Donald J. Roberts IRA v. Phillip H. McNeill, Sr.

IN THE COURT OF APPEALS OF TENNESSEE

AT JACKSON

Assigned On Briefs December 9, 2010

DONALD J. ROBERTS IRA, ET AL. v. PHILLIP H. MCNEILL, SR., ET AL.

Interlocutory Appeal by Permission from the Circuit Court for Shelby County

No. CT-004955-07 Jerry Stokes, Judge

No. W2010-01000-COA-R9-CV - Filed February 23, 2011

This is an interlocutory appeal from a class certification. The named plaintiffs, former

owners of preferred stock in Equity Inns, Inc., filed a class action against the company’s

former directors. Their amended complaint asserted breaches of the fiduciary duties

allegedly owed to the preferred shareholders during the negotiation and approval of a merger.

The trial court granted the plaintiffs’ motion for class certification with respect to “[a]ll

holders of Equity Inns preferred stock as of June 21, 2007.” We vacate and remand for

further consideration.

Tenn. R. App. P. 9 Interlocutory Appeal By Permission; Judgment of the Circuit

Court Vacated and Remanded

D AVID R. F ARMER, J., delivered the opinion of the Court, in which H OLLY M. K IRBY, J. and

J. S TEVEN S TAFFORD, J., joined.

John S. Golwen, Annie T. Christoff, Memphis, Tennessee and Edward J. Fuhr and Trevor

S. Cox (pro hac), Richmond Virginia, for the appellants, Phillip H. McNeill, Sr., Howard A.

Silver, Harry S. Hays, Raymond E. Schultz, Robert P. Bowen and Joseph W. McLeary.

Alan G. Crone, Memphis, Tennessee, and Lee A. Weiss (pro hac vice), New York, NY, for

the appellees, Donald J. Roberts IRA, Dr. James M. Byers IRA Rollover, Patrick Svoboda

IRA, Svoboda Realty, Inc. Defined Benefit Plan, and Jack Fulton.

OPINION

I. Background and Procedural History

This appeal follows the merger of Equity Inns, Inc. (“Equity Inns” or the “Company”)

into the Whitehall Street Global Real Estate Limited Partnership 2007 (“Whitehall”). Equity

Inns functioned as a publicly held real estate investment trust based in Memphis, Tennessee

which through its operating partnership owned 133 hotel properties in 35 states. In 2007, its

Board of Directors unanimously approved a definitive merger agreement under which the

privately held Whitehall would acquire Equity Inns in a transaction valued at approximately

$2.2 billion. The merger agreement provided owners of Equity Inns common stock $23 per

share in cash, a premium of approximately 28% over the stock’s 90 day average closing share

price or approximately 19% over its closing share price on June 20, 2007. The agreement

provided holders of Equity Inns’s two classes of preferred stock, Series B and Series C,

preferred stock in Whitehall having identical dividend and other relative rights, preferences,

limitations, and restrictions as their existing shares.1 The common stockholders, including

Jack Fulton, voted to approve the merger. The transaction closed on October 25, 2007.

The named plaintiffs, Donald J. Roberts IRA, Dr. James M. Byers IRA Rollover,

Patrick Svoboda IRA, Svoboda Realty Inc. Defined Benefit Plan, and Jack Fulton

(“Plaintiffs”), filed this class action as amended against the defendants, Phillip H. McNeill,

Sr., Howard A. Silver, Harry S. Hays, Raymond E. Schultz, Robert P. Bowen, and Joseph W.

McLeary (“Directors”).2 Their amended complaint asserted Directors owed the holders of

Equity Inns preferred stock the “utmost fiduciary duties of due care, loyalty, and good faith.”

Directors allegedly violated these fiduciary duties when they approved a merger that greatly

benefitted the common stockholders, including Directors, without properly evaluating the

impact of the merger on preferred shareholders. According to Plaintiffs, the announcement

of the merger caused a foreseeable diminution in the value of their preferred stock because

Whitehall was not subject to the reporting requirements of the Securities Exchange Act of

1934 and investors were unable accurately to value Whitehall’s preferred stock. Plaintiffs

alleged Directors’ breaches caused 32% and 33% decreases in the value of Equity Inns’

Series B and Series C preferred stock, respectively, prior to the closing of the merger.

Plaintiffs concluded that, by approving the merger and electing not to redeem the preferred

stock for cash, Directors impermissibly increased the payout for common stock to the

detriment of the preferred shareholders.

