Delaware, Confidential Arbitration and the Risks to Investors (Part 1)

In 2009, the Delaware Legislature adopted Section 349 of the Delaware Code (House Bill 49).  The provision permitted the use of confidential arbitration in "business disputes." 

What made the provision unique was the identity of the arbitrator.  The provision provided that the Court of Chancery had "the power to arbitrate business disputes when the parties request a member of the Court of Chancery, or such other person as may be authorized under rules of the Court, to arbitrate a dispute."  10 Del. C. § 349. In effect, therefore, parties would get the benefit of one of the Chancellors/Vice Chancellors at the Delaware Chancery Court (or one of the court masters). 

The Chancery Court has adopted implementing rules.  Chancery Court Rules 96-98.  At least two companies have already made use of the Rule, filing a confidential arbitration with the Chancery Court.  See Form 10-Q, Mattersight Corporation, Nov. 10, 2011, at 14 ("On October 25, 2011, an arbitration hearing between the Company and TCV (as defined below) took place before the Court of Chancery of the State of Delaware").  Chancellor Strine presided over at least one of the proceedings.  As one public filing described:

On October 31, 2011, Chancellor Strine of the Court of Chancery of the State of Delaware, acting as arbitrator in the arbitration proceedings between Skyworks Solutions, Inc., a Delaware corporation (“Skyworks”) and Advanced Analogic Technologies, Incorporated (“AATI”) regarding the parties’ May 26, 2011 Merger Agreement (the “Merger Agreement”), held a hearing on Skyworks’ request (reported in the Current Report on Form 8-K filed by Skyworks on Friday, October 29, 2011) to file an amended petition alleging certain additional matters. After the hearing, Skyworks filed the amended petition.

The case eventually settled.

The adoption of the system of confidential arbitration that relied on members of the Chancery Court has generated controversy.  The Delaware Coalition for Open Government has challenged the constitutionality of the system.  The DCOG alleged that the system violated the First and Fourteenth Amendment.  In effect, the Complaint asserts that there is a constitutional right to access to trials and that the the approach adopted by Delaware violates that right.  According to the Complaint:

Del. C. §349 and Chancery Court Rules 96, 97 and 98 deny plaintiffs, and the general public, their right of access to judicial proceedings and records. Although the statute and rules call the procedure “arbitration,” it is really litigation under another name. Although procedure may vary slightly, the parties still examine witnesses before and present evidence to the Arbitrator (a sitting judge), who makes findings of fact, interprets the applicable law and applies the law to the facts, and then awards relief which may be enforced as any other court judgment. The only difference is that now these procedures and rulings occur behind closed doors instead of in open court.

As a result, the system, according to the Complaint, constitutes "constitute an unlawful deprivation of the public's right of access to trials in violation of the First Amendment as applied to the states by the Fourteenth Amendment to the United States Constitution."

The system and the case brought by the DCOG has already generated some commentary.  This includes posts at the ADR Prof Blog and Prawfsblawg. 

At the same time, the litigation has generated interest from interest groups.  Nasdaq/NYSE has filed an amicus on the side of Delaware, supporting the constitutionality of the system, as has the Corporation Section of the Delaware Bar Association.  An amicus has been filed supporting the position take by the plaintiff by the Reporters Committee for Freedom of the Press and five other news organizations. 

The first amendment issue is an interesting one but beyond the competency of this Blog.  While arbitrations are typically confidential, the main issue is whether, given the role of the Chancery Court, this is really an arbitration or a trial.  

There is, however, a significant issue with the Delaware approach that is within the competency of this Blog.  The approach may be available to require investors to arbitrate disputes with management.  We will discuss how this might occur in the next post.

Primary materials are located at the DU Corporate Governance web site.