Summary
In Root v. GERS, Inc., No. 01 CV 326, 2002 WL 809539 (D. Neb. April 3, 2002), the court examined whether the specificity of pleading as to fraud fell closer to Marano or Farmland.
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Case No. 8:01CV326
April 3, 2002
MEMORANDUM AND ORDER
This matter is before the Court upon Defendants' Motion to Dismiss or Transfer (Filing No. 8). The parties have fully briefed the issues. For the reasons provided herein, the Defendant's motion shall be denied.
FACTUAL BACKGROUND
Plaintiff Terrence F. Root ("Root") was a shareholder and one of three Founders of FurnishNet, Inc., a company generally engaged in the business of formulating and offering e-business exchange solutions to customers within the furniture industry. (Root Aff. at ¶ 8, Filing No. 11). Defendant GERS, Inc. acquired FurnishNet on July 19, 2000. In exchange for the transfer of the Founders' common stock in FurnishNet, GERS provided each of the Founders with GERS common stock pursuant to a Restricted Stock Agreement, and each of the Founders began working for GERS pursuant to individual employment agreements. ( Id. at Exhibit B attached to Affidavit of Terrence Root). Approximately 380,000 shares of GERS stock were distributed to Root. The Restricted Stock Agreement gave GERS the right to repurchase up to 75 percent of Root's stock at a nominal purchase price, by way of a purchase option, but only if Root's employment with GERS was terminated for cause or if Root resigned without good reason. "Cause" specifically included poor performance. Thus, GERS could not terminate Root's employment without cause unless GERS was willing to relinquish its right to exercise the purchase option under the terms of the Restricted Stock Agreement.
Terrence Root, Timothy Morton, and David Hood are the founders of FurnishNet, and will be collectively referred to as the "Founders."
About seven months after GERS acquired FurnishNet, GERS President and a defendant herein, James Henderson ("Henderson"), requested that the Founders transfer back to GERS approximately 30 percent of the GERS common stock that was given to them in consideration for their FurnishNet stock. After several weeks of negotiation, the Founders agreed to transfer back approximately 25 percent of their GERS stock pursuant to the parties' Contribution Agreement and the Resolution of Final Issues Agreement. (Complaint at Exhibits 1 and 2 respectively, Filing No. 1).
The "Contribution Agreement" states that the Founders' returned stock would be used:
for the purpose of increasing the GERS stock option pool, with the objective of meeting the anticipated growth goals of GERS and enhancing its shareholder value by making additional incentive stock options available to employees and consultants of GERS who are critical resources to achieving these goals.Id. at Exhibit 1.
The Contribution Agreement was signed on or about April 20, 2001, by Henderson and all the Founders. On the same day, the same parties also signed the Resolution of Final Issues Agreement. ( Id. at Exhibit 2). This agreement outlines the consideration given to the Founders in exchange for their return of GERS common stock, including an agreement to restrict the meaning of "termination for cause" contained in each of the Founders' employment agreements. ( Id. at Exhibit 2).
The Contribution Agreement and the Resolution of Final Issues Agreement will be collectively referred to as the "Agreements."
During the negotiations relating to the transfer of shares back to GERS, the Founders proposed that all of their GERS common stock be released from the GERS purchase option, but GERS refused. In connection with the refusal, Henderson allegedly stated that GERS needed to maintain the incentive for the Founders to continue employment at GERS. Twenty-five days after the Agreements were executed, Root's employment at GERS was terminated without cause in connection with a reduction in force ("RIF"). Had his employment been terminated in this manner a month earlier, the GERS stock that he transferred back to the stock pool would not have been subject to GERS' purchase option, and Root would not have returned any of it.
ANALYSIS
Defendants seek to have this case dismissed pursuant to Fed.R.Civ.P. 12(b)(3) and 28 U.S.C. § 1406, or transferred to the Southern District of California pursuant to 28 U.S.C. § 1404(a), based on identical forum selection clauses that are contained in the Agreements. According to GERS, if the Court finds that there is a valid forum selection clause, the Court must dismiss under 28 U.S.C. § 1406. Section 1406 provides:
The district court of a district in which is filed a case laying venue in the wrong division or district shall dismiss, or if it be in the interest of justice, transfer such case to any district or division in which it could have been brought.
Id.
