A recent Delaware Court of Chancery opinion interpreted related agreements that included forum selection clauses that were conflicting.  In Mack v. Rev Worldwide, Inc., C.A. No. 2019-0123-MTZ (Del. Ch. Dec. 30, 2020), the court addressed forum selection provisions in two related agreements which the court treated as one because they were incorporated by reference.

The court was asked to decide whether Delaware was the proper forum when one of the forum selection clauses required courts in Texas to address certain issues–and the other forum selection provision provided for a California court to hear disputes.

Key Takeaways:
● The court recited the well-established Delaware law about the enforceability of forum selection clauses generally.  Slip op. at 15 to 17.
● The court also addressed Rule 12(b)(3) motions challenging venue and whether arguments required to be made in an initial Rule 12 motion are waived if all the grounds for such motions are not explained, as well as the impact of a second motion under Rule 12 in connection with an amended complaint.  The court explained why those arguments would generally not be waived, even if all the grounds for such a motion were not recited in the original motion.
● The court also observed that in some instances non-signatories to a forum selection clause may also be bound by it.
● The court reasoned that unlike the typical situation where conflicting forum selection clauses choose Delaware and another forum, in this instance competing forum selection clauses both required litigation in states outside of Delaware. Therefore, the court determined that because neither of the parties chose Delaware, a court in one of the other two forums selected would need to decide which of them would address the merits of the case.

For readers who follow the law regarding forum selection clauses, a recent article by Professor Joseph Grundfest should be of interest. The good professor addresses the December 2018 Court of Chancery decision in Sciabacucchi v. Salzberg (highlighted on these pages), and the intersection of Delaware law and Federal law in the context of forum selection clauses and the internal affairs doctrine. The abstract follows to his article titled: The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi

Abstract

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. Securities Act claims were historically litigated in federal court, but in 2015 plaintiffs began filing far more frequently in state court where dismissals are less common and weaker claims more likely to survive. D&O insurance costs for IPOs have since increased significantly. Today, approximately 75% of defendants in Section 11 claims face state court actions. Federal Forum Provisions [FFPs] respond by providing that, for Delaware-chartered entities, Securities Act claims must be litigated in federal court or in Delaware state court.

In Sciabacucchi, Chancery applies “first principles” to invalidate FFPs primarily on grounds that charter provisions may only regulate internal affairs, and that Securities Act claims are always external. In so concluding, Sciabacucchi adopts a novel definition of internal affairs that is narrower than precedent, and asserts that plaintiffs have a federal right to bring state court Securities Act claims. It describes all Securities Act plaintiffs as purchasers who are not owed fiduciary duties at the time of purchase. The opinion constrains all actions of the Delaware legislature relating to the DGCL to comply with its novel definition of “internal affairs.”

Sciabacucchi’s logic and conclusion are fragile. The opinion conflicts with controlling U.S. and Delaware Supreme Court precedent and relies critically on assumptions of fact that are demonstrably incorrect. It asserts that FFPs are “contrary to the federal regime” because they preclude state court litigation of Securities Act claims. But the U.S. Supreme Court in Rodriguez holds that there is no immutable right to litigate Securities Act claims in state court, and enforces an agreement that precludes state court Securities Act litigation. Sciabacucchi assumes that Securities Act plaintiffs are never existing stockholders to whom fiduciary duties are owed. But SEC filings and the pervasiveness of order splitting conclusively establish that purchasers are commonly existing holders protected by fiduciary duties. The opinion fears hypothetical extraterritorial application of the DGCL. To prevent this result, it invents a novel definition of “internal affairs” that it applies to constrain all of the Legislature’s past and future activity. But the opinion nowhere addresses the large corpus of U.S. and Delaware Supreme Court precedent that already precludes extraterritorial applications of the DGCL. It thus invents novel doctrine that conflicts with established precedent in an effort to solve a problem that is already solved. The opinion’s novel, divergent definition of “internal affairs” also conflicts with U.S. and Delaware Supreme Court precedent that the opinion nowhere considers.

