Zeffiro v. First Pennsylvania Banking and Trust Co.
| Decision Date | 29 May 1980 |
| Docket Number | No. 79-2259,79-2259 |
| Citation | 623 F.2d 290 |
| Parties | Fed. Sec. L. Rep. P 97,514 ZEFFIRO, Jay A., Individually and on behalf of all other persons similarly situated v. FIRST PENNSYLVANIA BANKING AND TRUST COMPANY, a Pennsylvania Corporation. SMITH, Isabella G., Bernard, Harry M., Jr., on behalf of themselves and all others similarly situated v. FIRST PENNSYLVANIA BANK, N. A., Capital First Corporation, First Pennsylvania Bank N. A., Appellants. |
| Court | U.S. Court of Appeals — Third Circuit |
Edward F. Mannino (argued), Mark J. Levin, Dilworth, Paxson, Kalish, Levy & Kauffman, Philadelphia, Pa., for appellant, First Pennsylvania Bank N. A.
Michael P. Malakoff (argued), Richard A. Finberg, Berger, Kapetan, Malakoff & Meyers, Pittsburgh, Pa., Joseph W. Anthony, Larkin, Hoffman, Daly & Lindgren, Ltd., Minneapolis, Minn., Abraham C. Reich, Fox, Rothschild, O'Brien & Frankel, Philadelphia, Pa., for plaintiffs-appellees, Jay A. Zeffiro and Harry M. Bernard, Jr.
Ralph C. Ferrara, Gen. Counsel, Jacob H. Stillman (argued), Associate Gen. Counsel, Elisse B. Walter, Asst. Gen. Counsel, Robert J. Mills, Atty., Securities and Exchange Commission, Washington, D. C., amicus curiae.
Before ROSENN and HIGGINBOTHAM, Circuit Judges and LAYTON, District Judge. *
The Trust Indenture Act of 1939, 15 U.S.C. § 77aaa et seq., regulates the terms of the agreement between debenture holders and the indenture trustee. This appeal presents to a United States Court of Appeals for the first time the question of whether the Act provides an injured investor with a cause of action in federal court against a trustee for breach of the agreement. We conclude, as did the district court, that a cause of action exists under the Act, allowing injured investors to bring suit in federal court.
Jay A. Zeffiro and Harry M. Bernard, Jr. each hold debentures issued in 1972 by Capital Equipment Leasing Corporation, a predecessor of defendant Capital First Corporation (Capital). The debentures were issued under a trust indenture which named First Pennsylvania Banking and Trust Company, a predecessor of defendant First Pennsylvania Bank, N.A. (First Pennsylvania), as indenture trustee. The indenture contained provisions mandated by the Act, detailing the duties of First Pennsylvania toward the debenture holders. In December 1976, Capital defaulted on its obligation to pay interest on the debentures and, subsequently, filed a petition under Chapter XI of the Bankruptcy Act.
Zeffiro and Bernard filed separate suits in the United States District Court for the Eastern District of Pennsylvania, later consolidated, alleging that First Pennsylvania breached certain duties imposed upon it by indenture provisions which were required by the Act and seeking damages. 1 First Pennsylvania moved under rules 12(b)(1) and 12(b)(6) to dismiss the actions for lack of subject matter jurisdiction and for failure to state a claim upon which relief can be granted. First Pennsylvania contended that the Act does not expressly provide for a federal cause of action or for federal jurisdiction and that, therefore, the debenture holders' suit must be brought in state court. Judge Bechtle denied the motions, holding that there is a federal cause of action in favor of debenture holders for breach of the provisions of a trust indenture when those provisions are mandated by the Act. 473 F.Supp. 201 (E.D.Pa.1979). The district court and this court certified First Pennsylvania's right to appeal this interlocutory order under 28 U.S.C. § 1292(b).
Before proceeding to a discussion of the merits, it may be useful to briefly outline the structure and background of the Trust Indenture Act. A study was conducted by the Securities Exchange Commission (SEC) in 1936 which revealed widespread abuses in the issuance of corporate bonds under indentures. 2 The main problems identified by the study were that the indenture trustee was frequently aligned with the issuer of the debentures and that the debenture holders were widely dispersed, thereby hampering their ability to enforce their rights. Furthermore, courts frequently enforced broad exculpatory terms of the indenture inserted by the issuer, which offered the investors less protection than the traditional standards of fiduciary duty.
