In blogging, it’s feast or famine. Some weeks I strain to find something to say; other times I’m spoiled for choice.
This week, we kick off with the Supreme Court’s decision in Slack v. Pirani, which Ben Edwards flagged in his post yesterday. I blogged extensively about the case previously here and here and here.
Not much to say about this one except that the unanimous reversal of the Ninth Circuit was probably the best outcome plaintiffs could reasonably have hoped for. The Court held – as expected – that Section 11 claims require plaintiffs to show they purchased shares registered on the defective registration statement, but it also allowed for the possibility that plaintiffs would be able to do so and remanded to the Ninth Circuit to make that determination. Plaintiffs, and their amici, raised arguments about statistical tracing and accounting methods; it’s not impossible those will stick. And, the Supreme Court remanded to the Ninth Circuit for reconsideration of the Section 12 claims, which means plaintiffs may try to make some new law there as well. These are all longshots, but the case survives to fight another day.
Next up, we have the Ninth Circuit’s en banc decision in Lee v. Fisher, upholding Gap’s forum selection bylaw requiring that all derivative claims – including Section 14(a) claims – be brought in Delaware Chancery, which has no jurisdiction to hear them. I blogged about this issue here and here and here and here; the decision creates a split with the Seventh Circuit’s Seafarers Pension Plan ex rel. Boeing Co. v. Bradway, 23 F.4th 714 (7th Cir. 2022), and it was 6-5 to boot, so I’m pretty sure this is Supreme Court bound unless someone settles something.
The majority opinion kicks off with an incorrect history of forum selection clauses and their relationship to Section 14(a) claims. None of that matters to the reasoning, really, it’s just annoying.
The court says:
Gap’s inclusion of a forum-selection clause in its bylaws is consistent with a modern corporate trend. … In the first decade of the 2000s, there was an increase in litigation, id., “brought by dispersed stockholders in different forums, directly or derivatively, to challenge a single corporate action,” … Because multiforum litigation could impose high costs and hurt investors, id., many corporations adopted forum-selection clauses in response…
That’s true as far as it goes, but multiforum litigation was an issue for state claims, not federal claims. For federal claims, the big concern was not multiforum litigation, but state court litigation, specifically Securities Act claims in state court. So, bylaws morphed from being a protection against state law multiforum litigation into being a protection against state court litigation of Section 11 claims. In fact, I’m, like, 90% sure that Gap’s bylaw – requiring that derivative claims be brought in Delaware Chancery – was in fact never intended to apply to federal claims at all, but was enacted with state law claims in mind. It was likely only after this particular derivative 14(a) claim was brought that Gap decided to apply its bylaw to federal Exchange Act claims.
Then the opinion says:
Lee’s complaint is consistent with another modern trend, in which plaintiffs frame corporate mismanagement claims that normally arise under state law (including challenges to corporate policies relating to “ESG [environmental, social, and governance] issues . . . such as environmentalism, racial and gender equity, and economic inequality”) as proxy nondisclosure claims under § 14(a), in order to invoke exclusive federal jurisdiction and avoid any forum-selection clause pointing to a state forum.
No, plaintiffs bring Section 14(a) claims because they are negligence-based and predicated on a simple material misstatement. If they brought mismanagement claims, they’d have to get around the business judgment rule and need to show a loyalty violation; negligence would be exculpated under 102(b)(7). That’s not a defense of the practice, or of this particular complaint; it’s just a correction of the Ninth Circuit’s history.
But onward to the main event. My big thing here, as you all are aware by now, is the assumption that bylaws and charter provisions are in fact contracts. Well, the Ninth Circuit just accepts that they are – and further that they are contracts governed by Delaware law – with no analysis at all.
In interpreting Gap’s forum-selection clause, we apply Delaware’s rules of contract interpretation, because “[c]orporate charters and bylaws are contracts among a corporation’s shareholders.” Airgas, Inc. v. Air Prods. & Chems., Inc., 8 A.3d 1182, 1188 (Del. 2010)….
The bylaws are not only a contract among stockholders, but are also considered “part of a binding broader contract among the directors, officers and stockholders formed within the statutory framework of the Delaware General Corporation Law,” Hill Int’l, 119 A.3d at 38, because “the certificate of incorporation may authorize the board to amend the bylaws’ terms and that stockholders who invest in such corporations assent to be bound by board-adopted bylaws when they buy stock in those corporations,” Boilermakers, 73 A.3d at 940…..
