Opinion ID: 692029
Heading Depth: 1
Heading Rank: 5

Heading: The Preclusive Effect of the Settlement of the Delaware Class Action

Text: Before addressing the Epstein plaintiffs' argument that the district court abused its discretion in denying their motion for class certification, we consider Matsushita's claim that the Epstein class action is barred by the judgment of the Delaware Court of Chancery settling the state class action. Although the Delaware class action was based exclusively on state law claims, the settlement agreement expressly stated that the federal securities law claims asserted in the Epstein action ... are hereby compromised, settled, released and discharged with prejudice.... In re MCA, Inc. Shareholder Litig., Order and Final Judgment (No. 11740) (Feb. 22, 1993), at 3-4, 1993 WL 43024, at  1. Matsushita makes a two-pronged preclusion argument. First, it argues that the Delaware judgment releasing the federal claims is entitled to preclusive effect as a matter of full faith and credit. Second, Matsushita argues that the release of the federal claims bars the Epstein action as a matter of contract. 22
The Delaware class action was filed on September 26, 1990, the day the financial press reported that Matsushita was negotiating to buy MCA. The suit named as defendants MCA and its directors, including Wasserman and Sheinberg. The essence of the complaint was that MCA's directors had breached their fiduciary duties by failing to implement a market check mechanism to maximize shareholder value upon a change of corporate control, as required by Revlon, Inc. v. MacAndrews & Forbes Holdings Inc., 506 A.2d 173, 182 (Del.1986). On December 2, 1990, three days after public disclosure of the terms of the tender offer, the Epstein class action was filed in the Central District of California. Unlike the state action, the Epstein complaint named Matsushita as a defendant and claimed that the tender offer violated SEC Rules 14d-10 and 10b-3. On December 4, 1990, the day after the Epstein action was filed in the Central District, lead counsel for the Delaware plaintiffs transmitted a letter to MCA's counsel that was to serve as the basis of an amended complaint. In that letter, the Delaware plaintiffs stated their intention to add additional claims against all directors. In particular, the complaint was amended to allege that MCA was wasting corporate assets by increasing its exposure to liability for violations of Rules 10b-13 and 14d-10, that directors Wasserman and Sheinberg had breached their fiduciary duties by negotiating preferential deals with Matsushita, and that MCA failed to make full disclosure of the benefits MCA insiders would receive from the takeover. Finally, Matsushita was added as a defendant and charged with conspiring with and aiding and abetting MCA directors in violating Delaware law. On December 11, 1990, a week after Delaware class counsel's letter proposing to amend the complaint and add Matsushita as a defendant, the defendants reported to the Central District that they had reached a settlement of the Delaware class action in principle. On December 14, the amended complaint was filed in the Court of Chancery, and on December 17, the parties agreed on the terms of a settlement to be submitted to the Vice Chancellor for approval. The settlement provided for the payment of $1,000,000 in fees to class counsel, but no monetary benefit for class members. The only arguable benefit to class members was a proposed change in the poison pill of the new corporation that was to be formed to own MCA's radio station if the tender offer succeeded. The Vice Chancellor found the value of this poison pill provision to class members to be illusionary. See In re MCA Shareholders Litig., Inc., 598 A.2d 687, 696 (1991). Finally, the settlement provided for the release of all claims arising out of the tender offer, both state and federal. In defending the settlement before the Vice Chancellor on January 30, 1991, class counsel argued that the state claims, while not frivolous, had little merit. Counsel also argued that the federal claims were frivolous and should not be pursued. On April 22, 1991, the Vice Chancellor disapproved the proposed settlement. He agreed with class counsel that the state law claims being compromised were at best, extremely weak and, therefore, have little or no value. In re MCA, Inc. Shareholders Litig., 598 A.2d at 694. In particular, he found the state claim of preferential treatment for Wasserman and other directors to be weak because no such state cause of action existed. Id. Under Delaware law, the Vice Chancellor noted, [a] shareholder is not prohibited, by his status as a director, from dealing in shares of the corporation, and that a director breaches his duty of loyalty only if he uses inside information for his personal benefit. Id. Finding that the value of the settlement to the class lacked any real monetary benefit, the Vice Chancellor rejected the settlement because of the significant value of the federal claims that would