Opinion ID: 3039127
Heading Depth: 3
Heading Rank: 2

Heading: Whether counts I and II are brought in the

Text: form of a “covered class action” SLUSA prevents would-be plaintiffs from bringing certain claims in the form of a “covered class action.” Under SLUSA, a covered class action is any single lawsuit in which damages are sought on behalf of more than 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, without reference to issues of individualized reliance on an alleged misstatement or omission, predominate over any questions affecting only individual persons or members. 15 U.S.C. § 78bb(f)(5)(B)(i). The statute further provides that, for purposes of this definition, “a corporation, investment company, pension plan, partnership, or other entity, shall be treated as one person or prospective class member, but only if the entity is not established for the purpose of participating in the action.” 15 U.S.C. § 78bb(f)(5)(D). This means that the court is to follow the usual rule of not looking through an entity to its constituents unless the entity was established for the purpose of 15 In its opposition to the Banks’ motion to dismiss, the Trust made essentially the same argument it makes here: that counts I and II are corporate claims, originally owned by AremisSoft, and assigned to the Trust by the AremisSoft bankruptcy estate. App. 482–85. 14 bringing the action, i.e., to circumvent SLUSA. The District Court concluded that counts I and II were brought “on behalf of” the 6000 beneficiaries of the Trust, and thus as “covered class actions.” D. Ct. Op. at 12 (app. 14). In arriving at this conclusion, the District Court ruled that the Trust should not be counted as a single entity under § 78bb(f)(5)(D) because it was established for the primary purpose of litigating shareholder claims. Accordingly, the District Court dismissed counts I and II. To evaluate the District Court’s ruling, it is first necessary to recall the nature and ownership of these claims. As explained above, counts I and II plead claims that at one time belonged to AremisSoft, the entity allegedly injured by its Directors’ breaches of duty and the Banks’ aiding those breaches. In bankruptcy, the claims passed to AremisSoft’s bankruptcy estate, 11 U.S.C. § 541(a)(1) & Note (explaining that the debtor’s interest in legal claims passes to its bankruptcy estate), but the debtor-in-possession did not assert them during the pendency of the bankruptcy. Rather, the bankruptcy estate assigned them to the Trust, a state-law entity created in large part to pursue these and similar claims for the ultimate benefit of the Purchasers, the only group whose interests were impaired by the plan of reorganization.16 Thus, the Trust can only bring these claims as assignee of the bankruptcy estate. At first glance, one might think that the claims are 16 Though the parties do not go into detail on this point, one would assume that this deal was struck so that the Purchasers would vote to approve the plan of reorganization, even though their interests were impaired. See 11 U.S.C. § 1126 (providing that impaired claim and interest holders are entitled to vote on plan approval). For a plan to be approved, either (1) each impaired class must accept the plan, or (2) the bankruptcy court must approve the plan as “fair and equitable” despite a class’s disapproval. 11 U.S.C. § 1129(b). To avoid having to obtain the court’s consent to an unapproved plan (known as a “cramdown”), parties to a bankruptcy often work hard to negotiate a plan that all impaired classes will accept. 15 brought “on behalf of” the Purchasers, as they, through the Trust, are the current beneficial owners of the claims.17 But examining the whole of the covered-class-action definition is instructive. The definition is two-pronged: to be a covered class action, (1) the claim must be brought “on behalf of 50 or more persons,” and (2) questions of law or fact common to “those persons” must predominate. 15 U.S.C. § 78bb(f)(5)(B)(i) (emphasis added). If we read “on behalf of 50 or more persons” as referring to the Purchasers, the second prong of the definition would lack any pertinence, because the Purchasers, for purposes of counts I and II, are merely the beneficial owners of the claims.18 There are no questions of law or fact that involve them, much less common ones that predominate over individual ones. Rather, the relevant issues are (1) whether the Directors were fiduciaries of AremisSoft, (2) whether the Directors made misrepresentations or traded on inside information in violation of their fiduciary duties, (3) whether the Banks provided material assistance with the requisite knowledge to be liable for aiding and abetting, and (4) whether AremisSoft was damaged by the concerted actions of the Directors and Banks.19 Gotham Partners, 817 A.2d at 172 (setting out elements of aiding and abetting a breach of fiduciary duty). Neither these elements nor 17 Because common-law trustees carry out all of their duties in the sole interest of the trust’s beneficiaries, see Restatement (Third) of Trusts § 78 (2007) (describing the sole-interest rule), they can be said to act on those beneficiaries’ behalf. 