Forum-Selection Bylaws as Defense-Side Options — Drulias v. 1st Century Bancshares, Inc.
Do defendants who agree to settle mergers and acquisitions litigation in one state, despite a forum selection bylaw in favor of another state’s courts, implicitly waive the right to enforce the bylaw if the settlement falls through? A trial court decision from California, Drulias v. 1st Century Bancshares, Inc,1 has held that they do not. The decision, now on appeal, demonstrates the powerful strategic option that forum selection clauses grant to corporate defendants, who may attempt to settle in a favorable forum but then litigate in a different jurisdiction if a settlement falls through.
Plaintiff Sues, and the Parties Settle, in California
The 1st Century case began as a typical M&A class action that led to a disclosure-only settlement. On May 3, 2016, plaintiff filed a class action complaint in the Superior Court of California for the County of Santa Clara challenging the merger between 1st Century Bancshares, Inc. (“1st Century”) and Midland Financial Co. Plaintiff alleged that the directors of 1st Century engaged in a flawed sale process, stood to receive personal benefits from the sale, and misrepresented or omitted material information in the proxy statement filed with regard to the merger.
Plaintiff and defendants accused each other of forum shopping. Plaintiff asserted that 1st Century adopted a forum selection bylaw at the time of the merger in order “to venue litigation involving the transaction with Midland in director-friendly Delaware, a jurisdiction that is known for its lax standards.” Defendants argued that plaintiff had “flouted” the bylaw, “presumably because Plaintiff has been sanctioned by the Delaware Court of Chancery for prior litigation misconduct.”2
The trial court never had the opportunity to rule on plaintiff’s motion to enjoin the merger. The parties reached a zero-dollar settlement under which defendants agreed to provide additional information to stockholders in a proxy statement. Following the stockholder vote and the close of the transaction, the parties moved for preliminary approval of their agreement, although only plaintiff filed a brief in support of settlement.
The California Court Rejects the Settlement and Stays Litigation
In a six-page order issued on November 21, 2016, the 1st Century court declined to approve the settlement. The court found it “very troubling” that, despite relying on Delaware law, plaintiff’s papers in support of the settlement did not discuss or acknowledge the Delaware Court of Chancery’s January 2016 decision criticizing disclosure settlements, In re Trulia, Inc. Stockholder Litigation.3 After discussing Trulia‘s standards for disclosure settlements, the California court found the disclosures not to be plainly material, and held that some of the purportedly new disclosures offered as consideration in the settlement had already been promulgated in the initial proxy. The decision described the release of claims as too broad to support a settlement, and denied plaintiff’s request for $400,000 in attorneys’ fees and expenses.
Following the rejection of the settlement, plaintiff filed an amended complaint, which defendants moved to dismiss based on 1st Century’s forum-selection clause. Plaintiff opposed the motion, arguing that defendants waived their forum selection bylaw by seeking judicial approval of the settlement and that California Corporation Code § 2116 provides stockholders with a right to sue in California notwithstanding a forum selection bylaw.
On June 20, 2017, the 1st Century court upheld the forum selection bylaw, reasoning that defendants’ attempt to settle the action did not constitute waiver and that the bylaw was enforceable. However, the court declined to dismiss the case, instead staying the action pending the assumption of litigation by the Delaware courts.
Analysis: Forum Selection Bylaws Offer Defendants a Potent Strategic Option
Rather than file an action in Delaware, plaintiff has filed a notice of appeal. If the decision is upheld, however, it will demonstrate the powerful option that forum selection provisions provide to corporate defendants in M&A litigation.
When Delaware corporate defendants are sued in advance of a merger, they face a timing problem. A plaintiff’s settlement leverage is greatest before a stockholder vote, when an injunction may disrupt or even terminate a deal. After stockholders approve a deal and a merger closes, however, defendants hold a stronger hand, as courts are more likely to review a transaction under the director-friendly business judgment rule.4
When facing a lawsuit outside of Delaware, this timing pressure encourages settlement rather than an attempt to enforce a forum-selection clause. Even a successful motion to stay litigation cannot avoid the risk that a plaintiff will refile in Delaware, resulting in an even more truncated schedule and increased deal risk. Settlement in the non-Delaware forum, on the other hand, puts the case on hold until after the deal closes. Defendants then enjoy the best of both worlds: if the settlement is approved, they pay fees to class plaintiffs in exchange for a release; and if the settlement is rejected, they may seek to transfer litigation to their favored forum.
If the 1st Century opinion withstands appeal, it will be interesting to observe how stockholder plaintiffs react. Most forum-selection provisions apply to state law claims. Thus, 1st Century may accelerate the trend of plaintiffs challenging mergers under federal securities law, aggravating the explosion of such litigation in federal courts since 2016. Plaintiffs may also begin to condition future settlements on the explicit waiver of forum-selection clauses. Nonetheless, the case illustrates that forum provisions may, in the right circumstances, prove strategically valuable to corporate defendants.
1 Case No. 16-cv-294673 (Cal. Super. Ct.–Santa Clara Cty.). Documents related to the case are available from the Santa Clara Superior Court Case Information Portal.
2 Defendants referenced the decision in In re SS&C Techs., Inc. S’holder Litig., 948 A.2d 1140 (Del. Ch. 2008).
3 129 A.3d 884 (Del. Ch. 2016).
4 For a discussion of recent Delaware cases regarding the effect of fully-informed stockholder approval of a transaction, see , et al., Lessons Beyond Corwin: Columbia Pipeline and Saba Software, Harvard Law School Forum on Corporate Governance and Financial Regulation (May 10, 2017).
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