The End of Securities Class Actions?

The Delaware Supreme Court's Ruling in Salzberg v. Sciabacucchi Raises More Questions Than It Answers

If the term "hotly anticipated corporate-law decision" is not a contradiction, it surely applies to the Delaware Supreme Court's recent ruling in Salzberg v. Sciabacucchi.¹ The question posed there was deceptively simple: May a corporation adopt a charter provision requiring that certain federal securities-law claims against the corporation and its directors and officers be brought only in federal court? Three corporations set to go public included language in their charters identifying federal court as the "exclusive" forum for claims brought under the federal Securities Act of 1933. In response, a stockholder brought suit seeking to have those forum-selection provisions declared invalid.

In a unanimous decision in March 2020, the Delaware Supreme Court rejected the stockholder's argument and upheld the charter language as a facial matter. For at least some claims under the 1933 Securities Act brought by some plaintiffs, the court ruled, forum-selection provisions are permissible; plaintiffs can indeed be forced to litigate those claims in federal court. That ruling would be a big deal in itself, given the influence over corporate law wielded by the courts of Delaware, where so many major businesses are incorporated.

But Sciabacucchi has also been closely watched because of what everyone expects to be the next big fight—over charter language requiring arbitration of securities claims. Since arbitration is typically conducted on a bilateral (one-on-one) basis, widespread adoption and acceptance of arbitration provisions could spell the end of securities class actions. That's the theory, at least. The Delaware Supreme Court touched on this issue only in passing, and its ruling leaves many of the relevant questions to be resolved in future cases. Still, Sciabacucchi arguably brings us one big step closer to a world in which securities claims are routinely arbitrated instead of litigated on a class-wide basis. The court's decision, and where things are likely to go from here, are discussed below.

How We Got Here

In the mid-1990s, Congress responded to a perceived flood of meritless securities class actions by passing legislation that (among other things) imposed heightened pleading standards and an automatic stay of discovery for certain private securities-fraud suits. The unintended consequence, however, was that plaintiffs' attorneys began filing their cases in state court, where those protections didn't apply or were applied without rigor. So Congress responded with new legislation, the Securities Litigation Uniform Standards Act of 1998 (SLUSA), another reform aimed at curbing abusive class actions.

But in 2018, in a case called Cyan, Inc. v. Beaver County Employees Retirement Fund,² the Supreme Court dealt a blow to those hoping to keep securities cases out of state court: It ruled that SLUSA had left state courts with concurrent jurisdiction over suits under the 1933 Securities Act; Cyan also required federal courts to remand such cases to state court in response to defendants' attempts to remove them. [Disclosure: Allon Kedem briefed and argued Cyan while an attorney in the Office of the Solicitor General.] Since that decision, the trend towards filing securities class actions in state courts has accelerated, with the result that securities litigation has become "considerably more complicated and presumably more expensive for defendants."³

Enter the forum-selection clause. Commentators had long argued that corporations should adopt language in their constitutive documents to channel securities suits into federal court and away from state court. The idea is that charters and bylaws are contractual in nature, and thus binding on shareholders; just as parties to a regular commercial contract may use a forum-selection provision to choose a preferred venue for resolving disputes, so may participants in the corporate relationship. Others have pushed back on the analogy, and the legality of corporate forum-selection has been hotly disputed. In the wake of Cyan, the debate has taken on even greater urgency.

Sciabacucchi

This case arises out of the 2017 initial public offerings of three corporations: Blue Apron Holdings, Roku, and Stitch Fix. Before filing their registration statements with the Securities and Exchange Commission, each company adopted a provision in its certificate of incorporation designating federal court as the exclusive forum for resolving claims arising under the 1933 Securities Act. The language of the three forum-selection clauses varied somewhat, but not in any way deemed material; two of the three provided:

Unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933. Any person or entity purchasing or otherwise acquiring any interest in any security of [the Company] shall be deemed to have notice of and consented to [this provision].

Matthew Sciabacucchi bought shares in the companies, either in their initial public offerings or shortly afterwards. He then filed a putative class action complaint against the companies and their directors, seeking a declaration that the federal-forum provisions were invalid as a matter of Delaware law.

