Okay, here I go, diving into Seafarers Pension Plan v. Bradway, recently out of the Seventh Circuit. The appeal was argued in November 2020, which means this opinion took about 100 years to come down in Seventh Circuit time, and, well, to be honest, I’m not sure they worked out all the kinks.
I blogged extensively about the district court decision in this case here (although in the interests of full disclosure I should probably mention I spoke with the plaintiffs’ attorneys about the appeal, after the blog post went up). The too-short version is that Boeing had a bylaw purporting to require that all derivative actions be filed in Delaware Chancery. Plaintiffs filed a derivative action in federal court alleging Exchange Act claims under Section 14(a). According to the plaintiffs, the Boeing defendants solicited shareholder votes in favor of their own reelection and compensation with false statements in the corporate proxy about the development of the 737 Max. Boeing moved to dismiss in favor of Chancery due to the bylaw. This was awkward because state courts, like Delaware Chancery, do not have jurisdiction to hear Exchange Act claims, and so enforcement of the bylaw in this case would be tantamount to a waiver of the claim. But the Exchange Act prohibits predispute waiver of claims, and so the plaintiffs argued that the bylaw was invalid as applied here.
The district court ruled in Boeing’s favor and dismissed. The plaintiffs appealed to the Seventh Circuit and, simultaneously, filed an action in Delaware Chancery alleging that the bylaw, as applied here, violated Delaware law. The Delaware case (Docket No. 2020-0556-MTZ) was stayed in favor of the Seventh Circuit, and last week, the Seventh Circuit reversed and remanded, by a 2-1 vote, with Judge Easterbrook dissenting.
[Warning: Very long discussion under the cut, which will get unfortunately into the legal weeds at times, can’t be helped]
Given all that, you would think that the main issue before the Seventh Circuit would be whether the bylaw violates federal securities law by forcing a pre-dispute waiver. (You might also think the issue would be whether the bylaw even constitutes a contract for Exchange Act purposes in the first place, but no one – not litigants, not courts – seems terribly interested in talking about that issue, even to weigh in on the reasoning of Salzberg v. Sciabacucchi, which is not binding outside of Delaware, so I’ll skip it).
Anyway, you might think that this case was about the requirements of the Exchange Act. But you would be wrong. Because the Seventh Circuit – sort of – decided this case as a matter of Delaware law. And through that lens, decided that Delaware would not permit a bylaw that violates federal securities laws, which this bylaw does, and so the bylaw was unenforceable as a Delaware matter.
If it was enforceable under Delaware law but violated the federal securities laws, would it still be invalid? I assume so but you would not know that by the Seventh Circuit’s reasoning, which was focused on determining what Delaware thinks.
Anyway, here are selected excerpts of the Seventh Circuit’s opinion:
Applying the forum bylaw to this case is contrary to Delaware corporation law and federal securities law. In Part III, we explain that the forum bylaw is unenforceable as applied to this case because its application would violate Section 115 of the Delaware General Corporation Law. Delaware corporation law gives corporations considerable leeway in writing bylaws, including bylaws with choice-of-forum provisions, but it respects federal securities law and does not empower corporations to use such techniques to opt out of the Exchange Act….
III. Applying Delaware Corporation Law
….
If it can be applied to this case, the by-law will force plaintiff to raise its claims in a Delaware state court, which is not authorized to exercise jurisdiction over Exchange Act claims. 15 U.S.C. § 78aa; Cottrell v. Duke, 737 F.3d 1238, 1247−48 (8th Cir. 2013). If that’s correct, checkmate for defendants. That result would be difficult to reconcile with Section 29(a) of the Exchange Act, which deems void contractual waivers of compliance with the requirements of the Act. 15 U.S.C. § 78cc(a).
- Delaware Corporation Law on Forum-Selection Bylaws
We read Delaware corporation law as rejecting Boeing’s use of its forum bylaw to foreclose entirely plaintiff’s derivative action under Section 14(a)….
