For the 2012 proxy season, Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis & Co. (“GL”) have taken positions on forum selection provisions. ISS has adopted a case-by-case policy with respect to forum selection proposals. This policy will take into account whether a company has adopted a number of shareholder-friendly governance practices and demonstrated material harm from litigating intra-corporate disputes outside Delaware. GL opposes forum selection provisions, having announced that it will not recommend in favor of such provisions and will recommend against governance committee chairs at companies that adopt a forum selection provision without shareholder approval or before going public. Additionally, the Council of Institutional Investors (“CII”) has announced its opposition to exclusive forum provisions.

In a recent development, at least four companies received non-binding shareholder proposals for the 2012 proxy season requesting repeal of board-adopted forum selection bylaws. The proponent appears to be testing the waters with these proposals, all of which were submitted to large-cap companies. It remains to be seen whether these proposals will ultimately appear in proxy statements, and if so, what support levels will look like.

Circumstances of Adoption. 52.8% of the provisions were adopted, or are in the process of being adopted, in connection with IPOs, 7.7% in connection with spin-offs or reorganizations, 5.1% in connection with reincorporating in Delaware, 2.6% following shareholder approval and 2.6% in connection with emerging from bankruptcy protection. AMN Healthcare Services, Inc. adopted an exclusive forum bylaw effective the day prior to entering into a merger agreement, while Curtiss-Wright Corporation adopted a forum selection bylaw shortly after losing its 2011 “Say on Pay” vote. That timing suggests both companies had concerns regarding strike suits being filed in jurisdictions other than Delaware. Reflecting the difficult capital markets, 7.8% of the IPO companies withdrew their registration statements. Apart from event-driven adoptions, at least 16 bylaws were adopted by boards of public companies on a stand-alone basis, while at least 46 were adopted concurrently with other bylaw amendments, often in connection with annual bylaw reviews. These two groups represent 8.2% and 23.6%, respectively, of the forum selection provisions in the Study.

Deemed Consent. 50.3% of the provisions state that those acquiring shares or any interest therein will be deemed to have notice of and to have consented to exclusive forum. Most commonly, deemed consent clauses were adopted (or are in the process of being adopted) in connection with IPOs and are in charters. However, they are increasingly common in bylaws. The deemed notice and consent clauses raise the question of why exclusive forum provisions, unlike other provisions in charters and bylaws, should merit such treatment.

Option to Select Alternative Forum. 64.1% of the provisions specify that the corporation may consent in writing to the selection of an alternative forum (“elective forum provisions”). The earliest forum selection provisions were mandatory, rather than elective. Mandatory provisions limit the ability of the company to proceed in an alternative forum where a suit has been filed, even if the board believes such an alternative might be advantageous, unless the forum selection clause is in the bylaws—and thus subject to amendment by the board. The plaintiffs’ bar might argue that elective provisions allow the board to do what shareholders are prevented from doing–forum shop.

Elective forum provisions first appeared in the charters of companies, including Financial Engines, Inc. and Primerica, Inc., beginning in March 2010. They began to appear in bylaws in September 2010, when Chevron Corporation adopted an elective forum selection bylaw. The percentage of companies adopting elective, rather than mandatory, forum clauses has steadily increased since April 2011 when the comparable percentage was 56.1%.

Principal Place of Business. 31.2% of the companies in the Study have their principal place of business in California, followed by 9.2% in Illinois, 7.7% in Texas, 6.2% in New York, 5.1% in each of Florida and Massachusetts and 4.6% in Colorado, seemingly reflecting concerns about the poor litigation climate in some of those states. For example, in 2010, a study ranking the lawsuit climate in each of the 50 states, conducted for the Institute for Legal Reform, an affiliate of the US Chamber of Commerce, ranked: California-46, Illinois-45 and Florida-42. [5] The companies in the Study have their headquarters in 35 states and three foreign jurisdictions.

Industries in Study. Based upon North American Industry Classification codes, 31.8% of the companies in the Study are in manufacturing, followed by 14.9% in finance and insurance, 9.7% in information, 7.7% in retail trade, 6.2% in professional, scientific and technical services, 4.6% in mining, 4.1% in real estate, rental and leasing and 3.6% in transportation and warehousing. Of the 61 California-based companies in the Study, 39.3% fall within the manufacturing category.

