DE Court Rejects Argument That Exclusive Forum Selection Clause Is Unenforceable

In Baker v. Impact Holding (C.A. No. 4960-VCP (Del. Ch. May 13, 2010)), the Delaware Court of Chancery recently validated a forum selection clause in which stockholders of a Delaware corporation agreed to the exclusive jurisdiction of state and federal courts located in Texas to adjudicate disputes over the terms of their stockholders agreement. In so ruling, the court rejected a public policy argument that parties to a stockholders agreement may not contract away the right of Delaware courts to oversee disputes between stockholders of a Delaware corporation. The court also found the clause applicable to an individual who controlled entities that were parties to the stockholders agreement, even though that individual did not sign the agreement in his individual capacity.

Background

In January 2008, two entities controlled by Bradley C. Baker sold all of the stock of Impact Confections, Inc. to Impact Holding, Inc., a Delaware corporation. In return, the Baker-controlled entities received stock in Impact Holding, the majority of whose stock is owned by Brazos Private Equity Partners, LLC.

The Baker-controlled entities (but, notably, not Baker) and Brazos entered into a stockholders agreement in connection with the sale. This agreement provides that Baker would serve as a member of the board of directors of Impact Holding for as long as he and his controlled entities continue to own their Impact Holding shares. In addition, the stockholders agreement requires that any legal action between the parties “to enforce any of the terms of this Agreement, or ' in any other way pertaining to this Agreement, shall be brought only in a State or Federal court sitting in the State of Texas in the city of Dallas and not in any other State or Federal court.”

In July 2009, despite the provision of the stockholders agreement guaranteeing Baker a board seat, Baker was removed from the Impact Holding board of directors. In response, Baker filed suit in the Delaware Court of Chancery, alleging that his removal from the board violated the stockholders agreement. Impact Holding moved to dismiss Baker's claim on the basis of improper venue, citing the stockholders agreement's exclusive forum selection clause. Baker countered that: 1) the forum selection clause, insofar as it “would oust Delaware courts of jurisdiction over a case involving the internal affairs of a Delaware corporation,” violates Delaware public policy; and 2) he is not bound by the forum selection clause because he (unlike his controlled entities) is not a party to the stockholders agreement. The court, siding with Impact Holding on both counts, dismissed Baker's claims, but “without prejudice to Baker's ability to refile his claims in an appropriate forum.”

The Court's Analysis

Validity of the Exclusive Forum Selection Clause As a Matter of Public Policy

The court first addressed Baker's claim that the forum selection clause violated Delaware public policy. Baker contended, on the basis of a provision of Delaware's Limited Liability Company Act, that “Delaware has a public policy that renders unenforceable contractual provisions that prevent Delaware courts from hearing matters related to the internal affairs of Delaware business entities.” Section 18-109(d) of the LLC Act states that a nonmanager member of a limited liability company “may not waive its right to maintain a legal action ' in the courts of the State of Delaware with respect to [the] internal affairs” of the LLC. When the Delaware Legislature added this provision to the LLC Act, it also amended ' 17-109(d) of the Delaware Limited Partnership Act “in an analogous fashion.” The court noted, however, that “importantly,” at that time the Delaware Legislature “did not enact such a provision in the corporate context. The Legislature easily could have amended the General Corporation Law in a similar fashion, but did not do so. I infer from this that the Legislature did not intend to make an analogous provision applicable to corporations and that Delaware does not have an overarching public policy that prevents the stockholders of Delaware corporations from agreeing to exclusive foreign jurisdiction of any matter involving the internal affairs of such entities.” In fact, “[b]ecause there is no statute or other clear indication of a legislative intent to limit the scope of forum selection clauses with respect to corporations,” and in light of the fact that “Delaware courts routinely enforce such forum selection clauses, even where they mandate exclusive foreign jurisdiction,” the Court found “no public policy of the State of Delaware” invalidating the stockholders agreement's exclusive forum selection clause.

Applicability of the Forum Selection Clause

The court next addressed whether the forum selection clause applies to Baker, even though he is not a party to the stockholders agreement and does not own any stock in Impact Holding in his personal capacity. Although Baker did sign the agreement on behalf of his controlled entities in a representative capacity, the court found that this “does not bind the signer in his personal capacity.”

