June 7, 2017

Delaware: Why Aren’t Exclusive Forum Bylaws Working?

Kevin LaCroix at “The D&O Diary” recently blogged about the continuing decline in the number of deal cases being brought in Delaware Chancery Court. Along the way, he raised an important question – weren’t exclusive forum bylaws supposed to prevent cases from being brought in other jurisdictions?

Kevin cited two different reasons why exclusive forum bylaws haven’t kept deal lawsuits in Delaware:

The first factor undermining the effectiveness of the forum selection provisions, and the reason for the plaintiffs’ lawyers recent pronounced preference for filing federal court lawsuits alleging violations of the federal securities laws (rather than state court lawsuits alleging violations of state law), is that Section 27 of the Securities Exchange of Act of 1934 gives the federal courts exclusive jurisdiction over actions alleging violations of the Act.

A company’s forum selection bylaw is ineffective with respect to action subject to the ’34 Act’s exclusive jurisdiction provision. The typical federal court merger objection lawsuit alleges that the company’s proxy materials omitted material information in violation of Section 14 of the Act and Rule 14-a-9 thereunder, and is subject to Section 27’s exclusive jurisdiction provision.

The second reason is a little more. . .well . . . Machiavellian:

As Fordham Law School Professor Sean Griffith points out in his January 2017 paper (here), defense counsel “must be seen as complicit in the out-of-Delaware dynamic because they have failed to exercise Exclusive Forum bylaws to bring the litigation back to Delaware.” As Griffith explains, the defendants’ failure to invoke the provision “must be seen as a revealed preference,” one that “demonstrates defendants’ continued interest in retaining the option of a cheap settlement and a broad release in an alternative jurisdiction.”

Some defendants are reportedly even going so far as to not bring the Trulia decision to the foreign court’s attention – even where Delaware law clearly applies. If so, Prof. Griffith suggests that the lawyers involved may be on shaky ethical ground:

Even if the settlement proponents have no interest in raising Trulia, perhaps they have some obligation to do so. The rules of professional conduct may obligate counsel under some circumstances to disclose authority contrary to their position even if that authority is not raised by opposing counsel.

The Delaware judiciary can’t be happy about these practices, and if Prof. Griffith is right on his assessment of the ethical issues, then it wouldn’t surprise me if one of these proposed settlements got very messy for the parties involved at some point in the future.

John Jenkins