have been released along with the valueless state claims. Id. at 696, 690. Despite the Vice Chancellor's opinion that the state claims had no merit and no value, Matsushita and its co-defendants took no action to dismiss the Delaware action. In fact, the docket of the Court of Chancery reflects no action of any kind--no discovery, no motions, no settlement or status conferences--until after the Central District awarded summary judgment to the defendants in the federal actions in February, 1992, more than a year after the Vice Chancellor disapproved the original Delaware settlement. On October 22, 1992, after the federal plaintiffs filed their notices of appeal of the summary judgment to the Ninth Circuit, the parties to the Delaware action entered into a new settlement agreement. It provided for the creation of a $2 million settlement fund, enough to pay shareholders two to three cents per share before payment of fees and costs. 23 Like the first settlement agreement, the second agreement provided for the release of all claims arising out of Matsushita's acquisition of MCA, both state and federal. Unlike the first agreement, the second settlement agreement permitted class members to opt out. 24 The Vice Chancellor approved the second settlement agreement, concluding that it is in the best interests of the class to settle this litigation and the terms of the settlement are fair and reasonable--although the value of the benefit to the class is meager. In re MCA, Inc. Shareholders Litig., 1993 WL 43024, at  1 (Del.Ch. Feb. 16, 1993). He approved the second settlement for the sole reason that the federal claims which he originally thought had significant value, had been reduced to minimal economic value by the summary judgment entered in the Central District. The Vice Chancellor uncritically accepted the summary judgment as having destroyed the value of the federal claims without considering the fact that the Ninth Circuit reviews summary judgments de novo. See T.W. Elec. Serv., Inc. v. Pacific Elec. Contractors Ass'n, 809 F.2d 626, 629 (9th Cir.1987). The Vice Chancellor downgraded the value of the federal claims even as he expressed reluctance to assess the merits of those claims because they were outside the jurisdiction of this Court. Id., 1993 WL 43024 at  4. Objectors argued that the settlement was collusive because the defendants cut a deal with the named plaintiffs in the Delaware action and their attorneys in order to extinguish the claims pending in the federal litigation. In re MCA, Inc. Shareholders Litig., WL 43024, at  5. The Vice Chancellor acknowledged that the potential for this type of abuse clearly exists in representative litigation, and that suspicions abound when the settling parties have previously proposed a patently inadequate settlement in which the class would have received no monetary benefit but the attorneys would have received $1 million in fees. Id.at  4. Nonetheless, he refused to make a finding of collusion on the record before him because objectors offered no evidence of any collusion. Id. at  5. The judgment incorporating the terms of the settlement was summarily affirmed by the Delaware Supreme Court. In re MCA, Inc. Shareholders Litig., 633 A.2d 370 (Del.1993).
1. The Jurisdiction of State Courts to Release Exclusively Federal Claims in a Class Settlement Matsushita first argues that the Epstein action is precluded because the Delaware judgment releasing the federal claims is entitled to full faith and credit. As a general rule, the Full Faith and Credit Act, 28 U.S.C. Sec. 1738, requires federal courts to give the same preclusive effect to state court judgments that those judgments would be given in the courts of the State from which the judgments emerged. Kremer v. Chemical Constr. Corp., 456 U.S. 461, 466, 102 S.Ct. 1883, 1889, 72 L.Ed.2d 262 (1982). This rule does not apply, however, if the state court did not have jurisdiction over the subject matter or the relevant parties. Underwriters Nat'l Assurance Co. v. North Carolina Life and Accidental Health Insurance Gty. Ass'n, 455 U.S. 691, 704-05, 102 S.Ct. 1357, 1365-66, 71 L.Ed.2d 558 (1982). See also Thomas v. Washington Gas Light Co., 448 U.S. 261, 283, 100 S.Ct. 2647, 2661-62, 65 L.Ed.2d 757 (1980); Durfee v. Duke, 375 U.S. 106, 110, 84 S.Ct. 242, 244-45, 11 L.Ed.2d 186 (1963); Grubb v. Public Util. Comm'n, 281 U.S. 470, 475, 50 S.Ct. 374, 376-77, 74 L.Ed. 972 (1930); Thompson v. Whitman, 85 U.S. (18 Wall) 457, 469, 21 L.Ed. 897 (1873). 