Colt Industries Shareholder Litigation v. Colt Industries Inc.

• Decision Date: 08 January 1991
• Citation: 77 N.Y.2d 185,565 N.Y.S.2d 755,566 N.E.2d 1160
• Parties: , 566 N.E.2d 1160, 59 USLW 2437 COLT INDUSTRIES SHAREHOLDER LITIGATION. Karen Woodrow, et al., Plaintiffs, v. COLT INDUSTRIES INC et al., Appellants. James S. Merritt Company, Respondent.
• Court: New York Court of Appeals Court of Appeals

Page 755

565 N.Y.S.2d 755

77 N.Y.2d 185, 566 N.E.2d 1160, 59 USLW 2437

COLT INDUSTRIES SHAREHOLDER LITIGATION. Karen Woodrow, et

al., Plaintiffs, v. COLT INDUSTRIES INC et al., Appellants. James S. Merritt Company, Respondent.

Court of Appeals of New York.

Jan. 8, 1991.

[77 N.Y.2d 186] [566 N.E.2d 1161] Barry H. Garfinkel, Marco E. Sehnabl, Seth M. Schwartz [77 N.Y.2d 187] and Cornelius J. Grealy, for appellants.

Robert L. Beerman, Charles W. German, W. Perry Brandt and David B. Cosgrove, for respondent.

OPINION OF THE COURT

WACHTLER, Chief Judge.

In this case, we consider whether the respondent, a Missouri corporation with no ties to New York, has a due process constitutional right to opt out of a New York class action in which the relief sought in the complaint was largely equitable in nature. We hold today that when a class action complaint demands predominantly equitable relief that will necessarily benefit the class as a whole if granted, the Trial Judge is not required to give class members the opportunity to opt out of the class. We also hold, however, that under that governing principle as applied to the facts of this case, the Trial Judge erred in approving a settlement agreement insofar as it purported also to extinguish the respondent's right to pursue a cause of action in damages.

This class action stems from a 1988 corporate merger involving appellant Colt Industries Inc (Colt), a Pennsylvania corporation with offices in New York City, and appellant Morgan Stanley Group Inc. (Morgan Stanley), a New York-based securities firm. Colt and its subsidiaries were in the business of manufacturing and selling firearms and machine and engine parts. At the time the merger was announced in March of 1988, Colt had 32 million shares of common stock outstanding and approximately 16,300 shareholders of record. Of those 32 million shares, 62,000 were owned by the respondent James S. Merritt Company (Merritt), a Missouri corporation with its principal place of business in Kansas City.

In 1986, two years before the merger, Colt underwent a major recapitalization. Each share of Colt common stock held by its public shareholders was exchanged for $85 in cash and one new share. More than 30 million shares were repurchased as a result and Colt incurred $1.5 billion in debt.

In January of 1988, Morgan Stanley advised Colt of its interest in acquiring the company. A special committee consisting of Colt's outside directors, with the assistance of Colt's financial advisor, the First Boston Corporation, engaged in negotiations with Morgan Stanley over the terms of a merger agreement. The agreement, which was reached in March of 1988, provided that Colt Holdings Inc., a Morgan Stanley affiliate that came into existence to effectuate the merger, would make a tender offer to purchase all outstanding shares of Colt common stock at $17 per share. This tender offer was to be followed by the merger, in which all remaining shareholders would be entitled to the same $17 consideration for their stock.

The proposed merger ignited 15 separate shareholder suits in State courts in New York and Pennsylvania. Counsel for these plaintiffs stipulated to an order that consolidated these suits in Supreme Court, New York County. Thereafter, class counsel filed a first amended consolidated class action complaint naming Colt and its officers and directors as defendants. In substance, they alleged that the defendants: (1) had breached their common-law fiduciary duties to the class by offering a price per share that was grossly inadequate; (2) had engaged in a course of conduct that lacked any valid business purpose and was designed solely to eliminate the class as Colt shareholders; (3) were not exercising independent business judgment and were in fact engaging in self-dealing to the detriment of the class; and (4) had failed to solicit other, possibly more beneficial, bids from potential buyers.

In their prayer for relief, the plaintiffs demanded a declaration that the action was a class action, preliminary and permanent injunctive relief blocking the merger, rescission in the event the merger did go forward, an order requiring the defendants to disgorge all benefits that they may have received as a result of the transaction, costs and disbursements, including attorneys' fees, and any damages as may have been sustained.

