No rule of corporate law may be more foundational than the internal affairs doctrine. The doctrine provides that the internal affairs of a corporation – the “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders”[1] – are governed by the laws of the state in which the corporation is chartered.

Lurking within this widely accepted principle, however, is an even more foundational question: Is the internal affairs doctrine simply a choice of law rule enabling a corporation and its shareholders to choose which state’s law will govern their private business arrangement? Or does the doctrine also demarcate the outer limits of what the corporation’s governing documents may regulate? These questions lie at the core of Salzberg v. Sciabacucchi[2] – a landmark decision with implications for state corporate law, federal securities law, and the rights of all shareholders.

In Salzberg, the Delaware Supreme Court upheld the validity of a corporate charter provision requiring any shareholder claims made under the federal Securities Act of 1933 to be brought in federal court (rather than state court). Thus, the federal forum provision (or “FFP”) at issue in Salzberg purported to regulate shareholder rights arising under federal securities law rather than state law. Nonetheless, the Salzberg court ruled that the “corporate contract,” created by state corporate law and comprised of a corporation’s charter and bylaws, may regulate the rights of shareholders to bring federal securities law claims.

Before Salzberg, several leading corporate and securities law scholars had prominently staked out the position that the corporate contract cannot regulate shareholder rights arising under federal securities law because such rights are beyond a corporation’s internal affairs, which has traditionally defined the boundaries of state corporate law. Indeed, an erudite opinion by the Delaware Chancery Court in Salzberg came to that same conclusion: that the scope of the corporate contract is inextricably tied to the internal affairs doctrine.[3]

In Salzberg, however, the Delaware Supreme Court ruled that the internal affairs doctrine is merely a choice-of-law principle and not a limit on the scope of the corporate contract that state corporate law creates. Thus, the high court concluded that, although rights arising under federal securities law lie beyond the internal affairs doctrine, they are nonetheless within the “Outer Band” of what may be regulated by a corporation’s governing documents.[4] Prior to Salzberg, this “Outer Band” – sandwiched between internal corporate affairs and external matters – was unknown to the law of corporations.

Despite its novelty, Salzberg might be interpreted pragmatically as simply another Delaware court decision responding to the needs of the state’s all-important corporate constituency. The FFP at issue in Salzberg offered a tidy state corporate-law solution to a federal securities law problem created by the recent U.S. Supreme Court decision, Cyan v. Beaver County.[5] And Delaware’s high court was loath to let its state law stand in the way, particularly when other states, hoping to divert corporate charters away from Delaware, would likely be more accommodating.

In a forthcoming paper, however, I argue that corporate theory, rather than instrumentalism, offers a more illuminating interpretation of Salzberg. From a theoretical perspective, Salzberg represents the Delaware Supreme Court’s further embrace of the contractarian theory of corporations. Under contractarian theory, corporate law is a species of private law, specifically contract law. In the contractarian framework, the internal affairs doctrine is merely a choice-of-law rule that accommodates contractual freedom and private ordering – akin to a choice-of-law provision typically found in commercial contracts. The doctrine enables the contracting parties to choose which state’s corporate law will govern their relationship. As a mere choice-of-law rule, however, the doctrine does not speak to what the parties may address in their private contractual agreement. The doctrine does nothing to limit the scope of the corporate contract.

The Delaware Supreme Court’s embrace of contractarianism stands in sharp contrast to the concession theory of corporations espoused by the Chancery Court in Salzberg – a theory that the state supreme court would ultimately reject. Under concession theory, corporate law is a species of public law. In the concession framework, the internal affairs doctrine is an expression of state sovereignty rather than private autonomy. The exclusive right of the chartering state to govern the internal affairs of a corporation derives from the chartering state’s integral role in bringing the corporation into existence. As a corollary, however, the internal affairs doctrine also marks the regulatory limits of the chartering state’s sovereignty and, therefore, the boundaries of the corporate contract that state corporate law creates.  Because a state like Delaware lacks the authority to regulate the rights of shareholders arising under federal securities law, it cannot devolve that authority to its corporate creations.

The contract-concession divide between the Delaware Supreme Court and the Court of Chancery in Salzberg echoes a broader and enduring debate about the essential nature of the corporation. Is the corporation a state-created entity imbued with a public dimension? Or is the corporation merely an aggregation of individuals that serves only private aims? Salzberg is a vivid reminder that the position courts take – whether consciously or not – on these lofty questions can have stark practical consequences.

Indeed, the contractarian theory embraced by the Delaware Supreme Court in Salzberg has implications for both state corporate law and federal securities law that go well beyond the immediate issue of the case. For one, Salzberg recasts the role of the internal affairs doctrine in contemporary corporate law. By severing the internal affairs doctrine from concession theory tenets of comity and deference to the sovereignty of the chartering state, Salzberg has reduced the doctrine to a mere choice-of-law rule and removed any barrier the doctrine might present to the regulatory reach of the corporate contract that state corporate law creates. In doing so, the Delaware Supreme Court has opened the door to other types of “Outer Band” provisions in corporate charters and bylaws. Among other things, “Outer Band” provisions might regulate shareholder rights arising under the federal Securities Exchange Act of 1934, including Sections 10(b) and 14(a) and Rules 10b-5, 14a-9, and 14a-8.

More importantly, however, Salzberg establishes the doctrinal foundation for mandatory arbitration of all shareholder claims, irrespective of whether such claims arise under state corporate law or federal securities law. After all, if a corporation’s governing documents are simply a species of contract, as Salzberg suggests, then the corporate contract is subject to the Federal Arbitration Act (the “FAA”).[6] Under the U.S. Supreme Court’s interpretation of the FAA, a binding arbitration provision in the corporate contract would be enforceable, notwithstanding contrary state law or the anti-waiver provisions of the federal securities statutes. Should mandatory arbitration of corporate and securities law claims proliferate, it would radically alter the economics and, therefore, frequency of such claims as well as the development of corporate and securities law.

Thus, the contractarian interpretation of the internal affairs doctrine that Salzberg espouses has profound implications for shareholder rights and the remedial and deterrence functions that shareholder litigation plays in both corporate governance and capital markets. Given these implications, it would be unsurprising to see the Delaware legislatureoverride Salzberg or strictly narrow its Outer Band. By amending the DGCL, the state’s General Assembly could statutorily confine the corporate contract to the bounds of the internal affairs doctrine and, thus, attempt to close the door that Salzberg has opened. In enacting such an amendment, the Delaware legislature would also provide another reminder that the corporate contract is unlike any ordinary contract. The corporate contract is the statutorily prescribed governing instrument of a state-created entity and, for that reason, beyond the grim orbit of the FAA.

ENDNOTES

[1] Edgar v. MITE Corp., 457 U.S. 624, 645 (1982); accord McDermott Inc. v. Lewis, 531 A.2d 206, 215 (Del. 1987) (quoting Edgar).

[2] 227 A.3d 102 (Del. 2020).

[3] See 2018 WL 6719718 (Del. Ch. Dec. 19, 2018) (Laster, V.C.).

[4] See Salzberg, 227 A.3d at 130-32.

[5] 138 S. Ct. 1061 (2018).

[6] See 9 U.S.C. § 2 (“A written provision in any . . . contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”).

This post comes to us from Professor Mohsen Manesh at the University of Oregon School of Law. It is based on his recent paper, “The Corporate Contract and the Internal Affairs Doctrine,” available here.