California Superior Court Enforces Federal Forum Selection Provision Under California Law

Key Takeaways

• In the first test outside of Delaware, a California court ruled that federal forum selection provisions enacted by Delaware corporations should be enforced so long as they are not unreasonable, meaning they do not alter substantive rights and do not direct litigation to burdensome venues.

• This ruling addresses a concern expressed by the Delaware Supreme Court that other states might not support its endorsement of federal forum selection provisions.

• The California court reached its conclusion under California and federal law because the internal affairs doctrine does not require deference to Delaware law when addressing federal forum selection provisions.
  
  
• The California court appeared skeptical about the constitutionality of the Delaware statute that grants Delaware corporations authority to enact federal forum selection provisions but declined to issue any ruling on this issue. Such a challenge may be asserted in the future.

In a case of first impression outside of Delaware, a California state court recently enforced a provision in a Delaware corporation’s bylaws requiring shareholders to bring federal securities claims under the 1933 Securities Act (“‘33 Act”) in an appropriate federal forum, as opposed to in state court.  See Wong v. Restoration Robotics, Inc., No. 18-civ-02609, (Cal. Sup. Ct., San Mateo Cnty., Sept. 1, 2020) (“Restoration Robotics”).  This decision answers a question left open by the Delaware Supreme Court in Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020) (“Sciabacucchi II”), which upheld substantively identical federal forum selection provisions under Delaware law, but expressed concern that other state courts might not uphold such provisions under their own states’ laws.  Because Sciabacucchi II held that such provisions did not involve corporate “internal affairs” to which other state courts would have been required to apply Delaware law, practitioners have been closely watching whether other forums would enforce such provisions, especially those in California where the majority of state-court ‘33 Act cases are filed.  This decision, in a state forum that historically had been very receptive to exercising jurisdiction over claims under the ‘33 Act, should give comfort to issuers that similar federal forum selection provisions will be enforced nationally, so long as the concerns expressed in Restoration Robotics are not ignored.

1. Following The U.S. Supreme Court’s Cyan Decision Confirming That ‘33 Act Claims Can Be Brought In State Courts And Cannot Be Removed To Federal Court, Issuers Began To Include Federal Forum Selection Clauses In Their Governing Documents.

The ‘33 Act states that claims asserted under that Act may be brought in state or federal court and, if brought in state court, cannot be removed to federal court.  Accordingly, when Congress passed the Private Securities Litigation Reform Act in 1995 (“PSLRA”), which imposed numerous procedural restrictions in federal courts designed to weed out meritless securities claims, the response from the plaintiffs’ bar was to file securities claims in state courts as often as possible.  This mass exodus from the federal courts led to the passage of the Securities Litigation Uniform Standards Act in 1998 (“SLUSA”), which provided a mechanism for certain “covered class actions,” in which litigants purport to assert traditional securities claims under state law theories, to be removed to federal court and dismissed.  However, SLUSA generated a split in authority on the question of whether claims asserted under the ‘33 Act could be removed to federal court, with California courts generally taking the position that removal was not permitted and New York courts generally allowing removal.

The Supreme Court resolved this split of authority in Cyan, Inc. v. Beaver County Employees Retirement Fund, 583 U.S. ___, 138 S. Ct. 1061 (2018) (“Cyan”) by holding that SLUSA did not alter the statutory language in the ‘33 Act that grants concurrent jurisdiction to state and federal courts and prohibits removal of such claims.  Following Cyan, state law claims could be removed pursuant to SLUSA, but ‘33 Act claims asserted in state courts could not be removed.  Issuers consequently began to employ a new strategy to ensure that ‘33 Act claims would be asserted in federal courts where plaintiffs would be unable to evade the procedural protections granted by the PSLRA: issuers began amending their charters and bylaws to include provisions expressly requiring ‘33  Act claims to be asserted in federal court.  These federal forum selection provisions (“FFPs”) since have become a point of contention in securities litigation.

2. The Delaware Supreme Court Upholds Federal Forum Selection Clauses, But Holds That Such Clauses Do Not Involve “Internal Affairs” That Would Require Other Courts To Apply Delaware Law.

The first fight over the validity of FFPs came in Delaware, where the Delaware Supreme Court found such provisions to be facially valid in Sciabacucchi II.  The central dispute in Sciabacucchi focused on whether Delaware corporate laws grant Delaware companies the authority to enact FFPs in their charters.  Initially, the Delaware Court of Chancery (Laster, V.C.) found such provisions to be invalid because Delaware law purportedly grants authority to corporations only to regulate their “internal affairs” but a claim under the ‘33 Act “does not implicate the internal affairs of the corporation.”  See Sciabacucchi v. Salzberg, 2018 WL 6719718, *2 (Del. Ch. Dec. 19, 2018) (“Sciabacucchi I”).  The Delaware Supreme Court reversed this ruling, holding that it was incorrect to base the validity of an FFP simply on a determination of whether ‘33 Act claims are “internal” or “external” to the corporation.  Instead, Sciabacucchi II held that there is a “continuum” between internal and external matters and that ‘33 Act claims fall in the middle of this continuum because, although such claims may not fall within the traditional understanding of a corporation’s internal affairs, such claims still “are ‘internal’ in the sense that they arise from internal corporate conduct on the part of the Board.”  Without drawing any line on this continuum between matters that can and cannot be regulated by corporate charter under Delaware law, Sciabacucchi II concluded that FFPs are facially valid under Delaware law.

