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Court of Chancery Enforces Broad Forum Selection Clause; Enjoins First-Filed Action

In ASDC Holdings, LLC, et al. v. The Richard J. Malouf 2008 All Smiles Grantor Retained Annuity Trust, et al., C.A. No. 6562-VCP (Del. Ch. Sept. 14, 2011), read opinion here, the Court of Chancery held that where a forum selection clause is enforceable in a Delaware court, the Court will enforce it even if Delaware, based on McWane Cast Iron Pipe Corp. v. McDowell-Wellman Engineering Co., would otherwise default to the first-filed forum. Accordingly, the Court enforced the forum selection clause and enjoined the first-filed action.

Background

Plaintiffs included a dental practice (“All Smiles”), a private equity firm and its management firm (“Valor”), a limited liability company formed by Valor to invest in All Smiles (“ASDC”), the CEO and director of the private equity firm, and some directors and officers of the dental group and private equity firm. Defendants are Dr. Richard J. Malouf, the founder and controlling shareholder of the dental practice, as well as a trust Malouf established and controls (collectively, “Defendants” or “Malouf”).

In a 2010 contract with Malouf, ASDC agreed to invest $65 million in All Smiles, receiving in return 71% of its stock. At the same time, some of the Plaintiffs entered into various side agreements (the “Agreements”) with the Defendants. In the Agreements, they agreed to the exclusive jurisdiction in Delaware for “any claim or cause of action arising under or relating to t[he] Agreement[s] . . . .” In February 2011, Malouf and three other parties filed suit in Texas against a number of the Plaintiffs. The Plaintiffs who were sued in the Texas action moved to dismiss on the grounds that the forum selection clause in the Agreements conferred jurisdiction only in Delaware.

The Plaintiffs then brought suit in Delaware in June 2011. Plaintiffs sought specific performance under the Agreements, a declaratory judgment that Defendants must litigate exclusively in Delaware, and a preliminary injunction to enjoin the Texas action. Defendants moved to dismiss, challenging the Court’s subject matter jurisdiction on the basis that Plaintiffs had an adequate remedy at law as they could have raised the forum selection clause as an affirmative defense in Texas. They also claim that Plaintiffs cannot satisfy the standard for a preliminary injunction. Specifically, Defendants contend Plaintiffs have not shown (1) a reasonable probability of success and (2) that they would suffer imminent and irreparable harm if the Texas court determined whether the forum selection clause applied.

Broad vs. Narrow Forum Selection Clauses

In Malouf’s motion to dismiss, he relied upon El Paso Natural Gas Co. v. TransAmerican Natural Gas Corp. where the Delaware Supreme Court affirmed the holding that the Court of Chancery lacked subject matter jurisdiction to enjoin a proceeding in Texas even though the parties had agreed to exclusive jurisdiction in the Court of Chancery.

The Court pointed to two key distinctions between El Paso and this matter. First, in El Paso the parties contracted to confer subject matter jurisdiction specifically on the Court of Chancery for both legal and equitable claims between the parties. Because the underlying claims in Texas were legal in nature, the Court of Chancery could not exercise jurisdiction. Contrary to El Paso, in this case the forum selection clause was broader than the one in the El Paso case and enforceable as to legal and equitable claims because the parties submitted “‘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, Delaware . . . with respect to any claim or cause of action arising under or relating to th[e] Agreement[s] . . . .’”

Second, the forum selection clause in El Paso was narrower than the one in this case. The El Paso clause was limited to “ALL ACTIONS TO ENFORCE OR SEEK DAMAGES, SPECIFIC PERFORMANCE . . . FOR THE ALLEGED BREACH OF THIS AGREEMENT . . . .” Such “narrow forum selection clauses only cover claims dealing directly with rights embodied in the relevant contract.” Because it was so narrow, even if there was subject matter jurisdiction, it was unlikely that the clause could have applied to the claims. The clause in this case, rather, concerned “any claim or cause of action arising under or relating to th[e] Agreement[s].” Such broad clauses “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.’” The Court concluded that where such a clause is enforceable the parties’ contract should be honored even if the McWane first-filed analysis would suggest otherwise.

Texas Action Should Be Enjoined

The Court found that Plaintiffs satisfied the three elements for a preliminary injunction. On the first element, the Court held that even though some of the Delaware plaintiffs in Texas were not signatories to the Agreements “‘officers and directors . . . have standing to invoke [a] Forum Selection Provision as parties closely related to one of the signatories such that the non-party’s enforcement of the clause is foreseeable by virtue of the relationship between the signatory and the party sought to be bound.’” It also held that there is a colorable argument that the breach of fiduciary, breach of contract, and unjust enrichment claims arise out of the Agreements, given their broad scope.

On the second element, the Court held that “the procession of a claim in an unwarranted forum poses a threat of irreparable harm warranting a preliminary injunction.” Accordingly, if Plaintiffs are forced to litigate in Texas, they would be deprived of what they bargained for in the forum selection clause. As to the final element, because the parties agreed to litigate in Delaware, the balance of equities weighed in favor of Plaintiffs and what they bargained for, as opposed to Malouf and his choice of Texas as a forum.

This summary was prepared by Kevin F. Brady and Ryan P. Newell.

 

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