The Delaware Court of Chancery, in a decision by Vice Chancellor J. Travis Laster, ruled in Mr. Sciabacucchi's favor.⁴ Relying on its understanding of "first principles" of Delaware corporate law, the court held that "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."⁵ In the court's view, claims under the 1933 Securities Act fell outside those corporate rights or relationships: Such claims don't "implicate the internal affairs of the corporation," it ruled, because the claims "arise from the investor's purchase of the shares," rather than from share ownership.⁶

The Delaware Supreme Court unanimously reversed. At the outset, the court emphasized that Mr. Sciabacucchi had brought a facial challenge, meaning it was his burden to prove that the forum-selection provisions could not operate legally "under any circumstances."⁷ In assessing whether Mr. Sciabacucchi had made that showing, the court turned first to Delaware law, examining two relevant statutory provisions.

Section 102(b)(1) of the Delaware General Corporation Law (DGCL) spells out the issues that can be addressed in a corporation's certificate of incorporation—broadly permitting "any provision" that manages the corporation's business and affairs, or "any provision" lawfully defining the powers of the corporation, its directors, and its stockholders.⁸ Federal-forum provisions can fit within that capacious language, the court explained, and also "provide a corporation with certain efficiencies in managing the procedural aspects of securities litigation."⁹ The court pointed to statistics showing a steep escalation in the number of suits filed in state courts under the 1933 Securities Act in the years since Cyan, including a large percentage filed in parallel in state and federal courts. Corporations thus may be well-served by channeling all such suits to a single federal forum. Nor did the court see any inherent inconsistency between forum-selection provisions and Delaware corporate law, which generally respects the right of corporations and their shareholders to agree upon terms that advance appropriate business interests.

Next, the court held that federal-forum provisions are consistent with Section 115 of the DGCL, which the Delaware legislature had added in 2015. Section 115 applies to "internal corporate claims," and forbids using a corporation's charter or bylaws to "prohibit bringing such claims in the courts of this State."¹⁰ But 1933 Securities Act claims—which arise under federal law, rather than Delaware law—do not fall within that prohibition, the court ruled.

Summarizing its interpretation of Delaware law, the court explained that corporations should be permitted to funnel at least some claims under the 1933 Securities Act to federal court. In particular, the court pointed to claims under Section 11 of the Act, in which the purchaser of a registered security can sue the issuing company, its directors, and anyone else involved in creating a false or misleading registration statement.¹¹ These claims don't fall within the category of "internal affairs" that must be litigated in Delaware courts; but they're also not necessarily so "external" that they cannot be addressed in the corporation's charter. At least where a Section 11 claim is asserted by an "existing" stockholder who already owns shares, and who bases his claim on the purchase of additional shares—as opposed to a first-time purchaser who previously owned no shares—the claim falls within what the court described as the "outer band": internal enough to be addressed in a charter provision, but external enough to be channeled to federal court.¹² And the existence of that "outer band" of claims, however large, was enough for the court to reject Mr. Sciabacucchi's facial challenge.

Having ruled that federal forum-selection provisions are permissible as a matter of Delaware law, the court went on to uphold them against Mr. Sciabacucchi's argument that they also violate federal policy. In Rodriguez de Quijas v. Shearson/American Express, Inc.,¹³ the US Supreme Court held that federal law permits parties to agree to arbitrate claims under the 1933 Securities Act. If parties can choose to arbitrate such claims, the Delaware Supreme Court reasoned, then stockholders who vote on a charter provision should be permitted to select a federal forum for litigating them, too.

The court also considered whether, in light of its decision, other states would be compelled to enforce forum-selection provisions as a matter of "horizontal sovereignty."¹⁴ Notwithstanding a provision channeling all 1933 Exchange Act claims to federal court, for instance, a plaintiff might file suit in the courts of a state other than Delaware. In such a situation, the sister state would not necessarily follow Delaware's lead in enforcing the federal-forum provision. But the Delaware Supreme Court identified "persuasive arguments" for doing so, including respect for shareholders' freedom of contract and traditional choice-of-law principles.¹⁵

Finally, the court addressed in a footnote the "concern" that if the federal-selection provisions were upheld in this case, "the 'next move' might be forum provisions that require arbitration of internal corporate claims."¹⁶ The court rejected that concern. "[A]t least from our state law perspective," the court explained, such arbitration provisions would violate Section 115's ban on charter or bylaw language that "prohibit[s] bringing [internal corporate claims] in the courts of this state.' "¹⁷

What's Next?

