The Saga Continues: Part II

On June 1, 2023, the majority of an en banc panel of the Ninth Circuit found that Gap Inc.’s forum selection clause does not violate the anti-waiver provision of the Securities Exchange Act of 1934 (the “Exchange Act”) or Delaware law, entrenching its split with the Seventh Circuit’s circuit ruling on the same questions and ensuring that the enforcement of forum selection clauses across jurisdictions will remain unsettled for the foreseeable future.

The appellant, Noelle Lee, filed a derivative suit in federal court against Gap in September 2020, alleging that Gap failed to meet its publicly stated goal of creating greater racial and ethnic diversity in the company’s board and executive management.  The Northern District of California dismissed the suit, finding that Gap’s bylaws contain a forum selection clause requiring derivative claims to be filed in the Delaware Court of Chancery.

On appeal, Lee argued that enforcing Gap’s forum selection clause would usurp federal jurisdiction over Exchange Act claims and violate the Supremacy Clause.  Lee further argued that the Delaware Court of Chancery could not grant relief for the type of claim raised, allowing corporations to avoid liability by using such forum selection clauses to their advantage.  The Ninth Circuit upheld the district court’s decision on May 13, 2022.

The Ninth Circuit’s holding created a circuit split with the Seventh Circuit’s ruling in Seafarers Pension Plan v. Bradway, 23 F.4th 714 (7th Cir. 2022), where that court held that Boeing’s same forum selection clause violated the Exchange Act’s anti-waiver provision and DGCL Section 115.

In light of the circuit split, the Ninth Circuit granted the request for an en banc rehearing and argument was held in December of 2022.

A focus of argument on rehearing (and a concern noted in public commentary) was whether enforcement of the forum selection clause would enable companies to escape federal enforcement of the Exchange Act. The court rejected that notion, holding that because shareholders like Lee can enforce compliance with the Exchange Act through a direct action brought in federal court, the forum selection clause does not infringe on the federal jurisdiction granted under the act.  In so holding, the court noted that Lee’s alleged injury was not dependent on harm to the corporation, thus opening a door for direct action under Section 14(a).

Next, the Ninth Circuit found that Gap’s forum selection clause does not contravene public policy under M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972).  Lee’s argument relied heavily on J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964), claiming that Borak established a private right of action for a shareholder to bring a federal cause of action for redress of injury caused by a proxy statement.  The Ninth Circuit found Borak to be less persuasive, stating that Borak held a shareholder could bring a direct action under Section 14(a).  But the court concluded that the Borak ruling inappropriately extended its reasoning to derivative suits, stating that “[e]ven at the time Borak was decided, [the Court’s reasoning] did not square with the Supreme Court’s jurisprudence regarding derivative actions.  Nor did Borak attempt to harmonize its statements on derivative actions with the Court’s precedent.”  The Ninth Circuit concluded that Borak failed to consider the role of state law in governing the scope of corporate conduct and that the Supreme Court had shifted away from implying private rights of action.  Noting jurisprudential evolution since Borak, the Ninth Circuit found that Gap’s forum selection clause does not meet the extraordinary circumstance of violating a strong public policy in favor of federal jurisdiction for derivative actions.

Last, the Ninth Circuit concluded that Gap’s forum selection clause is not contrary to Delaware law and, in so holding, affirmed its split with the Seventh Circuit in Seafarers.  DGCL Section 115 states that bylaws “may require…that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts of this State.”  8 Del. C. § 115.  The court found Lee (and thus the Seventh Circuit) misinterpreted Delaware law in arguing that Section 115 precludes a forum selection clause from requiring a federal claim (such as one under Section 14(a)) to be brought in state court where that court would have to dismiss the claim for lack of jurisdiction.  To the contrary, the Ninth Circuit held that Section 115 is silent, and thus inapplicable, to forum selection clauses addressing federal claims.  Section 115 speaks only on “internal corporate claims,” which the Ninth Circuit found to mean claims arising under the DGCL.  Acknowledging its divergence from the Seventh Circuit’s analysis in Seafarers, the court opined that Seafarers failed to consider and apply the reasoning of Salzberg v. Sciabacucchi, 227 A.3d 102, 117 (Del. 2020), and failed to recognize the availability to shareholders of a direct action under Section 14(a).

With the circuit split on both the impact under Delaware law of Section 115 following Salzberg, and the availability of Section 14(a) as a sufficient means for shareholders to directly enforce the Exchange Act in a federal forum, the forum selection saga is now certain to continue for the foreseeable future.  Stay tuned…

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.