Will California courts enforce federal forum selection clauses?

The first test of whether corporate "federal forum selection" clauses will be enforced by California courts will occur on Friday when the San Mateo County Superior Court will hear argument in In re Dropbox, Inc. Securities Litigation. Shareholders have advocated for freedom to file claims under the Securities Act of 1933 in multiple forums, especially in state courts that they view as more favorable to such lawsuits. Conversely, issuers have asserted that such claims belong exclusively in federal court, which they view as having greater expertise and stronger "gatekeeping" over securities claims. The Dropbox case is the latest chapter in this struggle and is the first test on whether any state outside of Delaware will enforce corporate bylaws that require shareholders to file securities claims in federal court.

Federal forum selection clauses gained popularity in the wake of the U.S. Supreme Court's decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), which held that state and federal courts have "concurrent jurisdiction" over claims arising under the 1933 Act and, moreover, that 1933 Act claims filed in state court could not be removed to federal court. As a result, plaintiffs began filing more cases in state courts and also began filing nearly identical lawsuits in both state and federal courts. In an effort to avoid these situations, many companies began enacting federal forum selection provisions in their charters and bylaws that require shareholders to assert federal securities claims exclusively in federal court. Many advocates from the plaintiffs' bar argued that such provisions were invalid.

The Delaware Supreme Court, however, upheld the validity of such provisions under Delaware law in Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). The court held that Delaware law permits corporations to enact provisions in their charters that address the "management of the business" and "the conduct of the affairs of the corporation," which the court ruled included federal forum selection provisions. The court also observed that corporate charters are treated like contracts between the corporation and stockholders and, thus, may be enforced like contracts. Despite the unambiguous endorsement for such provisions, however, the Sciabacucchi decision left open one key issue: whether courts outside of Delaware would apply such provisions under their own state's law.

Normally, the "internal affairs doctrine" dictates that the law of the state of incorporation will govern legal claims related to the "internal affairs" of a corporation wherever brought. But the Sciabacucchi court recognized there is a "continuum" between purely internal and purely external corporate actions, with "intra-corporate actions" falling in the middle. Although the enactment and enforcement of corporate bylaws are traditional "internal affairs," the resolution of claims asserted under the securities laws fall within this new category of "intra-corporate actions." Accordingly, the court expressed concern that other states may not feel bound by Sciabacucchi when shareholders challenge federal forum selection provisions outside of Delaware. Nevertheless, the Delaware Supreme Court stressed that courts outside of Delaware should follow Sciabacucchi because federal forum selection provisions are contractual in nature and because the same policy considerations underlying the internal affairs doctrine apply to them, namely, corporate officers and directors have a legitimate interest in uniformity and knowing what law will apply to their actions.

Dropbox is the first test of the enforceability of a Delaware corporation's federal forum selection provision in a court outside of Delaware post-Sciabacucchi. Multiple shareholders filed class actions following a decrease in Dropbox's stock price in August 2019, which were consolidated in San Mateo Superior Court. Dropbox, a Delaware corporation, has moved to dismiss on the basis that it enacted a valid federal forum selection provision and thus, under Sciabacucchi, the shareholders' 1933 Act claims can only be asserted in federal court.

Dropbox's shareholders have argued that Delaware law does not apply to their lawsuit because the internal affairs doctrine is inapplicable to federal forum selection provisions and such provisions are invalid under California law. Specifically, they argue that Dropbox's bylaws do not form a binding and enforceable contract between the corporation and shareholders under California law. Plaintiffs also argue that Dropbox's forum selection provision violates the commerce and supremacy clauses of the U.S. Constitution.

In response, Dropbox has argued that Delaware law should apply because it is well established that the enforcement of bylaws, regardless of their subject matter, falls squarely within the internal affairs doctrine. But even if the court were to apply California law, Dropbox argues that California has recognized that corporate bylaws may be enforced like contracts and should be enforced here. Dropbox also dismisses the plaintiffs' constitutional arguments on the basis that such arguments apply only to state actions, not private contractual agreements.

A favorable decision for the plaintiffs in Dropbox threatens a patchwork of inconsistent enforcement of such provisions depending on the state in which each suit was filed, leading to forum shopping and duplicative litigation. On the other hand, a favorable decision for Dropbox would be a ringing endorsement of federal forum selection provisions, which will make it increasingly more difficult for the plaintiffs' bar to exert pressure on companies to defend identical lawsuits in multiple courts at the same time, with the threat of inconsistent outcomes. Instead, companies will be able to select a single forum that will streamline resolution of such cases, reducing the costs and complications of litigation for companies and shareholders. An endorsement of federal forum selection clauses also would further the federal policy embedded in the Public Securities Litigation Reform Act and Securities Litigation Uniform Standards Act: to create exclusive federal jurisdiction for securities claims to ensure uniform application of these laws and prevent unmeritorious and abusive litigation against issuers. Securities issuers and litigation practitioners will be paying close attention to this important ruling. 