Ionosphere Clubs, Inc., In re
| Decision Date | 01 March 1994 |
| Docket Number | D,1019,Nos. 1018,s. 1018 |
| Citation | 17 F.3d 600 |
| Parties | In re IONOSPHERE CLUBS, INC., Eastern Air Lines, Inc., Bar Harbor Airways, Inc., Debtors. Frank SOBCHACK, Frank Kenneth Sobchack, Rhett G. Cooper, Jr., Annie Cooper, and Official Committee of Preferred Shareholders of Eastern Air Lines, Inc., Appellants, v. AMERICAN NATIONAL BANK & TRUST COMPANY OF CHICAGO, Mary Grace Shore, as assignees of the Eastern Estate, Martin R. Shugrue, Jr., As Chapter 11 Trustee of the Eastern Estate, Appellees. ockets 93-5079, 93-5081. |
| Court | U.S. Court of Appeals — Second Circuit |
Martin S. Siegel, New York, N.Y. (Berlack, Israels & Liberman, New York, N.Y.), for appellant The Official Committee of Preferred Shareholders of Eastern Air Lines, Inc.
Arthur Abbey, New York, N.Y. (Jill S. Abrams, Abbey & Ellis, New York, N.Y.), for appellants Frank Sobchack, Frank Kenneth Sobchack, Rhett G. Cooper, Jr. and Annie Cooper.
Adam C. Harris, New York, N.Y. (O'Melveny & Myers, New York, N.Y.), for appellees American National Bank and Trust Company of Chicago and Mary Grace Shore, as Assignees of the Eastern Estate.
Daniel J. King, New York, N.Y. (King & Spalding, on the brief), for appellee Martin R. Shugrue, Jr., as Chapter 11 Trustee of the Eastern Estate.
Before: PRATT, WALKER, and LEVAL, Circuit Judges.
This appeal arises out of the administration of the bankruptcy estate of Eastern Airlines, Inc. ("Eastern") in the United States Bankruptcy Court for the Southern District of New York. The appeal involves the question whether the bankruptcy court, Burton R. Lifland, J., acted in accordance with law in enjoining the holders of Eastern preferred stock from bringing claims based on breach of fiduciary duty and tortious interference with contract (the "Proposed Claims") against former officers and directors (the "Proposed Defendants"). This turns on whether, as a matter of Delaware law, the Proposed Claims are derivative claims belonging to the corporation or direct claims of the shareholders. In ruling on a proposed settlement made among the Eastern Estate, the Proposed Defendants, and several other parties, the bankruptcy court found that the Proposed Claims were derivative, that they were the property of the Eastern Estate, and were therefore extinguished when settled by the Eastern Estate. The court enjoined any person (including the preferred stockholders) from commencing, pursuing or prosecuting "any action or claim which is property of the Eastern Estate and which is settled and extinguished pursuant to the Settlement Agreement...." Order Authorizing and Approving Settlement Agreement, Oct. 1, 1992, at 16. The preferred stockholders (hereinafter "Preferredholders"), whose interests are represented by the Official Committee of Preferred Shareholders (appointed by the bankruptcy court) (the "Preferred Committee") and by certain individual holders proposing to act as class action representatives, contend that the Proposed Claims are direct and not derivative under the controlling Delaware law, and that the bankruptcy court erred, exceeded its power, and deprived them of their constitutional rights in extinguishing the claims and barring them from bringing suit.
On March 9, 1989, Eastern Airlines filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Sec. 101 et seq., and was authorized by the bankruptcy court to operate as a debtor in possession. For approximately three years, Eastern and Continental Airlines had been jointly owned by Texas Air, 1 in a corporate structure controlled by Frank Lorenzo. Shortly after Eastern's Chapter 11 filing, interested parties moved for the appointment of a trustee, alleging that Eastern's management had serious conflicts of interest arising from its domination by Texas Air and Lorenzo. The motion further alleged that Eastern's conflicted management had caused it to engage in a series of transactions with its affiliates (the "Intercorporate Transactions") through which it had transferred many valuable assets to Continental (and other affiliated entities) for inadequate consideration. On April 5, 1989, the court denied the motion for appointment of a trustee, but appointed an Examiner to investigate these allegations.
The Examiner, whose investigation lasted approximately one year, concluded that many of the Intercorporate Transactions could indeed form the basis of claims by the Eastern Estate. (It is not disputed that the Intercorporate Transactions seriously harmed Eastern.) The bankruptcy court appointed a Trustee in April, 1990.