Directors responded with a motion to dismiss the complaint under Rule 12.02(6) of

the Tennessee Rules of Civil Procedure for failure to state a claim upon which relief could

be granted. Directors argued, in part, that Plaintiffs based their complaint on general

1

Directors state the agreement also provided Series C shareholders an increased dividend rate in their

new shares of Whitehall preferred stock consistent with the terms of the Series C stock certificate.

2

The original complaint did not name Jack Fulton as a plaintiff. The trial court later granted a motion

to amend the complaint to add Mr. Fulton over the objection of Directors.

-2-

fiduciary duty principles that do not apply when determining the rights of preferred

shareholders in Tennessee. Directors maintained the rights of preferred shareholders are

governed by contract and, thus, Plaintiffs failed to state a claim because they did not allege

a breach of contract. Directors contended in the alternative that both the business judgment

rule and an exculpatory provision in the Company’s corporate charter precluded recovery.

The trial court denied Directors’ motion to dismiss but granted permission to seek

interlocutory appeal pursuant to Rule 9 of the Tennessee Rules of Appellate Procedure,

which this Court and the Tennessee Supreme Court denied. Directors thereafter filed an

answer asserting various affirmative and other defenses.

Plaintiffs moved to certify a class of “[a]ll holders of Equity Inns preferred stock as

of June 21, 2007” and to appoint Donald J. Roberts IRA, Dr. James M. Byers IRA Rollover,

and Jack Fulton as representatives of the class.3 Plaintiffs’ motion and initial supporting

memorandum argued the class representatives satisfied all requirements of Rule 23.01 and

23.02(3) of the Tennessee Rules of Civil Procedure. Directors disagreed and submitted a

detailed response arguing, inter alia, that the proposed representatives satisfied neither the

typicality nor the adequacy of representation requirements of Rule 23. Plaintiffs submitted

a memorandum in reply, seeking to counter the arguments of Directors and further support

their motion. On March 2, 2010, the trial court conducted a fairly lengthy hearing during

which the parties asserted their positions. Rather than announce a decision at the conclusion

of the hearing, the court took the matter under advisement.

On April 26, 2010, the trial court granted Plaintiffs’ motion for class certification with

respect to “the named class representatives” in an order that set forth relevant facts, offered

the court’s legal conclusions, and incorporated by reference the transcript of the parties’ oral

hearing. The court expressly acknowledged that the burden to demonstrate compliance with

Rule 23.01’s requirements—numerosity, commonality, typicality, and adequacy of

representation—rested with Plaintiffs. Upon examination of the issues, the court concluded

Plaintiffs carried their burden. The court also concluded Plaintiffs demonstrated a basis for

certification under Rule 23.02(3). Directors filed an application for interlocutory appeal

pursuant to Rule 9 of the Tennessee Rules of Appellate Procedure and Tennessee Code

Annotated section 27-1-125, which this Court granted.

3

The trial court’s order cited Donald J. Roberts IRA, Patrick Svoboda IRA, and Svoboda Realty Inc.

Defined Benefit Plan as the proposed class representatives for the Series B preferred shareholders and Jack

Fulton as the proposed class representative for Series B and C preferred shareholders. But Plaintiffs’ motion

for class certification and accompanying memoranda sought appointment of Dr. James M. Byers IRA

Rollover as a class representative, not Patrick Svoboda IRA or Svoboda Realty Inc. Defined Benefit Plan.

Likewise, Plaintiffs’ brief argues that Dr. James M. Byers IRA Rollover is an adequate representative of the

class. It does not address whether Patrick Svoboda IRA or Svoboda Realty Inc. Defined Benefit Plan meet

Rule 23's requirements.

-3-

II. Issues Presented

Directors raise the following issues, as we perceive them, on appeal:

(1) whether the trial court failed to apply a sufficiently rigorous, thorough,

and careful analysis of the class certification issues;

(2) whether the claims or defenses of the class representatives who owned

only Series B preferred stock are typical of the claims or defenses of the

class members who owned only Series C preferred stock;

(3) whether class representatives who owned only Series B preferred stock

are adequate representatives of the class members who owned only

Series C preferred stock;

(4) whether unique defenses apply to Jack Fulton as a common stockholder

who voted in favor of the merger which prevent him, as a matter of law,

from satisfying the typicality requirement;

(5) whether the named plaintiffs who owned only Series B preferred stock

have standing to pursue claims related to the Series C shares if Jack

Fulton is not an appropriate class representative; and

(6) whether common issues concerning the alleged breaches of fiduciary

duties predominate over individual issues.

III. Standard of Review

A trial court’s decision on class certification is entitled to deference. See Meighan v.

