Amicus Curiae Brief — California Public Employees' Retirement System v. Felzen

(E) FILED

NOV 10 iSys

No. 97-1732

OFFICE OF THE CLERK

——[—SEPREMECOURT, U.S.

IN THE

Supreme Court of the United States

OCTOBER TERM, 1998

CALIFORNIA PUBLIC EMPLOYEES RETIREMENT

SYSTEM AND FLORIDA STATE BOARD OF

ADMINISTRATION,

Petitioners,

V.

PAUL FELZEN, ET AL..,

Respondents.

On Writ of Certiorari to the United States Court of

Appeals for the Seventh Circuit

BRIEF OF PROFESSORS LAWRENCE A.

HAMERMESH AND MARY BRIGID McMANAMON

AS AMICI CURIAE SUPPORTING PETITIONERS

Professor Lawrence A. Hamermesh*

Professor Mary Brigid McManamon

Widener University School of Law

4601 Concord Pike

Wilmington, Delaware 19803

(302) 477-2100

DATE: November 10, 1998 *Counsel of Record

x0

(i)

TABLE OF CONTENTS

TABLE OF AUTHORITIES

INTEREST OF THE AMIC/

SUMMARY OF ARGUMENT

ARGUMENT

IN DERIVATIVE ACTIONS ASSERTING

CLAIMS ARISING UNDER STATE LAW,

_ STATE LAW RULES REGARDING THE

CONDUCT OF DERIVATIVE ACTIONS

AND THE PROSECUTION OF APPEALS

IN SUCH ACTIONS SHOULD GOVERN

DERIVATIVE ACTIONS IN-~ THE

FEDERAL COURTS.

THE COURT BELOW

UNDERESTIMATED THE SIGNIFICANCE

OF THE OBJECTORS’ INTEREST IN

THE DERIVATIVE ACTION AS A

MATTER OF SUBSTANTIVE LAW.

UNSUCCESSFUL OBJECTORS IN THE

DELAWARE COURTS MAY APPEAL

SETTLEMENT APPROVALS IN

DERIVATIVE ACTIONS WITHOUT

FORMAL INTERVENTION.

CONCLUSION

(ii)

TABLE OF AUTHORITIES

Cases

Bangor Punta Operations, Inc. v. Bangor & Aroostook

RR. AT USB. TERS. wwe een een ee 5

Bell Atl. Corp. v. Bolger, 2 F.3d 1304 (3d Cir. 1983)

8

Braun v. Fleming-Hall Tobacco Co., Inc., 92 A.2d 302

Gal: CEHRD . k on Se EOS eee eee 21, 22

Burghart v. Landau, 821 F. Supp. 173 (S.D.N.Y.

TOBE. 2 nn eek ih 6 Ee ee eee eee 6

Byrd v. Blue Ridge Rural Electric Cooperative, Inc.,

366 U.B. GRR COREE. 6 c+ bee ete eee 13, 14

Cohan v. Loucks, 1993 WL 121855 (Del. Ch. 1993) _.

23

Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 535

(T1O6R) . 5 0 e.6 kc We ool eee eee 5

Cohen v. Young, 127 F.2d 721 (6th Cir. 1942) ... 7

Daily Income Fund, Inc. v. Fox, 464 U.S. 523 (1984) .

16

Erie Railroad v. Tompkins, 304 U.S. 64 (1938) . . . 3

Gallup v. Caldwell, 120 F.2d 90 (3d Cir. 1941) ... 4

Gasperini v. Center for Humanities, Inc., 518 U.S. 415

We re ee 7

Geller v. Tabas, 462 A.2d 1078 (Del. 1983)... .. 23

Girsh v. Jepson, 521 F.2d 153 (3d Cir. 1975)... . 7

Gladstone v. Bennett, 153 A.2d 577 (Del. 1959) . .23

Goodman v. Futrovsky, 213 A.2d 899 (Del. 1965) .. .

Greenspun v. Bogan, 492 F.2d 375 (1st Cir. 1974) . 7

Grimes v. Donald, 673 A.2d 1207 (Del. 1996). . . .16

Hanna v. Plumer, 380 U.S. 460 (1965)... .. 14, 15

as

(iii)

Hawes v. Oakland, 104 U.S. 450, 26 L. ed. 827 (1881)

3,4

Heineman v. Datapoint Corp., 611 A.2d 950 (Del.

Me MMe Bes . 6 6k bee 8 6 6 17, 18

HFG Co. v. Pioneer Pubi’g Co., 162 F.2d 536 (7th Cir.

ee ek sw aoe eee 5

Hoffmann v. Dann, 205 A.2d 343 (Del. 1964). . . .23

In re Pittsburgh & Lake Erie R.R. Sec. & Antitrust Litig.,

543 F.2d 1058 (3d Cir. 1976) ............ 6

In re Resorts Int'l Shareholder Litigation Appeals, 570

a ae 24

In re Storage Tech. Corp. Sec. Litig., 804 F. _—_

ago. becca bs bo 0 «

Jones v. Nuclear Pharmacy, Inc., 741 F.2d 322 ‘on

kg ot a 7

Kahn v. Sullivan, 594 A.2d 48 (Del. 1991)... ... 24

Kamen v. Kemper Fin. Servs., inc., 500 U.S. 90 (1991)

5

Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1985)... . . 18

Krinsky v. Helfand, 156 A.2d 90 (Del. 1959). . . . . 23

Levine v. Smith, 1987 Del. Ch. LEXIS 524 (Del. Ch.

1987), affd, 591 A.2d 194 (Del. 1991)... ... 18, 19

Lewis v. Chiles, 719 F.2d 1044 (9th Cir. 1983) ... 6

Lewis v. Fuqua Industries, inc., 1982 WL 8783 (Del.

