U.S. Supreme Court May Strongly Enforce Forum Selection Clauses: Many Businesses Will Breathe a Sigh of Relief, While Smaller Contractors Might Brace for Impact

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The U.S. Supreme Court appears poised—for the first time in 25 years—to uphold the enforceability of forum selection clauses, which permit contracting parties to prospectively determine the location/court where a lawsuit will be adjudicated in the event of a dispute. Specifically, in cases where a plaintiff disregards that clause by filing suit in a federal court in its home state, the Supreme Court signaled it will streamline the process for the defending party to dismiss the lawsuit or transfer it to the contractually specified federal forum. This would provide some much-needed predictability for businesses that routinely conduct business across state lines and rely on forum selection clauses to control litigation costs accordingly.

However, the potential impact on the construction industry could be particularly significant. For example, while large general contractors who perform projects across the country will likely benefit, especially those engaged in federal contracting, smaller subcontractors potentially stand to lose the benefit of certain legal protections they rely upon to keep litigation close-to-home if Atlantic Marine Constr. v. U.S.D.C. West. Dist. Texas is decided the way the Supreme Court appears to be leaning.

The facts of this case are not unusual. Atlantic Marine Construction Co. (AMC), a general contractor based out of Virginia Beach, Virginia, was awarded an Army Corps of Engineers design-build contract at Fort Hood, Texas. AMC subcontracted to J-Crew Management, a local Texas subcontractor with only five employees. The form subcontract contained a dispute resolution clause mandating that all disputes be litigated in the state or federal courts located in Norfolk, Virginia.

At project completion, AMC withheld approximately $160,000 from J-Crew based on allegedly defective work. J-Crew disregarded the forum selection clause and filed suit in federal district court in Texas. The complaint included causes of action for violation of the Miller Act (40 U.S.C. § 3133), violation of various Texas statutes and breach of contract. J-Crew claimed venue in Texas solely pursuant to the Miller Act, which provides that a payment bond lawsuit must be brought in “any district in which the contract was to be performed.”

Citing the parties’ forum selection clause, AMC sought to dismiss the complaint or, in the alternative, transfer it to the Eastern District of Virginia. AMC cited 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 response, J-Crew made a strategic decision to dismiss its Miller Act claim and rely on an alternative basis for federal jurisdiction instead. Namely, by falling back on “diversity” jurisdiction—i.e. a plaintiff may maintain a lawsuit in federal court if the amount in controversy exceeds $75,000 and the plaintiff and defendant are citizens of different states—J-Crew could take advantage of the fact that the substantive law of the state where a lawsuit is filed normally governs the dispute. (The subcontract did not contain a choice of law provision). Thus, given that Tex. Bus. & Com. Code Ann. § 272.001 makes out-of-state forum selection clauses voidable at a contractor’s option, J-Crew argued that AMC’s motion to dismiss/transfer was moot because the federal court was required to enforce Texas public policy.

In the alternative, even if Texas law did not control, J-Crew argued the judge should exercise his discretion under 28 U.S.C. § 1404 to keep the lawsuit in Texas notwithstanding the forum selection clause, given that § 1404 permits a court to consider “the convenience of parties and witnesses” and “the interest of justice” in deciding whether to transfer a case. Under a § 1404 analysis, the forum selection clause specifying venue in Virginia would be just one of many factors to be considered, along with the fact that all the work occurred in Texas, J-Crew and its subcontractors were located in Texas, and, as noted above, Texas public policy disfavors litigation anywhere else.

The district court held that Texas § 272.001 was inapplicable because Fort Hood is an exclusive federal enclave. However, it agreed with J-Crew that § 1404 was the correct standard and exercised its discretion to deny AMC’s motion to dismiss/transfer. The 5th Circuit Court of Appeals affirmed the district court’s decision, setting up a U.S. Supreme Court showdown on the enforceability of forum selection clauses—a subject it had not addressed for nearly 25 years. The case was argued in October 2013.

