In Re: Cendant Corporation Litigation Martin Deutch, Derivatively on Behalf of Cendant Corp.

Citations: 264 F.3d 286; 50 Fed. R. Serv. 3d 841; 2001 U.S. App. LEXIS 19204; 2001 WL 980357Docket: 00-2684

Court: Court of Appeals for the Third Circuit; August 28, 2001; Federal Appellate Court

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Martin Deutch appeals the District Court's judgment approving a settlement in a securities fraud class action involving Cendant Corporation, its individual defendants, and Ernst & Young. The settlement entails Cendant paying $2.85 billion and Ernst & Young contributing $335 million to the class. Additionally, Cendant and certain individual defendants will pay 50% of any recovery from their cross-claims against Ernst & Young. In exchange, the class releases all potential claims against the defendants.

Deutch, who is a current shareholder of Cendant but not a member of the class, objected to the settlement and sought to intervene both as a shareholder and as a derivative action plaintiff. The District Court rejected his objections and those of other class members, subsequently approving the settlement. This led to multiple appeals, with the class members' appeals addressed separately, affirming that the District Court acted within its discretion regarding their objections. Deutch's appeal raises unique legal issues concerning a shareholder's ability to present claims on behalf of the settling corporation. The opinion notes that relevant facts will be elaborated in the principal opinion addressing the appeals of the objecting class members.

On December 17, 1997, CUC International, Inc. merged with HFS Inc., resulting in the creation of Cendant Corp., a major consumer and business services company. Following the merger, Cendant issued shares to HFS shareholders based on a Registration Statement and Joint Proxy Statement. On March 31, 1998, Cendant filed its Form 10-K with the SEC, including financial statements from 1997. However, on April 15, 1998, Cendant revealed accounting irregularities in former CUC business units, leading to a restatement of its financials. This announcement caused a significant drop in Cendant's stock price, which fell from $35.625 to $19.0625.

To investigate these irregularities, Cendant's Audit Committee engaged the law firm Willkie Farr & Gallagher, which in turn employed Arthur Andersen LLP for assistance. By July 14, 1998, Cendant announced further restatements for financial years 1995 and 1996, resulting in another stock drop to $15.6875. On August 28, 1998, a report from Willkie Farr disclosed that the financial statements for 1995, 1996, and 1997 materially misstated revenue and income, leading to a further decline in stock price to $11.625.

Subsequently, multiple plaintiffs filed securities fraud lawsuits against Cendant and others, alleging violations of federal securities laws. These lawsuits were consolidated in the U.S. District Court for the District of New Jersey. The court appointed the California Public Employees' Retirement System, New York State Common Retirement Fund, and New York City Pension Funds as Lead Plaintiffs, and approved Barrack, Rodos & Bacine and Bernstein Litowitz Berger & Grossmann LLP as Lead Counsel.

On December 14, 1998, the Lead Plaintiff filed an amended and consolidated class action complaint on behalf of all individuals and entities who purchased Cendant or CUC securities from May 31, 1995, to August 28, 1998. The complaint named Cendant, former officers and directors of CUC and HFS, and Ernst & Young as defendants, alleging violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5 by making false and misleading statements regarding revenues and operating income due to improper accounting practices that violated Generally Accepted Accounting Principles.

The Amended Complaint asserted that all defendants, except for Anne Pember and Scott Forbes, were responsible for misleading statements in the August 28, 1997 Registration Statement related to the CUC/HFS merger, violating Section 11 of the Securities Act of 1933. Additionally, Cendant was claimed to have violated Section 12(a)(2) by selling securities through a misleading prospectus. Certain individual defendants faced allegations under Sections 15 and 20(a) of the Securities Act, as well as related provisions of the Securities Exchange Act.

Concurrent with the Amended Complaint, Lead Plaintiff moved for class certification, which was granted by the District Court on January 27, 1999. Settlement negotiations began in June 1999 and culminated in settlements announced on December 7, 1999, involving Cendant, the HFS Individual Defendants, and later E&Y. The settlements included Cendant paying $2.8515 billion to the class, along with additional payments contingent on recoveries in cross-claims against E&Y. Cendant also agreed to implement corporate governance reforms, including a majority independent Board of Directors.

In exchange, class members released all claims against the settling defendants. The parties sought court approval for the settlements, requesting a bar on contribution claims under the Private Securities Litigation Reform Act while clarifying that Cendant retained the right to pursue claims against E&Y or related individuals. E&Y's settlement involved a $335 million cash payment to the class, with a Plan of Allocation proposed for distribution of settlement funds.

