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For many decades, Delaware has enjoyed a favored position as the first choice for incorporation.   Many U.S. companies incorporate in Delaware to benefit from its favorable tax and legal corporate environment.  And other states look to specialized Delaware courts for guidance, particularly the Delaware Court of Chancery, with its expertise and deep precedent in corporate and shareholder dispute resolution.  Delaware’s developed jurisprudence, with a perceived orientation to corporate interests, is unmatched in any other state and offers more guidance and certainty.

Now, the Delaware Supreme Court, in a closely-followed case, has endorsed the use of “federal forum” provisions in Delaware company charters.  These provisions require some forms of shareholder class actions to be filed in federal rather than state courts.  Commentators have acknowledged that driving cases to federal courts will significantly lower defense costs and could eventually ease the pressure on rising director suits and officer liability insurance rates.  The Delaware Supreme Court found the provisions serve the Delaware General Corporate Law’s (“DGCL”) underlying policies of “certainty and predictability, uniformity, and prompt judicial resolution to corporate disputes” for the benefit of all stakeholders.

On March 18, 2020, the Delaware Supreme Court released its unanimous ruling in  Salzberg, et al. v. Matthew Sciabacucchi, C.A. No. 2017-0931 (Del. 3/18/20).  The Court held that Delaware-chartered public companies can require litigation under the Securities Act of 1933 (“1933 Act”) to be filed in federal court rather than state courts, which are generally viewed as more plaintiff friendly.  The outcome validated “federal forum” provisions in company charters that require federal securities litigation to be filed in federal rather than state courts under Delaware law, overturning a Delaware Court of Chancery ruling.

The facts were straightforward.  The plaintiff shareholders purchased shares of the companies in their IPO’s and sought a declaratory judgment that the federal forum provisions were invalid.  The Delaware Chancery Court agreed that such provisions are invalid because the “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”

The Delaware Supreme Court, however, observed that the federal Private Securities Litigation Reform Act of 1995, which limited recoverable damages and attorneys’ fees, resulted in securities class action plaintiffs filing their cases in state court to avoid pleading strictures and remedial limitations in federal courts. In the next move in this jurisdictional chess match, some companies adopted the federal forum-selection provisions.

In light of these developments, the Delaware Supreme Court ruled “[t]his court has viewed the overlap of federal and state law in the disclosure area as ‘historic,’ ‘compatible,’ and ‘complementary.’”  “Accordingly, a by-law that seeks to regulate the forum in which such ‘intra-corporate’ litigation can occur is a provision that addresses the ‘management of the business’ and the ‘conduct of the affairs of the corporation” and is “facially valid” under Delaware law.  DGCL § 102 (b) (broad authorization of charter provisions not contrary to “settled rules of public policy.”)

The decision points to the U.S. Supreme Court’s unanimous March 2018 ruling in Cyan Inc. et al. v. Beaver County Retirement Fund et. al., 583 U.S.__, 138 S. Ct. 1061, 1066 (2018), which held that state courts have coextensive jurisdiction over securities offering litigation.  Cyan resolved a long-standing split among state and federal courts concerning state courts’ jurisdiction over securities class actions that exclusively allege claims under certain federal securities laws, specifically, the 1933 Act. Among other things, the 1933 Act provides private rights of action to certain securities offering purchasers. However, since the passage of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), both federal and state courts have disagreed on SLUSA’s jurisdictional impact with respect to 1933 Act claims. Some courts held that, after SLUSA, federal courts have exclusive jurisdiction over class actions asserting only 1933 Act claims.  Other courts, by contrast, concluded that SLUSA left intact state courts’ concurrent jurisdiction over such actions.

In a 9-0 opinion, the Supreme Court in Cyan held that state and federal courts have concurrent jurisdiction over class actions alleging only 1933 Act claims and that such claims are not removable to federal court.  This was a significant development for public companies engaging in securities offerings (and their directors and officers), underwriters, and investors who purchase in such offerings. It also impacted their respective advisors, including attorneys who practice in this area, and affected the allocation of judicial resources necessary to adjudicate such class actions.

From a defense perspective, enforcement of the forum provisions may now help companies avoid having to defend themselves in parallel proceedings in multiple jurisdictions. Lawsuits filed in multiple federal courts can be consolidated, by transfer and Multi-District Litigation proceedings, but those filed in multiple state courts cannot.  Moreover, costly and disruptive discovery may be delayed longer in federal courts, which reduces legal costs, and state court judges may be less knowledgeable about securities law than federal judges, who deal with it more frequently.

Undoubtedly, the plaintiff’s bar will resist then adapt.  As most public U.S. companies are incorporated in Delaware, and many have already begun to insert federal forum provisions in their charters, class action plaintiffs bent on state court jurisdiction will have to face the issue.  And it won’t be easy.  Most state courts, in the absence of local authority, defer to Delaware guidance in corporate disputes.  There is little reason to believe this ruling requiring these cases to be heard in federal court will be an exception.  Given the back-up in many state court dockets, it is likely many judges would be pleased to leave these types of class actions up to their federal counterparts.  Expect a flurry of motions on this issue when the courts resume more normal functions as COVID-19 hopefully wanes.

One wrinkle in the case bears watching, however.  Two major insurance brokers and six insurance companies, a veritable who’s who in D&O insurance, financed the appeal to the Delaware Supreme Court. It is clear they believed keeping class action cases involving IPO and secondary offering issuer, as well as certain M&A transactions involving stock, out of state court could help impact D&O rates. Underwriters may be more willing to provide coverage for companies going public or provide more competitive pricing in light of this ruling.  This form of collaboration beyond amicus filings could well be a model for future efforts to deal with insurance industry-wide legal challenges.

On the other hand, there are few cases to date following the Delaware Supreme Court’s lead.  In those jurisdictions that are less hospitable to insurance company interests, the organized effort may be cited as a reason to reject Delaware Supreme Court’s decision.  Another round of split courts could well lead to another visit with the Supreme Court.  Time will tell.

In the meantime, there is no disincentive for public companies to incorporate in Delaware or amend their charters to include federal forum provisions in order to secure federal securities class action protections.