Sciabacucchi II undoubtedly was a victory for FFPs, but it also contained at least two important limitations.  First, Sciabacucchi II addressed only a facial challenge to the validity of FFPs, meaning it still would be possible for litigants to assert “as applied” challenges to specific FFPs.  Second, Sciabacucchi II recognized that the determination that ‘33 Act claims are not part of a Delaware corporation’s internal affairs means that other states may choose not to defer to Delaware law when addressing such claims under the internal affairs doctrine, which generally requires courts to apply the law of a corporation’s state of incorporation when addressing claims related to the internal affairs of the corporation.  Thus, although Sciabacucchi II encouraged other state courts to uphold FFPs, it expressly recognized a risk that other states might apply their own laws to find grounds to invalidate or ignore FFPs.  Since Sciabacucchi II, practitioners have waited to see how other states—and California in particular—would treat challenges to a Delaware Corporation’s FFP in the wake of Sciabacucchi II.

3. In Its First Test Outside Of Delaware, A California State Court Upheld A FFP Adopted By A Delaware Corporation Under California Law.

On September 1, Judge Marie Weiner of the Superior Court of California, San Mateo County, issued her ruling in Restoration Robotics, which upheld the validity of a Delaware corporation’s FFP.  This is the first ruling outside of Delaware to address this issue following Sciabacucchi II.

In Restoration Robotics, a Delaware company moved to dismiss a claim filed in California state court under the ‘33 Act on the basis that the company had enacted a FFP.  On December 10, 2019, the California court denied that motion because, at the time, Sciabacucchi I was still valid law and it held that FFPs were invalid under Delaware law.  When Sciabacucchi II reversed Sciabacucchi I in March 2020, the defendant in Restoration Robotics filed a renewed motion to dismiss, citing the change in Delaware law.  The California court agreed that the law had changed and that the court’s original basis for denying the motion to dismiss was no longer valid.

Upon reconsideration, the California court recognized that FFPs are facially valid under Delaware law, but the court’s deference to Delaware law went no further.  As Sciabacucchi II had predicted, the California court held that the internal affairs doctrine did not apply because ‘33 Act claims are not part of the internal affairs of the corporation.  Instead, the California court held that California and federal law should govern the enforceability of the specific FFP at issue in Restoration Robotics.

Under California law, the court likened FFPs to other forum selection provisions that often are included in contracts and held that such clauses are generally enforceable unless proven to be unreasonable.  Here, even though the clause was enacted unilaterally, the court held that the plaintiff had failed to demonstrate that enforcement would be unreasonable.  In reaching this conclusion, the court specifically noted that the FFP at issue did not deprive shareholders of any substantive right under the ‘33 Act.  It also noted that that the FFP did not impose any additional “expense or inconvenience” on shareholders because the FFP allowed the shareholder to select any federal district court where venue would otherwise be appropriate.

The court further held that the plaintiff failed to identify any authority under federal law holding that forum selection clauses are unconstitutional or illegal.  Although the plaintiff had asserted that Delaware corporate law is unconstitutional to the extent that it, as interpreted by Sciabacucchi II, permits corporations to enact FFPs that functionally allow them to avoid ‘33 Act lawsuits in state courts, the California court declined to reach this question because a motion to dismiss “is not the proper avenue for adjudication of whether or not . . .  Delaware law is or is not constitutional.”  The court suggested that “a more appropriate procedural avenue might be a declaratory relief action in federal court specifically addressing the constitutionality of that Delaware statute.”  Accordingly, the California court held that the plaintiff had failed to meet his “heavy burden” of demonstrating, under either California law or federal law, that the otherwise-valid FFP should not be enforced.  

Restoration Robotics provides a roadmap for other courts outside of Delaware to apply FFPs enacted by Delaware corporations even if the courts hold that Delaware law does not govern application of such provisions.  It is a clear victory for FFPs that will provide strong support for their enforcement in other cases, including in another case currently pending in the same court that also seeks to address the enforceability of FFPs.  See In re Dropbox Inc. Securities Litigation, No. 19-civ-05089 (Cal. Sup. Ct., San Mateo Cnty., 2019).  Restoration Robotics suggests that it may not matter if courts apply Delaware law or forum law because FFPs should be enforceable to the same extent as any other forum selection clause, which are widely used in contracts prepared across the country.

4. Restoration Robotics Upheld The Specific FFP At Issue, But Also Opened The Door For Potential Challenges To FFPs In The Future.

Although Restoration Robotics rejected a plaintiff’s efforts to invalidate a FFP, the opinion also contains numerous statements that plaintiffs will likely use in the future in their continued efforts to invalidate FFPs.  The California court plainly disagreed with Sciabacucchi II’s determination that FFPs are valid under Delaware law and a significant portion of the Restoration Robotics opinion is dedicated to criticizing Sciabacucchi II.  The California court could not overrule Sciabacucchi II and declined to rule on the constitutionality of Delaware law, as interpreted by Sciabacucchi II but, as noted above, the California court suggested that plaintiffs may be able to assert a constitutional challenge in federal court.  Practitioners should expect the plaintiffs’ bar to assert such a challenge in the near future.

Even assuming Sciabacucchi II remains good law, Restoration Robotics also includes several qualifications that Delaware corporations should be careful to observe.  The California court repeatedly stated that the FFP at issue in Restoration Robotics was not “unreasonable” because it did not alter any substantive rights and did not specify any particular federal court, which could have had the effect of increasing costs and inconvenience for shareholders who do not reside in that forum.  In order to avoid having an FFP invalidated in California on the grounds that it is “unreasonable,” Delaware corporations would be wise to ensure their FFPs are written similarly to the ones at issue in Restoration Robotics and Sciabacucchi.