ARTICLE
7 November 2023

Reexamining The Enforceability Of Forum-Selection Provisions

KL
Kramer Levin Naftalis & Frankel LLP

Contributor

Kramer Levin provides its clients proactive, creative and pragmatic solutions that address today’s most challenging legal issues. The firm is headquartered in New York with offices in Silicon Valley and Paris and fosters a strong culture of involvement in public and community service. For more information, visit www.kramerlevin.com
Forum-selection provisions have become an increasingly common tool for managing corporate litigation risks.
United States Corporate/Commercial Law
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Forum-selection provisions have become an increasingly common tool for managing corporate litigation risks. By including these provisions in their charters or bylaws, corporations can designate an exclusive forum — most frequently, Delaware courts — for resolving certain shareholder lawsuits brought against them and their directors, officers or other employees. The rationales for doing so include minimizing the costs of multistate litigation and gaining the predictability and benefit of an experienced business-oriented judiciary.

The Delaware Court of Chancery has made clear that such forum-selection provisions are facially valid when they regulate the "internal affairs" of the corporation. Then-Chancellor Strine explained this doctrine in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), a seminal decision that distinguished lawsuits relating to "the business of the corporation," "the conduct of its affairs" and "the rights or powers of its stockholders" from those relating to "wholly external matters." The ruling was affirmed by the Delaware Supreme Court and then codified into law shortly after, with Delaware General Corporation Law (DGCL) Section 115 providing that "[t]he certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in [Delaware] ... ."

Courts around the country have by and large enforced such forum-selection provisions, requiring stockholders to litigate their claims in Delaware. That is unsurprising given that the opposing party ordinarily bears a heavy burden of proof. However, at least two recent decisions have raised questions regarding the universal enforceability of these provisions.

Last year, the U.S. Court of Appeals for the Seventh Circuit in a split decision held that a bylaw designating the Delaware Court of Chancery as "the sole and exclusive forum" for derivative suits was unenforceable with respect to a claim filed under Section 14(a) of the Securities Exchange Act of 1934 (as discussed here).1 The majority explained that federal courts have exclusive jurisdiction over such claims pursuant to Section 27(a), which is subject to the statute's anti-waiver provision. Enforcing the bylaw would therefore mean that the action could not proceed in its only proper forum.2

Meanwhile, an en banc panel of the Ninth Circuit reached the opposite conclusion as to a virtually identical forum-selection provision, creating a circuit split (as discussed here).3 The majority pointed out that while the Delaware Court of Chancery would have to dismiss the derivative action for lack of jurisdiction, the plaintiff could still bring these claims directly in federal court. Thus, there existed some procedure for enforcing the company's compliance with its statutory obligations, even if not the particular procedure favored by the plaintiff. The majority also determined that the plaintiff had failed to meet her "heavy burden" of showing that enforcement of the forum-selection provision would violate a strong public policy.4

More recently, a California appellate court declined to enforce a forum-selection clause providing for exclusive jurisdiction in the Delaware Court of Chancery on markedly different grounds, namely because it "threatene[d] to operate as an implied waiver" of the plaintiff's constitutional right to a jury trial in violation of that state's public policy.5 As the court pointed out, the Delaware Court of Chancery sits as a court of equity, and so a jury trial in that venue would be "advisory only."6 The impact of this decision going forward, however, may be limited. 7

For one, the plaintiff had asserted various claims, including fraudulent concealment, promissory fraud, breach of contract, breach of fiduciary duty and violations of California's Unfair Competition Law, only the first three of which allegedly carried the right to a jury trial. But the court did not separate out the remaining claims for purposes of its enforceability analysis, considering them all together. Breach of fiduciary duty claims — which in many instances would not carry a jury right in California — would seem the more frequently asserted claims relating to the "internal affairs" of the corporation.8 The motion, as litigated, considered the claims direct rather than derivative.9 Derivative claims also do not give rise to a jury trial right in California.10 From a precedential standpoint, there is no horizontal stare decisis in the California Court of Appeal, so the decision is not binding on another division or district.11

Despite these recent decisions, the modern trend of adopting forum-selection provisions will likely persist. The Delaware Court of Chancery, in particular, has emerged as a leading choice of venue given its well-developed body of case law and expertise in resolving corporate law disputes. Still, corporations should be aware that plaintiffs may continue to challenge the enforceability of these provisions.

Footnotes

1. See Seafarers Pension Plan v. Bradway, 23 F.4th 714 (7th Cir. 2022).

2. Judge Easterbrook's dissenting opinion described what the majority called a "novel proposal to send [the] dispute to state court in Delaware." He determined that the forum-selection provision did not preclude a shareholder from ever bringing a Section 14(a) claim against the corporation because it applied only to derivative actions, not direct ones. He also disagreed that federal courts hold exclusive jurisdiction over such derivative claims at all stages of litigation. He noted, for example, that it is state law that "determines both when a demand is required and when investors can step into a corporation's shoes." Finally, Easterbrook interpreted DGCL Section 115 as prohibiting only those bylaws that "prevent litigation in state court."

3. See Lee v. Fisher, 70 F.4th 1129 (9th Cir. 2023).

4. In particular, the Supreme Court's decision in J.I. Case Co. v. Borak, 377 U.S. 426 (1964), implying a private right of action to redress injuries caused by allegedly false and misleading proxy statements, did not establish a strong public policy in favor of allowing shareholders to bring derivative claims. The majority noted that there had been a jurisprudential shift since Borak was decided. This therefore raises questions regarding the continued viability of a private right of action for derivative claims arising under Section 14(a).

5. See EpicentRx, Inc. v. Superior Ct. of San Diego Cnty., 95 Cal. App. 5th 890 (2023), as modified on denial of reh'g (Oct. 10, 2023).

6. Notably, the court determined that because the right to a jury trial was unwaivable under state law, the burden shifted to the defendants having to prove that enforcing the provision would not substantially diminish that right, which they had failed to do.

7. This is not the first time that a California state court has declined to enforce a forum-selection clause on these grounds. See, e.g., West v. Access Control Related Enters., LLC, Case No. BC642062 (Cal. Super. Ct. July 29, 2020).

8. But see ZF Micro Sols., Inc. v. TAT Cap. Partners, Ltd., 82 Cal. App. 5th 992, 1001-02 (2022).

9. In their petition for rehearing, the defendants asserted the claims were derivative, but the court declined to consider their new argument.

10. See Caira v. Offner, 126 Cal. App. 4th 12, 39 (2005).

11. See Sarti v. Salt Creek Ltd., 167 Cal. App. 4th 1187, 1193-94 (2008), as modified on denial of reh'g (Nov. 26, 2008).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

ARTICLE
7 November 2023

Reexamining The Enforceability Of Forum-Selection Provisions

United States Corporate/Commercial Law

Contributor

Kramer Levin provides its clients proactive, creative and pragmatic solutions that address today’s most challenging legal issues. The firm is headquartered in New York with offices in Silicon Valley and Paris and fosters a strong culture of involvement in public and community service. For more information, visit www.kramerlevin.com
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