18 AremisSoft’s bankruptcy estate assigned the claims to the Trust. Thus, legal title to the claims rests in the Trust; beneficial title rests in the Purchasers (as beneficiaries of the Trust). 19 Delaware courts view aiding-and-abetting-a-breach-offiduciary-duty as a form of civil conspiracy. Allied Capital Corp. v. GC-Sun Holdings, LP, 910 A.2d 1020, 1038 (Del. Ch. 2006) (Strine, V.C.). The proper remedy generally is to hold the abettor jointly and severally liable for whatever remedies are appropriate to make good on the fiduciary’s breach. See Gotham Partners, 817 A.2d at 173 (affirming Chancellor’s decision to hold abettors jointly and severally liable for damages caused by breach of fiduciary duty). 16 the facts underlying them have anything to do with the Purchasers. The Purchasers need not prove anything regarding themselves in order to succeed; indeed, they need not even prove that they were injured, as they are not proceeding as injured parties, but as persons to whom beneficial ownership of the claims was assigned by the true injured party, AremisSoft.20 Prong two of § 78bb(f)(5)(B)(i), then, seems to use the terms “persons” and “members of the prospective class” to refer to the original owners of the claim—those injured by the complained-of conduct, as those are the persons who might have common questions of law or fact related to the claim that predominate over individual questions of law or fact. Reading prong one in light of prong two, the phrase “on behalf of 50 or more persons” seems to refer to someone bringing a claim on behalf of 50 or more injured persons. In other words, the phrase refers to the assignors of a claim, not to the assignee (or, if the assignee is a trust, to its beneficiaries). Under this reading, the Trust is not bringing its claims “on behalf of” the Purchasers, as SLUSA uses the term, because the Purchasers are not the injured parties; rather, the Trust is bringing the claims “on behalf of” AremisSoft. Section 78bb(f)(5)(D) buttresses this interpretation by clarifying that corporations are not to be counted as more than one person unless established for the purpose of litigation. In other words, when a corporation decides to bring a state-law 20 In contrast, were the Purchasers bringing a § 10b-5 securities claim, four of the six elements of that claim would involve them directly. The first two elements—a material misrepresentation and scienter—would involve only the Directors. But the Purchasers would also have to prove (1) a connection between the misrepresentation and their purchase or sale of securities, (2) that the misrepresentation was a but-for cause of their purchases (“transaction causation”), (3) their economic loss, and (4) a connection between the misrepresentation and their loss (“loss causation”). McCabe v. Ernst & Young, LLP, 494 F.3d 418, 424-25 (3d Cir. 2007) (citing Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341–42 (2005)); see also Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. ___, 128 S.Ct. 761, 768 (2008). 17 claim—even one alleging misrepresentations in connection with securities trades—SLUSA does not instruct the court to look through the corporation to its shareholders to determine the number of “persons;” instead, the corporation, in keeping with well-entrenched common-law principles, is counted as the one juridical person that it is. Cf. In re Owens-Corning, 419 F.3d 195, 211 (3d Cir. 2005) (noting that “courts respect entity separateness absent compelling circumstances”). SLUSA’s single exception to this rule is that when the corporation is established for the purpose of litigation, i.e., when plaintiffs try to avoid SLUSA by running their securities claims through a corporate entity, the court should look to the corporation’s constituents. Here, no one argues that AremisSoft, the original owner of counts I and II, was established for the purpose of this (or any other) litigation. Moreover, even if the Trust can be deemed to have been established for the purpose of litigation, a question we need not address, looking through it would only get the court to AremisSoft, the injured party, not to the Purchasers. Section 78bb(f)(5)(C) also supports this reading. It provides that exclusively derivative actions are not covered class actions for SLUSA purposes. Although, as the Banks note, the claims at issue here are not asserted derivatively, § 78bb(f)(5)(C) operates to preserve causes of action that belong to corporations, even if 50 or more shareholders bring such actions derivatively. What