Where sophisticated parties freely negotiate a forum selection clause in a private business agreement, unaffected by fraud, undue influence, or overwhelmingly unequal bargaining power, there are compelling reasons to give such clauses full effect. See M/S Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 12-13 (1972). However, where there are allegations of fraud, undue influence or disparate bargaining power, such clauses require more careful scrutiny. The Court must closely consider the application of the forum selection clause to the claims presented here and, if necessary, weigh the forum selection clause in the balance of competing interests to determine where venue is proper.
The United States Court of Appeals for the Eighth Circuit has identified the considerations that are key to determining venue under 28 U.S.C. § 1404(a) where, as here, the parties have agreed to a forum selection clause in a contract. See Terra Int'l, Inc. v. Mississippi Chemical, 119 F.3d 688, 691 (8th Cir. 1997). According to Terra, a district court must initially consider what kinds of claims the contracting parties intended the forum selection clause to cover. Then the court must determine whether the specific claims in the case are covered by the forum selection clause. If the claims are tort claims, then the Eighth Circuit Court has identified three approaches taken by other United States Circuit Courts to answer whether the tort claims are sufficiently connected to the contract that the forum selection clause should control the venue for those claims. Finally, the court must determine whether all the relevant factors, including the convenience of the parties, the convenience of the witnesses, and the interests of justice, weigh in favor of dismissal or transfer.
The Agreement contains the following clause:
Governing Law, Jurisdiction and Venue: This Agreement shall be construed and enforced pursuant to the laws of the State of California. The parties agree that the state and federal courts sitting in San Diego, California, will have exclusive jurisdiction over any claim or action arising out of or related to this Agreement.
Complaint at Exhibit 1 ¶ 10; Exhibit 2 at ¶ 15.
Root and the Defendants intended the forum selection clause to cover claims "arising out of or related to this Agreement." The language is broad and covers all contractual claims arising from the Agreements. In addition, the "related to" language demonstrates that the parties intended at least some tort claims that are "related to" the Agreements to be controlled by the forum selection clause.
The Court's next inquiry is whether the specific claims presented in this case are covered by the forum selection clause. Defendants contend that Plaintiffs' claims are governed by the forum selection clause so long as they bear some relationship to the Agreements, and that all of the claims in this action satisfy that requirement. They argue that the Plaintiffs' claims grow out of the Agreements, that the trier of fact will have to refer to the Agreements to determine 1) the validity of the Plaintiffs' claims, and 2) the amount of damages, if any, Plaintiffs are entitled to receive. According to Defendants, the "gist" of Plaintiffs' claims is the breach of the contractual relationship, and, therefore, the forum selection clause should govern the location of the action.
Plaintiffs contend that the claims are not covered by the forum selection clause because their claims relate to a time and to events that occurred before consummation of the Agreements. Plaintiffs contend that they were deceived into executing the Agreements because the GERS representatives in the negotiation owed Root a duty to disclose certain information about the upcoming RIF and the general financial health of the company; that they breached the duty by failing to disclose the information; and that if Root had the benefit of that information, he would not have signed the Agreements. Plaintiffs maintain that the very nature of their claims makes the Agreements unenforceable and the forum selection clause inapplicable.
In determining whether' tort claims are sufficiently connected to a contract such that a forum selection clause should control the venue, the Eighth Circuit Court has considered three different approaches taken by the Third, Ninth and First Circuit Courts. Terra, 119 F.3d at 694. The Third Circuit court has found that where tort claims ultimately depend on the existence of a contractual relationship between the parties, such claims are covered by contractually-based forum selection clauses. The Ninth Circuit Court considers whether resolution of the claims relates to interpretation of the contract, and the First Circuit Court asks whether the contract-related tort claims involve the same operative facts as a parallel claim for breach of contract would involve. Id. and cases cited therein. The Third Circuit Court's analysis does not fit the facts presented, but under either the Ninth or the First Circuit Courts' approaches, this Court finds that the tort claims are not sufficiently related to the Agreements to require deference to the Agreements' forum selection clauses. Resolution of the tort claims does not relate to an interpretation of the Agreements, nor does it they involve the same operative facts as would a breach of contract claim brought under the Agreements. The rights and liabilities under the Agreements are not in dispute. Rather, the entire premise of the Agreements is under attack.
