Courtesy of Mohsen Manesh
In Sciabacucchi v. Salzberg, the Delaware Supreme Court confronts a thorny question at the intersection of state corporate law and federal securities law. Specifically, the case asks whether a Delaware corporation may include a forum selection provision in its corporate charter governing shareholder claims brought under federal securities law. But that narrow question implicates a more controversial subject: whether a corporation may include in its corporate charter a provision compelling shareholders to arbitrate federal securities law claims.
The Chancery Court’s Sciabacucchi Decision and its Problems
In Sciabacucchi, the Delaware Chancery Court (Chancery Court) ruled that a forum selection provision governing shareholder claims brought under federal securities law is invalid under Delaware corporate law. To reach this conclusion, the Chancery Court invoked the internal affairs doctrine and reasoned that shareholder rights arising under federal securities law are external to the narrow legal relationship created and governed by state corporate law. Therefore, the Chancery Court concluded that a corporation’s charter may not, as a matter of state corporate law, regulate the rights of shareholders arising under federal securities law.
While that reasoning is defensible, it is not obviously correct. As I explain in a forthcoming paper, the court could have easily come to the opposite conclusion. That is because the boundaries of the internal affairs doctrine, on which the Chancery Court relied upon, are inescapably indeterminate. One cannot draw a neat line separating internal corporate affairs from external matters because the two inevitably bleed into one another. For example, the Chancery Court could have readily reasoned that the rights of shareholders arising under federal securities law are an internal corporate affair that may be regulated through the terms of a corporate charter. After all, such rights are predicated on the purchase or sale of a corporation’s stock, and the legal rights attendant the purchase or sale of a corporation’s stock is a quintessential internal corporate affair that is already regulated by Delaware corporate law.
Given the indeterminacy at the boundaries of the internal affairs doctrine, and the judicial discretion it invites, what should the Delaware Supreme Court do with Sciabacucchi? From Delaware’s perspective at least, there is no easy answer.
Affirm Sciabacucchi and Risk Losing Corporate Charters to Other States
On one hand, the Delaware Supreme Court could affirm the Chancery Court’s decision in Sciabacucchi. But simply because Delaware decides that shareholder rights arising under federal securities law are not an internal affair does not mean that other states will agree with Delaware’s judgment. As I argue in my paper, other states seeking to compete with Delaware’s lucrative corporate chartering business—for example, Nevada—could readily define the boundaries of the internal affairs doctrine more broadly, specifically authorizing corporate charter and bylaw provisions regulating shareholder rights arising under federal securities law. Such a change would enable Nevada corporations to include not just forum selection provisions of the type Sciabacucchi invalidated, but also fee-shifting and mandatory arbitration provisions covering federal securities law claims.
Because such provisions are now prohibited under Delaware law, there will be some number of Delaware corporations tempted to reincorporate in Nevada. To be sure, the number will depend on the willingness of investors to accede to any such provisions regulating their rights arising under federal securities law. But with respect to at least forum selection provisions governing federal securities law claims—the very type of provision the Chancery Court barred in Sciabacucchi—there are reasons to believe shareholders will not oppose, and may actually favor, such provisions. A recent study by Aggarwal, Choi, and Eldar shows that immediately following the Delaware Chancery Court’s Sciabacucchi decision the stock price of corporations with forum selection provisions governing federal securities law claims suffered significant declines. This evidence, the coauthors conclude, “generally lend[s] some support to the view the [such provisions] are desirable and do not undermine shareholders’ rights.” Thus, if the Delaware Supreme Court chooses to affirm Sciabacucchi, it risks driving some corporations away from incorporation in Delaware.
Reverse Sciabacucchi and Risk Uncertain Federal Consequences
On the other hand, the Delaware Supreme Court could reverse the Chancery Court decision in Sciabacucchi and rule that forum selection provisions governing federal securities law claims are valid. Doing so would avoid the risk of driving corporations away from Delaware. But it would also open the door to mandatory arbitration provisions in corporate charters governing federal securities law claims. After all, the U.S. Supreme Court has described an arbitration clause to be merely a “specialized kind of forum-selection clause.”
Of course, the enforceability of a mandatory arbitration provision governing federal securities law claims is ultimately a question of federal law, and the answer to that question is currently uncertain. But the U.S. Supreme Court’s recent jurisprudence enforcing the Federal Arbitration Act (FAA) coupled with the Delaware courts’ recent jurisprudence characterizing corporate charters as “contracts” between the corporation and its shareholder strongly suggest that mandatory arbitration provisions in corporate charters would be enforceable under the FAA.
The problem for Delaware is that if the FAA compels enforcement of arbitration provisions covering federal securities law claims, then Delaware’s statutory ban against mandatory arbitration provisions governing state corporate law claims—codified in DGCL 115—is almost certainly preempted by the FAA. That statutory ban ensures that Delaware state courts—the crown jewel of the state’s corporate law—remain the central regulatory authority for the nation’s corporations, and that those courts continue to produce new precedents to address emergent and novel issues relevant to corporations. The widespread use of arbitration to resolve state corporate law disputes would strip Delaware courts of their regulatory authority and, thus, retard the development of the state’s corporate law. For this reason, the preemption of DGCL 115 and the widespread use of arbitration has been described as an “existential threat” to Delaware corporate law.
Uncertain Path Ahead
Given the unattractive consequences associated with either affirming or reversing Sciabacucchi, it is difficult to predict how the Delaware Supreme Court will resolve the appeal. In a recent paper, Professor Grundfest proposes one alternative. Specifically, Professor Grundfest argues that a strictly “textual” reading of DGCL 115 would permit forum selection provisions governing shareholder rights arising under federal securities law while still banning mandatory arbitration of those rights. But even this interpretation of DGCL 115 would not preserve it from potential preemption under the FAA. Seemingly conceding this point, Grundfest argues that opponents of mandatory arbitration should “direct their residual concerns to Congress and to the [SEC] because their objections relate entirely to matters of federal law.” Although that is a principled response, it is not a particularly comforting answer for Delaware.
However the Delaware Supreme Court resolves Sciabacucchi, the indeterminate boundaries of the internal affairs doctrine is a problem that is unlikely to go away for Delaware. California’s new board gender diversity statute raises another challenge to the scope of the doctrine. Ultimately, as I conclude in my paper, continued challenges to the scope of the internal affairs doctrine could both erode Delaware’s corporate law hegemony and fundamentally reshape the regulation of corporate America.