The New Wave Of Breach Of Fiduciary Duty Forum-Shopping By Corporate Boards of Directors
[UPDATE: In related news, a federal judge in San Francisco recently ignored a forum selection bylaw that tried to force derivative suits to be filed in the Delaware Chancery Court. “A bylaw unilaterally adopted by directors…stands on a different footing [from contractual forum agreements],” Judge Seeborg wrote. “Particularly where, as here, the bylaw was adopted by the very individuals who are named as defendants, and after the alleged wrongdoing took place, there is no element of mutual consent to the forum choice at all, at least with respect to shareholders who purchased their shares prior to the time the bylaw was adopted.”
UPDATE II: The Harvard Forum on Corporate Governance discusses the case here.]
The business litigation blogs have been buzzing since Prof. Joseph A. Grundfest (Stanford Law) gave the annual Francis G. Pileggi Lecture (titled, “Choice of Forum in Intracorporate Litigation,”), in which Grundfest argued:
Privately held firms might best adopt elective forum selection provisions prior to an IPO, and publicly traded firms can adopt forum selection provisions in their charters or bylaws. Obtaining majority shareholder support for a charter amendment may be easier than some observers expect. If a corporation determines that it prefers not to amend its charter, board action is sufficient to amend the bylaws, as recently demonstrated by Chevron. The benefits of adopting a forum selection provision will likely exceed the costs for most entities. If this calculus is correct, there should be a large increase in the incidence of intra-corporate charter or bylaw forum selection provisions in coming years.
Prof. Steven M. Davidoff (UConn Law), a/k/a The Deal Professor, comments here:
If adopted, public corporations would put in place a bylaw or charter provision to provide that all shareholder litigation must take place in the state of incorporation (e.g., Delaware). The provision would be phrased in one of two ways: as a requirement that all shareholder litigation would occur in the jurisdiction of incorporation or as an option for the corporation to elect that all shareholder litigation would occur in the state of incorporation.
This provision would only be effective for state law claims involving breaches of fiduciary duty and the like, not federal claims, including federal securities fraud charges.
Since a majority of public companies are incorporated in Delaware, the net effect of the provision would be to channel the bulk of this litigation to that forum. This would have important implications since there is at least some evidence that plaintiffs have been drifting away from bringing suit in Delaware because of fears of adverse judgments. These provisions would be a response to claims that these shareholder plaintiffs are forum-shopping, selecting the jurisdiction most favorable to their suit.
As Davidoff notes, these provisions have been around for a while, but have taken off since Vice Chancellor J. Travis Laster of the Court of Chancery casually noted in the Revlon opinion in March that “if boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution, then corporations are free to respond with charter provision selecting an exclusive forum for intra-entity disputes.” Vice Chancellor Laster backed it up with a whopper of a footnote with supporting references for the idea.
Since that footnote a mere seven months ago, twenty-three companies have adopted such provisions, including giants like Chevron.
Let’s pause for a second and consider that important empirical fact. For nearly a century, Delaware has been the preeminent jurisdiction for incorporation and reincorporation of large companies with nationwide operations. Even private corporations, like Facebook, are drawn to it.
There’s a cottage industry of legal scholarship analyzing the preeminence of Delaware. Corporate officers and directors (and their defense lawyers) have maintained that Delaware is preferable because it has superior corporate law, in the sense that Delaware corporate law is more predictable — and thus less likely to result in litigation, and thus the expenses of defense and liability — than the laws of other jurisdictions. Activist shareholders (and their trial lawyers), in turn, have retorted that corporate officers and directors only prefer Delaware law because it is particularly friendly to them, and particularly unfriendly to shareholders alleging fraud, malfeasance, or breach of fiduciary duty.
There’s scholarship both ways; see, e.g., “The Mystery of Delaware Law’s Continuing Success,” which “challenges the widely held view that Delaware corporate law is dominant because it possesses superior traits, such as a well-understood statute, many judicial decisions interpreting the law, and wise and experienced judges administering that law.”
I don’t want to get into the details of that scholarship, but, like I said, we need to consider an important empirical fact: Delaware corporate law is so unpredictable that a mere footnote in a trial court opinion prompted nearly two dozen corporations to amend their charters or bylaws. If Delaware corporate law was really as clear as the officers and directors say it is, they wouldn’t have needed a court to tell them they could insert forum-selection clauses into their charters.
Which brings us to the issue at hand. Reflecting the inherent pro-management, anti-shareholder bias in much of the precedent and scholarship, nobody hesitates to call it “forum-shopping” when shareholders choose the jurisdiction most favorable to their suit, but it’s presumably “efficient and value-promoting” when officers and directors choose the jurisdiction most favorable to their defense.
