Sarah Voutyras and Melanie Saponara

Readers of this blog know that one of the litigation risk management steps well-advised companies are taking in the current litigation environment is the adoption of forum selection bylaws, including, in particular, bylaws specifying a particular forum for the consideration of shareholders’ derivative suits. In a series of recent decisions, federal courts have reviewed these bylaws. In the following guest post, Melanie Saponara, Claims Manager – Executive Risk, Beazley, and Sarah Voutyras, Partner, Skarzynski Marick & Black LLP, take a look at recent federal appellate court developments on this issue and consider the implications. I would like to thank Melanie and Sarah for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

As any seasoned lawyer knows, forum can be critical when evaluating the risks presented by a litigation. Over the past decade, corporations and their insurers have seen a troubling trend of event-driven derivative lawsuits commanding staggering settlements in amounts comparable with those previously reserved for significant stockdrop suits. Plaintiffs’ ability to forum shop has contributed to this trend, as has plaintiffs’ ability to assert federal securities claims along with their common law derivative claims to access multiple forums in state and federal courts.

Corporations have crafted forum selection provisions to curtail forum shopping for direct Securities Act claims. Doing so became critical after the Supreme Court in Cyan held that plaintiffs may assert Securities Act claims in state court, which resulted in an influx of state court securities suits, often parallel to and duplicative of federal court lawsuits. The costs associated with defending identical suits in multiple jurisdictions soon became a non-merits based factor in settling these cases. Another factor was the uncertainty associated with litigating in state court claims that previously had been adjudicated by only federal courts. Corporations sought to regain control over the adjudication of corporate matters by creating forum selection provisions requiring that securities claims be heard in federal court. Several jurisdictions have found that such federal forum selection provisions are enforceable: the Delaware Supreme Court in Sciabacucchi (Del. 2020), a New York trial court in Casa Systems (2021), and a California appellate court in Restoration Robotics (2022).

In the other hand, derivative suits traditionally sound in common law and mostly have been adjudicated by the state courts. Plaintiffs recently began including federal securities claims in their derivative litigations to access a new forum for their claims. As they did for direct Securities Act claims, corporations again turned to forum selection provisions to abate forum shopping and duplicative litigation. Corporations adopted forum selection provisions requiring that all derivative claims be brought in Delaware Chancery Court, which is known for its expertise in adjudicating corporate disputes. At the heart of the prior circuit split, discussed below, over the enforcement of these provisions​​ is whether they improperly extinguish shareholders’ right to bring derivative claims under the Exchange Act.

In October 2022, the Ninth Circuit vacated its decision enforcing a derivative forum selection provision and agreed to rehear the matter en banc. Corporations and the legal community eagerly await further regarding whether the Ninth Circuit will again endorse a corporation selecting the forum for litigation brought on its own behalf and against its D&Os.

The Seventh Circuit’s Decision in Seafarers

In January 2022, the Seventh Circuit refused to enforce a forum selection provision in Boeing’s bylaws designating Delaware Chancery as the exclusive forum for derivative actions. The plaintiff sought to hold Boeing’s D&Os liable for massive litigation costs and reputational harm from the recent 737 MAX aircraft crashes that caused 346 fatalities. In addition to common law derivative claims based on the D&Os’ alleged failure to monitor and respond to safety risks, the plaintiff asserted Section 14(a) claims alleging that the D&Os disseminated false and misleading proxy statements when seeking shareholders’ votes to approve the election of board members and executive compensation.

Including federal claims allowed the plaintiff to file its derivative suit in federal court, which the defendants argued violated Boeing’s forum selection provision. The district court agreed with the defendants, dismissing the suit based on forum non conveniens. The plaintiff appealed, arguing that Boeing’s attempt to designate Delaware Chancery Court as the exclusive forum for derivative actions effectively foreclosed its shareholders’ ability to assert derivative Section 14(a) claims, as state courts do not have jurisdiction to hear these federal claims.

The Seventh Circuit reversed and remanded, finding Boeing’s forum selection provision unenforceable because, as applied, it violated the Exchange Act’s anti-waiver provision[1] and thereby contravened Delaware corporate law. The Court cited Sciabacucchi and Boilermakers for the proposition that forum selection provisions may regulate “where—not whether—shareholders may file suit.”

In dissent, Judge Easterbrook critiqued the majority’s outcome-determinative approach, noting that Boeing’s shareholders remained free to assert Section 14(a) claims directly (as opposed to derivatively on Boeing’s behalf) and therefore were not deprived of any substantive rights. Judge Easterbrook contended that Delaware created derivative actions and therefore could abolish them without violating federal law. If Delaware could go as far as to abolish derivative actions, then it follows that Delaware could allow corporations to place conditions on where derivative actions can be brought.[2]

Ultimately, the parties settled this litigation for $6.25 million and an amendment to Boeing’s bylaws to allow federal derivative actions to be brought in the District of Delaware or the District of Virginia.

The Ninth Circuit’s Decision in Fisher, Recently Vacated

In Fisher, the Ninth Circuit panel took a more practical, policy-driven approach to analyzing the enforceability of these types of forum selection provisions. The plaintiff had brought derivative claims against Gap’s D&Os, seeking to hold them liable for failing to create meaningful diversity within the company. The plaintiff included Section 14(a) claims alleging that Gap’s proxy statements included misleading statements about the board’s commitment to diversity.

Like Boeing, Gap too had a forum selection provision requiring that derivative claims be brought in Delaware Chancery Court. The district court agreed that federal court was not the appropriate forum for the plaintiff’s claims, and the Ninth Circuit panel affirmed. The Ninth Circuit recognized a “strong presumption in favor of enforcing forum-selection clauses regardless of whether the clause points to a state court, a foreign court, or another federal court.”

