On June 1, 2023, in a much-anticipated decision, the Ninth Circuit held, in a split en banc decision in the long-running board diversity lawsuit filed against the board of The Gap, that the provision in the company’s bylaws designating a Delaware state court forum for derivative actions was enforceable, even as to claims asserted derivatively under Section 14(a), and, accordingly, the appellate court affirmed the district court’s dismissal of the action. The decision, which validates company’s use of these kinds of forum selection clauses, also creates a split in the federal judicial circuits which could mean that the issue could be headed to the U.S. Supreme Court. A copy of the Ninth Circuit’s decision can be found here.
As discussed here, The Gap is one of several companies whose boards were targeted in shareholder derivative lawsuits pertaining to the diversity of the companies’ boards of directors. The plaintiff claims that the company’s board of directors allegedly failed to create meaningful diversity on the board and within the company’s leadership. The plaintiff further claims that the company made false statements about its diversity efforts. The plaintiff brought derivative claims in an action filed in the United States District Court on behalf of the company for breach of fiduciary duty; aiding and abetting breach of fiduciary duty; abuse of control; unjust enrichment; and violation of Section 14(a) of the Securities Exchange Act of 1934.
The defendants moved to dismiss the plaintiff’s complaint on the grounds of forum non conveniens. The defendants argued that the forum selection clause in the Company’s Bylaws designates the Delaware Court of Chancery as the exclusive forum for the plaintiff’s claims.
The forum selection clause provides, in pertinent part, that: “Unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation; (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by and director, officer, employee or agent of the Corporation to the Corporation or the Corporation’s stockholders.”
As discussed here, the district court granted the defendants’ motion to dismiss based on the forum selection clause. In granting the motion, the district court expressly rejected the plaintiffs’ argument that enforcement of the forum selection clause would be contrary to public policy because the state court forum lacks jurisdiction to hear the plaintiff’s Section14(a) claims; forcing the plaintiff to Delaware state court would, the plaintiff argued, effectively deprive the plaintiff of any forum to consider the claims.
A three-judge panel of the Ninth Circuit affirmed the district court’s ruling, arguably creating tension with the Seventh Circuit’s 2022 decision in Seafarers Pension Plan v. Bradway (here), which held that a similar forum-selection clause to be invalid, because enforcing the provision would deprive the plaintiff of any forum in which to bring its derivative claims under Section 14(a). In light of the potential conflict between the two decisions, the Ninth Circuit agreed to rehear the Gap appeal en banc.
The June 1, 2023, En Banc Ruling
In a June 1, 2023, opinion written by Judge Sandra Segal Ikuta for a 6-5 majority, the Ninth Circuit affirmed the district court’s ruling dismissing the Gap board diversity action on forum non conveniens grounds, in reliance on the state court forum clause. In affirming the district court, the appellate court rejected the three grounds on which the plaintiff had argued that the forum selection clause was unenforceable.
First, the plaintiff had tried to argue that the forum selection clause was unenforceable because it is, the plaintiff contended, contrary to the anti-waiver provision in Section 29(a) of the Exchange Act. The anti-waiver provision provides that “any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder … shall be void.” The en banc majority rejected the plaintiff’s argument that the forum selection clause was contrary to Section 29(a) because the provision would prevent her from bringing a derivative Section 14(a) action in any forum, concluding that because the forum provision applies only to derivative actions, the plaintiff could still bring a direct Section 14(a) claim in federal court.
Second, the plaintiff had tried to argue that the forum-selection clause was unenforceable because it was contrary to the strong policy of allowing a shareholder to bring a Section 14(a) derivative action. The Ninth Circuit majority rejected the plaintiff’s argument that the authority on which the plaintiff sought to rely created a strong public policy to allow plaintiffs to bring Section 14(a) claims as derivative actions. The en banc majority concluded that the plaintiff had not carried the heavy burden of showing the sort of exceptional circumstances that would justify disregarding the forum-selection clause.
Third, the plaintiff had tried to argue that the forum-selection clause was invalid under Section115 of the Delaware General Corporation Law. The plaintiff had argued that because the company’s forum selection clause eliminates federal jurisdiction over her derivative Section 14(a) claim, it is not consistent with Section 115’s applicable jurisdictional requirements and therefore runs against the statute. The en banc majority disagreed, concluding that Section 115 does not apply to Section 14(a) claims because, according to the Delaware Supreme Court, federal claims are not “internal corporate claims,” and therefore that Section 115 does not prohibit forum-selection clauses that require federal claims to be brought in Delaware state court.
The en banc majority noted that its conclusions would create a split between the Ninth Circuit and the Seventh Circuit on the issue of the enforceability of the forum selection clause. The en banc majority described the Seventh Circuit’s reasoning in the Seafarers case as “flawed” and inconsistent with Delaware and federal precedent.
Four panel judges joined a dissent written by Judge Sidney R. Thomas, in which the five dissenting judges stated that because “state courts lack jurisdiction to hear Exchange Act claims … the bylaw provision is a litigation bridge to nowhere, depriving shareholders of any forum in which to pursue derivative claims.”
Readers will recall that, in order to try to address the curse of multi-forum litigation, often filed in connection with M&A transactions, many companies began adopting bylaws designating a specified forum (typically Delaware state court) for the litigation of derivative claims. In June 2013, in a decision by then-Delaware Chancellor Leo E. Strine, Jr., the Delaware Chancery Court held that forum selection provisions adopted by Chevron and Fed Ex, were statutorily and contractually valid, as discussed here. Since that time, many companies have adopted similar provisions (as well as separate provisions designating a federal forum for liability actions under the Securities Act of 1933). What made the this case interesting is that it involves the application of a state court forum selection provision to a specific type of derivative claim for which only federal courts have jurisdiction.
The most noteworthy aspect of the Ninth Circuit’s ruling is that it upholds the enforceability of the forum selection clause even though the practical impact of the ruling is that the plaintiff is deprived of any forum for her Section 14(a) derivative claims. The appellate court’s ruling that the provision is enforceable notwithstanding the fact that it deprives the plaintiff of a forum for her derivative Section 14(a) claims is directly contrary to Seventh Circuit’s ruling interpreting a similar forum provision. The Seventh Circuit expressly held that the provision violated the anti-waiver provision in the Securities Act and violated strong federal public policy.
The immediate likelihood is that this issue will continue to percolate in the federal circuit courts. There is now, as the Cooley law firm noted in its June 8, 2023, memo discussing the Ninth Circuit’s en banc ruling (here), “considerable uncertainty as to whether forum-selection clauses will be upheld in other jurisdictions.” The ruling also “tees up an important question that appears ripe for review by the U.S. Supreme Court.”
As Alison Frankel discussed in her interesting and detailed June 2, 2023, post on her On the Case blog (here), a U.S. Supreme court consideration of these issues could provide an opportunity for Court review of a larger question, which is whether or not Section 14(a) claims may in fact be brought derivatively at all, or if they must be and can only be brought directly. Frankel quotes Stanford Law School Professor Joseph Grundfest as saying that there “is no such thing” as a federal derivative action under Section 14(a). Frankel also quotes another source as saying that the Supreme Court’s consideration of these issues may be “inevitable.”