25 The Epstein plaintiffs argue that the Delaware class settlement is not entitled to full faith and credit to the extent it released federal claims which are beyond the subject matter jurisdiction of state courts. Matsushita responds that courts have uniformly held that a state court class action settlement properly may preclude, by release, continued litigation by members of the class of all claims--state or federal, whether or not within the exclusive jurisdiction of the federal courts--arising out of the same subject matter or transaction. Supplemental Brief of Matsushita at 13. In other words, Matsushita reads existing case law as sanctioning the release of exclusively federal claims in the settlement of state class actions as long as the state and federal claims arise out of the same subject matter or transaction. We believe Matsushita's argument represents an overly expansive reading of the case law. As we read the cases, they support only a limited state court power to release exclusively federal claims in a class action settlement. Of all the cases cited by Matsushita, only two, Grimes v. Vitalink Communications Corp., 17 F.3d 1553 (3d Cir.), cert. denied, --- U.S. ----, 115 S.Ct. 480, 130 L.Ed.2d 393 (1994) and Nottingham Partners v. Trans-Lux Corp., 925 F.2d 29 (1st Cir.1991), implicate the Supremacy Clause because in each, as here, a state court extinguished exclusively federal claims in settling a state class action. 26 In every other case cited by Matsushita, the state court had subject matter jurisdiction to adjudicate all the claims that were released in the class settlement. Class Plaintiffs v. City of Seattle, 955 F.2d 1268, 1287-89 (9th Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 408, 121 L.Ed.2d 333 (1992), for example, did not present the question of the preemptive effect of an exclusive federal jurisdiction statute on the power of a state court to release exclusively federal claims in settling a class action. Rather it involved the settlement of a federal class action based upon alleged violations of the federal securities laws. Our holding in Class Plaintiffs was that the Eleventh Amendment did not bar a federal district court from releasing claims against the State of Washington as part of a class settlement because the State had waived its sovereign immunity by participating in the settlement negotiations and consenting to be bound by the settlement agreement. Id. at 1289. For the same reason, In re Corrugated Container Antitrust Litig., 643 F.2d 195, 196 (5th Cir.1981), did not implicate the Supremacy Clause because the jurisdictional competence of a state court to release exclusively federal claims was not at issue. The holding of the Fifth Circuit was that a federal district court, in approving a class settlement of federal claims, had jurisdictional competence to extinguish state claims that were not pleaded, but which it had pendent jurisdiction to adjudicate. 643 F.2d at 221 n. 39. TBK Partners, Ltd. v. Western Union Corp., 675 F.2d 456 (2d Cir.1982), was also not a Supremacy Clause case because it too involved the approval of a class action settlement by a federal district court. In TBK Partners, the Second Circuit upheld a class settlement that extinguished state claims that were not pleaded and arguably beyond the jurisdiction of the district court to adjudicate. Id. at 460. Although not directly on point because it was not a preemption case--it did not involve the release of exclusively federal claims by a state court--TBK Partners is useful authority because it announced a principled test for limiting the preclusive effect of a judgment based upon a class settlement. Writing for the court, Chief Judge Newman reasoned, we see no reason why the judgment upon settlement cannot bar a claim that would have to be based on the identical factual predicate as that underlying the claims in the settled class action. We have previously assume[d] that a settlement could properly be framed so as to prevent class members from subsequently asserting claims relying on a legal theory different from that relied upon in the class action complaint but depending on the very same set of facts. National Super Spuds, Inc. v. New York Mercantile Exchange, 660 F.2d 9, 18 n. 7 (2d Cir.1981). Id. at 460 (emphasis added). Thus the Second Circuit gave preclusive effect to the settlement judgment's release of unpleaded state claims because the same facts were at the core of both the unpleaded state and the pleaded federal claims. Id. Had the judgment been based upon an adjudication rather than a settlement of the federal claims, the unpleaded state law claims would have been barred by the doctrine of issue preclusion because they turned on the very same set of facts. In applying an issue preclusion test to limit the preclusive effect of a judgment approving a class settlement, TBK Partners followed Judge Friendly's reasoning in National Super Spuds:  '[i]f a judgment after trial cannot extinguish claims not asserted in the class action complaint, a judgment approving a settlement in such an action ordinarily should not be able to do so either.'  