Sponsors. Of the IPO companies in the Study, at least 73.8% had private equity and/or venture capital backing. This statistic suggests that private equity and venture capital firms are concerned about the costs and liability issues associated with litigating Delaware law issues outside Delaware, and thus find value in forum selection provisions. In that regard, it is not surprising that KKR & Co., L.P. included a forum selection provision in its limited partnership agreement. The Carlyle Group, L.P. originally planned to include such a clause in its limited partnership agreement, but its latest IPO filings provide for mandatory arbitration.

What Lies Ahead. In view of the steadily increasing number of forum selection provisions in charters and bylaws and the unsettled state of the law, it seems likely that additional plaintiffs will challenge the enforceability of such provisions (particularly if they are included in bylaws), and practitioners will continue to refine the prevailing model in response to case law. With a view toward proactively addressing potential grounds for challenges and securing shareholder approval, as appropriate, companies should:

• Consider whether obtaining shareholder approval of a charter amendment is a realistic possibility since a charter provision is more likely to withstand a challenge than a bylaw;
  • If so, provide a compelling rationale for the provision that, as applicable, addresses how the company’s prior experience litigating Delaware issues in non-Delaware courts or in multiple jurisdictions harmed the company. Additionally, discuss the governance practices (such as a declassified board, majority vote standard in director elections and absence of a non-shareholder approved poison pill) demonstrating the board’s stewardship of the company. Such disclosures address the criteria in ISS’ policy, and help shareholders understand why the board believes a forum selection provision is in their best interests.
  • Analyze the company’s shareholder base to determine what percentage of shareholders will follow or take into account ISS or GL voting recommendations, and determine whether any of the company’s institutional shareholders have adopted their own policies on forum selection provisions;
  • Be prepared for the additional solicitation efforts that may be necessary to educate investors and secure approval;
• Consider an elective (rather than mandatory) forum provision, in order to maximize the board’s flexibility, recognizing, however, that the plaintiffs’ bar might argue that these provisions are not equitable;
• Consider the timing of adoption in relation to other events at the company that could result in potential litigation. If possible, provisions should be adopted at a time (for example, in connection with an annual governance review) when adoption cannot be characterized as a response to alleged corporate wrongdoing;
• Provide appropriate disclosure in SEC filings, including, as appropriate, in risk factors, so that shareholders are on notice of the forum selection provision and the associated limitation on their right to sue in other jurisdictions; and
• Recognize the real-world possibility that, although the company believes litigating in the Court of Chancery is in the best interests of the company and its shareholders, state courts in other jurisdictions or federal courts may not be willing to defer to the Court of Chancery.

There does not appear to be a material downside to adopting a forum selection clause, apart from questions relating to enforceability, investor perception and, as discussed above, GL’s voting policies on governance committee chairs. The potential upside is significant.

While Delaware corporations generally view forum selection provisions as a mechanism to reduce the costs of frivolous litigation and the cost and uncertainty of litigating Delaware law issues outside Delaware, those who oppose the provisions argue that exclusive forum clauses infringe upon shareholders’ rights. Both sides in the debate argue that they are acting in the best interests of all shareholders. In terms of governance trends, the adoption of forum selection provisions in charters and bylaws appears to be one of the few originating with companies, rather than shareholder activists.

The full Study, which includes graphs illustrating key findings and a table of companies analyzed, is available at here.

Endnotes

[1] Generally, courts will give first-filed complaints preference in determining the forum, absent overriding considerations or near contemporaneous filing. See McWane Cast Iron Pipe Corp. v. McDowell-Wellman Eng’g Co., 263 A.2d 281 (Del. 1970); In re Topps Co. Shareholders Litig., 924 A.2d 951, 957 (Del. Ch. 2007).
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[2] For example, a state law claim could potentially be filed in federal court on the basis of diversity jurisdiction. In addition, a plaintiff may bring a pendent state law claim for breach of fiduciary duty in connection with a federal securities law claim. The degree to which other courts (often in a corporation’s headquarters state, where the court has personal jurisdiction over the corporation) will be willing to respect a Delaware forum clause remains unpredictable.
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[3] 990 A.2d 940 (Del. Ch. Mar. 16, 2010) [hereinafter, “Revlon”]. While Vice Chancellor Laster discussed forum selection provisions in charters, but not bylaws, his discussion in Revlon nonetheless cited the forum selection clause contained in the bylaws of Oracle Corporation.
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[4] No. C 10-3392, 2011 WL 135215 (N.D. Cal. Jan. 3, 2011)[hereinafter “Galaviz”].
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[5] Harris Interactive, Inc., Ranking the States: Lawsuit Climate 2010, (U.S. Chamber Institute for Legal Reform) (available at http://www.uschamber.com/reports/ranking-states-lawsuit-climate-2010).
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