Lee v. Fisher is now pending before the Ninth Circuit Court of Appeals en banc. The case involves a derivative suit by a shareholder challenging The Gap. Inc.'s board of directors alleged lack of diversity. In addition to the state law claims, plaintiff alleged that the company had made false and misleading statements in its proxy soliciting materials in violation of Securities Exchange Act Section 14(a). The plaintiff asserted that the proxy claims could be brought derivatively.
The defendants filed a motion to dismiss alleging, among other things, that the forum selection clause in the Company's Bylaws designates the Delaware Court of Chancery as the exclusive forum for Plaintiff's claims. Gap's forum selection clause provides:
“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 any director, officer, employee or agent of the Corporation to the Corporation or the Corporation's stockholders, (iii) any action or proceeding asserting a claim against the Corporation arising pursuant to any provision of the Delaware General Corporation Law or the Corporation's Certificate of Incorporation or these Bylaws, or (iv) any action or proceeding asserting a claim against the Corporation governed by the internal affairs doctrine, in each case subject to said Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein.
Courts have routinely upheld forum selection clauses with respect to state law claims. Whether a forum selection clause may be validly applied to federal law claims, however, has been more controversial. In Butorin on behalf of KBR Inc. v. Blount, 106 F. Supp. 3d 833 (S.D. Tex. 2015), the court faced a slightly different forum selection clause:
Unless the Corporation consents in writing to selection of an alternative forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation, (ii) any action asserting a claim of breach of fiduciary duty owed by any director or officer or other employee of the Corporation to the Corporation or the Corporation's stockholders, ... shall be a state court located within the State of Delaware (or, if no state court located within the State of Delaware has jurisdiction, the federal district court for the District of Delaware.)
In Butorin, as in Lee, the claims included a derivative claim allegedly arising under 14(a). Setting aside the unique issues raised by the timing of the clause's adoption, the relevant part of the Texas court decision held that "the Forum Selection Bylaw is valid and enforceable and sua sponte TRANSFERS this case to the United States District Court in the District of Delaware."
The critical question in Lee is whether a forum selection clause can be enforced with respect to federal questions if the clause does not provide the option of bringing such claims in the District of Delaware.
In Fisher, plaintiff contended that Ninth Circuit law provides that:
An “exceptional reason” or “extraordinary circumstances” for not giving controlling weight to a forum-selection clause exists if the plaintiff made a strong showing that:
(1) the clause is invalid due to “fraud or overreaching,” (2) “enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision,” or (3) “trial in the contractual forum will be so gravely difficult and inconvenient that [the litigant] will for all practical purposes be deprived of his day in court.”
Lee v. Fisher, 20-CV-06163-SK, 2021 WL 1659842, at *3 (N.D. Cal. Apr. 27, 2021). On the facts before the court, only the second prong was seriously in play.
The California district court further explained that:
It is undisputed that the Exchange Act contains an anti-waiver provision and that federal courts have exclusive jurisdiction over Exchange Act claims. The Exchange Act voids “[a]ny condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title.” 15 U.S.C. § 78cc(a) (the “anti-waiver provision”). Therefore, if the Court were to enforce the forum-selection clause, Plaintiff would not be able to bring her claim under Section 14(a) of the Exchange Act. The issue is whether Plaintiff's lost opportunity to bring a Section 14(a) claim violates the strong public policy of the forum in which she filed this lawsuit.
The court concluded that the second prong could not be satisfied on its facts:
The Ninth Circuit has made clear that the strong federal policy in favor of enforcing forum-selection clauses supersedes the anti-waiver provisions in state and federal statutes, regardless whether the forum selection “clause points to a state court, a foreign court, or another federal court.” Yei A. Sun, 901 F.3d at 1090. Because the anti-waiver provision standing alone does not supersede the forum-selection clause, “in order to prove that enforcement of such a clause would contravene a strong public policy of the forum in which suit is brought, ... [P]laintiff must point to a statute or judicial decision that clearly states such a strong public policy.” Id. (quotation marks and citation omitted). Plaintiff fails to do so.
Plaintiff does not point to any statute or judicial decision that clearly states that enforcing the forum selection clause would contravene a strong public policy. Instead, Plaintiff first argues that enforcement of the cause would contravene the federal courts' exclusive jurisdiction over Exchange Act claims and that it would violate the Supremacy Clause of the U.S. Constitution. There is no dispute that federal courts have exclusive jurisdiction over the Section 14(a) claim under the Exchange Act. However, enforcement of the forum selection clause does not violate exclusive jurisdiction; enforcement of the forum selection clause means that Plaintiff cannot assert her Section 14(a) claim. Preventing a party from asserting a federal claim does not violate principles of exclusive federal jurisdiction. It is difficult to understand Plaintiff's argument that the federal courts' exclusive jurisdiction over Exchange Act claims supplies an independent basis, let alone the required strong public policy, to preclude enforcement of the forum selection clause.
Accordingly, the court concluded:
The Court finds that Plaintiff fails to demonstrate that enforcing the forum selection clause would contravene a strong public policy of this forum. Therefore, the Court GRANTS Defendants' motion, enforces the forum selection clause and DISMISSES this action without prejudice to Plaintiff filing claims against Defendants in the Delaware Court of Chancery.
