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Delaware Court of Chancery Upholds Boards' Unilaterally Adopted Forum Selection By-laws
Practical Law Legal Update 2-532-5111 (Approx. 7 pages)
Delaware Court of Chancery Upholds Boards' Unilaterally Adopted Forum Selection By-laws
by PLC Corporate & Securities
| Published on 27 Jun 2013 • Delaware |
The Delaware Court of Chancery ruled in Boilermakers Local 154 Retirement Fund v. Chevron Corporation that forum selection by-laws unilaterally adopted by the boards of directors of Chevron and FedEx were valid under Delaware law, and contractually valid and enforceable as forum selection clauses.
On June 25, 2013, the Delaware Court of Chancery issued an opinion in Boilermakers Local 154 Retirement Fund v. Chevron Corporation, holding that the forum selection by-laws that the boards of directors of Chevron and FedEx unilaterally adopted were valid under Delaware law, and contractually valid and enforceable as forum selection clauses.
Background
Section 109(a) of the Delaware General Corporation Law (DGCL) authorizes any Delaware corporation to provide in its certificate of incorporation that its board of directors can adopt, amend or repeal by-laws. The certificates of incorporation of the defendant corporations Chevron and FedEx each granted their respective boards this power. In an effort to control the costs associated with multi-forum litigation, the boards of Chevron and FedEx each unilaterally adopted a by-law providing that litigation relating to the corporations' internal affairs must be brought in the Delaware Court of Chancery (a course of action first recommended in dicta in In re Revlon, Inc. Shareholders Litigation). Chevron's board later amended its forum selection by-law to expand the forum to any state or federal court in Delaware with both subject matter and personal jurisdiction.
The plaintiff stockholders of both Chevron and FedEx separately sued the boards of directors in Boilermakers Local 154 Retirement Fund v. Chevron Corp. and Iclub Investment Partnership v. FedEx Corp. (respectively) for adopting the by-laws. The plaintiffs brought similar claims against the boards of ten other companies that had adopted forum selection by-laws, but those boards repealed the by-laws and the complaints against them were dismissed. The boards of Chevron and FedEx kept their forum selection by-laws and answered the plaintiffs' claims.
The plaintiffs argued for a declaration from the Court of Chancery that the forum selection by-laws:
- Are statutorily invalid because their subject matter is not a proper area for treatment in a corporation's by-laws.
- Are contractually invalid because they were adopted unilaterally by the boards and are therefore unenforceable against the stockholders.
The plaintiffs also brought fiduciary duty and other claims for which discovery was not complete, but the defendants moved to have a declaration made on the statutory and contractual validity claims first. For judicial expediency and in the interest of the parties, the Court of Chancery consolidated the two cases because of the similarity of the two by-laws and nearly identical complaints filed by the plaintiffs. The Court of Chancery also determined that a resolution of the validity claims could be made first and would be beneficial for other Delaware corporations who were unsure of the legality of forum selection by-laws.
Outcome
The Court of Chancery rejected both of the plaintiffs' claims, finding that the forum selection by-laws unilaterally adopted by the boards of directors of Chevron and FedEx were both valid under Delaware law and contractually valid and enforceable as forum selection clauses. The Court held that the plaintiffs failed to show that the by-laws:
- Did not address proper subject matters of by-laws under Section 109(b) of the DGCL.
- Can never operate consistently with the law.
By-laws Statutorily Valid
Section 109(b) of the DGCL permits a corporation's by-laws to contain any provision relating to the business of the corporation, the conduct of its affairs or the rights or powers of the corporation, its stockholders, directors, officers and employees. The by-laws adopted by Chevron and FedEx selected Delaware as the forum for the following types of suits:
- Derivative actions or proceedings brought on behalf of the corporation.
- Claims for breach of a fiduciary duty owed by any director, officer or other employee of the corporation.
- Claims arising under any provision of the DGCL.
- Claims governed by the internal affairs doctrine.
