Bylaws Not Contracts, Court Rightly Holds
In the first of many opinions likely to come, a California federal court last week refused to recognize a Delaware corporation’s by-law naming Delaware the exclusive place for derivative shareholder litigation. As noted here, on this hot issue in corporate law, Delaware courts no doubt would enforce such clauses, retaining litigation business, but other states may disagree.
Much of the fight in the case, Galaviz v. Berg, involving Oracle, concerned whether to take literally standard corporate law talk that classifies bylaws as “contracts” and describes the arrangement among corporate participants as a “nexus of contracts.” Oracle’s board, slavish to such rhetoric, classified the bylaw as a “contract” and urged that standard contract law principles applicable to choice of forum clauses apply.
The Galaviz court, rejecting such rhetoric, distinguished bylaws from contracts. Differences include how the Oracle board unilaterally adopted the bylaw change in 2006 without involving any Oracle shareholder, the challenged conduct occurred before the change was made, and claims involve directors who made the switch. Bylaws are not contracts and contract law principles do not apply.
The rhetoric of the corporation as a nexus of contracts was once widely-known to be merely useful imagery borrowed from the theoretical finance literature in the 1970s and 1980s. It was never intended to literally describe bylaws as a contract. But Delaware courts and some scholars over the last two decades seem to have gotten carried away with the metaphor, so that they actually think that bylaws are contracts. Oracle’s lawyers wrongly counted on that magic of making reality out of rhetoric to work outside of Delaware.