U.S. Sprint Commc'ns Co., 924 S.W.2d 632, 637 (Tenn. 1996). The grant or denial of class

certification is discretionary, and the court’s decision will stand absent abuse of that

discretion. Id. (citing Sterling v. Velsicol Chem. Corp., 855 F.2d 1188, 1197 (6th Cir. 1988)).

The abuse of discretion standard typically applies when a choice exists in the trial court

among several acceptable alternatives. Lee Med., Inc. v. Beecher, 312 S.W.3d 515, 524

(Tenn. 2010) (citing Overstreet v. Shoney’s, Inc., 4 S.W.3d 694, 708 (Tenn. Ct. App. 1999)).

Because the trial court is vested with the responsibility to make that choice, a reviewing court

cannot second-guess the lower court’s judgment or merely substitute an alternative it finds

preferable. Id. at 524 (citations omitted). A reviewing court must instead affirm the

discretionary decision so long as reasonable legal minds can disagree about its correctness.

Eldridge v. Eldridge, 42 S.W.3d 82, 85 (Tenn. 2001) (citing State v. Scott, 33 S.W.3d 746,

-4-

752 (Tenn. 2000); State v. Gilliland, 22 S.W.3d 266, 273 (Tenn. 2000)). The same principles

apply here; a trial court’s certification decision must stand if reasonable judicial minds can

differ about the soundness of its conclusion. Freeman v. Blue Ridge Paper Prod., Inc., 229

S.W.3d 694, 703 (Tenn. Ct. App. 2007) (citing White v. Vanderbilt Univ., 21 S.W.3d 215,

223 (Tenn. Ct. App. 1999)). “The abuse of discretion standard of review does not, however,

immunize a lower court’s decision from any meaningful appellate scrutiny.” Beecher, 312

S.W.3d at 524 (citing Boyd v. Comdata Network, Inc., 88 S.W.3d 203, 211 (Tenn. Ct. App.

2002)).

A trial court’s discretion is not unbounded. Cf. Gulf Oil Co. v. Bernard, 452 U.S. 89, 100

(1981). A trial court must consider controlling legal principles and relevant facts when making a

discretionary decision. Beecher, 312 S.W.3d at 524 (citing Konvalinka v. Chattanooga-Hamilton

Cnty. Hosp. Auth., 249 S.W.3d 346, 358 (Tenn. 2008); Ballard v. Herzke, 924 S.W.2d 652, 661

(Tenn. 1996)). A trial court abuses its discretion if it (1) applies an incorrect legal standard,

(2) reaches an illogical or unreasonable decision, or (3) bases its decision on a clearly

erroneous evaluation of the evidence. Elliott v. Cobb, 320 S.W.3d 246, 249-50 (Tenn. 2010)

(citation omitted); see also Walker v. Sunrise Pontiac-GMC Truck, Inc., 249 S.W.3d 301,

308 (Tenn. 2008) (citation omitted). Additionally, a trial court abuses its discretion if it

“strays beyond the applicable legal standards or when it fails to properly consider the factors

customarily used to guide the particular discretionary decision.” Beecher, 312 S.W.3d at 524

(citing State v. Lewis, 235 S.W.3d 136, 141 (Tenn. 2007)).

Appellate courts review a trial court’s discretionary decision to determine “(1)

whether the factual basis for the decision is properly supported by evidence in the record, (2)

whether the lower court properly identified and applied the most appropriate legal principles

applicable to the decision, and (3) whether the lower court’s decision was within the range

of acceptable alternative dispositions.” Id. at 524-25 (citing Flautt & Mann v. Council of

Memphis, 285 S.W.3d 856, 872-73 (Tenn. Ct. App. 2008)). We review the trial court’s legal

conclusions de novo with no presumption of correctness. Id. at 525 (citing Johnson v. Nissan

N. Am., Inc., 146 S.W.3d 600, 604 (Tenn. Ct. App. 2004); Boyd v. Comdata Network, Inc.,

88 S.W.3d 203, 212 (Tenn. Ct. App. 2002)). We review the trial court’s factual conclusions

under the preponderance of the evidence standard. Id. (citations omitted).

IV. Analysis

Rule 23 of the Tennessee Rules of Civil Procedure governs class action certification.

Walker, 249 S.W.3d at 307 (citing Hamilton v. Gibson Cnty. Util. Dist., 845 S.W.2d 218, 225

(Tenn. Ct. App. 1992)). The burden is on the proponent of class certification to demonstrate

that a class action is appropriate. Id. This burden is two-fold. The proponent must first

satisfy the numerosity, commonality, typicality, and adequacy of representation requirements

-5-

of Rule 23.01. Id. at 307-08 (citing Tenn. R. Civ. P. 23.01). Rule 23.01 permits class

certification if

(1) the class is so numerous that joinder of all members is impracticable, (2)

there are questions of law or fact common to the class, (3) the claims or

defenses of the representative parties are typical of the claims or defenses of

the class, and (4) the representative parties will fairly and adequately protect

the interest of the class.

