Delaware Court of Chancery Upholds Validity of Forum Selection Bylaws

June 28, 2013

On June 25, 2013, the Delaware Court of Chancery upheld the facial validity of corporate bylaws, adopted by the boards of directors of Chevron Corporation and FedEx Corporation, that select Delaware as the exclusive forum for derivative suits and other litigation concerning the corporations’ internal affairs.  In an opinion captioned Boilermakers Local 154 Retirement Fund v. Chevron Corp., et al., No. 7220-CS (Del. Ch.) and IClub Investment Partnership v. FedEx Corp., et al., No. 7238-CS (Del. Ch.), Chancellor Leo E. Strine, Jr. held that these forum selection provisions are both (1) statutorily valid under 8 Del. C. § 109(b), which governs what types of provisions may be included in corporate bylaws; and (2) contractually valid and binding on stockholders, since the certificates of incorporation for both Chevron and FedEx explicitly empower their boards to adopt bylaw amendments unilaterally (i.e., without stockholder approval).

This decision provides a means for corporations to limit multijurisdictional litigation and forum shopping by channeling many specifically enumerated types of stockholder litigation into a single forum, potentially reducing the costs associated with duplicative multi-front suits.  The Chancery Court made clear, however, that stockholders maintain important protections against unilateral board action that is unwarranted, including the power to vote to repeal unwanted forum selection provisions and to contest the application of those provisions based on the facts of particular cases.  

The Court’s Decision

In late 2010 and early 2011, the boards of both Chevron and FedEx adopted bylaws that designated the Delaware Court of Chancery as the sole forum for derivative suits, fiduciary duty suits, suits arising under the Delaware General Corporation Law ("DGCL"), and internal affairs suits, absent written corporate consent to the selection of an alternative forum in particular cases.  The provisions were adopted "in response to corporations being subject to litigation over a single transaction or a board decision in more than one forum simultaneously, so called ‘multiforum litigation.’"  Slip op. at 11.  As the defendants explained, such multiforum litigation "imposes high costs on the corporations and hurts investors by causing needless costs that are ultimately born by stockholders."  Id. at 12.  Chevron later amended its forum selection bylaw to provide that such suits could alternatively be filed in Delaware federal court (assuming the existence of federal jurisdiction).  Many other corporations followed suit; in fact, in the last three years, "over 250 publicly traded corporations have adopted such provisions."  Id. at 12. 

In February 2012, plaintiffs filed lawsuits against Chevron, FedEx, and a host of other corporations whose boards adopted such bylaws (and even some corporations that offered their stockholders the opportunity to vote on whether to adopt similar provisions).  Plaintiffs asserted a series of challenges to the provisions, attacking their facial validity and arguing that the boards that adopted them acted in breach of their fiduciary duties.  Id. at 13-14.  Most of the defendant corporations repealed their forum selection bylaws (or withdrew their proposals from a stockholder vote) in response to these lawsuits.  Chevron and FedEx, however, maintained their bylaws, defended the lawsuits, and ultimately moved for judgment on the pleadings with respect to the claims that contested the facial validity of their forum selection bylaws.

Considering the Chevron and FedEx cases together, the court confronted two questions: first, whether the subjects that may be addressed in bylaws, according to 8 Del. C. § 109(b), include the selection of an exclusive forum for certain types of litigation; and second, whether forum selection bylaws are contractually binding on stockholders, regardless of whether the stockholders voted to approve them. 

First, the court held that the forum selection bylaws are authorized by 8 Del. C. § 109(b).  Under 8 Del. C. § 109(b), bylaws may "contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees."  8 Del. C. § 109(b).  Delaware courts have observed that "bylaws typically do not contain substantive mandates, but direct how the corporation, the board, and its stockholders may take certain actions."  Slip op. at 26.  Here, the court held that the forum selection bylaws are not substantive mandates; rather, "they are process-oriented, because they regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation."  Id. (emphasis in original). 

Second, the court held that, even though stockholders did not vote on the adoption of these bylaws, they were contractually valid and enforceable.  That is because the certificates of incorporation for Chevron and FedEx authorized their boards to act unilaterally to adopt bylaws.  The court rejected the plaintiffs’ contention that stockholders had a "vested right" in the bylaws that existed before the bylaw amendments.  Since Chevron and FedEx "put all on notice that the by-laws may be amended at any time, no vested rights can arise that would contractually prohibit an amendment."  Id. at 33 (quoting Kidsco Inc. v. Dinsmore, 674 A.2d 483, 492 (Del. Ch. 1995)) (emphasis in original).  As the court explained, "the Chevron and FedEx stockholders have assented to a contractual framework established by the DGCL and the certificates of incorporation that explicitly recognizes that stockholders will be bound by bylaws adopted unilaterally by their boards."  Id.

The court further noted that stockholders have several means of recourse to challenge unwanted or improper forum selection bylaws.  First, 8 Del. C. § 109(a) "vests in the shareholders a power to adopt, amend or repeal bylaws."  Id. at 34.  Second, the DGCL gives "stockholders an annual opportunity to elect directors," giving stockholders a "potent tool to discipline boards who refuse to accede to a stockholder vote repealing a forum selection clause."  Id. at 35.  Third, stockholders could request the board to waive the restriction in a specific instance.  Fourth, under the rule of The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972), plaintiffs can file suit in an alternative forum and then mount an as-applied challenge to a forum selection bylaw, arguing that the forum selection clause "should not be respected because its application would be unreasonable" under the circumstances of a particular case.  Slip op. at 38.  In addition, under the rule of Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971), a plaintiff may also argue that the "forum selection clause should not be enforced because the bylaw was being used for improper purposes inconsistent with the directors’ fiduciary duties."  Slip op. at 38. 

