The Delaware Chancery Court’s ruling in Sciabacucchi v. Salzberg, et al. declared charter-based federal forum-selection provisions invalid and unenforceable to the extent that they apply to Securities Act claims—a ruling that has broad implications for corporate governance and for the accounting profession.
Sciabacucchi v. Salzberg, et al., C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018)
Last December, the Delaware Court of Chancery found that Delaware law prohibits corporations from including forum-selection clauses in their charters that require shareholder actions under the Securities Act of 1933 to be filed only in federal court. Granted, the Securities Act does require companies offering securities to the public to file registration statements with the SEC, and it does grant a private right of action under Section 11 for false or misleading information in those registration statements. Still, both state and federal courts are to have authority to hear and decide these cases, the reasoning being that federal law is the source of Securities Act claims, not a right or a relationship created under Delaware law. So Delaware corporations cannot regulate these claims through their charters or bylaws.
Stockholder challenged attempts to force post-IPO securities suits into federal court
In Sciabacucchi, three public Delaware companies—meal-kit service company Blue Apron Holdings, Inc., streaming device manufacturer Roku, Inc. and online personal styling service Stitch Fix, Inc.—adopted charter-based federal forum-selection provisions before launching their IPOs in 2017, all in an effort to push plaintiffs into the federal forum in the case of Securities Act claims. As you might imagine, the move was likely influenced by the perceived advantages for defendants in having the actions litigated in federal court. In fact, doing so has been known to reduce the risk of costly duplicative actions being filed in federal and state courts at the same time and to, instead, steer litigation to the federal forum where, in general, discovery is broader, summary judgment is more difficult to obtain, and the judges are thought to have more expertise in the area.
Matthew Sciabacucchi—the plaintiff in this case who purchased shares of common stock in connection with all three IPOs—challenged the legality of the federal forum-selection provisions by filing an action under Securities Act Section 11 (available on Thomson Reuters Checkpoint). He had standing to sue the (1) companies, (2) every individual who signed the registration statements, (3) every person who was a director at the time that the registration statements were filed, (4) every person who, with his or her consent, was named in the registration statements as being, or about to become, a director, (5) accountants and other experts who prepared or certified portions of the registration statements, and (6) underwriters. He decided, however, to bring action against the three Delaware companies and 20 signatories to their registration statements who served as their directors since they went public.
Court sided with stockholder
The defendants pushed back. In one of their several arguments, they claimed that they were justified in using their company charters to designate the federal forum as the exclusive one for hearing Securities Act claims because issuing securities and defending against securities lawsuits involve the business and affairs of the company and because a Securities Act Section 11 claim involves internal corporate relationships in that it seeks to hold corporate officials accountable for the content of registration statements. If your thinking is that company business and company affairs do not necessarily mean internal corporate affairs, then your thinking is in line with the reasoning of the Delaware Chancery Court. In fact, the Court disagreed with defendants’ argument, noting that Delaware corporations may adopt forum-selection clauses in their charters and bylaws only if the clauses are for matters related to the internal affairs of the corporation, meaning those governing the relationship between corporate managers (i.e., directors and officers) and stockholders (8 Del. C. §§102(b)(1), 109(b), 115). With a Securities Act claim, however, it is federal law, not Delaware law, that creates the claim, defines the elements of the claim, and stipulates who qualifies as a plaintiff and a defendant, making it an external-affairs claim. Delaware law does not govern external affairs, and simply because the plaintiff is a stockholder and the defendants include several directors does not change that fact.
Practical implications moving forward
It is not at all surprising that Blue Apron, Roku and Stitch Fix are considering whether to appeal the Sciabacucchi case to the Delaware Supreme Court. And that would not be such a bad idea because it would allow for more guidance on the matter from a higher court. In the meantime though, accountants, you should be mindful of the ruling when carrying out your financial reporting responsibilities. As noted earlier in the discussion, accountants are among the defendants who can be sued under a Securities Act Section 11 claim. Moreover, though you once had the benefit of having cases brought against you tried exclusively in, what is generally perceived to be, the corporate-friendly federal forum, now, in light of the ruling, Delaware charters and bylaws can no longer dictate the forum for post-IPO securities lawsuits and so these actions can be brought in either state or federal court.
As for Delaware companies, you should review, and amend if necessary, the forum-selection provisions in your charters and bylaws. And public companies in particular, you should file with the SEC any needed amended and restated charters and bylaws, as well as any needed updates to related disclosures in your periodic and current reports.
Another interesting implication relates to the fate of forum-selection clauses that mandate arbitration. If the Delaware Chancery Court ruling in the Sciabacucchi case stands, it would be bad news for you Delaware corporations seeking to use your charters and bylaws to subject Securities Act claims to arbitration. Though mandatory arbitration was not addressed in the Court’s decision, it is not a leap to think that the Court’s reasoning might also apply in that circumstance.
If, however, the Sciabacucchi case is overturned on appeal, then mandatory arbitration and federal forum-selection clauses in corporate charters and bylaws would likely become more widely-used tools to avoid Securities Act claims being brought in state court. An overturning of the case would also arguably constitute a violation of public policy, as it might blur boundaries between the scope of state and federal laws. In fact, Delaware law has traditionally regulated internal corporate governance affairs, while federal law has traditionally governed securities regulation. So validating federal forum-selection clauses in the case of Securities Act claims would be tantamount to saying that state corporate law could be used to regulate federal claims. This was actually another one of the arguments made by Mr. Sciabacucchi, and though it was not addressed by the Court, it remains worthy of note because of its potential far-reaching effects.