we take from reading § 78bb(f)(5)(C) and (D) together is that Congress did not intend SLUSA to reach any corporateoriginated claims, whether asserted by the corporation (or its assignee), as is addressed in § 78bb(f)(5)(D), or asserted derivatively by shareholders, as is addressed in § 78bb(f)(5)(C).21 21 The derivative-litigation exception to SLUSA preemption is commonly referred to as one of two “Delaware carve-outs.” Malone, 722 A.2d at 13. According to the Senate committee, the purpose of this carve-out was to ensure that shareholders would be able to bring derivative litigation based on corporate fiduciaries’ breaches of duty. S. Rep. No. 105-182, at  (1998). It is referred to as a “Delaware” carve-out because most such litigation occurs in Delaware before the Chancery Court. A key point to remember is that it would make little sense 18 Further supporting this reading is Congress’s clear intent not to reach claims asserted by a bankruptcy trustee on behalf of a bankruptcy estate. That Congress so intended is relevant here because counts I and II were claims that the debtor-in-possession once owned and chose to assign to the Trust (under the assumption that the Trust would be able to bring the claims as the debtor-in-possession’s assignee). Congress’s intent on this point is clear from the legislative history, in which the Senate Banking, Housing, and Urban Affairs Committee reported that, in the final version of the bill, [t]he class action definition has been changed from the original text of S. 1260 to ensure that the legislation does not cover instances in which a person or entity is duly authorized by law, other than a provision of state or federal law governing class action procedures, to seek for Congress to preserve derivative actions but preempt corporate direct actions, as doing so would turn our conception of derivative litigation on its head. Shareholder derivative litigation is a failsafe, a means of allowing corporate claims to go forward when the corporation’s board wrongfully refuses to prosecute them. See Grimes v. Donald, 673 A.2d 1207, 1216 (Del. 1996) (explaining that derivative litigation may only proceed when the board wrongfully refuses to pursue the action). It is a limited exception to the rule that corporations, like natural persons, have the unfettered discretion to decide whether to take legal action when they are wronged. See Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984) (“The bedrock of the General Corporation Law of the State of Delaware is the rule that the business and affairs of a corporation are managed by and under the direction of its board. . . . [B]ecause the derivative action impinges on the managerial freedom of directors, the law imposes certain prerequisites to the exercise of this remedy.”). Derivative litigation is premised on the notion that the corporation could bring the proffered action on its own behalf. See Grimes, 673 A.2d at 1216 (explaining that if the corporation deems proposed derivative litigation beneficial, it can take over and control the litigation). If this premise were not true, the moniker “derivative” would be inappropriate, as the shareholder litigation would not be derived from any cause of action the corporation possessed. 19 damages on behalf of another person or entity. Thus, a trustee in bankruptcy, a guardian, a receiver, and other persons or entities duly authorized by law (other than by a provision of state or federal law governing class action procedures) to seek damages on behalf of another person or entity would not be covered by this provision. S. Rep. No. 105–182, at 8 (May 4, 1998) (emphasis added). The original text of the bill would have brought within the definition of class action any action in which “one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated,” or “one or more of the parties seeking to recover damages did not personally authorize the filing of the lawsuit.” S. 1260, 105th Cong. § 2 (as introduced in the Senate, Oct. 7, 1997). Whether either of these provisions would have been read to cover a bankruptcy trustee is unclear; what is clear is that Congress sought to ensure that no provision of the bill as enacted would do so. In addition, the caselaw supports the notion that when a trustee brings a claim belonging to the bankruptcy estate, the claim is not a covered class action for SLUSA purposes. Smith v. Arthur Andersen, LLP, 421 F.3d 989, 1007–08 (9th Cir. 2005). Here, as the Trust is merely the assignee of the AremisSoft bankruptcy estate, it should be treated the same way. Giving effect to Congress’s desire not to preempt claims that pass from a debtor corporation to its bankruptcy estate is important because to do otherwise would work a significant change in the bankruptcy system that Congress created and, according to the legislative history cited above, intended