The Sixth Circuit Tackles Forum Selection Clauses

Image by Keith Johnston from Pixabay

When U.S. judges fight about forum selection clauses, they tend to fight about one of two things. First, they fight about whether a federal court sitting in diversity should apply state or federal law to determine whether a clause is valid and enforceable. Second, they fight about whether a non-signatory may be bound by a forum selection clause if the non-signatory is so “closely related” to a contracting party or a contractual dispute that it was “foreseeable” that the non-signatory would be bound.

In Firexo, Inc. v. Firexo Group Limited, the U.S. Court of Appeals for the Sixth Circuit tackled both questions. In this post, I first review the facts of the case. I then survey the arguments made by the majority, concurring, and dissenting opinions. I conclude with some advice for future judges who may be called upon to address these issues.

Facts

Firexo Group Limited (“FGL”) is a company based in the United Kingdom. It had a subsidiary, Firexo Corporation (“Firexo”), that was incorporated in Florida. In 2019, FGL entered into a Joint Venture Agreement (“JVA”) with Scot Smith, a resident of Ohio, by which Smith agreed to purchase 70% of the shares in Firexo. The JVA contained a forum selection clause designating England or Wales as the “exclusive jurisdiction to settle any dispute or claim that arises out of or in connection with this agreement or its subject matter or formation.”

In 2021, Firexo sued FGL for breach of contract in Ohio. Although the complaint did not mention the JVA, and although the contract claim alleged a breach of a separate oral distribution agreement, FGL argued that the suit had to be litigated in England, per the forum selection clause in the JVA. Firexo responded that, as a non-signatory to the JVA, it was not bound by that agreement’s forum selection clause.

The district court (Judge Jack Zouhary) sided with FGL. It held that Firexo was bound by the clause because Firexo was so “closely related” to the JVA that it was “foreseeable” that the clause would be applied to it. Firexo appealed to the Sixth Circuit. In a decision running to forty-four pages, that court reversed the district court. It held—in an opinion in which each of the three judges wrote separately—that the “closely related” doctrine was not applicable.

The Majority

Erie

The majority opinion, authored by Judge Alice Batchelder, held that a federal court sitting in diversity should not apply federal common law to determine whether a non-signatory is bound by a forum selection clause. Instead, the majority invoked the Supreme Court’s decision in Erie Railroad Co. v. Tompkins to hold that a court must perform a choice-of-law analysis using the choice-of-law rules of the state in which it sits and apply the substantive law that that analysis yields.

Interestingly, the majority did not conduct a formal Erie analysis. There is no discussion of whether applying federal law to this question would incentivize forum shopping or lead to the inequitable administration of the laws. Instead, the majority based its conclusion on a line of Supreme Court case law relating to arbitration clauses. The Supreme Court has held that courts should “look to the relevant state’s common law to decide when nonparties may enforce (or be bound by) an arbitration agreement.” Given the similarities between arbitration clauses and forum selection clauses, the majority reasoned that the same rule should apply in both contexts.

Although the majority did not conduct an Erie analysis, its conclusion that state law governs whether a non-signatory is bound by a forum selection clause is clearly correct. As Andy Hessick and I have argued, federal courts sitting in diversity should apply state law to all issues relating to a forum selection clause when it selects a state court or a foreign court. The only time when the Supreme Court has held that it is appropriate to apply federal law is when (1) the forum selection clause selects another federal court, and (2) the defendant seeks a transfer under 28 U.S.C. § 1404(a). In this context, the Court has held that it is appropriate to apply federal law to determine whether the clause is enforceable. Although Andy and I disagree with this decision, the point is moot on the facts of Firexo because the clause in question did not select another federal court. It selected the courts of England and Wales. When a defendant seeks to enforce a clause selecting a state or a foreign court by moving to dismiss on forum non conveniens, there is no basis for a federal court sitting in diversity to create a federal common law of forum selection clauses. That court should apply state law.

After concluding that this issue was not governed by federal common law, the majority held that the rights and obligations of the plaintiff with respect to this particular clause should be determined under English law. Under that law, the plaintiff was not bound by the clause as a non-signatory to the contract. Accordingly, the majority held that the district court erred in granting the defendant’s motion to dismiss based on that provision.

Closely Related

Judge Batchelder also devoted a significant amount of time in her opinion to questioning the viability of the “closely related” test. Many U.S. courts use this test to evaluate the rights of non-signatories vis-à-vis forum selection clauses. The majority opinion identified two weaknesses in these decisions. First, it suggested that the federal courts lack the power to create this test. Second, it argued that the test itself is deeply flawed.

With respect to the power of the federal courts to make contract law, the majority stated that “the ‘closely related’ doctrine is a federal common law rule of equitable contract interpretation that is best justified by its practical benefits (or policy purposes) and the fact that everyone else is doing it.” Nevertheless, the majority opined that the doctrine was “a dubious doctrine at best—a judicial concoction without underlying authority or justification” and that it “appeared ipse dixit and continues to exist primarily because no court has rejected it.” These concerns led the majority to state that “under federal common law . . . the ‘closely related’ doctrine should not survive as a stand-alone doctrine.”

