Dropbox Becomes Third California Superior Court Decision To Enforce Delaware Corporations’ Federal Forum Provision For Securities Act Lawsuits

Three separate California Superior Courts have recently upheld federal forum provisions (“FFP”) in governing corporate documents to preclude state court actions under the Securities Act of 1933 (the “Securities Act”) (15 U.S.C. § 77z-1).  These decisions are significant because they increase the number of applicable circumstances in which courts have allowed companies to use FFPs to avoid the risk of costly and duplicative parallel state and federal litigation or litigation in multiple states under the Securities Act and may pave the way for other courts, not bound by the decisions, to follow their logic and reach similar conclusions.

Background

In Cyan Inc. v. Beaver County Employees Retirement Fund,[1] the Supreme Court held state courts have jurisdiction over claims brought under the Securities Act of 1933, prohibiting removal of these claims to federal court.  The Cyan ruling allows plaintiffs to avoid at least some aspects of the Private Securities Litigation Reform Act’s (“PSLRA”) provisions designed to eliminate meritless securities litigation by filing Securities Act claims in state court while simultaneously filing nearly identical actions in federal court.  Cyan has resulted in duplicative, unnecessary, and costly litigation.  Immediately after the decision was issued, the number of Securities Act claims filed in state court increased.[2]  Moreover, nearly half of the state court cases filed in 2018-2019 coincided with concurrent filing of federal litigation.  Additionally, different state courts have reached contradictory conclusions as to whether federal safeguards, such as some of those provided by the PSLRA and federal common law principles, apply in state court proceedings.[3]  In the wake of Cyan, Professor Joseph Grundfest of Stanford Law School has advocated including federal forum selection clauses in certificates of incorporation or bylaws as a means of trying to combat the adverse effects of multiple jurisdiction litigation in Securities Act cases.  After the Cyan decision, and the publication of Professor Grundfest’s approach, it became more common for public corporations, particularly those incorporated in Delaware to include FFPs in their corporate documents.  

The Delaware Supreme Court addressed the enforceability of such a FFP under Delaware law in Sciabacucchi v. Salzberg (Blue Apron) [4] reversing the Chancery Court’s ruling that FFPs contained in a Delaware corporation’s charter are unenforceable under relevant provisions of Delaware General Corporation Law (“DGCL”).[5]  In Sciabacucchi, the Delaware Supreme Court held the FFP was not contrary to Delaware corporate law.  The court explained “Delaware courts attempt ‘to achieve judicial economy and avoid duplicative efforts among courts in resolving disputes.’  [FFPs] advance these goals.’”  Sciabacucchi was a significant step in validating the enforceability of FFPs and reducing the adverse effects of Cyan, but because it was not binding on courts in other jurisdictions it was unclear whether it would be adopted by courts in other states, particularly in traditionally plaintiff-friendly jurisdictions like California. 

Wong v. Restoration Robotics, Inc.

Restoration Robotics is a Delaware corporation with its principle place of business in California.  On May 23, 2018, a shareholder of Restoration Robotics filed a complaint alleging claims under the Securities Act in California Superior Court for San Mateo County.  Restoration Robotics moved to dismiss the complaint pursuant to a FFP in its charter, which the court initially denied, relying on the Delaware Chancery Court’s decision in Sciabacucchi.  After the Delaware Supreme Court reversed the Chancery Court’s holding, Restoration Robotics filed a Motion for Reconsideration and Renewed Motion to Dismiss on March 30, 2020.  On September 1, 2020, the court granted Restoration Robotics’ motion. 

On September 1, 2020, the California Superior Court for San Mateo County granted Restoration Robotics, Inc. and certain individual defendants’ (collectively, “Restoration Robotics”) Motion for Reconsideration and Renewed Motion to Dismiss in Wong v. Restoration Robotics, Inc., et al.[6]  The California Superior Court characterized Sciabacucchi’s holding that a FFP was permissible under Delaware law as “basically irrelevant,” and its discussion about federal law and policy and “suggest[ions] that other states should consider finding them enforceable under the laws of their own state” as nonbinding “dicta.”  However, notwithstanding this view of Sciabacucchi, the Restoration Robotics court upheld the FFP as valid, concluding that Restoration Robotics’ FFP, which was (i) narrowly drafted to leave intact all substantive rights and remedies under the Securities Act, (ii) included in corporate documents after the approval of a shareholder vote, and (iii) put into effect before the Section 11 lawsuit at issue was filed, was “akin to a contractual forum selection clause.”  Moreover, the court found there was no procedural loss of due process rights because shareholders could present their federal law claims to a federal court, in a state or province of a state close to their residence and shareholders would have the opportunity for discovery and trial by jury.

In re Uber Technologies, Inc. Securities Litigation

Uber is a Delaware corporation headquartered in California.  On February 11, 2020, shareholders of Uber filed a complaint alleging claims under the Securities Act in California Superior Court for San Francisco County.  Uber moved to dismiss the complaint pursuant to a FFP in its charter, which the California Superior Court granted on November 16, 2020 in In re Uber Technologies, Inc. Securities Litigation.[7]

In Uber, the California Superior Court found that the FFP was valid and enforceable.  Like in Restoration Robotics, the Uber decision focused on the fact that the FFP was contained in Uber’s charter and “was approved by a majority of its shareholders” and plaintiffs offered “no evidence to show that the FFP was unexpected or unreasonable.”  For these reasons, it concluded plaintiffs were “on notice, and presumptively agreed to the terms of Uber’s Charter by purchasing the securities.”  The Uber decision also found that the FFP was not unconscionable as the FFP did not “eliminate the substantive protections provided by the Securities Act” as the claims could be asserted in federal court where similar “rights to discovery, jury trial or appeal” would apply.    

