Strengthening the Internal Affairs Doctrine: Juul Labs, Inc. v. Grove.

• Author: Meyer, Andrew J.

1. INTRODUCTION

   The state of Delaware plays a significant role in shaping corporate law around the country. Delaware is home to a substantial number of corporations - more than half of publicly held corporations and over sixty percent of Fortune 500 companies are incorporated in the state. (1) Furthermore, it contains the most out-of-state incorporations - a situation where a business incorporates in Delaware but has a principal place of business in another state. (2) For instance, the State of Missouri has ten Fortune 500 corporations with their principal place of business in the state, two of which are incorporated in Delaware. (3) Delaware maintains that the large number of incorporations is due to the predictability and stability provided by the Delaware General Corporation Law ("DGCL"), the corporate law-focused Delaware Court of Chancery ("Chancery Court"), and the prompt and efficient service provided to corporations through the state's tailored legal system. (4) Regardless of the accuracy of these claims, commentators and experts generally agree on Delaware's importance in corporate law. (5)

   Because of this, a recent case decided in the Chancery Court could have an impact on corporate law throughout the country. In Juul Labs, Inc. v Grove, the Chancery Court considered whether a shareholder could invoke a California shareholder inspection law to demand inspection of the books and records of a Delaware corporation incorporated in Delaware that had its principal place of business in California. (6) The court held that the Internal Affairs Doctrine dictated that only Delaware law governs a shareholder's inspection rights of a Delaware corporation and the doctrine precluded the shareholder from demanding inspection under California law. (7) The Internal Affairs Doctrine is a court-made principle that states that disputes among the corporation, its directors, officers, and shareholders over the internal affairs of a corporation are governed by the laws of the state of incorporation. (8)

   This Note examines the history of the Internal Affairs Doctrine and analyzes the reasoning of the Chancery Court. Part II outlines the facts and holding of Grove, Part III details the background of the Internal Affairs Doctrine, Part IV describes the Chancery Court's decision in Grove. Finally, Part V critiques the court's decision and discusses its implications. It does so by discussing the various interests of the states and questioning whether Delaware's interests in regulating its corporations overrides the compelling interests of other states in regulating foreign corporations which principally reside within their borders. It concludes by discussing possible future disputes over laws regulating diversity on boards of directors and if the Internal Affairs Doctrine will apply.

2. FACTS AND HOLDING

   The plaintiff in Juul Labs, Inc v. Grove, Juul Labs, is a Delaware corporation whose principal place of business is in San Francisco, California. (9) Juul Labs is the result of a 2017 spin-off from Pax Labs, Inc., a company that creates vaporizer products using cannabis and a variety of other plant-based materials. (10) In 2015, Pax Labs released the e-cigarette known as JUUL, which serves as an alternative to traditional cigarettes and delivers nicotine to users through a vapor. (11) Pax Labs spun off Juul Labs, Inc. and the JUUL products to allow Juul to focus on cigarette alternatives while Pax Labs could focus on other plant-based materials. (12) The defendant, Daniel Grove, is a former employee of Juul Labs. (13) While employed at the company, Grove obtained options to acquire 20,000 shares of common stock in the company as part of his compensation. (14) To accept the options, Grove electronically signed a standard-form acceptance agreement on August 4, 2017. (15) On February 1, 2018, Grove exercised his options to purchase 5,000 shares of common stock by electronically signing a standard-form exercise agreement. (16) Both standard-form agreements contained similar provisions that stipulated Grove waived his inspection rights as a shareholder under Section 220 of the DGCL. (17) Furthermore, the company's certificate of incorporation contained a forum-selection provision designating Delaware courts as the exclusive forum for disputes governed by the Internal Affairs Doctrine. (18) Through the purchase of this stock, Grove became a minority shareholder in Juul Labs. (19)

