First Department Holds Alleged Fraud Invalidates Amendment to ByLaws Requiring Exclusive Jurisdiction in Delaware

• Posted on: Apr 27 2022

By: Jeffrey M. Haber

New York courts favor the enforcement of forum selection clauses. They do so because they provide certainty and predictability in the resolution of disputes. 

[Ed. Note: this Blog recently examined forum selection clauses here and here.]

A forum selection clause is “prima facie valid and enforceable unless it is shown by the challenging party to be unreasonable, unjust, in contravention of public policy, [or] invalid due to fraud or overreaching.” Because a forum selection clause is “prima facie valid and enforceable”, New York courts do not hesitate to dismiss actions that were brought in violation of the agreed upon forum. “[T]he party asserting the applicability of the forum selection clause has the burden of establishing that the forum selection clause applies.” 

In Massoumi v. Ganju, 2022 N.Y. Slip Op. 02760 (1st Dept. Apr. 26, 2022) (here), the Appellate Division, First Department reversed the dismissal of the action because the forum selection clauses at issue did not govern the dispute and was alleged to have been procured by fraud.  

Plaintiff is the co-founder, former Chief Executive Officer (“CEO”) and board member of non-party Zocdoc, Inc. (“Zocdoc”), a Delaware corporation with its principal place of business in New York. In September 2020, plaintiff commenced the action against defendants Oliver Kharraz, Nikhil Ganju (Zocdoc co-founders and officers), and Netta Samroengraja, alleging fraud and conspiracy to commit fraud. Plaintiff sought damages and declaratory relief that, inter alia, he should be restored to his former executive and board member positions. He also sought to invalidate Amendment No. 4 to Zocdoc’s bylaws, proposed in his absence, which purported to make the Court of Chancery of the State of Delaware the exclusive forum for issues governed by the internal affairs doctrine.

In November of 2015, Zocdoc’s board of directors voted to remove plaintiff as CEO. At the same meeting, the board voted to adopt a number of corporate actions, including an amendment to the company’s bylaws that made Delaware the exclusive forum for lawsuits that concerned the company’s internal affairs. After being approved by the board, the forum selection bylaw amendment was submitted for stockholder consent and ratification.

In October 2018, plaintiff made a shareholder inspection demand under Section 220 of the Delaware General Corporation Law (“DGCL”) to review certain non-public details about Zocdoc’s business (the “Demand”). In connection with the Demand, plaintiff signed a Confidentiality and Non-Disclosure Agreement (“NDA”), as a stockholder, to inspect Zocdoc’s books and records. The NDA required that a demanding stockholder who wished to file a claim based on “Confidential Inspection Material” must do so in Delaware. 

Under the NDA, the following information was excluded from the definition of “Confidential Inspection Material”: a) information generally available to the public; (b) information that was available to the demanding stockholder on a non-confidential basis prior to its disclosure by the company; and/or (c) information that was in the demanding stockholder’s possession prior to its disclosure by the company. 

As noted, plaintiff brought suit in connection with his removal from the company, claiming, among other things, fraud. In particular, plaintiff alleged that defendants lied to him about the purpose and agenda of the November 2015 board meeting and concealed the meeting’s true purpose from him. Plaintiff claimed that had he known the truth, he would have taken majority control of Zocdoc’s Class B common shares and protected his position with the company.

Defendants moved to dismiss the action pursuant to CPLR § 3211(a)(1) and (7), arguing that the forum selection clauses in the NDA and Amendment No. 4 to the bylaws required the plaintiff to bring his claims in Delaware, and, in any event, plaintiff failed to state a claim upon which relief could be granted. Plaintiff opposed the motion. The motion court granted the motion to the extent of “dismissing the complaint without prejudice to refiling the action in Delaware.” The First Department reversed, vacated the judgment issued in connection with the motion court’s decision and order, reinstated the complaint, and denied the defendants’ motion.

The Court held that “defendants failed to meet their burden of establishing that the forum selection clause in the NDA applie[d] to th[e] action.” The Court found that “[t]he complaint [was] not based on, [did] not rely on, and [did] not incorporate Confidential Inspection Material.” The Court explained that the “crux of the complaint concern[ed] actions taken in November 2015 — three years before the NDA — of which plaintiff ha[d] personal knowledge.” Under the NDA, said the Court, “Confidential Inspection Material [did] not include information that plaintiff already possessed prior to signing the NDA.”

Moreover, held the Court, “Confidential Inspection Material [did] not include public information.” The Court noted that plaintiff “specifically cite[d] to public information to support [his] allegation that nonparty Zocdoc, Inc. ha[d] lost value since defendants ousted him as CEO and chairman of the board, thus reducing the value of his Zocdoc shares.” The Court rejected the argument that Zocdoc’s current bylaws may constitute Confidential Inspection Material, noting that the focus of the complaint was “on the amendments that were passed in November 2015 … which … [were made] part of the non-confidential record on appeal.”

With regard to the forum selection clause in the amendment to the bylaws (i.e., Amendment No. 4), the Court held that the internal affairs doctrine did not warrant dismissal of the claims.  Under 8 Del. C. § 115, a corporation’s “bylaws may require … that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts [of Delaware]”. When they do, Delaware courts (and the courts of New York) require litigation concerning the corporation’s internal affairs to be brought in a Delaware court as such a provision is valid and enforceable to the same extent as other contractual forum-selection clauses.  

