The Gap nixes Exchange Act derivative claims via forum selection - 9th Circ.

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The sign for a Gap store is seen on 5th avenue in midtown Manhattan in New York June 16, 2015. REUTERS/Brendan McDermid

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(Reuters) - The fate of shareholder derivative suits claiming violations of the Securities and Exchange Act now depends on geography, after a ruling Friday from the 9th U.S. Circuit Court of Appeals.

The 9th Circuit held in Lee v. The Gap Inc that the retailer's bylaw requiring shareholders to litigate derivative claims in Delaware Chancery Court is enforceable, even if enforcement effectively eliminates shareholders’ ability to assert an Exchange Act case on behalf of the corporation.

Under this decision, in other words, companies based in California and other states in the 9th Circuit can eliminate the risk of an Exchange Act derivative suit by adopting a forum selection clause that steers shareholders' derivative claims to state court.

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That’s not possible, however, for companies in Illinois and other states in the 7th Circuit. In January, as I reported, a divided 7th Circuit panel rejected The Boeing Co’s bid to enforce its Chancery Court forum selection clause in an Exchange Act derivative suit arising from alleged misrepresentations about the board’s oversight of 737 MAX jet safety issues. The 7th Circuit majority ruled that it would be contrary to both federal and Delaware law and policy to send the derivative suit to Chancery Court because shareholders would then have no jurisdiction to assert their derivative Exchange Act claims.

The 9th Circuit panel in the Gap case – Judges Richard Clifton, Milan Smith and U.S. District Judge Christina Reiss of Burlington, Vermont, sitting by designation – addressed the 7th Circuit’s conflicting Boeing decision in a single paragraph in Friday's decision. Much of the Boeing court’s reasoning, the 9th Circuit said, was based on a provision of Delaware’s corporate code that permits companies to adopt forum selection clauses for “internal corporate claims.”

The 7th Circuit concluded that the provision is tailored to respect federal law and does not “empower corporations to use such techniques to opt out of the Exchange Act.” But the shareholder suing The Gap’s board for allegedly misrepresenting the company’s commitment to diverse leadership did not assert arguments about that particular Delaware provision in her opening brief, the 9th Circuit said, so she waived reliance on it.

Moreover, the 9th Circuit disagreed with the 7th Circuit’s holding that the Exchange Act’s anti-waiver provision precludes enforcement of a forum selection clause that would effectively kill shareholders’ ability to bring derivative claims under the statute.

The Exchange Act, as you know, bars companies from mandating a waiver of compliance from its statutory regulations. It also vests exclusive jurisdiction for Exchange Act claims in federal court. The 7th Circuit majority in Boeing said that companies therefore cannot enforce a forum selection provision that would require shareholders to sue in a court that does not have jurisdiction to hear their claims. (In dissent, as I’ve explained, 7th Circuit Judge Frank Easterbrook argued that Chancery Court, in fact, could hear state-court breach-of-duty claims arising from the Exchange Act. Boeing opted not to file an en banc petition to test Easterbrook's theory.)

The 9th Circuit in the Gap case said that under its binding precedent, the “strong federal policy in favor of enforcing forum-selection clauses” trumps the Exchange Act’s anti-waiver provision. The court cited 2018’s Sun v. Advanced China Healthcare Inc, which upheld enforcement of a forum selection clause in a case asserting state-law securities claims.

Plaintiffs counsel Frank Bottini of Bottini & Bottini did not respond to my email query about whether his client will seek en banc or U.S. Supreme Court review of the 9th Circuit’s ruling. In a reply brief in the Gap case that was submitted after the 7th Circuit's Boeing decision, shareholders argued that they had not waived arguments based on Delaware’s forum selection law. They also argued that 9th Circuit precedent from the Sun case was distinguishable because it did not specifically address the Exchange Act’s anti-waiver provision.

The Gap’s lead counsel, Roman Martinez of Latham & Watkins, declined to provide a statement on the 9th Circuit decision. In its appellate brief, The Gap argued that the derivative suit should be dismissed not just on forum selection grounds but also because shareholders hadn’t met demand futility requirements and failed to allege any actual misrepresentations in their “demonstrably false” complaint about the company’s diversity. (The Gap told the 9th Circuit that none of Bottini & Bottini's highly publicized derivative suits challenging corporate diversity efforts has survived a defense dismissal motions.)

So would the Supreme Court be interested in what appears to be a circuit split? Forum selection proponent Joseph Grundfest of Stanford Law School told me by email that he thinks the circuits’ divergence on a matter of statutory construction would pique the justices’ interest. “I would think that a grant of cert on this split is at least as likely as not, if a petition is filed,” Grundfest said.

There are also plenty of reasons for the Supreme Court to give the issue more time to develop. So far, only two circuits have ruled, and the 9th Circuit didn’t give much analysis to the 7th Circuit’s primary Delaware-law based reasoning because of its finding that shareholders failed to preserve those arguments. The Gap would likely also argue that its forum selection was only one of the many reasons why the derivative suit was doomed, so the Supreme Court shouldn’t waste its time.

On the other hand, there have been two federal appellate challenges so far to the enforcement of forum selection clauses in Exchange Act derivative suits – and the two courts to have decided those cases reached opposite conclusions. (The shareholder lawyer who prevailed in the Boeing case, Carol Gilden of Cohen Milstein Sellers & Toll, told me by email that her team "continues to believe the majority’s analysis in the Seventh Circuit’s Boeing decision correctly decided the issue.")

If the shareholder bar were eager for Supreme Court consideration of the scope of the Exchange Act’s anti-waiver clause, it could certainly make an argument for the justices to take up the Gap case. Whether plaintiffs lawyers want that review is another story.

Read more:

Boeing's forum selection bid to send 737 MAX derivative suit to Delaware nixed by 7th Circ

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.