California court approves enforcement of federal forum selection provision for Securities Act claims: Practical implications of Wong v. Restoration Robotics
The decision of the California Court of Appeal, First Appellate District in Wong v. Restoration Robotics, Inc. is the first authoritative California opinion upholding a federal forum provision adopted by a Delaware corporation – that is, a provision requiring stockholders to bring Securities Act claims in federal court unless the corporation consents otherwise in writing.
Background: federal securities law
The Securities Act of 1933 allows purchasers of securities to assert that a registration statement for a public offering contained a materially false or misleading statement at the time it became effective, exposing to potential liability the issuer, directors, other signatories, underwriters, auditors, and others for misrepresentations in the registration statement.
Claims under the Securities Act do not require a plaintiff to show scienter (the intent to defraud) or reliance, so the liability standard is lower than for securities fraud claims under Rule 10b-5. Although other statutory provisions may reduce the risk of being held liable, the Securities Act presents significant litigation risks for public companies issuing securities, including those going public in an IPO, and for their directors and officers.
Unlike claims of securities fraud under Rule 10b-5, which must be brought in federal court, Securities Act claims can be brought in either federal or state courts. The Securities Act also includes a provision generally barring removal of state court filings (subject to exceptions not directly relevant here).
After Congress enacted the Private Securities Litigation Reform Act in 1995, plaintiffs attempted to avoid its more demanding pleading standards and limitations on early discovery by filing securities class actions in state courts. Congress addressed that abuse in the Securities Litigation Uniform Standards Act (SLUSA), enacted in 1998. A split of authority subsequently emerged as to whether SLUSA permitted removal of state court class actions solely asserting claims under the Securities Act, but that split was resolved against removal by a unanimous Supreme Court in Cyan, Inc. v. Beaver County Employees Retirement Fund in 2018.
Federal forum selection provisions under Delaware law
Even before Cyan, and with the support of academic experts, some corporations began to adopt federal forum provisions in their certificates of incorporation or bylaws as another way to ensure that Securities Act cases naming them would be litigated in federal court. The adoption of such provisions increased after Cyan. A majority of US corporations are incorporated in Delaware, and that is where litigation challenging those provisions first arose.
In Salzberg v. Sciabacucchi (2020), the Delaware Supreme Court held that the Delaware General Corporation Law allows corporations to adopt federal forum provisions in their certificates of incorporation. The court, however, recognized a “down the road” question of whether federal forum provisions would “be respected and enforced” by other states, observing that the “the question of enforceability is a separate, subsequent analysis that should not drive the initial facial validity inquiry.” Wong provides the first authoritative answer to this question in a California appellate court.
Wong upholds the enforcement of a federal forum provision adopted by a Delaware corporation in its certificate of incorporation
Wong, issued on April 28, 2022, decides the appeal of one of several California trial court decisions upholding federal forum provisions in Securities Act class actions.
In Wong, Restoration Robotics’ board of directors and stockholders adopted a federal forum provision in an amended certificate of incorporation before the company went public, and the company attached the amended certificate as an exhibit to its registration statement filed before the IPO.
The trial court dismissed Wong under the rubric of a motion to dismiss for inconvenient forum, finding that Restoration Robotics’ federal forum provision, as adopted, was valid and that plaintiff had not shown it to be unenforceable, unconscionable, unjust, or unreasonable, including because it did not violate California law and was not unconstitutional or illegal under any federal law. In its discussion of when stockholders reasonably should expect corporations to adopt federal forum provisions, the court used the term “bylaw,” even though the provision at issue had been adopted in a certificate of incorporation.
The Court of Appeal first addressed whether federal forum provisions as a category are impermissible under the concurrent jurisdiction provision of the Securities Act or under various sections of the United States Constitution. The court ruled for defendants across the board on those issues. It held that such corporate provisions do not implicate the Securities Act’s prohibition on removal because they do not themselves remove cases to federal court; the Securities Act does not create an unwaivable right for plaintiffs to have claims adjudicated in state court; and the Delaware statutes authorizing corporations to adopt federal forum provisions do not purport to shut the doors of any state court to Securities Act cases.
The Court of Appeal then found the trial court did not abuse its discretion in finding that the federal forum provision adopted by Restoration Robotics was valid and enforceable. Applying Delaware law, the court concluded that Salzberg had settled the question of validity in the defendants’ favor. It found that plaintiff had not shown that the enforcement of the provision would be outside the reasonable expectations of the company’s stockholders, due in part to the fact that the provision “was made public in an amendment to the registration statement several weeks before the IPO, when it became effective.” For the same reasons, the federal forum provision was neither substantively unconscionable nor a contract of adhesion.
Practical implications
The most important fact about Wong is that the Court of Appeal certified it for publication. Many California appellate decisions are not published, which means they are not citable as precedent under California law. Trial court decisions are never binding precedent. As a to-be-published decision, Wong can be cited in other cases seeking enforcement of federal forum provisions.
Debate likely will continue on the constitutional issues raised in Wong among practitioners, scholars, and other courts. As a practical matter, Wong illustrates that even if Delaware (or another state) allows its domestic corporations to adopt federal forum provisions, it will be up to courts in other states to enforce those provisions. A corporation considering adoption of such a provision should publicly disclose the provision to maximize the probability of enforcement in response to future assertions that the provision was unexpected or unknown. A growing number of IPO companies have adopted these provisions in advance of their IPO, such that IPO investors asserting claims based on the registration statement for the IPO or on disclosure used in the IPO would need to bring those claims in federal court.
A corporation also should consider whether a federal forum provision should be adopted in a certificate of incorporation rather than in its bylaws. Salzberg and Wong considered the question in the context of certificates of incorporation, but the reasoning in both cases should apply to provisions adopted in corporate bylaws as well as certificates. So long as a federal forum provision is not inconsistent with law or a corporation’s certificate of incorporation, it seems like a facially valid bylaw. Moreover, Wong’s enforceability analysis relied on Drulias v. 1st Century Bancshares. Drulias enforced a different type of forum selection provision (which specified Delaware Chancery Court as the exclusive forum for a broad set of corporate law claims) that was contained in a Delaware corporation’s bylaws rather than its certificate.
While most companies include a federal forum provision in their certificates of incorporation rather than bylaws, we are monitoring whether this may change due to the ostensibly favorable language in Wong about these provisions in bylaws. A substantial majority of public company charters empower the corporation’s board of directors to amend the bylaws without stockholder approval. (This was how the forum selection provision in Drulias had been adopted.) Because public companies may find it useful to update, clarify, or even remove a federal forum provision without the time and expense associated with calling a stockholders’ meeting, soliciting proxies and the like, many companies would welcome cases that squarely permit including such provisions in their bylaws.
Please contact the author or your DLA Piper relationship partner should you have any questions regarding federal forum provisions.
