U.S. Supreme Court Holds That Forum Selection Clauses In Construction Contracts Should Be Rigorously Enforced

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[author: Eric Spencer, Snell & Wilmer]

As we predicted in October, the United States Supreme Court has issued a unanimous decision upholding a general contractor’s ability to require its subcontractors to litigate disputes in the state or federal court of its choosing. Thus, regardless of where the key witnesses or evidence are located, the fact that all the subcontractors are locally-based, or that a state has a public policy that prohibits enforcement of any clause in a construction contract that requires litigation elsewhere, federal courts are now required under Atlantic Marine Constr. v. U.S.D.C. West. Dist. Texas—in all but exceptional circumstances—to dismiss or transfer any subcontractor lawsuit that is filed other than where the general contractor specified. The result is boost for general contractors that operate across state lines, and wake up call for subcontractors to shift their lobbying efforts from the state capitols to the halls of Congress.

The Background

A more complete outline of how the Atlantic Marine case developed can be found in our previous alert [http://tinyurl.com/kbt6juy], but here are the key facts.

Atlantic Marine Construction Co. (AMC), a general contractor based out of Virginia Beach, Virginia, was awarded an Army Corps of Engineers contract to build a child development center at Fort Hood, Texas. AMC subcontracted a portion of the work to a local Texas subcontractor, J-Crew Management. AMC’s form subcontract contained a dispute resolution clause mandating that all disputes be litigated in the state or federal courts located in Norfolk, Virginia, near where AMC is headquartered.

At project completion, AMC withheld payment from J-Crew based on allegedly defective work. J-Crew responded by filing suit in federal district court in Austin, Texas.

Citing the parties’ forum selection clause, AMC sought to dismiss J-Crew’s complaint or, in the alternative, transfer it to a federal district court in Virginia. AMC relied on Rule 12(b)(3) of the Federal Rules of Civil Procedure, which permits dismissal for “improper venue,” and 28 U.S.C. § 1406(a), which requires dismissal or transfer of a lawsuit “laying in the wrong division or district.” In the alternative, AMC moved to transfer the lawsuit under 28 U.S.C. § 1404(a), which provides that “[f]or the convenience of the parties and witnesses, in the interest of justice, a district court may transfer any civil action to any other district or division where it might have been brought or to any district or division to which all parties have consented.”

In response, given that the parties’ subcontract did not contain a choice of law provision, J-Crew strategically dismissed its Federal Miller Act payment bond claim so that only its Texas-based claims remained. J-Crew’s goal was to get the district court to apply Texas law to the dispute, which—along with 21 other states—essentially prohibits enforcement of out-of-state forum selection clauses. In the alternative, J-Crew argued the judge should exercise his discretion under § 1404(a) to keep the lawsuit in Texas. Under J-Crew’s theory, the forum selection clause would be just one of many factors to be considered in a § 1404(a) analysis, along with the fact that all the work occurred in Texas, J-Crew and its subcontractors were located in Texas, and Texas public policy disfavors litigation anywhere else.

The district court deemed Texas public policy irrelevant as applied to a federal enclave like Fort Hood. It also held that § 1404(a) was the correct procedural mechanism to address AMC’s motions to dismiss/transfer, and after reading § 1404(a) the way J-Crew had suggested, the district court exercised its discretion to deny AMC’s motions accordingly. The 5th Circuit Court of Appeals agreed with that approach. However, since the 5th Circuit’s decision bucked the trend among most other appellate courts that had considered this issue, the Supreme Court decided to step in to resolve the split.

The Issue

The broader question before the Supreme Court was this: should forum selection clauses be rigorously enforced like most other types of contract clauses, such as arbitration clauses, or should federal courts balance certain factors in deciding whether to enforce a forum selection clause under the circumstances (and if so, which factors should be considered)?

The answer to these questions, although important for any company that conducts business across state lines, would have a particularly profound impact on the construction industry. Not only are forum selection clauses often found in construction contracts, but because the terms of these clauses are on occasion contained in the general contractor’s form subcontract with little or no discussion, subcontractors in many states (including Arizona, California, Nevada, Utah, Oregon and Texas) rely on state public policy as a backstop to curb what they perceive as potential overreaching by way of a general contractor’s superior bargaining power.

For general contractors who routinely work in multiple states—especially homebuilders and federal government contractors—forum selection clauses are critical in order to control litigation costs and expand their operations with some degree of predictability.

The Decision

Justice Alito’s decision this week, writing on behalf of a unanimous Supreme Court, came down strongly in the general contractors’ camp. But to be clear: that it is merely the effect of the decision, not necessarily the intent, given that the Court decided Atlantic Marine purely on the basis of statutory construction and not based on any of the unique aspects of the general contractor-subcontractor relationship.  The realities of the construction industry did not come into play in the Supreme Court’s decision whatsoever.