On appeal, the Ninth Circuit initially affirmed. Lee v. Fisher, 34 F.4th 777 (9th Cir. 2022). Subsequently, however, the court ordered that the case be reheard en banc. Presumably, the court did so because the initial panel decision created a circuit split with the Seventh Circuit. In Seafarers Pension Plan ex rel. Boeing Co. v. Bradway, 23 F.4th 714 (7th Cir. 2022). In Seafarers, a divided panel held that an identical Boeing forum-selection clause was unenforceable because it was “contrary to Delaware corporation law and federal securities law.” Id. at 718.
In Seafarers, the dissenting judge was Frank Easterbrook who was a famous law and economics scholar at Chicago before going on the bench. Critically, Judge Easterbrook opined that "plaintiff retains its right to sue directly under § 14(a) in federal court." Id. at 729.
Why is that critical? I quote from my book Corporate Law (Concepts and Insights):
No matter how closely one scrutinizes Securities Exchange Act § 14(a), one will not find anything relating to a private party cause of action under the statute or rules. In J. I. Case Co. v. Borak,[1] however, the Supreme Court implied a private right of action from the statute. Case proposed to merge with American Tractor Co. Borak owned around 2000 shares of Case stock and sought to enjoin the merger on the grounds, inter alia, that the company’s proxy materials were false and misleading. Borak claimed that the merger was approved by a small margin and would not have been approved but for the false and misleading statements. Case argued that Borak had no standing to sue, as the federal proxy rules provided no private party cause of action.
Despite the lack of any statutory authorization for a private party cause of action, Justice Clark’s opinion for the Court found that such an action in fact existed. To be sure, Justice Clark purported to find a statutory basis for the cause of action in Exchange Act § 27. Noting that § 27 gives district courts jurisdiction over “all suits in equity and actions at law brought to enforce any liability or duty” under the Act, Justice Clark contended that “[t] he power to enforce implies the power to make effective the right of recovery afforded by the Act. And the power to make the right of recovery effective implies the power to utilize any of the procedures or actions normally available to the litigant. . . .” The trouble with that argument is that Section 27 speaks of liabilities imposed by the Act, but nothing in § 14(a) or the rules thereunder creates such liabilities vis-à-vis shareholders.
Borak is better understood as an exercise of judicial fiat. A private right of action exists not because Congress intended it, but because a majority of the Supreme Court said so. The general legitimacy of implied private rights of action is beyond our purview, however.[2] Instead, we are concerned solely with Justice Clark’s policy justification for this particular cause of action.
Justice Clark was quite above-board as to his motivation—he wanted to deter fraud and other proxy violations. According to Justice Clark, private enforcement provides “a necessary supplement” to SEC efforts. He implied that shareholders are in a better position than the SEC to detect proxy violations—they have fewer proxy statements to review and presumably are better informed about the company. Again, however, the argument is spurious. Most shareholders do not carefully review proxy materials. Instead, they are rationally apathetic. They lack both the desire and the incentive to closely monitor the firm. Justice Clark doubtless knew that individual shareholders were unlikely to emerge as champions of corporate truth and justice. Instead, it seems probable that he was trying to provide incentives for the plaintiffs’ bar to become more active in proxy litigation.
This inference is supported by Clark’s characterization of the implied private right of action as being both direct and derivative in nature. Strikingly, he did so over Borak’s strong argument that the suit was only direct in nature. At the time Borak was decided, the modern federal class action procedure had not yet been adopted. If proxy actions were allowed to proceed only directly, and plaintiffs’ lawyers were limited to representing individual shareholders, the contingent fees generated by proxy litigation would be insufficient to attract quality lawyers. (The situation would be even worse in cases like Borak, where plaintiff sought only equitable relief.) Because the implied cause of action had a derivative element, however, a plaintiffs’ lawyer could effectively sue on behalf of all shareholders, by nominally suing in the corporation’s name, generating larger damage claims and bigger contingent fees
Today, as Easterbrook pointed out, a plaintiff thus has the option of bringing a direct suit as a class action. But Borak's holding that suit could be brought either directly or derivatively remains on the books.
Or does it? Law professors Joseph Grundfest and Mohsen Manesh have filed an amicus brief in the Lee case. Although they argue that the forum selection clause is valid, they preface that part of their brief with a much more aggressive argument that there is no implied private right of action to sue derivatively under Section 14(a):
As a foundational matter, there is no private right of action to bring a derivative claim under Section 14(a). The derivative Section 14(a) claim is implied, not express. It is a creature of the judicial imagination rooted in Borak’s dicta, not in any Supreme Court holdings. This implied claim’s remedies duplicate state law, and the claim’s very existence, as well as its essential metes and bounds, is contingent on state not federal law.
The Supreme Court commands that implied private rights be narrowly construed. Enforcing an implied private right based on dicta that generate redundant remedies in a cause of action that is existentially contingent on state law, not on federal law, is not narrow construction. It is sprawling overreach.
