The Conference Board Governance Center Blog

Dec
19
2012

Exclusive Forum Provisions: Putting on the Brakes

By Claudia H. Allen, Co-Chair, Corporate Governance practice, KattenMuchinRosenman LLP

Responding to the wave of lawsuits being filed against Delaware corporations and their boards outside Delaware, a growing number of Delaware corporations adopted1 exclusive forum charter or bylaw provisions during 2011.2 These provisions, which began to garner attention in 2010, require that derivative actions, shareholder class actions, and other intra-corporate disputes be litigated exclusively in Delaware, in the Court of Chancery. Many Delaware corporations view forum selection provisions as a mechanism to reduce the cost and uncertainty of litigating Delaware law issues outside Delaware and to address the phenomenon of lawsuits brought outside Delaware for the primary purpose of obtaining attorneys’ fees.

As 2012 began, it appeared that companies going public, being spun-off, emerging from bankruptcy, or reincorporating in Delaware would continue to adopt exclusive forum charter provisions without the need for public shareholder approval, while companies that were already public would adopt forum selection bylaws through unilateral board action.3 The charter trend continued apace. However, as discussed below, the bylaw trend ground to a halt and a number of companies chose to repeal their exclusive forum bylaws.

Potential Solutions

The phenomenon of Delaware corporations being sued “anywhere but Delaware” has been most acute in connection with merger and acquisition activity.4 In a typical situation, soon after a deal is announced multiple lawsuits are almost automatically filed in the state where the target is headquartered and perhaps Delaware as well. These suits are then settled prior to closing for attorneys’ fees and additional disclosure, but without any economic recovery for shareholders. Essentially, attorneys’ fees are paid to allow the transaction to proceed, and such fees have been dubbed a “merger tax.”5

Other solutions to the proliferation of multi-jurisdiction litigation have been proposed, including mandatory arbitration of intra-corporate disputes and Congressional legislation, but these approaches raise legal and political issues. For example, mandatory arbitration provisions covering federal securities law claims are disfavored by the staff of the Securities and Exchange Commission (“SEC”), and the staff generally will not allow a company to go public with such a provision.6 In terms of a legislative solution, the U.S. Chamber of Commerce recently proposed that Congress require merger and acquisition-related litigation be brought in the seller’s state of incorporation.7 However, Congressional action requires political will and consensus at a time of paralyzing partisanship in Congress. Accordingly, to date, exclusive forum provisions adopted on a company-specific basis have gained the most traction, while, at the same time, attracting opposition from a number of constituencies.

Lawsuits Filed Against Companies with Bylaws

The landscape began to change markedly in February 2012 when the plaintiffs’ firms, Prickett, Jones & Elliott, P.A. and Kessler Topaz Meltzer & Check LLP, filed largely identical suits in the Delaware Court of Chancery against 12 Delaware corporations with board adopted forum selection bylaws. The corporations targeted were: Air Products and Chemicals, Inc., AutoNation, Inc., Chevron Corporation, Curtiss-Wright Corporation, Danaher Corporation, FedEx Corporation, Franklin Resources, Inc., Jack in the Box, Inc., Navistar International Corporation, priceline.com incorporated, SPX Corporation and Superior Energy Services, Inc.8 Seven of the twelve are members of the S&P 500. The coordinated filings represented a high-profile, preemptive attempt to test the validity of forum selection bylaws under Delaware law, while effectively serving as a warning to public companies contemplating adoption of such a bylaw.

