As I’ve written elsewhere, including most recently for Forbes.com, Corporate America scored a big win recently in the Delaware Supreme Court. Thanks to the ruling in Sciabacucchi, public companies have a way to cut down on litigation over alleged false and misleading S-1 registration statements.
Delaware-incorporated companies can now adopt federal forum provisions in their charter documents. Federal forum provisions still allow shareholders to sue a company over a registration statement, but only in federal courts. The goal is to stop duplicative suits from being brought in state court as well—a troubling trend in recent years.
Directors and officers of Delaware-incorporated companies who want to cut down on frivolous litigation will seriously consider taking advantage of this ruling. In this article I will discuss some of the issues now in play for different types of companies.
For Recent IPO Companies That Already Have Federal Forum Provisions in Their Certificates of Incorporation
Prior to the ruling in Sciabacucchi, many IPO companies had adopted federal forum provisions. When the lower Delaware court ruled that these provisions were facially invalid, many companies publicly declared that they would not enforce the provisions until a Delaware court found them to be valid.
Now that this has happened, these companies can update their disclosures to remove mentions of plans to forebear enforcing these provisions.
Some of these companies are also currently facing litigation in state courts concerning their registration statement (“Section 11” litigation). These companies will want to consider moving to have their case dismissed for lack of jurisdiction.
As noted by Boris Feldman of the firm Wilson Sonsini (the firm that argued and won the Delaware Supreme Court appeal in Sciabacucchi):
For cases pending against companies that do have an FFP in place, aggressive action is warranted. Those companies probably should move immediately to dismiss the cases in state court based on the Provision. Even if the state court previously declined to rule on the validity of the FFP—or ruled against it—a jurisdictional issue can be raised at any time. [Emphasis added]
Unfortunately, companies that are being sued over registration statements in state court that do not have federal forum provisions will not be successful in moving to dismiss current state cases, even if they were to adopt such provisions now.
For Pre-IPO Companies or Companies Considering a Direct Listing
The US Supreme Court’s ruling in Cyan accelerated an unfortunate trend we had seen for the past several years: IPO and direct listing companies being sued in both federal and state courts for alleged material misstatements and omissions in their S-1 registration statement.
These suits all alleged the same set of facts but were filed in a way that kept the cases from being consolidated. As a result, defendants were forced to fight an expensive multi-front war.
Follow-on offerings where the stock price fell below the issue price often were met with a similar state court fate when the follow-on was conducted soon after the IPO.
To avoid the problem of being sued in state court, pre-public companies will want to insert federal forum provisions into their certificates of incorporation before conducting an IPO or direct listing. It’s a good idea to use the same language that the Delaware Supreme Court examined in Sciabacucchi.
Unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933. Any person or entity purchasing or otherwise acquiring any interest in any security of [the Company] shall be deemed to have notice of and consented to [this provision].
These companies will also want to put the federal forum provisions in certificates of incorporation, as was the case for the three defendant companies in Sciabacucchi.
For Public Companies Contemplating Registered Offerings, Including M&A
IPO and direct listing companies are not the only companies being dragged to state courts over registration statement litigation. I have also written about public companies facing similar suits when they used company stock for M&A purposes, and the value of that stock declined below the issue price shortly after the deal closed.
Theoretically, any registered offering, including a debt offering, could find itself the subject of Section 11 litigation in state court.
If a company plans to do a registered offering, including for M&A purposes, the company may want to expedite adopting federal forum provisions. One way to do this is for the board of directors to place such a provision in company bylaws.
Unlike amendments to certificates to incorporation, many Delaware company boards can amend their bylaws without a shareholder vote.
Boards that choose to do this will want to have a robust record of the considerations that went into making such a decision. There is some chance that a company may find itself with a facial challenge to federal forum bylaw provisions given that the Sciabacucchi‘s decision was about federal forum provisions in a company’s certificate of incorporation, not in a company’s bylaws.
This seems unlikely, however, given the robust reasoning in Sciabacucchi. It’s hard to imagine that any plaintiff’s firm would pursue such a case.
The other unknown for a board that places federal forum provisions into bylaws is how proxy advisors like ISS and Glass Lewis would respond. One hope is that they would have been tracking the burdensome nature of duplicative litigation, and thus would see the move as an appropriate expression of a board’s fiduciary duty to protect the value of a company for the benefit of shareholders.
If ISS and Glass Lewis disagree, however, they might recommend a “no” vote for a board that unilaterally inserts federal forum provisions in a company’s bylaws.
Given the cost and burden of state court litigation, however, a company contemplating a registered offering, including for M&A, may well conclude that the risks associated with inserting federal forum provisions into bylaws are worth taking.
For Public Companies Not Contemplating Registered Offerings, Including M&A
A company that is not contemplating a registered offering, including for M&A purposes, may be in less of a hurry to adopt federal forum provisions.
Indeed, any board of directors that doesn’t want to go the bylaw route could ask their shareholders to vote in favor of amending the company’s certificate of incorporation to include federal forum provisions.
This could be done as part of the annual shareholder vote process by including the proposal in the annual proxy statement.
This path has twin benefits. First, this path allows a company to stick more closely to what the Delaware Supreme Court actually examined and held to be valid in Sciabacucchi.
Second, ISS and Glass Lewis could have no objection to a company’s board’s recommendation if shareholders voted in favor of the adoption.
Will D&O Insurance Rates Drop for Companies That Adopt Federal Forum Provisions?
Given the very high increases in both premiums and self-insured retentions for D&O insurance in the last few years, all directors and officers would like to see Sciabacucchi have an immediate impact on the D&O market.
Sciabacucchi may ultimately contribute to lower D&O insurance rates, but a rapid decrease is not imminent. Insurance carriers will want to see some state courts dismiss pending Section 11 cases due to federal forum provisions before providing a discount.
In addition, the other factors that have contributed to increasing D&O insurance premiums, things like unusually high frequency rates and unusually high settlements for derivative suits, are still in play.
Having said that, when looking at D&O insurance pricing for IPO and recent IPO companies in the first quarter of 2020, price increases seems to be slowing. This may be the first signs of better pricing over all for the D&O insurance market.
In any case, companies will still want to consider adopting federal forum provisions, particularly given how high self-insured retentions have become for many companies, particularly recent IPO companies.
An IPO company with a $10 million self-insured retention is a company that, if sued, must pay $10 million out of its own pocket before its D&O insurance starts to respond. Thus, a real win (other than avoiding litigation altogether, of course) is to have less expensive litigation that doesn’t cause a company to have to pay the full $10 million self-insured retention. This will happen if the litigation gets resolved for less than that the amount of the self-insured retention.
Adopting federal forum provisions and eliminating duplicative state Section 11 cases will go a long way to achieving this goal.