The District Court preliminarily approved the settlements on March 29, 2000, and the Lead Plaintiff issued notices to over 478,000 class members, with only four objections received concerning the settlements or the Plan of Allocation.

Martin Deutch, a current Cendant shareholder, objected to a class action settlement, claiming it inadequately represented Cendant's interests due to conflicts of interest among its board members, 13 of whom were defendants. He argued that the settlement was unfair as it released individual defendants from contribution claims without meaningful compensation, failed to specify the allocation attributable to Section 11 claims, and constituted illegal indemnification of Cendant's officers and directors. Additionally, Deutch alleged the Notice of Settlement was defective for not informing shareholders that certain derivative claims would be compromised and that Cendant's contribution claims against HFS defendants would be barred. Following a fairness hearing on June 28, 2000, the District Court rejected these objections on August 15, 2000, approving the settlements and the Plan of Allocation. The court permanently barred all contribution claims while allowing Cendant to assert claims against certain individuals. Deutch appealed, arguing the court erred by not recognizing Cendant's lack of representation, improperly issuing a contribution bar without sufficient payment determination, failing to analyze the HFS Defendants' settlement fairness, denying his intervention motion under Fed. R. Civ. P. 24(a), and approving a Notice of Settlement that neglected to inform shareholders about the abrogation of contribution claims. He also contended that the court allowed Cendant to cover most of the settlement, effectively indemnifying individual defendants, and did not clarify the portion of the settlement tied to Section 11 of the 1933 Securities Act.

Jurisdiction is established under 28 U.S.C. § 1291, and a district court's approval of a class action settlement will be upheld unless there is an abuse of discretion. Cendant Deutch's main objection to the settlement is that the District Court did not adequately consider Cendant's interests, arguing that the court was obligated under Fed. R. Civ. P. 23(e) to evaluate the settlement's fairness, reasonableness, and adequacy, particularly due to conflicts of interest among Cendant's board members who faced personal liability in the class action. The District Court countered that its duty under Rule 23 focuses on protecting absent class members and ensuring the settlement is fair to the class as a whole, not on individual interests of the settling parties. The court referenced precedents emphasizing that it must confirm sufficient compensation is being provided to the class, without needing to assess the fairness of the defendants' contributions. It rejected the "entire fairness" standard proposed by Deutch, asserting that it would require the court to overstep its role and interfere with the board's judgment. Instead, any claims of unfairness regarding the settlement to Cendant should be addressed through derivative actions under Delaware law. Deutch further cites Eichenholtz v. Brennan to argue for consideration of broader interests, noting that a settlement in that case included provisions limiting claims between defendants.

The court emphasized that when third-party rights are at stake, it is insufficient to merely assess the fairness of a settlement for the settling parties; the interests of affected third parties must also be taken into account. However, the case of Deutch misinterprets this principle. The court previously determined that non-settling defendants had standing to object to a settlement due to claims of suffering cognizable prejudice from its approval but ultimately concluded that they would not be prejudiced since they would only bear their share of liability. Thus, the court affirmed the district court's approval of the partial settlement.

Cendant, which is a settling defendant, does not have the same standing as a non-settling defendant or an unrepresented third party. The case of In re Warner Comm. Sec. Litig. is referenced, where a class member sought to challenge a settlement, arguing for a larger contribution from the individual defendants. The Second Circuit upheld the settlement, noting that the district court's fiduciary duties were to the class members, not the defendants. Judge Newman, in his concurrence, highlighted that while normally the court need not concern itself with the defendants' liability allocation, scrutiny is warranted in cases where the apportionment could impact shareholder value significantly. Nonetheless, he concurred with the majority's decision due to prior determinations by the Delaware Court of Chancery regarding the fairness of the settlement's burden allocation.

Judge Newman’s perspective on the fairness of settlement allocation in derivative actions is supported, particularly concerning Deutch’s claims about Cendant's lack of representation during settlement negotiations due to board conflicts of interest. These claims are more appropriately addressed in a shareholder derivative action, as established in Wolf v. Barkes. A new derivative lawsuit can seek to remedy improper settlements without nullifying them, as seen in In re Warner Comm. Sec. Litig. If the objector believes the settlement is unfair, they should present their concerns in Delaware Chancery Court, where issues of settlement burden apportionment have already been adjudicated. 