Defendants rely on several cases, including an Eighth Circuit Court decision that affirmed the district court's dismissal of an action under 28 U.S.C. § 1406 on the basis of a forum selection clause. See Marano Enterp. v. Z-Teca Restaurants, L.P., 254 F.3d 753 (8th Cir. 2001). In Marano, plaintiffs brought a Missouri state court action against defendants alleging claims of fraud, constructive termination, and breach of contract in connection with franchise and development agreements. The defendants removed the case to the Western District of Missouri and moved for dismissal on the ground that the contracts' forum selection clauses required that actions be brought in Denver, Colorado. The district court agreed that the forum selection clause applied to the plaintiffs' claims and dismissed the action. Plaintiffs appealed the dismissal, but the Court of Appeals affirmed the district court's order of dismissal, stating:
Marano's complaint does not even remotely suggest that the clauses were inserted into the agreements as the result of fraud, and the brief on appeal offers no specifics concerning what the fraud might have been or how it was perpetrated. The general allegation by Marano that it was induced by fraud to enter into the franchise and development agreements is insufficient to raise an issue that the forum selection clauses within those agreements may be unenforceable because of fraud.Id. at 757.
Plaintiffs urge this court to follow Farmland Indus., Inc., v. Frazier-Parrott Commodities, Inc., 806 F.2d 848 (8th Cir. 1986), abrogated on other grounds by Lauro Lines S.R.L. v. Chasser, 490 U.S. 495 (1989) (abrogation relating to whether denial of a motion to dismiss on basis of forum selection clause was immediately appealable); and Armco, Inc. v. North Atlantic Ins. Co., Ltd., 68 F. Supp.2d 330 (S.D.N.Y. 1999). Both Farmland and Armco held that tort claims presented in those cases were not so closely related to the contract as to require enforcement of the forum selection clauses.
In Farmland, a customer sued a commodities broker alleging fraud, breach of fiduciary duty, and violations of the securities laws. In affirming the district court's refusal to enforce the forum selection clause, the Eighth Circuit Court stated:
[W]e believe that in a situation where a fiduciary relationship (such as between a commodities broker and its customer) is created by a contract tainted by fraud, the person defrauded can not be held to the contractual forum selection clause. To hold otherwise would be grossly unfair to Farmland because it would force Farmland to comply with an agreement which never would have been made had the existence of the fraud been known.Id. at 851-852. In addition, the court found that the suit was broader than the clause. Id. at 852 (stating that Farmland's causes of action did not all arise "directly of indirectly from the agreement.")
In Armco, the district court held that a forum selection clause in a sale contract did not apply to claims that were based on a scheme to defraud that commenced before the contract was executed. The forum selection clause identified venue for actions "arising out of or in connection with" the sales contract. The court found that the action was not about a lack of performance under the contract nor about any party's rights under the contract. Rather, the court found that the complaint involved "a series of fraudulent activities that included the negotiation and execution of the subject Sale Contract." Armco, 68 F. Supp.2d at 338. Based on this finding, the Court concluded that the plaintiff's action should be viewed independently of that contract, in large part, because the allegations included a large scale scheme to defraud that included several pre-contract activities by the defendants. Id. at 338, citing Anselmo v. Univision Station Group, Inc., 1993 WL. 117173 at *2 (S.D.N Y Jan. 15, 1993) (holding that plaintiff's tort claim did not "relate to" the agreement because the tort grew out of events that preceded the agreement.) The Armco court also found that plaintiff's claims did not derive from benefits granted under the sales contract. The same conclusions could be drawn from the facts alleged in Plaintiffs' Complaint.
The allegations of fraud and breach of fiduciary duty contained in Plaintiffs' Complaint fall somewhere between the specific and broad-based schemes to defraud described in Farmland and Armco and the vague allegations of fraud described in Marano, but align more closely with the Farmland and Armco decisions.
Plaintiffs' Complaint at paragraph 12 is the backdrop against which the other allegations, including the allegations of fraud, need to be considered. Plaintiffs allege that Root's GERS stock was subject to a Restricted Stock Agreement that gave to GERS "a right to repurchase up to 75 percent of the Root Common Stock, at a nominal purchase price, through a purchase option which could be exercised by GERS only if Root's employment with GERS was terminated for cause [which originally included poor performance] or if Root resigned without good reason." Complaint at ¶ 12. The purchase option expired monthly as to 2.083 percent of the Root stock. Id.
