Mandatory Shareholder Arbitration in Delaware

February 7, 2019

A recent ruling in Delaware Chancery Court effectively prohibits corporations  from forcing shareholders to litigate initial public offering (IPO) fraud claims in federal court through forum selection clauses in their corporate charters. This move invalidated provisions in the corporate charters of three companies that went public in 2017, demanding shareholders bring Securities Act lawsuits in federal court.

Although the ruling is believed by many to have a dire impact on mandatory shareholder arbitration, the implications of the decision go well beyond the forum selection clauses that were addressed. In fact, if this decision is affirmed by the Delaware Supreme Court, it will crush a growing movement to allow corporations to force shareholders to arbitrate their securities fraud claims. Corporations cannot regulate federal securities litigation through their charters or bylaws, and if they attempt to insert mandatory arbitration provisions in contracts with their shareholders, those provisions cannot be enforced.

Delaware Shareholder Claims

This ruling draws a firm line between shareholder claims brought under Delaware law and federal securities claims. With the former, Delaware corporations can adopt forum selection provisions, and with the latter, they cannot. The basis for this is the fact that the state does not have authority over other types of claims that are based on corporate contract because those claims do not come through internal corporate relationships. Incorporation does not support the application of the chartering state’s law to external claims.

The above reasoning will be tested at the Delaware Supreme Court, but it is grounded in precedent. In Boilermakers Local 154 Retirement Fund v. Chevron, forum selection clauses that require shareholders to litigate breach-of-duty claims in Delaware Chancery Court were validated. It was emphasized, in fact, that the forum selection clauses were restricted to internal affairs litigation that arose from the corporation’s business, the conduct of its affairs, and the rights of its stockholders.

If the Supreme Court agrees, Delaware corporations will not be able to force mandatory shareholder litigation of federal securities claims through corporate charters or bylaws, even if the Securities and Exchange Commission objects. Those corporations that prefer to impose arbitration on their shareholders will have to incorporate in another state or try to adopt mandatory arbitration through a registration statement. Currently, many believe that mandatory shareholder arbitration is in jeopardy in Delaware. However, there are those who feel that this ruling could have a major impact on investors’ ability to protect their substantive rights.

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At Jacobs & Crumplar, P.A., our Wilmington business lawyers work tirelessly to fight for your rights. Please call us today at 302-656-5445 to learn more or contact us online for an initial consultation. With offices in Wilmington and Georgetown, Delaware, we serve clients throughout the state, including the areas of Dover, Sussex County, and New Castle County.