In a blog essay written for the Delaware Journal of Corporate Law, Kyle Wu discusses the proposed amendments to the DGCL regarding the forum selection clauses contained within certificates of incorporation and bylaws. He argues the changes will ultimately reinforce what is already the status quo since many foreign jurisdictions already respect and enforce the ruling in Boilermakers.
Read more at http://www.djcl.org/blog.
In a blog essay written for the Delaware Journal of Corporate Law, Adam Young discusses the Tax Injunction Act’s applicability to notice and reporting requirements for out-of-state retailers. He argues that that the Supreme Court decision announced in Direct Mktg. Ass’n v. Brohl serves as a notice to out-of-state retailers that their days of tax advantages over in-state retailers may be coming to an end.
Read more at http://www.djcl.org/blog.
Lawrence A. Hamermesh and Norman M. Monhait(fn1)
An exchange last month in the Bank & Corporate Governance Law Reporter among Neil Cohen, Jack Coffee and Jay Brown(fn2) addressed the possibility that corporate bylaws might regulate the award of attorney’s fees in federal securities class actions. The Delaware Supreme Court’s 2014 opinion in ATP(fn3) sparked renewed interest in this possibility, and when the Delaware State Bar Association’s Corporation Law Section proposed legislation limiting the use of charter and bylaw provisions to shift litigation expenses, it was noted (correctly) that the proposed legislation did not apply to federal securities claims.(fn4) From this premise, it has been suggested (incorrectly, we say) that bylaws providing for fee-shifting in federal securities class actions were implicitly endorsed, or at least remained viable as a matter of Delaware law.(fn5)
We are responding to the foregoing suggestion to make two points: first, the now enacted Delaware legislation (“SB 75,” which includes amendments to Sections 102 and 109 and the Delaware General Corporation Law (DGCL), and the addition of Section 115 to that statute(fn6)) does not affect the question of the validity of bylaws providing for fee-shifting in federal securities class actions; and second, in our view the DGCL did not and after passage of SB 75 does not authorize such bylaws.
We begin with a point on which Professors Coffee and Brown appear to agree: namely, that SB 75 does not apply to federal securities class action litigation. By its terms, the legislation only applies to bylaws that provide for fee-shifting in connection with “internal corporate claims.” New Section 115 defines that term as “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.” If federal securities claims are covered by this term, they must fall within at least one of the two definitional clauses. It’s easy to see that clause (ii) does not cover federal securities claims, because the DGCL does not “confer[] jurisdiction upon the Court of Chancery” to hear such claims.
Nor do federal securities claims typically fall within clause (i) of the definition of “internal corporate claims.” The predominant form of federal securities class action litigation is based on Section 10(b) of the Securities Exchange Act of 1934(fn7) and SEC Rule 10b-5(fn8), and most commonly involves allegations that a material misstatement or omission induced class members to purchase securities before the misstatement or omission was corrected. In that situation, the fraud is visited upon investors, but not stockholders as such: it should be irrelevant whether a class member was or was not already a stockholder at the time of the alleged fraud. As Vice Chancellor Laster recently concluded in the Activision litigation: “A Rule 10b-5 claim under the federal securities laws is a personal claim akin to a tort claim for fraud. The right to bring a Rule 10b-5 claim is not a property right associated with shares, nor can it be invoked by those who simply hold shares of stock.”(fn9)
Accordingly, any duty breached under Rule 10b-5 (or under Sections 11 or 12 of the Securities Act of 1933(fn10)) does not arise from a director or officer’s duty to the corporation or its stockholders, and a Rule 10b-5 claim should not be considered an “internal corporate claim” within the meaning of new Section 115. Of course, if a director’s or officer’s violation of Rule 10b-5 were understood to involve a violation of his or her duty as a director or officer, then the amendments to DGCL Sections 102 and 109 would prohibit a bylaw providing for fee-shifting in connection with litigation of Rule 10b-5 claims. But like Professors Brown and Coffee, we think that a better reading of these amendments would regard them as limited to the Delaware “lane,” namely to breaches of duty arising under the DGCL and Delaware corporate decisional law. Therefore, we believe that the recent amendments to the DGCL do not address the validity of a bylaw purporting to shift fees in federal securities class action litigation.
