Gap’s Win Sends Investors, Companies Seeking Friendlier Courts

Gap’s victory over an investor’s diversity lawsuit creates a divide that motivates companies and individual shareholders to pursue courts they view as most favorable until the US Supreme Court steps in.

Gap Inc. scored a significant victory Thursday when a divided US Court of Appeals for the Ninth Circuit bench upheld a corporate bylaw that effectively killed an investor’s lawsuit alleging misstatements in proxy materials by specifying that derivative claims must be filed in the Delaware Court of Chancery—which can’t hear securities laws claims that only can be brought in federal courts.

However, that’s at odds with a prior Seventh Circuit victory for shareholders in a decision that didn’t enforce companies’ forum selection clause for derivative claims.

The split opens up an arms race between individual shareholders and companies jockeying for what each views as the most favorable forum to litigate allegations of poor management. Where the cases end up will be part of each side’s strategy to maximize their leverage—and there may be no proper venue.

Delaware is good for shareholders and companies because it offers stability, said Yaron Nili, a professor at the University of Wisconsin Law School.

“A lot of shareholders and companies have a preference for the Delaware judiciary and the reason is that a Delaware court is super well-regarded as a court that understands what’s going on for both parties,” he said in a phone interview.

“They all appreciate the fact that the Chancery Court is efficient, that it acts pretty quickly, and it has the power to give remedies that maybe other courts can’t,” he said.

In the Ninth Circuit case, Gap successfully fought off a shareholder’s allegation the company had overstated its diversity efforts, which opened it up to legal challenges and potentially damaged its public reputation. The company successfully argued the case should have begun in the Delaware Chancery Court.

The Ninth Circuit’s decision suggests individual shareholders who think they have been harmed by a company’s management can bypass Delaware Chancery and take their complaints directly to a federal court for resolution. However, that’s “perplexing,” said Scott Nelson of the Public Citizen Litigation Group, which was on the losing side of the case.

“The remedy sought in a derivative action is a monetary recovery or other relief to benefit the corporation, which can’t be obtained in a direct action,” he said in an emailed statement

There may be cases where shareholder attorneys will think it’s worth the time and effort to bring a direct claim for an individual shareholder who alleges being harmed by the company, said Verity Winship, a professor at the University of Illinois Urbana-Champaign College of Law.

But one shareholder’s claim often isn’t worth it. And with conflicting appeals court rulings, a shareholder attorney probably starts thinking, “I also am looking at other categories of suits, or I’m bringing them in the Seventh Circuit for now,” Winship said.

The US Chamber of Commerce and National Retail Federation had urged the Ninth Circuit to reject the shareholder’s claims against Gap. The investor still could sue for her own benefit in federal court under Gap’s bylaws, even if they stop her derivative lawsuit on the retailer’s behalf there, the business groups said in a November amicus brief backing the company.

Thursday’s decision “is a major victory for corporations and their stockholders,” Janet Galeria, senior counsel of the Chamber’s Litigation Center, said in a statement Friday. “Delaware forum bylaws help corporations to avoid unnecessary costs by directing actions raising issues of Delaware corporate law to the courts of Delaware.”

Delaware Benefits

It would be helpful for the Supreme Court to resolve the circuit split, but in the meantime, Delaware remains a solid option for companies incorporated there, said Joseph Grundfest, a professor of law and business at Stanford Law School and former Commissioner of the SEC.

“After all, those courts will be the most expert and authoritative when it comes to interpreting and applying the relevant law,” he said in an emailed statement

The Ninth Circuit opinion “also observes, correctly I think, that the Exchange Act does not bar litigating the derivative claim in a Delaware court where the plaintiffs have available to them all of the remedies that could be obtained in federal court, and where a substantial body of precedent requires that the claim be heard.”

Companies began incorporating forum selection clauses “because they were worried that opportunistic shareholders would try to find a court where the lack of knowledge or the sympathy of the judge would play in their favor,” Nili said.

And shareholders haven’t fought a constraint on the forum for derivative claims “because it makes sense,” he said.

The case is Lee v. Fisher, 9th Cir. en banc, No. 21-15923, 6/1/23.

Bloomberg Law reporter Andrew Ramonas in Arlington, Va., contributed to this story.