Well, it’s here, the SpaceX S-1.
I still haven’t gone through the whole thing, so I’m jumping specifically to the provisions limiting shareholder litigation rights.
As we all know, Texas does plenty of that all on its own, by immunizing officers and directors against any liability absent a showing of “fraud, intentional misconduct, an ultra vires act, or a knowing violation of law,” and by allowing (as SpaceX will opt into) its corporations to bar derivative claims unless the plaintiff holds at least 3% of the outstanding stock.
Naturally, SpaceX proposes to go further, with various forum selection and arbitration clauses.
First, interestingly, SpaceX has chosen to put these in the bylaws, and not in the charter. Why is this interesting? As we all know, bylaws can be amended unilaterally by directors; charter amendments require a shareholder vote. Back when the Delaware Supreme Court first authorized forum selection clauses governing federal securities claims in Salzberg v. Sciabacucchi, it did a very curious thing: first, it held these clauses would be treated as contractually binding in part because charters require a shareholder vote, and second, it held – with no further explanation – that bylaws are contractually binding as well.
I, of course, have long argued charters aren’t contracts, bylaws certainly aren’t contracts, and none of this can cover federal securities claims, etc etc, but after Salzberg, courts in other jurisdictions began to enforce forum selection provisions for federal securities claims, both in bylaws and charters, as contractually binding without much further thought (which I have angsted over repeatedly both in this blog, and in a paper). My sense was always, courts – especially generalist courts with no corporate expertise – really didn’t want to be bothered with the issue, especially when forum selection, directing federal securities cases to federal court, didn’t seem particularly unreasonable. Except that precedent exists now, that bylaws are contracts, as are charters, and that’s the precedent SpaceX will rest upon when it argues its arbitration bylaws are contracts. We’ll see if courts apply any more scrutiny to the issue now, if they distinguish between bylaws and charters, or if perhaps they figure that so long as the company went public with the bylaws in place, there’s no need to draw a distinction and they can worry about that onion slicing when an arbitration bylaw is unilaterally adopted by a corporate board midstream.
Moving on, and here’s where it gets long because I need to block quote a buncha stuff, so under the cut it goes.
Here’s what the bylaws provide:
To the fullest extent permitted by law, this Section 10.1 shall apply to all disputes between (i) one or more shareholders and (ii) the Corporation and/or its directors, officers, or controlling persons, or any underwriter of securities issued by the Corporation (or controlling person of the Corporation) relating to any of the following: (1) any derivative proceeding, meaning a civil dispute brought in the right of the Corporation; (2) any action based on the governance, governing documents, or internal affairs of the Corporation, including but not limited to any internal entity claim as that term is defined in the TBOC; (3) any action based on state or federal securities or trade regulation laws; (4) any action based on the alleged act(s) or omission(s) by any person(s) in his or her capacity as a shareholder, controlling person, director, officer, or other managerial official of the Corporation; (5) any action based on the alleged breach(es) by one or more shareholders, controlling persons, directors, officers, or other managerial officials of a duty owed, in his or her capacity as such, to the Corporation or to any shareholder(s) thereof; (6) any action seeking to hold one or more shareholders, controlling persons, directors, officers, or other managerial officials of the Corporation liable for an obligation of the Corporation, other than on account of a written contract signed by the person(s) to be held liable in a capacity other than as a shareholder or managerial official; or (7) any action arising out of the TBOC (each an “Internal Dispute”)….
Unless the Corporation consents in writing to the selection of an alternative forum and venue, the sole and exclusive forum and venue for Internal Disputes under this Section 10.1 shall be the Texas Business Court, Eleventh Division (the “Business Court”)….
[Jury waiver]
The governing law of any Internal Dispute commenced pursuant to this Section 10.1, shall be the law of the State of Texas or the federal law of the United States, as applicable to the issues raised in the Internal Dispute. For avoidance of doubt, the governing law shall include all requirements imposed by applicable law, including, without limitation, pleading and discovery limitations under the Private Securities Litigation Reform Act….
Collective Proceedings. Internal Disputes subject to resolution under this Section 10.1 must be brought only as an individual action or derivative proceeding, and, to the fullest extent permitted by law, may not be brought as a class action, mass action, or other form of collective action, and may not be consolidated or joined, in whole or in part, consistent with the Texas Rules of Civil Procedure; provided, however, that the Corporation at its sole option may elect to seek consolidation or joinder of matters as consistent with the Texas Rules of Civil Procedure….
