- Law firms
(Reuters) - Nine former high-ranking Delaware state court judges delivered a huge gift on Monday to The Gap Inc and other companies that have adopted forum selection clauses requiring shareholders to litigate derivative suits in Delaware Chancery Court.
The former judges, who hail from both the Delaware Supreme Court and Chancery Court, said in a terse letter brief to the en banc 9th U.S. Circuit Court of Appeals that when shareholders claim under the Securities and Exchange Act that their votes have been tainted by allegedly deceptive proxy disclosures, those claims belong directly to shareholders, not derivatively to the corporation.
That conclusion, as I’ll explain, should help Gap counter shareholders' arguments that its forum selection clause can’t be reconciled with the Exchange Act because it forces shareholders to cede substantive rights.
But perhaps even more importantly, the retired Delaware judges – including former Supreme Court chief justice Leo Strine and former chancellors Andre Bouchard and William Chandler — told the en banc 9th Circuit unequivocally that, in their (highly informed) view, Gap’s forum selection provision is enforceable under Delaware law.
If the en banc 9th Circuit ends up agreeing with the former judges, then Delaware companies that have adopted forum selection clauses can stop worrying about their board members facing derivative suits in federal court over allegedly misleading proxy disclosures. That outcome would eliminate an entire category of shareholder suits, said University of Oregon School of Law professor Mohsen Manesh, who co-authored an amicus brief cited in the ex-Delaware judges' letter.
In case you had doubts about the significance of the appeal, those should be resolved by a look at friend-of-the-court briefs filed for both sides in the month since the 9th Circuit agreed to hear the case en banc. In addition to the Delaware ex-judges' letter and the brief from Manesh and co-author Joseph Grundfest of Stanford Law School, The Gap received support from the U.S. Chamber of Commerce and the National Retail Federation.
Shareholder Noelle Lee, whose lawyers at Bottini & Bottini allege that Gap board members harmed the company by permitting discrimination against minorities, has amicus backing from Public Citizen (along with Better Markets and the Consumer Federation of America); the American Association for Justice; and 10 eminent securities law professors, including treatise co-author Joel Seligman of the University of Rochester. (Gap's lawyers at Latham & Watkins have vehemently denied Lee’s “demonstrably false” assertions of discrimination.)
Unfortunately for us bystanders, the issues in the appeal are as complex as they are consequential. But to summarize ruthlessly, the key question is whether companies can avert Exchange Act derivative suits via forum selection provisions mandating litigation in Delaware Chancery Court, which does not have jurisdiction to hear Exchange Act claims – or whether the Exchange Act’s anti-waiver provision precludes enforcement of such forum selection clauses because they require shareholders to surrender a substantive right.
Lee and her supporters – again, summarizing heavily – contend that under the U.S. Supreme Court’s 1964 ruling in J.I. Case Co v. Borak, shareholders are entitled to bring derivative suits alleging violations of the Exchange Act’s provision barring misrepresentations in proxy materials. Because Exchange Act claims can only be litigated in federal court, shareholders argue, companies run afoul of the law’s anti-waiver provision if they attempt to force plaintiffs into Delaware Chancery Court via forum selection clauses.
Companies should not be allowed to wield forum selection provisions “to opt out of accountability,” Public Citizen argued.
Gap and its friends, broadly speaking, insist that the Exchange Act’s anti-waiver clause does not preclude enforcement of forum selection clauses because shareholders don’t actually lose substantive rights even if they can’t litigate derivative suits alleging Exchange Act violations in federal court.
If shareholders want to accuse corporate directors of causing harm to the company, Gap and its amici argue, they can litigate derivative suits in Delaware. And if they want to assert Exchange Act claims based on misleading proxy statements, Gap said, they can bring direct federal-court class actions on their own behalf.
The ex-Delaware judges’ letter brief essentially confirms both of those points as a matter of Delaware law. All of the remedies shareholders are seeking in the federal court case could also be obtained in a Delaware derivative suit, the letter said. And to the extent that shareholders are relying on an Exchange Act claim that their votes were tainted by corporate misrepresentations, the ex-judges said, they’re acting directly for themselves, not derivatively for the company.
For what it’s worth, Grundfest and Manesh go considerably farther in their amicus brief than The Gap and the Chamber, arguing that even under the Supreme Court’s Borak decision, shareholders do not have private right of action to bring derivative Exchange Act claims.
Shareholder counsel Francis Bottini told me by email that The Gap and its amici are wrong to argue that Lee’s case is, for all intents and purposes, a direct suit in derivative clothing. “A derivative claim is brought on behalf of the company, not the shareholders, and seeks to redress a completely different kind of harm,” Bottini said. “[It] also permits the court to award equitable relief that is not available in a direct action, which is a pure legal claim.”
The 9th Circuit presumably granted en banc review — and vacated a three-judge panel decision validating Gap’s forum selection clause — to give thorough consideration to a January 2022 ruling from the 7th Circuit in an Exchange Act derivative suit against The Boeing Co.
The 7th Circuit refused to enforce Boeing’s forum selection clause, concluding that Delaware would not condone such maneuvering to extinguish the federal court derivative suit. “Delaware is not inclined to enable corporations to close the courthouse doors entirely on derivative actions asserting federal claims,” the opinion said.
That reasoning is seriously undermined by the retired Delaware judges’ letter in the Gap case. The ex-judges not only said that Gap’s forum selection clause is enforceable but also that the Delaware corporate code section at the heart of the 7th Circuit decision is “irrelevant.”
Oral argument is scheduled for Dec. 12.
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