Implied private rights of action exist in many areas of federal law. The Warren era Supreme Court was a big fan of so-called private attorneys general; i.e., the idea that private party litigation was an essential supplement to public enforcement of federal law. Federal prosecutors and regulators have limited resources and private party litigation thus can help ensure enforcement of federal laws that might otherwise fall through the cracks due to lack of government resources.
Borak was an early example of the court creating an implied private right of action and, accordingly, set out at some length the analytical framework for doing so.
The Rehnquist court subsequently abandoned the Borak approach:
Respondents would have us revert in this case to the understanding of private causes of action that held sway 40 years ago when Title VI was enacted. That understanding is captured by the Court's statement in J.I. Case Co. v. Borak, 377 U.S. 426, 433, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964), that “it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose” expressed by a statute. We abandoned that understanding in Cort v. Ash, 422 U.S. 66, 78, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975)—which itself interpreted a statute enacted under the ancien regime—and have not returned to it since. Not even when interpreting the same Securities Exchange Act of 1934 that was at issue in Borak have we applied Borak's method for discerning and defining causes of action. ... Having sworn off the habit of venturing beyond Congress's intent, we will not accept respondents' invitation to have one last drink.
Alexander v. Sandoval, 532 U.S. 275, 287 (2001).
I tell me students that the Supreme Court is thus out of the business of creating new implied private rights of action, but that ones that had been approved by a majority of the court in the past have been grandfathered into the law and are thus rarely if ever overturned. Ironically, I premise that conclusion on an article by Professor Grundfest. See Joseph A. Grundfest, Disimplying Private Rights of Action Under the Federal Securities Laws: The Commission's Authority, 107 Harv. L. Rev. 963, 992-94 (1994) (describing implied private right of action under section 10(b) and Rule 10b-5 as having been “grandfathered” by the Court).
Interestingly, Grundfest and Manesh's brief does not cite that article. Indeed, the brief makes no reference to well-established private rights of action being grandfathered. In contrast, courts seem to accept that the Borak derivative claim is well-established:
"It is now well established that a private party may bring suit for a violation of Section 14(a), ... and that a shareholder may bring s derivative suit on behalf of the corporation for a violation of Section 14(a)." Dillon v. Berg, 326 F. Supp. 1214, 1218 (D. Del. 1971), aff'd, 453 F.2d 876 (3d Cir. 1971). See also In re Trump Hotels Shareholder Derivative Litig., 96 CIV. 7820 DAB, 2000 WL 1371317, at *10 (S.D.N.Y. Sept. 21, 2000) ("It is well settled law that a Section 14(a) claim may be brought directly or derivatively.").
Indeed, it has been argued that the Supreme Court itself has "clarified that Borak has been grandfathered." William C. Tyson, The Proper Relationship Between Federal and State Law in the Regulation of Tender Offers, 66 Notre Dame L. Rev. 241, 358 n.186 (1990). I am not sure I would go quite that far. Professor Tyson relies on Touche Ross & Co. v. Redington, 442 U.S. 560, 577 (1979), which stated: "We do not now question the actual holding of that case, but we decline to read the opinion so broadly that virtually every provision of the securities Acts gives rise to an implied private cause of action." Not exactly a ringing endorsement.
In any case, Grundfest and Manesh argue that "Borak’s logic is overtly purposive and implements an interpretive approach that has been resoundingly repudiated by the Supreme Court." They then contend that Borak's statements regarding derivative standing were dicta.
I'm generally opposed to implied private rights of action, so I tried to review their argument sympathetically. But I don't buy it.
In Burks, for example, the Supreme Court stated (albeit arguably in dicta):
A fundamental issue in this case is which law—state or federal—governs the power of the corporation's disinterested directors to terminate this derivative suit. The first step in making that determination is to ascertain which law creates the cause of action alleged by the plaintiffs. Neither the ICA nor the IAA—the plaintiff's two federal claims—expressly creates a private cause of action for violation of the sections relevant here. However, on the basis of District and Circuit precedent, the courts below assumed that an implied private right of action existed under each Act. ... The two courts also sanctioned the bringing of the suit in derivative form, apparently assuming that, as we held in J. I. Case Co. v. Borak, 377 U.S. 426, 432, 84 S.Ct. 1555, 1560, 12 L.Ed.2d 423 (1964), “[t]o hold that derivative actions are not within the sweep of the [right] would . . . be tantamount to a denial of private relief.”
Burks v. Lasker, 441 U.S. 471, 475 (1979) (emphasis supplied). See also Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 66 (1977) (Stevens, J., dissenting) ("In Borak, the Court held that a derivative suit on behalf of the corporation could be brought under [section] 14(a), although it seems clear that the primary beneficiaries of that section were individual stockholders rather than corporations.").
I the suspect that the Ninth Circuit will not agree with Grundfest and Manesh, although I commend their audacity. Anyway, go read the brief. I have just sort of skimmed over their detailed and clever analysis.
[2] See Reschini v. First Fed. Sav. & Loan Ass’n of Ind., 46 F.3d 246, 255 (3d Cir.1995) (Borak “is still good law as a construction of the 1934 Act and Rule 14a–9. However, it is not clear that Borak, if it arose for the first time today, would be decided the same way.”).