ESSE a a 23

Lewis v. Hirsch, 1995 Del. LEXIS 62 (Del. Ch. 1995) .

20

Manacher v. Reynolds, 165 A.2d 741 (Del. Ch. 1960)

23

Marino v. Ortiz, 484 U.S. 301(1988)......... 10

Masterson v. Pergament, 203 F.2d 315 (6th Cir. 1953)

7

Matsushita Elec. indus. Ltd. v. Epstein, 516 U.S. 367

Se RN 25

(iv)

Moses v. Pickens, 1982 WL 17825 (Del. Ch. 1982) . .

23

Nathan v. Rowan, 651 F.2d 1223 (6th Cir. 1981) . 10,

11

Neponsit Investment Co. v. Abramson, 405 A.2d 97

GO, We boa ia GS? Ke ade ee ca 23

Neuwirth v. Allen, 338 F.2d 2 (2c Cir. 1964)... .. 7

Norton v. National Research Found., 141 F.R.D. 510

ee de eh ie 6

Osbom v. Bank of the United States, 22 U.S. (9

We WEED: ,. és 6 6 nA ee ao ee 9, 10

Pianta v. H.M. Reich Co., 77 F.2d 888 (2d Cir. 1935) .

11

Pogostin v. Rice, 480 A.2d 619 (Del. 1984)... .. 16

Polk v. Good, 506 A.2d 531 (Del. 1986)... . . 23, 24

Prezant v. DeAngelis, 636 A.2d 915 (Del. 1994). . .24

Ragan v. Merchants Transfer & Warehouse Co., 337

FN Ore aS ae 12

Rales v. Blasband, 634 A.2d 927 (Del. 1993). . . .16

RCM Sec. Fund, inc. v. Stanton, 928 F.2d 1318 (2d

Gi ME so = ecerech a es oe 2 oo 6

Rome v. Archer, 197 A.2d 49 (Del. 1964). ..... 23

Rosenbaum v. MacAllister, 32 F.3d 1439 (10th Cir.

GUD. c7s + wo ch % a EWS cls 4 Sdn t =

Rutman v.Kaminsky, 226 A.2d 122 (Del. 1967) .

S.A. Healy Co. v. Mwautee Meropoian Sewerage

Dist., 60 F.3d 305 (7th Cir. 1995) ..........

Salve Regina College v. Russell, 499 U.S. aiiien

7

Saminsky v. Abbott, 194 A.2d 549 (Del. Ch. 1963) . .

23

Shults v. Champion int'l Corp., 35 F.3d 1056 (6th Cir.

Gs & k when We ois Re ON ee oe 8

Spiegel v. Buntrock, 571 A.2d 767 (Del. 1990). . . 16

(v)

Stepak v. Ross, 1985 WL 21137 (Del. Ch. 1985) . .23

Torres v. Oakland Scavenger Co., 487 U.S. 312

Sr . 4 ce eee eee rs Ss Cec Ce hee 14

Tryforos v. Spanos, 518 F.2d 1258 (7th Cir. the

cert. denied, 423 U.S. 1091(1976) .........

United Founders Life ins. Co. v. EES

Ins. Co., 447 F.2d 647 (7th Cir. 1971). ....... 7

United States ex rel. Louisiana v. Jack, 244 U.S. 397

FOUND: & <5 gate te Oe ee Ce a he. 11

Walker v. Armco Steel Corp., 446 U.S. 740 (1980)

12

Woigin v. Simon, 722 F.2d 389 (8th Cir. 1983). . .

Zapata Corp. v. Maidonado, 430 A.2d 779 (Del. 1981)

16

Constitution, Statutes and Rules

IE aa aS ee nee G

i he ie eh ee +

I _

SER I SI ere eer 12, 13

AES ee mes ae at 16

Delaware Chancery Court Rule 23.1 ........ 19

REI ES Se ere 11, 12

Ne 12

a i a 13

NS oS a io ee Le le 8

res Se a ee a GS aie 8

EE ee 3,5

(vi)

Other Materials

3B James W. Moore, Federal Practice J] 23.1.24[3] (2d

i ee a ea oe ee 8

1947 Special Pamphiet to 28 U.S.C. §§ 721-723 . . 5

2 Business and Commercial Litigation in Federal

Courts 66 (Robert L. Haig, ed. 1998) ........ 20

7C Charles Alan Wright ef al., Federal Practice and

Procedure § 1826 (2ded.1986)...........

Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate

and Commercial Practice in the Delaware Court of

Chancery § 9-4(g) (1998) .............. 20

Proceedings of the American Bar Association Institute

on Federal Rules at Cleveland, Ohio 184 (W. Dawson

G6 TE ce eh oe 6 a ore 60 tke wes 4

BRIEF OF PROFESSORS LAWRENCE A.

HAMERMESH AND MARY BRIGID McMANAMON

AS AMICI CURIAE SUPPORTING PETITIONERS

The undersigned respectfully submit this brief as

ena ta tina the petiti "California Public

Employees’ Retirement System and Florida State Board

of Administration. '

INTEREST OF THE AMIC/

Professor Lawrence A. Hamermesh is Associate

Professor of Law, Widener University School of Law,

Wilmington, Delaware. A member of the Delaware Bar

since 1976, Professor Hamermesh practiced law in

Wilmington, Delaware, until 1994, principally in the field

of corporate litigation, including stockholder derivative

and class action litigation. Professor Hamermesh

teaches courses in business organizations, securities

regulation, corporate finance, and mergers and

acquisitions. Professor Hamermesh’s interest in

submitting this amicus brief is in ensuring that the Court

is duly apprised of the substantive law and practice of

Delaware in relation to stockholder derivative actions.

