Corporate Coverage Considerations: California Appellate Court Confirms Enforceability of Delaware Forum Selection Bylaws
In an issue of first impression in California, a California appellate court has rejected a shareholder plaintiff’s effort to avoid enforcement of a Delaware company’s forum selection bylaw, despite the shareholder’s arguments that the bylaw was inconsistent with California law and was otherwise unreasonable given the manner and timing of its adoption. Drulias v. 1st Century Bancshares, Inc., __ Cal.Rptr.3d __, 2018 WL 6735137 (Cal. Ct. App. Dec. 21 2018). While Delaware law plainly authorizes such forum selection bylaws, this ruling by a non-Delaware court is a welcomed confirmation that these provisions can be enforced in proceedings brought outside of the state.
The defendant corporation, while headquartered in California, was incorporated in Delaware. Contemporaneously with announcing its merger with another entity, the company’s board of directors amended the company bylaws to add a forum selection bylaw designating Delaware as the “sole and exclusive forum” for inter-corporate disputes, absent the company’s written consent. Nonetheless, a company shareholder instigated a putative class action on behalf of all shareholders against the company and its board, alleging breach of fiduciary duty in connection with the approval of the merger, and filed that action in California state court. After initial settlement efforts failed, the corporation moved to dismiss the action, arguing that the new corporate bylaw required the action be litigated in Delaware. The trial court agreed, staying the action, and the plaintiff appealed.
On appeal, while the plaintiff did not dispute that his cause of action fell within the terms of the bylaw, he contended that the bylaw was unenforceable as conflicting with section 2116 of the California Corporations Code, which provides:
The directors of a foreign corporation transacting intrastate business are liable to the corporation, [or[ its shareholders . . . for the making of unauthorized dividends, purchase of shares or distribution of assets or false certificates, reports or public notices or other violation of official duty according to any applicable laws of the state or place of incorporation or organization, whether committed or done in this state or elsewhere. Such liability may be enforced in the courts of this state.
Plaintiff asserted that the second sentence of Section 2116 creates a right of California shareholders to sue directors of foreign corporations in California. The appellate court rejected this argument, noting that section 2116 codifies the internal affairs doctrine, confirming the widely recognized principle that only one state should have the authority to regulate a corporation’s internal affairs, which state is typically the state of incorporation. The language relied upon by the plaintiff codifies the related notion that other states need not decline to exercise jurisdiction over a corporate dispute merely because it involves the internal affairs of a foreign corporation. However, the appellate court noted, it does not require a California court to decline to exercise jurisdiction where the action “would be more appropriately and justly tried elsewhere.”
Plaintiff also contended that the bylaw should not be enforced because (1) it was unilaterally adopted by the board with no notice to shareholders; (2) its contemporaneous adoption with the merger was unfair; and (3) the corporation had negotiated a proposed stipulation of settlement in the California action (rejected by the court), which rendered its subsequent decision to enforce the bylaw unreasonable. The court rejected all three arguments. First, it reasoned that Delaware law permitted unilateral adoption of the bylaw and, as the plaintiff knew the company was a Delaware corporation, he had implicitly consented to such unilateral action. Second, it noted that the merger constituted a valid reason to adopt the bylaw, and that case law generally rejected the notion that there was anything inherently unreasonable about enforcing forum selection provisions adopted after alleged wrongdoing. Finally, while acknowledging that the company had substantively proceeded with the California action prior to filing its motion to dismiss, the court emphasized that such conduct was largely settlement-related and that California had a public policy in support of settlement. As a result, enforcement of the bylaw provision was not unreasonable given the limited nature of the California proceedings. Accordingly, the appellate court affirmed the trial court ruling that the bylaw provision was fully enforceable.
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Impact for D&O Insurers: Forum selection provisions in this context provide an obvious boon to carriers. As noted by the court, such provisions have the effect of consolidating M&A litigation in a single forum, thereby reducing litigation expenses. Further, as the provisions generally result in a Delaware forum for Delaware corporations, they provide an additional measure of predictability in these cases as the same decision-makers will address the repeat issues that arise in such corporate litigation.