So where does that leave such bylaws in terms of validity under Delaware law? In our view, their validity remains exactly as it was before the legislation was enacted. There is nothing to suggest any intention to endorse or accomplish, by negative implication, a validation of bylaws (or charter provisions, for that matter) purporting to regulate litigation arising under any body of law (tort, contract, federal securities law) other than Delaware corporation law.
Instead, the efficacy of a fee-shifting charter or bylaw provision purporting to affect federal securities class actions must be determined under Delaware case law interpreting the scope of DGCL Sections 102(b)(1) and 109(b) – most notably, the opinions in ATP and FedEx/Chevron (fn11)(by then Chancellor Strine). And as we read those opinions, Sections 102(b)(1) and 109(b) cannot be read, despite their breadth and the presumptive validity of provisions adopted pursuant to them, to authorize provisions regulating litigation under the federal securities laws.
Both ATP and FedEx/Chevron are instructive in this regard. Starting with the latter (but earlier) opinion, we see that what the court was endorsing was a bylaw that it considered to affect forum selection for “the kind of claims most central to the relationship between those who manage the corporation and the corporation’s stockholders” – namely, “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn12) In contrast, the court went out of its way to distinguish a bylaw regulating “external” matters, such as “a bylaw that purported to bind a plaintiff, even a stockholder plaintiff, who sought to bring a tort claim against the company based on a personal injury she suffered that occurred on the company’s premises or a contract claim based on a commercial contract with the corporation.”(fn13) A bylaw regulating selection of a forum to litigate such external claims “would be beyond the statutory language of 8 Del. C. 109(b)” for the “obvious” reason that it “would not deal with the rights and powers of the plaintiff-stockholder as a stockholder.” (emphasis in original). As previously noted, a bylaw purporting to regulate the litigation of claims under Rule 10b-5 “would not deal with the rights and powers of the plaintiff[] as a stockholder,”(fn14) and would therefore not be within even the broad scope of Section 109(b).
Nothing in ATP altered this analysis. Addressing the principal certified question in that case, the Court was necessarily focused on “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn15) (emphasis added). In the underlying litigation, the plaintiffs alleged “Delaware fiduciary duty claims,” as well as antitrust claims.(fn16) There is no indication in the ATP opinion that the Supreme Court questioned former Chancellor Strine’s view that the “flexible contract” formed by the statute, charter, and bylaws could not extend to any litigation other than “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.” Indeed, if the underlying litigation had involved only antitrust claims, we have no doubt that the Court would have concluded (consistent with FedEx/Chevron) that the bylaw could not have provided for fee-shifting in relation to the claims presented. And having been asked merely to opine about the overall facial validity of the bylaw, the Court had no occasion to parse the facts to determine whether the bylaw could require shifting fees that might have been solely attributable to the antitrust claims.
In sum, the “flexible contract” identified in ATP and established by the DGCL, the certificate of incorporation, and the bylaws encompasses a great deal – the subject matter scope of Sections 102(b)(1) and 109(b) is broad. But it is not limitless, as FedEx/Chevron expressly teaches. And in our view, it does not extend so far as to permit the charter or the bylaws to create a power to bind stockholders in regard to fee-shifting in, or the venue for, federal securities class actions. In addition, we agreed with Professor Coffee’s forceful point that a state authorization of charter and bylaw provisions purporting to control fee-shifting and venue in federal securities class actions is likely to be held pre-empted, regardless of their validity or effect under state law.(fn17) Given our views of Delaware law, we saw no reason for a statutory amendment that purported to reach beyond the confines of internal governance litigation, and we supported drafting that, as Professor Brown rightly suggests, stayed within Delaware’s “lane.”
