An Intervention Requirement Provides Greater Benefit to the Corporation When Nonparty Shareholders Appeal Derivative Action Settlements: Felzen v. Andreas, 134 F.3d 873 (7th Cir. 1998).

• Publication year: 2021

79 Nebraska L. Rev. 171. An Intervention Requirement Provides Greater Benefit to the Corporation When Nonparty Shareholders Appeal Derivative Action Settlements: Felzen v. Andreas, 134 F.3d 873 (7th Cir. 1998).

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Note*

Matthew Anderson

An Intervention Requirement Provides Greater Benefit to the Corporation When Nonparty Shareholders Appeal Derivative Action Settlements: Felzen v. Andreas, 134 F.3d 873 (7th Cir. 1998).

TABLE OF CONTENTS

I. Introduction .......................................... 171
II. Background ............................................ 174
A. Before Felzen ...................................... 174
1. Class Actions ................................... 174
2. Derivative Suits ................................ 180
B. Felzen ............................................. 185
1. Facts ........................................... 185
2. Decision of the Seventh Circuit ................. 186
C. After Felzen ..................................... 190
III. Effects of Intervention ............................... 191
A. The Problems of the Derivative Action .............. 192
B. Theoretical Solution to the Problems ............... 194
C. Practical Solution to the Problems ................. 195
IV. Benefit to the Corporation ............................ 197
V. Conclusion ............................................ 198

I. INTRODUCTION

When a corporation has a legal problem, its board of directors will normally decide to take a course of action that it feels is in the corpo-ration's best interest. Sometimes this means litigation, while other times it means simply ignoring the problem. In some situations, however, the course of action that the board of directors decides to pursue may not be in the corporation's best interests. This often arises when

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directors breach a fiduciary duty to the corporation.1 When this occurs, the corporation will have a claim against the directors. The problem with this situation is that the same directors who breached their duty simultaneously control the corporation, so it is unlikely that they will decide to bring an action against themselves. For these special situations the law has created a mechanism that allows a shareholder to instigate an action on behalf of the corporation. Essentially, "[a] shareholder-controlled derivative suit is a usurpation of the directors' normal power to manage the business and affairs of a corporation justifiable only in circumstances where the directors are unable or unwilling to handle the litigation in the best interests of the corporation."2

To understand the significance of an appeal of a derivative suit, it is first necessary to understand the derivative suit itself. The structure of the derivative suit is rather unusual. "In its classic form, a derivative suit involves two actions brought by an individual shareholder: (i) an action against the corporation for failing to bring a specified suit and (ii) an action on behalf of the corporation for harm to it identical to the one which the corporation failed to bring."3 Since the shareholder takes action on behalf of the corporation, any recovery will go to the corporation rather than the specific shareholder bringing the action. As Judge Winter more elegantly put it in Joy v. North4:

[T]he shareholder plaintiffs are quite often little more than a formality for purposes of the caption rather than parties with a real interest in the outcome. Since any judgment runs to the corporation, shareholder plaintiffs at best realize an appreciation in the value of their shares. The real incentive to bring derivative actions is usually not the hope of return to the corporation but the hope of handsome fees to be recovered by plaintiffs' counsel.5

The court went on to state:

Since very few shareholders would pay an attorney's fee out of their own pocket to finance a suit that is brought on the corporation's behalf and normally holds only a slight and indirect benefit for the plaintiff, very few derivative actions would be brought if the law did not allow the plaintiff's attorney to be compensated by a contingent fee payable out of the corporate recovery.6

Thus, the role of the plaintiff's attorney is very important in derivative actions.

