The opinion of the court was delivered by: MAURICE B. COHILL, JR.
In the past few months the parties to this action have met with this Court several times in an effort to resolve their disputes and to pursue settlement of this action. The defendants have proposed a settlement of this action that involves the resolution of the class members tax dispute with the Internal Revenue Service ("IRS"). The unique nature of the proposed settlement, time pressures by the IRS and a petition by one member of the class to have class counsel replaced have combined to force this Court to become involved in the settlement discussions, to a greater degree than usual, in order to protect the interests of the class.
At a conference concerning these matters on June 8, 1992, the defendants and one of the representative plaintiffs through their counsel, who was proposed replacement counsel, requested that this Court preliminarily approve the proposed settlement, allow the defendant to notify the class of this Court's approval and then set a class-action settlement hearing.
In addition to these requests, the law firm of Reed, Smith, Shaw & McClay ("Reed Smith") has petitioned to intervene and act as class counsel for purposes of settlement. Reed Smith states that its client, Hoffman Electric, a representative plaintiff, wishes to accept the settlement offer. Given that the current class counsel does not consider this offer acceptable, Hoffman has moved, through Reed Smith, to have Reed Smith act as class counsel. Also, current class counsel, Patterson, Belknap, Webb and Tyler, has filed a motion to compel the defendants to accept the IRS settlement offer and also pay the class members' liability to the IRS under that settlement.
Given the number of issues raised by the parties and the deadline set by the IRS for acceptance of this offer, we placed the parties on an expedited briefing schedule. As a result, the parties have filed with this Court numerous briefs and voluminous appendices to those briefs. We feel that the information presented to us has been sufficient to allow us to make a preliminary determination as to the reasonableness of the settlement without oral argument.
In addition, we feel that we must also dispose of Reed Smith's motion to intervene as class counsel and current class counsel's "Motion to Force Emerson to Finance IRS Settlement." We will discuss each of these issues separately below.
The plaintiffs were limited partners in Emerson Research Partners ("ERP I"), which was formed to develop, manufacture and market a two-way automatic communication system (TWACS). TWACS was to be used by electric utilities companies to reduce peaks in demand for electrical power through remote control. After years of losses, Emerson offered to purchase ERP I for an amount approximately half of the limited partners' initial investment. This offer was contained in a proxy statement. Plaintiffs then brought this lawsuit alleging that the defendant had entered into a scheme to buyout ERP I at an unfairly low price.
The defendants are bad Management Development Corporation ("LMDC"), as general partner of ERP I, Harold F. Faught, owner of LMDC and Emerson Electric Company.
In our previous opinion in this case, Hoffman Electric, Inc. v. Emerson Electric, Co., 754 F. Supp. 1070 (W.D. Pa. 1991), we granted plaintiff's motion for class certification and granted defendants' motion to dismiss the RICO claim. We denied defendants' motion for partial summary judgment on the securities claim. Thus, the remaining counts involve a securities claim and pendent state claims. The plaintiffs have also filed a motion to amend their complaint which we decline to address in this Opinion.
Fairness of the Proposed Settlement
We find, preliminarily, that the settlement proposed by the defendants is adequate, fair and reasonable. Thus, we will order that the class be notified of the proposed settlement, this Court's view of that settlement and that a settlement hearing has been scheduled. We will also direct that the class members must express their opinion on this settlement by submitting their vote via ballot to he enclosed with the notice no later than 4:00 p.m. July 6, 1992. The ballot should be sent to the tax matters partner, Mr. Brian Cave, with copies to all counsel of record. If a majority of the class accepts the settlement, and if, after the full hearing, we continue to believe that this is an adequate settlement, this Court will approve the settlement.
We believe that the settlement offer is fair for two reasons;
1. First, after review of the submissions of the parties on this matter, we find that, should this case proceed to trial, the plaintiffs would have difficulty proving damages exceeding $ 2 million. Even assuming that the proxy statement representing the defendants' offer to buyout the plaintiffs' interest somehow misleading, the technology on which the partnership was based has done nothing but lose money since the buyout.
Since the date of the buyout one of the only two customers using the system no longer does. In addition, none of the other prospective customers identified by the plaintiffs have purchased the technology. As a matter of fact, Emerson spun off the TWACS business to its shareholders as part of another deal at no additional charge.
Emerson purchased the interest of the ERP I limited partners for $ 10 million. The board had authorized them to pay up to $ 12 million. Thus, the plaintiffs could use this difference between the price and the board authorization as proof that the allegedly misleading proxy statement resulted in $ 2 million in damages. But, given the decline in the business after the buyout, we do not believe that the plaintiffs will be able to prove any additional damages. The value of the settlement proposed by the defendants is $ 2 million. Thus, the amount of the settlement, in this Court's opinion, reasonably reflects the dollar value of this case.
2. Our second reason for preliminarily approving the settlement is its structure. At the time of Emerson's buyout of the ERP I limited partners, the IRS was investigating the deductions taken by the limited partners for the years 1984 - 1986. As part of the buyout, LMDC agreed to continue to fund the services of the Davis, Polk and Wardwell law firm to represent the limited partners in this matter. Also, under the buyout, LMDC continued to act as the Tax Matters Partner for the limited partners even after ERP I was dissolved.
Emerson through Davis Polk and Wardwell, has negotiated a settlement of these IRS claims. The settlement involves other entities aside from ERP I. Under the settlement, the IRS has agreed to assess against LMDC $ 2.5 million in tax liability. This liability represents the liability of ERP I and ERP II to the IRS for certain disallowed deductions taken by the limited partners of these separate research partnerships. Emerson has estimated that 70% of the total liability is allocable to ERP I. Thus, $ 1.75 million of the total $ 2.5 million represents the liability of the ERP I limited partners. Class counsel disputes this calculation. However, we can find no fault with the defendants figures.
