Appeal from the United States District Court for the Eastern District of Pennsylvania (D.C. M.D.L. No. 134).
Aldisert, Gibbons and Garth, Circuit Judges. Garth, Circuit Judge.
Appellant Irving Trust Company (Irving) is a trustee under two trust indentures executed by the predecessors of Penn Central Transportation Company (Penn Central) in anticipation of the public sale of their bonds. Pursuant to the terms of these indentures Penn Central pledged with and delivered to Irving as security a total of 116,698 shares of its stock in The Pittsburgh and Lake Erie Railroad Company (P&LE).*fn1 Irving, as pledgee of 22.5% of P&LE's outstanding stock, appeals from an order of the district court approving over its objections, the settlement of a series of class shareholder derivative actions brought by P&LE minority shareholders. The defendants in these actions were P&LE, certain of its officers and directors, certain present and former officers of Penn Central and others (including some banks and their employees). The parties to the settlement all contend that Irving, a nonparty, lacked standing to be heard in the district court in objection to the settlement. They would prefer that on this ground we refrain from reviewing the fairness of the settlement. But assuming that we recognize Irving's standing to object, they urge that the order approving the settlement be affirmed as a fair disposition of the class and derivative suits. We conclude that Irving did have standing to be heard in objection to the settlement, and that the district court abused its discretion in approving it. Accordingly, the settlement order must be vacated.
I. THE RELEVANT PROCEEDINGS BELOW
The settlement order arises out of eight separate actions filed in seven different districts by minority shareholders of P&LE. Six of these actions, by order of the Judicial Panel on Multidistrict Litigation, were transferred pursuant to 28 U.S.C. § 1407 to the Eastern District of Pennsylvania where two of the actions were already pending.*fn2 The pleadings establish that Penn Central owns approximately 93% of the outstanding capital stock of P&LE, including the 161, 198 shares pledged to Irving. The remaining 7% is publicly held. The derivative-suit plaintiffs charge the actual defendants*fn3 with (1) violations of § 10 of the Clayton Act, 15 U.S.C. § 20, which prohibits certain transactions between carriers having interlocking directorates; (2) violations of the federal securities laws for omitting information pertaining to these negotiated transactions from the 1969 P&LE Annual Report and for failing to register certain loan transactions; and (3) violations of fiduciary obligations imposed by state law. The class action plaintiffs, on behalf of all owners of the 7% publicly-held stock, charge P&LE and the other defendants with the same violations of § 10 of the Clayton Act. Both the federal and state law claims allege that in a series of transactions antedating the filing of its petition for reorganization, Penn Central (the 93% shareholder) was permitted to raid the assets of P&LE to the latter's detriment. Specifically, the plaintiffs claim that defendants improvidently permitted P&LE to make a series of loans to Penn Central at inadequate interest rates and at a time when they knew or should have known of the latter's precarious financial condition, and to enter into a conditional sales agreement with Penn Central to finance rolling stock at an excessive rate of interest.
Various interlocutory rulings, including the dismissal of the class action antitrust suit for failure to state a claim upon which relief could be granted, are set forth in the reported decisions of the district court.*fn4 Significantly bearing on the issues raised in this appeal is Judge Gorbey's most recently reported decision in this litigation.*fn5 Certain defendants had moved for a pretrial ruling limiting their liability to 7% of any damage allegedly sustained by P&LE. They proposed that any judgment be awarded directly to the 7% minority shareholders rather than to the corporation, thereby effecting a parity of benefits between these shareholders and Penn Central. Penn Central, they contended, had already been the principal beneficiary of the challenged transactions, and, as 93% shareholder, would benefit again from any recovery by P&LE. Holding that these derivative plaintiffs met the contemporaneous stock ownership requirement of Rule 23.1, Fed. R. Civ. P., and that P&LE would not reap a windfall if full recovery were permitted on behalf of the injured corporation, the court distinguished Bangor Punta Operations, Inc. v. Bangor & Aroostook R.R. Co., 417 U.S. 703, 41 L. Ed. 2d 418, 94 S. Ct. 2578 (1974), upon which the moving defendants had relied. In denying the motion to limit recovery, the court also emphasized that unlike the unique situation in Perlman v. Feldmann, 219 F.2d 173 (2d Cir.), cert. denied, 349 U.S. 952, 99 L. Ed. 1277, 75 S. Ct. 880 (1955), where a direct pro rata recovery by the minority shareholders had been permitted, the best interests of P&LE and the general public (in the enforcement of the federal securities and antitrust laws) would not be served by limiting the recovery to 7% of the alleged damages.*fn6
Once this decision was announced by the district court, it became obvious that all the defendants were potentially exposed to a huge liability. At the same time it was clear that since Penn Central was already in the process of reorganization, it was, as a practical matter, judgment proof. This left the individual and bank defendants potentially liable for all of the $30,000,000 damage allegedly suffered by P&LE. Shortly before a date was set for what promised to be a protracted trial, appellees proposed a settlement to the district court. Apparently acting pursuant to the last sentence of Rule 23.1, Fed. R. Civ. P., the district court ordered publication of notice of the proposed settlement and fixed a date for a hearing thereon. Irving received the notice and filed written objections to the terms of the settlement.
