Coming to Canada: Corporate disputes and litigation-related bylaws

Canadian companies are beginning to adopt US-style tactics in an effort to reduce the often significant risk and costs of corporate litigation. More specifically, Canadian companies have been, quietly, adopting amendments to their bylaws which require all corporate litigation to be conducted in a single jurisdiction, usually the place in which the company is headquartered. It has been reported that at least 14 Canadian companies have adopted such bylaws in 2015, with that number likely to grow.¹

In the United States, these "exclusive jurisdiction" provisions, as well as other litigation-related bylaws, have been the subject of much debate and litigation over the past two years, as companies have tried to reduce the risks and costs of multiple actions, in multiple jurisdictions, all related to the same incident. A series of court decisions and legislative amendments, primarily in Delaware, have clarified that, in large part, companies are permitted to adopt litigation-related bylaws, as long as they follow proper corporate procedures in adopting them. Initial surveys have shown that these bylaws have indeed led to a drop in multi-forum corporate litigation.

In Canada, however, litigation-related bylaws have received minimal judicial or legislative consideration, and the extent to which companies can use them is unclear. As in the United States, court, and possibly legislative, intervention is necessary in order to clarify the law.

Litigation-related bylaws in the United States

Over the past few years, there has been increasing litigation in the United States regarding efforts by companies to control jurisdiction and costs in the context of shareholder litigation. There has been particular focus on forum selection (exclusive jurisdiction) and fee-shifting provisions in bylaws and corporate charters. This litigation has clarified the use of these types of provisions, and has also resulted in amendments to the Delaware General Corporation Law (DGCL), Delaware's corporate law statute.

Exclusive jurisdiction clauses

The use of exclusive jurisdiction clauses in bylaws increased significantly in 2010, following a comment by the Delaware Court of Chancery about addressing multi-forum litigation. In response, dozens of companies amended their bylaws, making Delaware the exclusive jurisdiction for shareholder disputes. A lot of these amendments were adopted unilaterally by company boards, and by early 2012 a number of test cases challenging their validity had commenced in Delaware.

The leading decision on exclusive jurisdiction bylaws came in 2013 with Boilermakers Local 154 Retirement Fund v. Chevron Corporation.² In late 2010 and early 2011, the boards of Chevron and FedEx had amended their bylaws to require all derivative, shareholder or corporate law claims against the company to be brought in state or federal court in Delaware. In response to a shareholder's challenge, the Chancery Court held that boards are statutorily empowered to adopt such bylaws, as long as the specific corporate articles of organization permit director amendment of bylaws. In doing so, the Court noted that bylaws constitute a form of contract between a company and its shareholders, and that new bylaws unilaterally adopted by a board become a part of that contract.

The impact of the decision in Boilermakers has been significant. Between January 2014 and June 2015, more than 200 Delaware companies amended their bylaws to add exclusive jurisdiction provisions.³ The majority did so through unilateral board action, although a number have sought shareholder approval, including before an initial public offering (IPO). In addition, it has become common for publically-held companies to adopt exclusive jurisdiction provisions just before being taken over. This has led to anticipated litigation taking place in the designated courts and to a significant drop in multi-forum merger litigation.⁴

In August 2015, new amendments to the DGCL came into force expressly permitting exclusive jurisdiction provisions. A new section 115 provides that:

The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State.⁵

Interestingly, section 115 also expressly prohibits Delaware companies from adopting bylaws that exclude Delaware as a forum for corporate claims. This effectively overrules the 2014 decision in City of Providence v. First Citizens Bancshares, Inc., in which the Chancery Court dismissed a class action challenging a merger because a bylaw amendment, adopted by the board when the merger was announced, designated the state where the company was headquartered (North Carolina) as the exclusive forum.⁶

