The following post comes to us from Claudia H. Allen, Partner and Co-Chair of the Corporate Governance Practice at Katten Muchin Rosenman LLP. It is based on her recent paper entitled “Bylaws Mandating Arbitration of Stockholder Disputes?,” which is forthcoming in the Delaware Journal of Corporate Law and is available here.
Would a board-adopted bylaw mandating arbitration of stockholder disputes and eliminating the right to pursue such claims on a class action basis be enforceable? That question came to the fore as a result of late June 2013 decisions from the United States Supreme Court and the Delaware Court of Chancery, which, when read together, suggest that the answer to this question is yes. In American Express Co. v. Italian Colors Restaurant, the United States Supreme Court, interpreting the Federal Arbitration Act (“FAA”), upheld a mandatory arbitration provision, including a class action waiver, in a commercial contract. The decision focused upon the arbitration provision as a contract subject to the FAA. Next, the Delaware Court of Chancery rendered its opinion in Boilermakers Local 154 Retirement Fund v. Chevron Corp. The decision, which emphasized that bylaws are contracts between a corporation and its stockholders, upheld the validity of bylaws adopted by the boards of Chevron Corporation and FedEx Corporation requiring that intra-corporate disputes be litigated exclusively in Delaware courts.
Subsequent United States Supreme Court and Delaware Supreme Court decisions addressing forum selection and the board’s power to adopt bylaws have only strengthened the argument. For example, the United States Supreme Court views an arbitration clause as a specialized kind of forum selection clause, and in December 2013 reiterated the strong presumption in favor of the validity of such clauses. While Boilermakers was a Delaware Chancery Court decision, the Delaware Supreme Court effectively endorsed Boilermakers and the facial validity of board-adopted bylaws that may deter litigation in its May 2014 ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation) opinion upholding fee-shifting bylaws.
In addition to complementing each other, American Express and Boilermakers address a similar issue, namely, the explosion in class action and derivative litigation that settles primarily for attorneys’ fees, most commonly in the context of mergers and acquisitions. Class actions and derivative lawsuits are forms of representative litigation, in which named plaintiffs seek to act on behalf of a class of stockholders or the corporation itself. The plaintiffs are customarily represented by attorneys on a contingent fee basis, making the lawyer the “real party in interest,” although stockholders ultimately bear the costs of such litigation. If mandatory arbitration bylaws barring class actions were enforceable, the logical outcome would be a marked decline in class actions, since the alleged existence of a class is a principal driver of attorneys’ fees.
Bylaws Mandating Arbitration of Stockholder Disputes? examines the legal and policy issues raised by arbitration bylaws, including: whether arbitration bylaws regulate process or impermissibly regulate substance, whether such bylaws constitute the type of contract subject to the FAA, and whether the SEC staff’s policy against accelerating the registration statements of domestic companies that mandate arbitration of stockholder disputes can be addressed or overcome. The article also considers the limited case law on mandatory arbitration bylaws, likely reaction from stockholders, whether arbitration bylaws would be attractive to public companies, opportunities for private ordering and the terms of the small number of arbitration bylaws that have been proposed or adopted to date. Since arbitration is a creature of contract, the article argues that there are opportunities for corporations to craft bylaws that take into account company-specific issues, while responding to many likely criticisms. However, the inherent bias of some stockholders and corporations against arbitration is likely to make experimentation in this area slow and difficult.