Among the primary arguments raised in each suit are the following:9

  • The bylaw mandates that claims it covers must be brought in the Delaware Court of Chancery, regardless of whether the court has personal jurisdiction over the defendants or subject matter jurisdiction of claims in the action.
  • The bylaw is not a proper exercise of the board’s ability to enact bylaws under Section 109(b) of the Delaware General Corporation Law10 and the company’s certificate of incorporation.
  • The bylaw is not valid and binding because there was no mutual consent by each of the shareholders.
  • The bylaw is also invalid because it conflicts with federal constitutional and statutory provisions and impinges on federal jurisdiction and the jurisdiction of other state courts.
  • The bylaw is unreasonable and therefore is invalid. Moreover, the board breached its fiduciary duties of loyalty and care by enacting the “self-interested” bylaw “on an uninformed basis.”
  • The premise of the bylaw is that the Delaware Court of Chancery is best equipped to determine issues of Delaware corporate law. However, the bylaw seeks to force non-Delaware law issues to be litigated in the Delaware Court of Chancery.

Most of the 12 companies were sued in the run-up to their 2012 annual meetings, thus applying additional pressure to settle promptly. Ten of the targeted corporations promptly repealed their exclusive forum bylaws, and the suits against those corporations were dismissed on mootness grounds. Only Chevron Corporation and FedEx Corporation opted to litigate the underlying issues as to the validity of their forum selection bylaws and related fiduciary duty claims against their directors. In connection with the mootness fee petitions relating to the dismissed suits, some companies requested that the court delay ruling on fees until the suits against Chevron and FedEx were resolved. This argument was unsuccessful. Chancellor Strine stated: “I’m not going to decide a very hot issue and controversial issue under Delaware law unnecessarily at the instance of defendants who chose not to stand behind their bylaw.”11 The court ultimately awarded attorneys’ fees in nine of the ten suits, signaling that the mere adoption of an exclusive forum bylaw could result in litigation and the payment of fees. The tenth company, Danaher Corporation, demonstrated that its board had determined to repeal its bylaw before being sued.

While the exclusive forum bylaws adopted by Chevron and FedEx were virtually identical, Chevron amended its forum bylaw after being sued to address the arguments concerning subject matter and personal jurisdiction noted above. The amendments:

  • Expanded the permissible forum to include “any state or federal court in the State of Delaware,” thus recognizing the inherent limitations on the Court of Chancery’s subject matter jurisdiction;
    and
  • Included a carve-out for situations in which the Delaware Court of Chancery does not have personal jurisdiction over an “indispensable party.”

To date, a relatively small number of IPO companies, including Audeo Oncology, Inc., Performant Financial Corporation and The WhiteWave Foods Company, have followed the lead of Chevron by providing for exclusive jurisdiction in both the state and federal courts in Delaware. Expanding the permissible fora arguably undercuts one of the primary arguments in favor of Delaware exclusive forum provisions, namely, that the Court of Chancery and its highly regarded jurists are uniquely qualified to resolve intra-corporate disputes promptly in accordance with a well-developed body of case law.

A second lawsuit challenging Chevron’s forum selection bylaw was filed in March 2012 in the United States District Court for the Northern District of California.12 The complaint was largely copied from the corresponding state law complaint. On August 9, 2012, the court stayed the federal case for one year, based upon the previously initiated proceedings in the Delaware Court of Chancery. Ironically, the federal lawsuit resulted in Chevron simultaneously litigating multiple suits arising out of the same facts in multiple jurisdictions—the very fact pattern that exclusive forum provisions seek to address.

Lawsuits Filed Against Companies Seeking Shareholder Approval

Perhaps emboldened by their success in challenging exclusive forum bylaws, in April 2012, Prickett, Jones & Elliott, P.A. and Kessler Topaz Meltzer & Check LLP filed lawsuits against four companies planning to seek shareholder approval of forum selection provisions at their 2012 annual meetings. Three of those companies, Calix, Inc., Cameron International Corporation, and Fairchild Semiconductor International, Inc., planned to present charter amendments, while the fourth company, Hittite Microwave Corporation, planned to present an exclusive forum bylaw. Promptly after being sued, Calix, Inc., Fairchild Semiconductor International Inc., and Hittite Microwave Corporation withdrew the proposals from their annual meeting agendas. The fourth company, Cameron International Corporation, amended its proposed charter amendment and related proxy disclosures to address some of the personal jurisdiction, subject matter jurisdiction and other issues cited by the plaintiff.13 The Cameron proposal went to a vote and failed, receiving support from only 40.1 percent of the shares outstanding.14 Ultimately, the Court of Chancery awarded attorneys’ fees in all of these cases, other than the Hittite Microwave Corporation case, where the plaintiffs withdrew their fee petition.

