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August 19, 2014
Board-Adopted Forum Selection Bylaws Upheld by Delaware Court of Chancery
In an important opinion issued on June 25, 2013, the Delaware Court of Chancery rejected plaintiffs’ claims that forum selection bylaws which were unilaterally adopted without stockholder approval by the boards of directors of two Delaware corporations were statutorily and contractually invalid.1 Chancellor Leo E. Strine, Jr. stated that “a forum selection clause adopted by a board with the authority to adopt bylaws is valid and enforceable under Delaware law to the same extent as other contractual forum selection clauses.”
Forum selection bylaws adopted by Delaware corporations generally designate the Delaware Court of Chancery as the exclusive venue for stockholder litigation involving internal affairs and are intended to limit duplicative, costly litigation in multiple jurisdictions related to a single transaction or decision, such as suits alleging breaches of fiduciary duties, derivative suits, claims arising under the General Corporation Law of the State of Delaware (DGCL), and other internal affairs claims brought by stockholders. They are not intended to apply to lawsuits unrelated to internal corporate governance matters, such as suits alleging violations of federal securities laws or tort suits. Notably, in the last three years, over 250 publicly traded corporations have adopted forum selection provisions.
Although the decision is subject to appeal to the Delaware Supreme Court, which will have the final say, boards of Delaware corporations may want to consider whether to adopt a forum selection bylaw to attempt to minimize the risk and costs associated with simultaneous multiforum litigation. To do so without stockholder approval, a board must be authorized in the certificate of incorporation to unilaterally adopt or amend the corporation’s bylaws. When considering whether to unilaterally adopt a forum selection bylaw, boards should be aware that adoption may result in stockholder proposals to repeal the bylaw. Moreover, boards should consider, among other things, the latest positions of the proxy advisory firms, such as ISS and Glass Lewis, and the voting guidelines of the corporation’s institutional investors on unilaterally adopted forum selection bylaws to understand how such bylaws could impact the voting recommendations of the advisory firms and the voting of the institutional investors.
Statutory validity. DGCL section 109(b) provides that a corporation’s bylaws “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.” Chancellor Strine noted that the forum selection bylaws “easily meet” section 109(b)’s requirements “because they regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation.” In reaching his decision, Chancellor Strine emphasized the safeguards associated with the forum selection bylaws in question. Specifically, that the bylaws reserved the right to waive enforcement of the bylaw in a particular circumstance to satisfy the board’s obligation to use their power only for proper corporate purposes.2Chancellor Strine also stressed that, pursuant to the DGCL, stockholders have the power to unilaterally amend or repeal any board-adopted bylaws.
Contractual validity. Chancellor Strine rejected the plaintiffs’ claim that the bylaws were contractually invalid because they were unilaterally adopted by the boards without stockholder approval. As DGCL section 109(a) provides that certificates of incorporation may grant the power to boards to unilaterally adopt or amend bylaws, and the defendant Delaware corporations had granted to their boards in their respective certificates of incorporation the power to adopt and amend the bylaws unilaterally without a stockholder vote, Chancellor Strine found that the board-adopted forum selection bylaws were contractually valid under Delaware law. Chancellor Strine reasoned that “stockholders who invest in such corporations assent to be bound by board-adopted bylaws when they buy stock in those corporations” and “assent to not having to assent to board-adopted bylaws.”
Forum selection bylaws remain subject to “as-applied” challenge. Chancellor Strine rejected the plaintiffs’ “array of purely hypothetical situations in which they say that the bylaws…might operate unreasonably” because Delaware courts “do not render advisory opinions about hypothetical situations that may not occur.” Moreover, he noted that “forum selection bylaws, like other forum selection clauses, are not facially invalid because they might operate in a problematic way in some future situation.”
However, Chancellor Strine indicated that stockholders may, under particular circumstances, challenge the enforcement of a forum selection bylaw if, under the test established in M/S Bremen v. Zapata Off-Shore Co.,3 enforcement would be unreasonable. Chancellor Strine also indicated that a unilaterally adopted forum selection bylaw may be susceptible to stockholder challenge under Schnell v. Chris-Craft Indus., Inc.4notwithstanding the corporation’s compliance with DGCL section 109 if enforcement of the bylaw would result in a breach of the directors’ fiduciary duties. Examples of situations when a breach of fiduciary duty claim may be brought may include enforcement of the bylaw in response to dissident stockholder activity or to perpetuate management in office. Another example of a situation when a breach of fiduciary duty claim may be brought is if a board fails to waive enforcement of the forum selection bylaw when requested by a stockholder in a circumstance where the bylaw at issue would operate to entirely foreclose the plaintiff from bringing suit.
Thus, despite upholding the facial validity of the unilateral adoption of the forum selection bylaws on statutory and contractual grounds, the decision leaves open the possibility that the boards’ actions could be subject to challenge as a breach of fiduciary duty.
The decision did not address the facial validity of a forum selection clause in a Delaware certificate of incorporation, although in light of the decision it would appear that such a clause would be less susceptible to attack because stockholders would need to approve an amendment of the certificate of incorporation to insert such a clause. Moreover, it is unclear whether courts outside of Delaware will enforce board-adopted Delaware forum selection bylaws as evidenced by the 2011 decision of a California federal court that held such bylaws to be unenforceable.5
1. See Boilermakers Local 154 Ret. Fund, et al. v. Chevron Corp., et al., C.A. No. 7220-CS, and IClub Inv. P’ship v. FedEx Corp., et al., C.A. No. 7238-CS, 2013 WL 3191981 (Del. Ch. June 25, 2013), available at http://courts.delaware.gov/opinions/download.aspx?ID=190990.
2. Both bylaws begin: “Unless the Corporation consents in writing to the selection of an alternative forum….”
3. 407 U.S. 1 (1972).
4. 285 A.2d 437 (Del. 1971).
5. See Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011).
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