The Boilermakers decision has also led to litigation outside of Delaware, where exclusive forum provisions have been challenged, usually in the context of motions to dismiss actions on the basis of an exclusive forum provision. In most states, including New York, Illinois, California, Ohio, Texas and Louisiana, the provisions have been enforced and the actions in those states have been dismissed.⁷ An exception to this trend was a decision from Oregon, Roberts v. TriQuint Semiconductor, Inc.⁸ In that case, a trial court struck down a bylaw designating Delaware as the exclusive jurisdiction because the bylaw was adopted after the alleged wrongdoing had taken place. However, the Oregon Supreme Court overturned that decision in December 2014, finding that, as a matter of Delaware law, the bylaw was a valid forum-selection clause and bound the company's shareholders. The Court also held that the bylaw was enforceable under Oregon law.⁹

Fee-shifting clauses

A second wave of litigation-related bylaws came in the form of fee-shifting provisions. In the United States, as opposed to Canada, legal costs are generally not recoverable and therefore an adverse costs award is not a risk to potential plaintiffs. Presumably, the purpose of these types of provisions is to simultaneously reduce a company's litigation costs, while significantly increasing a potential plaintiff's financial risk in starting an action.

In May 2014, in answering a series of certified questions of law, the Delaware Supreme Court upheld the validity of fee-shifting bylaws in ATP Tour Inc. v. Deutscher Tennis Bund.¹⁰ The bylaw in question was unilaterally adopted by the board, and required an unsuccessful plaintiff in an intra-corporate action to pay the company's legal costs. The court held that fee-shifting provisions are valid, as long as they are adopted by appropriate corporate procedures, for a proper purpose. It also made clear that, in this case, the bylaw would apply to those who had purchased their shares before its adoption.

Despite causing significant controversy, the ATP decision led to at least 70 public companies, including those going through an IPO, adopted fee-shifting provisions.¹¹ However, the August 2015 amendments to the DGCL brought the practice to a halt by including express prohibitions on the use of fee-shifting provisions. A new subsection 102(f) provides:

The certificate of incorporation may not contain any provision that would impose liability on a stockholder for the attorneys' fees or expenses of the corporation or any other party in connection with an internal corporate claim, as defined in § 115 of this title.¹²

In addition, amendments to section 109(b) now expressly prohibits bylaws from containing "any provision that would impose liability on a stockholder for the attorneys' fees or expenses of the corporation or any other party in connection with an internal corporate claim."¹³ In both cases, the definition of "an internal corporate claim" is the same as that used in section 115, discussed above.

Arbitration Provisions and Beyond

Following the success of exclusive jurisdiction provisions, companies have continued to search for charter provisions and bylaws that may reduce the costs of corporate litigation. In particular, arbitration, class action waiver and minimum support provisions are the types of provisions that may be used more and, as a result, may spark further litigation.

In 2013 and 2014, a Maryland state court upheld a bylaw provision requiring shareholders of a REIT (real estate investment trust) to arbitrate all corporate claims. In Corvex Management LP v. Commonwealth REIT and Katz v. Commonwealth REIT, the court followed the reasoning in Boilermakers, applying the same analysis to the arbitration bylaw.¹⁴ The same bylaw was again upheld in a derivative action, this time brought in federal court by a group of the REIT's shareholders.¹⁵ In addition to finding that the issue was res judicata, the federal court noted that the enforcement of arbitration bylaws is supported by United States Supreme Court jurisprudence on the enforceability of arbitration clauses.

Following this reasoning - that bylaws are akin to contractual provisions - it is possible that arbitration bylaws will be extended to include class action waiver provisions, requiring claims to be brought individually. These types of provisions have recently been upheld in the context of consumer contracts, despite the fact that they preclude federal fraud and anti-trust class actions.¹⁶

Finally, a minimum support provision - one that requires the consent of a stipulated number of shareholders before a claim can be brought - passed an initial challenge in Florida. In October 2014, Imperial Holdings, Inc., a Florida corporation, adopted a novel minimum support provision precluding shareholders from bringing a derivative or class action against the company without the written consent of the holders of at least three percent of company's outstanding shares. The bylaw was almost immediately challenged in the context of a shareholder class action against the company's directors, but was upheld by a Florida court.¹⁷ Interestingly, the company put the minimum support bylaw to a shareholder vote at its annual meeting, and committed to rescind the bylaw if it was not approved. At the meeting in May 2015, the bylaw received approval.¹⁸