The court went on to note that “Delaware courts use a three-part inquiry to determine whether a non-signatory to an agreement is bound by a forum selection clause in that agreement.” The first inquiry considers the validity of the clause. Here, the court noted that “such clauses 'are presumptively valid and have been regularly enforced.'” As noted above, Baker's only challenge to the validity of the clause, his assertion that it violates Delaware public policy, was rejected by the court.

The second inquiry asks whether the non-signatory either “is a third-party beneficiary or closely related” to the agreement. The court noted that “[c]ase law suggests two ways a party can be closely related to an agreement: 1) the party receives a direct benefit from the agreement or 2) it was foreseeable that the party would be bound by the agreement.” Again the court sided with Impact Holding, agreeing that “a benefit need not be pecuniary to constitute a direct benefit.” In the court's view, a seat on the board of directors of a company in which his controlled entities have a substantial investment “is sufficient to constitute a direct benefit to Baker.”

As to the third inquiry, “whether Baker's claim arises from his standing relating to the [stockholders agreement],” the Court stated simply: “The answer is yes.” Based on this analysis of the three-part test, the court held that Baker was “estopped from asserting that the forum selection clause does not apply to him.”

Conclusion

The court's dismissal of Baker's claims on the basis of improper venue reinforces the proposition that Delaware courts will enforce the negotiated terms of a contract, even if that results in another forum applying Delaware law in resolving a dispute between stockholders of a Delaware corporation. It is interesting to note the court's refusal to extend the public policy underlying provisions of Delaware's Limited Liability Company Act and Limited Partnership Act to the corporate context.

Furthermore, the Baker opinion serves as a reminder that one must not necessarily be a signatory to an agreement in order to be constrained by certain of its provisions. A person as closely tied to an agreement as Baker was to the stockholders agreement, and in a position to directly benefit from it, will be bound by a valid forum selection clause even if that person is not a named party to the agreement.

Robert S. Reder, a member of this newsletter's Board of Editors, is a New York-based partner in the Global Corporate Group of Milbank, Tweed, Hadley & McCloy LLP. The author gratefully acknowledges Elad Roisman and Elena Hassan, associates in the firm's Global Corporate Group, who assisted in the preparation of this article.

In Baker v. Impact Holding (C.A. No. 4960-VCP (Del. Ch. May 13, 2010)), the Delaware Court of Chancery recently validated a forum selection clause in which stockholders of a Delaware corporation agreed to the exclusive jurisdiction of state and federal courts located in Texas to adjudicate disputes over the terms of their stockholders agreement. In so ruling, the court rejected a public policy argument that parties to a stockholders agreement may not contract away the right of Delaware courts to oversee disputes between stockholders of a Delaware corporation. The court also found the clause applicable to an individual who controlled entities that were parties to the stockholders agreement, even though that individual did not sign the agreement in his individual capacity.

Background

In January 2008, two entities controlled by Bradley C. Baker sold all of the stock of Impact Confections, Inc. to Impact Holding, Inc., a Delaware corporation. In return, the Baker-controlled entities received stock in Impact Holding, the majority of whose stock is owned by Brazos Private Equity Partners, LLC.

The Baker-controlled entities (but, notably, not Baker) and Brazos entered into a stockholders agreement in connection with the sale. This agreement provides that Baker would serve as a member of the board of directors of Impact Holding for as long as he and his controlled entities continue to own their Impact Holding shares. In addition, the stockholders agreement requires that any legal action between the parties “to enforce any of the terms of this Agreement, or ' in any other way pertaining to this Agreement, shall be brought only in a State or Federal court sitting in the State of Texas in the city of Dallas and not in any other State or Federal court.”

In July 2009, despite the provision of the stockholders agreement guaranteeing Baker a board seat, Baker was removed from the Impact Holding board of directors. In response, Baker filed suit in the Delaware Court of Chancery, alleging that his removal from the board violated the stockholders agreement. Impact Holding moved to dismiss Baker's claim on the basis of improper venue, citing the stockholders agreement's exclusive forum selection clause. Baker countered that: 1) the forum selection clause, insofar as it “would oust Delaware courts of jurisdiction over a case involving the internal affairs of a Delaware corporation,” violates Delaware public policy; and 2) he is not bound by the forum selection clause because he (unlike his controlled entities) is not a party to the stockholders agreement. The court, siding with Impact Holding on both counts, dismissed Baker's claims, but “without prejudice to Baker's ability to refile his claims in an appropriate forum.”