Based on that oral argument, however, the Supreme Court appears to be strongly leaning towards reversing the lower courts’ decisions and holding that forum selection clauses must be rigorously enforced, notwithstanding the convenience of witnesses or the location of evidence. Of course, the tenor of oral argument is not always a reliable predictor of the ultimate outcome in a case. However, given the lopsidedness of the Justices’ comments in AMC’s favor, it appears that the only issue in doubt is the Supreme Court’s rationale, not the outcome.

The stakes from this case are high. If the Court indeed rules in AMC’s favor, businesses that operate in interstate commerce will almost certainly come out the big winners. As the U.S. Chamber of Commerce points out, forum selection clauses are a staple of modern business practice, as these clauses routinely appear in employment and severance agreements, mergers and asset purchase agreements, financing agreements, securities transactions and franchise agreements, just to name a few. They often represent material terms of an agreement, such that a business will only be willing to grant certain concessions (for example, price) if it can be assured that potential litigation will occur in a predetermined forum.

Forum selection clauses are important because, among other things, they allow businesses to expand their geographical scope of operations with greater confidence, reduce potential litigation costs associated with hiring attorneys in multiple jurisdictions and avoid costly and time-consuming pre-trial motions concerning the question of where a dispute should be resolved. A decision strongly supportive of forum selection clauses, therefore, could have a stabilizing effect on businesses of all sizes, not to mention the economy itself.

The decision could have a particularly profound effect on general contractors. In this economy, federal contracting is propping up the construction industry and therefore contractors are increasingly looking for opportunities across state lines. Larger general contractors have the resources, experience and personnel, not to mention the bonding capacity, to seek out these cross-state opportunities. Thus, for general contractors that routinely bid public work across the country, rigid enforcement of their forum selection clauses will provide the predictability and cost control these contractors increasingly depend upon.

Yet, as various subcontractors point out, construction subcontracts do not always reflect a true arm’s length bargaining process that underlies other types of business contracts. The American Subcontractors Association (ASA) argues, for example:

[T]he financial and economic leverage of general contractors to dictate inequitable contract terms is a much larger public policy concern than is present in other economic transactions. The typical practice is that general contractors … dictate the subcontract form that subcontractors must use. Thus, if the subcontract has a forum selection clause, the “selected” forum will inevitably be the “home court” for the general contractor.

It is also far more prevalent in the industry that the general contractor will travel into foreign states to perform its work (and will, once there, hire local subcontractors). Since general contractors typically “hold” for some period of time the money paid by owners for subcontract work, it is subcontractors who typically must pay their own bills (payroll, home office rental, field rental, equipment rental, etc.) and “finance” the project, only to later “chase” the general contractor to recover monies they have already advanced. When the realities of the slanted terms of a proprietary subcontract form are added to the financial strains and demands of complex commercial litigation, the costs to litigate construction disputes can be prohibitively expensive to smaller family-owned companies. If a forum selection clause is added to the mix—with the venue changed to where one witness and documents are unavailable—the impact will again disproportionately fall on the party with the least bargaining power (typically the subcontractor). In this way, forum selection clauses in construction contracts can inequitably chill a litigant’s ability to pursue or obtain justice.

This is perhaps why 40% of the states have enacted laws that outlaw these types of forum selection clauses in the construction context. Yet there was not one mention during the Supreme Court oral argument about how forum selection clauses typically operate in the construction industry, what role (if any) states’ public policy should play, or even an acknowledgement (for example) that the Miller Act’s venue provision arguably demonstrates a Congressional preference for construction payment disputes to be adjudicated near the project location, where the subcontractors are likely to be located. The Supreme Court therefore could very well decide this case without taking into account the unique role (good or bad) that forum selection clauses play in the construction industry.

The consequences of a decision strongly upholding a defendant’s right to dismiss or transfer a lawsuit filed in the “wrong” federal district are potentially significant, especially for the construction industry. However, as demonstrated by some of the examples below, Atlantic Marine will not so much alter the balance of interests between general contractors and subcontractors, but rather accelerate existing trends that may not have been altogether noticeable until now.