Counsel for the Fisher plaintiff-appellant petitioned for en banc review “to resolve an inter-Circuit split [with the Seventh Circuit] created by the panel’s decision.” In late October 2022, the Ninth Circuit vacated the panel decision and ordered rehearing en banc.

Notably, the Ninth Circuit has requested supplemental briefing on the following two issues: (1) the legal impact of the fact that Gap’s forum-selection provision applies to only derivative claims, not direct claims, under the Exchange Act; and (2) the application of Delaware General Corporate Law Section 115. As to the first issue, Gap has responded that the plaintiff’s ability to bring a direct claim based on the same allegations raised in her derivative action confirms (i) that she has not been deprived of any substantive rights under the Exchange Act and (ii) that Gap remains legally bound to comply with the Exchange Act. As to the second issue, Gap argues that the plaintiff waived any Section 115 arguments below. Alternatively, Gap has argued that Section 115, which permits bylaws that are “consistent with applicable jurisdictional requirements,” applies only to claims arising under Delaware law and therefore is irrelevant to the Exchange Act claim at issue here.

Discussion and Concluding Thoughts 

In the authors’ experience, Section 14(a) claims rarely are the primary focus of derivative plaintiffs’ claims. Instead, they present merely one additional theory of liability that is secondary to plaintiffs’ common law derivative claims. Indeed, recent federal court decisions, such as in the derivative suits brought by shareholders of Qualcomm (D. Del. 2021), Tractor Supply (M.D. Tenn. 2022) and Cisco  (N.D Cal. 2022), show just how difficult it is to plead a meritorious derivative Section 14(a) claim. Plaintiffs must show a causal link between the conduct and the damages and face difficulty in tying business losses back to allegedly defective proxy materials used to solicit the board’s re-election. As the court in the Tractor Supply suit stated: “Without Plaintiff adequately alleging any facts that would establish that the alleged proxy violation actually caused harm to the Plaintiff, personal liability on the part of Defendants for Plaintiff’s Section 14(a) claim is highly unlikely.”  Nonetheless, even if these Section 14(a) claims typically are more defensible than other types of derivative claims, the fact that they provide plaintiffs with a path into federal court can increase both defense costs and settlement values. We highlight the FirstEnergy derivative litigation as an example of costly, duplicative litigation, where defense costs continue to accrue as one of the two U.S. district court judges overseeing the litigation refuses to grant preliminary approval of the parties’ $180M settlement.[3]

In the authors’ view, the Ninth Circuit panel’s approach to examining forum selection provisions—by weighing heavily in favor of enforcement, barring extraordinary circumstances—is persuasive. A derivative claim is a claim brought on behalf of a corporation. Therefore, it follows that the corporation should be able to dictate that such claims be brought in a forum such as Delaware Chancery Court, which is home to highly-experienced chancellors and a well-developed body of case law regarding intra-corporate disputes.

And while we have not yet had a Delaware court weigh in on whether these derivative forum selection provisions are valid and enforceable, we now have heard from Former Delaware Chief Justices, Justices, Chancellors, and Vice Chancellors,[4] who submitted an amicus letter to the Ninth Circuit in connection with its decision to rehear Fisher en banc. The amici curiae endorse enforcing Gap’s forum selection provision because “(1) the remedies available in this derivative action are duplicative of the remedies available in Delaware derivative actions; (2) the federal derivative claim at issue . . . is contingent on Delaware law both for its existence and for the definition of its critical metes and bounds; (3) where a stockholder claims that a false or misleading disclosure impaired the stockholder’s right to case an informed vote, that claim is direct, not derivative; (4) Delaware [GCL] Section 115 is irrelevant . . .; and (5) the forum selection provision at issue in this litigation is enforceable under Delaware law.” It remains to be seen whether the Ninth Circuit will be persuaded by Gap and its honorable amici to allow these forum selection provisions, restoring the circuit split with the Seventh Circuit.

Note from the Authors: The information set forth in this document is intended as general risk management information. It is made available with the understanding that Beazley does not render legal services or advice. It should not be construed or relied upon as legal advice and is not intended as a substitute for consultation with counsel.

[1] The Exchange Act’s anti-waiver provision provides that “[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of [the Exchange Act] or any rule or regulation [promulgated] thereunder . . . shall be void.”

[2] Notably, in a separate action, the plaintiff in Seafarers alleged that Boeing’s D&Os had breached their fiduciary duties by including the forum selection provision in Boeing’s bylaws in the first place. As Seafarers settled that case and the derivative 14(a) case, the court never reached the question of whether the breach of fiduciary duty claim was viable. However, it presents an interesting potential path forward for plaintiffs looking to challenge these types of forum selection provisions in the future.

[3] For more detail regarding the FirstEnergy saga, readers can visit Katryna Perera’s Law360 Article on the matter from October 12, 2022.

[4] The amici curiae who submitted the letter are the Honorable Leo E. Strine, Jr.; the Honorable Myron T. Steele; the Honorable Henry duPont Ridgely; the Honorable Jack B. Jacobs; the Honorable William B. Chandler III; the Honorable Andre G. Bouchard; the Honorable John W. Noble; the Honorable Donald F. Parsons, Jr.; and the Honorable Joseph R. Slights III. The amici curiae submitted their letter in support of the Brief of Amici Curiae Professors Joseph A. Grundfest and Mohsen Manesh, represented by Freshfields Bruckhaus Deringer US LLP.