Tenn. R. Civ. P. 23.01. The proponent of class certification must demonstrate compliance

with each of Rule 23.01’s requirements. Walker, 249 S.W.3d at 307-08.

The proponent must next establish the class action is maintainable under Rule 23.02.

Id at 308. In contrast to Rule 23.01, the proponent of class certification must establish only

one Rule 23.02 basis for the maintenance of a class action. Id. Rule 23.02 provides three

bases for class action certification:

(1) the prosecution of separate actions by or against individual members

of the class would create a risk of

(a) inconsistent or varying adjudications with respect to

individual members of the class which would establish

incompatible standards of conduct for the party opposing the

class, or

(b) adjudications with respect to individual members of

the class which would as a practical matter be dispositive of the

interests of the other members not parties to the adjudications or

would substantially impair or impede their ability to protect their

interest; or

(2) the party opposing the class has acted or refused to act on grounds

generally applicable to the class, thereby making appropriate final injunctive

relief or corresponding declaratory relief with respect to the class as a whole;

or

(3) the court finds that the question of law or fact common to the

members of the class predominate over any questions affecting only individual

members, and that a class action is superior to other available methods for the

fair and efficient adjudication of the controversy. The matters pertinent to the

findings include: (a) the interest of members of the class in individually

controlling the prosecution or defense of separate actions; (b) the extent and

nature of any litigation concerning the controversy already commenced by or

against members of the class; (c) the desirability or undesirability of

-6-

concentrating the litigation of the claims in the particular forum; (d) the

difficulties likely to be encountered in the management of a class action.

Tenn. R. Civ. P. 23.02. Class certification is permissible only if the proponent demonstrates

compliance with both Rule 23.01 and Rule 23.02. Freeman, 229 S.W.3d at 702 (citing

Hamilton, 845 S.W.2d at 225).

The trial court determined Plaintiffs carried their burden to establish the requirements

of Rule 23. The court held: (1) Directors conceded the numerosity issue, (2) the cause of

action for breach of fiduciary duty and the principal defense to that claim were common

issues of law subject to generalized proof, (3) the claims or defenses of the class

representatives were typical of the class claims, and (4) the proposed class representatives

would adequately represent the absent class members. The court further concluded common

issues predominated over individual issues involved in the action. Because a class action

provided the superior method of resolving the claims, the court certified the proposed class.

Directors argue the trial court abused its discretion. Directors cite several perceived

deficiencies in the trial court’s decision. Their principal criticism concerns the court’s

alleged failure to recognize the “impossibility of squaring the interests of the two competing

categories of shareholder plaintiffs,” which Directors largely attribute to the court’s alleged

failure to perform a sufficiently rigorous analysis of the class certification requirements. The

existence of an irreconcilable conflict precluding certification is a theme of Directors’ brief.

In their view, the court’s lack of appreciation for the conflict between Series B and Series C

preferred shareholders prevented the court from reaching a decision consistent with the

controlling legal framework.

Directors also argue that Mr. Fulton is an inadequate representative of the class and

his claims are atypical because he voted in favor of the merger as a common stockholder.

Directors contend certification of a class including Series C preferred shareholders is an

abuse of discretion if Mr. Fulton is unable to serve as a class representative. According to

Directors, the remaining named plaintiffs who held only Series B preferred stock are

inadequate representatives of the preferred shareholders who held only Series C preferred

stock. Further, they argue named plaintiffs who held only Series B preferred stock are

without standing to pursue claims for the breaches of fiduciary duties owed to the Series C

preferred shareholders. The dispositive issue set forth in Directors’ brief is whether Mr.

Fulton’s claims or defenses are typical of the claims or defenses of the class. All other issues

are pretermitted.4

4

We note Directors argue this Court should vacate the decision of the trial court for failure to perform

(continued...)

-7-

A. Typicality

Directors argue the trial court abused its discretion when it found the claims or

defenses of the class representatives typical of the class claims or defenses. “[A] plaintiff’s

claim is typical if it arises from the same event or practice or course of conduct that gives rise

to the claims of other class members, and if his or her claims are based on the same legal

theory.” Freeman, 229 S.W.3d at 703 (quoting In re Am. Med. Sys., Inc., 75 F.3d 1069, 1082

(6th Cir. 1996)) (alteration in original) (citation omitted) (internal quotation marks omitted).