Sciabacucchi is additionally problematic from a policy perspective. By using Delaware law to preclude a federal practice in federal court under a federal statute that is permissible under federal law, Sciabacucchi veers Delaware law sharply into the federal lane and creates unprecedented tension with the federal regime. Its narrow “internal affairs” definition invites sister states to regulate matters traditionally viewed as internal by Delaware, and advances a position inimical to Delaware’s interests. By propounding its divergent internal affairs constraint as a categorical restriction on the General Assembly’s actions, past and future, the opinion causes the judiciary to intrude into the legislature’s lane. And, data indicate that the opinion in Sciabacucchi caused a statistically and economically significant decline in the stock price of recent IPO issuers with FFPs in their organic documents.

In contrast, a straightforward textualist approach would apply the doctrine of consistent usage and use simple dictionary definitions to preclude any extension of the DGCL beyond its traditional bounds. Textualism avoids all of the concerns that inspire the invention of a divergent “internal affairs” definition. Textualism does not require counter-factual assumptions, conflict with U.S. or Delaware Supreme Court precedent, cause Delaware to constrain federal practice in a manner inconsistent with federal law, or advocate policy positions inimical to Delaware’s interest. Textualism also interprets the DGCL in a manner that profoundly constrains the ability of all Delaware corporations to adopt mandatory arbitration of Securities Act claims. Textualism validates FFPs in a manner that precludes the adverse, hypothetical, collateral consequences that animate Sciabacucchi’s fragile analysis, without generating Sciabacucchi’s challenging sequelae.

Keywords: Securities Act, forum selection, Delaware, jurisdiction, litigation, Section 11, charters, by-laws, internal affairs, federal forum provisions

JEL Classification: K22, K41

Suggested Citation

Grundfest, Joseph A., The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi (September 12, 2019). Rock Center for Corporate Governance at Stanford University Working Paper No. 241. Available at SSRN: https://ssrn.com/abstract=3448651 or http://dx.doi.org/10.2139/ssrn.3448651

 

A recent seminal decision of the Delaware Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. In the case of Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal Forum Provisions”).

Why this Case is Noteworthy: The court reasoned in its holding that: “The constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.  In this case, the Federal Forum Provisions attempt to accomplish that feat.  They are therefore ineffective and invalid.”

Overview of Key Points:

This opinion is destined to form part of the bedrock of foundational Delaware corporate decisions and could rightly be the subject of a lengthy law review article, but for purposes of this quick blog post, I will merely highlight a few of the more notable excerpts in bullet points.

  • A substantial basis for the court’s reasoning was a prior decision from the Court of Chancery which upheld the validity of corporate bylaws that required claims based on the internal affairs doctrine and related claims to be brought exclusively in the Court of Chancery. That decision by the current Chief Justice of Delaware, writing at the time as the Chancellor, was Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. June 25, 2018).
  • Although the Boilermakers case involved bylaws, the Sciabacucchi decision explained why that same reasoning applied to a certificate of incorporation which is governed by similar provisions in the Delaware General Corporation Law (DGCL). The court in Sciabacucchi explained that the reasoning in Boilermakers focused on the ability to enforce forum-selection clauses that related to the internal corporate matters of a Delaware corporation as opposed to external matters, such as claims arising under the Securities Act of 1933.
  • The Court buttressed its reasoning by referring to the codification of the Boilermakers decision, shortly after its publication, by means of the adoption of a new Section 115 of the DGCL. In connection with that new DGCL section, the Delaware General Assembly also passed new amendments to Sections 102 and 109 of the DGCL which prohibit fee-shifting provisions in the certificate of incorporation or bylaws particularly in connection with claims related to the internal affairs of a corporation as defined by DGCL Section 115.
  •  The Court’s reasoning was also supported by reference to what the court referred to as “first principles.” Those first principles included several basic tenets of corporate law such as the following: (i) Although the document filed with the state that gives rise to an artificial entity such as a corporation, and confers powers on it, is a contract, it is not an ordinary private contract among private actors; (ii) The certificate of incorporation is a multi-party contract that includes the State of Delaware. Unlike an ordinary contract, it also includes terms by reference that are imposed by the DGCL; (iii) Unlike an ordinary contract, a charter can only be amended to the extent that it complies with the DGCL; (iv) The DGCL specifies what provisions a charter may or may not include; and (v) Although the courts enforce both types of contracts, when enforcing relationships created by the corporate contract, the courts use an overlay of fiduciary duty. See pages 38 to 42 and footnotes 111 to 125.
  • A thorough analysis of the contours and policy behind the internal affairs doctrine is an important feature of this opinion. See, e.g., pages 41-46.