[In Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013)], [t]he plaintiffs asked a hypothetical question. Suppose the board of FedEx sought to enforce the forum bylaw to foreclose a plaintiff from bringing a claim within the exclusive jurisdiction of the federal courts? That’s this case. The Delaware Court of Chancery explained that in such a case, the board “would have trouble”…. [because the Boilermakers court believed such a bylaw would violate the Exchange Act]
[I]t is sufficient for our purposes that the reasoning of Boilermakers Fund does not authorize application of the Boeing forum bylaw to this case, where it would effectively foreclose a claim under federal securities law. The Court of Chancery made clear that enforcement of a forum bylaw to foreclose a plaintiff from exercising her rights under the Exchange Act of 1934 would be inconsistent with the anti-waiver provision of that Act. 73 A.3d at 962. No Delaware law, at least to our knowledge, authorizes such an inconsistency….
This entire discussion, to me, is baffling, because it’s almost an afterthought that the Seventh Circuit concludes the bylaw as applied here violates the anti-waiver provisions of the Exchange Act. Normally, you’d expect that to end the matter; whether Delaware does or doesn’t authorize the bylaw is beside the point, because the Supremacy Clause beats Delaware. Instead, the primary focus of the Seventh Circuit is what Delaware thinks of such bylaws – and whether, amazingly, a Delaware Chancery court thinks they violate the Exchange Act.
I mean no disrespect to Delaware Chancery or then-Chancellor Strine, who authored the Boilermakers opinion, it’s just … normally, I wouldn’t expect a federal court of appeals to defer to a trial-level state court’s interpretation of what federal law requires. But apparently sprinkling the words “bylaw” or “charter provision” over something imbues Delaware with a mystical power to supersede all other sources of law.
(I have previously expressed concern about Delaware consuming all legal systems in its path; this is the most spectacular example yet.).
To be sure, in Part IV of the opinion, the Seventh Circuit focuses solely on federal law to reject the defendants’ argument that similar forum selection clauses have been upheld in other cases. But even then, I read the Seventh Circuit as framing the issue in terms of whether Delaware would authorize an illegal forum selection clause, so that the federal issue is only relevant insofar as it sheds light on how Delaware would approach the matter. I.e., the Seventh Circuit explains that defendants are trying “[t]o avoid this result” – that is, invalidation under Delaware law – by claiming that the bylaw is similar to other forum selection clauses that pass muster under federal law, and the Seventh Circuit concludes the bylaw is not, in fact, similar to those other forum selection clauses.
With that said, let’s unpack this Matryoshka doll.
When it comes to the reasoning based solely on federal law, I think the Seventh Circuit has it right. The court begins by saying if the bylaw would deny the plaintiffs any forum for their claims, it would operate as a waiver, in violation of the Exchange Act (well, as you can see from the quoted bits above, it half says that, and half relies on Chancery saying that). The Seventh Circuit then addresses the argument that persuaded the district court: That there is precedent enforcing forum selection clauses – even those that operate as waivers of securities claims – so long as the plaintiffs can advance substantively similar claims in the chosen forum. The Seventh Circuit rejects that argument because the line of cases to so hold dealt with international securities transactions, where it was particularly important that the parties enjoy certainty as to which country’s law would apply.
That’s the point I made in my blog post on this case, that the international cases don’t justify enforcing a forum selection/waiver in the context of a purely domestic transaction.
So far so good.
But all this discussion of federal law was embedded in a discussion of Delaware law, and that’s where things went awry. Here’s the relevant part of the Seventh Circuit’s reasoning:
We read Delaware corporation law as rejecting Boeing’s use of its forum bylaw to foreclose entirely plaintiff’s derivative action under Section 14(a). Section 115 of the Delaware General Corporation Law addresses specifically bylaws that impose choices of forums for litigation involving corporate affairs. Section 115 provides in relevant part that “bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State.” 8 Del. C. § 115. Section 115 defines “internal corporate claims” to include derivative claims like this one: “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity … .” 8 Del. C. § 115.
For present purposes, the two key phrases in Section 115 are “consistent with applicable jurisdictional requirements” and “courts in this State.” As applied here, Boeing’s forum bylaw violates Section 115 because it is inconsistent with the jurisdictional requirements of the Exchange Act of 1934, 15 U.S.C. § 78cc(a). … The statutory language shows that Section 115 does not authorize application of Boeing’s forum bylaw to close all courthouse doors to this derivative action….
