McDonald v. Chicago Milwaukee Corp.

• Decision Date: 11 October 1977
• Docket Number: No. 77-1127,77-1127
• Citation: 565 F.2d 416
• Parties: Clement J. McDONALD, Individually and as Class Representative of Holders of 41/2% Convertible Income Bonds Series B, Plaintiff-Objector-Appellant, v. CHICAGO MILWAUKEE CORPORATION et al., Defendants-Appellees. Morton WEINRESS, Individually and as Class Representative of Holders of 5% Income Debentures Series A, Plaintiff-Appellee, and Raymond J. McDonald, Intervenor-Objector-Appellant, v. CHICAGO MILWAUKEE CORPORATION et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 416

565 F.2d 416

Clement J. McDONALD, Individually and as Class

Representative of Holders of 41/2% Convertible

Income Bonds Series B, Plaintiff-Objector-Appellant, v. CHICAGO MILWAUKEE CORPORATION et al., Defendants-Appellees.

Morton WEINRESS, Individually and as Class Representative of

Holders of 5% Income Debentures Series A, Plaintiff-Appellee, and Raymond J. McDonald, Intervenor-Objector-Appellant, v. CHICAGO MILWAUKEE CORPORATION et al., Defendants-Appellees.

No. 77-1127.

United States Court of Appeals Seventh Circuit.

Argued April 27, 1977.

Decided Oct. 7, 1977.

As Amended Oct. 11, 1977.

Donald C. Gancer, Querrey, Harrow, Gulanick & Kennedy, Chicago, Ill., for appellants.

Joe A. Sutherland, David D. Rosenstein, Jerome H. Torshen, Thomas P. Sullivan, U. S. Atty., Richard James Stevens, Harold E. Spencer, Chicago, Ill., for appellees.

Before PELL and WOOD, Circuit Judges, and GORDON, District Judge. ^*

PELL, Circuit Judge.

This appeal involves three class action suits, consolidated in the district court below, initiated by various holders of railroad securities. On December 9, 1976, the district court entered a judgment approving an agreement of settlement and dismissing the consolidated actions. Objectors Clement J. McDonald and Raymond J. McDonald, father and son, holders respectively of Series B Bonds and Series A 5% Income Debentures, jointly noticed an appeal from the judgment. ¹

The essential facts pertinent to our disposition of this appeal are the negotiation of the settlements and the district court's approval thereof. The published notice, set forth in an Appendix to this opinion, describes the fundamental allegations, issues, and theories of recovery. No useful purpose is furthered by duplicating herein its summation of the class actions. Because that notice provides no detail relating to the allegations of fraud and collusion which are raised in this appeal, our opinion will set forth pertinent material from depositions and affidavits relating to those charges. We note, however, that the truth or falsity of sworn testimony was for the district court to determine.

Objectors-appellants have made a direct allegation of conflict of interest and an inferential charge of collusion in arriving at the compromise of this litigation. Thus, the present appeal presents not only the typical issue of whether or not the district court abused its discretion by approving the settlements as fair, reasonable, and adequate as to all classes, but also brings into play related questions regarding the adequacy of representation by one of the named plaintiffs and the professional propriety of certain actions undertaken by his counsel. This court in Susman v. Lincoln American Corp., 561 F.2d 86 (7th Cir. 1977), discussed some of the constitutional and policy considerations relating to the "adequacy" requirement of Rule 23(a)(4), Fed.R.Civ.P. The present appeal necessitates further refinements in this circuit's approach to those matters.

I

Morton Weinress, the representative plaintiff in the Income Debentures action, has substantial holdings in the securities of the Milwaukee Road and further acts as a financial advisor to other investors who hold substantial interests in railroad securities. Weinress's holdings are not limited to Debentures but extend also to stock of Chicago Milwaukee Corporation and perhaps to its substantially held subsidiary, the Milwaukee Road itself. Moreover, David Rosenstein, the attorney for the class of Debenture holders, himself owns 700 shares of Chicago Milwaukee Corporation and $20,000 face value Series B Bonds, as well as Debentures. At the time of Weinress's motion for class certification, the fact of the stockholdings in the defendant corporation was not disclosed. Thus, the district court lacked important information when, on June 9, 1976, it designated Weinress as the representative of the class and likewise designated Rosenstein as attorney for the class.