In a nutshell, the Supreme Court held that the lower courts correctly identified § 1404(a) as the appropriate procedural mechanism, but they applied the incorrect standard as to how § 1404(a) motions should be evaluated. In other words, AMC likely would have prevailed on its transfer motion had the district court applied the correct standard under § 1404(a). The Supreme Court’s key holdings are as follows:

  1. Where a defendant seeks to have a lawsuit transferred to an alternative federal court, the forum selection clause may be enforced by a motion to transfer under § 1404(a).[1]
  1. When a defendant files a § 1404(a) motion, the federal district court should transfer the case unless extraordinary circumstances clearly disfavor transfer.

a. Normally, a district court must evaluate both the private interests of the parties (“the convenience of the parties and witnesses”) and the public-interest considerations (“the interest of justice”) in deciding whether to transfer under § 1404(a). However, in situations where the parties have entered into a forum selection clause, the parties have already established the parameters of their private interests. Accordingly, a district court may only consider public interests in deciding whether to transfer under § 1404(a).

b. Public-interest factors should rarely defeat a transfer motion, and therefore forum selection clauses should be enforced in all but unusual circumstances.

c. A plaintiff who files suit in contravention of the forum selection clause bears the burden of establishing that transfer is unwarranted.

  1. In cases where a plaintiff disregards the forum selection clause, the substantive law of the state where the case was originally filed does not transfer to the new forum. Thus, the plaintiff does not get the benefit of invoking that state’s choice of law rules by filing first.

Applying these standards, the Supreme Court reversed the lower court decisions because, among other things, the district court had improperly (1) placed the burden on AMC, rather than J-Crew, (2) gave weight to the parties’ private interests, such as where the witnesses were located, and (3) assumed—based on the mistaken premise that Texas law would automatically apply here—that a Texas-based judge was better equipped to adjudicate the case.[2]

On the merits, the Supreme Court opined that “no public-interest factors that might support the denial of Atlantic Marine’s motion to transfer are apparent,” but nonetheless remanded the case to the lower courts to resolve that question.

The Consequences

The Atlantic Marine decision brings some clarity on the enforceability of forum selection clauses, yet numerous important issues remain unresolved.  The following considerations should be evaluated when either filing or defending a lawsuit that will implicate a dispute over the enforceability of a forum selection clause.

Arbitration clauses are not affected. Arbitration clauses were already rigorously enforced under the Federal Arbitration Act. Thus, any arbitration provision that requires disputes to be arbitrated in a particular state, or arbitrated under a particular state’s law, will continue to be strongly enforced by federal courts notwithstanding the Supreme Court’s analysis here. See Scherk v. Alberto-Culver Co., 417 U.S. 506, 519 (1974); see also American Arbitration Association, Construction Industry Arbitration Rules, R-12 (“When the parties’ arbitration agreement requires a specific locale, … the locale shall be that specified in the agreement.”).

Federal versus state litigation. The Atlantic Marine decision only applies in federal courts. Thus, to the extent some subcontractors are determined to ignore a forum selection clause, they may attempt to file suit in state court rather than federal court. If the lawsuit concerns a payment dispute on a federal project, however, that would place the subcontractor in the difficult position of foregoing its Miller Act payment bond claim (assuming that the subcontractor had otherwise complied with the Miller Act’s prerequisites). On the flip side, general contractors may attempt to remove those state lawsuits to federal court if possible under federal law.

Construction contracts are not unique. The Supreme Court heard from two business interests prior to oral argument. The U.S. Chamber of Commerce filed an amicus brief emphasizing the importance of upholding businesses’ contractual expectations, while the American Subcontractors Association argued that construction subcontracts are not necessarily freely-negotiated instruments entered into among parties with equal bargaining power. The Supreme Court did not acknowledge ASA’s arguments, yet expressly relied on the Chamber’s position.  As a result, it is possible that any argument urging a federal court to treat a construction contract differently than other types of contracts may fall on deaf ears.

More Miller Act cases may wind up being subject to a forum selection clause. Subcontractors who pursue Federal Miller Act claims traditionally file suit where the project is located, given that the statute provides that lawsuits shall be brought in “any district in which the contract was to be performed.” 40 U.S.C. § 3133(b)(3). The Atlantic Marine court did not decide whether a forum selection clause can override that provision, although the Supreme Court has previously dismissed that statutory provision as “merely a venue requirement.” F. D. Rich Co. v. United States for the Use of Indus. Lumber Co., 417 U.S. 116, 125 (1974). Given that several lower courts already rely on F.D. Rich to justify enforcement of forum selection clauses in Miller Act cases, Atlantic Marine may bolster that trend since 28 U.S.C. § 1391—the statute at issue in this case—is likewise “merely” a venue statute.[3]

In light of the federal/state dichotomy mentioned above, however, a defendant cannot seek transfer of a Miller Act claim elsewhere based on a forum selection clause that specifies venue in a state court. See e.g. United States ex rel. B & D Mechanical Contractors v. St. Paul Mercury Ins. Co., 70 F.3d 1115, 1117-18 (10th Cir. 1995). A subcontractor (or supplier) bound to that type of forum selection clause, and who otherwise meets the statutory prerequisites to pursue a Miller Act claim, should feel confident in filing its claim in a federal court where the project is located.