The typicality inquiry focuses on whether the legal and remedial theories of the class

representatives are sufficiently similar to those of the unnamed class members.5 Mullen v.

Treasure Chest Casino, LLC, 186 F.3d 620, 625 (5th Cir. 1999) (citing Lightbourn v. Cnty.

of El Paso, Tex., 118 F.3d 421, 426 (5th Cir. 1997)); Hanon v. Dataproducts Corp., 976 F.2d

497, 508 (9th Cir. 1992) (citations omitted).

“A necessary consequence of the typicality requirement is that the representative’s

interests will be aligned with those of the represented group, and in pursuing his own claims,

the named plaintiff will also advance the interests of the class members.” In re Am. Med.

Sys., Inc., 75 F.3d at 1082 (citing 1 Herbert B. Newberg & Alba Conte, Newberg on Class

Actions § 3.13 (3d ed. 1992)). “The typicality requirement reflects the belief that a class

action’s progress should not be compromised by a diversion of attention from the substance

of the basic claim involved in the case.”6 Bayberry Assocs. v. Jones, 87-261-II, 1988 WL

137181, at *9 (Tenn. Ct. App. Nov. 9, 1988) (citation omitted), vacated for lack of a final

judgment, 783 S.W.2d 553 (Tenn. 1990). “Its purpose, therefore, is to screen out class

actions in which the legal or factual position of the representative party is markedly different

4

(...continued)

a “rigorous, thorough, and careful analysis” of Rule 23’s requirements. Gov’t Emps. Ins. Co. v. Bloodworth,

M2003-02986-COA-R10-CV, 2007 WL 1966022, at *7 (Tenn. Ct. App. June 29, 2007). Our supreme court

has not addressed whether Tennessee courts must conduct a rigorous analysis. E.g., Walker, 249 S.W.3d at

308; Meighan, 924 S.W.2d at 637. We express no opinion on whether the failure to perform a rigorous

analysis is itself grounds to vacate a trial court’s decision.

5

Although there are few reported opinions from Tennessee state courts addressing class certification

under Rule 23 of the Tennessee Rules of Civil Procedure, federal cases addressing class certification under

the Federal Rules of Civil Procedure are persuasive authority. Meighan v. U.S. Sprint Commc’ns Co., 924

S.W.2d 632, 637 n.2 (Tenn. 1996) (citing Bayberry Assocs. v. Jones, 783 S.W.2d 553, 557 (Tenn. 1990)).

6

We note the Tennessee Supreme Court vacated this Court’s decision in Bayberry Associates v.

Jones, 87-261-II, 1988 WL 137181 (Tenn. Ct. App. Nov. 9, 1988), vacated for lack of a final judgment, 783

S.W.2d 553 (Tenn. 1990), for reasons unrelated to that opinion’s substantive evaluation of the Rule 23

requirements. Several of the this Court’s well-supported statements regarding the typicality requirement are

nonetheless persuasive.

-8-

from that of the other members of the class, even though common issues of law or fact may

also be present.” Id. (citations omitted).

The claims or defenses of a class representative are atypical if a defense unique to that

person or a small subclass is likely to become a major focus of the litigation. Koos v. First

Nat. Bank of Peoria, 496 F.2d 1162, 1164-65 (7th Cir. 1974) (citation omitted); see also In

re Schering Plough Corp. ERISA Litig., 589 F.3d 585, 599-601 (3d Cir. 2009); Gary Plastic

Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 903 F.2d 176, 180 (2d Cir.

1990) (citations omitted); Rolex Emps. Ret. Trust v. Mentor Graphics Corp., 136 F.R.D. 658,

663-64 (D. Or. 1991) (citations omitted). Regardless of whether courts frame this issue in

terms of typicality or adequacy of representation, the danger is that a class representative will

not properly advance the interests of the absent class members if overly concerned with

defenses or affirmative defenses unique to him. Gary Plastic, 903 F.2d at 180 (citations

omitted); see also Beck v. Maximus, Inc., 457 F.3d 291, 301 (3d Cir. 2006) (“A proposed

class representative is neither typical nor adequate if the representative is subject to a unique

defense that is likely to become a major focus of the litigation.”).

Directors argue the claims or defenses of Mr. Fulton are atypical because he is subject

to unique affirmative defenses that are likely to become a major focus of the litigation.