The decision in Sciabacucchi resolves one important issue: Delaware law permits language in corporate charters channeling at least some claims under the 1933 Securities Act to federal court. But in doing so, the decision raises a host of other questions (some of which are already being litigated) about the use of forum-selection language in constitutive documents. The answers will determine whether the demise of securities class actions is imminent or is instead—as Mark Twain said about rumors of his own death—greatly exaggerated.

Other types of securities claims

Because the plaintiff in Sciabacucchi raised a facial challenge to the forum-selection provisions, the Delaware Supreme Court was able to reject that challenge by identifying a single type of securities claim to which the provisions could validly be applied—namely, claims under Section 11 of the 1933 Securities Act. The court didn't consider whether other types of securities claims could similarly be channeled to federal court.

There is reason to think the type of claim could matter. Section 11 claims are typically brought against the officers and directors of a company that has issued a security; as the Delaware Supreme Court explained, such claims "aris[e] out of the Board's disclosures to current and prospective stockholders in connection with an IPO or secondary offering."¹⁸ The court thus considered those claims to be a proper subject for a charter provision under Delaware corporate law, reasoning that the "drafting, reviewing, and filing of registration statements by a corporation and its directors is an important aspect of a corporation's management of its business and affairs and of its relationship with its stockholders."¹⁹

The same cannot necessarily be said of other securities-law claims. For instance, a claim under Rule 10b-5,²⁰ which implements § 10(b) of the Exchange Act of 1934,²¹ is often brought against someone other than a corporate officer or director—and often for conduct unrelated to the "corporation's management of its business and affairs and of its relationship with its stockholders." Privately filed Rule 10b-5 claims also require proof of reliance, a feature that focuses the claim on circumstances that are particular to the plaintiff, rather than inherent in the corporate relationship. It is therefore unclear whether the Delaware Supreme Court would approve use of a forum-selection provision for channeling such claims. The answer may well depend on the specific allegations involved in the claim, requiring the enforceability of the forum-selection clause to be determined on a case-by-case basis.

Suits by first-time stock purchasers

The Delaware Supreme Court similarly relied on the facial nature of the challenge in Sciabacucchi when conceiving of a hypothetical plaintiff whose claims could validly be channeled to a federal forum. The Court of Chancery had rejected use of forum-selection language for Section 11 claims on the premise that such claims are always external to the corporate relationship because they "arise from the investor's purchase of the shares," rather than from existing share ownership.²² But the Delaware Supreme Court rejected that premise as factually inaccurate: "[I]t is possible to have a scenario," the court explained, where "existing stockholders could assert that a prospectus relating to shares of stock the directors were selling in a registered offering, signed by the directors of a Delaware corporation, contained material misstatements and omissions."²³

The Delaware Supreme Court's response to the Court of Chancery—stating that a non-external claim was "possible," and pointing to an existing stockholder's suit as an example—suggests that a different result might be appropriate if the claim were instead brought by a plaintiff who was purchasing shares for the first time. In that case, it could be argued that charter language shouldn't be used to address such a claim, because the claim doesn't arise out of any pre-existing relationship between the corporation and its stockholders; it instead relates only to the formation of that relationship. On the other hand, any dispute brought by a litigant in his status as a shareholder is arguably a proper subject for a charter provision, even if the litigant is a first-time purchaser. The Delaware Supreme Court gave some support for this latter view when it identified, as examples of truly "external" claims, "a tort claim for personal injury suffered by the plaintiff on the premises of the company or a contract claim involving a commercial contract."²⁴ These examples are obviously far afield from shareholder suits.

All that can be said for certain at this point, however, is that suits by existing shareholders are sufficiently internal, while tort and commercial-contract suits are external. The grey area between those two extremes is still very much up for grabs.