Under the proposed settlement a fund of $2,250,000 was created into which P&LE would contribute $2,100,000 and the individual and bank defendants $150,000.*fn7 From the settlement fund $750,000 would be distributed to plaintiffs' attorneys, and the remaining $1,500,000, after deducting court costs, would be distributed to the 7% minority shareholders but not the individual defendants. In addition, P&LE and the trustees of Penn Central would exchange releases, thereby effecting a discharge of a loan balance of $12,800,000 (probably uncollectable) due to P&LE from Penn Central as of June 21, 1970. The proposed release would also discharge the liability (also probably uncollectable) of the Penn Central estate for damage to P&LE from other transactions which allegedly violated § 10 of the Clayton Act and state law fiduciary duties. The Penn Central trustee agreed, subject to the approval of the reorganization court (which was obtained in a separate proceeding) that no distribution of the settlement fund would be made in favor of the 93% of P&LE shares held in Penn Central's name. Finally, all parties to the settlement would exchange releases inter sese as to all claims, including any claims for indemnity, and P&LE received an assurance from Penn Central that past tax allocations would not be recomputed.*fn8 Thus, the primary effect of the proposed settlement was that from the P&LE equity attributable to the 93% shareholder, P&LE, on whose behalf the suit was brought, would pay the plaintiffs' attorneys fees and make a special one-time distribution to the 7% public shareholders.
At the hearing on Irving's objection the two indentures of which it is trustee were made a part of the record. Both provide that prior to default Penn Central has the right to vote the pledged stock, but that no proxy or power of attorney to vote the stock shall be used for any purpose inconsistent with the terms of the indenture.*fn9 Both provide that after an event of default (of which filing the reorganization petition was one) Irving may, without Penn Central's consent, "take such steps as in its discretion it shall deem necessary to protect the interest of the holders of the Bonds in respect of any collateral security at any time pledged . . . either by instituting or requesting or authorizing the institution of any legal proceedings to enforce payment of the collateral security or interest*fn10 thereon or to foreclose any lien securing the same, or otherwise to act in respect of the collateral security . . ."*fn11 Both indentures also give Irving the power upon default to foreclose the pledge by sale of the collateral.*fn12 It was established at the hearing, however, that in Order No. 1 of the Penn Central reorganization proceeding, foreclosure of the pledge had been enjoined. But in accordance with a subsequent agreement between Irving and the Trustees of Penn Central, which was approved by the reorganization court in Order No. 497 of November 18, 1971, dividends on the pledged P&LE stock were to be used in part to limit to six months the arrearage in interest on the Penn Central bonds secured by Irving's indentures.
The principal balance due to the bondholders at the time of the settlement hearing was $15,441,800. There was evidence that at the time of this hearing the bid price of P&LE stock traded in the over-the-counter market was $80 per share. Thus, the market value of the Irving collateral, assuming it could have been sold, and assuming also that a sale of so large a minority interest would not require a substantial discount from the bid price, was less than $13 million. Prima facie then, Irving's bondholders were substantially undersecured. In any equitable sense the bondholders, not Penn Central, owned the 22.5% of P&LE stock pledged to Irving. Yet the settlement would dilute the pledgee's equity in P&LE by approximately $472,500 (22.5% of $2.1 million) and would deplete the net working capital on which the bondholder's receipt of interest under Order No. 497 depended.