In sum, the court reasoned that the “constitutive documents of a Delaware corporation cannot bind the plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The opinion provides extensive citations to substantial scholarship, case law and statutes.

Prof. Ann Lipton provides extensive insights in her blog post about this case with links to her articles on the topic. The good professor’s scholarship on this issue was also cited by the court in the above opinion.

Many cases have been highlighted on this blog regarding forum-selection clauses in private agreements. See, e.g., here and here. In some of the posts on these pages about cases involving forum-selection clauses, a graphic of the Roman Forum adds color as well as an etymological connection.

SUPPLEMENT: Professor Stephen Bainbridge, a prolific corporate law scholar, kindly links to this post on his blog.

The Delaware Court of Chancery found that a forum selection clause that was merely permissive rather than exclusive, did not justify enforcing one forum only. In the case styled In re Bay Hills Emerging Partners, I, L.P., C.A. No. 2018-0234- JRS (Del. Ch. July 2, 2018), the court was presented with a case challenging the removal of general partners of a Delaware limited partnership. Many prior decisions upholding (mostly) exclusive forum selection clauses have been highlighted on these pages over the last 13 years.

Brief Background Facts:

Shortly after the Delaware action was filed, the limited partner initiated litigation in the Commonwealth of Kentucky in which it sought judicial declarations that its removal of the general partners was proper, along with other legal and equitable relief.

The defendants in Delaware moved to dismiss the action primarily on the basis of the forum selection clause in the relevant agreements that required the plaintiff in the Delaware case to litigate the dispute in Kentucky. The court disagreed, primarily because the applicable forum selection clause was only permissive, and not a mandatory, exclusive forum selection clause. This is recurring issue in corporate and commercial litigation.

The applicable clause stated that Franklin County Circuit Court in Kentucky is “a proper venue” but it did not designate that court as the “exclusive” forum.

Procedural Posture:

Even though the Kentucky action was filed eight days after the Delaware action, and the claims were nearly identical, the court sua sponte decided to stay the Delaware action in favor of the Kentucky action.

The court reviewed the motion under Rule 12(b)(3), which does not limit the court to the complaint but allows the court to consider extrinsic evidence. In addition to the forum selection clause, the motion to dismiss the Delaware action was based on forum non conveniens as well as “the interests of comity” and the doctrine of sovereign immunity because the Commonwealth of Kentucky was one of the interested parties.

Analysis of the Court:

One of the more interesting aspects of this decision was the analysis of 6 Del. C. § 17-109(d) which prohibits limited partners from waiving the right to litigate matters relating to the internal affairs of the limited partnership in the courts of Delaware.

Forum Selection Clauses:

The court recognized the well-settled rule in Delaware that courts generally should give effect to the selection in a private agreement to resolve disputes in a particular forum.

The Delaware courts often grant motions to dismiss where the parties use express language clearly indicating that the forum selection clause excludes the court where a party improperly filed an action. See footnotes 33 and 34.

Choice of Law Clauses:

There was a choice of law provision in this agreement which provided that the laws of the Commonwealth of Kentucky apply regardless of choice of law principles.

Delaware courts generally honor contractually-designated choice of law provisions, as long as the jurisdiction bears some material relationship to the transaction. See footnote 36.  In this case there is little doubt about the material relationship to Kentucky because the limited partner in each of the limited partnerships involved was a statutorily created entity that manages the retirement systems for the Commonwealth of Kentucky.

Notably, the court referred to the cases where there is a “false conflict” meaning that there is no material difference between the laws of competing jurisdictions–in which case the “court should avoid the choice of law analysis all together.” See footnote 38.  The court applied that principle in this case to decline to undertake a choice of law analysis.

Key Takeaways:

The key rulings with the most widespread applicability that can be gleaned from this case are the following:

1)         Where two cases are filed within a short time of each other, the court will treat them as being filed contemporaneously, and a forum non conveniens analysis will apply.  In this case it applied to favor a stay of the Delaware case and an application of Kentucky law because there were no unique issues of Delaware law presented.

2)         The court recognized the general enforceability of forum selection clauses, as well as choice of law provisions.  Many forum selection clause cases have been highlighted on these pages.