The synopsis accompanying the 2015 Amendments to the Delaware General Corporation Law anticipated the question posed in this case. It cautioned that the new Section 115 was “not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction, nor is Section 115 intended to limit or expand the jurisdiction of the Court of Chancery or the Superior Court.” S.B. 75, 148th Gen. Assemb., Reg. Sess. (Del. 2015) (synopsis). By eliminating federal jurisdiction over the Seafarers Plan’s exclusively federal derivative claims, Boeing’s forum bylaw forecloses suit in a federal court based on federal jurisdiction. That’s exactly what Section 115 was “not intended to authorize.”…
From these signals in the statutory text and Delaware case law, we conclude that Section 115 does not authorize use of a forum-selection bylaw to avoid what should be exclusive federal jurisdiction over a case, particularly under the Exchange Act.
The problem here is that Section 115 doesn’t apply to “derivative claims like this one.” Here’s what the Delaware Supreme Court said in Salzberg v. Sciabacucchi:
Neither side in this case argues that Section 115’s definition of “internal corporate claims” encompasses Section 11 claims. We think Section 115 likely was intended to address claims requiring the application of Delaware corporate law as opposed to federal law. Stated differently, we do not think the General Assembly intended to encompass federal claims within the definition of internal corporate claims. Thus, Section 115 is not implicated.
In my original post on this case, I asked whether maybe 115 could apply if you consider that demand standards for derivative Section 14(a) claims are drawn from Delaware law (more on that below), and one could certainly argue that Section 115 and its history shed light on the propriety of the bylaw, but the Seventh Circuit seems to be straight up interpreting Section 115 to govern this bylaw, and concluding that the bylaw violates Section 115 by denying plaintiffs access to the only forum with jurisdiction. But Section 115 does not, in fact, govern this bylaw, at least, not in the way the Seventh Circuit seems to mean it.
Does that mean the Seventh Circuit is wrong, and Delaware law does authorize the bylaw?
No, because the Seventh Circuit did address the argument – made by defendants – that the bylaw was authorized by the general power in Section 109(b). And it rejected that argument, as well. Partly, the Seventh Circuit (erroneously) held that the specific Section 115 was more applicable than the general Section 109(b), see Op. at 11, but then the Seventh Circuit also held that Section 109(b) only authorizes provisions “not inconsistent with law,” which this bylaw is not, because, well, federal law. Further, the Seventh Circuit said, Boilermakers – which was dealing with Section 109(b) – strongly suggested that a bylaw that denied plaintiffs access to a federal forum on an Exchange Act claim would be invalid.
So, says the Seventh Circuit, whether you look at it as a matter of Section 115, or as a matter of Section 109(b), Delaware law does not authorize a bylaw that denies access to the only courts with jurisdiction, and for that reason, the bylaw is unenforceable as to these plaintiffs.
Okay. That’s the majority.
But Easterbrook dissents! Easterbrook points out, correctly, that Section 14(a) does not contain a private right of action; instead, one was inferred in J.I. Case Co. v. Borak, 377 U.S. 426 (1964). The bylaw does not apply to direct claims, and so plaintiffs are free to file direct claims in federal court. (Well, not these plaintiffs; as I explained in my prior post, there’s already a direct federal securities class action pending against Boeing; that’s why these plaintiffs filed derivatively. But the bylaw would not affect all plaintiffs’ ability to file direct Section 14(a) claims.)
But when it comes to derivative claims under Section 14(a), Easterbrook says, these are not really federal claims at all; instead, they are basically vehicles for state law claims:
Recall what a derivative action is. An investor who wants a corporation to sue members of its own board or management proceeds in multiple steps. First the investor demands action from the board. If the board says no, the investor sues the directors seeking a judicial order compelling them (or permitting the investor on their behalf) to require the corporation to sue. If a court issues such an order, the corporation (perhaps represented by the investor as its agent) litigates against the directors. The first two steps, which address the question “Who speaks for the corporation?”, are matters of corporate internal affairs under state law. So Kamen v. Kemper Financial Services, Inc., 500 U.S. 90 (1991), holds with respect to derivative suits whose ultimate (third) step would rest on federal law. It is state law, Kamen tells us, that determines both when demand is required and when investors can step into a corporation’s shoes. And the third step—in which a corporation, author of the proxy materials, sues its own directors—also rests on state law. Plaintiff’s theory at the third step would be that the directors violated their state-law duty of care by permitting Boeing to do things that exposed it to liability under federal law. Section 14(a) plays a role in such litigation, to be sure, but does not create the claim. Nor is the derivative claim necessary to enforce the federal rule, which is done through investors’ or the SEC’s direct suits.