(1) State laws that deem out-of-state forum selection clauses unenforceable in the construction context could be rendered toothless.

Currently, 18 states consider these forum selection clauses void against public policy in the construction context, while another 4 states deem these clauses unenforceable in certain instances:

(Still other states, such as Arizona, also deem out-of-state choice of law provisions void against public policy in the construction context.) The ability for federal courts to even take these state laws into account is at stake in Atlantic Marine.

It is important to point out, however, that most of these laws were enacted by states that already live under the rule Atlantic Marine is poised to establish nationwide. Specifically, 8 circuit courts of appeal[1] (covering 39 total states) already follow one of the approaches AMC advocated before the Supreme Court:

Thus, for all intents and purposes, only plaintiffs filing suit in Louisiana, Ohio, Pennsylvania, Tennessee or Texas have been able to take advantage of state public policy up to this point.

Nonetheless, to the extent subcontractors bound by out-of-state forum selection clauses do not already do so, Atlantic Marine will reinforce the necessity for them to keep disputes out of federal court. Keep in mind that the ruling in Atlantic Marine will be limited to deciding what procedure must be utilized to request dismissal/transfer when a lawsuit is filed in an otherwise proper federal court but in contravention of a forum selection clause that specifies lawsuits must be filed in a different federal forum. The case will not affect state court procedure whatsoever. State courts faced with these lawsuits are far more likely (indeed, are duty-bound) to honor their state’s public policy and may refuse to enforce the forum selection clause—that is, if the construction project is not located on an exclusive federal enclave.

Yet the real strategy is not in filing a lawsuit in state court; it’s keeping it there. A general contractor will likely seek to remove the subcontractor’s lawsuit to federal court, where the forum selection clause can be enforced under Atlantic Marine. (Nevermind the irony of removing a lawsuit to a federal court, only to turn around and claim venue is improper). Anticipating this possibility, plaintiffs sometimes intentionally attempt to craft a state court lawsuit that will prove difficult to remove to federal court later on. However, this is usually unrealistic and courts may come down hard on plaintiffs who attempt to manipulate jurisdiction. See e.g. Moore v. Interstate Fire Ins. Co., 717 F. Supp. 1193 (S.D. Miss. 1989) (imposing sanction on plaintiff who fraudulently named a defendant in order to preclude removal to federal court).

Even if a subcontractor can keep its lawsuit away from the federal courts, one undesirable consequence of doing that—at least for subcontractors working on federal projects—is the necessity to forego a payment bond claim under the Miller Act. Claiming against a payment bond and drawing the general contractor’s surety into the litigation is oftentimes a very effective litigation strategy for subcontractors (not to mention suppliers), assuming they meet the statutory requirements. But if the subcontractor seeks to truly eliminate federal jurisdiction, the Miller Act claim must become a casualty, along with any other federal remedies such as the Federal Prompt Pay Act.

And, to the extent subcontractors have any options to disregard a forum selection clause, it should be noted that general contractors have some options as well. For example, a general contractor might prospectively facilitate its ability to remove a subcontractor’s lawsuit to federal court by refraining from incorporating or forming a subsidiary in the state where the project is located. This is easier to accomplish for general contractors working on a one-off project; for example, AMC never established an office, mailing address, bank account or even telephone number in Texas. However, for most private contractors, like homebuilders, who maintain a regional presence in several states, it is often advisable (for liability purposes, for example) or necessary (to obtain a contractor’s license, for example) to incorporate locally. There is no universal answer here, but the point is that general contractors have options too.

In sum, the public policies of 22 states may no longer have any relevance in federal court (if they ever did to begin with) when it comes to addressing the enforceability of forum selection clauses. This should give subcontractors pause to the extent they have relied on their own state laws to protect them from out-of-state litigation.