3)         The court observed that both the Delaware LLC Act and the Delaware LP Act prevent non-managers of LLCs and non-general partners of LPs from waiving their right to litigate internal affairs issues in Delaware, but those provisions do not require them to litigate in Delaware; nor do those provisions require LLC managers or general partners of limited partnerships to litigate in Delaware.

In Greetham v. Sogima L-A Manager, LLC, et al., 2008 Del. Ch. LEXIS (Nov. 3, 2008), read opinion here, the Delaware Chancery Court addressed three legal issues that are of substantial practical importance in many corporate and commercial litigation cases, and the court’s rulings are also useful tools for the toolbox of those who labor in the fields of business litigation.

First, the court upheld a clause in an agreement that made Delaware law govern any issues that arose, and that also required the parties to litigate in Delaware Chancery Court. In addition to cases cited in support for this well-recognized position in Delaware, reference was made to the specific Delaware statute that provides authority for allowing parties to consent to the jurisdiction of the Delaware courts as long as at least $100,000 is in dispute. See Section 2708 of Title 6 of the Delaware Code.

Second, the court determined that the irreducible minimum elements of an enforceable contract were not evident in the record after trial and therefore the court rejected the contract claim. Notably, the court recognized that customs in a particular industry and/or prior practice of  the parties may in some instances serve as evidence of "missing terms" in an agreement.

Finally, the court recited the elements of promissory estoppel and found them wanting.

 In an abbreviated and conclusory fashion, the factual basis of this case, which was extensively described by the court, began with a group of eight people who started a company that was to invest in municipal tax liens. However, among the problems that arose was the failure of the parties to confirm in writing all the terms of all the various additional "agreements" that were allegedly intended to "flesh out" the details of each of the roles that the parties would play in their venture. In addition, not all the parties who were required to contribute capital had that capital available at the time of closing on the deal.

The court also rejected an "unclean hands" defense.

 

 

Delaware will retain jurisdiction over a dissolution claim notwithstanding a mandatory New York forum selection clause, according to the recent Delaware Court of Chancery opinion in Seokoh, Inc. v. Lard-PT, LLC, C.A. No. 202-0613-JRS (Del. Ch. March 30 2021). This case involved the petition for dissolution of a Delaware LLC while litigation between the parties also was filed in New York. The LLC agreement had a deadlock provision but it was not effective for resolving the parties’ dispute. For example, there was no formula or deadline for a buyout.

Several important statements of Delaware law make this 45-page decision noteworthy (and blogworthy), as well as well-worth the time to read the whole opinion for those who need to know the latest iteration of Delaware law on the following topics:

  • Although Delaware courts generally enforce forum selection clauses, even when they require disputes to be litigated in a foreign forum–this is a notable exception: when a petition for dissolution of a Delaware LLC is filed pursuant to Section 18-802 of the Delaware LLC Act. See footnote 43. (The parties in this case agreed to the foregoing exception and the Court noted that they were correct in doing so.)
  • This opinion features a useful recitation of the factors the court will consider under Section 18-802 in order to determine if the statutory prerequisites for an LLC dissolution have been satisfied. See Slip op. at 24 to 27 and footnotes 119 to 128.

A recent blog post highlighted on these pages featured another Chancery decision addressing a deadlock in an LLC that formed the basis of a dissolution petition.

A recent Court of Chancery decision is almost as noteworthy for what it decided as for what was not decided. In JUUL Labs, Inc. v. Grove, C.A. No. 2020-0005-JTL (Del. Ch. Aug. 13, 2020), Delaware’s court of equity enforced an exclusive forum selection clause in a company charter, based at least in part on the internal affairs doctrine, to prevent a stockholder in a Delaware corporation from filing suit in California in reliance on a California statute to demand the inspection of corporate records, notwithstanding a California statute that appears to allow a stockholder to sue in California for corporate records if the Delaware company has its principal place of business in California.

What the court did not decide is whether a stockholder may contractually waive her rights under DGCL section 220. Count this writer as a skeptic on that point. The court reviewed several overlapping agreements, such as a stock option exercise agreement, that the stockholder signed and that purported, at least in the company’s view, to waive inspection rights under DGCL section 220. Some of the agreements were governed by Delaware law and some by California law.