Irving, in its written objections, contended that the proposed settlement was illegal and fundamentally unfair.*fn13 The district court disposed of this objection as follows:
38. The proposed settlement is not unfair with regard to bondholders under the Collateral Trust Indentures. The dividends which Penn Central receives from P&LE are used by Penn Central to pay the interest to the bondholders. Interest is not more than six months in arrears and the settlement will not affect P&LE's ability to continue paying dividends at the rate paid in the past. Nor will the settlement materially affect the value of P&LE stock pledged to Irving Trust Company. In short, Irving Trust Company is not a minority shareholder of P&LE, and neither it nor the bondholders has standing to object. The bondholders have, through Irving Trust as pledgee, already been granted an arguably preferential status by Judge Fullam in the Penn Central Reorganization Proceedings as beneficiaries of the escrow agreement (Opinion and Order No. 497, November 18, 1971, Civil Action #70-347), but Judge Fullam expressly declined to recognize in Irving Trust any right impairing the degree of ownership and control possessed by the Penn Central Trustees which permits consolidated-return treatment and the concomitant on-going benefit to the Penn Central estate of the tax allocation agreement in effect as to the P&LE. We agree with Judge Fullam's conclusion that the Penn Central Trustees and not the Irving Trust own the P&LE shares pledged as collateral. Any other finding would result in a windfall to bondholders who have no interest in this matter.*fn14
It is not clear what the court meant by this paragraph of the order approving the settlement. Appellees, who prepared the text of the order, present three alternative interpretations in their consolidated brief: (1) that this paragraph is a determination that Irving lacked standing to object to the terms of the settlement; (2) that it is a finding that the settlement is fair to Irving since it does not affect the value of the collateral under the trust indentures; or (3) that it is a recognition by the district court that the order of the reorganization court approving this settlement, from which no appeal was taken, must be given collateral estoppel effect against Irving. Irving, on the other hand, contends: (1) that it did have standing to object to the settlement; (2) that its bondholders' interests were adversely affected by the terms of the settlement, which is fundamentally unfair; and (3) that the reorganization court did not and could not pass on the merits of the settlement's effect on the bondholders' interest.
II. THE MOTION TO DISMISS THE APPEAL
The appellees moved before this court to dismiss the appeal on the ground that Irving, having no standing to object to the settlement, cannot appeal. A party denied standing to sue, or to intervene, or to object, may obviously appeal such a determination. The question of standing does not go to whether or not the appeal should be heard, but rather to its merits.*fn15 Accordingly, the motion to dismiss the appeal will be denied.
III. IRVING'S STANDING TO OBJECT TO THE SETTLEMENT
In determining Irving's standing to object to the settlement, we must, of course, assume the truth of its claim that the security of its bondholders will be adversely affected by the implementation of the settlement. The question is whether, assuming this is so, the law permits Irving to be heard.
A. Choice of Law Considerations
In its order approving the settlement the district court did not adequately develop the somewhat complex issues of choice of law lurking in the standing question. Irving is an indenture trustee with duties prescribed to some extent by federal law.*fn16 It acts under indentures executed, so far as we can tell from the record, in New York. One indenture was made by New York Central, a Delaware Corporation, and the other by Penn Central Company, a Pennsylvania corporation. The stock pledged under both indentures was issued by P&LE, a Delaware corporation. The proposed settlement disposes of a derivative suit alleging claims arising under both federal and state law.
Irving, while it maintains that it should be treated as an owner of P&LE shares for purposes of determining standing, also claims that the settlement of a derivative suit which involves the distribution of the nominal corporate defendant's assets may affect persons other than shareholders holding an interest in that corporation's securities. A pledgee of any corporate security, it urges, has an interest in the assets of the issuer which may be adversely affected by a distribution of those assets. Irving's separate interests, as an equitable owner of P&LE stock, and as a creditor of Penn Central holding a security interest in securities of P&LE, however, may not be governed by the same law. While the status of an equitable shareholder may implicate the law of Delaware under which P&LE was incorporated, the status of a creditor of Penn Central, having a derivative interest in the P&LE assets, may depend either upon the law of the place where the debt obligation was incurred (in this case apparently New York), or upon a federal standard because of the pervasive federal interest manifested in the several federal statutes regulating the extraction of debt capital from the national security markets.*fn17
A further complication present in this case is that, at least to the extent that choice of law is a state law issue, the transferee court may be required to take into account the choice of law rules of the six other territorial jurisdictions*fn18 from which these suits were transferred for consolidation with the two suits pending in the Eastern District of Pennsylvania.*fn19 Moreover, to some extent, Rules 23.1 and 24, Fed. R. Civ. P., federalize the standard for derivative suit standing and intervention.
We address the choice of law problem by first examining the application of federal law which ...