(1) Mr. Monhait is the immediate past chair, and Professor Hamermesh a prior chair and a member, of the Council of the Delaware State Bar Association’s Corporation Law Section. The views expressed here, however, are solely those of the authors, and do not necessarily represent the views of the Association, the Section, or its Council.
(2) J. Robert Brown, Jr., Staying in the Delaware Corporate Governance Lane: Fee Shifting Bylaws and a Legislative Reaffirmation of the Rules of the Road; John C. Coffee, Jr., What Happens Next?; Neil J. Cohen, What Is the Outlook for Fee-Shifting in Securities Fraud Litigation After Delaware Passes a Ban on These Provisions for “Internal Corporate Claims”?.
(3) 91 A.3d 554 (Del. 2014).
(4) John C. Coffee, Jr., Delaware Throws a Curveball, Mar. 16, 2015, available at http://clsbluesky.law.columbia.edu/2015/03/16/delaware-throws-a-curveball/ (“read literally, the new legislation would not preclude a board-adopted bylaw that shifted the corporation’s and other defendants’ expenses against a plaintiff who lost (or was less than substantially successful) in a federal securities class action (at least so long as the action did not allege a “violation of a duty” by any corporate officer or director).”).
(5) Id. (“the proposed legislation may protect “Delaware-style” litigation from the threat of fee-shifting, but not securities class actions.”).
(6) SB 75, available at http://legis.delaware.gov/LIS/lis148.nsf/vwLegislation/SB+75/$file/legis.html?open.
(7) 15 U.S.C. §78j(b).
(8) 17 C.F.R. §240,10b-5
(9) In re Activision Blizzard Inc. Stockholder Litigation, C.A. No. 8885-VCL (Del. Ch. May 21, 2015), slip op. at 50.
(10) 15 U.S.C. §§ 77k, 77l.
Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013).
(11) 73 A.3d at 952.
(12) Id.
(13) Id. In cases involving such external claims, the stockholders indirectly bear the costs of the litigation to the corporation, but FedEx/Chevron makes clear that this circumstance does not convert the matter into one within the internal affairs of the corporation and subject it to regulation by the charter or bylaws of the corporation.
(14) Id.
(15) 91 A.3d at 556.
(16) John C. Coffee, Jr., Federal Pre-Emption and Fee-Shifting, (Jan. 26, 2015), available at http://clsbluesky.law.columbia.edu/2015/01/26/federal-preemption-and-fee-shifting/.
Jennifer Buckley (Widener Delaware ’16) concludes her article on the fee-shifting controversy as follows:
The current effort to legislate away fee-shifting bylaws is to be applauded for attempting to combine strong protection of shareholder interests with an acknowledgement of corporate concerns in the legitimization of forum selection bylaws. If it passes, then those concerned about excessive litigation will no doubt develop another tool for deterring frivolous shareholder lawsuits. If it does not pass, then one way to generate broad support could be to adopt one or more of the moderate approaches described here. These proposals seek to balance the legitimate interests of plaintiff shareholders with those of the corporations in which they invest. Moving forward, any legislation that seeks to protect shareholders must keep in mind the business community’s concern over excessive litigation. Likewise, proponents of fee-shifting bylaws must be willing to agree to reasonable limitations that soften their negative impact on plaintiff shareholders, especially those without a ready market for their shares. As with most policy debates, the answer likely lies somewhere in the middle ground.
Ms. Buckley’s article can be reviewed at:
In a recent Court of Chancery case, Miramar Police Officers’ Retirement Plan v. Murdoch, Chancellor Bouchard held that a spinoff corporation was not bound by the settlement agreement entered into by the parent corporation. In a blog essay written for the Delaware Journal of Corporate Law, DJCL Manuscript Editor Justin Forcier examines the opinion and concludes that the Chancellor’s well-reasoned holding reflects the most principled outcome for the case.
Read more at www.djcl.org/blog.