to leave undisturbed. As this case demonstrates, legal claims can be some of the most important and valuable assets that a bankruptcy estate has, particularly as respects a debtor’s unsecured creditors and equity holders, since liquidating such claims may be their only chance at significant recovery. Chapter 11 is often described as a process that brings all interested parties to the bargaining table and encourages them, against the background of insolvency law, to work out a plan of reorganization with which 20 they all can live.22 For this process to work, the parties must be able to gather, assess, and freely alienate and distribute the estate’s assets. Under the Banks’ argument, SLUSA preemption would prevent the estate from assigning certain legal claims to any class of creditors or equity holders containing more than 50 persons, but it would allow assignment to classes with fewer constituents. This result would make little sense, as we see no indication that Congress’s aim in fashioning the “covered class action” definition was to control the number of constituents to whom a bankruptcy estate’s claim is assigned. Rather, the statutory text and legislative history signal that the definition was designed to prevent securities-claims owners from bringing what are, in effect, class actions by assigning claims to a single entity. See Golub v. Hill, Rogal & Hobbs Co., 379 F. Supp. 2d 639, 643 (D. Del. 2005) (ruling that more than 50 persons could not circumvent SLUSA by assigning their claims to a trust). Put simply, Congress’s goal was to prevent a class of securities plaintiffs from running their claims through a single entity, not to prevent a single bankruptcy estate from assigning its claims to an entity capable of acting to protect the common interests of a class of people. Moreover, it is difficult to see what purpose would be served by holding otherwise. If we held that the key issue is to whom a claim is assigned, then we would likely see two results. First, we might see parties to bankruptcies engage in some rather creative class construction to keep numbers below 51. Parties’ ability to do this would not turn on any factor related to preventing frivolous securities litigation, but on the creativity of the parties’ lawyers and the particulars of a debtor’s pre-petition liabilities. Second, in many bankruptcies, treating unliquidated legal claims as distributable assets would become infeasible. Rather than assigning unliquidated claims to large classes of 22 See, e.g., A. Mechele Dickerson, The Many Faces of Chapter 11: A Reply to Professor Baird, 12 Am. Bankr. Inst. L. Rev. 109, 113, 125 (2004); Select Advisory Comm. on Bus. Reorganization, First Report of the Select Advisory Comm. on Bus. Reorganization, 57 Bus. Law. 163, 197 & n.58 (2001); Richard F. Broude, Cramdown & Chapter 11 of the Bankruptcy Code: The Settlement Imperative, 39 Bus. Law. 441, 454 (1984). 21 creditors, the debtor-in-possession would have to initiate a lawsuit, prosecute any claims to their conclusion, and then distribute the proceeds to the estate’s creditors and interest holders. We fail to see what salutary effect this would have on deterring frivolous securities litigation; the only likely result would appear to be a marked increase in the difficulties attendant on reorganizing Chapter 11 debtors in a timely fashion, a consequence we see no indication Congress intended. The Banks present the curious argument that recognizing that the claims at issue here are corporate in nature does the Trust no good, because the claims are still brought on behalf of the 6000 Purchasers. If the claims are also brought on behalf of AremisSoft, then, according to the Banks, that brings the grand total of persons on whose behalf the claims are brought to 6001. This argument, which neither brief explains in more than two sentences, see Bordier Br. at 44, Dominick Br. at 54, seems to misapprehend that the corporate claims are not asserted on behalf of the corporation and Purchasers (thus, 6001 persons), but on behalf of the corporation alone. The Banks further note that all damages will go to the Purchasers. This, however, is irrelevant because the Purchasers would not recover in their capacities as individual purchasers of securities, but in their capacities as beneficial owners of the claims assigned to the Trust by the AremisSoft bankruptcy estate. In sum, we conclude that a corporation’s claims do not take the form of a “covered class action,” irrespective of whether the claims are asserted by the corporation directly, its shareholders derivatively, its bankruptcy estate, its bankruptcy estate’s assignee, or its successor. This conclusion accords with the text of § 78(f) and with Congress’s intent, as reflected in the legislative history, not to preempt corporate claims, and to leave the bankruptcy process undisturbed.