Eagle v. American Tel. and Tel. Co.

• Decision Date: 19 August 1985
• Docket Number: No. 84-1636,84-1636
• Parties: Alexander F. EAGLE, Plaintiff-Appellant, v. AMERICAN TELEPHONE AND TELEGRAPH COMPANY, a corporation, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 541

769 F.2d 541

3 Fed.R.Serv.3d 68

Alexander F. EAGLE, Plaintiff-Appellant, v. AMERICAN TELEPHONE AND TELEGRAPH COMPANY, a corporation Defendant-Appellee.

No. 84-1636.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Dec. 13, 1984.

Aug. 19, 1985.

Samuel L. Holmes, Angell, Holmes & Lea, San Francisco, Cal., for plaintiff-appellant.

Gary L. Simms, Richard W. Odgers, Pillsbury, Madison & Sturo, San Francisco, Cal., for defendant-appellee.

Appeal from the United States District Court for the Northern District of California.

Before CHOY, CANBY and NORRIS, Circuit Judges.

CANBY, Circuit Judge:

Pacific Telephone and Telegraph was ordered to refund $381 million in rate overcharges in 1980. That refund precipitated this lawsuit. Alexander F. Eagle filed a class action on behalf of Pacific's minority shareholders against Pacific's majority shareholder American Telephone and Telegraph (ATT), alleging that ATT breached its fiduciary duty owed to the minority shareholders. After the complaint was filed, ATT purchased the plaintiffs' shares in the merger of Pacific into ATT. The case was removed from state court to the District Court for the Northern District of California, which granted judgment in favor of ATT. At issue on appeal are (1) whether the case was properly removed from state court; (2) whether, assuming jurisdiction, the $381 million refund injured the minority shareholders; and (3) whether a pretrial order precluded Eagle from alleging a new claim at the summary judgment stage.

We affirm. We conclude that this class action was properly removed from state court because the federal court had original diversity jurisdiction. The minority shareholders' claims can be aggregated to satisfy the jurisdictional amount because the shareholders' claims derive entirely from an alleged injury to the corporation. We affirm the district court's finding that Eagle and other minority shareholders were not damaged by the refund. We also hold that the district court did not abuse its discretion in enforcing the pretrial order.

BACKGROUND

The minority shareholders seek relief for two alleged injuries. First, in 1980, the California Public Utilities Commission (CPUC) ordered Pacific to refund $381 million in rate overcharges to its ratepayers. Second, by 1981, Pacific had incurred a $1.5 billion tax liability that was on its books at the time of the ATT-Pacific merger. The minority shareholders contend that the refund and tax liability injured them by depressing the value of their Pacific stock.

The shareholders' allegations can only be understood in the context of a dispute in regulatory philosophy at the root of the refund and tax liability. In 1954, Congress enacted the accelerated depreciation tax provisions. A dispute arose over the appropriate treatment of accelerated depreciation for utility ratemaking. ATT and its subsidiaries advocated the use of normalization accounting. Under this method, the utility takes accelerated depreciation deductions and investment tax credits on its tax returns but only takes straight-line depreciation on its accounts used for ratemaking. The increment of actual tax savings above the straight-line deduction reflected in the ratemaking account is placed in a reserve account that generates income for investment in the utility plant. This method of treatment is supported as being in accord with the intent of Congress in allowing accelerated depreciation; it makes the tax savings available for investment in plant and equipment.

Some state regulatory commissions, however, adopted the view that any tax savings resulting from accelerated depreciation should inure immediately to the benefit of the ratepayers. California was one of them, during much of the period relevant to this litigation. CPUC consequently took the position in 1960 that if a utility elected to use accelerated depreciation, then it must use a "flow-through" method of accounting for ratemaking purposes, which has the effect of passing the tax savings directly on to ratepayers.

The sparring among Congress, CPUC and similar state regulatory commissions, and Telephone companies like Pacific took a number of twists and turns. At the risk of oversimplification, only a few of them will be related here. Pacific initially refused to use accelerated depreciation (thereby losing some tax savings) because CPUC's policy would have required those savings to be passed on to ratepayers. (Pacific also asserted other reasons for preferring straight-line depreciation.) CPUC responded by ruling that it would set rates based on accelerated depreciation whether or not the telephone company elected it (thereby virtually forcing such an election whenever the company was free to make it). Congress in 1969 rejoined the battle by passing 26 U.S.C. Sec. 167(l ), which precluded companies from taking accelerated depreciation if they were forced to pass the tax savings on to ratepayers. CPUC subsequently adopted a number of differing positions, some induced by state court decisions reversing its rulings. At one point it permitted Pacific to elect accelerated depreciation and to retain the tax savings, and at another it required a flow-through, even retroactively.

