Enforcing Forum-Selection Clauses in D&O Agreements in Bankruptcy
The enforceability of forum-selection clauses in Chapter 11 proceedings remains a point of contention in Delaware bankruptcy practice. The debate over whether such provisions should be recognized in a Chapter 11 often is particularly salient in the context of director and officer agreements (hereinafter referred to as D&O agreements).
As with other pre-petition agreements, the exclusive equitable jurisdiction bestowed upon a bankruptcy court can trump bargained-for forum-selection clauses in D&O agreements. Disregarding these provisions often forces directors and officers to litigate ostensibly "nonbankruptcy" issues in an atypical, and sometimes distant, forum. To further complicate matters, certain courts have adopted the view that filing a proof of claim in a Chapter 11 case subjects a director or officer to the jurisdiction of the bankruptcy court and negates the effectiveness of the forum-selection clause. This creates a Cornelian dilemma that, under certain circumstances, makes it exceedingly difficult for a director or officer to navigate the Chapter 11 process while attempting to preserve rights under a forum-selection clause.
The recent turmoil in the financial markets along with the lagging economy has caused numerous high-profile Chapter 11 filings, which in turn has focused attention on the liability of directors and officers in charge of these companies. Most directors and officers are shielded from personal liability for suits relating to the actions taken on behalf of the corporation through contractual provisions for indemnification and advancement of legal fees. The rationale for including such protections in D&O agreements is that shielding directors and officers from personal liability consistent with their respective fiduciary duties is necessary for attracting and retaining sought-after directors and officers.
Forum-selection clauses are standard in many D&O agreements, particularly in light of the multijurisdictional nature of modern corporate structures. D&O agreements employ forum-selection clauses as a commercial tool to provide certainty for both companies and their respective directors and officers that disputes will be litigated in a mutually agreeable forum. The clauses are intended to provide comfort to both parties that the designated forum is both logistically convenient and well-versed in relevant corporate law necessary to tackle complex commercial issues. Commonly, forum-selection clauses establish that a specified forum, often Delaware, has exclusive jurisdiction over disputes arising from the D&O agreement and that both parties waive the right to assert any objection on the grounds of venue or jurisdiction.
The interjection of a Chapter 11 filing can undermine the terms of a forum-selection clause under certain circumstances, even where the merits of the dispute unquestionably involve resolution of state-law issues. In general, Delaware bankruptcy courts have shown a willingness to respect bargained-for contractual provisions in the context of Chapter 11 and enforce forum-selection clauses in deference to the parties' private agreement. This approach is consistent with the U.S. Supreme Court's decision in Bremen v. Zapata Off-Shore Co., which instructs that a forum-selection clause is enforceable notwithstanding a Chapter 11 filing unless it: (1) is the result of fraud or overreaching, (2) would violate public policy or (3) would be so gravely difficult and inconvenient for a party to be deemed unreasonable.
Seizing on the "public policy" option, certain courts have found that enforcement of a forum-selection clause is violative of public policy where it undermines the goal of centralization of all bankruptcy matters before the bankruptcy court. In determining whether the dispute is a proceeding that should be before the bankruptcy court, courts rely upon the distinction between "core" and "noncore" matters as defined under the Bankruptcy Code.
Section 157(b) of the Bankruptcy Code provides that bankruptcy judges are empowered to hear all core proceedings and enumerates a nonexhaustive list of core proceedings, which includes "matters concerning the administration of the estate," "allowance or disallowance of claims against the estate" and "counterclaims by the estate against persons filing claims against the estate." (See 8 U.S.C. § 157(b)(2).) A core proceeding also has been characterized as one invoking a substantial right provided by the Bankruptcy Code or that by its nature could only arise in a bankruptcy proceeding. Relying on this core versus noncore distinction, certain courts have concluded that the public policy in favor of adjudicating core matters in a bankruptcy proceeding trumps the interest in respecting the forum-selection clause.
Against this backdrop, bankruptcy courts analyzing forum-selection clauses in D&O agreements generally recognize that litigation involving indemnification and fee-advancement provisions are matters of state law that do not constitute core bankruptcy matters. An interesting wrinkle exists in this analysis, however, where a director or officer files a proof of claim against a bankrupt company on account of the liability for indemnification or advancement. Certain courts have adopted the view that the act of filing a proof of claim invokes the bankruptcy court's "core" jurisdiction because it triggers the process of "allowance or disallowance of claims against the estate" under Section 157(b) of the Bankruptcy Code. Therefore, these courts conclude that the filing of a proof of claim transforms a pre-petition state law cause of action into a core proceeding, thereby rendering any applicable forum-selection clause unenforceable.
