Kent Schmidt
Dorsey, Costa Mesa
schmidt.kent@dorsey.com

A long-awaited decision from the California Supreme Court may disrupt a commonly accepted tradition and feature of United States corporate law, with far-reaching implications around the world. For decades, corporations organised under Delaware law have compelled shareholders to bring any claims relating to the corporation in the Delaware Court of Chancery. This result is achieved through inclusion of a forum selection clause in the shareholder agreement and other corporate documents.

Now California is set to decide a case that not only challenges this norm, but also affects companies around the world – even outside the shareholder context. The California court precedent may invalidate forum selection clauses for parties to commercial agreements if such a provision would violate a California party’s right to a jury trial.

The general acceptance of forum selection clauses

US courts generally enforce forum selection clauses in contracts.^[1] This is true in California as well, and is based in the law’s adherence to the principle of honouring the freedom of contract.^[2]

Despite general acceptance, California courts will decline to enforce a contractually agreed-to forum if it substantially diminishes the rights of California residents in a way that violates the state’s public policy.^[3] A party opposing enforcement of a forum selection clause bears the substantial burden of persuading the court why it should not be enforced. But when the claims are based on unwaivable rights created by California statutes, the burden is reversed and the party seeking to enforce the forum selection clause must show that litigating the claims in the contractually designated forum will not diminish the substantive rights afforded under California law.^[4]

Outside the consumer or employment context, courts rarely set aside a forum selection clause. If two commercial parties agree on the forum and the issues do not involve public policies unique to California, the provision will be enforced.

Preferred forum of Delaware

This extends to shareholder agreements. Given that Delaware is the most common state of incorporation for most US companies and foreign subsidiaries, management has historically compelled shareholders around the world, including those in California, to bring their lawsuits before the Delaware Court of Chancery. Corporations prefer this forum. A Chancellor or Vice Chancellor, steeped in the intricacies of US corporate law, carefully considers evidence, applying Delaware’s well-developed standards on matters ranging from breach of fiduciary duty to the business judgment rule. This leads to predictability as to corporate governance. The inconvenience faced by shareholders having to appear in Delaware may be viewed as an additional benefit in discouraging lawsuits due to the inconvenience and cost of having to litigate in Delaware. Moreover, corporations avoid jury trials which are not permitted in the Delaware Court of Chancery.

EpicentRX’s surprising result

In EpicentRx Inc v Superior Court,^[5] a minority shareholder of a California-based corporation sued the corporation and directors in the California Superior Court. The corporation and other co-defendants moved to dismiss based on the forum selection clauses in the company’s certificate of incorporation and bylaws which dictated that all such suits would be heard in the Delaware Court of Chancery.

The trial court denied the motion, holding that the provision was a pre-contractual waiver of a jury trial, contravening California law and the California Constitution’s guarantee of a jury trial.^[6] The Court of Appeal affirmed. It noted that the Delaware Court of Chancery is a court of equity which generally does not recognise a right to a jury trial.^[7]

‘Because enforcement of the forum selection clause here has the potential to contravene a fundamental California policy of zealously guarding the inviolate right to a jury trial, which is unwaivable by predispute agreements, the defendants bear the burden of showing that litigation in Delaware Chancery Court will not diminish in any way EpiRx’s substantive rights… under California law. The defendants do not even try to satisfy their burden of showing that litigation in the Delaware Court of Chancery would not diminish EpiRx’s rights under California law. Having failed to satisfy their burden, the defendants have not established that the trial court erred when it declined to enforce EpicentRx’s forum selection clauses.’^[8]

The California Supreme Court’s awaited decision

The California Supreme Court granted review on 13 December 2023, but declined to stay the decision, although it remains uncitable pending resolution.^[9] The case is briefed and the California Supreme Court will issue its decision likely later this year after oral arguments.

Unless the California Supreme Court reverses the Court of Appeal, the case creates great uncertainty for contracting parties all over the world. Parties must legitimately question the efficacy of forum selection clauses if the counterparty has a nexus with California. Although this case pits a California jury trial against the contractually selected Delaware Court of Chancery and arises in the shareholder context, if affirmed, EpicentRx could upend all sorts of forum selection clauses the parties believed were unassailable, including in other contexts.

Consider an ordinary commercial contract between a party in California and a company based in Sweden, Japan, Australia or any other location. Suppose the contract dictates that the law of that country controls and disputes will be decided in that non-US forum. If a California party asserts legal claims subject to a jury trial, a California court may override the forum selection clause.

This would result not only in the non-US party having to litigate the issue in California courts, but having 12 California laypersons decide the case, regardless of its complexity or the millions of dollars in controversy. To say that this result may be an unpleasant surprise, particularly to those outside the US who look in puzzlement at our civil jury system, is an understatement. The opportunities to enjoy the sights and weather during an extended jury trial in California are little consolation, given the harsh realities of facing a California jury trial.

What to do?

Fortunately, prudent companies can avoid this quagmire with relative ease. The solution is not to include an express contractual waiver of a jury trial – those are disallowed under California law.^[10] The only surefire way to avoid a California jury trial in a contract with a party based in California is through an enforceable arbitration provision.

US courts strongly favour arbitration. While California courts have a history of reluctance to enforce arbitration provisions in the consumer and employment context, in the commercial context and with some prodding from the US Supreme Court^[11] and the Federal Arbitration Act, California will recognise and enforce a valid agreement between parties to arbitrate a dispute.

As we await a decision from the California Supreme Court in EpicentRX, companies should assess whether their forum selection provisions in contracts with California parties should be amended to provide for arbitration.