Id. at 462 (quoting National Super Spuds, Inc. v. New York Mercantile Exchange, 660 F.2d at 18). Thus, in TBK Partners, the Second Circuit upheld the release of unpleaded claims in a settlement judgment which would have been barred by the issue preclusive effect of a judgment based upon an adjudication of the pleaded claims. As we read TBK Partners, Matsushita's reliance on it as dispositive authority for its argument that we should give preclusive effect to the Delaware settlement judgment merely because the state and federal claims arise out of the same transaction is completely misplaced. First, TBK Partners is not a Supremacy Clause case. Second, TBK Partners announced and applied an issue preclusion test, not an arising out of the same transaction test, in defining the limits on a court's power to release claims in a class settlement. As the Second Circuit summed up in TBK Partners: [w]e therefore conclude that in order to achieve a comprehensive settlement that would prevent relitigation of settled questions at the core of a class action, a court may permit the release of a claim based on the identical factual predicate as that underlying the claims in the settled class action even though the claim was not presented and might not have been presentable in the class action. Id. at 460 (emphasis added). We now turn to the only two cases cited by Matsushita that involved the preclusive effect of a state court judgment approving a class action settlement that included a release of exclusively federal claims. In both cases TBK's issue preclusion test was applied; in neither case was Matsushita's arising out of the same transaction test applied. In Nottingham Partners v. Trans-Lux Corp., 925 F.2d at 29, the First Circuit, citing TBK Partners, applied an issue preclusion test in holding that the release of exclusively federal claims in a state court settlement judgment was entitled to preclusive effect. Tracking the reasoning of both TBK Partners and National Super Spuds, the First Circuit's rationale was that the federal claims depended on the same underlying facts as the state claims--the failure of a corporation to disclose allegedly material facts in a proxy statement. Id. at 30-31, 33. In Grimes v. Vitalink Communications Corp., 17 F.3d at 1553, the Third Circuit followed the First Circuit's lead in Nottingham Partners in applying TBK Partners' issue preclusion test. The district court, citing TBK Partners and Nottingham Partners, had held that this federal securities case is barred by the collateral estoppel effect of the Delaware judgment [releasing those claims as part of a class settlement].... Id. at 1556. The Third Circuit affirmed because the facts that underlie the federal non-disclosure claims were actually litigated during the state court proceeding and were conclusively resolved against the objectors, here the federal plaintiffs. Id. at 1562. Thus, the cases cited by Matsushita fail to support its contention that we should give preclusive effect to the Delaware settlement judgment because the federal claims it released arose out of the same transaction as the state claims. Instead, these cases stand for a more restrictive limitation on the power of state courts to extinguish exclusively federal claims in approving class action settlements: a state court may release exclusively federal claims that would have been extinguished by the issue preclusive effect of an adjudication of the state claims. National Super Spuds and TBK Partners together provide the doctrinal framework for using issue preclusion in determining the limits of judicial authority to release unpleaded claims in settling class actions. But though neither National Super Spuds nor TBK Partners involved the preemptive effect of an exclusive federal jurisdiction statute on the reach of state judicial power in settling class actions, both involved the release of unpleaded state claims by federal district courts which had or may have had pendent jurisdiction to adjudicate the claims. Nonetheless, in both cases the Second Circuit recognized the importance of limiting judicial authority generally to release unpleaded claims in class settlements. Nottingham Partners and Grimes, in contrast, did implicate the Supremacy Clause because, as in the instant case, exclusively federal securities claims were extinguished by a state court judgment approving a class settlement. In both cases, the judgment was given preclusive effect because the state and federal claims arose out of the identical factual predicate. In other words, had the judgment followed an adjudication rather than a settlement, it would necessarily have resolved the federal claims as a matter of issue preclusion. In deciding the preclusive effect of the Delaware judgment at issue in this case, we need not decide whether to follow Nottingham Partners and Grimes in giving preclusive effect to a class action settlement that releases exclusively federal claims that turn on the same underlying facts as the state claims. All we need decide today is whether to break new ground in giving preclusive effect to a state court judgment that extinguishes exclusively federal claims that are factually unrelated to the state claims pleaded in the class action. 