What Do You Mean I Have to Litigate There? Corporate Bylaws May Dictate the Forum of Intra-corporate Disputes

Corporate bylaws that require intra-corporate disputes to be resolved in a specific forum may be enforceable, even when they call for litigation in distant states.  This can pose a major obstacle to efficient resolution of such disputes.

Background

When you find yourself in a business dispute, and it looks like the only way the dispute will be resolved is through litigation, a major consideration at the outset of litigation is where the litigation will take place.  It can affect what legal counsel you hire, what rules and law will be applied to resolve the dispute, and who will make the decisions about your case.

Where one litigates usually is driven either by where the acts giving rise to litigation occurred or the place specified in a contract as to where a dispute must be resolved.  If you are in a dispute with a California resident, you generally will be able to litigate the case in California.  Sometimes, parties have entered into an agreement to arbitrate the dispute, and that may require the parties to hire an arbitrator and have the case heard in a specific, agreed-upon location.  Sometimes, you have agreed to litigate the case in court, but only in a specific location.  Then there are times that you haven’t agreed to litigate the case in a particular court, but someone else can force you to litigate in their preferred forum.

Generally, you want to avoid litigating in your adversary’s preferred forum when that forum is inconvenient for you, or where the judges in that forum will apply rules and laws that are unfavorable to your position.

The Role of Corporate Bylaws

A case from the end of 2018 shows that corporate bylaws requiring intra-corporate disputes to be resolved in a specific forum can pose a major obstacle to the efficient resolution of such disputes.  In Drulias v. 1st Century Bancshares, Inc., 30 Cal.App.5th 696 (2018), a shareholder in a corporation wanted to file claims against the board of directors arising out of their decision to approve a merger agreement with a competing bank.  The corporation was headquartered in California, and the plaintiff shareholder resided in California.  But the corporation was incorporated under the laws of Delaware, and the board had, consistent with Delaware law, inserted a provision in the bylaws requiring that any intra-corporate dispute be litigated exclusively in Delaware. Notably, this provision was added to the corporate bylaws after the Plaintiff purchased his shares.

Based on that bylaw provision, the California trial court dismissed the case.  The appellate court recognized that it hadn’t been decided yet in California whether a bylaw provision like this could force a California resident to litigate the case in Delaware.  The Court of Appeal decided that such a provision is enforceable in California, provided it was “reasonable” to apply it to a particular case.  The Court of Appeal then found it was reasonable to apply the provision in that case because the shareholder should have anticipated that the board of directors might change the bylaws and add the position.  Given the Court of Appeal’s reasoning, it could be difficult to argue that enforcement of the provision would be unreasonable in a new case.

Takeaways

The lesson from this case is that when you decide to incorporate a business, or to invest in a business that is incorporated, you may be forced to litigate any internal disputes arising out of that business in a distant forum.  Consider restricting the ability of those with whom you do business to enact such a requirement by including a provision in the corporate charter preventing it or putting in place from the outset a forum selection provision.