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Levine v. Bradlee

decided: May 24, 1967.


Biggs, Hastie and Seitz, Circuit Judges. Seitz, Circuit Judge (dissenting).

Author: Biggs


BIGGS, Circuit Judge.

The issue in this case is whether Samuel R. Levine, the plaintiff, may maintain a suit for his expenses and attorney's fees incurred in a stockholders' derivative suit without giving security for expenses.

F. R. Wills, Chairman of the Board and Chief Executive Officer of General Acceptance Corporation, GAC, a Pennsylvania corporation, was given an option by GAC to purchase 53,061, as adjusted, shares of its common stock at $12.98 a share. When Wills exercised the option and purchased the stock, he gave his personal promissory note in the amount of $600,000 not payable in full for five years and secured by 50,000 of the shares, received by him under the option, delivered to GAC. Wills retained the rights to receive all dividends declared on and to vote the stock pledged by him. The complaint alleged that GAC has paid dividends on the stock at the rate of $1.10 a share or approximately 8.5%, while the note bore interest at the rate of only 5%. Since the case was not heard on the merits we take the allegations of the complaint to be correct. It appears, therefore, that the dividends received by Wills have exceeded, probably by at least $28,000 a year, the amounts of interest due on his note.*fn1

The plaintiff, Levine, a holder of 106 shares of common stock of GAC, brought suit on February 3, 1965, in the court below naming as defendants Wills and the other directors of GAC and GAC itself. The complaint alleged both violations of the Securities Exchange Act of 1934, Section 10(b), 15 U.S.C.A. § 78j (b) and Rule 10(b) (5) of the Rules of the SEC. Jurisdiction in this part of Levine's suit is based upon federal law. The second portion of the suit is based on diversity jurisdiction bottomed on Article 16, Section 7 of the Pennsylvania Constitution, P.S., and 15 P.S. § 2852-603, subd. A of the laws of Pennsylvania.

On March 8, 1965, Wills and several of the other directors filed a motion for security for costs pursuant to Rule 35(a) of the United States District Court for the Eastern District of Pennsylvania and GAC filed a motion for security for expenses pursuant to 15 P.S. § 2852-516, subd. B. In Judge Grim's opinion in the court below, D.C., 248 F. Supp. 395, he set out Levine's causes of action, federal and state, and held that the defendants were not entitled to security for expenses under the statute for the federal cause of action, McClure v. Borne Chemical Co., 292 F.2d 824 (3 Cir. 1961), but that as to that part of the suit based on the Pennsylvania Constitution and laws applicable to stockholders' derivative suits, security for expenses should be required of Levine. Judge Grim, however, concluded that he had nothing before him to indicate what the defendants' reasonable expenses in the suit might be, including attorney's fees, and that, therefore, he could not set any bond pursuant to 15 P.S. § 2852-516, subd. B. Judge Grim, however, directed that a cost bond, as distinguished from a bond for expenses, in the sum of $600 be filed under Rule 35(a) of the rules of the court below.*fn2 On December 20, 1965, Levine filed the required bond for costs. On December 14, 1965, Levine's counsel had moved for an order dismissing the action on the ground that it had become moot because, without notifying the plaintiff or the court, Wills had prepaid his note on or about May 18, 1965. Levine's counsel nevertheless expressly reserved the issue of attorney's fees.

On June 8, 1966, Judge Luongo*fn3 proceeded to dismiss the complaint as to the individual defendants on the ground that it was moot. The suit against GAC remained. Thereafter, on June 13, 1965, Judge Luongo ordered Levine to post a bond in the sum of $3,500, granting leave in the same order to GAC to apply for an increase in the amount if warranted by circumstances, if Levine pursued his application for counsel fees under the cause of action based on the Pennsylvania statute. The court further ordered that all proceedings should be stayed until the $3,500 bond was posted. This is to be contrasted with the position of Judge Grim who in his opinion held, relying upon our opinion in McClure, that no security for expenses but only security for costs could be granted under the federal action. This is true whether or not Levine's claim for fees and expenses be treated as "integrally related" or not "integrally related" to his cause of action and whether it is or is not a "reserved issue" in his suit against the directors under the Securities Exchange Act of 1934. This, of course, means that Levine can proceed on his claim for counsel fees under the federal law without giving bond and we so hold. So much for that portion of Levine's claim for counsel fees based on the federal law. We now turn to the issues under the Pennsylvania Constitution and statutes.

Levine asserts that his claim for reimbursement of expenses and attorney's fees is a direct action against the corporation, one without the ambit of the Pennsylvania statute, and that no security may properly be demanded. The issue is whether a claim for attorney's fees, assuming it to be valid, arising from a derivative cause of action, is within the purview of the Pennsylvania Security for Expenses statute, 15 P.S. § 2852-516, subd. B, which provides that, "In any such [secondary] suit instituted * * * by a holder * * * of less than five per centum of the outstanding shares of any class of such corporation * * * unless the shares * * * held by such holder * * * have a fair market value in excess of fifty thousand dollars ($50,000), the corporation in whose right such action is brought shall be entitled at any stage of the proceedings, to require the plaintiff * * * to give security for the reasonable expenses, including attorneys' fees * * *."