Professor Mary Brigid McManamon is Associate

Professor of Law, Widener University School of Law,

: No counsel for a party authored any part of this

brief. The Council of Institutional Investors, which is an

association of institutional investors, is making a

monetary contribution to the preparation and submission

of this brief. The parties consented to the filing of this

brief, as reflected in letters on file with the Court.

2

Wilmington, Delaware. She has been teaching in the

field of federal procedure, including courses in Civil

Procedure, Federal Courts, Complex Litigation, and

Conflict of Laws, since 1985. In addition, she has

published law review articles on the history of federal

procedure and has been a co-author of one of the major

casebooks on Civil Procedure since 1997. Professor

McManamon's interest in submitting this amicus brief is

in ensuring that the Court is duly apprised of the

historical practice under Federal Rule of Civil Procedure

23.1, with particular emphasis on the federalism

concerns raised by the Seventh Circuit's creation of new

federal common law.

SUMMARY OF ARGUMENT

1. In a stockholder derivative action, the law

of the state of incorporation of the entity on behalf of

which claims are being asserted should determine the

entitlement of a stockholder to appeal approval of a

settiement of the action, just as the law of the state of

incorporation determines the entitlement of a

stockholder to initiate and conduct the action.

2. In declining to permit a stockholder to

appeal approval of a settlement without formally

intervening as a party, the court below underestimated

the stockholder’s interest in such a settlement as a

matter of applicable state substantive law, here

Delaware law.

3. Consistent with the interest of stockholders

as a matter of substantive law in the settlement of a

derivative action on behalf of a Delaware corporation,

~ eee

3

the Delaware courts have consistently allowed objectors

to a settiement of such an action to appeal approval of

a settlement without having formally intervened as a

party. This Court should direct that this approach be

followed in this case.

ARGUMENT

l. IN DERIVATIVE ACTIONS ASSERTING CLAIMS

ARISING UNDER STATE LAW, STATE LAW

RULES REGARDING THE CONDUCT OF

DERIVATIVE ACTIONS AND THE

PROSECUTION OF APPEALS IN SUCH

ACTIONS SHOULD GOVERN DERIVATIVE

ACTIONS IN THE FEDERAL COURTS.

in 1938, this Court both promulgated Federal

Rule of Civil Procedure 23(b), now Rule 23.1, and

limited its scope by holding in Erie Railroad v. Tompkins,

304 U.S. 64, 78 (1938), that, “[e}xcept in matters

governed by the Federal Constitution or by acts of

Congress, the law to be applied in any case is the law of

the state.” The impact of this holding on former Rule

23(b) was recognized immediately. At the Proceedings

of the Institute on Federal Rules held July 21, 1938,

William D. Mitchell, chair of the Supreme Court Advisory

Committee, noted:

Many years ago, in Hawes v.

Oakland, 104 U.S. 450, 26 L. ed. 827

(1881), the Supreme Court held, as an

equitable principle, that a shareholder

could not maintain [a derivative action on

behalf of the corporation] if he did not own

4

the shares when the act complained of

was committed.

Now, if the question of the right to

maintain suit, depending on whether the

plaintiff owned the shares when the act

was complained of or not, is a matter of

substantive right, then it is possible under

Erie Railroad v. Tompkins, which now

makes the decision of the state court

binding on federal courts in the matter of

substantive law, that the court may say

that this question of the right of a

shareholder to sue and the condition on

which his right is predicated, is a matter of

state law, and the federal courts no longer

may have a rule of their own, but must

follow the local state decisions on that

point.

Proceedings of the American Bar Association Institute on

Federal Rules at Cleveland, Ohio 184 (W. Dawson ed.

1938).

Mr. Mitchell’s concern proved well-founded, as

the federal courts immediately had to grapple with the

question of whether Rule 23(b) impermissibly affected

substantive rights. As early as 1941, the Third Circuit

held that a shareholder's ability to participate in the

litigation of a derivative suit is a substantive issue, which

must be determined in a diversity action by the law of

the state of incorporation. Gallup v. Caldwell, 120 F.2d

90, 93 (3d Cir. 1941). After some early confusion on this

5

issue among the circuits,” this Court directed that Rule

23(b), and later Rule 23.1, should be interpreted so as

not to affect substantive rights,’ and the Gallup court's

2 In 1944, the Advisory Committee on Rules for

Civil Procedure considered amending Rule 23(b),

noting:

As a result of the decision in Erie R.

Co. v. Tompkins, 304 U.S. 64, 58 S.Ct.

817 (82 L.Ed. 1188, 114 AL.R. 1487)

(decided April 25, 1938, after this rule was

promulgated by the Supreme Court,

though before it took effect) a question

has arisen as to whether the provision

above quoted deals with a matter of

substantive right or is a matter of

procedure.

1947 Special Pamphiet to 28 U.S.C. §§ 721-723, at 19,

quoted in HFG Co. v. Pioneer Publ’g Co., 162 F.2d 536,

539 (7th Cir. 1947). The committee decided to do

nothing at that time, however, concluding that “[t}here is

reason to say that the question is one which should not

be decided by the Supreme Court ex parte, but left to

await a judicial decision in a litigated case.” /d. at 22,

quoted in HFG Co., 162 F.2d at 539.

* See, e.g., Kamen v. Kemper Fin. Servs., Inc.,

500 U.S. 90 (1991); Cohen v. Beneficial Indus. Loan

Corp., 337 U.S. 535 (1949); see also Bangor Punta

Operations, Inc. v. Bangor & Aroostook R.R., 417 U.S.

703, 713-14 (1974) (applying law of state of

incorporation to question of standing in state law

claims). In Kamen, this Court went so far as to hold that

position is now the generally accepted rule.* This rule,

that the applicable substantive law governs a

shareholder's right to participate in the litigation of a

derivative suit, applies not only to the plaintiff, but also

to a shareholder objecting to a proposed settlement.