Then there’s the arbitration provision:
To the extent a court of competent jurisdiction determines in a final and unappealable judgment that an Internal Dispute is not subject to the sole and exclusive venue and forum or jurisdiction of the Business Court, then to the fullest extent permitted by law, this Section 10.2 shall apply to any such Internal Disputes that are not subject to the sole and exclusive venue and forum, or jurisdiction, of the Business Court (an “Other Dispute”)….
Other Disputes shall be exclusively and finally settled by arbitration under the Expedited Procedure Provisions of the Rules (the “Arbitration Rules”) of the International Chamber of Commerce (“ICC”), pursuant to Article 30 thereof, or as those rules may be periodically updated, irrespective of the amount in dispute…
Other Disputes must be brought only as an individual action or a derivative proceeding (with derivative proceedings being separately subject to the requirements and limitations stated in Section 9.4), and, to the fullest extent permitted by law, may not be brought as a class action, mass action, or other form of collective action, and may not be consolidated or joined, in whole or in part, consistent with the Arbitration Rules; provided, however, that the Corporation at its sole option may elect to seek consolidation or joinder of matters as consistent with the Arbitration Rules….
If more than three claims arising from the same or similar conduct, transaction, or occurrence are submitted to arbitration pursuant to this Section 10.2 within any three-year period, all but the first-filed claim shall be stayed pending final resolution of that first-filed claim. In such circumstance, the Corporation and each shareholder asserting such a claim shall bear equal shares of the ICC fees and arbitrator(s) fees. Provided, however, that if any shareholder party or parties are ultimately successful on all of their claims, the Corporation shall reimburse the successful shareholder party or parties for the ICC fees and arbitrator(s) fees paid by such shareholder party or parties in accordance with this Section 10.2(g)(i). Following resolution of the first-filed claim, the Corporation and each shareholder asserting a claim that was stayed shall negotiate in good faith to resolve their disputes with the benefit of the resolution of the first-filed claim….
If any claim submitted to arbitration pursuant to this Section 10.2 is determined by the tribunal to be frivolous, without reasonable cause, or for an improper purpose such as bad faith or vexatious litigation, the Corporation shall be entitled to recover its reasonable attorney’s fees and costs incurred in defending against such claim, including any ICC fees and arbitrator(s) fees….
The tribunal’s application of the pleading and discovery limitations imposed by the Private Securities Litigation Reform Act is mandatory for applicable claims and shall not constitute a refusal to hear evidence pertinent and/or material to the controversy under Texas or federal law….
Here’s how this is all described in the S-1:
Our bylaws will contain a section (the “Forum Section Bylaw”) that will provide that, unless the Company consents in writing to the selection of an alternative forum, the sole and exclusive forum for the filing, adjudication, and trial of all disputes between (i) one or more shareholders and (ii) the Company or its directors, officers, or controlling persons, or any underwriter of securities issued by the Company (or controlling person thereof) relating to any of the following: (1) any derivative proceeding, meaning a civil dispute brought in the right of the Company; (2) any action based on the governance, governing documents, or internal affairs of the Company; (3) any action based on state or federal securities or trade regulation laws; (4) any action based on the alleged act(s) or omission(s) by a person in its capacity as a shareholder, controlling person, director, officer or other managerial official of the Company; (5) any action based on the alleged breach(es) by one or more shareholders, controlling persons, directors, officers, or other managerial officials of a duty owed, in his or her capacity as such, to the Company or to any shareholder thereof; (6) an action seeking to hold a shareholder, controlling person, director, officer, or other managerial official of the Company liable for an obligation of the Company, other than on account of a written contract signed by the person to be held liable in a capacity other than as a shareholder or managerial official; and (7) any action arising out of the TBOC, will be the Texas Business Court, Eleventh Division (the “Business Court”) (for purposes of this summary, each, an “Internal Dispute”).
…
SpaceX maintains that the Forum Selection Bylaw, including without limitation the selection of the Business Court as the sole and exclusive forum for all actions brought under federal securities laws, accords with the law and is enforceable. However, the law governing the selection of a forum other than a federal court for certain actions brought under the federal securities laws is unsettled, and there is some risk that, if an Internal Dispute were filed under the Exchange Act (or the rules and regulations thereunder) in a court other than the Business Court, that court could deny a motion to transfer the action to the Business Court pursuant to the Forum Selection Bylaw.
Accordingly, the bylaws provide that to the extent that a court of competent jurisdiction were to determine in a final and unappealable judgment that an Internal Dispute is not subject to the sole and exclusive venue and forum or jurisdiction of the Business Court (such Internal Dispute, an “Other Dispute”), such Other Dispute would be exclusively and finally settled by arbitration, pursuant to the Texas Arbitration Act, under the Expedited Procedure Provisions of the Rules of the International Chamber of Commerce, pursuant to Article 30 thereof. To be clear, absent Company consent, a shareholder would not be able to file an arbitration demand pursuant to the Dispute Resolution Clause without first obtaining a final and unappealable judgment that the shareholder’s Internal Dispute is not subject to the sole and exclusive venue and forum or jurisdiction of the Business Court. The governing law of such Other Dispute would be the federal law of the United States or the law of the State of Texas, as applicable to the issues raised in the Other Dispute, including without limitation the pleading and discovery limitations of the Private Securities Litigation Reform Act.