Notably, counsel for Cendant indicated that Deutch's attorney has initiated a separate derivative action in Delaware, Resnik v. Silverman et al., which includes similar allegations regarding breaches of duty by Cendant's directors. This suggests that Deutch’s arguments may be presented within that framework. 

The court finds Deutch's assertions about the inadequacy of the state law derivative action unconvincing, emphasizing that the damages sought in such actions often parallel contribution claims. Deutch raises concerns about the demand requirement in derivative actions, as outlined in Aronson v. Lewis, and the potential for indemnification under Delaware law for Cendant’s directors. However, these factors do not undermine the derivative action's adequacy in protecting Cendant's interests.

According to Fed. R. Civ. P. 23(e), the court’s role is to ensure the settlement is fair, reasonable, and adequate to the class, given that many affected parties may not participate directly in litigation. The court must ensure that the settlement provides sufficient benefits to the class in exchange for relinquishing their litigation rights. Deutch has not successfully demonstrated that the court’s fiduciary responsibilities under Rule 23(e) should extend to the defendants, even if they are influenced by conflicted individuals.

Deutch argues that the Notice of Settlement inadequately informed current Cendant shareholders about the elimination of Cendant's rights to contribution. However, it is established that Rule 23(e) only requires notice to class members, and there is no obligation to notify non-class current shareholders. Thus, Deutch's objection is rejected. Additionally, Deutch contends that the District Court wrongly denied his motion to intervene as of right to protect Cendant's contribution rights. Under Fed. R. Civ. P. 24(a), intervention is allowed when an applicant has a significant interest in the action that may be impaired unless adequately represented. Since the court did not find Cendant unrepresented during settlement negotiations, Deutch's intervention is deemed unnecessary, and his motion is only granted as permissive under Rule 24(b).

Deutch's further claims suggest that Cendant may have overpaid in the settlement benefiting the HFS Individual Defendants. He argues that the District Court should not have released the HFS Individual Defendants from contribution claims without first assessing their fair share of the settlement. The court's order approving the settlement bars all contribution claims and stresses that it does not prevent Cendant from pursuing claims against other parties involved. The court felt bound by the Reform Act’s provision stating that a settling party is discharged from future contribution claims upon settlement approval.

Deutch interprets subsection (ii) to state that only individuals who have paid to settle their own liability are eligible for a contribution bar, arguing that the HFS Individual Defendants, who have not contributed their fair share, should not benefit from such a bar and remain liable for contribution claims from Cendant. The District Court's order does not specify which parties are covered by the contribution bar, but it acknowledged that all parties agree the HFS Individual Defendants are included for Section 10(b) claims and that the coverage extends to directors outside of HFS for Section 11 claims. The impact of the contribution bar on the CUC Individual Defendants, who are not part of the settlement yet have their liability extinguished, remains contested. Deutch contends that the District Court wrongly imposed a contribution bar without first determining whether the HFS Individual Defendants had paid their fair share. However, it is noted that this issue is premature since no contribution claims have been filed, and resolving the specifics of the contribution bar’s scope is unnecessary at this stage. The text of 15 U.S.C. § 78u-4(f)(7)(A) and its legislative history do not mandate such a determination, which the court declines to impose. Deutch's assertion that the Reform Act's emphasis on proportionate liability supports his position is refuted, as the Act specifies that a defendant is liable only for their proportionate share of a judgment. In cases of partial settlements, the judgment is adjusted to prevent non-settling defendants from facing undue liability, but the current situation involves a complete settlement of claims.

Deutch cites two cases, Eichenholtz v. Brennan and TBG, Inc. v. Bendis, which involved partial settlements that could prejudice non-settling defendants if proportionate fault was not established. However, these cases do not address full settlements, where the rationale for proportionate fault reduction does not apply, as the primary benefit of a full settlement is to avoid merit determinations. The court clarifies that its role under Fed. R. Civ. P. 23(c) is not to try the case but to evaluate the proposed compromise, aimed at reducing trial-related delays and costs. 