We also reject the dissent’s argument that the forum-selection clause is unenforceable because Gap’s shareholders —whether they are “sophisticated parties” or not, Dissent 66—did not “consent” to its inclusion in the corporate bylaws, Dissent 65, and had “no opportunity to negotiate the content of the bylaws or alter terms not to their liking.” Dissent 66. This argument fails as a matter of both federal and Delaware law. The Supreme Court has expressly rejected the “determination that a nonnegotiated forum-selection clause in a . . . contract is never enforceable simply because it is not the subject of bargaining.” Carnival Cruise Lines, Inc. v. Shute, 499 U.S. 585, 593 (1991). We have likewise held that “a differential in power or education on a non-negotiated contract will not vitiate a forum selection clause.” Murphy v. Schneider Nat’l, Inc., 362 F.3d 1133, 1141 (9th Cir. 2004). And because “state law governs the validity of a forum-selection clause just like any other contract clause,” DePuy Synthes Sales, Inc. v. Howmedica Osteonics Corp., 28 F.4th 956, 963–64 (9th Cir.), cert. denied, 143 S. Ct. 536 (2022), it is even more significant that Delaware courts have not agreed with the dissent’s reasoning.
Obviously, I’m tearing my hair out over here, but rather than type it all out again, I’ll just direct y’all’s attention to my latest paper on the subject, Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine, the proofs of which are now actually at the printer and so thankfully I don’t have to update it to address this latest decision.
Working off the premise that bylaws are contracts, the Ninth Circuit spends most of its time dealing with the question whether you can contract to bring a derivative Section 14(a) claim in a forum that has no jurisdiction to hear it. Functionally, of course, such a contract is the equivalent of a waiver of the claim, so the real issue is whether such a waiver is prohibited under federal law.
The Exchange Act prohibits “[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, . . .” 15 U.S.C. § 78cc(a). Courts, including the Ninth Circuit, have uniformly held that a predispute agreement not to bring a private claim under the securities laws is the equivalent of a prohibited waiver of Exchange Act compliance, see, e.g., Petro-Ventures v. Takessian, 967 F.2d 1337 (9th Cir. 1992), although there is some circuit disagreement about what exactly counts as a predispute agreement not to sue.
In this case, though, the Ninth Circuit held that Gap’s bylaw does not run afoul of the Exchange Act because it only eliminates derivative Section 14(a) claims, not direct claims. And, the court further held, false proxy statements are really more injuries to shareholders’ individual voting rights than to the company generally, which means they are a poor fit for derivative claims, and the plaintiff in this case could have brought the same claims directly. So, according to the Ninth Circuit, the company’s substantive obligations under the Act remain intact, and no prohibited waiver is effectuated:
The dissent has failed to identify any § 14(a) claim that cannot be brought as a direct action, and therefore has failed to show that the unavailability of a derivative § 14(a) action precludes enforcement of any substantive obligation arising under § 14(a). Accordingly, the dissent’s observation that “[d]irect and derivative suits are not interchangeable,” Dissent 60, is irrelevant here. Because § 29(a)’s antiwaiver provision is concerned only with waiver of the substantive obligations imposed by the Exchange Act, the availability of any particular method of enforcing those obligations is not material.
So. The bylaw did not run afoul of the Exchange Act antiwaiver provision.
The court then turned to the plaintiff’s argument that even if the bylaw did not count as a prohibited waiver of Exchange Act claims, it still ran afoul of the general policy of the federal securities laws, which intended to allow these claims to go forward.
At this point, relying a lot on Joseph Grundfest & Mohsen Manesh’s article, Abandoned and Split But Never Reversed: Borak and Federal Court Derivative Litigation, the court held that the derivative private right of action under Section 14(a) was kind of a judicial mistake – dicta in the case that recognized it, J.I. Case Co. v. Borak, 377 U.S. 426 (1964), and out of place in the securities laws generally. The court did not purport to overrule Borak and eliminate the right; it simply held that given the right’s weak pedigree, preserving it did not qualify as a sufficiently important policy to override the forum selection provision.
A lot of the court’s reasoning here went back to the idea that false proxy statements are really more properly brought as direct claims, because they impair stockholders’ voting rights. The court held there was no reason not to follow Delaware’s conception of the direct/derivative distinction in this case for the purpose of interpreting federal 14(a) rights, because Delaware’s conception makes sense and is not inconsistent with the federal policy underlying the Section 14(a) cause of action.
