Franklin v. Kaypro Corp.

Citations: 884 F.2d 1222; 1989 WL 101575Docket: Nos. 88-5931, 88-5934

Court: Court of Appeals for the Ninth Circuit; September 6, 1989; Federal Appellate Court

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An appeal has been filed regarding a pretrial order from the district court that approved a settlement with certain defendants in a class action securities litigation related to Kaypro Corporation. The plaintiff class consists of individuals who purchased Kaypro common stock between August 25, 1983, and July 17, 1984, excluding the defendants, which include Kaypro Corporation and its officers, Peat Marwick Main Company, and Prudential-Bache Securities, Inc. The appeal is brought by Prudential-Bache and Peat Marwick, who assert that their substantial legal rights are impacted by the district court's order, thus giving them standing to appeal.

The plaintiffs allege that Kaypro misled investors through false statements regarding its financial status after its initial public offering of shares in August 1983. Following the disclosure of significant financial discrepancies, the stock price plummeted. The plaintiffs seek $25 million in damages, supported by analyses suggesting damages between $19 million and $22 million, while Peat Marwick claims damages do not exceed $5 million. A settlement of $9.25 million was reached between the plaintiffs and the settling defendants.

After a good faith hearing conducted by a magistrate, the district court confirmed the settlement's approval. The nonsettling defendants argued against this approval, suggesting it was improperly granted. The appeal raises concerns about the balance between expediting court proceedings in complex litigation and ensuring fairness and legal accuracy in the settlement process. The appellate court affirms in part and remands in part the district court's decision.

Federal courts promote pretrial settlements to alleviate court congestion and reduce costs for litigants and the judicial system. Settlement conferences are integrated into pretrial procedures, and in class actions, court approval is required for settlements. The majority of class action lawsuits settle before trial, with studies indicating that approximately 71% reach a resolution prior to trial. Settling offers advantages such as reducing uncertainties associated with litigation and ensuring some recovery for plaintiffs, which may outweigh the risks of trial. Settlement may also allow plaintiffs’ counsel to secure funds to continue pursuing claims against remaining defendants. However, multi-party litigation complicates settlement due to potential cross claims and counterclaims, necessitating a "bar order" to provide finality for settling defendants by discharging their obligations and preventing further claims from nonsettling defendants. The case in question involves an appeal related to a bar order issued after hearings, which nonsettling defendants argue restricts their right to seek contribution from settling defendants. This situation raises a novel legal question regarding the implications of a bar order under subsection 11(f) of the Securities Act of 1933, which allows for contribution among jointly and severally liable defendants in securities actions.

Subsection 11(f) of 15 U.S.C. 77k, which allows for contribution among joint tortfeasors, was largely derived from England’s Companies Act of 1929. Contribution rights are not limited to this subsection; they also exist under the Securities Exchange Act of 1934, including sections 9(e) and 18(b), and under claims related to section 10(b) and Rule 10b-5. Federal law governs the right to contribution, as established in cases such as Heizer Corp. v. Ross and Laventhol, Krekstein, Horwath v. Horwitch. Contribution is based on the relative culpability of tortfeasors rather than a pro rata basis, as confirmed in Smith v. Mulvaney. Historically, American and English common law disallowed contribution among joint tortfeasors, a principle originating from Merryweather v. Nixan. This rule was initially applied to willful misconduct but expanded to negligent tortfeasors as procedural changes allowed for their joinder in lawsuits. Over time, criticism of this rule led to the introduction of the Uniform Contribution Among Tortfeasors Act by the American Law Institute in 1939 and its amended version in 1955. By the 1970s, most states had enacted laws permitting contribution among tortfeasors. Although contribution was not part of early American common law, it has become a significant aspect of law, evolving through various state statutes and judicial decisions. In federal securities law, contribution under section 77k(f) lacks a comprehensive statutory or regulatory framework and is not supported by a substantial body of case law. Congress has not adopted the Uniform Act, and the legislative history of section 11(f) is limited. Nevertheless, its intent aligns with the overall goals of restoring market confidence as outlined in the Securities Act of 1933 and the Securities Exchange Act of 1934.