The District Court's order approving the settlement allows Cendant to preserve claims against former officers or directors, ensuring that derivative action plaintiffs are not prejudiced. Deutch's argument that the court should assess whether the HFS Individual Defendants paid their fair share is rejected; the court did not err in imposing a contribution bar without such a determination. Deutch's reliance on Girsh v. Jepson is misplaced, as there was no record deficiency in this case. The District Court adequately considered the nine Girsh factors and acknowledged concerns regarding the HFS Individual Defendants' contributions, noting they would contribute 50% of any recovery against Ernst & Young (E&Y). The court determined that the settlement was fair, reasonable, and adequate, despite Deutch's assertion that the promise to give 50% of the recovery was illusory, arguing it created no obligation for the HFS Defendants to actively pursue the suit post-settlement.

Implicit in the settlement is a promise to make a good faith effort to pursue recovery against E&Y. Courts generally interpret contracts to avoid making promises illusory, emphasizing an implied obligation of good faith, which prevents such findings. Deutch contends that the District Court failed to determine the amount paid into the settlement for claims under Section 11 of the 1933 Securities Act, arguing that the contribution bar cannot apply to inside directors for these violations. The Court concludes that the extent of coverage under the contribution bar for the HFS Individual Defendants is more appropriately addressed in a future contribution claim. The Court holds that neither it nor the trial court is obligated to make definitive conclusions regarding the merits of the underlying dispute when approving settlements.

Deutch also argues that Cendant's payment of the entire settlement amount constitutes impermissible indemnification of the HFS Individual Defendants for securities law violations. Citing past rulings, he asserts there is no right to indemnification under federal securities laws. Indemnification typically involves reimbursement for liabilities incurred in official capacities, but in this case, Cendant directly pays the class a settlement of $2.85 billion rather than reimbursing the defendants. Deutch has not provided precedent for viewing a full settlement as indemnification, leading the Court to reject claims that the settlement constituted indemnification for the HFS Individual Defendants.

Deutch failed to substantiate his objections to the settlement based on applicable law or demonstrate a need for new rules regarding derivative action plaintiffs. The issue of whether Cendant's board members breached their fiduciary duties is more appropriately addressed in a derivative action rather than during the approval of a class action settlement. The District Court was not obligated under Rule 23 or the Reform Act to evaluate the settlement's impact on Cendant or to assess the defendants' relative fault prior to settlement approval. Consequently, the court did not abuse its discretion in dismissing Deutch's objections.

Additionally, Deutch previously initiated a derivative action on Cendant's behalf against numerous CUC and HFS Individual Defendants for alleged breaches of fiduciary duty related to insider trading and mismanagement. Although the court determined that Deutch was excused from demanding action from Cendant's board, it dismissed claims against Bear Stearns for lack of standing. After the settlement announcement, Deutch sought partial summary judgment against the individual defendants, alleging violations under Section 11 of the 1933 Securities Act and claiming entitlement to contribution for settlement payments.

On April 14, 2000, the District Court denied Deutch's motion for summary judgment, determining it was premature as any right to contribution only arises post-settlement approval and after Cendant pays its fair share. The court noted Deutch's derivative action lacked allegations concerning Cendant's settlement decision and structure. Subsequently, Deutch's attorney faced Rule 11 sanctions for the improper motion, a matter still pending. Deutch did not specify the individual defendants in his complaint, but it is inferred that they include several named individuals based on a related derivative action filed in Delaware. Deutch also sought to intervene as a Cendant shareholder to protect his interests, which the District Court rejected, stating that allowing such intervention would hinder corporate settlements. Although Deutch raised this issue on appeal, he failed to argue it in his brief, resulting in its abandonment. Additionally, the Act mandates that in private actions, courts must instruct juries or make findings regarding each person's contribution to the plaintiff's loss, including whether they violated securities laws and their percentage of responsibility. The Girsh factors outline nine considerations for assessing the fairness, reasonableness, and adequacy of class action settlements, including litigation complexity, class reaction, discovery stage, and various risks associated with liability, damages, and class action maintenance.

The settlement fund's reasonableness is evaluated based on both the best possible recovery and potential recovery considering the risks associated with litigation. The district court did not analyze the Gluck settlement, leaving uncertainty about the appropriateness of the $10,000 settlement amount, which could be perceived as either overly generous or insufficient. The fairness of this settlement aspect relies on further factual developments. Additionally, Cendant and the HFS Individual Defendants filed successful cross-claims against E&Y, overcoming a motion to dismiss. The term "covered person," as used in the context of 15 U.S.C. § 78u-4(f)(10), refers to defendants in private actions related to Section 10(b) and Section 11 claims, specifically including outside directors of the issuer involved.