This decision could be the topic of a law review article due to the many core principles of corporate law and doctrinal underpinnings the court carefully analyzes. Alas, for now, I’ll only provide a few bullet points with an exhortation that the whole opinion be reviewed closely.

    • The court provides an in-depth discussion of the foundational concepts that undergird the internal affairs doctrine as it applies to the request for corporate records, as well as related constitutional issues that arise.
    • But footnote 7 acknowledges contrary authority that suggests that a local jurisdiction may apply its law to a demand by a local resident for corporate records of a foreign corporation.
    • The court compares DGCL section 220 with its counterpart in the California statutory regime.
    • The exclusive forum selection clause in the charter was addressed, and the court explained that but for this provision, the California court would be able to apply DGCL section 220.
    • Importantly, the court emphasized that is was not deciding whether a waiver of DGCL section 220 rights would be enforceable. Although at footnote 14 the court provides citations to many Delaware cases that sowed doubt about the viability of that position–but then the court also cited cases at footnote 15 that more generally recognized the ability to waive even constitutional rights.
    • Footnote 16 cites to many scholarly articles, and muses about the public policy aspects of the unilateral adoption of provisions in constitutive documents, such as forum selection clauses in Bylaws. Early in the opinion, at footnote 7, by comparison the court waxes philosophical about the concept of the corporation as a nexus of contracts–as compared to it being viewed as a creature of the state. The latter view has implications about the exercise of one state’s power in relation to other states, especially when private ordering may be seen as private parties exercising state power by proxy.
    • By coincidence or otherwise, this decision was published the same week that a California court in another case refused to enforce a Delaware forum selection clause because the California court ruled that forcing a California resident to litigate in the Delaware Court of Chancery would deprive that resident of a constitutional right to a jury trial.
    • The foregoing hyperlink leads to an article in Delaware Business Court Insider of Aug. 7, 2020, that describes an apparent settlement to allow the case to proceed in Delaware Superior Court, a trial court of general jurisdiction with juries available. The counterpart suit in Delaware has its own procedural history. See William West v. Access Control Related Enterprises, LLC, et al., C.A. No. N17C-11-137-MMJ-CCLD, opinion (Del. Super. June 5, 2019).

Delaware law allows for non-signatories to be bound by a forum selection clause if a three-part test is met, and a recent Delaware Court of Chancery opinion provides an analysis of those factors while granting a motion to dismiss in Highway to Health, Inc. v. Bohn, No. 2018-0707-AGB (Del. Ch. April 15, 2020).

The most noteworthy aspects of this pithy decision are: (i) a reminder that Delaware enforces forum selection clauses; and (ii) that a non-signatory can be bound by a forum selection clause if a three-part test is satisfied. See footnotes 46-47 and accompanying text. The directors of a Delaware company sought a declaratory judgment against non-residents of Delaware regarding a dispute about stock-appreciation-rights (SAR) that, by contract, required the board to fulfill fiduciary duties towards the SAR holders.

Three-Part Test for Binding Non-signatories

The three-part test requires one to demonstrate that: (i) the forum selection clause is valid; (ii) the non-signatories are third-party beneficiaries; and (iii) the claims arise from their standing relating to the agreement. Slip op. at 15. The third element of the test was not satisfied based on the facts of this case because the agreement containing the forum selection clause was not the same agreement that gave rise to the substantive claims brought by or against the non-signatories.

Long-Arm Statute and Specific Personal Jurisdiction

This decision also features an analysis of the Delaware long-arm statute, and explains why the “specific jurisdiction” requirements under Section 3104(c)(1) of Title 10 of the Delaware Code were not satisfied because there was no relevant act that actually occurred in Delaware. The Court factually distinguished a case that found specific jurisdiction based on an amalgamation of factors that included: Delaware lawyers drafting the agreement at issue; a Delaware choice-of-law provision; and issues related to the sale of capital stock in a Delaware company. See NRG Barriers, Inc. v. Jelin, 1996 WL 377014 (Del. Ch. July 1, 1996).

Although the plaintiffs in this case did not avail themselves of the opportunity, the Court observed that limited discovery may be allowed in connection with the plaintiff satisfying its burden of proof to establish personal jurisdiction over defendants.