By an order on consent dated April 12, 1988, the trial court certified the class action for purposes of settlement and defined the class as consisting of Colt's common shareholders as of March 1, 1987. The court noted that the prerequisites for a class action under CPLR 901 had been satisfied in this case. The court ordered that all members of the class be given notice of the proceeding and enjoined all class members from filing any other lawsuit in any other jurisdiction based on the facts giving rise to the New York-based class action.

The parties to the action on April 29, 1988 prepared a stipulation and agreement of compromise and settlement, based on an earlier Memorandum of Understanding. In substance, the agreement provided: (1) that Colt Holdings Inc. agreed to reduce, from $12 million to $10 million, the amount that it would be entitled to receive as reimbursement if the merger agreement were terminated; (2) Colt Holdings Inc. agreed to waive certain conditions to the offer that permitted Colt Holdings to terminate the offer or refuse to make payment for tendered shares if any change occurred in the operations or condition of Colt or if any material representations made in the merger agreement were not true and correct; (3) defendants agreed not to oppose plaintiffs' application for attorneys' fees in the amount of $425,000; and (4) plaintiffs agreed to the dismissal, with prejudice, of the class action, and to the release of all claims that could be asserted by the class regarding the offer and the merger.

By order dated May 10, 1988, the trial court redefined the class to include all Colt common shareholders as of March 1, 1988, scheduled a hearing for June 15, 1988 to determine whether the proposed settlement was fair and reasonable, and approved a Notice of Pendency of Action, Class Action Determination, Proposed Settlement of Class Action and Settlement Hearing that had been prepared by the parties and appended to the stipulation of settlement. The court ordered that this notice be published in the national editions of the New York Times and Wall Street Journal on or before May 17, 1988.

Merritt learned of the pendency of the class action and of the proposed settlement by reading the notice contained in the May 17 edition of the Wall Street Journal. Merritt's attorneys sent a registered letter to the trial court, dated May 27, requesting exclusion from the class. On June 9, Merritt filed a separate action for damages against Colt and other defendants in the United States District Court for the Western District of Missouri. One day later, on June 10, Colt's shareholders approved the merger.

On June 15, 1988, the Trial Judge signed an order denying Merritt's application for exclusion from the class. After conducting the settlement hearing, the court approved the settlement and the request for attorneys' fees. In the judgment, the trial court dismissed the class complaint with prejudice and enjoined class members and their successors-in-interest from asserting any "class, derivative, or individual claim for violations of federal, state, or other law, or of the common law * * * which has been or might have been asserted in the actions in connection with, arising out of or in any way related to * * * the leveraged buyout of Colt, the Agreement and Plan of Merger * * * the Offer to Purchase all outstanding shares of Colt common stock * * * the merger of Colt Transition Inc. with and into Colt * * * the consideration received or to be received by any Colt shareholder pursuant to the Offer or the Merger and the disclosures made in connection with the Offer or the Merger." The judgment released all claims against "each individual defendant, Colt, [Colt] Holdings, Morgan Stanley Group, Inc., and The Morgan Stanley Leveraged Equity Fund II, L.P. and their respective agents, servants, attorneys, investment advisors (including, without limitation, The First Boston Corporation), current and former officers, directors and employees, partners, subsidiaries, affiliates, stockholders, heirs, executors, representatives, successors and assigns and each trust or estate in which any individual defendant has any interest." Merritt appealed the assorted orders and judgments that denied its opt-out request, bound it to the settlement agreement and precluded it from asserting its own damage claims. The Missouri action, while currently pending, is in abeyance pending the outcome of this appeal.

The Appellate Division, First Department, ruled in Merritt's favor (155 A.D.2d 154, 553 N.Y.S.2d 138). The court stated that the merger on June 10 mooted out the class' equitable claims and left remaining only the request for fees and expenses, which the court categorized as a claim for damages. Consequently, the court concluded that Merritt had a due process right to receive notification of the class action and to seek exclusion from the class, citing Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 105 S.Ct. 2965, 86 L.Ed.2d 628.

We agree with the Appellate Division that the Supreme Court's analysis in Shutts is relevant in determining whether Merritt had a right to opt out of the class. We believe, however, that the Appellate Division rested its reading of Shutts, and consequently its holding, upon a faulty premise--that the June 10 merger mooted the class' equitable claims and converted the entire action into one for damages. The only element of the complaint that became moot upon consummation of the merger was the request for an injunction preventing the merger from going forward. The class' request for rescission, also...