US District Court's Enforcement of Delaware Forum Selection By-Law Precludes Section 14(a) Claim | Practical Law

US District Court's Enforcement of Delaware Forum Selection By-Law Precludes Section 14(a) Claim | Practical Law

The US District Court for the Northern District of California (NDCA) enforced The Gap, Inc.'s forum selection by-law designating the Delaware Court of Chancery as the exclusive forum for all derivative claims, including as to a claim under Section 14(a) of the Exchange Act. The Court's decision effectively precludes the plaintiff from bringing a Section 14(a) claim.

US District Court's Enforcement of Delaware Forum Selection By-Law Precludes Section 14(a) Claim

by Practical Law Corporate & Securities
Published on 20 May 2021Delaware, USA (National/Federal)
The US District Court for the Northern District of California (NDCA) enforced The Gap, Inc.'s forum selection by-law designating the Delaware Court of Chancery as the exclusive forum for all derivative claims, including as to a claim under Section 14(a) of the Exchange Act. The Court's decision effectively precludes the plaintiff from bringing a Section 14(a) claim.
On April 27, 2021, the US District Court for the Northern District of California (NDCA) granted The Gap, Inc.'s (Gap) motion to dismiss a derivative lawsuit brought against it and its board of directors alleging misstatements about company diversity. In its ruling, the NDCA enforced Gap's forum selection by-law designating the Delaware Court of Chancery as the exclusive forum for all derivative claims, including as to a claim under Section 14(a) of the Exchange Act alleging Gap made false statements about its diversity efforts in its proxy statement (Lee v. Fisher, (N.D.C.A. April 27, 2021)). Since federal courts have exclusive jurisdiction over Exchange Act claims, the Court's decision effectively precludes the plaintiff from bringing a Section 14(a) claim.

Background

Plaintiff Noelle Lee filed a derivative shareholder lawsuit against Gap and current and former members of its board of directors (Defendants) based on Gap's failure to create meaningful diversity in company leadership and on the board of directors, as well as for making false statements about its diversity and efforts to become more diverse. Lee filed suit in September 2020 in the NDCA, bringing state law derivative claims, such as for breach of fiduciary duty, and a federal securities law claim for violation of Section 14(a) of the Exchange Act and Exchange Act Rule 14a-9.
Gap's by-laws include a forum selection clause designating the Delaware Court of Chancery as the exclusive forum for shareholder derivative claims, and the Defendants filed a motion to dismiss on the basis that the forum selection by-law required the lawsuit be brought in Delaware state court. Lee argued that enforcing the forum selection clause with respect to the Section 14(a) claim would violate public policy and the Exchange Act's anti-waiver provision, because it would preclude her from being able to bring the claim.

Enforcing Gap's Forum Selection By-law

In Fisher, the Court stated it is undisputed that the Exchange Act has an anti-waiver provision and that federal courts have exclusive jurisdiction over Exchange Act claims. Thus, the Court acknowledged it is also undisputed that Lee's Section 14(a) claim would, in effect, be waived if the Court enforces the forum selection by-law requiring Lee's derivative suit be brought in Delaware state court.
However, the Court found that the Ninth Circuit made clear in Yei A. Sun v. Advanced China Healthcare Inc. that a statutory anti-waiver provision alone does not supersede a forum selection clause, and that Lee had to point to a statute or judicial decision clearly establishing that enforcement of the forum selection clause would contravene strong public policy (Fisher, at *4) (citing Yei A. Sun, 901 F.3d 1081 (9th Cir. 2018)). In addition, the Court found that because Delaware law permits shareholders to bring derivative claims, enforcing the forum selection by-law would not leave Lee without a remedy in Delaware even if precluded from bringing a Section 14(a) claim.
As Lee was unable to point to a statute or judicial decision clearly stating a strong public policy and Delaware still affords Lee some remedies, the Court enforced Gap's forum selection by-law and granted the Defendant's motion to dismiss.

Practical Implications

Fisher is the latest case to raise questions about how federal courts are enforcing forum selection clauses as to federal securities law claims. Last year in Seafarers Pension Plan v. Bradway, which the Court also cites in Fisher, the Northern District of Illinois similarly enforced a Delaware forum selection by-law as to a Section 14(a) claim, holding that enforcing the forum selection clause did not waive any substantive rights provided by the federal securities laws since derivative claims are permitted in Delaware (, at *3 (N.D. Ill. June 8, 2020)).
The Seafarers decision also highlights the competing variables and complexity of the issue, as the Court's opinion both:
  • Discusses the "good reasons" for a corporation to adopt such a forum selection by-law, namely the avoidance of multi-forum litigation.
  • Sympathizes with the plaintiffs as the outcome denies them "the right to proceed in federal court under a duly enacted federal law."
The plaintiffs in Seafarers appealed and are awaiting a decision from the Seventh Circuit Court of Appeals.
While further developments are likely on this issue, companies should consider the Fisher and Seafarers decisions when drafting forum selection clauses for their certificates of incorporation or by-laws. The impact of these cases so far is that companies can use their forum selection provisions to essentially prevent shareholders from ever raising Section 14(a) claims because they cannot bring proceedings in federal court.
For more information on Section 14(a) claims, see Practice Note, Securities Act and Securities Exchange Act Liability Provisions: Overview: Section 14(a). For a sample Delaware forum selection provision for the certificate of incorporation or by-laws of a Delaware corporation, see Standard Clause, By-Laws or Certificate of Incorporation: Delaware Forum Selection.