So.
As a policy matter, my problem with the decision is that, contra the Ninth Circuit, in fact, direct claims do not function as a complete substitute for derivative claims. Suppose an acquiring company needs a shareholder vote to complete a merger, and the proxy statement is misleading. Suppose the merger is a bad deal for the company. Under Delaware law, that’s an injury to the company, not the shareholder – and, in fact, in the very Delaware cases cited by the Ninth Circuit for the proposition that these should be brought as direct claims, Delaware also held that it could not identify any injury that would justify an award of damages directly to the stockholders, because the only harms were derivative. In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d 766 (Del. 2006); In re Tyson Foods, Inc., 919 A.2d 563 (Del. Ch. 2007). Ironically, the Ninth Circuit cited Tyson Foods for the proposition that there must be a direct remedy available for false proxy statements, when that case itself dismissed the direct claims because there was no relief anyone could think of.
So there absolutely are false proxy situations that are more naturally brought as derivative claims. And Delaware apparently won’t provide a remedy, or might only provide a nominal damages remedy – because the psychic harm is direct but the economic harm is derivative, which is not something Tooley really contemplated. Plus, it’s necessary that federal law provide the cause of action, because Section 14(a) imposes liability for negligence. Delaware state law does not; companies can exculpate claims for negligence under DGCL 102(b)(7).
All of which is to say: There is no remedy under Delaware law for negligent proxy statements whether the claim is brought directly or derivatively (with an asterisk), and if federal law is following Delaware, there’s no remedy for shareholders suing directly under federal law for transactions that harm the company, at least not unless shareholders manage to act quickly enough to halt the transaction entirely. That’s the hole that derivative Section 14(a) claims can fill.
(Now, some courts have held that 102(b)(7) provisions can even exculpate negligence claims under federal law, as I discuss in Inside Out; let’s just say that I think these decisions are wrong and pretty clearly violate the Exchange Act’s antiwaiver provisions.)
But let’s go further. As I said, unless someone backs down or settles, this case is Supreme Court bait. Once it gets there, I would be surprised if we did not see an argument that predispute claim waivers simply do not run afoul of the antiwaiver provisions of the Exchange Act at all. I.e., even though federal courts are in agreement that predispute waivers are unenforceable – and the Ninth Circuit agreed they are here, if there is no alternative federal claim preserved – I expect defendants or their amici to argue that the Exchange Act only prohibits waiver of substantive compliance with the Act; that does not necessarily translate into prohibiting private contracts not to sue. After all, the SEC can still sue for Exchange Act violations, so the company is still bound to its substantive obligations.
I would also not be surprised if the Supreme Court were to find that argument compelling, and endorse it, or come very close (there must be some sliver of a private right remaining, or something; maybe you can waive fraud on the market claims so long as direct reliance claims remain, that kind of thing; there is already a circuit split about just how much of a private securities claim you can waive by contract). In fact, after the Ninth Circuit’s decision, some version of that argument – you can eliminate claims this far but no farther – will probably be shopped with or without Supreme Court involvement.
If that happens, then, leaving aside what the effect might be on private contracts, the whole mess is dumped back into Delaware’s lap. Delaware will have to decide how far companies can go in charters and bylaws to waive private securities fraud claims. Delaware will have to decide when enforcing such waivers is a violation of directors’ fiduciary duties, and when directors are conflicted in enforcing such waivers, and whether enforcement of a waiver is a conflict transaction that needs to be reviewed under entire fairness. It will add a whole separate layer of state litigation on top of the federal, where Delaware will decide the contours of the federal right. And it will be doing so in the shadow of jurisdictions like Nevada, which may very well adopt permissive rules. We might even start with whether Delaware does, in fact, agree that directors may, consistent with their fiduciary duties, completely bar derivative Section 14(a) claims, especially if a situation comes up where, whether due to 102(b)(7) or Delaware’s vision of the direct/derivative distinction, Delaware would not provide any remedy but federal law would provide a derivative one. And of course, arbitration provisions may make a comeback – even apart from the FAA, Delaware then gets to decide whether and to what extent invoking arbitration for securities claims is consistent with Delaware-imposed fiduciary duties. This is the race to the bottom on the Autobahn.
And that is exactly my point in Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine.
And … we aren’t even done with interesting business law developments this week, but this post is long enough so, more later.