Directors cite several cases as demonstrating that the affirmative defenses of acquiescence,

ratification, or waiver bar Mr. Fulton’s claim as a common stockholder who voted in favor

of the merger. E.g., Cohen v. Mirage Resorts, Inc., 62 P.3d 720, 730 (Nev. 2003) (citations

omitted) (“Shareholders who vote in favor of the merger generally have no standing to

contest the validity of the merger.”); Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 842

(Del. 1987) (“An informed minority shareholder . . . who either votes in favor of a merger

or accepts the benefits of the transaction cannot thereafter attack the fairness of the merger

price.”); Howard v. Eatonton Co-op. Feed Co., 177 S.E.2d 658, 662 (Ga. 1970) (“When the

defendants voted for the merger, they agreed to all of the terms of the merger agreement, and

will not now be heard to complain . . . .”). Plaintiffs disagree, distinguishing these cases on

the basis that Mr. Fulton was allegedly unable to evaluate the fairness of the merger with the

informed consent that Plaintiffs submit is vital to the application of the asserted affirmative

defenses.

The trial court acknowledged Mr. Fulton voted in favor of the merger. The court’s

order nevertheless did not analyze the effect of that vote in relation to requirements of

typicality or adequacy of representation. Likewise, the court did not offer an express opinion

regarding the existence of the above defenses under Tennessee law or address their

applicability under the facts. Plaintiffs contend the trial court’s decision not to make an

express legal conclusion is inconsequential because the court heard Plaintiffs’ legal argument

at the class certification hearing. Plaintiffs argue the trial court impliedly agreed with their

-9-

assertion that informed consent is essential to proving the asserted affirmative defenses if

they are indeed available to Directors under Tennessee law. Plaintiffs further suggest the

court impliedly rejected Directors’ position because Mr. Fulton could not have voted with

informed consent with respect to the effect of the merger on the preferred stock.

We disagree that the trial court’s silence equates to approval of Plaintiffs’ position.

Although it appears informed consent is generally a prerequisite to the application of the

asserted affirmative defenses, the possibility remains that Mr. Fulton’s actions constituted

acquiescence, ratification, or waiver under the unique facts of this case. Since this is an issue

of first impression in Tennessee, it is possible that the trial court may apply the above

defenses in a novel way that bars Mr. Fulton’s claim. Additionally, the court may have

premised its rejection of Directors’ position on an erroneous conclusion that a unique defense

likely to become a major focus of the litigation does not defeat typicality in Tennessee. We

disagree that the court’s silence implies rejection of the existence of the asserted affirmative

defenses in Tennessee or application of these defenses under the facts of this case without

something more. Even if the court impliedly rejected Directors’ position, the court may

change its opinion prior to the entry of a final judgment.

Directors clearly intend to pursue the affirmative defenses of acquiescence,

ratification, and waiver against Mr. Fulton. Given the nature of these proceedings and the

unsettled nature of the law in this regard, it is highly likely Directors will have an opportunity

to revisit the issue in future proceedings where the trial court has offered no express legal

conclusion in favor of Plaintiffs on this merits issue.7 Although we think it inappropriate to

express a conclusion regarding the existence or application of the asserted defenses in this

appeal, our review of the cases cited above persuades us that Directors’ position is not merely

speculative. At the very least, issues concerning the existence and application of these

asserted defense are likely to become a major focus of litigation, especially where Mr.

Fulton’s removal as a class representative might affect the ability of the class to remedy the

alleged breach of fiduciary duties owed to Series C preferred shareholders.8 These defenses

7

The trial court’s silence may indicate only that the court believed such legal questions best resolved

at summary judgment or at trial where the court would have an opportunity to analyze the application of the

defenses in light of the undisputed or established facts. The court indicated at the Rule 23 hearing it did not

intend to reach merits issues.

8

Directors contend the court cannot certify a class including Series C preferred shareholders unless

at least one named plaintiff has standing to assert a breach of the fiduciary duties allegedly owed to that

group. See Griffin v. Dugger, 823 F.2d 1476, 1483 (11th Cir. 1987) (concluding at least one named plaintiff

must have standing to pursue each class claim); but see Payton v. County of Kane, 308 F.3d 673, 680 (7th

Cir. 2002) (concluding courts should first address the question of class certification and then address standing

(continued...)

-10-

are likely to become a major focus of the litigation regardless of whether they are ultimately

meritorious.

We are unable, however, to determine on the record whether these affirmative

defenses are unique to Mr. Fulton or a small subset of the class. The record is without

adequate information to determine how many preferred shareholders owned common stock,

how many of those shareholders voted in favor of the merger, or how many of the

shareholders opposed the merger. As a result, we are unable to determine whether Mr.

Fulton stands in a position typical of absent class members or whether litigation of the

defenses asserted against him will impermissibly detract from the pursuit of the class claims.