Rather than allow the SEC direct supervision of trustee behavior and thereby provide for a more overt intrusion into capital markets, the Act establishes a standard of behavior indirectly by refashioning the form of the indenture itself. The Act is structured so that before a debt security non-exempted from the Act may be offered to the public, the indenture under which it is issued must be "qualified" by the SEC. The indenture is deemed "qualified" when registration becomes effective. 3 Before registration of the debenture is declared effective it must be qualified under the following conditions: (1) the security has been issued under an indenture; (2) the person designated as trustee is eligible to serve; and (3) the indenture conforms to the requirements of §§ 310-318, 15 U.S.C. §§ 77jjj-77rrr. Judge Bechtle aptly described the operative provisions of the Act, §§ 310-318, as follows.
Sections 310 through 318 form the core of the Act in that they outline the substantive duties that the indenture must impose on the trustee. These sections are of three types. The first type is proscriptive in nature, prohibiting certain terms. For example, § 315, 15 U.S.C. § 77ooo (d), prohibits provisions in the indenture which would relieve or exculpate the trustee from liability for negligence. The second type of section is merely permissive in nature. An example of this type of section is § 315(a), 15 U.S.C. § 77ooo (a)(1), which states that the indenture may contain a provision relieving the trustee of liability except for the performance of such duties as are specifically set out in such indenture.
The third type of section, and the most important for our purposes, is mandatory and prescriptive in nature. These sections begin with the phrase "indenture to be qualified shall provide" or "shall require." An example of this type of section is § 311, 15 U.S.C. § 77kkk, which states that the indenture shall require the trustee to establish certain accounts for the benefit of bond holders in the event the trustee also becomes a creditor of the issuer and the issuer defaults on the bonds.
The SEC has no enforcement authority over the terms of the indenture once the registration statement becomes effective, and it cannot issue a stop order for violation of indenture provisions by the indenture trustee. After the effective date of the indenture the SEC's role is limited to general rulemaking and investigation. 15 U.S.C. §§ 77ddd(c), (d), (e); 77eee(a), (c); 77ggg; 77sss; 77ttt. The Act contains criminal liability for certain willful violations and misrepresentations 4 and express civil liability for any omission or misstatement in the filing documents. 5
Enforcement of the terms of the indenture is left to the parties. The plaintiffs in this case contend that the Act necessarily allows for enforcement of the indenture in federal court to insure compliance with the Act. First Pennsylvania argues that, because the Act only mandates certain terms of the indenture in order for it to be qualified by the SEC, the remedy is contractual under state law and not one for federal jurisdiction.
The plaintiffs' 6 first argument is that the Act expressly creates a federal cause of action. In Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975), the Supreme Court set out four factors to aid in determining whether a statute creates an implied federal cause of action.
First, is the plaintiff "one of the class for whose especial benefit the statute was enacted," that is, does the statute create a federal right in favor of the plaintiff? Second, is there any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one? Third, is it consistent with the underlying purposes of the legislative scheme to imply such a remedy for the plaintiff? And finally, is the cause of action one traditionally relegated to state law, in an area basically the concern of the States, so that it would be inappropriate to infer a cause of action based solely on federal law?
422 U.S. at 78, 95 S.Ct. at 2088. Since Cort, the Supreme Court has been reluctant to imply private rights of action under the securities laws. 7 Thus, plaintiffs' argument in favor of an express private right of action is an apparent attempt to escape the perceived strictures of the Cort analysis.
The cornerstone of plaintiffs' first argument in favor of an express federal cause of action is the jurisdictional provision of the Act, section 322, which provides:
(b) Jurisdiction of offenses and violations under, and jurisdiction and venue of suits and actions brought to enforce any liability created by, this subchapter, or any rules or regulations or orders prescribed under the authority thereof, shall be provided in section 77v(a) of this title. 8
The argument is essentially that the mandated provisions of the indenture were "created by" the Act, and thus section 322 confers federal jurisdiction in suits for breach of such indenture terms.
Two cases which have considered a private right of action under the Act 9 have accepted this argument, holding that section 322 expressly confers federal jurisdiction. 10 In Morris v. Cantor, 390 F.Supp. 817, 822 (S.D.N.Y.1975), the court reasoned that the Act provided an "indirect method of imposing nationally uniform and clearly defined obligations," and therefore the terms of the indenture were "created by" the Act and enforceable in federal court. In In Re Equity Funding Corp. of America Securities Litigation, 416 F.Supp. 161, 203 (C.D.Cal.1976), aff'd 603 F.2d 1353 (9th Cir. 1979), the court...
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