See In re Pittsburgh & Lake Erie R.R. Sec. & Antitrust

Litig., 543 F.2d 1058, 1065-67 (3d Cir. 1976) (holding

standing to object to settlement of federal claim is

federal law question). Given the very real problem of

collusion in the settlement of shareholder derivative

suits (see Br. of Amicus Curiae Council of inst’! Investors

Part |, A), the underlying substantive law recognizes that

the objecting shareholder is every bit as important to the

vindication of the corporation's rights as the named

plaintiff. See discussion infra Part Il.

in a derivative action arising under federal law, the need

for uniformity in corporate governance overcame any

need for uniformity of federal practice, and thus a

sharehoider’s standing should be determined by the law

of the corporation's state of incorporation, unless that

law frustrated federal objectives. 500 U.S. at 97-98.

* E.g., RCM Sec. Fund, Inc. v. Stanton, 928 F.2d

1318, 1329-30 (2d Cir. 1991); Wolgin v. Simon, 722

F.2d 389, 391-92 (8th Cir. 1983); Burghart v. Landau,

821 F. Supp. 173, 176-78 ‘S.D.N.Y. 1993); Norton v.

National Research Found., .41 F.R.D. 510, 512 (D. Kan.

1992); In re Storage Tech. Corp. Sec. Litig., 804 F.

Supp. 1368, 1375 (D. Colo. 1992); see Lewis v. Chiles,

719 F.2d 1044, 1047-48 (9th Cir. 1983); see also 7C

Charlies Alan Wright ef al., Federal Practice and

Procedure § 1826 (2d ed. 1986).

The objecting shareholder's role does not end

with the approval of a settlement. The governing

substantive law recognizes the importance of the

objector’s right to appeal such approval to assure

vindication of the corporation's rights. See discussion

infra Part lll. It is entirely appropriate for the circuit

courts, hearing appeals in diversity cases, to be

sensitive to that important state interest. This Court has

recently reminded us that that the principles of Erie

govern the appellate courts, as well as the trial courts.

See Gasperini v. Center for Humanities, Inc, 518 U.S.

415 (1996); Salve Regina College v. Russell, 499 U.S.

225 (1991). And the federal courts have recognized and

been sensitive to the importance of the objecting

shareholder in the derivative suit. In 1942, the Sixth

Circuit expressly allowed such a shareholder to appeal

the approval of a settlement without the need to

intervene below. Cohen v. Young, 127 F.2d 721, 724

(6th Cir. 1942). Thereafter, the circuits routinely allowed

objectors in shareholder derivative suits to appeal

without intervening.’ The Seventh Circuit itself declared:

The law is clear that a non-party

shareholder who appears, pursuant to a

° See, e.g., Jones v. Nuclear Pharmacy, Inc., 741

F.2d 322 (10th Cir. 1984); Girsh v. Jepson, 521 F.2d

153 (3d Cir. 1975); Greenspun v. Bogan, 492 F.2d 375

(1st Cir. 1974); United Founders Life Ins. Co. v.

Consumers Nat'l Life Ins. Co., 447 F.2d 647 (7th Cir.

1971); Neuwirth v. Allen, 338 F.2d 2 (2d Cir. 1964):

Masterson v. Pergament, 203 F.2d 315 (6th Cir. 1953).

Rule 23.1 notice, to present objections to

a proposed dismissal or settlement of a

derivative action may appeal an adverse

decision even though he has not been

formally made a party to the action.

Tryforos v. Spanos, 518 F.2d 1258, 1263 n.22; see 3B

James W. Moore, Federal Practice J 23.1.24[3] (2d ed.

1996).

With the exception of the Seventh Circuit's

opinion in the case at bar, no circuit has reversed its

posi 9n on an objecting shareholder's right to appeal.

Quite the contrary. Every circuit that has discussed the

question in recent years has reaffirmed the objector’s

right to appeal without intervention. See Rosenbaum v.

MacAllister, 32 F.3d 1439, 1441-43 (10th Cir. 1995)

(allowing objector to appeal without intervention, noting

difference between Rule 23 case and Rule 23.1 case);

Shults v. Champion Int'l Corp., 35 F.3d 1056, 1059-60

(6th Cir. 1994) (expressly reaffirming its earlier opinion

in Cohen v. Young); Bell Ati. Corp. v. Bolger, 2 F.3d

1304, 1307-10 (3d Cir. 1993) (expressly holding that

objecting shareholder may appeal without intervening).

In contrast, the Seventh Circuit, overruling

precedent and showing no sensitivity to the very real

regulatory concerns of the underlying state law, held that

an objecting shareholder must intervene in order to

appeal the approval of a settlement in a Rule 23.1

derivative action. Moreover, the court rejected the

thoughtful reasoning of its own precedent as well as that

of the other circuits and ignored the role that an objector

plays in a derivative suit. Instead, the court below held

that it could not entertain the objector’s appeal because

it was outside the court's jurisdiction. The court's

reasoning, however, cannot withstand close scrutiny.

When determining if a matter is within the

jurisdiction of a federal court, the first place to look is the

jurisdictional statute. In this case, the controlling statute

is 28 U.S.C. § 1291. That section provides: “The courts

of appeals . . . shall have jurisdiction of appeals from all

final decisions of the district courts of the United States,

.. . except where a direct review may be had in the

Supreme Court.” The Seventh Circuit had before it a

final decision of the U.S. District Court for the Central

District of Illinois, and this case is not one in which there

may be a direct review in this Court, cf. id. § 1253

(providing for direct review from decisions of three-judge

courts). Thus, there is no statutory bar to the Seventh

Circuit's hearing this appeal.