The court rejected the plaintiffs’ reliance on hypothetical examples of circumstances in which a corporation’s reliance on a forum selection bylaw might be inconsistent with the law, reasoning that Delaware courts "do not render advisory opinions about hypothetical situations that may not occur."  Id. at 39.  The court also explained that a clause in the bylaws that allows the corporations to consent to suit in an alternative forum "counsels against the need to [address plaintiffs’ hypothetical scenarios,] as by that tool, the board, as the statutory instrumentality charged with advancing the corporation’s best interests, is empowered to permit a plaintiff" to proceed with a suit in specific instances.  Id. at 46. 

For these reasons, the court granted defendants’ motions, dismissing the facial challenges to their forum selection bylaws.

Practical Considerations

The ultimate impact of the decision may yet be clarified by the Delaware Supreme Court, if the plaintiffs appeal, and by the courts of other jurisdictions that will be asked to enforce the forum selection bylaws.  Assuming the decision is affirmed, however, the decision will resolve two major grounds for challenging forum selection bylaws.

Corporations should consider whether and when to adopt forum selection provisions and carefully evaluate their potential advantages and disadvantages.  As noted in the opinion, forum selection provisions can benefit corporations and their stockholders by reducing the cost and disruption of multiforum lawsuits.  Forum selection provisions may also help address concerns over forum shopping by plaintiffs, who have recently sought to advance novel theories of liability (such as those witnessed over the past year challenging various types of proxy statement disclosures) in jurisdictions where corporate litigation is less frequent.  On the other hand, corporations may conclude that there are benefits to relying on traditional forum selection jurisprudence.  Other factors that corporations should consider when evaluating whether to adopt forum selection bylaws include the following:

1. The Certificate of Incorporation Must Authorize the Directors to Enact Bylaws Unilaterally.  One key factor in the court’s holding that the forum selection bylaws are contractually valid is that the certificates of incorporation for both Chevron and FedEx authorize their boards of directors to enact bylaws under Section 109(b) unilaterally, as is typical of the certificates of publicly traded corporations.  To the extent that a corporation’s certificate of incorporation does not so authorize its board of directors, this holding may not apply.  Corporations incorporated in states other than Delaware will also want to review their state of incorporation’s statutory and decisional law before moving forward. 

2. The Forum Selection Bylaw Cannot Regulate External Matters.  In this case, the forum selection bylaws designated Delaware the sole forum for derivative suits, fiduciary duty suits, DGCL suits, and other internal affairs suits.  The court did not hold that bylaws could select Delaware as the exclusive forum for lawsuits under the federal securities laws or other litigation concerning matters beyond corporate internal affairs, such as "a tort claim against the company based on a personal injury [a plaintiff] suffered that occurred on the company’s premises or a contract claim based on a commercial contract with the corporation."  Id. at 26. 

3. Plaintiffs Can Assert As-Applied Challenges to Forum Selection Bylaws.  Though the court did not address plaintiffs’ hypothetical challenges to the forum selection bylaws, it acknowledged that future plaintiffs could raise "as-applied" challenges to such bylaws in particular cases.  That is, rather than arguing that forum selection provisions in general are invalid, plaintiffs can argue that applying such a provision would be unreasonable, unjust, or inconsistent with directors’ fiduciary duties based on the circumstances of their case.  Id. at 36.  

4. A Forum Selection Bylaw Should Allow Exceptions at the Discretion of the Corporation.  Both the Chevron and FedEx forum selection bylaws contain clauses that allowed their boards to consent in writing to the selection of an alternative forum.  Because the corporations retained that discretion, the court reasoned, it was unnecessary to address the plaintiffs’ assertions that enforcing the forum selection provisions in some hypothetical circumstances might be inappropriate.  Corporations that do not retain the discretion to make such exceptions might be more vulnerable to arguments about instances in which forum selection provisions should not be enforced. 

5. Engagement with Stockholders Remains Advisable.  Although forum selection provisions may benefit stockholders, some stockholders may be wary of the provisions.  Similarly, although the Court of Chancery has rejected facial attacks to forum selection bylaws that were adopted unilaterally, such unilateral action may be disfavored by some stockholders or their advisors.  For example, companies that unilaterally adopt these provisions may receive stockholder proposals requesting the company to repeal the provision or put it to a stockholder vote.  In addition, Glass, Lewis & Co., Inc. recently affirmed that its policy generally is to recommend votes "against" the chair of a corporation’s nominating/governance committee if during the past year the board adopted a forum selection provision without shareholder approval.  To date, most companies that have submitted proposals to adopt forum selection provisions to a stockholder vote have seen their proposals pass, some by a comfortable margin, although some have failed to obtain approval.  In evaluating those proposals, as well as in evaluating stockholder proposals at companies that have adopted forum selection provisions, Institutional Shareholder Services looks at governance factors such as whether the company has an annually elected board, a majority vote standard applicable to uncontested director elections and the absence of a stockholder rights plan (unless the rights plan was approved by stockholders).  Paradoxically, however, ISS also considers whether a company’s stockholders have already been harmed by multiforum litigation, instead of recognizing the benefit of adopting a provision in advance of harmful litigation.  As reflected by these considerations, in connection with evaluating whether and how to adopt a forum selection provision, corporations should consider engaging with their stockholders to educate them on the benefits of a forum selection bylaw.  Boards considering adoption of forum selection provisions should assess their corporation’s stockholder base, and consult with their investor relations and proxy solicitation advisers, as part of that consideration.