While derivative actions would rarely be brought without plaintiffs' attorneys, the fact that plaintiffs' attorneys bring the actions also causes a major problem. As many courts and commentators have pointed out, "[o]ne of the risks flowing from shareholders' difficulty in

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monitoring derivative litigation is that plaintiffs' counsel and the defendants will structure a settlement such that the plaintiffs' attorneys' fees are disproportionate to any relief obtained for the corporation."7 Derivative litigation brings with it a risk that a plaintiff's attorney will settle on an agreement that provides little benefit to the corporation but provides high fees for herself.8

The law has, however, created a mechanism that helps to ensure that the settlement agreements are fair and reasonable. Federal Rule of Civil Procedure 23.1 requires the court to approve the settlement and to give notice of the proposed compromise or dismissal to the shareholders.9 This notice not only informs the shareholders of the pending litigation and terms of the settlement,10 but also provides the shareholders with a chance to object to the settlement at the settlement hearing.11 Once notice is given, shareholders that disapprove of the settlement have the option to voice their objections to the court. After hearing the shareholders' objections, the court will then determine whether to approve the settlement.12

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When the court approves the proposed settlement over the nonparty shareholders' objections, some shareholders may try to appeal that decision. The question then arises whether a shareholder who has not been formally made a party to the action by intervening under Federal Rule of Civil Procedure 24, but who has appeared, pursuant to court notice, to voice his objections to the proposed settlement, may appeal the district court's approval of the settlement reached between the named parties.

This note argues that the Seventh Circuit's recent holding in Felzen v. Andreas,13 which was affirmed by an equally divided Supreme Court,14 and which requires nonparty shareholders to intervene before they will be allowed to appeal, will result in the most benefit to the corporation. Before reaching this conclusion, however, Part II will review not only Felzen, but the case law leading up to it and one case that was decided after it. Part III will then describe the two main problems that result from class and derivative actions and will set forth and explain the argument of this note: that the rule requiring intervention provides the best solution to these problems. Part IV will provide further support for this conclusion by illustrating how it will benefit the corporation.

II. BACKGROUND

A. Before Felzen

1. Class Actions

Although this analysis focuses on nonparty appeals of derivative actions, how courts have handled the appeals of unnamed class members is particularly relevant to determining whether nonparty shareholders should be required to intervene before they will be allowed to appeal a district court's approval of a settlement agreement. In fact, when determining whether a nonparty shareholder may appeal without intervening, many courts have not even distinguished between the two actions.15 In addition, since the two actions involve the same problems,16 how the courts have handled these problems in the class action setting is instructive.

In Research Corp. v. Asgrow Seed Co.,17 the Seventh Circuit decided the first of what would become a line of related cases leading to its recent decision in Felzen. There, the plaintiff brought a patent infringement action, naming six companies as defendants and repre

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sentatives of a class of alleged infringers.18 Eventually, the plaintiff reached a settlement with the named defendants. After a hearing during which the appellants, who were unnamed class members, made no objections, the court entered a consent judgment. Dismissing the appellants' appeal, the court stated that "[i]f a class member intervenes or even appears in response to a notice pursuant to Fed. R. Civ. P. 23(e) and objects to the dismissal or compromise, he has a right toappeal from an adverse final judgment."19 Significantly, however, the court mentioned in a footnote that the appellants' failure to intervene after receipt of notice before the final judgment foreclosed their right to appeal.20 Recognizing the inconsistency of the two positions taken by the court, subsequent courts reviewing the judgment have ignored the footnote.21

The Seventh Circuit reaffirmed its holding in Research Corp. in two subsequent cases. The first case was Patterson v. Stovall,22 where the issue was whether the district court abused its discretion in approving the settlement agreement reached between the parties.23 The appellants in that case were unnamed class members who had objected to the settlement in the district court. In a footnote, the court noted that "there is no doubt that the objectors have standing to ap-peal."24 Similarly, in Armstrong v. Board of School Directors,25 the court stated that the right of a class member to appeal "exists independent of any motion made in the district court."26

The Third Circuit reached a similar result in Ace Heating and Plumbing Co. v. Crane Co.27 This case was unique in that the class members were given the opportunity to decide whether to join the class after they were informed of the substantial terms of the settlement. The court recognized that "[o]rdinarily, aggrieved class members may appeal any final order of a district court in proceedings held

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pursuant to Rule 23."28 Even...