CALIFORNIA COURT REFUSES TO ENFORCE BYLAW AMENDMENT COMPELLING ARBITRATION BY THE MEMBERS OF THE CORPORATION
There have been several recent Delaware court decisions and much commentary regarding the enforceability of bylaw provisions that establish rules governing stockholder litigation, including fee-shifting provisions and forum selection clauses, and several Maryland court decisions concerning bylaw provisions mandating arbitration of shareholder disputes. Now the California Fourth District Court of Appeal has issued an opinion refusing to enforce a bylaw amendment requiring arbitration of disputes that was adopted by a California corporation following the filing of a complaint against it by several of its former and current members. Cobb v. Ironwood Country Club, Case No. G050446 (January 28, 2015).
In August 2012, Ironwood was sued in a declaratory relief action by several former and current members who alleged the country club failed to honor its agreement to repay loans made by the members to purchase additional land for the club. Four months later, the Board of Directors of Ironwood notified its membership that it was contemplating amending its bylaws to require arbitration of any claims or disputes of past or present members against the country club or its officers, directors or agents. The Board did not hear significant objections from its members and adopted the bylaw amendments on December 28, 2012.
Shortly thereafter, Ironwood filed a motion to compel plaintiffs to arbitrate their complaint, asserting that the newly-adopted arbitration provision applied because the lawsuit concerned an ongoing dispute between the parties and that Ironwood’s right to amend its bylaws applied both to current and former members. The trial court denied the motion, finding that the plaintiffs had not agreed to arbitrate the dispute.
The appellate court affirmed the trial court’s order. The appellate court held that it is impermissible for one party to a contract–here, the bylaws–to unilaterally amend the contract governing the parties’ relationship in a way that violates the covenant of good faith and fair dealing by retroactively impairing accrued rights. The appellate court also found that Ironwood’s assertion that by agreeing to bylaws permitting future amendments, each member, including a member who subsequently resigns, is automatically bound by every future bylaw provision, would render the agreement illusory and unenforceable. The appellate court also expressed concern that the “one-sided” arbitration provision “when coupled with the purported waiver of punitive or consequential damages, could be deemed unconscionable.”
The appellate court decision can be viewed as consistent with the views expressed in Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011) in which a federal district judge in California declined to uphold a forum selection bylaw clause partly because “the bylaw was adopted by the very individuals who are named as defendants, and after the alleged wrongdoing took place.”
In reaching its decision, the appellate court in Cobb did not address several recent Maryland cases upholding a bylaw provision requiring arbitration for shareholder claims, nor recent Delaware decisions that have upheld bylaw provisions establishing fee-shifting and forum selection requirements in certain circumstances. (For the Maryland cases, see Katz v. CommonWealth REIT, Case No. 24-C-13-001299 (Md. Cir. Ct. February 19, 2014); Corvex Management LP v. CommonWealth REIT, Case No. 24-C-13-001111, 2013 WL 1915769 (Md. Cir. Ct. May 8, 2013). For the Delaware cases, see ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A. 3d 554, 2014 WL 1847446 (Del. May 8, 2014); Boilermakers Local 154 Retirement Fund and Key West Police & Fire Pension Fund v. Chevron Corp., 73 A. 3d 934 (Del. Ch. 2013)).
Although it is not surprising that the court here refused to enforce a bylaw provision that mandated arbitration even on claims brought by former members who had ceased being members and had already initiated a lawsuit at the time of adoption of the bylaw provision, it is possible that a different result would occur under facts more favorable to a corporation attempting to enforce an arbitration clause. It is also conceivable that the Cobb decision may have implications in other contexts, including for example some limited liability operating agreements that grant broad authority to one or several members and/or managers to amend significant provisions regarding the rights and duties of its members and management.
This e-bulletin was written by William Ross. Mr. Ross is of counsel to the law firm of Hirschfeld Kraemer LLP, and represents clients on business matters, including the formation, operation, acquisition, disposition and dissolution of business entities.