The Era of Section 11 Litigation in State Courts Appears To Be Ending
On April 28, 2022, a state appellate court for the first time addressed provisions in a public company’s certification of incorporation that designate federal court as the sole forum for the litigation of Section 11 claims. Wong v. Restoration Robotics, Inc., – Cal. Rptr. 3d –, 2022 WL 1261423. Section 11 of the Securities Act of 1933 gives stock purchasers a claim against stock issuers and a broad range of other defendants for materially false or misleading statements in registration statements. Section 11 claims are attractive to the plaintiffs’ bar because stock purchasers do not need to prove reliance, causation, or intentional wrongdoing by defendants—only a materially false or misleading statement. The Restoration Robotics court ruled in the defendants’ favor, holding that issuers may validly provide in a certification of incorporation that Section 11 claims can be brought only in federal court.
The plaintiffs’ and defense bar have been battling about the availability of a state court forum for securities litigation for more than 25 years. After Congress passed the defendant-friendly Private Securities Litigation Reform Act in 1995, securities plaintiffs fled to state court, where many of the statutory reforms did not apply. Congress shut this down with the 1999 Securities Litigation Uniform Standards Act, which made federal court the exclusive forum for all fraud-based securities class actions. But the matter was different for Section 11 claims, which require only false statements—not fraudulent ones. State and federal courts have had concurrent jurisdiction over Section 11 claims since the passage of the Securities Act in 1933. Seeking to extend the benefits of the 1995 statutory reforms to Section 11 claims, issuers argued that Section 11 class actions had been carved out from state court jurisdiction. The Supreme Court rejected that argument in Cyan v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018). Cyan opened state courthouse doors wide for Section 11 class actions.
During the runup to the Cyan decision, however, a growing number of stock issuers and their attorneys, fearing defeat in Cyan, began employing a workaround. They included forum selection clauses in their articles of incorporation, providing that Section 11 claims—both class and individual—may be brought only in federal court. In that way, the issuers sought to hedge against a defeat in Cyan. Even if state court was a viable forum for Section 11 claims as a general legal matter, the federal forum provisions represented a private, contractual restriction of those claims to federal court. Because issuers referred stock purchasers to that restriction in IPO and secondary offering registration statements, the purchasers were on notice of that restriction.
The plaintiffs’ bar has been challenging the legality of the federal forum provisions since they began to appear. At first, plaintiffs succeeded. The Delaware Chancery Court held in 2018 that federal forum provisions are invalid under Delaware’s corporations statutes. Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018). But plaintiffs’ victory was short-lived. The Delaware Supreme Court reversed in 2020, holding that the provisions were valid under the Delaware statutes governing certifications of incorporation, and that they violated neither Delaware nor federal law or policy. Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020).
In reaching that conclusion, however, the Delaware Supreme Court acknowledged “legitimate concerns” that “our sister states might react negatively to what could be viewed as an out-of-our-lane power grab.” The Salzberg court thus suggested that the courts of other states might need to determine for themselves whether Delaware’s validation of federal forum provisions violated “horizontal sovereignty.”
This suggestion set the stage for Restoration Robotics, one of a number of Section 11 cases brought against Delaware corporations located in California that had adopted federal forum provisions. In 2018, the trial court held that the company’s federal forum provisions were unenforceable; at that time, the Chancery Court’s decision invalidating such provisions was the last word from Delaware. But after the Delaware Supreme Court reversed, the California trial court followed suit, dismissing the action because plaintiffs had brought it in the wrong court.
The California Court of Appeal agreed. It held in Restoration Robotics that federal forum provisions do not violate the Securities Act, that the Delaware statutes permitting companies to adopt federal forum provisions do not violate the Supremacy Clause or the Commerce Clause of the U.S. Constitution, and that federal forum provisions do not reflect an “unconscionable” act by a party with superior bargaining power.
California is obviously a pro-plaintiff jurisdiction. The Restoration Robotics decision thus strongly signals that federal forum provisions will be enforced by state courts across the country—and that the decades-old effort of the plaintiffs’ bar to litigate Section 11 claims in what they believe to be a more hospitable state court forum has likely been defeated once and for all. Companies that have not yet adopted federal forum provisions in their certificates of incorporation would be well advised to consider doing so.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.
