We have an interesting decision out of a California appellate court regarding the intersection of inspection rights and forum selection clauses.
First, it filed a declaratory judgment action in Delaware seeking an order that it was not obligated to comply with the California statute; and second, it moved to stay in California, claiming the applicability of its forum selection bylaw – which required any “internal affairs” claim to be litigated in Delaware.
The California trial court granted the stay, but Delaware dismissed the Orchid action, on the ground that it did not have personal jurisdiction over the shareholder.
So, the whole thing gets to the California appellate court. And the first question is, are California inspection rights “internal affairs” such that the forum selection bylaw applies?
And through a combination of plaintiff concessions and waivers, the court essentially assumes that Delaware law governs the interpretation of the meaning of the bylaw. And since under Delaware law, inspection rights are an internal affairs matter, then – even though California might treat inspection rights differently – the plaintiff’s inspection claim was an internal affair issue governed by the bylaw.
However, the court went on to hold that forum selection provisions will not be enforced if they contravene California’s public policy. And here, California had an unwaivable public policy of allowing shareholders to inspect records, even of foreign corporations. That meant it was Orchid’s burden to show the shareholder would get the same records if he litigated in Delaware – and Orchid did not make that showing. Orchid conceded (correctly) that a Delaware court would not apply California’s statute, but Delaware’s. Leading to the question, is Delaware’s inspection right comparable to California’s? And the court held – no! Because California’s inspection right is broader than Delaware’s. Among other things, Delaware recently amended its statute to require a showing of compelling need for documents beyond those in the enumerated categories, and California’s inspection statute does not require such a high threshold. Plus, California permits shareholders to recover attorneys’ fees in a books-and-records action; Delaware does not, absent bad faith conduct.
Which meant, the forum selection clause was unenforceable, the trial court should not have granted a stay, and the whole case was remanded.
And I’ll just finish with, I just posted an essay arguing that, as the category of “internal affairs” is broadened, and as states use their corporate governance laws to effectuate more distinct (and controversial) public policies, other states are going to push back. And that is exactly what happened here; the California court engaged in an extensive discussion of the recent amendments to DGCL 220 and how they would impede California’s public policy. Which, I should add, is especially strong given the number of startups headquartered in California that pay California residents in private stock, which is apparently what happened here. (I will also plug my paper, Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine, where I pointed out California might have a particular interest in protecting its worker-shareholders at privately-held startups).