On March 18, 2020, in a landmark ruling in Salzberg v. Sciabacucchi, No. 346, 2019 (Del. March 18, 2020), the Delaware Supreme Court upheld the validity of provisions included in a Delaware corporation's certificate of incorporation that require shareholders of that corporation to sue in federal court, rather than state court, over alleged violations of the Securities Act of 1933 (the Securities Act). (For more details on the Salzberg decision, see Michael G. Bongiorno, et al., Delaware Supreme Court Upholds Validity of Federal Forum Provisions in Landmark Ruling, March 19, 2020).

This much-anticipated decision provides Delaware corporations with a new tool—a federal-forum provision—to exercise control over the venue for Securities Act litigation, thereby avoiding duplicative litigation filings and steering cases to federal courts more accustomed to hearing federal securities claims. But, now that the dust has had a chance to settle, many corporations and practitioners are asking themselves, what are the limitations to this ruling? This article explores what the Salzberg decision resolved and what still remains an open question.

What We Know

The Salzberg decision confirmed the facial validity of federal-forum provisions in certificates of incorporation of Delaware corporations. However, the decision makes clear that securities plaintiffs may still challenge the application of such provisions to particular cases, in other words, they may bring as-applied challenges.

The decision provides a ground for dismissal of state court actions. Thus, if a plaintiff brings state court Securities Act claims against a Delaware corporation that has a federal-forum provision, that corporation can move to dismiss on the ground that plaintiffs are contractually bound by the provision and must sue in federal court. The decision does not mean that every motion to dismiss brought on these grounds will be successful, and if a Delaware corporation lacks a federal-forum provision, this decision has no impact on the corporation's ability to change venues.

The decision is most significant with respect to class actions relating to a company's IPO. The decision does not apply to securities fraud cases under §§14 or 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which were already limited to federal court. Further, although the decision technically applies to any Securities Act class action (which generally challenge securities offerings), follow-on offerings are rarely challenged under the Securities Act because it is generally difficult or impossible to disaggregate whether market purchases of fungible shares are "traceable" to any particular offering. Thus, the principal impact will be in class actions arising from IPOs.

Questions Left Open

There are a number of questions left open after the Salzberg decision. Some of the more significant are as follows:

What happens to underwriters? IPO underwriters are often named as defendants in securities class actions, but it is not clear that a federal-forum provision could govern a claim against an underwriter. Indeed, the Delaware Court of Chancery observed, in finding that Securities Act claims were not internal to the company, that the potential defendants in a Securities Act case are not limited to the company's officers and directors, and may include, for example, underwriters, accountants, or other professionals. See Sciabacucchi v. Salzberg, No. CV 2017-0931-JTL, 2018 WL 6719718, at *16-17 (Del. Ch. Dec. 19, 2018) (citing 15 U.S.C. §77k(a)). While the Delaware Supreme Court's decision overruled the Delaware Court of Chancy on this finding and found that Securities Act claims were "intra-corporate," it did not address underwriters, nor did it need to for purposes of finding federal-forum provisions facially valid.

This poses a practical problem for companies engaged in offerings because underwriters uniformly demand contractual indemnity rights. Plaintiffs likely will continue to sue underwriters of IPO offerings in state courts, thus creating a practical dilemma for issuers who have the ability to shift claims against the issuers to federal court, but possibly not claims against underwriters that also, through indemnity obligations, create exposure for issuers. The practical reality may be that dual forum litigation continues to be common.

Can federal-forum provisions appear in the bylaws instead of the certificate of incorporation? Except in pre-IPO companies, the bylaws are simpler to amend than the certificate of incorporation, because the latter always requires shareholder approval. The Salzberg decision by its terms only pertains to certificates of incorporation. While there is every reason to believe that the logic of the decision would apply to bylaws, it technically remains an open question. In addition to this legal question, existing public companies that want to add a federal-forum provision to their bylaws without obtaining shareholder approval will need to consider the expected reaction from investors and proxy advisory firms, which could result in votes against the directors at the next annual meeting. It is also unclear whether a federal-forum provision appearing in the certificate of incorporation—thus bearing shareholder approval—is more likely to be enforced than a bylaw provision adopted without shareholder approval.

Will there be issues of enforceability? The Salzberg decision dealt only with a "facial challenge" to federal-forum provisions; a facial challenge asks only whether there is any possible scenario in which the provisions could be permissible. The court recognized that there could be "as-applied" challenges that could make federal-forum provisions unenforceable in the circumstances in which they arise. For example, the court implied that it is possible that a federal-forum provision would not be upheld if it was invoked against a new purchaser who did not already hold stock in the company because that could fall outside of the reach of §102 of the DGCL. See Salzberg v. Sciabacucchi, No. 346, 2019, at 31 (Del. March 18, 2020). Further, because Delaware corporations will attempt to enforce federal-forum provisions in other states, those claims will be subject to those respective states' policy considerations in determining whether such provisions are enforceable.

Will other states follow suit? The Salzberg decision applies only to Delaware corporations, so an open question is whether other states will allow federal-forum provisions. The Model Business Corporation Act, on which many states base their corporation act, includes language analogous to Delaware's §102(b)(1). Compare Model Business Corp. Act §2.02(b)(2) (2016 Revision) ("The articles of incorporation may set forth…provisions not inconsistent with law regarding…managing the business and regulating the affairs of the corporation…[and]…defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders"), and Mass. Gen. Laws ch. 156D, §2.02(b) (same), with 8 Del. C. §102(b)(1) ("the certificate of incorporation may also contain any or all of the following matters…[a]ny provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders …"). Accordingly, other states may find the decision persuasive in deciding whether to uphold similar federal-forum provisions enacted by corporations incorporated outside of Delaware.

Where We Go From Here

The Salzberg decision is a significant victory for corporations by allowing them flexibility to manage potential Securities Act litigation arising from their IPOs. However, because plaintiffs can still challenge the application of federal-forum provisions to particular cases and because the court's reasoning does not explicitly apply to bylaw provisions or underwriters, practitioners should include appropriate caveats when advising on whether corporations should adopt federal-forum provisions, whether such provisions should be included in the certificate of incorporation or bylaws, and the extent to which corporations should rely on such provisions.

Michael Bongiorno and Timothy Perla are partners, and Megan Barriger and Jessica Lewis are counsel, at Wilmer Cutler Pickering Hale and Dorr.