Delaware Legislature to Resume Debate in January on Bylaws Imposing Liability on Shareholders

The ability of corporations to impose liability on shareholders through bylaws and charter provisions has been the subject of much debate recently.  On May 8, 2014, the Supreme Court of Delaware held in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 555 (Del. 2014), that “a fee-shifting provision in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law.” This decision (in favor of ATP) prompted a proposed amendment to the Delaware General Corporation Law (DGCL) that would eliminate the ability of Delaware stock corporations to impose liability on shareholders through bylaw and charter provisions, including fee-shifting liability, and a debate about the use of bylaws to define the bounds of shareholder litigation. Act to Amend Title 8 of the Delaware Code Relating to the General Corporation Law, S.B. 236, 147th Gen. Assemb. (Del. 2014).  Senator Bryan Townsend, D-Newark, was able to delay the debate on the proposed legislation until the Delaware legislature reconvenes in January 2015.

While the Supreme Court’s decision in ATP was the catalyst for the legislative development, ATP was not the first time that a court in Delaware had validated bylaws defining the bounds of shareholder litigation. Last year, the Delaware Court of Chancery upheld the validity of board-adopted forum selection bylaws in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013).  In that case, cited by the Delaware Supreme Court in ATP, the Delaware Court of Chancery held that a board of directors has the statutory authority to unilaterally adopt forum selection bylaws if the corporation’s certificate of incorporation permits the board to amend its bylaws.  The Court of Chancery noted that board-adopted forum selection bylaws were statutorily valid because they were process-oriented, in that they concerned when a shareholder may sue a corporation.  The Chancery Court contrasted forum selection bylaws with substance-oriented bylaws, which would involve whether a shareholder is barred from suing or the type of remedy a shareholder may recover, and could not be unilaterally adopted by a board of directors.  The Chancery Court held that process-oriented bylaws were matters concerning the rights of shareholders that bylaws properly may address under 8 Del. C. Section 109(b).  Id. at 952.

Moreover, the Chancery Court in Boilermakers found that the forum selection bylaws were contractually valid and enforceable, rejecting plaintiffs’ argument that the board-adopted bylaws could not be a contractual forum selection clause because the stockholders had not approved such provisions.  Title 8 Del. C. Section 109(a) permits a corporation, through its certificate of incorporation, to grant its directors the unilateral power to adopt and amend the bylaws, and the boards inBoilermakers had the power to amend their corporations’ bylaws under their certificates of incorporation. Therefore, the Court of Chancery reasoned, when investors purchased stock in these corporations, they agreed 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.”  Id.at 939.  In addition, the Chancery Court noted that because of this “flexible contract” between the shareholders and the corporations, shareholders who object to forum selection bylaws have the option to amend or repeal the bylaws and the opportunity to elect directors on an annual basis. For more on the ATP and Boilermakersdecisions, see Ralph Ferrara and Rachel Wolkinson, “When the Camel’s Nose Gets Under the Tent: Fee-Shifting and Forum Selection in Delaware,” Corporate Governance Advisor.

Interestingly, between the date of the Boilermakers decision and late September 2013, approximately 70 companies, including 21st Century Fox, DuPont, JCPenney, Electronic Arts, and Air Product & Chemicals adopted exclusive forum-selection provisions.  See Glass Lewis on Exclusive Forum Provisions, Sept. 25, 2013.

A recent decision by the Court of Chancery provides further support for the validity of board-adopted forum section bylaws.  In City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229, 234 (Del. Ch. 2014), issued on September 8, 2014, the Court of Chancery again upheld the validity of a forum selection bylaw, addressing for the first time the question of “whether the board of a Delaware corporation may adopt a bylaw that designates an exclusive forum other than Delaware for intra-corporate disputes.”  The forum selection bylaw at issue in City of Providence was “virtually identical” to the bylaw adopted in Boilermakers with the exception that, unlike the bylaws in Boilermakers, which designated Delaware as the exclusive forum, the bylaw designated “as the forum the United States District Court for the Eastern District of North Carolina, or, if that court lacks jurisdiction, any North Carolina state court with jurisdiction, instead of the state or federal courts of Delaware.”  Id. at 230.  Relying on Boilermakers, the Chancery Court dismissed the plaintiffs’ facial validity challenge, citing Sections 109(a) and (b) of the DGCL and explaining that First Citizen’s charter granted the board the power to amend the bylaws, therefore putting stockholders on notice that the board “may act unilaterally to adopt bylaws addressing” topics subject to regulation by bylaw under section 109(b).  Id.  at 234.

As to the question of whether the board of a Delaware corporation may adopt a bylaw designating an exclusive forum other than Delaware for intra-corporate disputes, the Chancery Court held that the analysis of Delaware law outlined inBoilermakers compelled the same conclusion in this matter.  Although Delaware may be the most reasonable forum for disputes regarding the internal affairs of corporations, the Chancery Court explained that “nothing in the text or reasoning of [Boilermakers] can be said to prohibit directors of a Delaware corporation from designating an exclusive forum other than Delaware in its bylaws.”  Id.

The Chancery Court declined to address City of Providence’s argument that the forum selection bylaw improperly stripped the court of the “‘exclusive jurisdiction’ vested upon it by the General Assembly” as a “hypothetical as-applied challenge,” noting that “Vice Chancellor Laster recently . . . concluded that a grant by the General Assembly of ‘exclusive’ jurisdiction to this Court for claims arising under a particular statute does not preclude a party from asserting a claim arising under that statute in a different jurisdiction” and that “any attempt by the General Assembly to bestow . . . a ‘substantive right’ to bring a claim only in this Court would conflict with the Supremacy Clause of the United States Constitution and federal diversity jurisdiction.”  Id. at 236.

City of Providence should provide some confidence in the numerous forum selection bylaws boards have adopted post-Boilermakers. Meanwhile, debate over the proposed DGCL amendment when the legislature reconvenes next month will no doubt add to the evolving discussion over the use of bylaws to define the bounds of shareholder litigation.

We will keep you apprised of developments on this issue in the upcoming year.