This statutory grant of jurisdiction must, of course,

be tested by the bounds of Article Ill of the U.S.

Constitution. In this regard, there are two issues that

must be addressed. First, is this case within the judicial

power of the United States? As Chief Justice John

Marshall declared, with the exception of those cases

within the original jurisdiction of this Court, “the [judicial]

power [of the United States] is to be exercised in its

original or appellate form, or both, as the wisdom of

Congress may direct.”. Osbom v. Bank of the United

States, 22 U.S. (9 Wheat.) 738, 820 (1824). Thus, if this

case is within the bounds of Article Ill in its original form,

it is also within the bounds of Article Ill in its appellate

form. The district court had subject matter jurisdiction

over this diversity case. Therefore, the Seventh Circuit

10

is also competent to hear this matter. Second, does this

case present an Article Ill “case or controversy,” i.e., do

the appellants have standing? Objecting shareholders

have consistently been found to have standing to appeal

the approval of the compromise of a derivative action.

See discussion supra. Even the Seventh Circuit did not

deny that the objectors in the case at bar had standing.

See 134 F.3d at 876. Thus, there is no constitutional

bar to the Seventh Circuit’s hearing this appeal.

So, on what authority did the Seventh Circuit

conclude that it lacked jurisdiction to hear this appeal?

First, the court cited Marino v. Ortiz, 484 U.S. 301, 304

(1988). That case, however, is completely inapposite to

the one at bar. In Marino, non-class members objected

to the settlement of a class action without intervening.

Not surprisingly, this Court affirmed the lower court's

dismissal of their appeal. They had no relationship to

the parties or the lawsuit and would not have been

barred by res judicata. \|n the present case, objecting

shareholders, who are in privity with the parties, Nathan

v. Rowan, 651 F.2d 1223, 1226 (6th Cir. 1981),° have

appealed the compromise of a derivative suit. Not only

will res judicata apply to them, id., but, because they

appeared in court in answer to the court's notice to show

cause why a settlement should not be approved, they

are considered to be “like a defendant who is

summoned by process of court and after an adverse

® “[IJn shareholder derivative actions arising

under Fed.R.Civ.P. 23.1, parties and their privies

include the corporation and all nonparty shareholders.”

Id.

11

ruling has the right to appeal."” Cohen v. Young, supra,

127 F.2d at 724.’ There are too many legally important

differences between Marino and the present case for

the former to control the latter.

As further evidence that Marino is inapplicable to

this case, one need only look at the case relied on by

this Court as authority for its ruling: United States ex rel.

Louisiana v. Jack, 244 U.S. 397, 402 (1917). The Jack

Court was faced with an appeal of a settlement involving

certain real estate by the State of Louisiana after the

Supreme Court of Louisiana had held that the state had

no interest in the lands in controversy. In other words,

the nonintervening objector could not appeal the

approval of the settlement because the goveming state

law denied it the right to object. That is the converse of

the present case, in which the governing state law

specifically gives the objectors the right to appeal, see

discussion infra Part Ill, and thus cannot control the

Second, the Seventh Circuit relied on Federal

Rule of Appellate Procedure 3(c), which merely provides

that, “[a] notice of appeal must specify the party or

parties taking the appeal by naming each appellant in

either the caption or the body of the notice of appeal.”

This language is very odd to choose as evidence of a

jurisdictional bar, especially in light of this Court's

’ The Sixth Circuit quoted Pianta v. H.M. Reich

Co., 77 F.2d 888, 890 (2d Cir. 1935), which applied the

same principle to nonintervening nonparty creditors who

wished to challenge the acts of receivers.

12

conclusion that requiring a nonparty to seek intervention

before appealing is simply “the better practice.” Marino,

484 U.S. at 304. More importantly, however, Rule 3(c),

formerly Federal Rule of Civil Procedure 73(b), was

promulgated pursuant to the Rules Enabling Act, 28

U.S.C. § 2072, which provides that “[sJuch rule[ ] shall

not abridge, enlarge or modify any substantive right.”

An objecting sharehoider in a derivative suit plays an

important role, both at the trial and appellate levels, in

the vindication of the substantive rights of the

corporation. See discussion infra Parts Il, Il.

Interpreting Rule 3(c) as the Seventh Circuit did

eviscerates that role. This Court, when faced with such

a choice, has wisely chosen to interpret the Federal

Rule narrowly, thus avoiding a conflict with the

“Federal courts have interpreted the Federal Rules .. .

with sensitivity to important state interests and

regulatory policies.” Gasperini, supra, 518 U.S. at 427

n.7.

* in Gasperini, this Court cited Walker v. Armco

Stee! Corp., 446 U.S. 740, 750-52 (1980) (reaffirming

decision in Ragan v. Merchants Transfer & Warehouse

Co., 337 U.S. 530 (1949), that state law rather than

Federal Rule of Civil Procedure 3 determines when a

diversity action commences for the purposes of tolling

the state statute of limitations; Rule 3 makes no

reference to the tolling of state limitations, the Court

observed, and accordingly found no “direct conflict”);

S.A. Healy Co. v. Milwaukee Metropolitan Sewerage

Dist., 60 F.3d 305, 310-12 (7th Cir. 1995) (finding state

provision for offers of settlement by plaintiffs compatible

with Federal Rule of Civil Procedure 68, which is limited

to offers by defendants). See a/so Cohen v. Beneficial

Indus. Loan Corp., 337 U.S. 535 (1949) (finding state

provision for security for expenses did not conflict with

then Rule 23(b), which was silent on the question).

* Another example of such a de facto party might

be a nonintervening nonparty creditor challenging the

actions of a receiver. See supra note 7.