27 The question of first impression confronting us is whether Congress, in denying state courts subject matter jurisdiction over 1934 Act claims, intended to leave state courts with the power to extinguish exclusively federal claims by approving a class action settlement that could not have been extinguished by adjudicating the class action. We can imagine no reason for imputing such an intent to Congress. We recognize that Congress could reasonably have been concerned about accommodating the interests of state courts in achiev[ing] a comprehensive settlement that would prevent relitigation of settled questions at the core of a class action, TBK Partners, 675 F.2d at 462, but that concern would not be served by authorizing state courts to settle questions not at the core of a class action. The very cases Matsushita relies upon counsel against an expansive state court power to release exclusively federal claims. In applying an issue preclusion test rather than a same transaction test, the cases embrace Judge Friendly's common sense reasoning that a court's jurisdiction to extinguish claims by class settlement should not exceed its jurisdiction to extinguish claims by adjudication. Ignoring this reasoning, Matsushita asks us to impose a same transaction test without offering logic or precedent in support of such a test. 28 As we shall now show, the federal claims extinguished by the Delaware judgment could not have been extinguished by the issue preclusive effect of an adjudication of the state claims because, although the federal and state claims arose out of the same transaction, they are based upon different underlying facts. 2. The Disparity Between the State and Federal Claims Matsushita makes no attempt to argue that any of the Williams Act claims of the Epstein plaintiffs share any predicate facts in common with the state law claims that formed the basis of the Delaware class action. Instead, Matsushita rests its preclusion argument solely on the fact that the claims arose out of the same transaction--Matsushita's acquisition of MCA. The gravamen of the federal class action is that Matsushita violated SEC Rules 14d-10 and 10b-13 by offering greater value for the stock of Wasserman and Sheinberg than it offered for the stock of other shareholders. 29 Thus the legal theory underlying the federal claims is that Matsushita breached a duty to shareholders that is imposed on tender offerors by federal securities laws. The relevant factual inquiry is whether Wasserman and Sheinberg received greater consideration than other MCA shareholders during the tender offer, section 14d-10(a)(2), or a type of consideration not offered to other MCA shareholders. Sec. 14d-10(c)(1). The gravamen of the state class action is that MCA directors breached their fiduciary duty of care to MCA as imposed by Delaware law. First, the Delaware plaintiffs claimed that MCA's directors breached their fiduciary duty by failing to take steps to maximize shareholder value upon a change of corporate control as required by Revlon, Inc. v. MacAndrews & Forbes Holdings, 506 A.2d at 182. Plainly, this Revlon claim turns on different fact issues than the federal securities claims do. The question whether the MCA directors took the steps required by Revlon to assure maximum shareholder value is completely distinct from the question whether Matsushita violated the Williams Act by extending preferential treatment to some of the shareholders in making the tender offer. The second state claim was that MCA's directors breached their duty of candor by failing to disclose to the shareholders information concerning the merger such as the compensation packages MCA officers received under the terms of the merger agreement. But whether or not the MCA directors breached their fiduciary duty by failing to make disclosures has no bearing on whether directors received preferential treatment from Matsushita in violation of the Williams Act. 30 The third state claim was that the defendants breached their fiduciary duty of loyalty by making preferential arrangements for themselves as part of the tender offer, and that Matsushita aided and abetted the MCA defendants in this breach. At first glance, this claim appears to be at least in the same ball park as the Rule 14d-10 claim. However, although this state claim is no doubt artfully drafted to resemble the 14d-10 claim, there is in fact no Delaware statutory or common law rule that prohibits a shareholder from obtaining the best deal for himself as part of a change of corporate control. 31 Thus, adjudication of the claim would not have raised a question of fact whether Wasserman or Sheinberg received preferential treatment from Matsushita. In sum, the state and federal claims are completely disparate. The only thing they share in common is that they arise out of the same transaction, which is the sole nexus Matsushita relies upon in arguing that the Delaware judgment's release of the federal claims is entitled to full faith and credit. Since the Delaware class action settlement judgment in this case attempted to extinguish exclusively federal claims which it could not have extinguished through adjudication, we hold that the decree exceeds the jurisdiction of the state court and, therefore, is not entitled to full faith and credit.