The Second and Ninth Circuit Courts of Appeals are directly opposed on a fine point of securities litigation: whether a failure to disclose a “known trend or uncertainty” under Item 303 of Regulation S-K can give rise to a fraud class action under Section 10(b) of the Securities and Exchange Act of 1934. In a blog essay written for the Delaware Journal of Corporate Law, DJCL staff editor Sabrina Hendershot discusses the circuit split and concludes that although no shareholders have been successful on this potential cause of action, issuers should take great care in deciding whether to disclose certain trends to the SEC to ensure compliance and avoid litigation.
Read more at www.djcl.org/blog.
The Delaware legislature is considering amendments to Delaware’s public benefit corporation statute. If enacted, these amendments stand to make Delaware more open to B corporations such as Etsy, one of the first certified B corporations to go public. In a blog essay written for the Delaware Journal of Corporate Law, DJCL Articles Editor John Gentile analyzes the potential issues that could arise with a company like Etsy trying to balance pursuing societal responsibilities and maximizing shareholder profits.
Read more at www.djcl.org/blog.
Two years removed from the Third Circuit’s dismantling of Delaware’s arbitration process, the state has now enacted the Delaware Rapid Arbitration Act to ensure the speedy resolution of business disputes for parties looking to avoid litigation. In a blog essay written for the Delaware Journal of Corporate Law, DJCL staff editor Alexander Bonder discusses the DRAA’s innovative provisions and the implication for parties looking to avoid litigation.
Read more at www.djcl.org/blog.
Delaware appraisal litigation has been receiving its fair share of attention from commentators and the judiciary. In a blog essay written for the Delaware Journal of Corporate Law, DJCL staff editor Jacob Fedechko addresses the proposed legislative amendments to Delaware’s appraisal statute, specifically a proposed “de minimis exception” for publicly traded shares and a proposed “option to pay and limit the accrual of interest.” He concludes that while the de minimis exception may not have a significant impact in practice, the option to pay amendment has a good chance of yielding material results.
Read more at www.djcl.org/blog.
From Thursday March 12, 2015 to Sunday March 19 2015, the Widener Moot Court Honor Society hosted the 2015 Ruby R. Vale Interscholastic Corporate Competition. Eighteen teams participated in the competition, which is the only corporate moot court competition in the country.
Paul L. Regan, Associate Professor of Law and Associate Director of the Institute of Delaware Corporate and Business Law authored the competition problem.
The appeal challenged a Preliminary Injunction Order by the Court of Chancery that enjoined the application of a corporate bylaw adopted by the board of directors (the “Board”) of Talbot Inc. (the “Company”) (collectively “Appellants”). The Board consisted of nine members, only one of whom—CEO Timothy Gunnison—was an officer of the Company. The Board-adopted bylaw required a dissident shareholder group who launches an ultimately unsuccessful proxy contest to reimburse the Company for reasonable professional fees and expenses incurred in resisting the proxy contest. The bylaw also included the possibility that the Board could waive the fee-shifting after the fact. The Board adopted the proxy contest fee-shifting bylaw in December 2014 in response to a Schedule 13D filing by Appellee Alpha Fund Management L.P. (“Alpha” or the “Alpha Fund”), in which Alpha had disclosed its 7% ownership stake in the Company and its intention to nominate up to four candidates for election to the Company’s nine-person Board at the next annual meeting of stockholders in May 2015. The appeal raised two primary issues for the Delaware Supreme Court: (1) whether the board-adopted proxy fee-shifting bylaw is facially under the Delaware General Corporation Law; and (2) whether the board adopted the bylaw for an inequitable purpose.
Teams representing Appellants were expected to argue that the board-adopted proxy fee-shifting bylaw is facially valid because it is similar to the fee-shifting bylaw upheld as valid in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), the board-adopted exclusive forum bylaws upheld as valid in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013) and City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014), and other valid board-adopted bylaws affecting the domain of stockholder rights.