Okay, let’s start with the obvious:
It is in no way remotely an unsettled question whether the Texas state business courts have jurisdiction over Exchange Act claims, i.e., Section 10(b) and Section 14(a) claims, and did I just find the first intentionally false representation in the SpaceX S-1 filing? If so, do I get a prize?
Anyhoo, here’s what the federal statute says on the subject:
The district courts of the United States and the United States courts of any Territory or other place subject to the jurisdiction of the United States shall have exclusive jurisdiction of violations of this chapter or the rules and regulations thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by this chapter or the rules and regulations thereunder.
Here’s what the Ninth Circuit said on the subject:
§ 27(a) of the Exchange Act gives federal courts “exclusive jurisdiction of violations of this chapter or the rules and regulations thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by” the Act.
Here’s what the Seventh Circuit said on the subject:
the Exchange Act provides that only federal courts may exercise jurisdiction over claims that arise under the Act
Thus, I can only assume that, notwithstanding the S-1’s language, and going solely by the language of the bylaw itself, the company does not intend Exchange Act claims to be covered under its forum selection provisions.
After all, SpaceX requires all claims to be filed first in the Texas business courts; aggrieved investors are not permitted to, say, realize that the Texas business court has no jurisdiction over Section 10(b) claims, and therefore go directly to arbitration. No, they have to waste time, money, and legal fees first filing in a Texas state court, and wait for a final adjudication that the court has no jurisdiction.
Of course, such a filing would be frivolous, and therefore potentially a violation of the attorneys’ ethical obligations, which means, once again, I can only assume, that notwithstanding the language of the S-1, SpaceX’s bylaw is not, in fact, drafted to cover Exchange Act claims.
Moving on.
Disputes first have to go to the Texas Business Court, and that includes Section 11 claims under the Securities Act, as well as any state law claims. Notice, SpaceX is purporting to prohibit class actions even in a court. Usually, those prohibitions are coupled with arbitration clauses, because that ensures their enforceability; the enforceability of standalone class waivers – decoupled from arbitration clauses – is still an evolving area. I don’t know if Texas has weighed in yet. Leave it there.
SpaceX wants to import the PSLRA pleading standards and discovery stay to the Texas state court system. My recollection is that currently, state courts have reached mixed conclusion about whether PSLRA provisions automatically apply in state courts; it’s a whole ‘nother question whether you can import them contractually (or, not contractually, but via bylaw), does that mean parties can contract for their own civil procedure rules that will be binding on courts in general?
Then there’s arbitration, if the Texas Business Court has no jurisdiction. In general, corporations have so far been hesitant to adopt arbitration clauses, because they fear mass arbitrations, without the procedural protections afforded them under the PSLRA. And here’s where SpaceX’s hack may turn out to be pretty effective, and a model for other corporations. First, by requiring a stay if more than three actions are filed, it prevents mass claims; second, by specifying ICC expedited rules, it may largely eliminate discovery, especially if the ICC arbitrators treat as binding the specification that any arbitral complaints will still be subject to PSLRA pleading standards.
Which means, I suspect, any shareholder claims are DOA in arbitration.
Because here’s the thing. Arbitrators have every incentive to be fair and evenhanded when they are selected by parties of roughly equal bargaining power; they want business, they want to collect their fees, and if they signal they’re in the tank for one side or another, then the other side won’t agree to arbitrate.
But when one side can unilaterally pick the arbitrator, the incentives flow toward appeasing the repeat player; otherwise, that player will take their toys and go find another arbitrator. The biggest counterincentive, really, would be regulatory: If an arbitrator gets a reputation of being biased, there’s a risk that sooner or later the court system or regulators will bar mandatory arbitration or treat the selection of particular arbitrators as unconscionable, that kind of thing.
But what happens when that risk is entirely absent, because federal regulators have made it very clear that they’re hostile to private lawsuits? At that point, the incentives flow in only one direction.
And if that story of incentives reminds anyone of the turmoil in a very small state with a history of chartering corporations, well, it is what it is.
And another thing. New Shareholder Primacy podcast is up! Me and Mike Levin interview Jeff Mahoney of the Council of Institutional Investors. Here at Apple; here at Spotify; and here at YouTube.