Pittsburgh & L. E. R. Co. Securities and Antitrust Litigation, In re

• Decision Date: 01 September 1976
• Docket Number: No. 76-1089,76-1089
• Citation: 543 F.2d 1058
• Parties: Fed. Sec. L. Rep. P 95,807 In re The PITTSBURGH AND LAKE ERIE RAILROAD COMPANY SECURITIES AND ANTITRUST LITIGATION, Appeal of OBJECTOR IRVING TRUST COMPANY, as Trustee.
• Court: U.S. Court of Appeals — Third Circuit

Page 1058

543 F.2d 1058

Fed. Sec. L. Rep. P 95,807

In re The PITTSBURGH AND LAKE ERIE RAILROAD COMPANY SECURITIES AND ANTITRUST LITIGATION Appeal of OBJECTOR IRVING TRUST COMPANY, as Trustee.

No. 76-1089.

United States Court of Appeals Third Circuit.

Argued May 4, 1976.

Decided Sept. 1, 1976.

David H. Pittinsky, Lawrence D. Berger, Dilworth, Paxson, Kalish & Levy, Philadelphia, Pa., for appellant; Stephen A. Weiner, Winthrop, Stimson, Putnam & Roberts, New York City, of counsel.

Gilbert J. Helwig, Reed, Smith, Shaw & McClay, Pittsburgh, Pa., Liaison Counsel, for defendants-appellees.

Victor Wright, Henry C. Fader, Fox, Rothschild, O'Brien & Frankel, Philadelphia, Pa., for plaintiffs-appellees.

Frederick N. Egler, Egler & Reinstadtler, Pittsburgh, Pa., Phillip H. Strubing, Nancy J. Gellman, Pepper, Hamilton & Scheetz, Thomas M. Kittredge, Arthur R. Littleton, Morgan, Lewis & Bockius, Lewis H. Van Dusen, Jr., Raymond K. Denworth, Jr., Drinker, Biddle & Reath, Thomas B. Rutter, Mitchell S. Pinsly, Joseph Neff Ewing, Jr., Saul, Ewing, Remick & Saul, Philadelphia, Pa., Eben H. Cockley, Robert J. Hoerner, Jones, Day, Cockley & Reavis, Cleveland, Ohio, John J. McCarty, James F. Mundy, Raynes, McCarty & Binder, Philadelphia, Pa., J. Howe Brown, Booth, Prichard & Dudley, Fairfax, Va., for defendants-appellees.

Before ALDISERT, GIBBONS and GARTH, Circuit Judges.

OPINION OF THE COURT

GIBBONS, Circuit Judge.

Appellant Irving Trust Company (Irving) is a trustee under two trust indentures executed by the predecessors of Penn Central Transportation Company (Penn Central) in anticipation of the public sale of their bonds. Pursuant to the terms of these indentures Penn Central pledged with and delivered to Irving as security a total of 116,698 shares of its stock in The Pittsburgh and Lake Erie Railroad Company (P&LE). ¹ Irving, as pledgee of 22.5% of P&LE's outstanding stock, appeals from an order of the district court approving over its objections, the settlement of a series of class shareholder derivative actions brought by P&LE minority shareholders. The defendants in these actions were P&LE, certain of its officers and directors, certain present and former officers of Penn Central and others (including some banks and their employees). The parties to the settlement all contend that Irving, a nonparty, lacked standing to be heard in the district court in objection to the settlement. They would prefer that on this ground we refrain from reviewing the fairness of the settlement. But assuming that we recognize Irving's standing to object, they urge that the order approving the settlement be affirmed as a fair disposition of the class and derivative suits. We conclude that Irving did have standing to be heard in objection to the settlement, and that the district court abused its discretion in approving it. Accordingly, the settlement order must be vacated.

I. THE RELEVANT PROCEEDINGS BELOW

The settlement order arises out of eight separate actions filed in seven different districts by minority shareholders of P&LE. Six of these actions, by order of the Judicial Panel on Multidistrict Litigation, were transferred pursuant to 28 U.S.C. § 1407 to the Eastern District of Pennsylvania where two of the actions were already pending. ² The pleadings establish that Penn Central owns approximately 93% of the outstanding capital stock of P&LE, including the 161,198 shares pledged to Irving. The remaining 7% is publicly held. The derivative-suit plaintiffs charge the actual defendants ³ with (1) violations of § 10 of the Clayton Act, 15 U.S.C. § 20, which prohibits certain transactions between carriers having interlocking directorates; (2) violations of the federal securities laws for omitting information pertaining to these negotiated transactions from the 1969 P&LE Annual Report and for failing to register certain loan transactions; and (3) violations of fiduciary obligations imposed by state law. The class action plaintiffs, on behalf of all owners of the 7% publicly-held stock, charge P&LE and the other defendants with the same violations of § 10 of the Clayton Act. Both the federal and state law claims allege that in a series of transactions antedating the filing of its petition for reorganization, Penn Central (the 93% shareholder) was permitted to raid the assets of P&LE to the latter's detriment. Specifically, the plaintiffs claim that defendants improvidently permitted P&LE to make a series of loans to Penn Central at inadequate interest rates and at a time when they knew or should have known of the latter's precarious financial condition, and to enter into a conditional sales agreement with Penn Central to finance rolling stock at an excessive rate of interest.