Objector Raymond McDonald first argues that there is a clear conflict of interest on the part of both class representatives, the named plaintiff and the attorney for the class. He cites J. Moore, Federal Practice § 23.07(3), at 23-401 (2d ed. 1975), as authority for the proposition that, in order adequately to represent a class or subclass, a party's interests must be wholly compatible with and not antagonistic to those whom he would represent. He argues that the record in the instant case gives rise to a strong inference that Weinress and the defendants were not situated at arm's length regarding the negotiation of the settlement.

The conflict-of-interest argument rests not merely upon the fact of stock ownership but upon an analysis of the variance in the responses by the defendants to various named plaintiffs. In the Series B Bond case, when Clement J. McDonald filed his motion for certification, the defendants learned that he also owned 100 shares of railroad stock, acquired for the purpose of receiving annual reports, and objected to his adequacy as a representative plaintiff. ² However, when Weinress filed his motion for class certification in the Income Debentures case, no deposition was taken, no objections were filed by defendants, and no memoranda in opposition were filed. This inaction occurred even though Quinn, Chairman of the Milwaukee Road, and Merrill, General Counsel and one of the attorneys of record for the railroad, had actual knowledge that both Weinress and Rosenstein had a similar securities position. Objector McDonald thus contends that there is an inescapable inference that the defendant was pleased to have Weinress and Rosenstein as class representatives, knowing they were more interested in their overall investments in the securities of the railroad than with getting the best results for the class of Debenture holders. McDonald submits that the fact that the railroad failed to call the court's attention to the conflict of interest which both Weinress and Rosenstein had gives rise to the inference of much less than an arm's length relationship, if not to an inference of collusion.

McDonald further observes that Weinress supposedly commenced negotiating as representative of the Debenture class in the Spring of 1975, at a time when he had not yet even filed suit let alone been appointed class representative. He further notes that the final settlement agreement was essentially concluded shortly after April 2, 1976, but that Weinress was not appointed class representative until June 9, 1976. He cites as authority for the impropriety of premature, unauthorized settlement negotiations in class actions a passage in the Manual for Complex Litigation. ³

In Susman, supra, 561 F.2d 86 at 90, this court observed that whether a party will adequately protect the interests of the class is a question of fact depending on the circumstances of each case, citing Schy v. Susquehanna Corporation, 419 F.2d 1112, 1116 (7th Cir. 1970), cert. denied, 400 U.S. 826, 91 S.Ct. 51, 27 L.Ed.2d 55; 7 Wright & Miller, Federal Practice and Procedure § 1765, at 622 (1972 ed.). We further recognized that a district judge's determination of the adequacy of representation is a matter of discretion and will not be disturbed on appeal unless abuse of discretion is shown. We also noted that a basic consideration of fairness requires that a court undertake a stringent and continuing examination of the adequacy of representation by the named class representatives at all stages of the litigation. Susman, supra at 89. The principles articulated in Susman were by no means novel, and they are fully applicable to the instant appeal.

The district court's formulation of its ultimate finding that the settlement was achieved after extensive negotiations at arm's length does not refer formally or directly to the allegations of unauthorized negotiations, the differential response to McDonald and to Weinress, or to the conflict position of one who simultaneously holds debt and equity instruments. Omission of a detailed statement of the history of settlement negotiations is unfortunate in a case where non-frivolous allegations of fraud and collusion are raised, even if such a statement might generally not be necessary when passing upon the fairness of a proposed class settlement.

We turn to the first set of allegations. The record does establish that Weinress and Rosenstein were involved in settlement negotiations with the defendants prior to the time of class certification. However, these negotiations, in substantial part, related to the settlement of related state court litigation. Indeed, the complaint in No. 75 C 2033 was filed only after those discussions broke down.

Approximately three weeks after the defendants filed a motion to dismiss Clement McDonald's Series B action, Weinress and Rosenstein met with officers of the Milwaukee Road, i. e., Quinn and Merrill. At that meeting, neither officer was able to explain the origin or purpose of the "deficit carry forward" provision of the Indenture applicable to the Series A 5% Income Debentures. Rosenstein, acting as Weinress's legal advisor, subsequently wrote to Quinn and Merrill stating that no provision of the Debenture Indenture should be construed to require that available net income, as defined therein, take into account any deficits of prior years. Within a month or so of that letter, the Milwaukee Road filed suit in the Circuit Court of Cook County seeking, among other things, a construction of the Debenture Indenture which would require the deficit to be carried forward to succeeding years.

The procedural history of the state court litigation provides the requisite context within which to assess the charge that Weinress and his attorney violated the suggested procedure set forth in the Manual. Weinress sought to intervene in the state court action. Moreover, he and Rosenstein met with officers and attorneys of The First National Bank of Chicago, Trustee under the...