14

Fed. R. Civ. P. 73 advisory committee's note. When this

Rule was re-promuigated in 1967 as Federal Rule of

Appellate Procedure 3(c), the Advisory Committee,

noting that the Rule was “identical with corresponding

provisions in FRCP 73(b),” stressed only the importance

of timeliness in the filing of a notice of appeal. See Fed.

R. App. P. 3 advisory committee's note. Additionally,

this Court has held that

[t]he purpose of the specificity requirement

of Rule 3(c) is to provide notice both to the

opposition and to the court of the identity

of the appellant or appellants. The use of

the phrase “et al.,” which literally means

“and others,” utterly fails to provide such

notice to either intended recipient.

Permitting such vague designation would

leave the appellee and the court unable to

determine with certitude whether a losing

party not named in the notice of appeal

should be bound by an adverse judgment

or held liable for costs or sanctions.

Torres v. Oakland Scavenger Co., 487 U.S. 312, 318

(1988) (emphasis added). None of these policies would

be frustrated, or even slightly affected, by interpreting

the phrase “party or parties” to include those treated as

parties by the governing substantive law.

Finally, to adopt the Seventh Circuit's unique

approach would invite the kind of forum shopping this

Court hoped to prevent by its decision in Erie. See

Hanna v. Plumer, 380 U.S. 460, 468 (1965) (“twin aims

of the Ene rule: discouragement of forum-shopping and

15

avoidance of inequitable administration of the laws”). In

the case at bar, the substantive law provides the role of

the objecting shareholder as a check on the very real

threat of collusion between plaintiffs’ attorneys and

defendants in shareholder derivative suits. If Rule 3(c)

is interpreted to place such burdens on playing that role

that the check will be significantly eroded in federal court

(see Br. for Barclays Global Investors, State of Wis. Inv.

Bd., & Certain Other Inst'l Investors as Amici Curiae

Supp’g Pet'rs Part |), given the choice, plaintiffs’

attorneys will always choose federal court over state

court, thus leading to the inequitable administration of

the laws depending on the accident of diversity.

Ut. THE COURT BELOW UNDERESTIMATED THE

SIGNIFICANCE OF THE OBJECTORS’

INTEREST IN THE DERIVATIVE ACTION AS A

MATTER OF SUBSTANTIVE LAW.

At least tacitly acknowledging the relevance of

the position of the stockholder under applicable

substantive law, the court below did examine the

substantive position of stockholders of a Delaware

corporation in relation to a stockholder derivative action.

Several of its assertions in this regard, however, were

inconsistent with Delaware substantive law. First, the

court below asserted that stockholders “may not

displace the board in litigation”; second, it asserted that

“[s]harehoiders have no more the attributes of parties

when managers settle derivative litigation than when

managers settle antitrust litigation”; and most bluntly and

incorrectly, the court below asserted that “shareholders

... have no more right to speak for the firm or control its

litigation decisions than bondholders or banks or

16

landiords, all of whom have contractual interests that

may be affected by litigation.” 134 F.3d at 874-76.

This failure to distinguish stockholders from the

various other constituencies affected by the disposition

of a stockholder derivative action contravenes settled

Delaware law defining the stockhoider’s interest in the

control and disposition of the derivative action. Contrary

to the assertion of the court below, the stockholders do

“displace the board in litigation” where a derivative

action is allowed to proceed: what they displace, more

specifically, is the ordinary prerogative of the board of

directors to determine, without stockholder approval or

control, whether, when, and how to pursue litigation on

behalf of the corporation."® Indeed, it is that very

characteristic of derivative litigation that has resulted in

strict limitations upon the ability of stockholders to

initiate derivative actions, in which the ordinary

managerial authority of the board of directors over the

handling of corporate claims is displaced by stockholder

action."' See, for example, Heineman v. Datapoint

® Spiegel v. Buntrock, 571 A.2d 767, 772-73

(Del. wen Zapata Corp. v. Maidonado, 430 A.2d 779,

782 (Del. 1981) (“Directors of Delaware corporations

derive their managerial decision making power, which

encompasses decisions whether to initiate, or refrain

from entering, litigation, from 8 Dei. C. §141(a).”).

"" Eg. Grimes v. Donald, 673 A.2d 1207, 1215

(Del. 1996) (citing Pogostin v. Rice, 480 A.2d 619, 624

(Del. 1984)); Rales v. Blasband, 634 A.2d 927, 932 (Del.

1993); Spiegel v. Buntrock, 571 A.2d 767, 773 (Del.

17

Corp., 611 A.2d 950 (Del. 1992), which holds that even

though the board of directors ordinarily “makes the

ultimate decision of whether or not to prosecute the

[corporation's] claim,” stockholders may initiate and

prosecute the claim derivatively where:

a reasonable doubt exists that the board has the

ability to exercise its managerial power. in

relation to the decision to prosecute, within the

strictures of its fiduciary obligations.

Id. at 952.

Thus, where the board of directors is considered

capable of dealing with the corporation's claim “within

the strictures of its fiduciary obligations,” the stockholder

derivative action must be dismissed for failure to make

pre-suit demand. in contrast, where a stockholder

derivative action is settled, and not dismissed for failure

to make demand upon the board, it is at least implicit, if

not explicit, that the plaintiff stockholder has the

authority as a matter of substantive corporate law to

pursue the action on behalf of the corporation without

the approval of the board of directors.'? In other words,

1990) (citing Daily Income Fund, Inc. v. Fox, 464 U.S.

523, 531 (1984)).

2 In the instant case, the defendants sought to

dismiss the action for failure to make a presuit demand

upon the board of directors. The defendants chose to

settle the action, however, rather than have the trial court

determine their motion to dismiss. By doing so, the

18

and contrary to the assertion by the court below, the

board of directors’ power over the conduct of the

litigation is displaced. No other constituency—neither

the “bondholders or banks or landlords” mentioned in

the opinion below—has this power “to speak for the firm

[and] control its litigation decisions” that the state

substantive law confers upon stockholders. 134 F.3d at

874.

