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By Jacob Rund
More companies going public are following Snap Inc.'s lead by including provisions steering certain securities lawsuits to federal courts.
Companies for years have adopted provisions in their bylaws or charters making a certain state court the “exclusive forum” for various corporate law claims. It’s a way to avoid costly lawsuits in multiple states and steer litigation to perceived corporate-friendly venues.
The latest twist that emerged last year among IPO companies is to include bylaw provisions that force investors suing under the 1933 Securities Act to bring their complaint in a federal court — rather than a state court. Newly public companies are often hit with investor lawsuits based on a provision of the 1933 Act that holds them and their executives liable for misstatements or omissions in securities registration statements.
Twenty of the 241 companies with offering sizes of at least $10 million that began trading between Jan. 1, 2017 and May 3, 2018 had provisions designating federal courts as the only forum for securities law complaints, according to a Bloomberg Law analysis of documents from Bloomberg Law’s transactional precedent database. Those companies also had provisions designating a state court for corporate claims.
The trend has gotten the attention of one investor, who has asked the Delaware Chancery Court to invalidate the practice as a violation of the state’s corporate law.
Snapchat owner Snap Inc. kicked off the trend among IPO companies when it went public in March 2017. Its certificate of incorporation says that U.S. federal district courts “shall be the exclusive forum for any complaint” under the 1933 Securities Act, unless the company consents in writing to an “alternative forum.”
Dropbox Inc., which operates a file-sharing platform and went public in March, is among the latest IPO companies with provisions in its bylaws laying out when state and federal courts can be the exclusive forums for certain types of lawsuits against the company.
No company with an IPO above $10 million in 2016 specified a federal court for securities lawsuits, but 76 specified state courts, Bloomberg Law data show. Companies going public have traditionally included provisions designed to steer lawsuits to their state of incorporation, which, for many public companies, is Delaware.
Almost two-thirds of the 186 companies with an IPO in 2017 (65 percent) had state forum selection bylaws, and most of those named Delaware Chancery Court as their exclusive venue, Bloomberg Law data show.
The more recent federal exclusive forum bylaws are designed to make sure an IPO-related securities class action complaint doesn’t wind up in state court. Companies find these provisions an appealing way to bypass state courts, which have concurrent jurisdiction over securities class actions, as affirmed by the U.S. Supreme Court in a March decision in Cyan v. Beaver County Employees Retirement Fund.
Federal forum selection provisions are being challenged in Delaware by a stockholder of recent IPO companies Roku Inc., Stitch Fix Inc., and Blue Apron Holdings Inc. The investor, Matthew Sciabacucchi, claims that forcing securities claims to be brought in federal court is a violation of Delaware corporate law.
The chancery court in 2013 upheld the validity of exclusive forums for corporate claims brought in state court, and the Delaware legislature codified this in 2015. But the validity of federal forum selection provisions remains in question.
“It certainly is not covered by the existing [Delaware] statute,” said Darrick Mix, a partner at Duane Morris LLP who heads the firm’s capital markets group. “But that doesn’t necessarily mean they are invalid.”
The complaint says exclusive forum provisions could be a slippery slope that could lead to forced arbitration and similar company mandates. “It’s just kind of [about] where’s the line?” Mix said.
For IPO companies at this point, however, federal forum provisions are “really no harm, no foul,” Mix said. If Delaware strikes them down, “companies will either remove them or keep them, but they’ll be ineffective. But if they don’t put the provisions in, they lost out on the ability to assert federal court jurisdiction” if they face a securities lawsuit later on.
Companies, especially those that are privately held, often adopt exclusive forum provisions through bylaw amendments approved by their boards.
But some publicly traded companies introduce the provisions through changes to their corporate charters, giving stockholders a chance to vote and opening the door for opposition. This has mostly involved state exclusive forums for internal corporate claims.
Marc Goldstein, head of U.S. research at Institutional Shareholder Services Inc., said the firm recommended voting against most, if not all, state exclusive forum proposals put before shareholders in the past five years.
Goldstein said ISS takes a “case-by-case” approach to these proposals, and it’s willing to support them if companies can prove that they would lead to a reduction in litigation costs. ISS typically won’t take action against a board if it adopts exclusive forum provisions without a shareholder vote, he said.
More than 100 provisions designating a state court as the exclusive forum for derivative claims and other merger-related litigation were voted on between 2012 and 2017, Goldstein said, adding that the number of votes seen each year is “trailing off.”
To get a nod from ISS, Goldstein said companies should show “specific evidence” that they have suffered, or could suffer, harm from multi-forum litigation. They should estimate the costs of litigating cases beyond their state of incorporation.
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