The legislation aimed to enhance public confidence by mandating the disclosure of sufficient facts for prudent investors to assess the risks of purchasing publicly offered securities. A significant reform was the accountability of all parties responsible for public reports. Early discourse on the federal right to contribution highlighted the phrase “as in cases of contract,” which was included to address issues in English tort law. However, this reliance is complicated, as it suggests a shift from the traditional tort law principle of no contribution. 

In determining the applicable law regarding pretrial settlements among defendants, it was recognized that there is no clear statutory or established federal common law, creating a legal vacuum. Courts have employed various approaches, with some opting to apply the forum state's law, which offers the benefit of a consistent legal framework. However, this approach has drawbacks, as not all states have contribution laws, and those that do can vary significantly. This lack of uniformity can lead to confusion and promote forum shopping.

Consequently, there is a consensus among some courts advocating for the establishment of federal common law to govern contribution issues in securities cases. The impact of partial settlements and bar orders on substantive rights underscores the necessity for federal courts to address these matters comprehensively.

Three alternatives are presented for establishing federal common law regarding settlements and contribution rights. Nonsettling defendants argue against settlements that bar further contribution, asserting that contribution is a vested statutory right that cannot be waived before a full trial. They interpret prior case law as prohibiting such bars; however, the document counters that neither the statute nor previous decisions explicitly prevent contribution from being satisfied prior to a trial. It cites In re Nucorp Energy Securities Litigation and other cases to illustrate that the right to contribution is recognized, but there is no mandate against pretrial settlements. 

The text emphasizes the public interest in resolving disputes, particularly in class actions, and posits that the nonsettling defendants' position would effectively prevent partial settlements, forcing all parties to trial if one defendant refuses to settle. The document rejects the notion that Congress intended to eliminate partial settlements or render contribution rights inextinguishable.

The second alternative suggested by the Second Circuit involves treating settlement payments as offsets against total damages determined at trial. This method adheres to the principle of one satisfaction for each injury, ensuring that the total compensation paid does not exceed the damages incurred. However, the document critiques this approach, noting potential disadvantages, including the risk of collusion between plaintiffs and certain defendants, enabling plaintiffs to secure low settlements while continuing litigation without reducing their overall recovery.

Plaintiffs may settle for lower amounts with resource-limited defendants, which can lead wealthier defendants to pay disproportionately higher amounts if all parties do not proceed to trial. Some believe that implementing a good faith hearing can mitigate this issue; however, it is argued that such hearings complicate and delay the settlement process, effectively transforming it into a mini-trial. A good faith hearing would necessitate a comprehensive evidentiary review of each party's culpability, undermining the efficiency of settlements. Settlements inherently involve reduced amounts due to the cost-saving appeal to plaintiffs, who accept less than what might be awarded in full litigation. Courts are guided to accept these discounts when assessing partial settlements. Nonetheless, the offset scheme causes non-settling defendants to cover the discount amounts, which raises concerns about fairness. 

In Smith v. Mulvaney, the issue of whether contribution rights should reflect relative culpability or be divided equally was discussed, concluding that equitable apportionment is essential to maintaining fairness among wrongdoers. The Eastern District of Pennsylvania's framework in In re Sunrise Securities Litigation addresses the need for equity, allowing for a district court-approved partial settlement while mandating that juries determine the total damages and the culpability percentages of each defendant. Non-settling defendants are jointly liable only for their respective culpability percentages, preserving their rights of contribution among themselves. This structure aligns with statutory goals of accountability for wrongdoers and encourages settlement while preventing collusive agreements. Settling defendants pay voluntarily agreed amounts, and non-settling defendants are assured they will not pay more than their trial liability, which adheres to the equitable principle of contribution.