First, similar to the fee-shifting bylaw in ATP, the Proxy Fee-Shifting Bylaw is facially valid and enforceable under the DGCL because it merely allocates risks concerning the costs of a proxy contest among the principal parties in a particular context, and therefore satisfies “the DGCL’s requirement that bylaws must ‘relate 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.’” ATP, 91 A.3d at 558 (citing 8 Del. C. § 109(b)). Second, like forum selection bylaws, the Proxy Fee-Shifting Bylaw is a procedural rule for the operation of the Company adopted to facilitate the convenient functioning of business, in this instance, the business of managing a contested election of directors. Appellants relied on the Court of Chancery’s reasoning in Chevron to argue that the Proxy Fee-Shifting Bylaw does not touch on substantive issues and plainly relates to the business of the corporation because it merely enables the Company to be reimbursed for expenses reasonably incurred in resisting a “meritless” proxy challenge. Chevron, 73 A.3d at 951. Finally, the Proxy Fee-Shifting Bylaw is similar to valid Advance Notice Bylaws, Director Qualification Bylaws, and the “Poison Pill” Rights Plan in Moran v. Household International Inc., 500 A.2d 1346 (Del. 1985), because they all have a measure of restrictive influence on a proxy contest. The Proxy Fee-Shifting Bylaw has no greater regulatory effect on a proxy contest than the bylaws and Rights Plan that have been upheld as valid despite the imposition of some degree of regulatory impact on the exercise of the stockholder franchise.
On the other hand, teams representing Appellees were expected to argue that the Proxy Fee-Shifting Bylaw is facially invalid because it has an improper chilling effect on the stockholders’ exercise of their rights to undertake a proxy contest against management, and it disturbs the allocation of authority between the Board and the stockholders by moving beyond the procedural realm of bylaws and impermissibly touching on substantive issues, i.e., the stockholder franchise. The Board improperly limited the stockholders’ fundamental right to nominate and promote (by proxy contest) candidates for election by artificially and substantially raising the financial stakes of an electoral challenge to their incumbency; thus any resulting vote on an uncontested slate would be an empty exercise. The election of directors and the power to oust unsatisfactory incumbent directors who stand for elections is the sole province for stockholders. The enactment of a fee-shifting penalty for not being sufficiently victorious in a proxy contest is therefore an affront to the director-stockholder relationship that violates the DGCL because the directors are effectively intruding into the stockholders’ sphere of power.
Appellees were also expected to argue that the Proxy Fee-Shifting Bylaw is facially invalid because it is fundamentally different and distinguishable from the fee-shifting bylaw in ATP, and that various provisions of the DGCL support a corporate statutory framework designed to protect the stockholder franchise from board interference. ATP can be factually distinguished in a vital way from the Proxy Fee-Shifting Bylaw because there is a fundamental difference between proxy contests, which implicate the stockholder franchise, and mere intra-corporation litigation, which is not a fundamental stockholder right of the same ilk as the stockholder franchise. Because the electoral process is fundamental to the underpinnings of corporate governance, it should be viewed differently, and far more guardedly, than a board adopted fee-shifting bylaw in the litigation context.
In contrast to statutory provisions that require that substantive limitations or restrictions on the rights of stockholders be set forth in the certificate of incorporation, e.g., DGCL Sections 102(a)(4) and 151(a), Section 109(b) only permits the adoption of bylaws “not inconsistent with the law or the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs [etc] . . . .” Because the phrase “relating to” in Section 109(b) confirms that bylaws may only “relate to” stockholder rights and cannot go so far as to impose substantive “qualifications, limitations or restrictions,” the Proxy Fee-Shifting Bylaw is invalid because it does not merely “relate to” a stockholder’s right to conduct a proxy contest, but rather purports to impose substantial financial restrictions on an attempt to exercise that right. Additionally, DGCL Sections 228(a) and 141(d) provide powerful statutory corroboration that any limitation or restriction on the fundamental power of the stockholders to remove, replace, or reelect the board of directors must be set forth in the certificate of incorporation or a stockholder-adopted bylaw.
