Delaware Court of Chancery Upholds Facial Validity of Board-Adopted Delaware Forum Selection Clauses Contained in Bylaws

July 11, 2013

The Delaware Court of Chancery recently upheld the validity of bylaw amendments adopted without shareholder approval requiring that suits pertaining to the internal affairs of Delaware corporations be filed in Delaware.  Boilermakers Local 154 Retirement Fund v. Chevron Corporation, et al., No. 7220-CS, and ICLUB Investment Partnership v. FedEx Corporation, et al., No. 7238-CS (Del. Ch. June 25, 2013).  This is important for Delaware corporations that have enacted or are considering such provisions for at least two reasons: (1) Delaware forum selection provisions foreclose the possibility of suits challenging a single transaction being prosecuted in multiple jurisdictions and (2) ensure that litigation placing in issue the internal affairs of Delaware corporations is resolved in the Delaware court system, access to which is among the reasons many businesses select Delaware as their state of incorporation in the first  place.

The Bylaw Forum Selection Provisions

The two provisions challenged (in separate suits consolidated for purposes of the court’s ruling) were bylaw amendments adopted by the boards of Chevron (a Delaware corporation headquartered in California) and FedEx (a Delaware corporation headquartered in Tennessee) requiring that litigation relating to the companies’ internal affairs be conducted in the Courts of Delaware and the Delaware Court of Chancery, respectively.  Each was unilaterally adopted (i.e., without formal shareholder approval) by the companies’ respective boards in response to the threat of multi-jurisdictional litigation over single transactions or board actions (because most Delaware corporations are headquartered out of state, they unavoidably are subject to jurisdiction in multiple venues).1

The Plaintiffs’ Challenges to the Provisions

The Chancery Court’s decision disposed of two challenges to the bylaw provisions:  (1)  that the provisions were statutorily invalid because their passage exceeded the boards’ authority under the Delaware General Corporation Law (“DGCL”) and (2) that the bylaws were contractually invalid and cannot be enforced under the reasonableness test adopted by the Supreme Court of the United States in The Bremen v. Zapata Offshore Co., 407 U.S. 1 (1972) (holding that venue selection provisions are valid provided they are unaffected by fraud, undue influence, or overweening bargaining power or enforcement would otherwise be unreasonable).  In Delaware, challenges to the facial validity of bylaws require that plaintiffs demonstrate that they cannot operate lawfully or equitably under any circumstances.

The Chancellor’s Ruling

As to the statutory challenge, Chancellor Strine ruled that the bylaw provisions, which were limited to directing where suits (such as direct or derivative fiduciary duty actions or special proceedings under the DGCL) implicating the internal affairs of the corporations could be brought, are within the scope of 8 Del. C. § 109(b).  Section 109(b) provides that the bylaws “may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers and the rights of powers of its stockholders, directors, officers or employees.”  Because venue provisions govern the procedure by which challenges to internal affairs may be pursued (while imposing no limitations on the substantive rights of stockholders), and because Delaware otherwise recognizes and enforces valid forum selection provisions, the Chancellor held that the provisions were not facially invalid as a matter of statutory law.

The contractual challenge likewise was rejected.  Emphasizing that bylaws are part of a broader, flexible contract among the directors, officers and stockholders, and that the DGCL (8 Del. C. § 109(a)) permits charter provisions granting directors the power to adopt and amend bylaws unilaterally, the court noted that both the Chevron and FedEx charters expressly authorized their respective boards to unilaterally amend the bylaws; thus, concluded the court, when those companies’ stockholders purchased shares, they did so knowing that the bylaws may be amended by the boards, that the DGCL allows bylaw provisions governing the business, internal affairs and rights and powers of the stockholders, and that board-adopted bylaws are binding on stockholders.  The Chancellor noted that plaintiffs’ contention that stockholders’ rights may not be regulated by board-adopted bylaws essentially sought to revive the “vested rights” doctrine (i.e., that boards unilaterally cannot modify bylaws in a manner that arguably diminishes pre-existing stockholder rights) rejected long ago in Delaware in favor of a more flexible regime that gives boards greater latitude in amending the corporate contracts to meet emerging concerns and circumstances.

Potential Limitations to Ruling

While the court upheld the facial validity of bylaw forum selection provisions, its ruling was not boundless.  The court declined to address a host of “what-if” challenges involving hypothetical situations in which, the plaintiffs argued, the enforcement of such provisions could, by design or by happenstance, work a breach of the directors’ fiduciary duties. For example, the court acknowledged that there may be situations in which the invocation of a bylaw forum selection provision may be challenged as circumstantially “unreasonable” under Bremen or as being wielded for improper purposes.  The adjudication of such situation-specific limitations, however, must await an actual case or controversy.

1 Forum selection provisions contained in LLC agreements and stockholder agreements already have been upheld by the Delaware Supreme Court.  In the last three years, over 250 publicly traded corporations have adopted forum selection bylaw provisions.  At least ten have been repealed in Delaware in response to stockholder challenges.