It is possible that the defenses raised with respect to Mr. Fulton are not unique because a

substantial part of the class is similarly situated. It is also possible, on the other hand, that

Mr. Fulton is the sole preferred shareholder, or a member of a small subclass of preferred

shareholders, who voted in favor of the merger. The record is silent on these issues. We

have attempted in view of the abuse of discretion standard to discover evidence in the record

that would support a finding of typicality in light of the controlling legal principles. We are

unable to do so.

Plaintiffs ask this Court to affirm certification of the class even if Mr. Fulton is an

inappropriate class representative. Plaintiffs contend Donald J. Roberts IRA and Dr. James

M. Byers IRA Rollover meet each requirement of Rule 23.01 and that the potential removal

of Mr. Fulton as a class representative does not effect the court’s analysis of Rule 23.02.

Plaintiffs further contend the question of standing is irrelevant to the certification

determination. See Defer L.P. v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 210

(S.D.N.Y. 2009) (citations omitted) (stating the question of whether a named plaintiff can

represent class members is not a question of standing but rather a question of typicality). We

find it appropriate, however, to vacate the court’s decision and remand under the unique

circumstances of this case.

We vacate and remand for several reasons. First, the record does not demonstrate that

the claims or defenses of the representative parties are typical of the claims or defenses of

8

(...continued)

“with reference to the class as a whole, not simply with reference to the individual named plaintiffs”).

Directors argue that Donald J. Roberts IRA and Dr. James M. Byers IRA Rollover lack standing to bring suit

on the alleged breaches of fiduciary duties owed to Series C preferred stockholders if Mr. Fulton is an

inappropriate class representative. In their view, the inability of Mr. Fulton to establish typicality precludes

certification of a class that includes Series C preferred shareholders. The trial court did not address this

question likely because the class it certified includes at least one named plaintiff with standing to assert both

the claims of Series B and C preferred shareholders. Because resolution of this issue may become

unnecessary upon remand, we decline to address it.

-11-

the class. This is enough in our view to vacate the decision of the trial court. Second,

remand prevents this Court from authoring a potentially advisory opinion on whether at least

one named plaintiff must possess standing for each claim in a class action, which is a matter

of first impression before Tennessee courts. While Mr. Fulton’s status as a class

representative stands in jeopardy, it is possible that the trial court will determine upon review

of the relevant evidence that he satisfies both the typicality and adequacy of representation

requirements. Third, it is not entirely clear that the trial court would have reached the same

decision on certification if it had concluded upon examination of the necessary evidence that

Mr. Fulton was an inadequate representative. The court’s order suggests it considered only

Mr. Fulton a proposed class representative for Series C preferred shareholders. Finally,

remand gives the trial court an opportunity to correct an apparent error in its decision

regarding which named plaintiffs sought to serve as class representatives and to clarify which

class representatives met Rule 23’s requirements.9 We accordingly vacate the trial court’s

decision and remand for further consideration.

B. Subclassing

In vacating the trial court’s decision, we decline to order sua sponte subclassing of the

preferred stockholders. Rule 23.03 of the Tennessee Rules of Civil Procedure permits the

division of a proposed class into subclasses. Tenn. R. Civ. P. 23.03(4). Courts may employ

subclasses to address conflicts that arise among definable groups of a larger class. See

Boucher v. Syracuse Univ., 164 F.3d 113, 118-19 (2d Cir. 1999). “[T]he usual situation in

which a court will divide a class into subclasses under that provision is when the class is

found to have members whose interests are divergent or antagonistic.” 7AA Charles Alan

Wright, Arthur R. Miller, & Mary Kay Kane, Federal Practice and Procedure § 1790 (3d

ed. 2004). If a court discerns a conflict, the proper solution is often to create subclasses of

persons or entities whose interests are aligned. Boucher, 164 F.3d at 118-19 (citing Payne

v. Travenol Labs., Inc., 673 F.2d 798, 812 (5th Cir. 1982)). At least one federal appellate

court has ordered a trial court to create subclasses on remand, even though the trial court in

that case did not abuse its discretion in certifying the larger class. E.g., Marisol A. v.

Giuliani, 126 F.3d 372, 378-79 (2d Cir. 1997) (per curiam) (ordering the trial court to divide

a properly certified class into subclasses).

Creating subclasses might address some of the alleged conflicts set forth in Directors’

9

The trial court stated in its order that Plaintiffs sought appointment of Patrick Svoboda IRA and

Svoboda Realty Inc. Defined Benefit Plan as class representatives, whereas Plaintiffs actually sought

appointment of Dr. James M. Byers IRA Rollover. As a result, the court’s order appears to conclude that

Patrick Svoboda IRA and Svoboda Realty Inc. Defined Benefit Plan are appropriate representatives of the

class but does not expressly address the status of Dr. James M. Byers IRA Rollover.

