Forum-Selection Provisions in Delaware
Delaware companies are increasingly adopting exclusive forum-selection provisions requiring that shareholder class action and derivative suits be filed in a single court. Most companies adopting these provisions designate the Delaware Court of Chancery, which is known for its expertise and knowledge in corporate law and efficiency in administrating cases on an expedited schedule, as the exclusive venue for shareholder litigation.
Since 2010, when the Delaware Chancery Court implicitly endorsed the ability of a Delaware company to designate an exclusive forum for the resolution of certain intra-corporate disputes, forum-selection provisions have become an effective method of shielding corporations from the financial and other burdens imposed by multi-forum litigation. Filing twice, a tactic increasingly used by the plaintiffs bar to generate leverage, creates more opportunities for plaintiffs attorneys to serve as lead counsel, receive a fee award, and increase the settlement value of the litigation. These duplicative actions unduly burden corporations and their shareholders by increasing the costs of litigation and the likelihood of unfavorable and/or inconsistent judgments.
The volume of multi-forum litigation has risen dramatically in recent years, which is likely a significant factor in the recent increase in the adoption of forum selection provisions. Currently, at least 200 companies designate Delaware as the exclusive venue for intra-corporate disputes, as compared with only 82 that employed these provisions in April 2011. Many, but not all, provisions also include one or more exceptions where an alternate forum would be permissible.
Most companies adopting exclusive forum clauses do not seek shareholder approval to do so, instead opting for board-adopted bylaw amendments or, if going public, implementation through the governing documents in place at the time of the IPO. To date, only 12 public companies have relied on the uncertain outcome of a shareholder vote for implementation, despite legal challenges and opposition from proxy advisory firms and, recently, shareholder activists, to provisions unilaterally adopted post-IPO.
The validity of board-adopted forum-selection bylaws was first questioned in Galaviz v. Berg, where the Federal District Court for the Northern District of California denied dismissal of a derivative action for improper venue, finding that the board-approved forum-selection bylaw of a Delaware company was unenforceable. Because the decision was limited to the facts in that case and was reached on the basis of federal common law, the number of bylaws adopted continued to increase.
In, February 2012, class actions were filed in the Delaware Chancery Court challenging validity of forum selection bylaws unilaterally adopted by the boards of 12 Delaware companies. While 10 of the complaints have since been dismissed following the repeal of the bylaws in question, the defendants in the mooted cases were unable to stay plaintiffs fee petitions, which may be an indication of how the court will rule on the issue of validity in the two cases (against Chevron Corporation and FedEx Corporation) that are still proceeding. Chevron has since addressed two of the legal challenges asserted in the complaints by amending its forum-selection bylaw to permit claims to be brought in any Delaware court (instead of just in the Delaware Chancery Court) and to preclude applicability if such court does not have personal jurisdiction over a necessary defendant.
During the 2011 proxy season, MSCI/Institutional Shareholder Services (ISS) recommended against forum-selection provisions unless the company had employed one of four best-practices governance features, including an annually elected board, a majority vote standard in uncontested director elections, the absence of a poison pill, or a meaningful special meeting right. Based on this policy, ISS recommended against all of the 2011 management proposals, except for the one proposal that was grouped with another favorable governance measure.
In 2012, ISS made recommendations on a case-by-case basis, weighing the 2011 good governance features (excluding the meaningful special meeting right) together with whether the company has been materially harmed by shareholder litigation outside its jurisdiction of incorporation. Notwithstanding the revised policy, ISS recommended against all of the management proposals to adopt forum selection and for the four shareholder proposals that sought to repeal forum-selection bylaws already in place.
Notably, ISS supported shareholder resolutions at Chevron and United Rentals Inc., even though both companies exhibited good governance practices in all areas and had documented specific instances of significant harm. ISS reported that in both cases, it was unable to conclude from the companys disclosure that the harm caused was material.
Unlike ISS, Glass, Lewis & Co. unequivocally opposes all forum-selection provisions, and according to its 2012 guidelines, will even recommend against the chairman of the board or governance committee of a company that either does not present forum selection as a separate proposal or unilaterally adopts the provision, even if adopted in connection with the companys IPO.
In light of the recent challenges to enforceability, shareholder sentiment on the issue of forum selection is an important indicator of whether boards of directors will continue to unilaterally adopt these provisions rather than seeking shareholder approval. Although in 2011 shareholders marginally approved standalone forum-selection charter amendments and did not seek to repeal any of the unilaterally adopted bylaws, the 2011 proxy season was probably not a reliable indicator of shareholder sentiment because shareholders were only beginning to examine the issue at that time.
The 2012 voting results seem to suggest that shareholders are beginning to support forum-selection charter provisionsand perhaps even board-adopted bylawssince, despite ISSs recommendation, shareholders did not approve the shareholder proposals seeking to repeal such bylaws when given the opportunity to do so this year. However, the new resolution was submitted to just four companies, and only tested at two (Chevron and United Rentals). It was withdrawn from the other two (Superior Energy Services Inc. and Roper Industries Inc.) after both companies repealed the bylaw in question. As such, it is too early to predict whether unilaterally adopted provisions will receive consistent shareholder support going forward.
Given the cost and disruption caused by parallel shareholder litigation, it is clear that forum-selection provisions will continue to be an important topic in corporate governance circles in 2013 and beyond.
Frank Aquila is co-head of Sullivan & Cromwells global corporate practice. He has a broad multidisciplinary practice that includes extensive experience in negotiated and unsolicited mergers and acquisitions and corporate governance matters. Mr. Aquila has been recognized as a Dealmaker of the Year by The American Lawyer and has been named to the Directorship 100one of the 100 most influential people in corporate governance and inside the boardroomby the National Association of Corporate Directors (NACD). He can be reached at email@example.com. Anna Kripitz is an associate in the general practice group at Sullivan & Cromwell. Ms. Kripitz focuses her practice on executive compensation and benefits matters, as well as corporate governance issues. She can be reached at firstname.lastname@example.org.