Print PDF

Delaware’s Court of Chancery Prevents Parties from Escaping Their Chosen Forum by Artful Pleading

October 26, 2011
Lewis H. Lazarus
Delaware Business Court Insider

Parties to a well-drafted contract can expect the Delaware courts to enforce the bargain reflected in their agreement, and that includes an agreement on forum selection. The Court of Chancery's Sept. 14 decision in ASDC v. The Richard J. Malouf All Smiles Grantor Retained Annuity Trust provides guidance to practitioners on how to draft and enforce a forum selection clause. The key takeaway is that a party who negotiates for dispute resolution in a Delaware forum can expect the Delaware Court of Chancery to enforce its forum selection and, where appropriate, enjoin the opposing party from going forward with litigation elsewhere.

That outcome, however, results only when the parties properly draft their forum selection clause not only to choose a forum that has jurisdiction, but also to provide that their clause covers all disputes that arise from or relate to their contract. In these circumstances, a Delaware court will specifically enforce the agreement and enjoin the breaching party from litigation elsewhere as the Malouf decision illustrates.

BACKGROUND TO DELAWARE LITIGATION

Malouf arose out of a purchase by a private equity firm, Valor Equity Partners, through its wholly owned subsidiary, ASDC Holdings LLC (ASDC), of 71 percent of the equity in a Texas-based dental practice, All Smiles Dental Center Inc. (All Smiles). Malouf and The Richard J. Malouf All Smiles Grantor Retained Annuity Trust (collectively Malouf) owned a minority block of shares in All Smiles after ASDC's acquisition. As part of the acquisition, the parties entered into five agreements, each of which required that "any dispute regarding [the] agreement[s] [would be resolved] through binding arbitration."

Disputes arose between ASDC and All Smiles and Malouf post-acquisition. ASDC and All Smiles therefore initiated arbitration and, in response, Malouf asserted his own claims in the arbitration. Malouf and three other parties who had entered into certain leases with All Smiles and entities affiliated with ASDC or its parent also initiated litigation in Texas (Texas plaintiffs). The Texas plaintiffs included as defendants Valor Equity Partners and certain of its officers and directors who were also officers or directors of All Smiles but not parties to any of the five agreements. The Texas plaintiffs initiated the Texas action notwithstanding that Malouf had agreed in each of the five agreements "to the exclusive jurisdiction of any state court within New Castle County, Delaware or, if it can obtain jurisdiction, the United States District Court for the District of Delaware sitting in Wilmington, Del. ... with respect to any claim or cause of action arising under or relating to th[e] agreement[s]." The parties named as defendants in the Texas litigation then initiated the Delaware action seeking to enforce the forum selection clause in the five agreements and to enjoin the Texas plaintiffs from going forward with the Texas action.

COURT REJECTS ARGUMENT THAT TEXAS COURT SHOULD DETERMINE FORUM ISSUE

Malouf and the other Delaware defendants relied primarily upon the 1994 case El Paso Natural Gas Co. v. TransAmerican Natural Gas Corp. to argue that the Court of Chancery lacked subject matter jurisdiction because the Delaware plaintiffs could raise their forum selection argument as an affirmative defense in Texas. In that circumstance, plaintiffs would have an adequate remedy at law and the Court of Chancery would lack subject matter jurisdiction. Although the El Paso court so held, the Court of Chancery distinguished that case on two grounds.

First, the Court of Chancery ruled that, unlike the forum selection clause at issue in the All Smiles action, the El Paso clause reflected an attempt to provide jurisdiction where there was none. This was because the claims at issue in the foreign proceeding in El Paso were all legal and the parties' forum selection clause attempted to provide jurisdiction in the Court of Chancery over all claims, legal and equitable. Therefore, in El Paso, there was no enforceable forum selection clause because the Court of Chancery lacks subject matter jurisdiction over purely legal claims. The All Smiles selection clause was enforceable as it properly provided for jurisdiction in Delaware courts over all claims, legal and equitable, and not simply in the Court of Chancery.

Malouf's second argument was that because the Delaware plaintiffs could raise the forum selection issue in the Texas litigation, the court ought to stay or dismiss the Delaware plaintiffs' second-filed action under the McWane doctrine. In rejecting this argument, the Court of Chancery relied upon the breadth of the forum selection clause at issue and explained the difference between a broad and a narrow clause as follows:

"Thus, narrow forum selection clauses only cover claims dealing directly with rights embodied in the relevant contract. Broad forum selection clauses, on the other hand, which expressly cover, for example, all claims between the contracting parties that 'arise out of' or 'relate to' a contract, apply not only to claims dealing directly with the terms of the contract itself, but also to "any issues that touch on contract rights or contract performance."

Because the All Smiles forum selection language applied to all claims or causes of action arising out of or relating to the five agreements, the court found the Delaware Supreme Court's 2010 holding in Ingres Corp. v. CA Inc. to be controlling. The Ingres court held that:

"Where contracting parties have expressly agreed upon a legally enforceable forum selection clause, a court should honor the parties' contract and enforce the clause, even if, absent any forum selection clause, the McWane principle might otherwise require a different result. The reason is that the McWane principle is a default rule of common law, which the parties to the litigation are free to displace by a valid contractual agreement." (internal citations omitted).

In Malouf, the court concluded that it had subject matter jurisdiction because "requiring plaintiffs to litigate the forum selection issue in Texas, when they bargained for a contractual provision that would avoid such a result, would deprive plaintiffs of the benefit of their bargain and cannot be an adequate remedy at law."

COURT ENJOINS MALOUF FROM PROSECUTING TEXAS ACTION

In deciding to enjoin Malouf and his trust from litigating in Texas, the court determined that the Delaware plaintiffs, Valor Equity Partners and certain of its officers and directors who were also officers or directors of All Smiles, could enforce the forum selection clause even though they were not signatories to any of the five agreements. The court relied upon Delaware precedent that permits nonsignatories to enforce forum selection clauses against a signatory as "parties closely related to one of the signatories such that the nonparty's enforcement of the clause is foreseeable by virtue of the relationship between the signatory and the party sought to be bound." (See the 2010 Delaware Supreme Court opinion in Ashall Homes Ltd. v. ROK Entertainment Group Inc.) The court rejected Malouf's argument that the fiduciary duty claims did not relate to the agreements, particularly the stockholders agreement and stock purchase agreement, even if they did not arise from them and criticized Malouf for attempting by artful pleading with some different plaintiffs and defendants to escape from his agreement to litigate any disputes relating to the agreements in Delaware.

LESSONS LEARNED

This case provides guidance to deal and litigation lawyers alike. For the deal lawyers, a broad forum selection clause that validly confers jurisdiction over all claims in the chosen forum is critical for the client to be able to enforce the agreement against a party who later sues elsewhere. For litigators, careful examination of the relevant clause may prevent a fruitless effort to attempt litigating in a forum prohibited by the parties' agreement. For all concerned, the bottom line is that the Delaware courts will enforce the parties' choice of Delaware as the exclusive forum as long as the parties properly draft language that covers the disputes at issue and provides for a forum that in fact has subject matter jurisdiction.