The approach discussed maintains the burden of proof, addressing Prudential-Bache's concerns that a good faith hearing under section 877.6 unduly shifts this burden to nonsettling defendants. While there may be "finger-pointing" at absent defendants, settling defendants are safeguarded by a bar order, ensuring that all parties remain motivated to argue their cases vigorously at trial. This method encourages settlements by allowing defendants to settle without facing penalties. The Second Circuit's assertion that this approach could violate the one satisfaction rule is disputed. The one satisfaction rule allows a plaintiff to receive only one total compensation for an injury, and it is argued that the plaintiffs do not receive double recovery through separate settlements and trial awards. The distinction is made that all defendants contribute, preventing any single defendant from bearing the entire damages. Moreover, the applicability of the one satisfaction rule in these scenarios is questioned since it is grounded in common law rather than statutory requirements, which are governed by contribution statutes. 

The district court's handling of the Rule 23 hearing, in line with California Code of Civil Procedure section 877.6, was found appropriate, though the resulting bar order was deemed insufficient. While it restricted nonsettling defendants from seeking further contributions from settling defendants, it did not adequately limit their liability exposure. The remand instructs the district court to adjust the order to reflect nonsettling defendants' actual liability percentages. Additionally, Prudential-Bache's reliance on contractual indemnity clauses was rejected as these clauses contradict the policy intentions of section 77k(f), affirming the district court's decision to invalidate them.

Compensation and contribution principles conflict with the objectives of full disclosure and settlement under securities laws. A proposed solution is a rule permitting only proportional liability when a contribution bar is established through a pretrial partial settlement, which would be integrated into federal common law due to Congressional silence. The parties involved will bear their own appeal costs, with the decision being partially affirmed and partially remanded.

Section 877 outlines that a good faith release or settlement among multiple tortfeasors does not discharge others from liability for contribution but does protect the settling party from contribution claims. Section 877.6 allows any party in a joint tortfeasor situation to request a court hearing on the good faith of a settlement. The court can determine good faith based on affidavits or additional evidence, and if determined in good faith, it bars further claims from other tortfeasors. The burden of proving lack of good faith lies with the party asserting it, and aggrieved parties can seek judicial review of the determination within a specified timeframe.

The settlement agreement includes a provision for a Good Faith Hearing, where the parties will jointly request the court to confirm that their settlement is made in good faith per California law. It will also extinguish all contribution or indemnification claims against the Settling Defendants related to the settled claims.

Historically, the Companies Act 1929 imposed liability solely on directors and preparers of the prospectus, while Section 11 of the Securities Act extends this liability to underwriters, mirroring the language of Section 11(f). Individuals liable for payments can seek contribution from others who would have been liable if joined in the original action.

15 U.S.C. 78i and 15 U.S.C. 78r address the principles of contribution among jointly liable parties, highlighting a distinction between general rules and exceptions regarding indemnity and contribution. Professor Reath critiques the longstanding interpretation of *Merryweather v. Nixan*, asserting it represents an exception rather than the general rule, which allows for contribution among joint tortfeasors, except in cases of willful wrongdoing. The discussion references the 1935 Law Reform (Married Women and Tortfeasors) Act in England, which abolished the contribution bar, and notes the varying sources of contribution rights across U.S. states.

The excerpt explains that in securities law, unlike civil rights actions, there is a statutory right to contribution, paralleling federal antitrust laws. However, due to the absence of specific federal legislation on this right, federal courts can create common law. Judicial policy considerations influence the choice between adopting state law or establishing a federal standard.

The Second Circuit's ruling in *Herzfeld v. Laventhol* is cited, indicating that a settling defendant who pays more than their fair share is no longer liable for contribution. The opinion asserts that proof of good faith for settlements will align with Rule 23 requirements, emphasizing that section 11(f) aims to ensure accountability among wrongdoers rather than focusing solely on their right to seek contribution.

Additionally, the excerpt outlines the dynamics of settlements, highlighting their benefits, including cost management, privacy, and resolution opportunities outside of court. It introduces a formula for determining relative culpability among parties involved in settlements, asserting that plaintiffs' voluntary settlements do not negate the overall goal of justice. Nonsettling defendants are not liable for costs or fees related solely to legal services for plaintiffs or settling defendants during these partial settlements.