On June 1, the Ninth Circuit en banc in Lee v. Fisher issued a consequential decision calling into question the scope of the implied right of action recognized by J.I. Case Co. v. Borak and creating a stark split with the Seventh Circuit.
The Rise of Derivative Borak Suits
In 1964, the Supreme Court in Borak held that, under Section 14(a) of the Securities Exchange Act of 1934, as implemented by Rule 14a-9, shareholders enjoy an implied private right of action to bring claims for false or misleading proxy statements. Importantly, Borak explained that a shareholder lawsuit under Section 14(a) may be brought as either a direct action, on behalf of individual shareholders, or a derivative action, on behalf of the corporation.
As we explain in a forthcoming article, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiffs’ bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation to regulatory compliance to diversity, equity, and inclusion. Stated differently, these derivative suits concern internal corporate affairs – matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Court of Chancery. But rather than bringing a state law claim for breach of fiduciary duty, these federal derivative suits make the tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits aim to establish federal court jurisdiction and, thereby, avoid the likely failure that such suits would face before a Delaware judge.
Lee v. Fisher
The suit in Lee exemplifies this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of the Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership. As a derivative claim, the Lee suit alleged that the Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed the company by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation.
The Gap sought to dismiss the suit by invoking a forum provision in its corporate bylaws that required all derivative suits to be litigated in the Delaware Chancery Court. Because federal courts have sole jurisdiction to hear Exchange Act lawsuits, directing all derivative claims to the Delaware Chancery would effectively preclude the plaintiff’s derivative Boraksuit. Nevertheless, the Ninth Circuit en banc ruled that the forum bylaw is enforceable against the plaintiff, as a matter of both Delaware and federal law, and dismissed the plaintiff’s federal derivative lawsuit.
Lee has immediate practical implications. In the Ninth Circuit, corporations may now use a forum bylaw to force all derivative claims into Delaware Chancery and, thus, eliminate federal derivative Borak suits altogether. Shareholders remain free to bring (i) the same Borak claim as a direct or class action to recover any damage they suffered personally and (ii) a derivative action under state corporate law to recover any damage suffered by the corporation. But duplicative federal derivative suits brought under Borak can be quashed by a corporate forum provision that requires all derivative suits to be filed in Delaware.
Lee also has significant doctrinal ramifications. Citing our forthcoming article, Lee ruled that Borak’s recognition of an implied derivative right under Section 14(a) is dicta and not binding precedent. In doing so, Lee wholeheartedly embraces our argument that, under the Supreme Court’s post-Borak precedents, the implied right of action under Section 14(a) is limited to direct claims.
Ever since Borak was decided, the Supreme Court has repeatedly criticized the 1964 precedent and told us that it must be narrowly interpreted. Moreover, the court has said, and reiterated, that state law – not federal common law – defines what a derivative action is. Indeed, Borak could well be the most denigrated Supreme Court precedent that has not been expressly reversed.
Any lower court that spends time examining the court’s post-Borak precedents would conclude that Borak’s implied derivative right of action is nonbinding dicta, as the Ninth Circuit has now done, and that private Borak suits are limited to direct claims only. Even in the absence of a corporate forum bylaw directing all derivative suits to Delaware, there is no cognizable federal derivative cause of action under Section 14(a).
The Circuit Split
Significantly, the Ninth Circuit’s decision in Lee squarely conflicts with an earlier Seventh Circuit ruling, in Seafarers v. Bradway. Seafarers held, over a dissent by Judge Easterbrook, that a corporate forum bylaw identical to the one at issue in Lee is unenforceable against a derivative Borak suit, both as a matter of Delaware law and under the Exchange Act’s anti-waiver provision.
The Ninth Circuit en banc in Lee concluded that Seafarers was “flawed” and “mistaken” as to both Delaware and federal law. On the former, Seafarers was clearly wrong, a belief supported by former Delaware judges who submitted a letter to the Ninth Circuit. Delaware law plainly establishes that (i) a corporate forum provision may regulate federal securities law claims, and (ii) a claim alleging that a false or misleading proxy statement misled shareholders is a direct rather than derivative claim.
Borak is in Jeopardy
Given the split between Seafarers and Lee, and the dissents each decision generated, it seems likely that the Supreme Court will revisit Borak – even if the plaintiffs in Lee don’t seek cert.
In 2019, when the Supreme Court granted cert in Emulex v. Varjabedian, a case involving the implied right of action under Exchange Act Section 14(e), much of the court’s attention was focused on Borak and its meaning for implied rights of action under Section 14. During oral arguments, the chief justice remarked that “we now know that [Borak] was not the right approach,” that “Borak would not be decided the same way today,” and that, “from today’s perspective, what we did back then [in Borak] was a mistake.” Ultimately, the court decided that cert was improvidently granted in Emulex because that case dealt with Section 14(e), not Section 14(a). But the oral arguments in Emulex make clear that the Supreme Court is interested in revisiting Borak through Lee or another case that squarely presents the proper question. At that point, all of Borak may be in jeopardy. If so, Lee is about much more than the enforcement of a forum selection clause. It is also about the continuing vitality of Borakas valid precedent for an entire body of private securities litigation.
This post comes to us from professors Mohsen Manesh at the University of Oregon School of Law and Joseph A. Grundfest at Stanford University Law School. It is based on their recent article, “Abandoned and Split But Never Reversed: Borak and Federal Court Derivative Litigation,” available here.