-12-

brief. We nevertheless decline to order subclassing because we are unable to evaluate fully

which subclasses might satisfy Rule 23’s requirements. The creation of subclasses does not

obviate compliance with Rule 23; each subclass must independently satisfy the requisite

certification requirements. See Tenn. R. Civ. P. 23.03(4) (directing courts to treat each

subclass as a class and apply the provisions of Rule 23 accordingly); see also Betts v.

Reliable Collection Agency, Ltd., 659 F.2d 1000, 1005 (9th Cir. 1981); State of W. Va. ex rel.

Chemtall Inc. v. Madden, 607 S.E.2d 772, 785 (W. Va. 2004) (citations omitted). “The

creation of a number of subclasses may result in some that are too small to satisfy the

numerosity requirement, may make the case unmanageable, or, in a Rule 23(b)(3) suit, may

defeat the superiority requirement.” Manual for Complex Litigation (Fourth) § 21.23 (2004).

We are without sufficient information in the record to determine conclusively whether

potential subclasses of preferred shareholders in this case would satisfy Rule 23's

requirements. We cannot, for example, determine whether a subclass of preferred

shareholders who voted in favor of the merger as common stockholders would satisfy the

numerosity requirement. We accordingly decline to order subclassing or to require

consideration of subclassing, even if Rule 36 of the Tennessee Rules of Appellate Procedure

would allow it.10

We note, however, that the trial court must actively guard against the development of

conflicts and consider subclassing if it becomes necessary. Cf. Barney v. Holzer Clinic, Ltd.,

110 F.3d 1207, 1214 (6th Cir. 1997) (citing Grigsby v. North Miss. Med. Ctr., Inc., 586 F.2d

457, 462 (5th Cir. 1978); Key v. Gillette Co., 782 F.2d 5, 7 (1st Cir. 1986); In re General

Motors Corp. Engine Interchange Litig., 594 F.2d 1106, 1124 (7th Cir.), cert. denied, 444

U.S. 870 (1979); Burns v. U.S. R.R. Ret. Bd., 701 F.2d 189, 191-92 (D.C. Cir. 1983)).

“Because the stakes and scope of class action litigation can be great, class actions often

require closer judicial oversight and more active judicial management than other types of

litigation.” Manual for Complex Litigation (Fourth) § 21 (2004). Courts must be “especially

vigilant” to safeguard the due process rights of absent class members through adequate

representation because the judgment in a class action conclusively binds them. Berger v.

Compaq Computer Corp., 257 F.3d 475, 480 (5th Cir. 2001) (citation omitted). The court

has the power and the duty in its role as guardian of the absent class members “to ensure that

the class representative and class counsel do nothing to compromise or otherwise prejudice

the interests of those whom they have undertaken to represent.” Blanchard v. EdgeMark Fin.

10

Rule 36 may not provide authority to create subclasses for the first time on appeal if the

consideration of subclassing in the first instance lies within the province of the trial court. See Tenn. R. App.

P. 36(a) (giving appellate courts authority to “grant the relief on the law and facts to which the party is

entitled or the proceeding otherwise requires and may grant any relief, including the giving of any judgment

and making of any order; provided, however, relief may not be granted in contravention of the province of

the trier of fact”).

-13-

Corp., 175 F.R.D. 293, 298-99 (N.D. Ill. 1997) (footnote omitted) (citing Shelton v. Pargo,

Inc., 582 F.2d 1298, 1306 (4th Cir. 1978); Grunin v. Int’l House of Pancakes, 513 F.2d 114,

123 (8th Cir. 1975); Runion v. U.S. Shelter, 98 F.R.D. 313, 318 (D.S.C. 1983)). If the court

determines on remand that an irreconcilable conflict exists or arises that will unduly

prejudice the interests of the class, the court has an independent duty to reject certification,

to decertify the class, or to resolve the conflict with subclasses. We express no opinion,

however, on whether such a conflict presently exists or is likely to arise. We instead vacate

the trial court’s decision and remand for further proceedings.

V. Conclusion

For the foregoing reasons, we vacate the order granting class certification and

remand for further consideration. We tax the costs of this appeal to the appellees, Donald

J. Roberts IRA, Dr. James M. Byers IRA Rollover, Patrick Svoboda IRA, Svoboda Realty

Inc. Defined Benefit Plan, and Jack Fulton, for which execution may issue if necessary.

_________________________________

DAVID R. FARMER, JUDGE

-14-