On September 1, 2020, a California Superior Court judge in San Mateo County upheld a federal forum provision (“FFP”) in the charter of Delaware company Restoration Robotics, Inc., which mandated that stockholder claims under the Securities Act of 1933 (“Securities Act”) be brought exclusively in federal courts. Deciding an issue of apparent first impression, the court held that the FFP was enforceable under California law and accordingly dismissed Securities Act claims brought in state court against Restoration Robotics and its officers and directors.
This decision should be considered alongside the Delaware Supreme Court’s ruling earlier this year in Salzburg v. Sciabacucchi, 227 A.3d 102 (Del. 2020), as summarized in our earlier update, in which that court held that FFPs are lawful under Section 102(b) of the Delaware General Corporation Law. Taken together, the two decisions suggest that Delaware companies, particularly those headquartered in California, can receive the benefits of litigating Securities Act claims exclusively in federal court by adopting FFP provisions in their charters, if they have not already.
In 2017, Restoration Robotics adopted an Amended and Restated Certificate of Incorporation, effective upon completion of the company’s IPO, which contained the FFP at issue. The company’s shareholders had the opportunity to vote on the Amended and Restated Certificate of Incorporation.
Following the IPO, shareholders brought a class action in California state court asserting claims under the Securities Act. The California Superior Court initially denied defendants’ motion to dismiss based upon the FFP, relying on the decision of the Delaware Court of Chancery in Salzburg—which held that FFPs were not permissible as a matter of Delaware law. After the Delaware Supreme Court reversed the Court of Chancery’s decision in Salzburg, holding that FFPs are permissible under Delaware law, the California Superior Court granted a motion to reconsider its earlier ruling in light of the intervening change in law.
The Court’s Opinion
In its decision, the Superior Court held that the Restoration Robotics FFP was not unenforceable under California law. The court found that the FFP was analytically akin to a contractual forum selection clause and reviewed the FFP in the context of California caselaw regarding the enforceability of forum selection clauses. As the court noted, under that authority “the trial court has the discretion whether to decline to exercise jurisdiction” but “the burden rests with the opposing party to show that the application of the forum selection clause would be unfair or unreasonable.” Here, the court found that plaintiffs had not satisfied their burden of demonstrating that the FFP is unenforceable, unconscionable, unjust or unreasonable, because, among other reasons, “there is no disruption of the substantive rights of the shareholders to all protections provided by the Securities Act of 1933 – only the procedural aspect of state versus federal forum.” Under the FFP, plaintiffs “can present their federal law claims to a federal court, in a state or province of a state close to their residence, have the opportunity for discovery, and trial by jury.”
It is often advantageous for defendants to litigate Securities Act claims in federal court instead of state court, particularly because the defendant will receive the protections afforded by the federal Private Securities Litigation Reform Act of 1995 (“PSLRA”), such as the automatic stay of discovery during the pendency of a motion to dismiss and limitations on recoverable damages and attorneys’ fees, among other reasons. Some plaintiffs have strategically avoided federal court for that reason, instead bringing their Securities Act claims in state court. The U.S. Supreme Court held in its 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), that federal and state courts have concurrent jurisdiction over class actions brought under the Securities Act, and thus such claims are not removable to federal court. But when there are simultaneous actions brought in state and federal court against the same company, defendants will be subjected to the increased costs and inefficiencies associated with litigating similar issues in multiple forums.
Now, however, the Delaware Supreme Court’s decision in Salzburg and the California Superior Court’s decision in Restoration Robotics suggest that Delaware companies, particularly those based in California, may be able to avoid or minimize these burdens and inefficiencies by adopting FFPs directing that stockholder Securities Act claims must be brought exclusively in federal district court. Public companies can elect to adopt FFPs by amending their certificate of incorporation to adopt FFPs following board approval and stockholder approval at a special or annual meeting of stockholders. Companies may also elect to adopt FFPs through a bylaw amendment, although the enforceability of an FFP adopted in that manner is not settled. Indeed, the Superior Court in the Restoration Robotics case appeared to give significant weight to the fact that the Restoration Robotics FFP was subject to a stockholder vote.
Notably, while the Superior Court granted defendants’ motion to dismiss with respect to the claims against Restoration Robotics and its officers and directors, the court denied the motion with respect to the underwriter defendants and venture capital defendants. The court denied those defendants’ motion because they “presented no legal authorities supporting the proposition that they – as non-part[ies] and non-signator[ies] to the subject Amended and Restated Certificate of Incorporation containing the [FFP] – have the right or authority to enforce that provision.” This means that as a practical matter, where third-party defendants such as underwriters and venture capital defendants are named, the inefficiencies arising from parallel proceedings in federal and state courts involving the same or similar claims under the Securities Act, such as duplicative discovery proceedings and the risk of inconsistent judicial rulings, may still be a consideration notwithstanding a properly adopted FFP. Moreover, the common existence of indemnification undertakings between issuers and underwriters in securities offerings that are the basis for Securities Act claims means that a company with an FFP conceivably may still have continuing financial obligations in connection with a state-court claim even where they are dismissed. The outcome of claims against these types of third-party defendants may be different in future cases if underwriters and venture capital defendants present legal authority suggesting that they are allowed to enforce an FFP, for example, on the basis that they are third-party beneficiaries to an FFP or that it was otherwise foreseeable that claims against them would be subject to an FFP.
Finally, it is also worth noting that while the Superior Court’s decision in Restoration Robotics may be considered persuasive authority by other California courts, as a trial court decision, it is not binding on other courts. Further, the decision will very likely be appealed by plaintiffs, leaving the California appellate courts to weigh in.