While arbitration, class action waiver and minimum support provisions are not expressly prohibited under the DGCL, including its recent amendments, the success of these types of provisions is far from guaranteed. For example, the US Securities and Exchange Commission has been critical of provisions that restrict shareholders' ability to seek a remedy under the federal securities laws, and has refused to permit an IPO where the corporate charter or bylaws contained an arbitration provision.¹⁹ Further litigation and legal developments are sure to come.

The Canadian experience - What can we expect?

No existing jurisprudence

To date, Canadian courts have not tested the validity of exclusive forum provisions in corporate bylaws.

The closest a Canadian court has come is a decision of the Ontario Superior Court of Justice in Momentus.Ca v. Canadian American Association of Professional Baseball Ltd.²⁰ The case concerned the enforcement of forum selection and arbitration provisions in the bylaws of a professional baseball league. The Court found that the plaintiffs, under a lease agreement with the league, had agreed to be bound by the bylaws. Moreover, the plaintiffs were unable to meet their burden of establishing a good reason why they should not be bound by the forum selection provision. As a result, the Court enforced the forum selection provision and declined jurisdiction.

Momentus is not directly on point, as it involved league bylaws to which the plaintiff had agreed to be bound under a contract. The decision does not address whether corporate bylaws are a form of contract between a corporation and its shareholders, as they are in Delaware.

Given the lack of relevant jurisprudence in Canada, we expect the increasing use of exclusive jurisdiction bylaws here to raise the following issues in future litigation:

• Are bylaws contractual in nature?
• If bylaws are akin to contracts, how will Canadian courts treat bylaws containing: exclusive jurisdiction clauses, arbitration clauses or class action waivers?
• To what extent will boards be able to adopt these sorts of bylaws unilaterally?

Corporate Bylaws as Contract in Canada

The legal status of corporate bylaws in Canada is unclear.²¹ In contrast to Delaware, there is no modern authority deeming corporate bylaws to be part of a contract between the corporation and its shareholders.

Before the enactment of Canadian corporate law statutes, such as the Ontario Business Corporations Act (OBCA)²² and the Canada Business Corporations Act (CBCA),²³ corporate bylaws were treated as a contract between the corporation and its shareholders.²⁴ This principle arose from memorandum of association corporate law regimes, where a company's constitution was deemed to have the effect of a contract binding the company and its shareholders.²⁵

However, statutes such as the OBCA and CBCA do not address whether bylaws are contractual in nature.²⁶ One commentator's view is that as corporate bylaws are private instruments, there is a "certain logic" to interpreting them using ordinary principles of contractual interpretation.²⁷ On the other hand, he acknowledges that as the power to create bylaws is conferred by statute, statutory interpretation principles may also be applicable. As such, the legislative intent underlying Canada's corporate law statutes is also likely to be relevant to the interpretation of corporate bylaws in Canada.²⁸

This issue is important because the way Canadian courts treat litigation-related bylaws will likely depend, in part, on whether they are viewed as a form of contract or not.

Exclusive Forum Clauses

In contract cases, Canadian courts are inclined to enforce forum selection clauses in contracts when there are no compelling reasons not to enforce them.²⁹ The Delaware authority for the proposition that corporate bylaws are a form of contract may be persuasive in Canada. If Canada follows Delaware's lead, exclusive jurisdiction bylaws may generally be enforceable here as well based on contract law principles.