Corporate practitioners have generally assumed that successfully challenging an exclusive forum charter provision, particularly one approved by shareholders, would be more difficult than challenging a bylaw adopted through unilateral board action. Since the charter cases described above were settled in the early phases of litigation, that premise, whether involving a facial challenge or a challenge to the application of a charter provision, has yet to be tested. It appeared that the validity of a forum selection charter provision might be tested in a class action suit filed in New York against FX Alliance, Inc. in connection with a proposed business combination.15 The company indicated that it intended to enforce the exclusive forum provision in its charter. However, the plaintiffs thereafter elected to refile in the Delaware Court of Chancery.16 One legacy of the charter lawsuits has been the inclusion of language in IPO prospectuses warning that a court could find exclusive forum charter provisions to be “inapplicable or unenforceable.”17

The extent to which the bylaw and charter lawsuits have affected the already limited willingness of public companies to put an exclusive forum provision to a shareholder vote is unclear. Apart from the four proposals cited above, only four corporations, Beasley Broadcast Group, Inc., Biogen Idec, Inc., Snap Interactive, Inc., and Sally Beauty Holdings, Inc., put exclusive forum amendments to a shareholder vote during the 2012 proxy season.18 All of those  proposals involved charter amendments, and all passed. However, the votes at these companies are likely not representative of broader shareholder sentiment due to company-specific factors:

  • The charter amendment at Beasley Broadcast Group, Inc. was approved by 98.6 percent of the shares outstanding, but the Beasley family holds over a 60 percent beneficial voting interest in Beasley Broadcast Group, Inc.19
  • Biogen Idec, Inc. already had a forum selection bylaw in place when shareholders were asked to approve a forum selection charter provision. The charter amendment was approved, but only by 56.2 percent of the shares outstanding, representing a relatively narrow margin.20
  • The charter amendment at Snap Interactive, Inc. was approved by 68.9 percent of the shares outstanding, but Snap Interactive, Inc. is a small cap company with a sole director who serves as Chairman, CEO, and President. The CEO also beneficially owns over 57 percent of the outstanding shares.21
  • The charter amendment at Sally Beauty Holdings, Inc. was approved by 73 percent of the shares outstanding, but Sally Beauty Holdings, Inc. had a private equity investor that beneficially owned 35.5 percent of the outstanding shares at the time of its annual meeting.22

The small number of proposals in 201223 is consistent with 2011, when only six charter amendment proposals went to a vote.24 All but one of the 2011 proposals passed.

Non-Binding Shareholder Repeal Proposals

Another prong of the 2012 campaign against exclusive forum provisions involved shareholder proposals. Four companies received non-binding repeal proposals from Amalgamated Bank Longview Funds:25 Roper Industries, Inc., Superior Energy Services, Inc., Chevron Corporation, and United Rentals, Inc. Of those companies, both Superior Industries, Inc. and Chevron Corporation were also sued based upon their exclusive forum bylaws. In an attempt to exclude the proposal from its proxy statement, Roper Industries, Inc. sought no action relief from the SEC, on the theory that the repeal proposal related to ordinary business operations and did not involve a significant policy issue.26 The SEC staff, however, denied the request.27 Ultimately, Roper Industries, Inc. and Superior Energy Services, Inc. elected to repeal their bylaws. By contrast, Chevron Corporation and United Rentals, Inc. opted to take the proposals to their shareholders.28 At both companies, the proponent and the company filed additional solicitation materials in an attempt to sway shareholders.29

Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis Inc., the influential proxy advisory firms, recommended supporting both repeal proposals.30 Chevron Corporation filed additional solicitation materials challenging ISS’ recommendation.31 Notably, those materials included an article by Richard H. Koppes, the former Deputy Executive Officer and General Counsel of the California Public Employees’ Retirement System (CalPERS), explaining why he personally supported Chevron’s exclusive forum provision:

Chevron is a perfect example of a company with an exceptionally strong record of good governance and shareholder rights with a forum selection provision that is narrowly drawn to address the meaningful economic impact to shareholders from defending multiple identical lawsuits. Chevron has an annually elected board (by majority vote) with a strong lead independent director, no antitakeover provisions and a robust history of working constructively with the shareholder community. Indeed Chevron had modified its forum selection provision in response to suggestions from shareholders and has used restraint in applying its provision, not seeking consolidation where there is a good reason for shareholders to file suit outside of Delaware. As a long-time shareowner myself in Chevron, I am comfortable deferring to the board on an economic question such as this because I believe this is a board that has shown good judgment and can be held accountable to shareholders if it fails to do so in the future.32

In its report on United Rentals, Inc., ISS acknowledged that the company had the good governance practices required by ISS’ case-by-case policy on forum selection provisions, and that the company had explicitly discussed harm resulting from two instances of multi-jurisdiction litigation in its proxy statement. Nonetheless, ISS concluded that the company had not demonstrated “material harm” from these proceedings,33 raising the practical question of what type of harm ISS would find to be material.34

The proposals at both Chevron and United Rentals were defeated by close to a two-to-one margin,35 thereby highlighting that shareholder sentiment on exclusive forum provisions is far from uniform. At the same time, the proposals did well, particularly for a new type of shareholder proposal.

Statistics Comparing Adoptions in 2012 to 2011

The multi-pronged opposition to forum selection bylaws described above appears to have had a tangible impact. When the data I have collected on 2012 adoptions of Delaware forum selection provisions is broken down to distinguish bylaw adoptions from charter adoptions, the trend is striking. As shown in Figure 1, of the 76 total charter and bylaw provisions adopted from February through October of 2011, 47 percent (36) were bylaws. For the comparable period of 2012, 78 provisions were adopted, of which only 10 percent (8) were bylaws. Thus, while the aggregate number of provisions for the two periods is approximately equal, the percentage of bylaws dropped from 47 percent to 10 percent. Moreover, no forum selection bylaws were adopted in June, July, September or October of 2012. It thus appears that established public companies considering a forum selection bylaw are sitting on the sidelines pending the outcome of the Chevron and FedEx lawsuits. This hesitancy to act also reflects an apparent understanding that merely adopting an exclusive forum bylaw could lead to a lawsuit or a shareholder proposal.

Monthly Breakdown of Charter and Bylaw Adoptions

Click to enlarge

An analysis of the eight exclusive forum bylaws adopted in 2012, reveals that six were adopted in connection with an IPO, business combination, or other special circumstance. Aspen Group, Inc., the sole company to adopt an exclusive forum bylaw in February 2012, adopted both a charter and bylaw provision in connection with a shell company merger. In March, M/A-Com Technology Solutions Holdings, Inc. adopted both a charter and bylaw provision in connection with its IPO, while Chevron Corporation amended its existing forum bylaw. In April, Infoblox, Inc. took the relatively rare step of adopting a bylaw, rather than a charter provision, in connection with its IPO. In May, Golfsmith International Holdings, Inc. adopted a forum selection bylaw bylaw on the same day that the company agreed to be acquired,36 thereby suggesting a specific concern about strike suits being filed. AVX Corp. also adopted a bylaw in May, but unlike the current generation of provisions, that bylaw designates the United States District Court for the District of Delaware sitting in New Castle County (or the state courts of Delaware with jurisdiction over New Castle County if the federal court lacks jurisdiction) as the exclusive forum. Only, Medgenics, Inc. and Spectrum Pharmaceuticals, Inc. adopted exclusive forum bylaws without special surrounding circumstances.