There were two results of this protracted skirmishing that are relevant to this lawsuit. In 1974, CPUC permitted Pacific to retain tax savings from accelerated depreciation but, after a reversal in state court, it retroactively required a flow-through. It accordingly ordered a refund to ratepayers of $381 million ($418 million with interest). Pacific's former minority shareholders seek relief for that refund, arguing that management could somehow have avoided the loss if it had adopted accelerated depreciation from the beginning.

A second result was that, because of CPUC's ultimate position that tax savings had to be passed through, Pacific became ineligible for accelerated depreciation tax treatment under 26 U.S.C. Sec. 167(l ). Accordingly, it accrued a federal tax liability of some $1.5 billion. That tax liability was still on Pacific's books when ATT, then a 90 percent shareholder of Pacific, proposed a stock-for-stock merger with Pacific in October of 1981.

In September 1981, Eagle had filed this class action in California state court on behalf of Pacific's minority shareholders similarly situated. The complaint alleged that ATT used its ability to control Pacific to its own advantage and to the minority shareholders' detriment. Specifically, the complaint alleged that ATT caused Pacific to forego taking accelerated depreciation and investment tax credits, that ATT's imprudent decision caused Pacific to refund $381 million in rate overcharges and that the refund injured the minority shareholders by approximately $38 million (ten percent of the total refund).

ATT removed the class action to federal court pursuant to 28 U.S.C. Secs. 1332 and 1441. After unsuccessfully petitioning for remand to state court, Eagle filed an amended complaint. The allegations remained essentially the same. Eagle, however, amended the damage allegation to state that the refund caused approximately $3.00 per share depreciation in the value of each share owned by minority shareholders and that Eagle individually was damaged by approximately $4,200. The complaint also alleged that after the initial complaint was filed, ATT offered to purchase the minority shares at a depressed price without compensating the minority shareholders for the damage caused by the refund. Eagle then filed a second motion for remand to state court that was denied.

In the meantime, Pacific and ATT filed for approval of the proposed stock-for-stock merger. CPUC held hearings at which Eagle and other minority shareholders appeared and contested the fairness of the proposed terms to the minority shareholders. Eagle argued that the proposed price for minority shares was inadequate because it did not reflect "pending federal legislation, which if enacted, would relieve (Pacific) of a substantial recorded tax liability," the $1.5 billion tax liability. CPUC, however, found that the exchange offer was "fair and reasonable" and that the approval of the merger would not adversely affect the interests of minority shareholders.

After the merger was complete, Congress enacted the Surface Transportation Assistance Act of 1982, Pub.Law No. 97-424, 96 Stat. 2097, which reduced the $1.5 billion tax liability to approximately $320 million. Eagle then attempted to bring the tax liability into the class action at the summary judgment stage. Eagle alleged that the $1.5 billion tax liability depressed the value of the Pacific's shares at the time of the merger and that ATT received a windfall from the tax relief after the merger was consummated.

On cross-motions for summary judgment, the district court ruled in favor of ATT. The court held that the $381 million refund did not damage the minority shareholders because if Pacific had adopted accelerated depreciation in 1968, Pacific would not have collected an offsetting amount in rates. The court also held that a pretrial order precluded Eagle from asserting for the first time at the summary judgment stage that the tax liability depressed the exchange price he received for Pacific's shares in the ATT-Pacific merger. Alternatively, the court held that Eagle was collaterally estopped from making this claim by the CPUC finding that the exchange offer was fair to minority shareholders despite the possible tax forgiveness.

DISCUSSION

1. Jurisdiction

Eagle contends that this class action ¹ was improperly removed from state court because Eagle's claim and the claims of some of the other shareholders that he represents do not satisfy the jurisdictional amount. The district court has original diversity jurisdiction in all civil matters where the parties are of diverse citizenship and the matter in controversy exceeds $10,000. 28 U.S.C. Sec. 1332. The diversity of citizenship...