However, the case law favouring the enforcement of forum selection clauses is grounded in the premise that parties to a contract should be "held to their bargain."³⁰ Unlike a contract, a corporate bylaw may be in place even if a shareholder has not agreed to the bylaw, or has voted against the bylaw. This is an important distinction that courts will have to address in deciding whether to enforce litigation-related corporate bylaws

Arbitration Clauses and Class Action Waivers

Courts in Canada also favour the enforcement of arbitration clauses in contracts. In the absence of legislation to the contrary, courts will enforce arbitration clauses freely entered into, even contracts of adhesion.³¹ Thus, courts may be comfortable enforcing arbitration bylaws, particularly where the bylaws are in place at the time the shareholder purchases shares. Shareholders who invest in a corporation can arguably be presumed to have assented to being bound by the bylaws of the corporation, which is the approach courts take in Delaware.

It is important to note that some provinces have enacted consumer protection legislation to preclude arbitration clauses³² or clauses that purport to restrict consumers' rights to bring class actions.³³ Depending on the type of claim at issue, there is a possibility that the clause could be precluded by legislation. Moreover, arbitration clauses may be unenforceable in limited circumstances in which it would result in unfair or unequal treatment of the parties. For example, an arbitration clause was found to be unenforceable in an oppression case where the act of enforcing the arbitration clause amounted to an act of oppression.³⁴

There is also conflicting jurisprudence as to whether class action waivers should be treated differently than arbitration clauses. For example, there is federal court authority for the proposition that class action waiver provisions should be treated the same way as arbitration clauses.³⁵ Given that arbitration clauses can effectively preclude class actions, this approach seems logical. However, the Court of Queen's Bench of Alberta has found that class action waivers cannot operate to prevent an application for certification of a class action.³⁶ Without guidance from the Supreme Court of Canada, decisions on this issue may vary across Canada.

Arbitration clauses and class action waivers raise controversial issues that give rise to litigation in the context of contracts. Therefore, we expect that if Canadian corporations attempt to adopt arbitration and class action waivers in corporate bylaws as well, they will also lead to litigation.

Power to Enact Bylaws Unilaterally in Canada

The analogy between contracts and corporate bylaws works best when the bylaw is put in place before shareholders purchase shares (e.g. just prior to an initial public offering). As alluded to above, we expect that litigation-related bylaws will be more controversial when boards adopt them unilaterally after shareholders have already purchased their shares.

Canadian corporate law statutes typically afford directors statutory authority to enact new bylaws.³⁷ Once enacted, the bylaw is effective until the next meeting of the shareholders, where the bylaw must be submitted to a shareholder vote. If a bylaw is rejected by the shareholders, or the directors fail to submit it to a vote, it ceases to be effective on the date the next shareholder meeting is held.

In effect, this would allow directors to unilaterally enact an exclusive forum bylaw on a temporary basis. However, whether or not the bylaw would continue to be effective would depend on what transpired at the next shareholder meeting. For example, in Wells v. Melynk,³⁸ directors enacted a bylaw purporting to reduce the quorum for a shareholders meeting to 25%. The Ontario Superior Court of Justice found that directors failed to submit the bylaw to a vote at the next shareholder meeting. Accordingly, the bylaw ceased to be effective at that next meeting because it was not confirmed by the shareholders.

Given that shareholders ultimately have the power to vote down a bylaw that is enacted unilaterally, courts may find it unnecessary to intervene. Instead, courts may find that shareholder meetings are the proper forum for dealing with such bylaws.

Looking Ahead

It will be interesting to see how Canadian courts treat exclusive forum bylaws in Canada. Courts prefer to enforce forum selection clauses in contract cases. However, those decisions are based largely on the idea that the parties must be held to their bargain. A more nuanced analysis is required when dealing with corporate bylaws, which raises issues such as the interests of dissenting shareholders, statutory interpretation and differing policy goals.

To date, Canadian exclusive forum clauses have been directed at internal corporate matters, such as oppression claims. Canadian corporations may soon attempt to follow the lead of American companies and experiment with arbitration provisions and class action waiver in bylaws. We expect that these sorts of issues will give rise to new developments in shareholder litigation in the near future.