The federal court decision on Thursday to strike down the use of the Delaware Chancery Court for private arbitration is likely to be the end of an interesting experiment.
In 2009, the Delaware legislature amended its laws to permit the Delaware Chancery Court to arbitrate private disputes confidentially without public access. The idea was to enhance the Delaware courts' prestige and extend its ability to adjudicate the nation's most complex business disputes.
Delaware judges and its courts are already renowned for their expertise in these matters. And with these provisions, the courts arbitrate not only commercial and corporate matters but also intellectual property disputes, adding some technology expertise.
There was a lot of excitement at the time about these provisions.
The Delaware Supreme Court and Chancery Court judges highlighted the provisions publicly, and there was talk that this was a game-changer. Companies would flock to Delaware to t ake advantage of this expertise through private arbitration.
Francis G.X. Pileggi, a partner Eckert Seamans and operator of the Delaware Corporate and Commercial Litigation blog, told The Wilmington News Journal at the time that the “Chancery Court is already known far and wide for its ability to adjudicate cases quickly. This is the natural evolution of that existing benefit.†Mr. Pileggi lauded the secrecy of these proceedings, stating that a “lot of people do business together and may not want to air their dirty linen in public, so to speak.â€
The arbitrations would also generate substantial revenue as Delaware would charge $6,000 a day for the service with a $12,000 filing fee.
It didn't turn out that way.
The Delaware Chancery Court adopted the provisions in January 2010. Since that time there have only been six arbitrations, five of them lasting only a day and generating about $60,000.
One likely reason for the spare usage: the Del aware Coalition for Open Government.
In October 2011, the coalition sued, challenging the secrecy of these proceedings. The core claim was that these proceedings violated the First Amendment's requirement that the public have qualified access to civil and criminal trials.
The federal court's decision was succinct and, at 26 pages, much shorter than the Delaware Chancery Court's own opinions, which typically can run far longer. Essentially, the federal court found that the arbitration proceedings were effectively a civil trial, with no difference in judges, place or proceeding except the secrecy and the arbitral nature. And since this was effectively a civil trial, it was required to be open.
The federal court opinion flows from its decision to effectively treat these cases as civil trials. Once the court made that conclusion, the Delaware arbitration ruling was history because there is clear precedent that civil trials cannot be secret under the First A mendment.
But there are counterarguments as to why this proceeding is constitutional. Judges do participate in mediation and there are some quasi-arbitration like acts they participate in. More relevantly, these were private disputes that were likely to be subject to arbitration anyway. The use of Delaware judges really made no difference and in fact might have produced a better outcome for all involved.
Other events may have influenced views on the appropriateness of Delaware judges as arbitrators. The most prominent of the six arbitration proceedings so far, involved an effort by Skyworks Solutions to escape its $262.5 million deal to buy Advanced Analogic Technologies. In that deal, Skyworks invoked the material adverse change clause in the companies' merger agreement.
This was not a truly private dispute as the rights of shareholders in both companies were implicated. Shareholders had to wait weeks to find out the eventual determination.
As B rian Quinn at the M&A Law Prof Blog wrote at the time, “The problem with trying to follow a dispute like this from the outside is that nothing is public unless the parties want it to be. So, we end up getting bits and drabs of information here and there. It becomes very difficult for an observer, or the market, to get any idea what the issues are. Welcome to the world of private arbitration.â€
The parties settled two days into the arbitration proceedings and shareholders still don't know what the exact claims were or assess their validity.
Then there was the Carlyle Group's effort to adopt a provision requiring all of its shareholders to litigate all state fiduciary duty and federal securities law disputes in Wilmington, Del. It made people even more queasy about arbitration.
Having companies litigate private disputes may have been tolerable, but the Delaware arbitration provisions had the potential to lock shareholders out of many claims as companies s hifted these claims to arbitration in order to keep them confidential and stop shareholder class action lawsuits.
Given the events in Skyworks and Carlyle, some commentators became quite uneasy with the potential scope of Delaware's arbitration provision. Though, in fairness it still had a mass of support in the Delaware bar because it had judges do something that would be arbitrated anyway.
In this light, the court's ruling on Thursday makes logical sense, at least to me.
It's one thing for a dispute by two companies over a joint venture in a foreign country to arbitrate the dispute. And it makes sense for Delaware judges to be picked for this task. But when it is a dispute that directly implicates third parties like shareholders, the arbitration provision may go a bit too far.
In some ways the arbitration provisions may be a victim of Delaware's success. The court's five Chancery Court judges are really the best in the country at adjudicating cor porate law disputes involving shareholders. The reason is not only their competence but their experience in deciding these matters.
So, it is no surprise that to the extent companies want to extend arbitration to previously public domains, these provisions would come into play. The likely reasons they have not been used more often are the pending litigation and the fear that companies have of their validity. But had the provisions really been confined to purely private disputes without affecting shareholders, they might have been more defensible in the federal court.
The Delaware Chancery Court, through noted a law professor, Lawrence A. Hamermesh, who is assisting in representing the court in this matter, stated on Thursday that it would appeal the decision. I am no constitutional law expert, but if the Third Circuit Court of Appeals views these matters through the same lens that the federal court did, the appeal will not go far. If so, it will end Delaware's i nteresting experiment.
