California court enforces federal forum charter provision

A California superior court recently held that a provision in a Delaware corporation's articles of incorporation requiring stockholders to bring claims under the Securities Act of 1933 exclusively in federal court was enforceable under California law. See Wong v. Restoration Robotics, Inc., 18CIV02609 (San Mateo Cty. Super. Ct., Sept. 1, 2020). The decision, the first of its kind in California, potentially opens the door for securities issuers to protect themselves against the burden and expense of simultaneously litigating duplicative securities class actions in state and federal court.

The Superior Court's Decision

In Wong v. Restoration Robotics, Inc., a shareholder brought Securities Act claims in state court against a Delaware company, and certain of its directors, officers, investors and underwriters, asserting that the defendants made false or misleading statements in connection with the company's 2017 initial public offering. Before the IPO, however, the company added a provision to its certificate of incorporation requiring that shareholders bring Securities Act claims exclusively in federal court. The company invoked this charter provision and moved to dismiss the case. Relying on a then-current decision from the Delaware Court of Chancery that such provisions were facially invalid, the San Mateo County Superior Court initially held that the defendant's federal forum provision was unenforceable. However, the Delaware Supreme Court reversed the Court of Chancery earlier this year in Salzberg v. Sciabacucchi, 227 A.3d 102 (2020). The defendants thereafter moved for reconsideration.

After extensively examining the Delaware Supreme Court's decision in Salzberg, and California law on forum selection clauses, the superior court granted the company's motion for reconsideration and enforced its exclusive federal forum provision. In determining that the federal forum provision was enforceable, the court first examined and rejected several potential analytical frameworks, and concluded that such provisions are most analogous to forum selection clauses in corporate charters and bylaws requiring that claims related to a company's internal governance be brought where the company is incorporated. The court noted that in a pair of 2018 decisions, the California Court of Appeal held that such provisions are generally valid and enforceable unless the plaintiff proves that enforcement would be unreasonable in a particular case. The court held that the plaintiff failed to meet its burden to show that enforcing an exclusive federal forum provision would be unreasonable, because Securities Act plaintiffs have all of the same substantive rights in federal court that they would enjoy in state court.

Historical Background

The dispute at issue in Wong represents the latest chapter in a longstanding battle between securities issuers and the plaintiffs' class action bar over duplicative securities litigation. For decades, defendants have faced difficulties in consolidating overlapping securities class actions due to jurisdictional differences between the Securities Act and the Securities Exchange Act of 1934. Specifically, while federal courts have exclusive jurisdiction over Exchange Act claims, Securities Act claims may be brought in either federal or state court, notwithstanding that the claims are pursuant to federal statute. Moreover, the Securities Act bars removal to federal court of claims filed in state court. This statutory scheme permits securities plaintiffs to file Securities Act class actions in state court, while filing Exchange Act class actions premised on nearly identical allegations in federal court, with defendants essentially forced to litigate the same case twice in different fora.

In 1998, Congress passed the Securities Litigation Uniform Standards Act. Among other things, SLUSA permits defendants to remove certain "covered class actions" to federal court. Following the passage of SLUSA, courts in New York held that SLUSA permitted removal of Securities Act class actions filed in state court, while courts in California held that SLUSA did not permit removal of the very same Securities Act class actions. In 2018, the U.S. Supreme Court in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), resolved whether SLUSA permits removal of such Securities Act class actions and held that it does not. Thereafter, Plaintiffs continued to file federal securities claims under the Securities Act in state courts.

In the wake of Cyan, a number of securities issuers incorporated in Delaware sought to use contractual principles to curb duplicative securities class actions by adding provisions to their corporate charters that require stockholders to bring Securities Act claims exclusively in federal court. Such provisions are referred to as exclusive federal forum provisions. These provisions were promptly challenged, and in late 2018, the Delaware Court of Chancery held that the Delaware General Corporation Law does not permit corporations to require that stockholders bring claims unrelated to internal corporate governance in any particular forum. Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018). In March 2020, however, the Delaware Supreme Court reversed the Court of Chancery, holding in Salzberg v. Sciabacucchi that exclusive federal forum provisions are facially valid under Delaware law, and opening the possibility that other states would enforce such provisions.

Significance of the Court's Decision

The superior court in Wong v. Restoration Robotics, Inc. took up the question, and ultimately did hold that a provision in a Delaware corporation's articles of incorporation requiring stockholders to bring claims under the Securities Act exclusively in federal court was enforceable under California law. The court's decision is significant as the first California decision to enforce an exclusive federal forum provision since Salzberg, and may represent an important win for securities defendants if it is upheld on appeal, and followed by courts elsewhere. If issuers are able to concentrate all securities litigation in the federal courts, they are less likely to face overlapping and duplicative class actions, because all federal courts are part of the same system, and federal law contains a number of procedural vehicles that permit the transfer and consolidation of related claims in a single case.

Defendants may also be able to avoid the extensive (and uncertain) motion practice involved in attempting to convince one court to stay its proceedings while another court adjudicates overlapping class action claims, which is often the only available option to prevent overlapping state and federal class actions from proceeding simultaneously. Concentrating securities litigation in the federal courts also ensures that the procedural protections of the Private Securities Litigation Reform Act will apply as intended -- including, among other things, a lead plaintiff process to permit the presumptively most adequate plaintiff to control the litigation and a stay of discovery to disincentivize unnecessary discovery before a motion to dismiss is decided. (The plain language of the PSLRA requires courts to apply an automatic stay of discovery to any action filed pursuant to the securities laws, whether or not in state or federal court. See 15 U.S.C. Section 77z-1(b)(1) ("In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds, upon the motion of any party, that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." (emphasis added)). Many state courts appropriately honor the statutorily mandated stay of discovery. See, e.g., In re Everquote, Inc. Sec. Litig., 106 N.Y.S.3d 828, 834 (N.Y. Sup. Ct. 2019). A minority of state courts have not. See In re Pac. Biosciences of Cal. Inc. Sec. Litig., CIV 509210, 2012 WL 1932469 (Cal. Super. Ct. May 25, 2012).)

Considering Salzberg and Wong, corporations planning to launch an initial public offering or that believe their public securities offerings otherwise may become the target of securities litigation may wish to consider adding exclusive federal forum provisions to their certificates of incorporation. Foreign corporations with American Depositary Shares listed on a U.S. stock exchange also may wish to consider adding language to their deposit agreements requiring Securities Act claims to be brought in federal court. Corporations considering such an exclusive federal forum provision should consult their outside counsel. 