Last week, in Lee v. Fisher [1], the Ninth Circuit en banc issued a consequential decision calling into question the scope of the implied right of action recognized by J.I. Case Co. v. Borak [2] and creating a stark split with the Seventh Circuit. Prof. Ann Lipton has blogged extensively about the case. Readers of this blog will recall that Prof. Bainbridge has also discussed Lee, commending the amici brief submitted by Joe Grundfest and I for its “audacity,” but expressing some skepticism the Ninth Circuit would agree with us.
Ultimately, the Ninth Circuit did agree with us, and Prof. Bainbridge kindly invited me to provide this update.
The Rise of Derivative Borak Suits
In 1964, the Supreme Court in Borak held that, under Section 14(a) of the Exchange Act, shareholders enjoy an implied private right of action to bring claims for false or misleading proxy statements. Importantly, Borak explained that a shareholder lawsuit under Section 14(a) may be brought as either a direct action, on behalf of individual shareholders, or a derivative action, on behalf of the corporation. As the Borak Court stridently asserted,
The injury which a stockholder suffers from corporate action pursuant to a deceptive proxy solicitation ordinarily flows from the damage done to the corporation, rather than from the damage inflicted directly upon the stockholder. The damage suffered results not from the deceit practiced on him alone but rather from the deceit practiced on the stockholders as a group. To hold that derivative actions are not within the sweep of the section would therefore be tantamount to a denial of private relief. [3]
As Grundfest and I have explained, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiff’s bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation, to oversight of regulatory compliance, to corporate policies concerning diversity, equity and inclusion. Stated differently, these derivative suits concern internal corporate affairs—matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Chancery. But rather than bringing a state law claim for breach of fiduciary duty in Delaware courts, these federal derivative suits make the more tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits transparently aim to establish federal court jurisdiction and, thereby, avoid the likely fate that such suits would face before a skeptical Delaware judge.
Lee v. Fisher
The suit in Lee exemplified this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of The Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership ranks. As a derivative suit, the Lee plaintiff alleged that The Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed The Gap by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation packages.
The Gap sought to dismiss the derivative suit by invoking a forum provision in its corporate bylaws that required all derivative suits to be litigated in the Delaware Chancery Court. Because federal courts have sole jurisdiction to hear Exchange Act lawsuits, directing all derivative claims to the Delaware Chancery would effectively preclude the plaintiff’s derivative Borak suit. Nevertheless, the Ninth Circuit en banc ruled that the forum bylaw is enforceable against the plaintiff, both as a matter of Delaware law and federal law, and dismissed the plaintiff’s federal derivative lawsuit.
Practical Implications
Lee has immediate practical implications. In the Ninth Circuit, corporations may now use a forum bylaw to force all derivative claims into the Delaware Chancery and, thus, eliminate federal derivative Borak suits altogether. Shareholders remain free to bring (i) the same Borak claim as a direct or class action to recover any damage they suffered personally and (ii) a derivative action under state corporate law to recover any damage suffered by the corporation. But duplicative federal derivative suits brought under Borak can be quashed by a corporate forum provision that requires all derivative suits to be filed in Delaware. As Alison Frankel observes, “If [Lee] is right, a whole category of shareholder suits can be erased.”
Doctrinal Implications
Beyond the immediate practical implications, Lee has doctrinal significance. Citing our forthcoming Business Lawyer article, Lee ruled that Borak’s recognition of an implied derivative right under Section 14(a) is dicta and not binding precedent. [4] In doing so, Lee wholeheartedly embraces our article’s argument that, under the Supreme Court’s post-Borak precedents, the implied right of action under Section 14(a) is limited to direct claims only.
As we explain in the article, ever since Borak was decided, the Court has repeatedly criticized the 1964 precedent [5] and told us that it must be narrowly interpreted. [6] Moreover, the Court has said, and reiterated, that state law—not federal common law—defines what a derivative action is. [7]
Looking to state law, Delaware is unambiguous. “[W]here it is claimed that a duty of disclosure violation impaired the stockholders' right to cast an informed vote, that claim is direct.” [8] The claim is direct, not derivative, because “where a shareholder has been denied one of the most critical rights he or she possesses—the right to a fully informed vote—the harm suffered is almost always an individual, not corporate, harm.” [9]
Any lower court that spends time examining the Court’s post-Borak precedents would conclude that Borak’s implied derivative right of action is nonbinding dicta, as the Ninth Circuit has now done, and that private Borak suits are limited to direct claims only. Even in the absence of a corporate forum bylaw directing all derivative suits to Delaware, there is no cognizable federal derivative cause of action under Section 14(a) to begin with.
The Circuit Split
Significantly, the Ninth Circuit’s decision in Lee squarely conflicts with an earlier Seventh Circuit ruling in Seafarers v. Bradway. [10] In Seafarers, a bare majority of a three-judge panel ruled, over the dissent of Judge Easterbrook, that a corporate forum bylaw, identical to the one at issue in Lee, is unenforceable against a derivative Borak suit, both as a matter of Delaware law and under the Exchange Act’s anti-waiver provision.
The Ninth Circuit en banc in Lee concluded that Seafarers was wrong as to both Delaware and federal law. On the former, as we explain in our paper, Seafarers was clearly wrong, a belief that is supported by a venerable cadre of former Delaware Chief Justices, Justices, Chancellors, and Vice Chancellors who submitted a separate letter to the Ninth Circuit. The Delaware Supreme Courts’ landmark 2020 decision in Salzberg v. Sciabaccuchi [11] plainly establishes that a corporate forum provision may regulate shareholder rights arising under federal securities law.
Borak is in Jeopardy
Given the stark split now opened between Seafarers and Lee, and the fact that both decisions generated pointed dissents, it seems likely that the Supreme Court will be revisiting Borak at some point. Even if the plaintiffs in Lee don’t seek cert, perhaps because they fear the Supreme Court precedent that might result, we now have a consequential circuit split on the meaning of Borak. This issue is certain to come up in other circuits.
In 2019, when the Supreme Court took cert in Emulex v. Varjabedian, involving the implied right of action under Exchange Act Section 14(e), much of the Court’s attention was focused on Borak and what it meant for implied rights of action under Section 14. During oral arguments, the Chief Justice remarked that “we now know that [Borak] was not the right approach,” that “Borak would not be decided the same way today,” and that, “from today’s perspective, what we did back then [in Borak] was a mistake.” Ultimately, the Court dismissed cert in Emulex as improvidently granted because that case dealt with Section 14(e), rather than Section 14(a). But it was clear at that time that the Court was really interested in revisiting Borak. Lee, or another case like it, squarely presents the Court with that opportunity. At that point, the whole entirety of Borak may be in jeopardy.