Suppose Delaware were to abolish derivative suits. Investors still could sue managers for violating the state-law duties of care or loyalty. Investors still could sue companies under statutes such as §14(a). Would abolishing derivative actions violate federal law? I can’t see how. And if states can abolish derivative suits without violating §14(a), they can permit corporations to establish conditions on derivative suits. The federal right is for investors or the SEC to sue directly….
The Supreme Court has never held or even intimated that there is a federal right to pursue a derivative claim under §14(a) when the investor can pursue a direct claim. J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964), holds that §14 supports a derivative claim when its denial would “be tantamount to a denial of federal relief”; that condition does not hold when the private plaintiff can pursue a direct action in federal court….
Without getting into too much detail, he eventually concludes that because derivative actions inherently arise under state law, they can be litigated in state court – even if the claim depends on Section 14(a). Which means that the bylaw has not effected a substantive waiver of the claim at all.
I’m not really sure what to make of this and to be entirely honest, I’m also not sure I completely understand his reasoning, but from what I think he’s saying, I’ll start with: I’m not sure he understands that direct and derivative suits are not interchangeable. Right now, the legal system treats certain claims as necessarily derivative or direct depending on the nature of the harm alleged; if Delaware were to “abolish derivative suits,” that doesn’t mean “[i]nvestors still could sue managers for violating the state-law duties of care or loyalty”; without more, it means there would be no claim at all for derivative harms arising from violation of the duties of care and loyalty. He does not seem to fully internalize that certain kinds of harms are characterized as direct or derivative, and simply eliminating one form of action does not mean investors automatically could sue under the other, let alone get the same relief.
Beyond that, he relies on Kamen to conclude that derivative claims are governed by state law, and here, I take issue with his reading of that case. Kamen was about the Investment Company Act (ICA), and here’s the relevant quote:
It is clear that the contours of the demand requirement in a derivative action founded on the ICA are governed by federal law. Because the ICA is a federal statute, any common law rule necessary to effectuate a private cause of action under that statute is necessarily federal in character…
It does not follow, however, that the content of such a rule must be wholly the product of a federal court's own devising. Our cases indicate that a court should endeavor to fill the interstices of federal remedial schemes with uniform federal rules only when the scheme in question evidences a distinct need for nationwide legal standards, or when express provisions in analogous statutory schemes embody congressional policy choices readily applicable to the matter at hand. Otherwise, we have indicated that federal courts should “incorporat [e] [state law] as the federal rule of decision,” unless “application of [the particular] state law [in question] would frustrate specific objectives of the federal programs. The presumption that state law should be incorporated into federal common law is particularly strong in areas in which private parties have entered legal relationships with the expectation that their rights and obligations would be governed by state-law standards…. Corporation law is one such area.
In other words, for derivative Section 14(a) claims, you might incorporate state law demand standards to effectuate the right. But that doesn’t transmogrify the claim into one originating in state law; the rule itself is still federal, with content borrowed from state law. And if the state law standard undermined federal law (by, say, abolishing derivative actions) it would not be used.
If there were any doubt that these are federal claims, well, there’s Borak:
It appears clear that private parties have a right under s 27 to bring suit for violation of s 14(a) of the Act. Indeed, this section specifically grants the appropriate District Courts jurisdiction over ‘all suits in equity and actions at law brought to enforce any liability or duty created’ under the Act.
N.B.: Derivative suits are a tool of equity
While the respondent contends that his Count 2 claim is not a derivative one, we need not embrace that view, for we believe that a right of action exists as to both derivative and direct causes.
The purpose of s 14(a) is to prevent management or others from obtaining authorization for corporate action by means of deceptive or inadequate disclosure in proxy solicitation. …While this language makes no specific reference to a private right of action, among its chief purposes is ‘the protection of investors,’ which certainly implies the availability of judicial relief where necessary to achieve that result.
The injury which a stockholder suffers from corporate action pursuant to a deceptive proxy solicitation ordinarily flows from the damage done 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. As in anti-trust treble damage litigation, the possibility of civil damages or injunctive relief serves as a most effective weapon in the enforcement of the proxy requirements….
We, therefore, believe that under the circumstances here it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose.
