California Court of Appeal Upholds Enforceability in California of Forum-Selection Bylaw of Delaware Corporation Headquartered in California

On December 21, 2018, the Court of Appeal of California, Sixth Appellate District, affirmed in Drulias v. 1st Century Bancshares, Inc., 2018 Cal. App. LEXIS 1202, a trial court ruling that a forum-selection bylaw adopted by a Delaware corporation headquartered in California without stockholder approval was enforceable in California.

The decision arose out of a putative class action filed in California state court on behalf of the stockholders of 1st Century Bancshares, Inc., a publicly-held Delaware corporation (“1st Century”), against 1st Century and its directors, alleging breach of fiduciary duties in approving a merger agreement in which 1st Century was to be acquired by Midland Financial Co. Per 1st Century’s certificate of incorporation, which allowed its Board of Directors to adopt, amend and repeal its bylaws, subject to the power of its stockholders to alter or repeal any bylaws whether adopted by them or otherwise, the Board of Directors amended the bylaws at the time it approved the merger agreement to provide for a forum-selection clause that, unless otherwise agreed to by 1st Century, Delaware was the exclusive forum for any intra-corporate disputes, including a claim of breach of fiduciary duty.

Among other decisions made by the trial court, including rejecting a proposed settlement agreed to by the parties, that court ruled that the forum-selection clause required that plaintiff’s complaint be litigated in Delaware, not California. In affirming that decision, the appellate court noted that the parties agreed that Delaware law governed the breach of fiduciary duty claim as well as the validity of the forum-selection bylaw provision, and that the plaintiff did not contest its validity under Delaware law. The issue to be decided by the appellate court was whether California law rendered the bylaw provision unenforceable in California.

The appellate court held that the bylaw provision did not conflict with California law or public policy and that the trial court did not err in deciding that enforcement of the provision was reasonable in this case. Specifically, the appellate court rejected plaintiff’s contention that the provision conflicted with the last sentence of Section 2116 of the California Corporations Code. That section reads as follows (with the last sentence bolded for emphasis): “The directors of a foreign corporation transacting intrastate business are liable to the corporation, its shareholders, creditors, receiver, liquidator or trustee in bankruptcy for the making of unauthorized dividends, purchase of shares or distribution of assets or false certificates, reports or public notices or other violation of official duty according to any applicable laws of the state or place of incorporation or organization, whether committed or done in this state or elsewhere. Such liability may be enforced in the courts of this state.”

The appellate court rejected plaintiff’s assertion that the last sentence conferred a substantive and statutory right under California law for shareholders to sue directors of a foreign corporation in this state. Instead, the court found that Section 2116 codified the internal affairs doctrine, “a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation’s internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands.” The last sentence of Section 2116 simply reflected the view of recent courts that they do not have to decline jurisdiction over cases involving a foreign corporation and its internal affairs. However, “nothing in the provision requires a California court to exercise jurisdiction over such a case where it finds ‘that in the interest of substantial justice [the] action should be heard in’ another forum.”

The appellate court also concluded that neither the manner in which the bylaw was adopted, by the Board without notice to stockholders, nor the timing of such adoption, at the same time as adopting the merger agreement, was unreasonable. The court noted that Delaware and California law do not require forum-selection clauses to be freely negotiated to be enforceable and that the forum-selection bylaw “is entirely consistent with [plaintiff’s] reasonable expectations at the time he chose to purchase stock in 1st Century.” Moreover, the court found that the timing of the adoption of a forum-selection bylaw provision should not determine its validity, noting that “the public announcement of virtually every transaction involving the acquisition of a public corporation provokes a flurry of class action lawsuits alleging that the target’s directors breached their fiduciary duties by agreeing to sell the corporation for an unfair price.” In such circumstances, and absent any evidence to the contrary, there was no reason to believe “the bylaw at issue was adopted for any reason other than to consolidate merger-related litigation into a single forum, where it could be resolved efficiently and cost-effectively.”

In reaching its decision, the appellate court found unpersuasive the reasoning in Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011) in which a federal district judge in California, applying federal common law, declined to uphold a forum-selection bylaw provision partly because “the bylaw was adopted by the very individuals who are named as defendants, and after the alleged wrongdoing took place.”

Drulias follows a recent Delaware case also involving the enforceability of forum-selection bylaw provisions. In Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Delaware Court of Chancery held invalid under Delaware law a forum-selection provision in a certificate of incorporation that required any claim under the federal Securities Act of 1933 to be brought in federal court. The court distinguished this clause from valid forum-selection provisions that require claims based on the internal affairs doctrine to be litigated exclusively in the Court of Chancery. It is unclear how a California court would decide this kind of case.

This e-Bulletin was prepared by William Ross, of counsel to Hirschfeld Kraemer LLP, where he represents clients on corporate matters. Mr. Ross practices in Santa Monica, California.