(2) Miller Act claims could become more difficult to pursue. Subcontractors who pursue Miller Act claims against a payment bond traditionally expect to keep those lawsuits close to home, considering that the statute expressly provides that lawsuits shall be brought in “any district in which the contract was to be performed.” 40 U.S.C. § 3133(b)(3).

However, four circuit courts of appeal (covering 20 states) have addressed the impact of forum selection clauses on the Miller Act’s venue provision,[2] and all four have enforced the clause:

Thus, for subcontractors (and suppliers) performing work in those jurisdictions, they already remain bound by their forum selection clauses notwithstanding the Miller Act’s venue provision.

The Atlantic Marine court will not decide this particular issue, given that J-Crew voluntarily dismissed its Miller Act claim prior to appeal. However, the Supreme Court has previously indicated that the Miller Act’s venue provision is not sacrosanct. F. D. Rich Co. v. United States for the Use of Indus. Lumber Co., 417 U.S. 116, 125 (1974) (the predecessor statute to § 3133(b)(3) is “merely a venue requirement”). Given that lower courts already rely on F.D. Rich to justify enforcement of forum selection clauses, Atlantic Marine may only bolster that trend: if the court upholds dismissal/transfer of a lawsuit that was otherwise filed in accordance with 28 U.S.C. § 1391, the federal venue statute, there is no reason why contracting parties cannot override the Miller Act’s venue provision under the same rationale.

Of course, a defendant cannot seek dismissal/transfer of a Miller Act claim 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 payment bond claim where the project is located. However, it is for this very reason that most forum selection clauses specify that venue shall lie in the state or federal courts of a particular state.

(3) A loophole allowing a plaintiff to control which state’s law will govern the dispute may be closed.

The fact that a construction contract contains a forum selection clause does not necessarily mean that the substantive law of the state selected for venue purposes will govern the dispute. The only way to guarantee that is to include a choice of law provision in the contract.

In the absence of a choice of law provision, the state law that will substantively govern the dispute never really becomes an issue if the plaintiff files suit in the contractually specified venue: absent a federal question, a federal court will usually apply the law of the state where it sits. Klaxon v. Stentor Electric Mfg. Inc., 313 U.S. 487, 496 (1941).

However, in jurisdictions that follow the approach advocated by J-Crew, whereby discretionary transfer to another federal district is accomplished by way of 28 U.S.C. § 1404, a plaintiff who breaches the forum selection clause by filing suit in its home state is oddly rewarded by having the substantive law of that home state govern the dispute, even if the case is transferred to another venue. That is because when a case is transferred pursuant to § 1404, ordinarily the original state’s substantive law will transfer as well. See Van Dusen v. Barrack, 376 U.S. 612, 639 (1964) (“[T]he transferee district court must be obligated to apply the state law that would have been applied if there had been no change of venue. A change of venue under § 1404(a) generally should be, with respect to state law, but a change of courtrooms.”); Ferens v. John Deere Co., 494 U.S. 516, 522-23 (1990). Thus, even if a plaintiff is unsuccessful in controlling the forum, it can still choose the applicable law if it races to the local courthouse.

Moreover, even if a contract contains a choice of law clause, it is conceivable that a § 1404 approach could render that clause unenforceable. That is because some states have a public policy that not only addresses forum selection clauses, but choice of law clauses as well. See Arizona Rev. Stat. § 32-1129.05 (declaring void any “provision, covenant, clause or understanding in, collateral to or affecting a construction contract that makes the contract subject to the laws of another state or that requires any litigation arising from the contract to be conducted in another state”).

However, any opportunity to control the choice of law in either of these manners will likely be foreclosed going forward since the law of the new forum state usually governs when cases are dismissed or transferred under the approach being considered by Atlantic Marine.[3]

*  *  *

These are just some of the potential ramifications if the Atlantic Marine court issues a decision strongly enforcing forum selection clauses. However, no matter where your business comes down in this debate, the reality is that many, if not most, modern construction contracts call for alternative dispute resolution in lieu of litigation. And no matter what the Atlantic Marine court decides, contracts that require disputes to be arbitrated in a particular state, or arbitrated under a particular state’s law, will continue to be strongly enforced. 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 …. When the parties’ arbitration agreement is silent with respect to locale, … the locale shall be the city nearest to the site of the project in dispute.”). Thus, the shift—or, depending on one’s vantage point, the solidification—of the balance of interests in the construction industry potentially brought about by Atlantic Marine must be tempered by the reality that a large percentage of disputes will never make it into a courtroom in the first place.