In re Dropbox, Inc. Securities Litigation

Dropbox is a Delaware corporation with its principal place of business in California.  On August 30, 2019, shareholders of Dropbox filed a complaint alleging, among other causes of action, a claim under Section 11 of the Securities Act in California Superior Court for San Mateo County.  Dropbox moved to dismiss the complaint pursuant to a FFP in its bylaws, which the California Superior Court granted on December 4, 2020 in In re Dropbox, Inc. Securities Litigation.[8]

In dismissing the action, the Dropbox court referred to Restoration Robotics, which it noted “appears to be the first decision outside of Delaware to have decided this issue” but “is not precedent.”  The court then found the FFP valid under both Delaware and California law because, pursuant to both state law analyses, the court would “still determine whether the clause is unfair or unreasonable.”  The court rejected the notion that a forum selection clause is unreasonable simply because it is not negotiable and emphasized that “when Plaintiffs acquired their shares, their purchases were subject to the Dropbox Bylaws and they assented to the FFP.”  As in Restoration Robotics and Uber, the court determined the FFP was not substantively unconscionable because it permitted the plaintiffs to “file in any federal court” and did “not take away the right to discovery, jury trial or appeal.”  Moreover, it observed Dropbox provided a “legitimate business need to support the FFP”—“to avoid the unnecessary costs and burden of defending multiple cases simultaneously in both state and federal courts and the possibility of inconsistent judgments and rulings.”       

Conclusion

Restoration Robotics, Uber and Dropbox indicate a broad consensus among different California courts to enforce FFPs in a manner consistent with the non-binding Delaware Supreme Court decision in Sciabacucchi.  Restoration Robotics and Dropbox are significant in part because the Superior Court for San Mateo County in the past has been considered a plaintiff-friendly jurisdiction.  Restoration Robotics effectively upheld Sciabacucchi’s holding, despite a clear reluctance to do so.  The courts in Uber and Dropbox reached the same conclusion as Sciabacucchi.  These decisions suggest other California courts considering FFPs pertaining to Delaware corporations may also enforce them, particularly where shareholders have voted to approve FFPs in corporate documents.  Nonetheless, the decisions are not binding precedent even in California nor do they address FFPs for entities incorporated outside of Delaware.  Ultimately, congressional reform would be the preferred method of remedying the potential duplicative litigation and inconsistent court rulings following the Cyan decision, including providing a remedy to the unfairness and wasteful expense of allowing parallel state and federal proceedings for a claim brought under the Securities Act.  In the meantime it is recommended that public companies, wherever incorporated, include an FFP in their corporate documents, where feasible with shareholder approval.

[1] 138 S.Ct. 1061 (2018) (“State-court jurisdiction over 1933 Act claims thus continues undisturbed”).

[2] See “Two Areas for Reform in Securities Litigation,” Gregory A. Markel and Sarah A. Fedner, The D&O Diary (June 9, 2020) (available at https://www.dandodiary.com/2020/06/articles/securities-litigation/guest-post-two-areas-for-reform-in-securities-litigation/).

[3] Compare In re Dentsply, Inc. v. XXX, Index No. 155393/2018, 2019 WL 3526142 (Sup. Ct. N.Y. Cnty. Aug. 2, 2019) and In re PPDAI Group Sec. Litig., No. 654482/2018, 2019 WL 2751278 (Sup. Ct. N.Y. Cnty. July 1, 2019) (holding PSLRA’s stay of discovery during a pending motion to dismiss did not apply in state court proceedings) with In re Everquote, Inc. Sec. Litig., Index No. 651177/2019, 2019 WL 3686065 (Sup. Ct. N.Y. Cnty. Aug. 7, 2019) (finding Cyan did not control whether the PSLRA discovery stay applied to state courts and concluding discovery is stayed during a pending motion to dismiss); see also Switzer v. Hambrecht & Co., No. CGC-18-564904, 2018 WL 4704776 (Cal. Super. Ct. Sept. 19, 2018) (holding the PSLRA’s discovery stay does not apply in state court); cf. City of Livonia Retiree Health and Disability Benefits Plan v. Pitney Bowes, No. X08-FST-CV-18-6038160-S, 2019 WL 2293924 (Conn. Super. Ct. May 15, 2019) (holding the PSLRA discovery stay applies).

[4] 227 A.3d 102 (Del. 2020).

[5] No. 2017-0931-JTL, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018), appeal dismissed, 204 A.3d 841 (Del. 2019), and judgment entered, (Del. Ch. 2019), vacated, (Del. Ch. 2020), and rev'd, 227 A.3d 102 (Del. 2020).

[6] No. 18CIV02609, 2020 Cal. Super. LEXIS 227 (Cal. Sup. Ct. Sept. 1, 2020).  The court denied the motion to dismiss as to the underwriter and venture capital defendants, explaining that neither were signatories to the “Amended and Restated Certificate of Incorporation” that contained the FFP.

[7] No. CGC-19-579544 (Cal. Super. Ct. Nov. 16, 2020).

[8] No. 19-CIV-05089 (Cal. Super. Ct. Dec. 4, 2020).