While eight exclusive forum bylaws were adopted in 2012, 15 companies have repealed exclusive forum bylaws, with 14 of the repeals occurring in 2012.37 Thus, the total number of Delaware corporations with exclusive forum bylaws is declining. When comparing charter and bylaw trends, it is also worth bearing in mind that the relative and absolute increase in the number of exclusive forum charter provisions did not result from companies that are already public making a choice between a charter provision and a bylaw. Rather, the increase largely appears to reflect concerns about the difficulty of obtaining shareholder approval after a company is public and the relative health of the IPO markets.

Figure 2 illustrates adoptions on a monthly basis from January 2011 through October 2012, again highlighting the drop-off in bylaw adoptions during 2012. Interestingly, Figure 2 indicates that bylaw adoptions dropped off sharply in January 2012, before the lawsuits were filed. It is not clear, however, whether specific factors contributed to the January 2012 drop-off.

Charter vs. Bylaw Adoption by Month

Click to enlarge

The Future

The aftermath of the 2012 bylaw (and charter) lawsuits stands in sharp contrast to corporate America’s response to the January 2011 decision of the United States District Court for the Northern District of California in Galaviz v. Berg.38 In that case, which was the first to test the validity of an exclusive forum bylaw, the court declined to dismiss a shareholder derivative suit against Oracle on the basis of its forum selection bylaw. As indicated in Figure 2, in the month following the Galaviz decision, the  number of forum selection bylaws adopted spiked, rather than tapered. A number of factors may help explain the differing reactions of public companies in 2011 and 2012. In particular, the federal court in the Galaviz case cited federal common law as the basis for its refusal to dismiss, without ever reaching the underlying Delaware law issues. By contrast, the clustered 2012 lawsuits involved a facial challenge to Delaware forum selection provisions and their adoption.

The outcome of the Chevron and FedEx bylaw cases could potentially reopen the door to public companies adopting exclusive forum bylaws, perhaps with modifications to address specific issues, or foreclose future adoptions.39 Should the Delaware Court of Chancery uphold exclusive forum bylaws in some form, or otherwise provide guidance on the scope of a permissible bylaw, many more companies are likely to adopt such provisions, particularly in light of the current litigation environment. Nonetheless, companies would still have to confront opposition from some shareholders and the practical issue of whether non-Delaware courts will defer to the Court of Chancery. The answer may well depend upon the jurisdiction and the facts of a specific case.

About the Guest Blogger:

Claudia H. Allen

Claudia H. Allen, Partner, Katten Muchin Rosenman LLP

Claudia H. Allen serves as co-chair of the Corporate Governance practice at KattenMuchinRosenman LLP. She counsels boards, management and investors in public and private companies on corporate governance matters and related issues, such as shareholder activism and engagement, shareholder proposals, defensive measures including shareholder rights plans, takeover preparedness, board/committee process and structure and fiduciary duties. Her practice also encompasses transactional matters, including private and public mergers and acquisitions, and securities matters, including compliance with the Dodd-Frank and Sarbanes-Oxley Acts.

A recognized speaker on corporate governance issues, Claudia has made presentations to the American Bar Association, the Association of Corporate Counsel, Institutional Shareholder Services’ Governance Exchange, the Minority Corporate Counsel Association, the National Investor Relations Institute and the Society of Corporate Secretaries & Governance Professionals. She has also appeared on CNBC’s Power Lunch and Squawk on the Street.

Claudia has been selected for inclusion in The Best Lawyers in America (2012–2013), the International Who’s Who of Corporate Governance Lawyers (2013) and Expert Guides’ Women in Business Law – Corporate Governance (2012). 

This post originally appeared in BNA Bloomberg 10 CARE 1286, 12/14/2012.


Footnotes for the blog article are available here.



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