Corporate Control in the Courtroom
Corporate litigation has long followed a predictable pattern. When a corporation announces a restatement or similar bad news, shareholders race to the courtroom, filing nearly identical complaints in multiple courts. Congress sought to halt this practice in federal securities cases through the Private Securities Litigation Reform Act, but the practice continues unabated in state law cases. The Delaware Court of Chancery has been the clear loser of this filing strategy. Empirical evidence suggests that shareholder lawsuits are leaving Delaware in droves. Defense lawyers even claim that plaintiffs now use an “Anywhere but Chancery” approach when filing state law class actions and derivative suits.
The Delaware Court of Chancery recently suggested one way for corporations to protect themselves from these practices. Last summer, Vice Chancellor Laster stated in dicta that “if boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution,” these corporations should adopt a charter provision selecting this forum as the exclusive venue for shareholder lawsuits. This idea was not unprecedented—a small number of companies had already included such provisions in their governing documents—but it was the first time (to my knowledge) that the concept received judicial approval. The defense bar quickly picked up the charge, with Wachtell, Lipton, Rosen & Katz recommending to its corporate clients that they adopt a charter amendment requiring that the Delaware Court of Chancery be the “sole and exclusive forum” for any breach of fiduciary duty suit filed against the company or its officers, directors, or shareholders. A recent memorandum by Latham & Watkins reports that more than 70 companies have included these provisions in their bylaws or charters.
This development raises intriguing questions about how much control corporations should have when it comes to lawsuits filed by their shareholders. If corporations can choose the venue of these suits, can they also control other aspects of the litigation? As just one example, could a corporation adopt a charter provision limiting who can file a shareholder derivative suit on its behalf? Under current state law, any shareholder can file a shareholder derivative suit on behalf of a corporation. The law imposes minimal adequacy requirements, but otherwise a shareholder who owns as little as a single share of stock in a given corporation can file a multi-million dollar lawsuit on the corporation’s behalf. This power is unprecedented in the corporate world—shareholders generally do not have any individual power unless they own a majority of the corporation’s shares. The few exceptions to this rule, such as proxy access rules, require shareholders to own a certain percentage of shares (usually 5 percent). Given the problems in many shareholder lawsuits, I imagine that standing limitations might be appealing to many corporate boards.
Alternatively, could a corporation adopt a charter or bylaw provision requiring that shareholder claims be subject to arbitration? Part of the risk in a shareholder lawsuit is the uncertainty over how the claims will fare before a judge or jury. Corporations might try to alter the settlement dynamics by mandating that these claims be decided in arbitration.
I am not sure if provisions of this type would pass judicial muster, but I would not be surprised to see corporations test these limits over the next several years. The law does offer some general guideposts that might help corporate lawyers think about these questions. First, corporations should include these provisions in corporate charters, not bylaws. Charter amendments must be approved by the board and a majority of the shareholders; bylaw amendments, in contrast, can be approved by the board acting alone in most instances. It is one thing if the shareholders approve limitations on the board’s liability. It is obviously more problematic if the board limits its own liability. The Northern District of California recognized this point last year, invalidating a bylaw provision that purported to establish Delaware as the sole venue for certain corporate lawsuits (as discussed here).
Second, corporations likely cannot alter the substantive law at issue in the lawsuit. Some corporations might not be content tinkering with the procedural rules and might try to limit substantive fiduciary duties. Given recent judicial decisions, I cannot imagine that courts would allow such limitations. Nor do I think courts would allow procedural restrictions that have the substantive effect of eliminating shareholder lawsuits. For example, a corporation might adopt a provision stating that no shareholder can file a derivative suit on its behalf unless the shareholder owns at least twenty percent of the corporation’s stock. In most large public corporations, this restriction would have the practical effect of eliminating shareholder derivative suits, making it impossible to enforce the board’s fiduciary duties.
Third, any provision should only apply to conduct that occurs after the provision is adopted. A board should not be allowed to breach its duties and then adopt procedural protections that help shield it from liability.
Beyond these restrictions, my own view is that companies should be allowed to alter the procedural rules in shareholder litigation, at least in certain respects. But I would be interested in hearing the thoughts of others. Is there some obvious dividing line between venue provisions and standing rules, for example, that I am missing?