This $ 1.75 million would satisfy what the IRS and Davis Polk and Wardwell agree is the ERP I limited partners estimated $ 6,117,587 tax liability. According to the calculations presented by the defendants, the estimated tax liability for each partnership share is $ 30,900. The settlement allows the parties to satisfy that liability at the reduced price of $ 8,800 per share. In addition to this benefit, the liability will be assessed against LMDC, not the individual limited partners. Thus, these individuals will not have to file amended tax returns for the years 1984 - 1986. Also, the IRS has stated that if LMDC pays this liability for the limited partners, it will not consider this monetary benefit to the partners as taxable income. As a result, $ 1.75 million of this settlement will not be taxable to the members of the class.
The administrative convenience of this method of resolving this tax dispute weighs heavily in favor of accepting the settlement. In addition, the value of the settlement parallels this Court's opinion as to the value of the plaintiffs' claims, assuming that the claims themselves have merit. While we decline to make any suggestion as to the merits of these claims, we do suspect that the plaintiffs may find it difficult to prevail should this case proceed to trial. However, we are not firmly convinced that the $ 2 million settlement offer is perfect as it stands.
Emerson has agreed to sweeten the pot with $ 250,000 in cash, in addition to paying the limited partners' tax liability in order to settle this case. Class counsel feels that this additional cash is not sufficient. We agree with class counsel that this $ 250,000 may not cover the expenses to class counsel during the pendency of this action. Thus, we believe that a settlement involving the payment of the IRS liability under the proposed settlement and additional cash for a total value of between $ 2 million and $ 2.2 million would be an adequate settlement.
We hasten to add that we have only expressed our views on the proposed settlement as the rationale for authorizing the vote by the class members. Our views are, of course, in no way binding on the class.
For the reasons stated above we will grant preliminary approval to this settlement offer. However, final approval of the settlement will depend on the response of the class and the evidence presented at the settlement hearing.
We also find that the attached notice, if sent via facsimile or overnight mail, by the defendants at the defendants' expense will satisfy Federal Rule of Civil Procedure 23(e). This Court must evaluate 5 factors to determine whether notice to a class of a settlement hearing is sufficient; 1) the notice period; 2) the mechanism of the notice; 3) prior communications with the class regarding the proposed settlement; 4) the characteristics of the class; and 5) the contents of the notice.
As to the first factor, notice period, we find that, if the notice is sent to the class the day this Opinion and Order are signed, June 26, 1992, the class will have been given sufficient notice to allow a settlement hearing to be held on July 8, 1992. The rush inherent in this process comes from pressure by the IRS. The IRS has agreed, according to the plaintiff's brief, to hold its settlement offer open until July 10, 1992. Thus, the settlement hearing must be held prior to July 10th. We find that this period is sufficient given recent communications with the class regarding settlement. Thus, this notice will not come as a complete surprise.
The second factor, mechanics of the notice, also weighs in favor of the adequacy of the notice. The defendants have agreed to convey this notice to the class via overnight mail. Thus, should the notice be sent today, all the class members will receive notice by Monday, June 29, 1992 at the latest. We will also order the defendants to send the notice via facsimile, in addition to the overnight mail, to those class members with facsimile machines. The defendants informed the Court at the most recent status conference that many of the class members have facsimile machines. Thus, every attempt will be made to get notice to the class members today.
The third factor, prior communications with the class, also supports this notice. The class members have been aware of the dispute with the IRS since September 20, 1988. In addition, the class members received notices from the defendants and class counsel regarding this settlement offer in May 1992. Class counsel included a ballot in their notice which approximately 75 of the 198 class members have returned. Thus, the class members have already received notice of the proposed settlement and many have expressed an opinion on that settlement. The class is aware of the current negotiations, so this notice of the settlement hearing will not come as a complete surprise.
The characteristics of the class, also work in favor of the sufficiency of this notice. To invest in ERP I each of the limited partners had to have a net worth of at least $ 1 million. Thus, the court can infer that the class members are sophisticated investors. Many of the class members are lawyers or have their own investment advisors. Thus, the class members should be able to seek advice or reach their own determination of the reasonableness of the settlement by the hearing date of July 8, 1992.
We also find that this notice is quite complete. The settlement is described in sufficient detail to appraise the parties of the benefits and detriments of the settlement. In addition, it contains this Court's opinion of the reasonableness of the settlement. Thus, the notice fairly apprises the class members of the nature of the settlement and the ballot allows them to express their opinion as to settlement prior to the settlement hearing.
Plaintiffs' Motion to Order Emerson to Finance the IRS Settlement
In this motion, the plaintiffs assert that Emerson, by stating that it will stop funding the class' representation in the IRS dispute if the class does not accept this settlement offer has breached its fiduciary duty to the class. Because of this threat, class counsel argues that the defendants should be forced to accept and pay the IRS settlement. We find no merit to this motion.
In the proxy statement, LMDC agreed that it would
"continue contesting the IRS dispute until a resolution is reached which the General Partner believes is reasonable to accept (taking into account the estimated ne tax consequences to the Limited Partners, the costs of continuing the IRS Dispute and other relevant factors.)
. . . A limited partner who elects not to be bound by a settlement entered into by the General Partner will thereafter bear the responsibility individually (or together with other non-electing Limited Partners) to ...