On January 8, 1991, the bankruptcy court assigned Eastern's claims arising out of the Intercorporate Transactions to interested parties (the "Assignees") for prosecution on behalf of the Estate. Negotiations commenced among Eastern (represented by the Trustee, the Assignees, and Eastern's Unsecured Creditors Committee), the family of Texas Air affiliates including Continental, the Proposed Defendants (to the Preferredholders' Proposed Claims), and various other parties. The Preferred Committee was originally among the parties assigned to prosecute Eastern's claims; on March 6, 1992, however, the Preferred Committee withdrew from the assignment, contending that it was not being consulted by the other Assignees. In early 1992, several of the Preferredholders had made it known that they intended to initiate class action litigation against the Proposed Defendants asserting individual, nonderivative actions arising out of the Intercorporate Transactions.
In the meantime, Continental Airlines had entered the protection of the United States Bankruptcy Court for the District of Delaware. On June 4, 1992, on the application of Continental and Texas Air, the Continental bankruptcy court preliminarily enjoined the Eastern Preferredholders from bringing any such action pending the conclusion of the settlement negotiations. The Delaware preliminary injunction was entered over opposition submitted by the Preferredholders.
On July 2, 1992, the parties to the Eastern settlement negotiations entered into a proposed settlement (the "Settlement Agreement") and sought the approval of Bankruptcy Judge Lifland for the compromise of Eastern's claims. The Settlement Agreement provides, inter alia, for payment of consideration to the Eastern Estate and its release of all claims against the settling parties. In paragraph 13, it states that any claim against any signatory "which is predicated upon damage to Eastern ... that arises from or relates to ... the Intercorporate Transactions (including without limitation the Preferred Derivative Claims) ... shall be extinguished...." Under the Bankruptcy Code's priority structure, the monies to be paid to Eastern under the agreement will not suffice to provide any recovery either for the Preferredholders or for the holders of $328 million of Eastern's subordinated debt.
On July 15, 1992, the bankruptcy court's order-to-show-cause was served on the Preferredholders advising them that the Settlement Agreement would be presented for authorization and approval and that objections should be submitted in writing. The Preferred Committee and the representative Preferredholders submitted written objections and memoranda (including a copy of their Delaware submission opposing the injunction). Their submissions argued that their Proposed Claims were direct and not derivative and, therefore, could not be extinguished by the settlement in which they had not participated and did not join.
Judge Lifland held hearings on the Preferredholders' objections to the settlement, and approved the settlement in its entirety. His October 1, 1992 "Order Authorizing and Approving Settlement Agreement" provided that the causes of action
set forth in the Preferred Stockholders' Pleadings and the Preferred Stockholders' Objections, are causes of action which are property of the Eastern Estate and which only the Eastern Estate has standing to pursue. The Settlement Agreement extinguishes these causes of action in that they are property of the Eastern Estate arising out of or relating to the Intercorporate Transactions. 2
Id. at p 19. The order went on to provide in decretal p D that
D. The Settlement Agreement shall be binding in all respects upon all creditors and equity security holders of Eastern, as well as all other parties in interest in the Eastern case, and no "person" ... may commence, pursue or prosecute any action or claim which is property of the Eastern Estate and which is settled and extinguished pursuant to the Settlement Agreement, including but not limited to any action or claim which is property of the Eastern Estate and arises out of or relates to the Intercorporate Transactions.
The Preferredholders appealed to the district court, contending that under Delaware law their Proposed Claims were not derivative but direct, and that Judge Lifland therefore erred in ruling that they were extinguished by the Settlement Agreement. The district court, Robert W. Sweet, J., upheld the bankruptcy court's determination that the claims asserted by the Preferredholders were derivative, and thus could be prosecuted, or settled, only in the name of the Eastern Estate. This appeal followed.
We agree with the well-reasoned conclusions reached by Judges Sweet and Lifland that the claims submitted by the Preferredholders to the bankruptcy court are derivative under Delaware law (which the parties agree is governing). They therefore belong exclusively to the Eastern Estate and were extinguished by its settlement of those claims. In re Ionosphere Clubs, Inc., Nos. 89 B 10448, 89 B 10449, 91 B 10287 (Bankr.S.D.N.Y. Oct. 1, 1992); In re Ionosphere Clubs, Inc., 156 B.R. 414, 438-39 (S.D.N.Y.1993).
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