Litigating Delaware governance law in an alien land

Larry Ribstein —  23 May 2010

A recent Delaware case, Baker v. Impact Holding, Inc.,  raises several interesting questions on a topic I’ve discussed recently – where to litigate cases involving Delaware business entities. Francis Pileggi has a good summary of the case.  I want to explore the case’s implications for jurisdictional competition. 

First some general background before getting into the case’s details.

Let’s begin by asking why the parties to a Delaware LLC or corporation would want to litigate anywhere other than Delaware.  After all, Delaware is widely noted for the sophistication of its courts, particularly on business matters.  Bruce Kobayashi and I in our recent Jurisdictional Competition for LLCs provide evidence that larger LLCs overwhelmingly choose to organize in Delaware, and that they do so to take advantage of the quality of Delaware’s legal system rather than because of any particular feature of its law. 

Moreover, in a recent decision, In re Revlon, Inc. S’holders Litig., 2010 WL 935626, (Del. Ch. Mar. 16, 2010), discussed here, VC Laster suggested that Delaware corporations clarify their choice of forum if they “believe that a particular forum would provide an efficient and value-promoting locus for dispute resolution.” Laster presumably had Delaware in mind as that forum.

These observations should be set against the background of a trend documented by Armour, Black & Cheffins toward hearing cases involving Delaware corporations outside of Delaware courts.  In an analysis of that paper, I noted that the out-of-Delaware trend may reflect grabs of jurisdiction by state and federal courts rather than party preferences.  I also observed that the study looked only at corporate cases and therefore may reflect indeterminacy problems with corporate cases that do not apply to unincorporated firms.

This brings me to the Baker case. The court (VC Parsons) enforced a corporate shareholder agreement that provided for litigation only in a Dallas, Texas state or federal court.  Here we do clearly have the parties’ preference for a non-Delaware forum – but in a corporation rather than an LLC.  Moreover, the firm was apparently a closely held corporation, where Delaware’s adjudication superiority is arguably less clear than for Delaware public corporations or the uncorporation cases discussed in my article linked immediately above.

The case has an odd legal background.  The Delaware Supreme Court, in Elf Atochem North America, Inc. v. Jaffari, 727 A2d 286 (Del Super 1999), held enforceable an LLC agreement providing for exclusive jurisdiction in the San Francisco, California, state or federal courts.  The relevant statute, §109(d) of the Delaware LLC act, authorized agreements providing for exclusive jurisdiction in Delaware or for non-exclusive jurisdiction in non-Delaware courts.  It would seem, then, that the court went a bit out of its way to authorize escape from Delaware. 

I explained in Ribstein & Keatinge §13:3 that “the court balanced the policy of ensuring uniformity of results through adjudication in Delaware courts against strong Delaware policies favoring freedom of contract and alternative dispute resolution, including arbitration.” [By contrast, Delaware courts are more careful in staying actions involving Delaware LLCs pending elsewhere.  See Choice Hotels Intern., Inc. v. Columbus-Hunt Park DR. BNK Investors, L.L.C., 2009 WL 3335332 (Del.Ch., October 15, 2009), discussed here.]

Following Elf, the Delaware legislature amended §109(d) to provide that   

a member who is not a manager may not waive its right to maintain a legal action or proceeding in the courts of the State of Delaware with respect to matters relating to the organization or internal affairs of a limited liability company.

VC Parsons held in Baker that a director suing for his alleged wrongful removal from a corporate board could not take advantage of this provision because the LLC Act provision didn’t apply to a corporation, and even if it did Baker was a director and therefore equivalent to a manager who may waive the provision.

Focusing on the first of these issues, does the amendment suggest Delaware has a general public policy against waiver of Delaware jurisdiction that should apply to corporations as well?  Parsons said no, and that seems obvious from the fact that the legislature had, seemingly deliberately, not amended the corporation statute while putting this provision in both the LLC and limited partnership statutes.  However, it is worth noting that Delaware GCL §225(a) seems to provide for an absolute right by a director to bring the sort of declaratory judgment action that plaintiff was bringing in this case.   This arguably raises a question as to whether corporations should be distinguished in this regard from uncorporations.

The answer may be that the Delaware legislature recognized an important difference between uncorporations and corporations. In the former situation, as discussed in my indeterminacy article linked above, the Delaware uncorporation statutes provide for plenary contracting on virtually all issues, particularly including fiduciary duties and member-management relationships, and Delaware courts have developed an extensive and detailed jurisprudence regarding the interpretation of these agreements.  There is no equivalent statutory provision or jurisprudence for corporations.  This suggests Delaware would be a lot more concerned about members trying to avoid Delaware uncorporate law than the corresponding Delaware corporate law.  Delaware would not, however, be equally concerned about managers’ waiving application of Delaware law, since the contractibility of fiduciary law is primarily for their benefit.

The puzzle from a theoretical and empirical perspective is why the parties went to the trouble of choosing Delaware law but then contracting for a Texas forum.  Recall that the data indicates that LLCs generally seem to be choosing Delaware primarily for its courts.  If the parties don’t want a Delaware court, then why choose Delaware law?

The choice of a Delaware court is not too surprising here given control of the corporation by a private equity group, Brazos Private Equity Partners, LLC, based in Dallas.  The private equity firm, with an eye to a possible sale down the line, may have wanted a Delaware entity because Delaware law has more credibility in business community than Texas law.  So the parties’ choices here do not seem to reflect a general concern with Delaware courts and law.

Perhaps the most puzzling aspect of the case is that it let Baker enforce the forum selection clause in the agreement despite the fact that it applied only to an action “between the parties hereto” and Baker was not a party.  Rather, Baker was just the manager and trustee of Impact’s selling shareholders whom the shareholder agreement designated as a member of the corporation’s board.  Baker sued for breach of that provision. The court held that the agreement was for Baker’s benefit, which seems at least debatable. 

A possible explanation is that it is not clear whether Baker has a right to sue at all in Texas – that would depend on whether Texas has a provision like Delaware GCL §225.  The court might have hesitated giving Baker a right to sue in Delaware given both the forum choice provision and the jurisdiction-specific nature of Baker’s remedy.  In any event, it is worth noting that here, as in Elf, the court had to stretch to apply the forum choice provision, indicating that Delaware courts are not over-possessive about suits relating to the internal affairs of LLCs.

Finally, Google reveals some background to the story.  I wondered why Baker cared so much about his directorship given that his firms had sold out to Brazos.  I see that Brazos says on its website that it “puts a premium on building long-term relationships with successful operating executives, working closely and in partnership with company management, to execute its value creation strategy.” Brazos also says that the specific company involved, Impact, was  

Founded by Brad Baker in 1980 as a manufacturer of premium lollipops[.] * * * In 2006, Brad Baker sought to partner with an experienced investor who could not only provide partial liquidity to cultivate shareholders, but also assist in the growth strategy of the business.

Apparently the partnership ended sooner than Baker hoped or expected. (Was Baker a sucker?)

A last detail is that an Impact factory is in Roswell, New Mexico.  Is that where they make this lollipop?

Larry Ribstein

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Professor of Law, University of Illinois College of Law