By Frank Reynolds

In a first-of-its-kind decision, a federal judge in San Francisco has refused to enforce Oracle Corp.'s bylaw that requires all shareholder derivative litigation against the software giant to be brought in the Delaware Chancery Court. 

U.S. District Judge Richard Seeborg said federal courts need not be swayed by such venue-choice bylaws that are based on state law, especially where, as here, they were unilaterally adopted by directors who were involved in the alleged wrongdoing that is the subject of the affected litigation. 

The order issued by the Northern District of California judge rebuffed Oracle’s bid to dismiss two related shareholder suits that claimed its officers and directors allowed fraudulent practices that exposed the company to charges by the federal government. 

AN EMERGING ISSUE 

Judge Seeborg’s ruling is the first reported decision on the much-discussed idea of forum-selection bylaws. 

The adoption of bylaws specifying the vaunted Delaware Chancery Court to speedily resolve shareholder suits has been widely supported by corporate law experts.  The bylaws would avoid duplicate actions in the state where the company is based and in Delaware, where most large corporations are chartered. 

Former Securities and Exchange Commission member Joseph Grundfest promoted the idea last fall in an address to Delaware's bench and bar. 

Grundfest, now a Stanford Law School professor and renowned securities law expert, said corporate governance cases lag behind contract and employment law, where agreements commonly specify the court that will decide disputes. 

He said a shareholder vote is not normally needed for this type of bylaw change, but shareholders theoretically could exercise their right to change the bylaws to designate a different court. 

WHAT ABOUT THE SHAREHOLDERS? 

In the Oracle case, the fact that the change was made without a shareholder vote made all the difference to Judge Seeborg because, he said, the bylaw lacks the element of mutual consent that is found in contracts. 

"Particularly where, as here, the bylaw was adopted by the very individuals who are named as defendants and after the alleged wrongdoing took place, there is no element of mutual consent at all," at least for investors who bought stock before the bylaw adoption, the judge wrote. 

Investors who bought stock after that should have, or at least could have, known that the company had the provision when they decided to buy. 

WRONG COURT? 

The derivative lawsuits against Oracle charge its directors with breach of fiduciary duty and abuse of control regarding $1 billion in software sales to the government.  The company allegedly overcharged the government by millions of dollars, and the Justice Department is now pursuing Oracle for violations of federal false-billing laws.  

Oracle and its directors recently asked the California federal court to consolidate and dismiss the suits on the ground that they were not brought in the proper venue, which was Delaware, according to the bylaw the board adopted in 2006.  

Judge Seeborg noted that although the suits were not filed until four years after that, they are based on alleged wrongdoing that was taking place when the defendant directors adopted the bylaw changes. 

He said that if the forum-selection provision had been in the form of a charter amendment that received an approval vote from the Oracle shareholders, the case for enforcing it "would be much stronger." 

However, whether the forum selection is made via a bylaw or a charter change, the power to make that change is based on state law, Judge Seeborg noted. 

"Oracle has not shown federal law requires or even permits the federal courts to defer to any provisions of state corporate law that might give a corporation's directors the power to control venue under the circumstances discussed," the judge said in denying the motion to dismiss. 

THE CALL FOR FEDERALIZATION 

Shareholder activists have urged the Obama administration to widen the power of federal agencies such as the SEC to regulate corporate governance matters.  They say the Delaware courts are too willing to give manipulative officers and directors the benefit of the doubt. 

Attorney Francis G.X. Pileggi, a partner with Fox Rothschild in Wilmington, Del., who is not involved in the case, commented in his corporate law blog, "Perhaps this ruling is an insight for those who might favor the federalization of corporate law." 

Since the decision came from only one of hundreds of federal judges around the country, Pileggi said, "the future could present us with hundreds of other decisions on this corporate issue that we may need to sort out in the coming years." 

Galaviz v. Berg et al., No. 10-3392; Prince v. Berg et al., No. 10-4233, order entered (N.D. Cal. Jan. 3, 2011).