Forum-Selection Bylaws Refracted Through an Agency Lens

The following post comes to us from Deborah A. DeMott, David F. Cavers Professor of Law at Duke University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Director-adopted bylaws that affect shareholders’ litigation rights have attracted both praise and controversy. Recent bylaws specify an exclusive judicial forum for litigation of corporate-governance claims, require that shareholder claims be arbitrated, and (most controversially) impose a one-way regime of fee shifting on shareholder litigants. To one degree or another, courts have legitimated each development, while commentators differ in their assessments. My paper, Forum-Selection Bylaws Refracted Through an Agency Lens, brings into clear focus issues so far blurred in the debate surrounding these types of bylaws.

Focusing on forum-selection bylaws (likely the least controversial development) and the Delaware context, I argue that beginning with the standpoint common-law agency reveals the attenuated and incoherent concept of consent underlying forum-selection bylaws when they are adopted unilaterally by directors once shareholders have invested in a firm. Of course, corporate law in the United States does not situate directors as shareholders’ agents, but an agency framework is illuminating. For starters, consent is a carefully articulated concept within agency law, as are various forms of knowledge and notice. Agency law also delineates with precision the consequences of an agency relationship, which are not identical to those stemming from contract law. However, many accounts of directors’ bylaw powers presuppose the applicability of contract-law analysis, which can sideline the fiduciary role occupied by directors within an ongoing governance relationship.

Additionally, my paper demonstrates that within contract law, forum-selection bylaws are problematic, even within the genre of contracts characterized as “boilerplate.” Legitimated by the Delaware Court of Chancery as a type of “flexible contract” through which shareholders consent, when they invest, to subsequent uses directors may make of bylaw power conferred on them by the corporation’s charter, forum-selection bylaws (and more aggressive uses of bylaw power) are singular even when considered against the boilerplate quality of many consumer contracts. Thus, the “flexible contract” is too weak to bear the weight assigned it. It may represent an instance of idealizing or generalizing “contract” as a mode of entity governance without assessing whether the characterization is plausible or will be optimal in application.

To be sure, as noted by the Court of Chancery and academic commentators, shareholders too have power to adopt, amend, or repeal bylaws, including those adopted by directors. But to exercise that power shareholders act subject to constraints, including legally-enabled limits on their power to call meetings or act by written consent. These constraints, too, could be rationalized as part of the “flexible contract” to which shareholders consent by investing, but this move leads one to wonder just how far the flexibility might go. Likewise, Delaware’s equitable precedents enable the court to assess a fiduciary’s use of power through after-the-fact review and thus are a basis on which shareholders may challenge directors’ adoption of a bylaw. Agency law, in contrast, draws cleaner lines that do not rely on after-the-fact review: if an agent purports to commit the principal to a transaction and lacked actual or apparent authority to do so, the principal need not persuade the court to inquire into the merits of the transaction. The resolution is categorical and much simpler: the principal is not bound by the transaction, for example, an agreement to arbitrate disputes for which the agent lacks actual or apparent authority to bind the principal.

Both practical as well as theoretical problems stem from the fact that nothing in the Delaware General Corporation Act (DGCL) itself or any other Delaware statute explicitly alerts investors to the downstream risk that limitations may subsequently be imposed—and with no shareholder vote—on their rights to sue in compliance with generally-applicable rules of civil procedure. In contrast, a person who agrees to become an officer or director of a Delaware corporation impliedly consents to the corporation’s registered agent as that person’s agent for service of process, implied consent grounded in an explicit statutory provision. And although the DGCL explicitly regulates provisions exculpating directors from monetary liability stemming from breaches of duty to the corporation, nothing in the DGCL regulates either the acceptable content of forum-choice bylaws or the process through which they may be adopted. The “flexible contract” view of forum-selection bylaws presupposes that shareholders (or their advisors) know or could know a fact—the bylaw—that did not exist when the shareholders invested. This skates close to the position of officers and directors before Delaware’s adoption of the consent statute noted above, once prompted by the Supreme Court’s rejection in Shaffer v. Heitner of Delaware’s sequestration procedure. Directors and officers were subject to “unknown risks of litigation,” in Justice Stevens’s assessment, based only on the fact of having bought stock on the open market. Additionally, through amendments the DGCL could introduce limits and requirements applicable to litigation-related bylaws as well as enabling them explicitly. Situated within a corporation statute, such limits and requirements, unlike contract-law doctrines, become integral to the state’s specification of the internal governance and affairs of any corporation created pursuant to the statute.

The full paper is available for download here.

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