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A Delaware Supreme Court ruling last week that restricts some shareholder lawsuits to federal courts will significantly lower defense costs and could eventually ease the pressure on rising directors and officers liability insurance rates, experts say.
The ruling, which reversed a lower court decision, held that companies incorporated in the state that issue initial public offerings can require litigation under the federal Securities Act of 1933 be filed in federal court rather than state courts, which are generally viewed as more plaintiff friendly.
The ruling by the Delaware high court is seen as significant because many U.S. companies incorporate in the state, where they can benefit from its favorable tax and legal environment for corporations.
The case hinged on whether “federal forum” provisions in company charters that require litigation arising under the federal securities law be filed in federal rather than state courts are valid under Delaware law. The state supreme court said in its unanimous March 18 ruling in Matthew B. Salzberg, et al. and Blue Apron Holdings Inc., Stitch Fix Inc., and Roku Inc. v. Matthew Sciabacucchi that the provisions were valid, in overturning a Delaware Court of Chancery ruling.
Observers say the litigation’s funding was unusual, in that two brokers and six insurance companies financed the appeal.
Its funding was organized by Woodruff Sawyer & Co., with participation by fellow broker Arthur J. Gallagher & Co. and eight insurers: Allianz SE, Allied World Assurance Co. Holdings Ltd., Beazley PLC, Chubb Ltd., Great American Insurance Group, Hiscox Ltd., Old Republic Insurance Group and Swiss Re Group.
“There are opportunities for more of that kind of collaboration in the future, and they’ve kind of shown the way” to how the D&O market can “act collectively and address the problems facing the whole industry,’ said Kevin LaCroix, executive vice president of RT ProExec, a division of R-T Specialty LLC, in Beachwood, Ohio.
The shareholder in the case, Matthew Sciabacucchi, had bought shares of the companies in their initial public offerings and had sought a declaratory judgment in Delaware’s Court of Chancery that the federal forum provisions were invalid.
The lower court held in its 2018 ruling that the provisions were invalid because the “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”
In overturning that ruling, the Delaware Supreme Court said the federal Private Securities Litigation Reform Act of 1995, which limited recoverable damages and attorneys fees, had the unintended consequence of prompting some members of the plaintiffs bar to avoid federal courts and file in state courts instead. That led some companies to adopt the forum-selection provisions.
“This court has viewed the overlap of federal and state law in the disclosure area as ‘historic,’ ‘compatible,’ and ‘complementary,’” the Delaware Supreme Court ruling said.
“Accordingly, a by-law that seeks to regulate the forum in which such ‘intra-corporate’ litigation can occur is a provision that addresses the ‘management of the business’ and the ‘conduct of the affairs of the corporation” and is “facially valid” under Delaware law.
The decision points to the U.S. Supreme Court’s unanimous March 2018 ruling in Cyan Inc. et al. v. Beaver County Retirement Fund et. al., which held that securities offerings litigation can be heard in state court in addition to federal courts.
Observers say that in addition to IPOs, the ruling will affect Delaware-incorporated companies that issue secondary offerings as well as merger and acquisition transactions that involve stock.
Plaintiff attorney Darren J. Robbins, a partner with Robbins Geller Rudman & Dowd LLP in San Diego, said, “The ruling is a little bit off base in several regards.”
In approving the Private Securities legislation Congress “took the time and effort to carefully modify” the structure of the 1933 statute “and address claims brought under state law,” Mr. Robbins said. The Delaware ruling “alters that structure and flies in the face” of the unanimous Cyan decision, he said.
Mr. LaCroix said, “It’s a big win for the companies, it’s a big win for the D&O insurers. It provides a way to mostly resolve the problems caused by Cyan without having to depend on Congressional legislation.
“It certainly mutes the effect of Cyan,” said Kristin Kraeger, Boston-based managing director of Aon PLC’s financial services group.
“It’s still untested, and it doesn’t necessarily help companies that are organized outside of Delaware, but for companies that are in Delaware it gives them some hope and a new tool for mitigating risks relating to IPOs,” said Rob Yellen, New York-based executive vice president of Willis Towers Watson PLC’s FINEX North America practice.
The ruling “could end up alleviating a lot of the costs” associated with plaintiffs filing litigation in state courts across the country, said Rick S. Horvath, of counsel, litigation department, at Paul Hastings LLP in San Francisco, who represents boards of directors, large investors and public companies.
Experts say the ruling would prevent companies from having to defend themselves in multiple jurisdictions. Lawsuits filed in multiple federal courts can be consolidated, but those filed in multiple state courts can’t, they say.
In addition, discovery, which is costly, may be delayed longer in federal courts, which reduces legal costs, and state court judges may be less knowledgeable about securities law than federal judges, who deal with it more frequently.
Observers say companies had already begun to insert federal forum provisions in their charters, subject to the court’s ruling, in Delaware, where most public U.S. companies are incorporated.
Observers say they generally expect state courts to defer to the Delaware ruling by permitting these cases to be heard in federal court. The state courts are already probably so overwhelmed, “I think most of them will be fine not having to deal” with them, said Sarah Downey, New York-based US D&O product leader, Marsh LLC.
Priya Cherian Huskins, San Francisco-based senior vice president, D&O, for Woodruff Sawyer & Co., noted that plaintiffs can still file suit in federal courts in the state where they reside.
Matthew W. Close, a partner with O’Melveny & Myers LLP in Los Angeles, said he represents multiple clients who have introduced these federal forum provisions in their charters since the Cyan ruling. “We have been looking forward for when the courts reopen so we can move to dismiss” pending securities suits in state court.
The ruling may eventually lead to lower directors and officers rates, experts say. “The fact that it somewhat counteracts the Cyan decision will hopefully have a positive impact on the D&O market at some point in the future,” Ms. Downey said.
D&O underwriters may take the ruling into consideration and be more willing to provide coverage for companies going public and/or provide more competitive pricing, she said.
Iyan G. Alfredson, senior vice president and co-national practice leader of executive liability at Risk Strategies Inc. in Chicago, said, “D&O rates have skyrocketed” since the Cyan decision, but “should certainly drop” as companies modify their charters to reflect the federal forum provision.
Ms. Huskins said, however, “Everybody wants to see rates for IPO companies immediately go back to 2014 levels, and I don’t think that will happen immediately.”
“Part of the issue is that Cyan was not the only thing that was causing rates to go up for IPO companies. It’s also the case that I expect insurance carriers to want to see some state courts respect the Delaware federal forum provision,” she said.
Ms. Huskins added, “I do think that ultimately we should expect to see insurance rates for IPO companies go back to more normal levels. It just won’t happen all at once.”