Bridging “The Gap”: Ninth Circuit Puts Derivative §14(a) Claims in Limbo

On June 1, 2023, the United States Court of Appeals for the Ninth Circuit issued the decision Lee v. Fisher[1], which held that forum selection clauses in the bylaws of Delaware corporations were not void under the Securities Exchange Act’s (“Exchange Act”) anti-waiver provision[2].  However, tucked away in Lee is a discussion about whether a shareholder could bring a false proxy claim derivatively under §14(a) of the Exchange Act.  Relying on a flawed analysis, the Court decided they could not be.

Lee v. Fisher delt with a derivative action brought on behalf of The Gap, Inc. (“Gap”), which included a §14(a) claim (which could only be asserted in federal court).  Gap had a forum selection clause which required derivative actions to be brought in the Chancery Courts of the State of Delaware, Gap’s state of incorporation.  The forum selection clause did not have any exceptions for claims brought under the Exchange Act.  The District Court dismissed the derivative action under the doctrine of forum non conveniens.  On appeal, the Ninth Circuit panel affirmed the dismissal, and the derivative plaintiff sought an en banc hearing.  This hearing resulted in the Lee decision. 

The Court addressed numerous reasons why the District Court should be reversed, including that dismissal “would violate the federal forum’s strong public policy of allowing a shareholder to bring a §14(a) derivative action.”[3]  The Court gives three reasons for rebutting this argument: (1) there is no such public policy; (2) §14(a) claims are direct claims; and (3) the Supreme Court has shifted away from implying private rights of action.  The Court’s reasoning for arguments (1) and (3) amount to a simple disagreement with the Supreme Court’s recognition of derivative §14(a) claims in Borak[4].  However, the Court’s reasoning under argument (2), if accepted, would create confusing and inconsistent rulings.

The Court begins by discussing the role of state law in filling the “gaps in [federal] statutes bearing on the allocation of governing power within the corporation should be filled with state law unless the state law permits action prohibited by the [Exchange Act], or unless its application would be inconsistent with the federal policy underlying the cause of action.”[5]  The Court then proceeds to state that under Delaware law, claims such as §14(a) would be direct rather than derivative.  However, the Court obscures the relevant Delaware law. 

The Court cites In re J.P. Morgan Chase & Co. Shareholder Litig., 906 A.2d 766, 772 (Del. 2006) for the proposition that “the injury caused by a violation of § 14(a) gives rise to a direct action under Delaware law, not a derivative action.”  However, In re J.P. Morgan recognizes corporate injury from proxy statements, “[t]o the extent the plaintiffs’ claim is that the compensatory damages worth $7 billion flow from the disclosure violation, that damages claim is derivative, not direct. Even if it were assumed that improper proxy disclosures induced JPMC’s shareholders to approve the merger (including the $7 billion overpayment), the harm resulting from the overpayment was to JPMC. Therefore, any damages recovered would flow only to JPMC, not to the shareholder class.”[6]  (emphasis added). The Lee Court thus misstates the relevant Delaware law on proxy disclosure violations. 

Further, even if the Lee Court’s analysis on this point was correct, it would only apply to shareholders of Delaware corporations.  While Delaware corporate law is influential throughout much of the United States, not all states wholly subscribe to it.  As a result, if shareholders of corporations incorporated in any of the other 49 states file §14(a) claims derivatively, Federal Courts will be called upon to answer whether each of those state would follow Delaware law as the Ninth Circuit has misstated it. Thus, more confusion and potentially inconsistent rulings will likely follow.

The Lee Court’s flawed analysis on whether §14(a) claims may be brought derivatively is contrary to Delaware law and as a result has placed such claims in limbo.  Lee thus unfairly dissuades proper derivative claims from being brought in the Ninth Circuit under fear of dismissal. 

[1] 70 F.4th 1129 (9th Cir. 2023).

[2] See §29(a) of the Exchange Act; 15 U.S.C. §78cc(a).

[3] Lee, 70 F.4th at 1143. 

[4] J.I. Case Co. v. Borak, 377 U.S. 426 (1964).

[5] Lee, 70 F.4th at 1147. (Quotations omitted.) 

[6] Id. at 722.

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