Various interlocutory rulings, including the dismissal of the class action antitrust suit for failure to state a claim upon which relief could be granted, are set forth in the reported decisions of the district court. ⁴ Significantly bearing on the issues raised in this appeal is Judge Gorbey's most recently reported decision in this litigation. ⁵ Certain defendants had moved for a pretrial ruling limiting their liability to 7% of any damage allegedly sustained by P&LE. They proposed that any judgment be awarded directly to the 7% minority shareholders rather than to the corporation, thereby effecting a parity of benefits between these shareholders and Penn Central. Penn Central, they contended, had already been the principal beneficiary of the challenged transactions, and, as 93% shareholder, would benefit again from any recovery by P&LE. Holding that these derivative plaintiffs met the contemporaneous stock ownership requirement of Rule 23.1, Fed.R.Civ.P., and that P&LE would not reap a windfall if full recovery were permitted on behalf of the injured corporation, the court distinguished Bangor Punta Operations, Inc. v. Bangor & Aroostook R.R. Co., 417 U.S. 703, 94 S.Ct. 2578, 41 L.Ed.2d 418 (1974), upon which the moving defendants had relied. In denying the motion to limit recovery, the court also emphasized that unlike the unique situation in Perlman v. Feldmann, 219 F.2d 173 (2d Cir.), cert. denied, 349 U.S. 952, 75 S.Ct. 880, 99 L.Ed. 1277 (1955), where a direct pro rata recovery by the minority shareholders had been permitted, the best interests of P&LE and the general public (in the enforcement of the federal securities and antitrust laws) would not be served by limiting the recovery to 7% of the alleged damages. ⁶

Once this decision was announced by the district court, it became obvious that all the defendants were potentially exposed to a huge liability. At the same time it was clear that since Penn Central was already in the process of reorganization, it was, as a practical matter, judgment proof. This left the individual and bank defendants potentially liable for all of the $30,000,000 damage allegedly suffered by P&LE. Shortly before a date was set for what promised to be a protracted trial, appellees proposed a settlement to the district court. Apparently acting pursuant to the last sentence of Rule 23.1, Fed.R.Civ.P., the district court ordered publication of notice of the proposed settlement and fixed a date for a hearing thereon. Irving received the notice and filed written objections to the terms of the settlement.

Under the proposed settlement a fund of $2,250,000 was created into which P&LE would contribute $2,100,000 and the individual and bank defendants $150,000. ⁷ From the settlement fund $750,000 would be distributed to plaintiffs' attorneys, and the remaining $1,500,000, after deducting court costs, would be distributed to the 7% minority shareholders but not the individual defendants. In addition, P&LE and the trustees of Penn Central would exchange releases, thereby effecting a discharge of a loan balance of $12,800,000 (probably uncollectable) due to P&LE from Penn Central as of June 21, 1970. The proposed release would also discharge the liability (also probably uncollectible) of the Penn Central estate for damage to P&LE from other transactions which allegedly violated § 10 of the Clayton Act and state law fiduciary duties. The Penn Central trustee agreed, subject to the approval of the reorganization court (which was obtained in a separate proceeding) that no distribution of the settlement fund would be made in favor of the 93% of P&LE shares held in Penn Central's name. Finally, all parties to the settlement would exchange releases inter sese as to all claims, including any claims for indemnity, and P&LE received an assurance from Penn Central that past tax allocations would not be recomputed. ⁸ Thus, the primary effect of the proposed settlement was that from the P&LE equity attributable to the 93% shareholder, P&LE, on whose behalf the suit was brought, would pay the plaintiffs' attorneys fees and make a special one-time distribution to the 7% public shareholders.

At the hearing on Irving's objection the two indentures of which it is trustee were made a part of the record. Both provide that prior to default Penn Central has the right to vote the pledged stock, but that no proxy or power of attorney to vote the stock shall be used for any purpose inconsistent with the terms of the indenture. ⁹ Both provide that after an event of default (of which filing the reorganization petition was one) Irving may, without Penn Central's consent, "take such steps as in its discretion it shall deem necessary to protect the interest of the holders of the Bonds in respect of any collateral security at any time pledged . . . either by instituting or requesting or authorizing the institution of any legal proceedings to enforce payment of the collateral security or interest ¹⁰ thereon or to foreclose any lien securing the same, or otherwise to act in respect of the collateral security . . ." ¹¹ Both indentures also give Irving the power upon default to foreclose the pledge by sale of the collateral. ¹² It was established at the...