The Grundfest Solution Works Again and Corporate Counsel of Public Companies Should Take Notice of the Upside of Federal Forum Selection Clauses

On April 28, 2022, the California Court of Appeals became the first appellate court outside of Delaware to uphold a federal forum provision (“FFP”) in governing corporate documents. The appellate decision was issued in the case of Wong v. Restoration Robotics, Inc., et al.,[1] which was also the first trial court to enforce a FFP outside Delaware in the wake of the landmark case Cyan Inc. v. Beaver County Employees Retirement Fund.[2] The appellate court’s opinion is the latest signal that FFPs are a low-cost, high benefit measure companies can take to reduce the risk of costly and duplicative parallel state and federal litigation or litigation in multiple states under the Securities Act of 1933 (the “Securities Act”) (15 U.S.C. § 77z-1). It may also influence other courts, not bound by the decision, to follow its logic.

Background

In Cyan, 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.[3] 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.[4] 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) [5] 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”).[6] 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.

Since Sciabucucchi, trial courts in states other than Delaware to address FFPs, including California, Utah, and New York, have universally enforced the FFPs included in corporate documents. [7] 

Wong v. Restoration Robotics, Inc. (San Mateo Superior Court)

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 and a judgment of dismissal without prejudice was entered in its favor.

In Restoration Robotics, 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.

Wong v. Restoration Robotics, Inc. (California Court of Appeal)

A unanimous three-judge panel of the California Court of Appeal upheld the trial court’s enforcement of the FFP, rejecting the plaintiff’s arguments that (1) the FFP violated the “anti-removal” provision of the Securities Act; (2) the FFP violated the “anti-waiver” provision of the Securities Act; (3) the FFP violated the dormant Commerce Clause of the Constitution; and (4) the FFP violated the Supremacy Clause of the Constitution. The California Court of Appeal found neither the “anti-removal” nor the “anti-waiver” provision of the Securities Act were violated because FFPs do not create any affirmative obligation or duty. The appellate court rejected the plaintiff’s constitutional challenges finding the FFP provisions did not implicate state law or action. The appellate court also held that because FFPs are valid provisions within the certificates of incorporation of Delaware corporations under Sciabacucchi, their validity under California law need not be considered and found them enforceable under California law. [8]

Conclusion

The Restoration Robotics decision is further indication that upcoming IPOs and existing companies alike should consider including an FFP in their corporate documents. Ultimately, congressional reform would be the preferred method of remedying the abuses possible following the Cyan decision, including providing a remedy to the unfairness and wasteful extra expense of allowing parallel state and federal proceedings for a claim brought under the Securities Act. In the meantime, it is strongly recommended that public companies, wherever incorporated, include an FFP in their corporate documents, and, if feasible or required, seek shareholder approval.

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[1] 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.

[2] 138 S.Ct. 1061 (2018) (“State-court jurisdiction over 1933 Act claims thus continues undisturbed”).

[3] 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/).

[4] 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).

[5] 227 A.3d 102 (Del. 2020).

[6] 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).

[7] Restoration Robotics (Cal. Sup. Ct. Sept. 1, 2020), In re Uber Technologies, Inc. Securities Litigation, No. CGC-19-579544 (Cal. Super. Ct. Nov. 16, 2020); In re Dropbox, Inc. Securities Litigation, No. 19-CIV-05089 (Cal. Super. Ct. Dec. 4, 2020).; Casa Systems Inc. (NY Commercial Division Aug. 30, 2021); Volonte v. Domo, Inc.(Utah April 13, 2021)

[8] The appellate court also noted in dicta that the FFP at issue was approved by the board of directors and its then stockholders before the initial public offering through which Wong purchased his shares and was included in the Certificate of Incorporation at the time Wong bought his shares.