The Court's Analysis

Validity of the Exclusive Forum Selection Clause As a Matter of Public Policy

The court first addressed Baker's claim that the forum selection clause violated Delaware public policy. Baker contended, on the basis of a provision of Delaware's Limited Liability Company Act, that “Delaware has a public policy that renders unenforceable contractual provisions that prevent Delaware courts from hearing matters related to the internal affairs of Delaware business entities.” Section 18-109(d) of the LLC Act states that a nonmanager member of a limited liability company “may not waive its right to maintain a legal action ' in the courts of the State of Delaware with respect to [the] internal affairs” of the LLC. When the Delaware Legislature added this provision to the LLC Act, it also amended ' 17-109(d) of the Delaware Limited Partnership Act “in an analogous fashion.” The court noted, however, that “importantly,” at that time the Delaware Legislature “did not enact such a provision in the corporate context. The Legislature easily could have amended the General Corporation Law in a similar fashion, but did not do so. I infer from this that the Legislature did not intend to make an analogous provision applicable to corporations and that Delaware does not have an overarching public policy that prevents the stockholders of Delaware corporations from agreeing to exclusive foreign jurisdiction of any matter involving the internal affairs of such entities.” In fact, “[b]ecause there is no statute or other clear indication of a legislative intent to limit the scope of forum selection clauses with respect to corporations,” and in light of the fact that “Delaware courts routinely enforce such forum selection clauses, even where they mandate exclusive foreign jurisdiction,” the Court found “no public policy of the State of Delaware” invalidating the stockholders agreement's exclusive forum selection clause.

Applicability of the Forum Selection Clause

The court next addressed whether the forum selection clause applies to Baker, even though he is not a party to the stockholders agreement and does not own any stock in Impact Holding in his personal capacity. Although Baker did sign the agreement on behalf of his controlled entities in a representative capacity, the court found that this “does not bind the signer in his personal capacity.”

The court went on to note that “Delaware courts use a three-part inquiry to determine whether a non-signatory to an agreement is bound by a forum selection clause in that agreement.” The first inquiry considers the validity of the clause. Here, the court noted that “such clauses 'are presumptively valid and have been regularly enforced.'” As noted above, Baker's only challenge to the validity of the clause, his assertion that it violates Delaware public policy, was rejected by the court.

The second inquiry asks whether the non-signatory either “is a third-party beneficiary or closely related” to the agreement. The court noted that “[c]ase law suggests two ways a party can be closely related to an agreement: 1) the party receives a direct benefit from the agreement or 2) it was foreseeable that the party would be bound by the agreement.” Again the court sided with Impact Holding, agreeing that “a benefit need not be pecuniary to constitute a direct benefit.” In the court's view, a seat on the board of directors of a company in which his controlled entities have a substantial investment “is sufficient to constitute a direct benefit to Baker.”

As to the third inquiry, “whether Baker's claim arises from his standing relating to the [stockholders agreement],” the Court stated simply: “The answer is yes.” Based on this analysis of the three-part test, the court held that Baker was “estopped from asserting that the forum selection clause does not apply to him.”

Conclusion

The court's dismissal of Baker's claims on the basis of improper venue reinforces the proposition that Delaware courts will enforce the negotiated terms of a contract, even if that results in another forum applying Delaware law in resolving a dispute between stockholders of a Delaware corporation. It is interesting to note the court's refusal to extend the public policy underlying provisions of Delaware's Limited Liability Company Act and Limited Partnership Act to the corporate context.

Furthermore, the Baker opinion serves as a reminder that one must not necessarily be a signatory to an agreement in order to be constrained by certain of its provisions. A person as closely tied to an agreement as Baker was to the stockholders agreement, and in a position to directly benefit from it, will be bound by a valid forum selection clause even if that person is not a named party to the agreement.

Robert S. Reder, a member of this newsletter's Board of Editors, is a New York-based partner in the Global Corporate Group of Milbank, Tweed, Hadley & McCloy LLP. The author gratefully acknowledges Elad Roisman and Elena Hassan, associates in the firm's Global Corporate Group, who assisted in the preparation of this article.