The internal affairs doctrine governs claims that, among other things, “are based upon a violation of a duty by a current or former director or officer or stockholder,” or “as to which [the DGCL] confers jurisdiction upon the [Delaware] Court of Chancery.” “Matters falling within the scope of the [internal affairs doctrine] … [also] include … the election or appointment of directors and officers, the adoption of by-laws, … the holding of directors’ and shareholders’ meetings, … [and] by-law amendments[.]” 

The Court found that based upon the allegations in the complaint, Amendment No. 4 was not valid.  The Court explained that “plaintiff ha[d] set forth sufficient allegations that the amendment was part of the fraud perpetrated upon him.” Under New York law, fraud vitiates the entire agreement, including a forum selection clause found therein. The same is true under Delaware law, where the courts have held that “the use of deception as a means by which to conduct a Delaware corporation’s affairs” is prohibited. 

Finally, the Court rejected the defendants’ contention that Amendment No. 4 was valid because Zocdoc’s shareholders ratified it. Since the fraudulent acts rendered the amendment void, said the Court, it could not “be cured by shareholder approval.” In other words, said the Court, “[i]f an action is ‘the product of fraud,’ it is void.” 

Takeaway

Massoumi highlights the distinction between acts that are void and voidable. As noted by the Court, acts of fraud are void. And, in the corporate context, such acts cannot be ratified by shareholder vote and approval.

The distinction between void and voidable acts was an issue in Klaasen v. Allegro Dev. Corp., cited herein. There, the Delaware Supreme Court, in an en banc decision, held that board action carried out by means of deception is per se void, not voidable. In doing so, the Court made the distinction between void and voidable acts, corrected past cases that blurred the distinction, and partially overruled two other cases. 

New York takes the same approach. In DeSola Group v. Coors Brewing Co., the First Department held that fraudulent acts vitiate an agreement in its entirety: “Even assuming the Agreement is applicable, the forum selection clause contained therein is unenforceable since the record is replete with allegations indicating that the entire Agreement was permeated with fraud…. Since plaintiff’s allegations of fraud pervading the entire Agreement would render the entire Agreement void, the forum selection clause contained therein is unenforceable.” 

The takeaway, therefore, is the importance of the distinction between void and voidable acts. As shown in Massoumi, acts that are the result of alleged fraudulent behavior are void and not subject to equitable defenses (such as acquiescence and ratification).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

References

1. Brodsky v. Match.com LLC, 2009 WL 3490277, at *4 (S.D.N.Y. Oct. 28, 2009).
2. Boss v. Am. Express Fin. Advisors, Inc., 6 N.Y.3d 242, 246 (2006).
3. Premium Risk Grp. v. Legion Ins. Co., 294 A.D.2d 345, 346 (2d Dept. 2002).
4. Creative Mobile Techs., LLC v. Smart Modular Techs., Inc., 97 A.D.3d 626, 627 (2d Dept. 2012); British W. Indies Guar. Tr. Co. v. Banque Internationale a Luxembourg, 172 A.D.2d 234, 234 (1st Dept. 1991).
5. U.S. Immigration Fund LLC v. Litowitz, 2019 WL 1421377, at *6 (Sup. Ct., N.Y. County Mar. 29, 2019), aff’d as modified, 2020 N.Y. Slip Op. 02533 (1st Dept. 2020). 
6. The factual discussion of Massoumi comes from the Court’s decision and the briefing of the parties before the motion court and the First Department. 
7. Slip Op. at *1 (citing, DeSola Grp. v. Coors Brewing Co., 199 A.D.2d 141 (1st Dept. 1993)).
8. Id.
9. Id.
10. Id.
11. Id. at *2.
12. Id.
13. Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013). See also Hemg Inc. v. Aspen Univ., 2013 WL 5958388, at *2-3 (Sup. Ct., N.Y. County Nov. 4, 2013).
14. 8 Del. C. § 115.
15. Restatement (Second), Conflict Of Laws § 302, cmt. a.
16. Slip Op. at *2. 
17. Id. (citing, DeSola, 199 A.D.2d at 141).
18. Amazing Home Care Servs., LLC v. Applied Underwriters Captive Risk Assur. Co. Inc., 191 A.D.3d 516, 518 (1st Dept 2021). See also DeSola, 199 A.D.2d at 141-142.
19. Klaasen v. Allegro Dev. Corp., 106 A.3d 1035, 1046 (Del. 2014). See also Bäcker v. Palisades Growth Capital II, 246 A.3d 81, 106 (Del. 2021) (noting that board actions tainted by deception are invalid); Hockessin Cmty. Ctr., Inc. v. Swift, 59 A.3d 437, 458 (Del. Ch. 2012) (actions taken by a board or director that were “obtained through trickery or misrepresentation” are invalid).
20. Slip Op. at *2 (quoting, Nevins v. Bryan, 885 A2d 233, 245 (Del. Ch. 2005), aff’d, 884 A.2d 512 (Del. 2005)).
21. Id. (citing, Nevin, 885 A.2d at 253 n.77).
22. DeSola Group v. Coors Brewing Co., 199 A.D.2d 141, 141-142 (1993).