Forum-selection language in corporate bylaws

The three companies at issue in Sciabacucchi adopted forum-selection provisions in their certificates of registration, which stockholders approved before the companies went public. In upholding the use of such provisions, therefore, the Delaware Supreme Court had no occasion to decide whether the same analysis would apply to analogous language adopted by the corporation in a post-IPO charter amendment or in its bylaws.

Again, the court's decision leaves ample room for interpretation. Under Delaware law, the court noted, forum-selection clauses that have been agreed upon contractually are presumptively enforceable; and "corporate charters are viewed as contracts among the corporation's stockholders."²⁵ But what about, for instance, a forum-selection provision adopted in a bylaw by a board of directors without shareholder input—would that be sufficiently contractual in nature? The opinion in Sciabacucchi can be read to support either view: It emphasized that "charter provisions must be subjected to and approved by a vote of the stockholders,"²⁶ but also praised state corporate law as being highly "flexible" because "it leaves the parties to the corporate contract (managers and stockholders) with great leeway to structure their relations."²⁷

Selecting a particular federal court

The forum-selection provisions at issue in Sciabacucchi required suit to be brought in "the federal district courts of the United States," without attempting to specify which federal court. But it's easy to imagine a corporation wanting to further limit that choice to a particular jurisdiction—perhaps the District of Delaware, or wherever the corporation has its principal place of business. The Delaware Supreme Court's decision doesn't shed much light on whether it would approve such a limitation, other than its observation that "Delaware forum provisions" have in recent years been "sanctioned" by the Court of Chancery and also "respected by other states."²⁸ A corporation's choice of another forum, by contrast, may or may not receive the same sanction, or command the same respect.

Arbitration clauses

As the Delaware Supreme Court acknowledged, "[m]uch of the opposition" to federal-forum provisions can be traced to concern about the "next" likely step: charter or bylaw provisions requiring arbitration of securities claims.²⁹ Allowing corporations to adopt arbitration-only language would profoundly change the legal landscape. Such clauses can—and increasingly do—specify that arbitration must be conducted on a bilateral (one-on-one) basis, and the US Supreme Court has made clear that, per the Federal Arbitration Act (FAA), that choice must be respected.³⁰ Companies could thus use arbitration provisions to opt out of class litigation entirely, at least for certain categories of securities claims.

The Delaware Supreme Court attempted to address this concern in a footnote. The court stated that, from its own "state law perspective," a mandatory-arbitration provision would be unlawful.³¹ Such a provision, the court explained, would violate the statutory ban under Section 115 of the DGCL on charter and bylaw language that prohibits bringing internal corporate claims "in the courts of this state."³² That response is unlikely to put the issue to rest, however. For one thing, the court had already held, earlier in its decision, that 1933 Securities Act claims "are not 'internal corporate claims,' [such that] Section 115 does not apply" to them.³³ That conclusion, which was based on the court's doubts that "the General Assembly intended to encompass federal claims within the definition of internal corporate claims," would seem to apply just as readily to arbitration provisions as to federal-forum provisions.³⁴

But even if the footnote were conclusive as to the impermissibility of arbitration clauses under Delaware law, that would only raise the further question whether such a state-law prohibition was consistent with federal law. The US Supreme Court has read the Federal Arbitration Act as establishing an "equal-treatment principle" that forbids states from discriminating against arbitration agreements.³⁵ A state statute that allowed forum-selection language opting for federal court, but forbade comparable language selecting an arbitral forum, would seem to run afoul of that rule. Even if the Delaware Supreme Court correctly identified Section 115 as a roadblock to mandatory arbitration of securities claims, therefore, there is good reason to think it would be preempted under the FAA.

That said, the extinction of the securities class action is hardly inevitable. Some corporations have resisted shareholders' calls to adopt mandatory-arbitration language, giving rise to proxy fights and litigation.³⁶ The Securities and Exchange Commission has thus far been unwilling to approve corporate registration statements that include arbitration clauses, although there are signs that at least some commissioners are open to the idea.³⁷ And commentators have argued that the FAA, which applies only when arbitration has been chosen through voluntary contractual arrangements, simply doesn't apply to the corporation-shareholder relationship.³⁸ The future of securities litigation is still yet to be written.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.