It is true, as the court below observed, 134 F.3d

at 875 (citing Kamen, supra), that the board of directors

may, upon appropriate action, reclaim the power to

control the conduct (or dismissal) of a derivative

action.'* Where such power has not been exercised,

however, the stockholders are, as a matter of

substantive corporate law, not strangers to the

controversy; to the contrary, they continue to hold the

power to conduct the litigation of the corporation's

claims. See, e.g., Levine v. Smith, 1987 Del. Ch. LEXIS

524, *16-"17 (Del. Ch. 1987), affd, 591 A.2d 194 (Del.

1991) (when a special litigation committee seeks

defendants have secured a bar against prosecution of

settied claims on behalf of the corporate defendant by

anyone, anywhere, rather than simply a dismissal of the

plaintiff in this action alone.

'S Grimes v. Donald, 673 A.2d 1207, 1216 n.13

(Del. 1996); Kaplan v. Wyatt, 499 A.2d 1184 (Dei. 1985);

Zapata Corp. v. Maidonado, 430 A.2d 779, 785-89 (Del.

1981) (establishing standards for judicial review of

special litigation committee motion to terminate

stockholder derivative action).

19

dismissal of the derivative action, “managerial power to

control the destiny of the corporation's claim . . . is

presumed to be properly vested in the stockholder-

plaintiff,” and the only issue is whether that power

“should in essence be ‘revested’ in the Board of

Directors.”).

This substantive law position of stockholders in

derivative actions is consistent with the the requirement

of both Federal Rule of Civil Procedure 23.1 and

Chancery Court Rule 23.1 that the stockholders be

given notice of a settlement of a derivative action. That

notice requirement reflects a recognition that the

stockholders of the corporation have a unique and

meaningful interest in the settlement of a derivative

action, in contrast to the “employees, vendors, and

lawyers” or other persons potentially affected by the

settiement of a derivative suit, 134 F.3d at 874, none of

whom are required by Rule to be given notice of the

settlement. Thus, stockholders who objected to the

settlement in this action, unlike members of other

corporate constituencies, were invited by the trial court

to appear at the settlement hearing to “show cause why

the proposed Settlement should not be approved,”

including submission of “papers and briefs.”"*

Objectors to the settlement of a derivative action

are distinguished from members of such other corporate

constituencies in a number of additional ways not

reflected in Federal Rule of Civil Procedure 23.1, that

‘* Notice of Hr’'g on Proposed Settlement of

Derivative Actions, dated May 30, 1997, at 7.

20

confirm the substantive significance of the stockholders’

interest. Notably, stockholders objecting to a proposed

settlement of a stockholder derivative action are, unlike

nonparties generally, usually afforded access to the

discovery process, albeit on a limited basis consistent

with the limited scope of the issues presented to the trial

court in reviewing the proposed settlement.'® Moreover,

so significant is the interest of the stockholders in the

derivative action that final judgments entered in

settlement of such actions routinely make explicit that

the judgment binds the stockholders individually and

preciudes them from asserting settled claims."© In

contrast, we are aware of no judgments in stockholder

derivative actions that attempt to operate explicitly and

directly upon any other kind of person (employee,

vendor, etc.) who may be affected by the judgment.

In sum, the court below failed to acknowledge the

" See, e.g., Lewis v. Hirsch, 1995 Del. LEXIS 62,

*3 (Del. Ch. 1995). See generally Donald J. Wolfe, Jr.

& Michael A. Pittenger, Corporate and Commercial

Practice in the Delaware Court of Chancery § 9-4(g)

(1998).

"© See 2 Business and Commercial Litigation in

Federal Courts 66 (Robert L. Haig, ed. 1998) (model

form of order and final judgment). The final judgment

entered in this case likewise purports to operate directly

on the individual stockholders of the corporation. See

Petition for Certiorari herein, dated April 21, 1998,

Appendix B, J7 (releasing claims “by any sharehoider of

[the] company derivatively on its behalf... .”).

21

significant role played by stockholders, including

objectors to settlements, in the stockholder derivative

action. Its assessment of the objectors’ entitlement to

appeal may thus have rested upon an underestimation

of the objectors’ substantive position under applicable

Delaware law.

ll. UNSUCCESSFUL OBJECTORS IN THE

DELAWARE COURTS MAY APPEAL

SETTLEMENT APPROVALS IN DERIVATIVE

ACTIONS WITHOUT FORMAL INTERVENTION.

In Delaware, widely recognized as_ the

predominant jurisdiction of incorporation of corporations

the shares of which are publicly traded,"’ including the

corporate defendant in this case, the courts have

invariably and frequently allowed stockholders who have

objected to the settlement of a derivative action, but who

have not intervened as parties in the action, to appeal

the approval of the settlement by the trial court, the

Delaware Court of Chancery.

Nearly fifty years ago, the Delaware Supreme

Court faced the very question now before this Court.

Braun v. Fleming-Hall Tobacco Co., Inc., 92 A.2d 302

(Del. 1952). The proponents of the settlement of a

" According to the Division of Corporations of the

Secretary of State of the State of Delaware, 60% of the

Fortune 500 companies are incorporated in Delaware,

and 50% of the corporations with shares listed on the

New York Stock Exchange are incorporated in Delaware

<http:/Awww.state.de.us/corp.index.htmi>.

