Collision Course: The Consequences of Conflicting Forum-Selection Provisions

On January 6, 2023, Vice Chancellor Laster issued an opinion in Fairstead Capital Management LLC v. Blodgett concerning a “dispute-resolution collision” between two applicable forum-selection clauses. The collision arises from the termination of a principal of an investment fund, whose partners fired him for allegedly breaching his employment agreement and also cancelled his member interests in two LLCs that owned rights to the profits generated by the fund. Unhappy with his ouster, the former principal wanted to litigate against his former partners and the LLCs. But that raised the question at the core of this Vice Chancellor Laster’s opinion: where to litigate?

Pursuant to the arbitration clause in his employment agreement, the former principal commenced an arbitration action against the other partners of the fund and the LLCs. But the partners did not want to arbitrate, and the LLC agreements required that litigation arising from those agreements be filed in state or federal courts in Delaware. The partners therefore sued the former principal in Delaware court for breach of the LLC agreements. Each side asked the Delaware court to issue a permanent injunction requiring the overall dispute to be resolved in its preferred forum and to grant summary judgment on the forum-selection issue.

The court’s decision illustrates the complexities involved in these “dispute-resolution collisions” — and the inefficiencies that can result. The court first noted that though an arbitration provision ordinarily would be a “clean winner” for the former principal, its analysis was complicated by the involvement of the LLCs, who were not parties to the employment agreement. The court determined that the LLCs had accepted a direct benefit under the arbitration agreement: the services the former principal provided to them through his employment. Therefore, under equitable principles, the LLCs were bound by that agreement.

The court’s analysis did not stop there. The next wrinkle arose from the application of the LLC agreements and their competing forum-selection clauses. In light of the conflict between those provisions and the employment agreement, the gating decision of whether the dispute is arbitrable was not clearly delegated to the arbitrator and, thus, fell to the court to decide.

The court came to the reluctant conclusion that the appropriate forum was a “mixed bag,” depending on the issue underlying each claim. The key to the analysis was a provision of the LLC agreements stating that they superseded any prior contracts or agreements as to any issues covered by the LLC agreements. As a result, any issues encompassed by the LLC agreements, including claims about the bases for cancelling the former principal’s member interests (to the extent unrelated to the employment agreement), must be decided by Delaware courts, per the LLC agreements’ forum-selection provisions. However, any issues that fall within the scope of the employment arbitration agreement, including whether the principal violated that agreement at all, must be arbitrated.

As the court bemoaned, this analysis “means that litigation will proceed inefficiently in at least two fora” — unless, of course, the parties could reach a new agreement to arbitrate the full dispute. (The court recognized that the parties’ differing views on the desirability of arbitration makes such an agreement unlikely.) In addition, even if the parties could agree to arbitrate the full dispute, any after-the-fact agreement would not wash away the costs and inefficiencies already generated by the collision of the relevant forum-selection terms.

Forum-selection clauses are common in commercial contracts, and there are sound reasons why different types of agreements might prefer different fora. A limited liability company, for example, might prefer to resolve disputes over its operating agreement in the courts of the state where it is chartered, while an employer might favor the privacy of arbitration for employment disputes. Whatever the preferred forum, Vice Chancellor Laster’s opinion illustrates why drafters of agreements should be cognizant of other potentially intersecting contracts and should draft forum-selection clauses with an eye toward avoiding potentially costly and inefficient “collisions” between arbitration and the courts.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.