The Court found that the plain language of the by-laws clearly falls within the scope of Section 109(b) by addressing the rights of the stockholders in their role as stockholders and regulating where they may bring the enumerated claims against the corporation and its directors and officers (for language identical to the language in the adopted by-laws, see Standard Clause, By-laws or Certificate of Incorporation: Delaware Forum Selection). The Court noted that the by-laws only dictate where a plaintiff may bring a lawsuit, but do not limit what types of lawsuits may be brought. In addition, the by-laws do not attempt to select a forum for contractual or tort disputes (such as personal injury claims) in which the litigant is not bringing a claim in a stockholder role. Therefore, the by-laws adopted by the boards did not go beyond the authority granted in Section 109(b) and the certificates of incorporation.
The Court also addressed an argument that because forum selection is not a "traditional" subject matter for by-laws, it follows that it is an inappropriate matter for inclusion in a corporation's by-laws. In rejecting this argument, the Court cited the decision of the Delaware Supreme Court in Moran v. Household International, Inc. that authorized boards of directors to implement a poison pill for the purpose of defending against hostile tender offers. The Moran opinion, quoting Unocal, emphasized that Delaware's "corporate law is not static" and grows in response to developing needs.
Continuing the comparison with poison pills, the Court of Chancery noted that:
- As with poison pills, which are redeemable by the board, the Chevron and FedEx boards reserved the right in the by-laws themselves to waive the forum selection by-law if necessary.
- While stockholders cannot redeem a corporation's poison pill, they can repeal forum selection by-laws by a majority vote. Under Section 109(a) of the DGCL, the board's authorization in the certificate of incorporation to adopt, amend or repeal by-laws does not diminish the stockholders' prior right to do the same.
- Unlike a poison pill, which stands ready as takeover defense mechanism, the forum selection by-law must itself be raised as a jurisdictional defense if the corporation wishes to obtain a dismissal of a claim brought outside the selected forum.
By-laws Contractually Valid
The plaintiffs' second claim was that by-laws unilaterally adopted by a board using its statutory authority are not contractually binding because this method does not require the assent of the stockholders. The Court of Chancery rejected this argument for two reasons:
- The certificate of incorporation explicitly granted the power to adopt by-laws unilaterally. This put potential stockholders on notice that the by-laws could be unilaterally amended by the board. By purchasing the stock, the stockholder acknowledged the board's power to do so.
- The plaintiffs were relying on the "vested rights" doctrine, which holds that a board cannot modify by-laws that diminish or divest pre-existing stockholder rights without stockholder consent. The Court explained that this doctrine has been rejected wherever the corporation's certificate of incorporation or by-laws put potential stockholders on notice that the by-laws may be amended at any time by the board.
In rejecting the argument based on the "vested rights" doctrine, the Court also explicitly rejected the reasoning by a California federal court in Galaviz v. Berg, which held that by-laws adopted by the board are not like regular contracts because of the lack of stockholder assent. The Court considered the reasoning to be incompatible with the contractual framework for Delaware corporations and their stockholders under the DGCL (for more on the Galaviz decision, see Legal Update, California District Court Holds Forum Selection Clause in By-laws is Unenforceable). The Court emphasized that stockholders are protected by the DGCL, even where the board has been granted the power to adopt by-laws, because no corporation can diminish the stockholders own powers to adopt, amend or repeal by-laws under Section 109(a). Therefore, the stockholders can repeal the board-adopted by-laws, making the by-laws an "inherently flexible contract" between the stockholders and the corporation.
No Ruling on Hypothetical Situations
The plaintiffs also conjured several hypothetical "as-applied" challenges to argue that forum selection by-laws are inconsistent with law and therefore facially invalid. The Court rejected this approach, noting that courts do not provide advisory opinions on hypothetical situations. The Court further noted that, in the majority of situations, the forum selection by-laws would work without any of the issues presented in the hypotheticals.
Practical Implications
The Chevron decision upholds the power of a board to unilaterally adopt by-laws that specify the exclusive venue for claims relating to the internal affairs of the corporation. This will permit corporations to attempt to prevent multi-forum litigations, where the same issue is litigated in multiple forums or even in both state and federal courts. In the last three years, according to the Court's opinion, 250 publicly traded corporations have adopted this type of forum selection provision. Following this decision, more public companies can be expected to adopt forum selection by-laws and withstand challenges to them brought by activist shareholders.