22

stockholder derivative action sought to dismiss an

objecting stockholders appeal of the trial court's

approval of the settlement on the ground, among others,

that the objector “had not obtained an order granting him

leave to intervene as a party.” /d. at 307. The Delaware

Supreme Court at first acknowledged that such

intervention had been “the practice” of persons objecting

to settlements. /d. at 308. Despite that recognition,

however, the court found the nonintervening objector

entitied to appeal approval of the settlement, reasoning:

[The objector] was under a rule to appear before

the Court of Chancery if he considered his

interests in jeopardy; and it was pursuant to that

rule that his counsel filed written objections to the

settlement and made oral argument against the

approval thereof. Nobody objected to either of

these activities in the trial court. What took

place, therefore, amounted to actual intervention,

even though it was without express leave of court.

If counsel for [the objector] had asked to

intervene, an order granting leave would

undoubtedly have been entered. /n these

circumstances, therefore, we do not regard the

failure to ask permission to intervene as any more

than the oversight of a formality.

ld. (emphasis added).

In the half century or so since Braun was decided,

what the court described as “the oversight of a formality”

has become common practice: objectors almost

invariably assert their position without intervening

formally, and the Delaware Supreme Court has never

23

once questioned the ruling in Braun that this approach

does not preclude appeal by an unsuccessful objector."®

To the contrary, that court has repeatedly entertained,

on the merits, appeals by objectors to settlements of

derivative actions, despite their not having intervened as

parties. Gladstone v. Bennett, 153 A.2d 577 (Del.

1959); Krinsky v. Helfand, 156 A.2d 90 (Del. 1959);

Rome v. Archer, 197 A.2d 49 (Del. 1964); Hoffmann v.

Dann, 205 A.2d 343 (Del. 1964); Goodman v. Futrovsky,

213 A.2d 899 (Del. 1965); Rutman v.Kaminsky, 226 A.2d

122 (Del. 1967); Neponsit Investment Co. v. Abramson,

405 A.2d 97 (Del. 1979); Geller v. Tabas, 462 A.2d 1078

(Del. 1983) (noting that objectors who had brought

separate suit in another State had made no attempt to

intervene in the Delaware action, but ruling on the merits

of objectors’ appeal from approval of the settlement);

Polk v. Good, 506 A.2d 531 (Del. 1986) (at time of

approving the settlement, the Court of Chancery had

denied objectors’ motions to intervene, and appellate

review addressed the merits of the objections without

comment on the intervention ruling).

'® Similarly, stockholders routinely submit

objections to proposed settlements in the Court of

Chancery without seeking formal leave to intervene as

a party. E.g., Cohan v. Loucks, 1993 WL 121855 (Del.

Ch. 1993); Stepak v. Ross, 1985 WL 21137 (Del. Ch.

1985); Moses v. Pickens, 1982 WL 17825 (Del. Ch.

1982); Lewis v. Fuqua Industries, Inc., 1982 WL 8783

(Del. Ch. 1982); Saminsky v. Abbott, 194 A.2d 549 (Del.

Ch. 1963); Manacher v. Reynolds, 165 A.2d 741 (Del.

Ch. 1960).

24

This Delaware practice of allowing appeals by

nonintervening objecting stockholders in derivative

actions has continued unabated after this Court's

decision in Marino. \n In re Resorts Int'l Shareholder

Litigation Appeals, 570 A.2d 259 (Del. 1990), one of

several objectors to the settlement of a class and

derivative action filed separate suit, shortly after filing of

the settlement agreement, but none of the objectors

sought to intervene in the action in which the settlement

was submitted. The Delaware Supreme Court

proceeded to rule on the merits of the appeal,

notwithstanding that failure to intervene. Similarly, in

Kahn v. Sullivan, 594 A.2d 48 (Del. 1991), California

Public Employees Retirement System (CalPERS, one of

the appellants in this case) had intervened in an action

challenging conduct of Armand Hammer, the chief

executive officer of Occidental Petroleum Corporation,

a Delaware corporation, in relation to the funding of a

museum to house Mr. Hammer's extensive art collection.

In a separate derivative action (the Sullivan action) in

the Delaware Court of Chancery addressing the same

alleged misconduct, the parties agreed to a settlement

and presented it for approval at a hearing on notice to

the other Occidental stockholders, including CalPERS.

Without having intervened in -the Sullivan action,

CalPERS submitted objections to the settlement, and

appealed the approval of the settlement to the Delaware

Supreme Court. That court entertained the appeal

without any suggestion that CalPERS should have

intervened in the action in which the settlement was

25

approved. "*

CONCLUSION

For the reasons set forth above, we respectfully

submit that the decision of the court below, denying the

right of appeal to a stockholder who duly objects to a

proposed settlement of a stockholder derivative action,

is inconsistent with pertinent state law and practice. In

order to give effect to the underlying substantive law of

the state of incorporation, here Delaware, this Court

should determine that the petitioners, who duly objected

to a proposed settlement of a stockholder derivative

action arising under and governed by Delaware law, are

entitied to appeal the trial court's approval of the

settlement, notwithstanding any failure to intervene as

parties under Federal Rule of Civil Procedure 24.

'* Kahn v. Sullivan is thus similar to Prezant v.

DeAngelis, 636 A.2d 915 (Del. 1994), a case noted

extensively by this Court in Matsushita Elec. Indus. Ltd.

v. Epstein, 516 U.S. 367 (1996). In Prezant—a class

action—the objector had filed a separate action, but

submitted objections to a settlement without intervening

in the case in which the settlement was approved. After

approval of the settlement, the objector appealed—

successfully—to the Delaware Supreme Court, again

without any suggestion that intervention was necessary

to the appeal.

Respectfully submitted,

LAWRENCE A. HAMERMESH

Counsel of Record

MARY BRIGID MCMANAMON

Widener University School of Law

4601 Concord Pike

, Delaware 19803

(302) 477-2100

Amici Curiae

DATED: November 10, 1998