A recent decision from the Delaware District Court in Kurz v. EMAK Worldwide Inc. exemplifies the conundrum that directors and officers may face in trying to enforce a forum-selection clause without forfeiting a right to receive a distribution from a corporate debtor's bankruptcy estate. In Kurz, a director of the corporation and the corporation entered into an indemnification agreement that contained a forum-selection clause designating that all matters related to the agreement would be litigated in Delaware Chancery Court. The director initiated litigation to enforce the advancement provision contained in the D&O agreement in the Chancery Court (advancement action), however, prior to conclusion of that action the corporation filed for bankruptcy in the Central District of California (California bankruptcy case), according to the opinion.
Because of the filing of the California bankruptcy case, the advancement action was stayed, however, a bar date for claims against the corporation was set in the California bankruptcy case. Seeking to protect his right to distribution, the director filed a proof of claim in the California bankruptcy case prior to the bar date and sought to lift the automatic stay to proceed with the advancement action in the Delaware Chancery Court in accordance with the forum-selection clause. The corporation, however, sought to have the advancement action transferred to California to be adjudicated in the California bankruptcy case in conjunction with the director's proof of claim, according to the opinion.
The Delaware District Court in Kurz sided with the corporation and adopted the position that the director's filing of the proof of claim was sufficient to transform the advancement action into a core matter, thereby overriding the enforceability of the relevant forum-selection clause. The Kurz decision is a stark reminder to directors and officers of the effect that the seemingly innocuous act of filing a proof of claim can have on the ability to enforce a forum-selection clause in a D&O agreement.
Obviously, the dynamic created by Kurz and other courts adopting this position results in a double-edged sword for directors and officers seeking to obtain the bargained-for benefits of indemnification and advancement under a D&O agreement while also preserving the forum-selection clause. Directors and officers have a strong interest in litigating disputes concerning indemnification and advancement in the agreed-upon forum based on both legal and practical considerations. Opting not to file a proof of claim in order to preserve a forum-selection clause results in a pyrrhic victory, however, since declining to file a proof of claim likely would bar any recovery from the debtor company's bankruptcy estate regardless of the success in obtaining indemnification or advancement under a D&O agreement.
Although this scenario places a director or officer seeking to preserve a forum-selection clause in a difficult situation, there are three important caveats whether arguing to enforce or disregard a forum-selection clause in a D&O agreement under these circumstances:
irst, whether the issue of whether a forum-selection clause is per se unenforceable when a matter is deemed core remains an open question in this jurisdiction. Courts adopting this view have looked to the 3rd U.S. Circuit Court of Appeals' 2008 decision in In re Exide Technologies. The Exide decision, however, merely recognized in dicta that whether a proceeding is core is often determinative as to whether a forum selection is enforceable but did not establish a per se rule to that effect.
Second, the actual holding of the 3rd Circuit's decision in Exide is that the filing of a proof of claim cannot transform a state law cause of action into a core proceeding when the state law cause of action exists strictly between nondebtors. This is true even where the debtor company may be liable for contribution or indemnification to the nondebtor defendant. Thus, to the extent a director or officer seeks to enforce a D&O agreement against a nondebtor entity where a related corporate entity that may have contingent liability is in Chapter 11, the filing of a proof of claim should not affect the forum-selection clause.
Third, the June 23 U.S. Supreme Court decision in Stern v. Marshall may provide an avenue to challenge the conclusion that filing a proof of claim based on a right to indemnification or advancement automatically triggers core jurisdiction that would trump a forum-selection clause. In Stern, the Supreme Court found that a bankruptcy court lacked constitutional authority under Article I to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim. Although the holding in Stern is limited to state law counterclaims that must be resolved independently of the claims allowance process, the potential ramifications of the decision as to concept of core jurisdiction of the bankruptcy court could present ammunition for a director or officer seeking to preserve a forum selection clause while also filing a proof of claim.
As demonstrated by Kurz, directors and officers may be surprised to learn that merely filing a proof of claim against a corporate debtor can serve to wipe out the bargained-for protections of a forum-selection clause under certain circumstances. Although directors and officers can face a Catch 22 in seeking to enforce a forum-selection clause, understanding the interplay between filing a proof of claim and bankruptcy court jurisdiction can better equip counsel in weighing the options to determine the best way to proceed to protect the interests both of preserving the forum-selection clause and ultimately receiving a distribution from a bankruptcy estate.
Reprinted with permission from 11/09/2011 issue of the Delaware Business Court Insider© 2011 ALM Media Properties LLC. Further duplication without permission is prohibited. All rights reserved.