Matsushita argues that regardless of the technical res judicata effect of the Delaware judgment, the Epstein plaintiffs are barred from litigating their Williams Act claims in federal court as a matter of contract. As Matsushita puts it, just as an individual plaintiff may, as a part of a settlement in state court, agree to release exclusively federal claims, so, too, may a class give such a release as part of a judicially approved class settlement. Brief of Matsushita at 20. This attempt to equate class settlements with the settlement of traditional litigation by individual parties falls short. Matsushita is correct, of course, that individual plaintiffs may release whatever claims they choose in settling traditional non-class litigation, whether or not related to the claims asserted in the pleadings. Because court approval of ordinary settlements is not required, the amount and form of consideration a party is willing to give or receive to settle a case is a matter of judicial indifference. Whether the forum court has jurisdiction over the claims a party chooses to release in settling traditional litigation is irrelevant. See Green v. Ancora-Citronelle Corp., 577 F.2d 1380, 1383 (9th Cir.1978) (an individual litigant who releases exclusively federal claims as part of a settlement of a state action may not relitigate them in federal court). Indeed, general releases are commonly exchanged between individual litigants in settlements. However, the settlement of a class action is fundamentally different from the settlement of traditional litigation. 32 First, Matsushita is simply wrong to assert that a class may give a release as part of a settlement. A class is not an entity that has rights; the rights belong to the class members. But class members, unlike individual litigants in traditional lawsuits, are bound by the settlement even though they do not individually consent to its terms. Instead, consent is given by class representatives, who derive authority to represent members not by obtaining their consent, but by obtaining a court order designating them the representatives. Second, class members may only give a release as part of a judicially approved settlement. Class representatives lack the power to give a release of the class rights on their own, absent judicial approval of the release and entry of a judgment. National Super Spuds, 660 F.2d at 18 (quoting Haudek, The Settlement and Dismissal of Stockholders' Action--Part II: The Settlement, 23 Sw.L.J. 765, 773 (1969)). Because class actions do not require the active participation of class members, class settlements pose a danger not present in traditional litigation: that representative plaintiffs and their lawyers will endeavor to obtain a better settlement by sacrificing the claims of others at no cost to themselves. Id. at 19. For this reason, a court may not delegate to [class] counsel the performance of its [own] duty to protect the interests of absent class members. Plummer v. Chemical Bank, 668 F.2d 654, 659 n. 4 (2d Cir.1982). Instead, in order to protect the rights of absent class members, the court must assume a far more active role than it typically plays in traditional litigation. A class action, thus, is less an individual lawsuit than a quasi-administrative proceeding, conducted by the judge. Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 809, 105 S.Ct. 2965, 2973, 86 L.Ed.2d 628 (1985). This notwithstanding, Matsushita argues that the failure of the Epstein plaintiffs to opt out of the class is sufficient reason to bind them contractually to the release of their federal claims. In Matsushita's view, the opportunity to opt out changes the essence of a class action settlement from an exercise of judicial power restrained by jurisdictional limits into an exercise of individual consent. This argument fails for two reasons. First, that the class members have a right to opt out does not diminish the extent to which a class action settlement is an exercise of judicial power. Regardless of whether class members are given opt-out rights, the court is still required to ensure that representation is adequate and that the settlement is fair to class members. See, e.g., Prezant v. Salton/Maxim Housewares, Inc., 636 A.2d 915 (Del.1994). The settlement of the class action is not an act of judicial mediation; it is an act of judicial power. Second, the consent purportedly given by class members in deciding not to opt out is hardly comparable to the consent given by individual plaintiffs in deciding to settle their own traditional lawsuits. Because opt-out rights are, as the Delaware Supreme Court has observed, infrequently utilized and usually economically impracticable, Prezant, 636 A.2d at 924, we would be blind to reality to think that any consent implied by class members in deciding not to opt out is comparable to the consent given by individual plaintiffs in settling their own lawsuits. In sum, we reject Matsushita's effort to equate class settlements with settlements of individual lawsuits. We believe that a state court cannot require passive class members to contractually release their exclusively federal claims in order to enjoy the benefits of a state class action, when the court has no jurisdictional power to dispose of those claims either directly or indirectly through the doctrine of issue preclusion. 33
We respectfully decline to give full faith and credit to the Delaware judgment to the extent that it releases exclusively federal claims that depend upon different underlying facts than the state claims depend upon. 34 Accordingly, we hold that the Delaware judgment does not preclude the Epstein class action.