Delaware Court of Chancery Upholds Forum Selection Bylaws

In recent years, hundreds of publicly-held corporations have adopted forum selection provisions in their charters or bylaws. These provisions can benefit corporations and their stockholders by reducing the cost and disruption of multiforum litigation (i.e., litigation brought by stockholders simultaneously in different forums that challenges the same corporate action) and addressing concerns with respect to forum shopping by plaintiffs.  In many cases, these provisions were approved by the corporation's stockholders, with such approval often occurring in advance of the corporation's initial public offering. For existing public companies, forum selection provisions have primarily been adopted in the form of a bylaw amendment approved by the board of directors without stockholder approval.

There has been uncertainty as to the enforceability of forum selection bylaws when unilaterally adopted by a board of directors. In February 2012, complaints were filed in the Delaware Court of Chancery against 12 Delaware corporations whose boards of directors had adopted forum selection bylaws without a stockholder vote. Ten of the 12 defendant corporations repealed these bylaw provisions following the filing of the complaints, with the cases against Chevron (a Delaware corporation headquartered in California) and FedEx (a Delaware corporation headquartered in Tennessee) thereafter being consolidated into one action for purposes of deciding the common legal issues.

The bylaw provisions of Chevron and FedEx provided for the following types of litigation to be brought exclusively in specified Delaware courts:

• derivative actions brought on behalf of the corporation;
• actions alleging a breach of fiduciary duties by directors or officers of the corporation;
• actions asserting claims pursuant to the Delaware General Corporation Law (DGCL); and
• actions implicating the internal affairs of the corporation (i.e., matters peculiar to the relationships among the corporation and its officers, directors and stockholders).

Both bylaw provisions allowed actions to be brought in an alternative forum with the corporation’s written consent.

The plaintiffs’ challenges regarding the forum selection bylaws included the following:

• such bylaws were statutorily invalid because they addressed subject matter that was beyond the authority granted under the DGCL;
• such bylaws were contractually invalid because they were adopted unilaterally by the Chevron and FedEx boards without stockholder approval; and
• the Chevron and FedEx boards breached their fiduciary duties in adopting the bylaws. 

The Court's opinion addressed the first two claims – i.e., the facial statutory and contractual validity and enforceability of the forum selection bylaws.

The Court's Decision

The Court concluded that the forum selection bylaws adopted by the Chevron and FedEx boards were statutorily valid under Delaware law. Section 109(b) of the DGCL provides that bylaws of a corporation “may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.”  Because the forum selection bylaws related to the “internal affairs” of the corporation and Delaware respects forum selection clauses generally, the Court found that the bylaws met the requirements of Section 109(b). The Court noted that the forum selection bylaws were process-oriented and not substantive because they regulated where stockholders may file suit and not whether they may file suit or the kind of remedies available to the stockholders.

The Court also concluded that the forum selection bylaws were contractually valid and enforceable.  The Court rejected the plaintiffs’ argument that the board-adopted bylaws could not be a contractual forum selection clause because the stockholders did not approve such provisions.  Section 109(a) of the DGCL allows a corporation, through its certificate of incorporation, to grant the directors the unilateral power to adopt and amend the bylaws.  Each of the Chevron and FedEx boards had the power to amend the corporation’s bylaws under its certificate of incorporation.  Thus, according to the Court, when investors purchased stock in these corporations, they assented to be bound by any board-adopted bylaws as “part of a binding broader contract among the directors, officers, and stockholders formed within the statutory framework of the DGCL.” 

The Court further noted that stockholders who object to forum selection bylaws have other means of recourse, including the right to amend or repeal the bylaws and the opportunity to elect directors on an annual basis.  Also, stockholders could request that the board waive the exclusive forum restriction in a specific instance.

In addition, although the Court declined to address hypothetical as-applied challenges posed by the plaintiffs, the Court noted that in a particular factual situation:

• as with other forum selection clauses, a plaintiff may argue that forum selection bylaws should not be respected under the reasonableness standard adopted by the U.S. Supreme Court in The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972); and
• as with bylaw provisions generally, a board’s use of its powers under a forum selection bylaw is subject to challenge as being for improper purposes inconsistent with the directors’ fiduciary duties under the principles adopted in Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971).

Considerations

This decision may prompt boards of directors of Delaware corporations to consider whether to adopt forum selection bylaws to the extent that they have the authority to do so under the corporation’s certificate of incorporation.  While it is likely that such provisions will become more prevalent as a result of this ruling, a board should note the following open questions before taking any action:

• The decision of the Court of Chancery will likely be appealed by the plaintiffs to the Delaware Supreme Court. 
• The decision related only to the facial validity of the forum selection bylaws on a statutory and contractual basis.  As a result, the application of a forum selection bylaw provision in a particular situation remains subject to challenge based on equitable principles or breach of fiduciary duty.
• It is uncertain whether non-Delaware courts will give effect to forum selection bylaws if a stockholder seeks to pursue a suit in a non-Delaware forum.  For instance, in Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011), a federal court in California found that a board-adopted bylaw provision providing for Delaware as the exclusive forum for litigation was not enforceable and therefore denied the motion to dismiss the lawsuit on grounds of improper venue.  It is unclear whether this case would have been decided differently after the recent Delaware Court of Chancery decision.  In addition, the court’s decision was influenced in some part by the fact that the bylaw provision at issue was adopted after the event giving rise to the litigation.
• The decision did not address whether Delaware corporations may select arbitration or other alternative dispute resolution methods for any disputes concerning the corporation’s internal affairs.  For instance, it is unclear whether Delaware courts will follow the lead of Maryland in Corvex Management LP v. CommonWealth REIT, No. 24-C-13-001111 (Md. Cir. Ct. May 8, 2013), in which the court applied contract law principles to determine that an arbitration bylaw was enforceable.  In doing so, the Maryland court found that (1) the plaintiffs had knowledge of the arbitration bylaw and assented to such provision through their stock purchases and (2) the arbitration agreement was not one-sided or illusory because the power of the CommonWealth trustees to amend the bylaws was derived from the company’s Declaration of Trust and Maryland law and not the bylaws themselves. 

Further, in considering whether to adopt forum selection bylaws, the board should review the corporation’s stockholder base and consult with the corporation’s investor relations team and proxy solicitation firm, as stockholders and proxy advisory firms may react negatively to such bylaws.  For instance, Institutional Shareholder Services (ISS) has indicated that it will review exclusive venue proposals on a case-by-case basis, taking into account:

• whether the corporation has been materially harmed by stockholder litigation outside of its jurisdiction of incorporation (based on disclosure in the corporation’s proxy statement); and
• whether the corporation 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 approved by stockholders).

Glass, Lewis & Co. generally opposes forum selection bylaws unless the corporation:

• provides a compelling argument as to why the provision would directly benefit stockholders;
• provides evidence of abuse of legal process in other, non-favored jurisdictions; and
• maintains a record of good corporate governance practices.

In addition, Glass Lewis may recommend a vote against the chair of the corporation’s governance committee if during the past year the board adopted a forum selection provision without stockholder approval.