Appellants were expected to argue that the Proxy Fee-Shifting Bylaw was adopted in an informed manner and for a proper corporate purpose as a legitimate response to concerns over the substantial costs of defending against a proxy contest. The facts showed that, before adopting the Proxy Fee-Shifting Bylaw, the Board had hear presentations from a senior officer, the Company’s general counsel and outside legal counsel. The Court of Chancery has also concluded that the Board was “well-informed” in its decision to adopt the Proxy Fee-Shifting Bylaw.
Any improper purpose was secondary, and not the Board’s primary purpose, and the bylaw’s definition of “success” shows the Board’s intent to distinguish between valid challenges and meritless “nuisance” challenges. Further, even if the Board’s primary purpose was to discourage or perhaps thwart a proxy challenge, the Proxy Fee-Shifting Bylaw should nevertheless be upheld and enforced as valid because mitigating the potential adverse financial impact of proxy contests is a sufficient justification to find that the Board’s adoption of the Proxy Fee-Shifting Bylaw was equitable, and the possibility of waiver embodied in the bylaw is sufficient to cure any inequity in the Board’s initial adoption of the bylaw.
Moreover, this is not a case of “unilateral board action intended to inequitably manipulate the corporate machinery” because stockholders still have a full and fair opportunity to exercise their right to vote at the upcoming May 2015 election. Additionally, at the May 2015 election, Alpha could ask the stockholders to repeal the Proxy Fee-Shifting Bylaw, which would cure any inequity. Finally, the compelling justification standard espoused in Blasius does not apply here because nothing about the Proxy Fee-Shifting Bylaw prevents an insurgent from prevailing in a proxy context or otherwise thwarts the effective exercise of the stockholder franchise.
Appellees, on the other hand, were expected to argue that the Board adopted the Proxy Fee-Shifting Bylaw primarily, if not solely, for the improper purpose of thwarting Alpha’s right to fully and fairly participate in the electoral process when it adopted the bylaw in reaction to Alpha’s Schedule 13D filing. The record showed that four of the nine directors explicitly saw the adoption of the Proxy Fee-Shifting Bylaw as a deterrent to dissuade Alpha from undertaking its proxy contest at all. The Board’s reserved power to waive fee-shifting does not affect the fundamental impropriety of the adoption of the bylaw in the first instance. Further, here, the Board had resolved not to waive the fee-shifting for the expected Alpha proxy contest.
Additionally, the ex-ante deterrent effect of the Proxy Fee-Shifting Bylaw is a complete answer to any asserting that the bylaw would not affect Alpha’s ability to win a proxy contest against the incumbent Board. Because it was adopted primarily for the purpose of interfering with the effectiveness of a stockholder vote, the Proxy Fee-Shifting Bylaw should be reviewed under a compelling justification standard. Here, there is no such compelling justification, and the bylaw should be held unenforceable in equity. Any good faith reason for enacting the bylaw is irrelevant because even well-meaning directors are not permitted to disrupt the exercise of the stockholder franchise.
The teams from the University of Oklahoma College of Law and Ohio State University Moritz College of Law argued before a final bench comprised of the Honorable Karen Valihura and the Honorable James T. Vaughn, justices on the Delaware Supreme Court, the Honorable J. Travis Laster and the Honorable Donald F. Parsons, Jr., vice chancellors on the Delaware Court of Chancery, and Donna M. Nagy, Executive Associate Dean and Professor of Law at Indiana University Maurer School of Law, who delivered the Distinguished Scholar Lecture.
The University of Oklahoma College of Law team, represented by Kendra Norman, David Postic, and Ruthie Stevens, prevailed in the final round. The team from Ohio State University Moritz College of Law, Ryan Edmiston, Katie Kalbacher, and Susan Restrepo, won the second place prize. Michael Mullavey and Caroline Mockler, from the University of Florida Levin College of Law, won the Donald E. Pease Award for Best Brief. Brian Kesten, from Georgetown University Law Center, was named the competition’s Best Oral Advocate.
The competition, now in its 27th year, is named for Ruby R. Vale, who lived in Milford, Del. and practiced law in Philadelphia, specializing in corporation, banking, and insurance law.