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Court Upholds Facial Validity of Board-Approved Bylaws

July 10, 2013
Lewis H. Lazarus
Delaware Business Court Insider

Roscoe Pound once wrote that "law must be stable and yet it cannot stand still." The Delaware Supreme Court in Unocal v. Mesa Petroleum, 493 A.2d 946, 957 (Del. 1985), likewise noted that "our corporate law is not static." Circumstances change and the law cannot be so inflexible as to require the law to stand still. Recently, the burden and expense of stockholder litigation in multiple forums, particularly in merger cases, has increased, creating the additional risk that a court other than the appellate court in the state of incorporation will resolve novel and fundamental questions affecting the internal affairs of a corporation. It is to address this threat that the directors of Chevron and FedEx (and 250 other public corporations) used the power conferred in their certificates of incorporation to adopt bylaws that made Delaware the exclusive forum to bring suit for matters involving the internal affairs of the corporation. In Boilermakers Local 154 Retirement Fund v. Chevron, Civil Action No. 7220-CS (Del. Ch., June 25, 2013), Chancellor Leo E. Strine Jr. echoed Pound and followed Unocal to find that the mere fact that Section 109(b) of the Delaware General Corporation Law had not previously been used to create binding forum-selection clauses for specified shareholder litigation did not preclude boards of a Delaware corporation from so acting today. In so holding, the court provides a useful primer on the standard applicable to facial challenges to bylaws, and a clear rationale for why a board-adopted forum-selection clause is valid statutorily and why it creates a contractual obligation binding on the stockholders even though they did not approve it.

Stockholders Bear Burden of Establishing Invalidity

Delaware law presumes the validity of bylaws. A plaintiff challenging the facial statutory and contractual validity of a bylaw bears the burden of showing "that the bylaws cannot operate lawfully or equitably under any circumstances." To prevail, a plaintiff must show that the bylaw does not address a subject matter within the scope of Section 109(b) and can never operate consistently with law. The court emphasized that whether a bylaw that serves a legitimate purpose may also be used inequitably is irrelevant to its determination of facial statutory and contractual validity. Such a challenge can occur when there is a real-world, extant controversy over the enforcement of a forum selection clause. "By long-standing, settled law, such as-applied challenges are to be raised later, when real-world circumstances give rise to a genuine, concrete dispute requiring judicial resolution," the opinion said.

Board-adopted Forum-Selection Bylaws are Statutorily Valid

The bylaws at issue require all disputes brought derivatively or involving the law of fiduciary duty, the Delaware General Corporation Law, or the internal affairs of the corporation to be resolved exclusively in the state or federal courts of Delaware. They are intended to address the threat posed to corporations and their stockholders of expensive multiforum litigation arising out of a single corporate act. As such, the court had little difficulty finding the bylaws to be within the subject matter of Section 109(b) as "relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees." The court found the bylaw to be similar to other process-oriented bylaws by merely regulating where a stockholder may sue, not what he or she may sue for or the kind of remedy he or she may seek. The court distinguished this from a bylaw that purported to regulate where a stockholder with a tort claim for injury suffered on corporate premises might bring suit. The latter would fail because, unlike the bylaws at issue, they would be directed at the rights and duties of parties other than as stockholders.

Three other points supported the validity of the bylaw. The court found it inconceivable that "choosing the most obviously reasonable forum — the state of incorporation, Delaware — so that internal affairs cases will be decided in the courts whose Supreme Court has the authoritative final say as to what the governing law means, somehow takes the forum selection bylaws outside of [Section] 109(b)'s broad authorizing language." Second, the board remains subject to breach of fiduciary duty claims if a stockholder could show in a real case that the board acted inequitably in adopting the bylaw. Finally, stockholders by majority vote retain the right to eliminate forum selection clauses just as they have the indefeasible right to repeal all bylaws.

Bylaws Create Obligations Binding on Stockholders

Critical to the court's analysis was its rejection of plaintiffs' argument that the forum selection bylaws could not be valid because the plaintiffs never approved them. This argument, said the court, misapprehends Delaware law. Stockholders who buy stock in a Delaware corporation do so knowing their charter and bylaws are subject to amendment, including by the directors where their charter so provides. The court thus rejected plaintiffs' reliance on Galaviz v. Berg, 743 F. Supp. 2d 1170, 1174 (N.D. 2011), which rejected a board-approved bylaw because the stockholders had not assented to it because that view failed to appreciate "the contractual framework established by the DGCL for Delaware corporations and their stockholders." While the court declined to address all of the plaintiffs' hypothetical parade of horribles, it did note that, like all forum selection clauses, a stockholder could sue elsewhere and attempt to argue invalidity due to "fraud, undue influence or overweening bargaining power" under The Bremen v. Zapata Off-Shore, 407 U.S. 1, 10 (1972).

Avoid Overreaching When Adopting Provisions

The Court of Chancery's determination that board-adopted bylaws to mandate forum selection in Delaware for internal governance disputes are valid likely will lead to adoption of such provisions in most corporations. Boards that do so must be careful to avoid overreaching. For example, existing litigation in another forum could not likely be removed based on a newly-board-adopted bylaw mandating a Delaware forum. Questions remain as well concerning the scope of the board's power, such as its ability to require that disputes be resolved by arbitration. But what is now clear, subject to the Supreme Court's review, is that board-adopted bylaws mandating a Delaware forum for internal governance disputes, are statutorily facially valid and binding on stockholders.