After GERS asked for the return of 30 percent of the Founders' GERS stock, the parties began negotiating. Root alleges that during the negotiations, Defendants Henderson and Larkin were officers of GERS and as such, each owed him fiduciary duties in his role as a minority shareholder. Id. at ¶ 14. Root also alleges that a key negotiating point was that GERS, in exchange for the stock, changed the terms governing the purchase option to restrict the circumstances under which the purchase option could be exercised. As a result of this negotiation, the parties agreed that "cause" when used in connection with termination for cause was to exclude poor performance. Id. at ¶ 15.
Also during negotiations, the Founders proposed that all of their GERS stock be released from the purchase option. GERS refused to consider this proposal, and Henderson is alleged to have stated that GERS needed the purchase option as an incentive for the Founders to remain employed by GERS. Id. at ¶ 16.
At the end of the negotiations, the Agreements were signed. The Founders received no money for their return of 25 percent of their stock, but they received consideration in the form of contractual modifications to the Restricted Stock Agreement, including an agreement that the purchase option would immediately lapse as to 8.332 percent of the Root common stock and a change in the definition of termination for cause to exclude poor performance. Id. at ¶ 17.
Twenty-five days after Root transferred back 82,471 shares of GERS common stock, he was terminated from GERS pursuant to a reduction in force. Id. at ¶ 18. The termination was not for cause. Root alleges that if he had known that his employment was to be terminated as a result of a RIF, or that he was being considered as a candidate for lay-off, then he would not have transferred 82,471 shares of stock back to GERS because those shares would no longer have been subject to the purchase option.
Root alleges that Henderson and Larkin acted with scienter or with reckless disregard when they withheld information about the RIF and about the possibility that Root would be selected for lay-off. He also alleges that Henderson made material misrepresentations to the Founders when he stated that GERS needed to retain the purchase option to give the Founders an incentive to remain employed with GERS. See Complaint at ¶¶ 24-28. These allegations of fraud and misrepresentation form the basis of all Plaintiffs' claims under theories of securities fraud, id. at ¶¶ 22-30; fraudulent concealment, id. at ¶¶ 31-37; and breach of fiduciary duty, id. at ¶¶ 38-41. Plaintiffs also assert claims pursuant to a theory of negligent misrepresentation, id. at ¶¶ 42-47, alleging that even if the GERS representatives did not have actual knowledge of the RIF during the negotiations, in the exercise of reasonable care and inquiry they should have known and discovered facts relating to the RIF.
Although the allegations of fraud are not as complicated as the schemes alleged in Farmland and Armco, they are more specific than anything referenced by the Marano court. Accordingly, the Court concludes that the allegations of fraud are sufficiently specific, and the tort claims and allegations of damages are sufficiently distinct from the Agreements that enforcement of the forum selection clause would not be reasonable in this case.
According to Terra, the Court must weigh several considerations to determine proper venue under Section 1404(a). Terra, 119 F.3d at 696. The Court considers the convenience of the parties, the convenience of the witnesses, and the interests of justice. Plaintiffs are Nebraska residents and have unequivocally stated that their preference is to proceed in Nebraska. Plaintiffs have identified several witnesses who may be called to testify, some of whom reside in Nebraska and some in North Carolina. A potentially key witness who advised Root about the stock transfer is a Nebraska resident.
In the employment contract, Nebraska is identified as Root's home, and all written notices and communications with him were directed to his Omaha, Nebraska, address. During all times that Root worked for FurnishNet or for GERS, he resided in Nebraska. During the negotiations relating to the Agreements, and at the time when the concealment and fraud are alleged to have taken place, Root resided in Nebraska, and GERS presumably communicated with him here.
On the other hand, the Defendants are California residents, and presumably, many of GERS' witnesses are California residents. GERS' brief states that it "does not debate for a moment that it conducted business in Nebraska" and that it would be subject to the personal jurisdiction of this court.
Documents and other exhibits for trial are located in both Nebraska and California.
GERS argues that the interests of justice would be served by proceeding in California because the choice of law clause in the contracts requires California law to be applied. While the Court will not now consider whether the Agreements' choice of law provision applies, there is little doubt that this court could apply California law to the facts presented so this factor does not weigh heavily against proceeding in Nebraska.
Given all these considerations, the Court concludes that the balance of competing interests weighs in favor of finding venue appropriate in Nebraska. Because the forum selection clauses in the Agreements are not enforceable as to Plaintiffs' claims, the balance of factors weighs in favor of venue remaining where the Plaintiffs selected.
IT IS ORDERED:
Defendants' Motion to Dismiss or Transfer (Filing No. 8) is denied.