State public policies are likely unenforceable. Over a period of years, local contractors likely bargained intensely—and quite effectively—to convince the legislatures in 22 states to declare out-of-state forum selection clauses in construction contracts to be void or potentially void:

The question, in light of Atlantic Marine, is whether those laws still have teeth. They probably do not, because while the Supreme Court opened one door by adopting § 1404(a) as a transfer mechanism, it closed another door by holding that very few cases will ever justify refusing to transfer a case under that statute.

To be clear: the role of state public policy was not at issue before the Supreme Court. The district court had dismissed J-Crew’s public policy argument and J-Crew did not appeal that aspect of the district court’s order. Furthermore, the Supreme Court left the door open for future courts to potentially consider state public policy. Namely, district courts must consider the “public-interest factors” in deciding whether to refuse transfer, one of which is “the local interest in having localized controversies decided at home.” See Atlantic Marine at fn. 6 (quoting Piper Aircraft Co. v. Reyno, 454 U.S. 235, 241, n.6 (1981)). This is the potential hook to hang a state public policy argument upon.

However, a district court would be hard-pressed to conclude that state public policy qualifies as a sufficiently compelling local interest to justify non-transfer. Several portions of the Atlantic Marine decision make clear that a plaintiff’s burden is impossibly high. For one thing, a forum selection clause must be “given controlling weight in all but the most exceptional circumstances.” In particular, the Court stated that public interest factors will “rarely defeat a transfer motion” and therefore “the practical result is that forum-selection clauses should control except in unusual cases.” The Court continued: “Although it is ‘conceivable in a particular case’ that the district court ‘would refuse to transfer a case notwithstanding the counterweight of a forum selection clause,’ such cases will not be common.” And, despite no doubt being aware that J-Crew cited Texas public policy in the district court below, not to mention the fact ASA’s amicus brief emphasized the state public policy argument, the Supreme Court nonetheless concluded that “no public-interest factors that might support the denial of Atlantic Marine’s motion to transfer are apparent on the record before us.” 

In light of these admonitions, it is difficult to conclude that the public policies in 44% of U.S. states would qualify as the “rare,” “unusual” or “extraordinary” circumstances the Supreme Court was thinking about.  The Court more likely contemplated the example Justice Alito gave during oral argument: “[I]f there had been a hurricane that wiped out the courts of the Eastern District of Virginia for some period of time so no cases could be tried, … maybe that would be … something that might amount to an exceptional circumstance, but everything else is off the board.”[4] Thus, although this issue remains an open question, a subcontractor should not necessarily rely on state public policy to write the forum selection clause out of the subcontract it signed.

These are just some of the many issues to consider in light of the Atlantic Marine decision this week. For your business, the case should serve as a reminder to review the “template” forum selection clauses in standard agreements. And, if your business does not regularly use a forum selection clause, such a clause is now needed in light of the uncertainty that may result otherwise. In either case, a knowledgeable construction attorney should assess whether the particular forum selection clause you are faced with is enforceable in the first place.

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Notes

[1] In the event a forum selection clause specifies a non-federal forum (for example, if the clause specifies litigation must be brought in a certain state court or in a foreign country), the defendant may enforce that clause through the related doctrine of forum non conveniens. Forum non conveniens is a common law doctrine that permits courts to refuse to accept a case when there is a more appropriate forum elsewhere. Section 1404(a) is merely a codification of that doctrine for the subset of cases in which the transferee forum is another federal court. The Supreme Court made clear that both § 1404(a) and forum non conveniens motions should be treated identically when a defendant seeks to enforce a forum selection clause. [back]

[2] Even though the Supreme Court ruled in AMC’s favor, it squarely rejected AMC’s principal legal argument. The Court held that AMC could not rely on Rule 12(b)(3) (“improper venue”) or 28 U.S.C. § 1406(a) (lawsuits “laying in the wrong division or district”) because those provisions have no applicability when a lawsuit is filed in a venue otherwise proper under federal law. Namely, since 28 U.S.C. § 1391(b) permits a lawsuit to be filed (for example) in a federal district where the events giving rise to the claim occurred, a lawsuit filed in that district is, by definition, “proper” under federal. Section 1404(a) is therefore the more appropriate procedural mechanism. [back]

[3] See footnote 2. [back]

[4] States such as Arizona also deem out-of-state choice of law provisions void against public policy in the construction context. See A.R.S. 32-1129.05(A)(1). To the extent forum selection public policies are unenforceable in light of Atlantic Marine, so too will be statutes that require the home state’s choice of law rules to be applied. [back]