That does not, to me, suggest you do a case by case analysis to see whether direct claims are sufficient in a particular case; it sounds like, because direct claims are not always sufficient, derivative claims are authorized under the statute. In Borak itself, after all, the Court specifically held it did not have to decide whether the claims were properly styled as direct or derivative because either way Section 14(a) authorized the action; it did not hold that derivative claims were available on those facts because direct claims on those facts were unavailable. And in the years since Borak, well, see Yamamoto v. Omiya, 564 F.2d 1319 (9th Cir. 1977) (“a shareholder who alleges a deceptive or misleading proxy solicitation is entitled to bring both direct and derivative suits.”); Enzo Biochem, Inc. v. Harbert Discovery Fund, LP, (“In 1964, the Supreme Court held in Borak that a shareholder has an implied right of action to bring suit, either in a direct or derivative capacity, under Section 14(a) of the Exchange Act.”). Etc.
Some of Borak’s reasoning is that if you’re not fooled by a false proxy, but other people are, you might not have direct standing – which may have been an issue 1964 but wasn’t by 1970. See Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970). But the rest of Borak’s reasoning is that Section 14(a) claims may be derivative because the harm falls on the corporation itself. Like, shareholders may be tricked into voting for some kind of action that harms the company rather than the shareholder individually. For example, what if directors issue a false proxy statement that tricks shareholders into voting to authorize a new stock issuance that is used to fund a bad acquisition? The harm is classically derivative (though yes I realize some 14(a) cases have alleged direct harms in that scenario). Delaware state law doesn’t have a great remedy for that kind of harm, not if the misstatement was negligent rather than intentional, but Section 14(a) – which permits claims based on negligence – does.
So imagine such a claim. Is Easterbrook saying that there’s no federal Section 14(a) derivative claim in that circumstance? Does that mean Section 14(a) necessarily provides a direct remedy (I can think of some defendants who would disagree)? What if there was no provable market reaction; what would the direct remedy be? Or is he saying that because direct claims under Section 14(a) would not be sufficient to capture the harm in that instance, Section 14(a) derivative claims would be authorized? And that these Boeing plaintiffs are different, because they aren’t arguing that they were tricked into authorizing a bad merger, but that they were tricked into voting for directors who then violated state law duties?
If that last point is what he’s getting at here, it may be unnecessary to boot, because some courts have held that claims under Section 14(a) already have a tight loss causation requirement, to wit:
the mere fact that omissions in proxy materials, by permitting directors to win re-election, indirectly lead to financial loss through mismanagement will not create a sufficient nexus with the alleged monetary loss. Rather, damages are recoverable under Section 14(a) only when the votes for a specific corporate transaction requiring shareholder authorization, such as a corporate merger…
Gen. Elec. Co. v. Cathcart, 980 F.2d 927 (3d Cir. 1992); see also Edward J. Goodman Life Income Tr. v. Jabil Cir., Inc., 594 F.3d 783 (11th Cir. 2010) (no Section 14(a) losses because “it was management’s failure to follow corporate policies, and not the actual election of directors, that contributed to the shareholder’s loss”). To be fair, there is some disagreement about this, see discussion in Employees Retirement System of City of St. Louis v. Jones, 2021 WL 1890490 (S.D. Ohio 2021) – but my point is, that’s the framing for addressing harms that are somewhat removed from the shareholder vote itself, not by treating the whole case as arising out of state law.
Given that, I’m not sure how Easterbrook’s analysis is, umm, helpful, though it is possible Section 14(a) could use some clarity on the direct/derivative distinction. Not as a matter of determining what private rights of action are authorized under the statute, but as a matter of determining when the harm alleged is properly identified as a corporate harm.
Anyhoo, neither side actually advocated for Easterbrook’s proposal – that the Section 14(a) claims be litigated in Delaware Chancery – so I’m guessing that it won’t appear much in further arguments.
Which means we’re left with:
(1) Will the defendants seek certiorari? I will say this for the Seventh Circuit: By embedding the federal analysis within the Delaware law analysis, it conjured a pretty powerful Supreme Court-repelling charm. (This Law360 article also suggests Boeing might seek en banc review, but considering the headache the case apparently gave the panel, I would be surprised if the full court was tempted to wade into the mess.)
(2) What about the simultaneous Delaware Chancery action? Does Delaware Chancery now get to decide whether the Seventh Circuit was right or wrong when it says that a Delaware corporation can’t authorize a bylaw that illegally waives federal securities claims?
(3) What about the Lee v. Fisher case, which I blogged about here? It’s currently on appeal to the Ninth Circuit, and poses very similar questions.
I have no idea.