Why would officers and directors want to have all litigation occur in Delaware? For the same reason that they want to incorporate in Delaware: because they believe Delaware to have some of the least-shareholder-favorable law in the country.
Such belief, although empirically questionable — as one minor example, as the unofficial court reporter for the Delaware Court of Chancery, Francis G.X. Pileggi, notes, there’s a “relative paucity of analysis” on the fiduciary duties of officers, one of the key issues affected by the forum-selection changes — is not unreasonable. With all that in mind, Davidoff drops a bombshell:
This is an odd thing to say, but litigation can have a social purpose.
It’s not an odd thing for trial lawyers like me to say. Indeed, none of what Davidoff says is odd:
I think Professor Grundfest is right, although I have a lingering concern over the effect of solidifying jurisdiction with Delaware.
We will most likely have less shareholder litigation and this will be viewed by many as a significant benefit, but this may also have effects in terms of limiting the ability of shareholder lawyers to bring suit when there is a real case. This decline in cases may also hamper the development of Delaware doctrine on the subject.
These days most deals face litigation. This is a cost, but there are benefits in terms of keeping the Delaware court consistently engaged in the evolving deal flow. Professor Grundfest comes out in favor of these opinions since he looks at both sides of the conflict and comes down in the face of consistency given both conflicts.
I think he has another good point here: Given the high quality of the Delaware judiciary and the need to keep the quality and consistency of its law, these clauses deserve a hard look. They might not change the landscape as much as plaintiffs’ lawyers fear because Delaware will still have incentives to keep litigation in its courts to keep its doctrine developing, albeit most likely at a lower pace to exclude clearly spurious suits.
This “development of Delaware doctrine” goes hand-in-hand with the predictability of Delaware law. Indeed, it wasn’t until last year, in Gantler v. Stephens, that the Delaware Supreme Court ruled that officers had the same fiduciary duties as directors. Lawsuits serve important social purposes beyond merely compensating injured parties — lawsuits are the only way in which the judiciary can speak on what the law actually is, thereby guiding future parties and settling the nature of relations.
Getting back to the overall point, though, why do we need these forum selection clauses in the first place? “Clearly spurious suits” in far-flung jurisdictions tend to be transferred to the correct jurisdiction or they die a quick death by dismissal, and there’s no empirical evidence to my knowledge of a real problem with “clearly spurious suits” alleging breaches of fiduciary duties by Delaware corporations. (The little bit of empirical evidence there is relating to shareholder lawsuits all involves federal securities class actions, which would be unaffected by the forum-selection clauses, and even that “evidence” sits on shaky ground.)
Grundfest weighs the pros and cons of the forum-selection clauses and comes up with:
Plaintiff counsel are susceptible to well known conflicts of interest:
Simple example: Plaintiff counsel prefer jurisdictions that award the highest attorneys fees (all other factors equal), even though those awards reduce net recoveries to investors.
Allowing plaintiff counsel to control forum selection therefore cannot invariably promote shareholder welfare.
It makes superficial sense, but “award [of] the highest attorneys fees” is often a low priority because the “other factors” are never equal. The primary factors considered by plaintiff’s counsel — typically compensated on a purely contingent fee basis, even in class action cases involving a lodestar analysis — when choosing the forum are (i) the likelihood of success; (ii) the likely size of recovery; and (iii) the likelihood of transfer to a different venue. On all three of those factors, their interests are aligned precisely with those of the shareholders. The possibility of higher fees in some jurisdictions may enter into plaintiff’s counsel’s mind, but it takes a backseat to the overall merits of the action, since the attorney’s fees in a losing case are not just “zero,” but in fact negative given the time and money spent on the case. Moreover, I wouldn’t be surprised if there was more variation in attorney’s fees awards among judges within a particular venue than across multiple venues.
In contrast, as Grundfest notes, “Management may want the case heard in the jurisdiction least likely to protect shareholder interests against management over-reaching.” Indeed, that’s the main reason why they want to choose Delaware for everything: to protect themselves, not to benefit the shareholders.
Which makes me wonder about the viability of these provisions when adopted without clear shareholder consent. As we saw in eBay v. Newmark, fiduciary duty cases in Delaware can have a serious bite, even when the majority ownership opposes the lawsuit. What’s going to happen when the board of directors adopts one of these resolutions, or pushes out to the shareholders an ambiguous amendment to the charter, but can’t show any non-speculative evidence that Delaware is an inherently better venue for shareholders?
Sounds like an invitation to (successful) litigation for me; so much for predicability and efficiency.