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Litigation: How to Control Venue for Shareholder Derivative Actions

Gaining shareholder consent is the key.

Judge Richard Seeborg of the Northern District of California recently denied Oracle Corp.’s motion to dismiss a shareholder derivative lawsuit for improper venue because the company’s forum-selection clause was unilaterally adopted by the Board of Directors (the “Board”) after the alleged wrongdoing had occurred.

Specifically, the court observed that “the venue provision was unilaterally adopted by the directors who are defendants in this action, after the majority of the purported wrongdoing is alleged to have occurred and without consent of the existing shareholders who acquired their shares when no such bylaw was in effect.” Prince v. Berg, 3:10-cv-094233 (N.D. Cal. Jan. 3, 2011)

In Berg, the plaintiff-shareholders alleged that between 1998 and 2006, Oracle made sales of software and licenses to the U.S. government totaling approximately $1.08 billion. They further alleged that through a variety of fraudulent and improper practices, Oracle failed to apply certain discounts to which the government was contractually and legally entitled, resulting in millions of dollars of overcharges. As a result, plaintiffs sued the Oracle directors for breach of fiduciary duty and abuse of control.

Oracle moved to dismiss the derivative actions for improper venue, relying on a forum-selection provision in its corporate bylaws that purports to govern shareholder derivative actions. In 2006—after the alleged overbilling scheme took place, but before this action was filed—Oracle’s Board of Directors amended the corporate bylaws to add a provision requiring derivative lawsuits to be brought exclusively in Delaware Chancery Court. According to the Board minutes submitted by Oracle, all of the directors named as individual defendants were present at the meeting and unanimously approved the resolution.

According to Judge Seeborg, such bylaws are “reportedly a recent phenomenon, apparently occasioned by a passing comment in In re Revlon, Inc. v. Shareholders Litigation, 990 A.2d 940, 960 (Del. Ch. 2010).” There, the Delaware Chancery Court opined that “if boards of directors and stockholders believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes.”

Recognizing that there is virtually no precedent on point, the defendants relied on the enforcement of similar clauses in the context of general contract law. In other words, Oracle argued that the corporate bylaws should be treated as any other contract, relying on Supreme Court precedent that forum-selection provisions that arise by “freely negotiated” contract are generally enforceable. (See M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972).)

From this, the 9th Circuit has distilled the rule that contractual forum-selection clauses must be given effect unless there is a showing that: (i) its incorporation into the contract was the result of fraud, undue influence or overweening bargaining power; (ii) the selected forum is so gravely difficult and inconvenient that the complaining party will for all practical purposes be deprived of its day in court; or (iii) enforcement of the clause would contravene a strong public policy of the forum in which the suit is brought. These factors are referred to as the so-called Argueta factors.

Oracle argued that corporate bylaws are equivalent to a contract between a board and its shareholders and, unless any of the Argueta factors are met, forum-selection clauses within corporate bylaws must be enforced.

Judge Seeborg flatly rejected this argument, finding that because the forum-selection bylaw had been enacted unilaterally by the Board pursuant to Delaware corporate law, it was not analogous to a contract between parties. Indeed, the defendants could not cite any contract case upholding a venue provision that was inserted by unilateral amendment into an existing contract, and the court observed that “Oracle cannot persuasively contend that its bylaws are like any other contract … while simultaneously arguing that it was permitted under corporate law to amend those bylaws in a manner that it could not have achieved under contract law.”

Unlike a true bilateral contract, the court continued, “the venue provision was unilaterally adopted by the directors who are defendants in this action, after the majority of the purported wrongdoing is alleged to have occurred, and without the consent of existing shareholders who acquired their shares when no such bylaw was in effect.”

Though the court refused to enforce the forum-selection clause here, not all is lost for public companies that wish to incorporate a venue provision in their bylaws. As Judge Seeborg observed, where a majority of shareholders do consent to such a provision, “the arguments for treating the venue provision like those in commercial contracts would be much stronger, even in the case of a plaintiff shareholder who had personally voted against the amendment.”

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Matthew Ingber

Matthew Ingber is a litigation partner at Mayer Brown.

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