Bloomberg Law
Dec. 9, 2022, 10:45 AM

Gap Diversity Case Pits Corporate Bylaws Against Stockholders

Martina Barash
Martina Barash

A Gap Inc. shareholder suing to improve the clothier’s diversity efforts will battle current and former directors before the full Ninth Circuit over a corporation’s ability to use its bylaws to knock out a derivative claim filed on its behalf.

The judges may even address whether the species of derivative claim advanced by the stockholders—one arising from proxy statements—exists at all. And the case could create a circuit split, opening a path to the US Supreme Court.

Gap’s bylaws say all shareholder suits brought on its behalf—derivative suits—must be heard in Delaware state court. But some derivative claims, including one in this suit, can only be brought in federal court. The directors, pointing to the bylaws, say the investors’ suit is a legal impossibility.

A lower court, and a three-judge panel of the US Court of Appeals for the Ninth Circuit in May, agreed with the Gap directors. Then the full Ninth Circuit decided it needed to weigh in. Oral argument is set for Dec. 12.

Another court called a similar situation in an unrelated case “checkmate” in favor of the defendants.

If the case’s dismissal is upheld, that “will deprive investors of meaningful enforcement of securities laws and undermine corporate accountability,” said Micah Hauptman, an attorney for the Consumer Federation of America.

But bylaws specifying a particular forum “serve the interests of both corporations and their stockholders,” two business organizations said in a friend of the court brief. The clauses ensure “that suits raising matters of corporate governance are brought in the courts of the state in which a corporation is organized and whose law thus governs the corporation’s internal affairs,” the US Chamber of Commerce and the National Retail Federation said.

Gap is a Delaware corporation.

“There are so many arguments here,” said Professor Ann M. Lipton of Tulane University Law School in New Orleans. The Ninth Circuit could go in a number of different directions, she said—some with “extraordinary implications.”

Shareholder Vote on Diversity Sought

Investor Noelle Lee alleges board members misled shareholders about the level of diversity the company achieved, contending the directors’ conduct hurt the company by opening it to discrimination lawsuits and damaging its reputation and goodwill.

She seeks to force a shareholder vote on proposals that include replacing at least two current board members with Black directors and creating a $700 million fund to fill more management positions with Black and minority employees.

The Gap directors, for their part, deny the company fell short in its commitment to diversity and inclusion.

Lee filed the suit in federal court in California. Her complaint included claims for breach of fiduciary duty under state law and a derivative claim under Section 14(a) of the Securities Exchange Act of 1934, which prohibits false statements in proxy statements.

Gap’s bylaws require that “any derivative action or proceeding on behalf of the corporation” be filed in Delaware Chancery Court. But the Exchange Act says claims under its provisions may only be brought in federal court.

Acknowledging that sending the claims to state court would effectively extinguish them, the retailer asked the US District Court for the Northern District of California to enforce the bylaw by determining that the case was brought in an inconvenient forum. The court did so and dismissed the suit.

A three-judge Ninth Circuit panel’s decision affirming the dismissal was vacated when the full court took the case Oct. 24.

‘To Waive Compliance’

A central focus of the parties’ briefing is an Exchange Act provision that voids any “condition, stipulation, or provision binding any person to waive compliance” with the act’s requirements.

Lee says, in a brief, that enforcing the forum-selection clause “would amount to a waiver” of her 14(a) claim—her right to sue. She says the anti-waiver provision therefore invalidates the bylaw and makes it unenforceable.

But the defendant Gap directors say the company’s forum-selection clause doesn’t waive their duty of “compliance” at all. The duties it must comply with are the Exchange Act’s “substantive obligations” not to issue misleading proxy statements, which it maintains it didn’t do, the directors said in a November brief.

That position, if endorsed by the Ninth Circuit, would create a split with the Seventh Circuit, where the same sort of bylaw was at issue.

The “checkmate” result of shutting down the claim “would be difficult to reconcile with Section 29(a) of the Exchange Act,” the anti-waiver provision, the Seventh Circuit said in Seafarers Pension Plan v. Boeing Co., a divided opinion issued in January. The Chicago-based appeals court also said that result would violate Delaware law, which “respects the non-waiver provision” in the federal law.

The Ninth Circuit could say there’s no waiver problem, Professor Mohsen Manesh of the University of Oregon School of Law in Portland told Bloomberg Law. Lee has alternatives and isn’t waiving any rights because she can bring a direct, rather than derivative, claim under Section 14(a), and has Delaware state-law claims at her disposal, he said.

In an unusual step, several former prominent Delaware state judges joined the amicus brief that Manesh submitted with Professor Joseph A. Grundfest of Stanford Law School, saying they saw no violation of Delaware law.

But the CFA’s Hauptman said that the Exchange Act “provides an avenue for shareholders, either directly or derivatively,” when companies don’t tell the truth in proxy statements.

Derivative claims serve different purposes from direct shareholder claims, which usually seek damages, he said. Derivative suits often seek “to reform corporate misconduct, typically board misconduct,” he said. They “improve outcomes for investors.” The CFA participated in an amicus brief.

Right Doesn’t Exist, Some Say

But Manesh and Grundfest say the right to sue derivatively under Section 14(a) isn’t in the text of the Exchange Act or even within the holding of a key US Supreme Court precedent, J. I. Case Co. v. Borak.

It’s an implied right, Grundfest said. “The Supreme Court has cautioned that implied rights of action should be interpreted narrowly,” he said.

The pair’s amicus brief, and one submitted by two business organizations, gave another reason why courts shouldn’t recognize a derivative action under Section 14(a). The claim is direct, they say. The “injury in a proxy misstatement claim is to the stockholder’s individual right to cast an informed vote,” said the US Chamber and the National Retail Federation.

‘Dire’ Spillover Effects

The case raises even broader issues, Hauptman said: it could implicate other statutes, other causes of action, and even arbitration. “The potential ramifications are significant and dire for investors,” he said.

Lipton, too, pointed to possible implications if the ruling is affirmed. Delaware and other states allow corporations to absolve directors of liability for negligent actions, she said. If the Ninth Circuit eliminates derivative suits under 14(a), or allows them to be shunted into a court without jurisdiction to hear them, investors will lose an important tool against board members, she said.

And if forum-selection clauses can stop proxy claims by sending them to the Delaware Court of Chancery, “what about anti-fraud claims?” Lipton said. “Why not just create a bylaw” to bar those? she asked.

The case is Lee v. Fisher, 9th Cir., No. 21-15923, rehearing en banc 12/12/22.

To contact the reporter on this story: Martina Barash in Washington at

To contact the editors responsible for this story: Carmen Castro-Pagán at; Andrew Harris at

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