With respect to the test’s merits, the majority observed that “[i]t is not entirely apparent . . . that its benefits outweigh its concerns, especially the absence of consideration under the objective theory of contracts.” The court cited an article that I co-authored with Robin Effron to support this point. It is a fundamental principle of law that a party cannot be bound to a contract without its consent. While there are a number of doctrines that might allow a court to sidestep this rule—alter ego, agency, estoppel, etc.—the “closely related” doctrine goes a step further by allowing a court to bind an unwilling non-signatory to a forum selection clause based solely on their proximity to a contract or a contracting party. To bind an unwilling non-signatory to an agreement on this basis, the majority correctly held, is inconsistent with basic notions of contractual consent.

The Concurrence

A concurring opinion by Judge Joan Larsen agreed with the majority that it was inappropriate to apply federal common law to determine the rights and obligations of non-signatories. The concurrence also agreed that the line of related Supreme Court cases in the arbitration context compelled this conclusion.

The concurrence did not join the majority opinion in full, however, because Judge Larsen did not believe that it was necessary to “to endorse particular theories of contract law or to discredit the ‘closely related’ test generally” to decide the case. The concurrence also pointed out—correctly—that if the law of England had called for the application of the “closely related” test, then the court would be bound to apply that law even if it had concerns about the underlying merits of the doctrine.

The Dissent

In dissent, Judge Richard Griffin first argued that the question of whether a non-signatory is bound by a forum selection clause is governed by federal law. In support of this argument, he contended that this issue is properly viewed as one going to the enforceability of the clause rather than its underlying validity as a matter of contract law. Because the Supreme Court has held that the enforceability of a clause is governed by federal law, the dissent reasoned, the court must necessarily apply federal law to resolve the non-signatory question.

There are two problems with this argument. First, as noted above, the Supreme Court has only held that the enforceability of a forum selection clause is governed by federal law in cases when the defendant is seeking transfer under 28 U.S.C. § 1404(a). The existence of the federal transfer statute, the Court reasoned in Stewart Organization, Inc. v. Ricoh Corporation (1988), authorized the creation of a limited body of federal common law dealing with the enforceability of forum selection clauses in diversity cases. The defendant in Firexo was not, however, seeking transfer to another federal court. It was seeking dismissal under the forum non conveniens because the clause selected a foreign court. In contrast to transfers, no federal statute regulates forum non conveniens. The Court’s decision in Stewart thus provides no insight into whether federal or state law should control the enforceability of forum selection clauses in motions to dismiss for forum non conveniens in diversity actions.

The second problem with the dissent’s argument is that the issue of whether a non-signatory is bound by a forum selection clauses is nowhere addressed by the Court’s seminal decision about clause enforceability: The Bremen v. Zapata Off-Shore Company (1972). In that case, the Court held that a forum selection clause was not enforceable as a matter of federal admiralty law if it was (1) unreasonable, or (2) contrary to the public policy of the forum. Nothing in that decision suggested that a federal court sitting in diversity should apply federal law to answer such basic contract questions as whether someone is a party to the contract. To characterize the issue of non-signatories as going to the “enforceability” of a clause, as the dissent does, ignores the history and context in which that concept first evolved.

The dissent was led astray, it seems to me, by its focus on prior precedent in the Sixth Circuit and other federal circuits. It does not cite Stewart or The Bremen. Nor does it cite Atlantic Marine Construction Company v. U.S. District Court (2013), a case in which the Court stated that only forum selection clauses that were “contractually valid” could compel the transfer or dismissal of a case. Had the dissent paid more attention to these decisions, it might have come to a different conclusion.

In any event, having decided that the non-signatory issue was governed by federal law, the dissent argued that the “closely related” doctrine was a part of that law. It then reasoned that Firexo was so “closely related” to the JVA that it was “foreseeable” that it would be bound by the forum selection clause in that agreement. Accordingly, the dissent took the position that Firexo should have been required to litigate the case in England notwithstanding the fact that it was not a signatory to the JVA.

Advice

I would like to take this opportunity to offer three pieces of advice to judges who are called upon to consider these issues in the future.

First, begin with the text of the contract. The JVA in Firexo contained the following language: “Third Party Rights. This agreement is made for the benefit of the parties and their successors and permitted assigns and is not intended to benefit, or be enforceable by, anyone else.” This contract provision, to my mind, resolves this case. It would be perverse to hold that a contract binds a non-signatory when the parties to that contract have expressly agreed that the agreement does not apply to third parties. The overwhelming majority of courts to have considered the question have held that it is inappropriate to invoke the closely-related-and-foreseeable test when the contract contains a clause stating that there are no third-party beneficiaries to the agreement. Had the Sixth Circuit followed this line of reasoning, its opinion would have been forty pages shorter.

Second, when the contract is silent as to third-party rights, a federal court sitting in diversity should apply the choice-of-law rules of the state in which it sits to ascertain the governing law. Once that governing law has been identified, the court should apply it to determine whether and to what extent a non-signatory is bound by a forum selection clause. This is the proper result under both Erie and Stewart regardless of whether the clause selects a state, federal, or foreign court because this issue goes to the validity of the clause. It has nothing to do with the enforceability of a clause under The Bremen.

Third, one must be mindful of the fact that the “closely related” test operates differently in different contexts. The doctrine is most objectionable when (1) it is invoked against an unwilling non-signatory plaintiff (as in Firexo), or (2) it is invoked against an unwilling non-signatory defendant (as in EPAC, a case currently on appeal to the New York Court of Appeals). When a willing non-signatory is clamoring to be covered by the clause, by contrast, then the use of the doctrine is less troubling. In such cases, there is no issue with consent. And applying the doctrine helps to ensure that disputes arising out of the same nucleus of fact are heard in a single court.