   In recent years, Juul Labs has come under scrutiny from the public and the United States Government over (20) a large increase in use of e-cigarettes by children and the emergence of lung injuries attributable them. (21) In 2017 and 2018, the United States Food and Drug Administration reported a seventy-eight percent increase in students vaping, with approximately 3.6 million children using e-cigarettes. (22) According to the United States Centers for Disease Control and Prevention, there have been 2,807 reported hospitalizations or deaths linked to lung injuries caused by e-cigarettes and vaping products, with sixty-eight confirmed deaths. (23)

   In response to these and other issues, Grove demanded to inspect the records and books of Juul Labs under the authority of Section 1601 of the California Corporate Code. (24) Section 1601 allows shareholders residing in California to demand inspection of the accounting books, records, and meeting minutes of any domestic corporation of California or any foreign corporation that maintains records or a principal executive office in California. (25) Grove indicated that if Juul Labs refused or failed to respond to his demand, he might seek a court order to compel production. (26)

   Instead of complying with Grove's inspection demand, Juul Labs filed an action in the Chancery Court on January 6, 2020, for declaratory and injunctive relief against Grove. (27) Juul sought a declaration from the court that the corporation was not obligated to make its books and records available to Grove. (28) It also moved to enjoin Grove from using California law to circumvent the waiver included in his stock-purchase agreements. (29) on February 10, 2020, Juul Labs and Grove each moved for a judgment on the pleadings in the Chancery Court. (30) On August 13, 2020, the court granted Juul Labs' motion for judgment on the pleadings, holding that, under the Internal Affairs Doctrine, the right of a shareholder to seek inspection of the books and records of a Delaware corporation exists only under Delaware law. (31) It further held that, in Grove's case, any action to enforce that right must be brought in a Delaware court because the forum-selection clause in the company's charter stipulated that Delaware courts had jurisdiction over any action governed by the Internal Affairs Doctrine. (32)

3. LEGAL BACKGROUND

   In the United States, corporate law is primarily the province of the states. (33) Provisions of state corporation laws range from "trivial housekeeping to the fundamental fashioning of shareholder-manager relations." (34) They can specify something as small as requiring that a corporation's name be placed in its charter to something as significant as specifying the fiduciary duties of directors and the voting rights of shareholders. (35) Corporate laws can vary considerably from one state to another. (36) To account for these variations among corporate laws, states largely apply the Internal Affairs Doctrine to ensure consistency and predictability in governing corporations that operate in multiple states. (37)

   The Internal Affairs Doctrine is a court-made conflict-of-law policy which requires that disputes among the corporation, its directors, officers, and shareholders over the internal affairs of a corporation be governed by the laws of the state of incorporation. (38) While the policy is easy to recite, interpreting and applying it can be more difficult. Specifically, whether an affair should be categorized as internal or external may be open to debate. (39)

   Subpart A presents the historical context under which the Internal Affairs Doctrine emerged. Subpart B then outlines the doctrine's modern justifications and rationales. Finally, Subparts C and D briefly discuss the application of the doctrine in the state of Missouri and the emergence of state outreach statutes that challenge the doctrine.

   1. The History of the Internal Affairs Doctrine

      The history of the Internal Affairs Doctrine and how it came to be is unclear. (40) This is partly due to the fact that adherence to the doctrine requires states to voluntarily give up their power to regulate foreign corporations using their own laws and instead apply the laws of the incorporating state. (41) If Missouri, or any other state, wishes to regulate a particular business activity or market, it is generally within its power to do so as a sovereign jurisdiction within the United States. (42) However, most states adhere willingly to the doctrine, and some have chosen to codify it. (43)

      Prior to industrialization, choosing to incorporate in one state while operating in others was typically not an option. (44) Businesses generally operated locally at low volumes of production and exchange due to the technological limitations of the time and were primarily partnerships consisting of family members. (45) States granted charters to businesses through special acts of the legislature rather than through the simple modern day administrative process. (46) Businesses that operated in multiple states obtained a charter from each state. (47) States held a territorial monopoly over regulating businesses within their borders due to the localized nature of commerce in the pre-industrial era, and an exertion of power over foreign corporations would likely have been seen as an intrusion upon the other state's sovereignty. (48)

      Spurred in part by improvements to transportation, communication, and energy production, industrialization brought both business growth and an increase in interstate...