Atlantic Marine will be decided in a few months. In the meantime, businesses should take another look at their own forum selection clause and/or give closer scrutiny to the forum selection clause they are asked to sign. And, if your business does not regularly use a forum selection clause, ask yourself whether you need one in light of the uncertainty that may result otherwise. In either case, consult with a litigation attorney—and if you are a contractor, preferably consult a construction litigator—to make sure your company is best positioned to meet the potential legal changes on the horizon.

_________________

Notes

[1] The vast majority of circuit courts rely on Fed. R. Civ. P. 12(b)(3) to grant dismissal when a lawsuit is filed in a federal district other than the one specified in the parties’ forum selection clause. See TradeComet.com LLC v. Google, Inc., 647 F.3d 472, 478 (2nd Cir. 2011); Sucampo Pharms. v. Astellas Pharma, Inc. 471 F.3d 544, 548-50 (4th Cir. 2006); Muzumdar v. Wellness Int’l Network, Ltd., 438 F.3d 759, 760-62 (7th Cir. 2006); Union Elec. Co. v. Energy Ins. Mut. Ltd., 689 F.3d 968, 970-73 (8th Cir. 2012); Richards v. Lloyd’s of London, 135 F.3d 1289, 1294-96 (9th Cir. 1998) & Spradlin v. Lear Siegler Management Servs. Co., 926 F.2d 865, 867-68 (9th Cir. 1991); Riley v. Kingsley Underwriting Agencies, Ltd., 969 F.2d 953, 956 (10th Cir. 1992); Slater v. Energy Servs. Grp. Int’l, Inc., 634 F.3d 1326, 1333 (11th Cir. 2011) (while § 1404 is the proper avenue of relief where a party seeks transfer of a case to enforce a forum selection clause, Rule 12(b)(3) is the proper avenue for a party’s request for dismissal based on a forum selection clause); Commerce Consultants Int’l, Inc. v. Vetrerie Riunite, 867 F.2d 697, 699-700 (D.C. Cir. 1989); see also Rivera v. Centro Medico de Turabo, Inc., 575 F.3d 10, 15-16 (1st Cir. 2009) (enforcing dismissal by way of Fed. R. Civ. P. 12(b)(6)). [back]

[2] See United States ex rel. Pittsburgh Tank & Tower, Inc., v. G&C Enterprises, 62 F.3d 35, 36 (1st Cir. 1995); In re Fireman's Fund Ins. Cos., 588 F.2d 93, 95 (5th Cir. 1979); FGS Constructors, Inc. v. Carlow, 64 F.3d 1230, 1233 (8th Cir. 1995); United States ex rel. B & D Mechanical Contractors v. St. Paul Mercury Ins. Co., 70 F.3d 1115, 1117 (10th Cir. 1995). [back]

[3] See Ellis v. Great Sw. Corp., 646 F.2d 1099, 1109-10 (5th Cir. 1981); Martin v. Stokes, 623 F.2d 469, 473 (6th Cir. 1980); Wisland v. Admiral Beverage Corp., 119 F.3d 733, 735-36 (8th Cir. 1997); Roofing & Sheet Metal Servs., Inc. v. La Quinta Motor Inns, Inc., 689 F.2d 982, 992 (11th Cir. 1982).

Topics:  Construction Disputes, Contract Drafting, Contractors, Federal Jurisdiction, Forum Selection Clause, Miller Act, SCOTUS, Subcontractors

Published In: Civil Procedure Updates, General Business Updates, Construction Updates, Government Contracting Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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