Forum-Selection Provisions in Corporate “Contracts”

Helen Hershkoff is the Herbert M. and Svetlana Wachtell Professor of Constitutional Law and Civil Liberties at the New York University School of Law. Marcel Kahan is the George T. Lowy Professor of Law at the New York University School of Law. This post is based on a recent paper by Professor Hershkoff and Professor Kahan.

In our paper, we consider the emergent practice of including clauses in corporate certificates of incorporation or bylaws that specify an exclusive judicial forum for lawsuits. So far, state and lower federal courts that have considered whether such clauses are valid or enforceable have applied a contractual approach that mimics judicial treatment of forum-terms in ordinary contracts.

It is old news that parties to a contract are allowed to do things that the state cannot. The U.S. Supreme Court has upheld the validity of contractual forum-selection terms on the view that it is efficient and fair to let the parties decide to choose where and how to litigate. Under the corporation-as-contract conception, permitting a corporate charter or bylaw—the constitutive documents of a corporation—to specify where shareholders can sue the company would seem the logical next doctrinal step.

We say: not so fast. Treating corporate charter and bylaw forum-terms as a matter of ordinary contract doctrine is neither logical nor justified. While there is a family resemblance, a corporation’s charter and bylaws are no ordinary contracts. Rather, they are hybrid legal structures that provide a mechanism for collective choice in the context of substantial state regulation and straddle the public-private divide in ways that make them quite dissimilar from ordinary contracts.

Indeed, their unusual features make applying a contractual paradigm to corporate forum-terms vulnerable to two significant challenges. First, charters and bylaws involve a type of consent that often is only distantly related to contract principles. Even academic proponents of the corporation-as-contract model admit that terms added after a company has issued its stock are contractually suspect. These so-called “mid-stream” amendments do not bear a hallmark of consent equivalent to ordinary contracts.

Second, charters and bylaws involve the state in ways that are at odds with private-ordering principles. To be sure, state judicial decisions routinely call the state a party to the corporate “contract” of a domestic corporation. But the state reserves rights that typically are not a part of an ordinary contract—above all, the unilateral right to enact laws that retroactively modify or render invalid aspects of the corporate-governance structure.

States, however, operate under legal constraints that do not apply to private actors. These constraints are particularly pronounced in the context of laws that restrict access to the courts or disfavor the interests of other states. Thus, the Constitution generally does not permit a state to adopt a “forum-selection” statute that eliminates a party’s right to sue in the courts of a sister state or in federal court. Should the notionally private corporate “contract” be subject to these constraints imposed on the state because the state is considered to be a party to the contract? Conversely, should the intermediary of the “corporate contract” permit the state to achieve indirectly goals that it could not achieve directly because of constitutional limits on state government power?

These questions have current importance. Several states, including Delaware, recently amended their laws to authorize companies to designate the courts of the state of incorporation as exclusive fora for corporate litigation via a charter or bylaw provision. Corporations, in increasing numbers, have adopted such provisions. The propriety of such terms goes to core matters of judicial federalism and corporate governance.

Moreover, even if corporate forum-terms can be justified, corporations have started to use the contractual paradigm to adopt provisions that have farther reaching effects on jurisdictional doctrine. In particular, corporations have begun to adopt bylaw provisions that postulate that a shareholder who bought stock after the term was added shall be “deemed” to have “consented” to personal jurisdiction in the selected-forum court to enforce the forum-selection term if that shareholder were to file an action in a different court. A state could not mandate such a result, but it is a result that very quickly could become entrenched through the reflexive—and, in our view, inappropriate—application of the contractual approach.

Although the contractual paradigm is not a sufficient basis for the blanket enforcement of corporate forum-terms, enforcement may often be desirable. Arguably, the emergence of corporate forum-terms is attributable to a strategy to curb abuses in representative litigation, with the Delaware judiciary as chief designer of that strategy. Delaware judges recently have announced a crackdown on settlements in merger-related corporate disputes that provide for minimal recovery to shareholders, high fees to plaintiffs’ attorneys, and broad releases of claims. These settlements are doubly problematic as they both induce plaintiffs’ attorneys to bring low-merit “strike” suits and, by releasing occasional meritorious claims without investigation, undermine incentives to comply with the law. Centralizing representative merger-related litigation involving Delaware corporations in Delaware—as is achieved through corporate forum-terms—may be necessary to assure that Delaware’s strategy is not undermined by other courts. The benefits from this strategy may be lost if party consent is the sole touchstone for the enforceability of corporate forum-terms turns.

We argue that the type of consent provided, the state’s role in corporate law, principles of federalism, and the implications of a forum-term for the efficiency of litigation and the ability to vindicate private rights should all bear on the enforceability of these provisions. Because the relevant plaintiffs have provided no meaningful consent, corporate forum-terms that purport to encompass claims by non-shareholders that are not derivative should not be enforced. Likewise, forum-terms that divest federal courts of diversity jurisdiction should only be enforced against shareholders who affirmatively consented to the term (such as by voting in favor).

In other situations, courts should consider, before enforcing a corporate forum-term, whether adjudicating the entire dispute in the designated forum would be efficient (e.g., whether the court has subject matter jurisdiction over all claims) or fair (e.g., whether the procedural rules, including the limitations period, of the designated forum are substantially more advantageous to the defendants than those of the state that supplies the substantive law). One implication of this approach is that forum-terms that select the courts of the state of incorporation for “internal affairs” disputes should generally be enforceable, but that forum-terms that select an alternate forum should receive greater scrutiny. Similarly, in the context of representative suits, the limited form of “consent” by class members to these suits and the benefits of avoiding the pathologies of multi-forum litigation militate in favor of enforceability of forum-terms. By the same token, however, any decision by the corporation to waive a forum-term in a representative suit needs to receive careful judicial scrutiny.

Moving beyond adjudicative practice, we also assess the likely impact of corporate forum-terms upon interstate competition for incorporation and for corporate litigation. As the quality of the Delaware courts is generally seen as a significant factor in inducing corporations to incorporate in Delaware, permitting Delaware companies to select a forum-term choosing its courts will increase Delaware’s competitive edge in the market for incorporations. But requiring that a lawsuit be filed in a certain jurisdiction also benefits the bar in that jurisdiction. To the extent that the statutes adopted in some of the several states, permitting only the designation of that state’s courts as exclusive fora, but barring companies from selecting another state’s courts, were meant to promote the self-interest of the local bar, the Commerce Clause may provide grounds for sister states to refuse to enforce the forum-terms.

The complete paper is available for download here.

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