The obligation to reimburse a shareholder who brings a successful derivative suit is an obligation of the corporation. In 1881 the United States Supreme Court decided Trustees v. Greenough, 105 U.S. 527, 26 L. Ed. 1157, stating, "Where one of many parties having a common interest in a trust fund, at his own expense takes proper proceedings to save it from destruction and restore it to the purposes of the trust, he is entitled to reimbursement, either out of the fund itself, or by proportional contribution from those who accept the benefit of his efforts." Id. at 532-533. The rationale of Trustees v. Greenough is that where a party (1) in effect represented a class with a common interest in a fund, i.e., became a trustee eo nomine for the fund; and (2) in fact succeeded in creating or preserving a fund for the benefit of that class, the fund thus created became obligated to reimburse the trustee eo nomine just as it would have been obligated to reimburse an actual trustee. See Hornstein, The Counsel Fee in Stockholder's Derivative Suits, 39 Colum.L.Rev. 784 (1939). The principle of Trustees v. Greenough took firm judicial root. Thus in 1894, the Pennsylvania Supreme Court could say in Weed's Estate, 163 Pa. 600, 30 A. 278, "It would be an affectation of research to cite the long line of cases, English and American, which recognize and enforce [the principle of Trustees v. Greenough]. * * *"

Later opinions applied substantially the same basic theory to creditors' suits. The "litigating" creditor was designated as trustee eo nomine and the funds he made available to other creditors the corporation became obligated to reimburse him expenses. Miller v. Myers, 300 Pa. 192, 204-205, 150 A. 588 (1931). Adopting this theory, this court in Giesecke v. Pittsburgh Hotels, Inc., 180 F.2d 65 (1949), allowed attorneys' fees to a successful stockholder in a derivative action, but only as to that part of the suit which was successful. Counsel fees, however, were allowed directly against the corporation and not against the fund created by the suit, since the corporation as real plaintiff received the recovery. See Holthusen v. Edward G. Budd Mfg. Co., 55 F. Supp. 945 (D.C.E.D.Pa.1944), where the court allowed a fee to the attorney for a stockholder who succeeded in restraining waste of corporate property. The preservation of corporate property was treated for the purpose of the allowance of a fee as the equivalent of the creation of a fund. But we can perceive no difference in substance between a payment of attorney's fees from a fund created by a stockholder's derivative suit and a payment from corporate funds where benefit has been conferred upon the corporation by a stockholder's suit.

Although the obligation to pay attorney's fees is that of the corporation, it has been argued that a claim for attorney's fees after an out-of-court or courtapproved settlement of a derivative suit is but a "reserved issue" of the derivative suit. It has been considered by some authorities to be so integrally related to the original derivative suit as to be simply an issue in it. Support for this conclusion is found in the fact that the success of the derivative claim determines the success of the claim for attorney's fees. If the case is actually tried, an actual adjudication on the merits will be entered. If, on the other hand, the case is settled, a decision on the "meritorious" quality of the derivative claim must be reached.

What is the status of Levine's claim for attorney's fees under the Pennsylvania statute? Although the language of the Pennsylvania statute clearly is limited to "secondary" actions proponents of the theory that the right to counsel fees is a reserved issue claim the policy of security-for-expenses statutes militates against a holding that a claim for attorney's fees is technically a direct action. What then is the policy of the Pennsylvania statute? As was clearly demonstrated in McClure, supra, the statute was designed to eliminate "strike" suits. The legislature decided to measure the seriousness of a derivative suit by the size of the stockholdings of the shareholder bringing the suit. If he owns more than 5% or $50,000 of the corporate stock, his claim is presumed not to be frivolous and no security is demanded.

As was said in Shapiro v. Magaziner, 418 Pa. 278, 284-285, 210 A.2d 890, 894-895 (1965): "The purpose of Section 516B and its precursors is to prevent 'strike suits' -- shareholder derivative actions begun 'with the hope of winning large attorney's fees or private settlements, and with no intention of benefiting the corporation on behalf of which suit is theoretically brought.' Security For Expenses Legislation -- Summary, Analysis, and Critique, 52 Colum.L.Rev. 267 (1952). See also Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541, 547-549, 69 S. Ct. 1221, 93 L. Ed. 1528 (1949). It was thought that such 'strike suits' were usually brought by shareholders with only a small financial stake in the corporation and who, therefore, had little to lose by starting an action. However, it also was recognized, as Mr. Justice Jackson observed in Cohen v. Beneficial Industrial Loan Corp., supra, at p. 548, 69 S. Ct. at p. 1226, that the shareholder's derivative suit is a 'remedy born of stockholder helplessness * * * long the chief regulator of corporate management and has afforded no small incentive to avoid at least grosser forms of betrayal of stockholders' interests.' Consistent with this background, the New York 'security for expenses' legislation, followed by Pennsylvania and now embodied in Section 516B, was not intended to discourage derivative actions generally, a result which would follow if appellees were to prevail, but only to prevent 'abuses attending the maintenance of such actions by persons whose financial stake in the corporation is slight.' Isensee v. Long Island Motion Picture Co., 184 Misc. 625, 54 N.Y.S.2d 556, 559 (1945)." In Isensee it was stated that the legislation was aimed at the abuses of strike suitors in cases in which a settlement is reached out of court for the strike suit motives of the complaint make it unlikely that the action will be carried to a conclusion. Further, as Ballantine defines "strike suitors" the term includes both speculators in attorney's fees and persons seeking private settlements. Ballantine, Corporations, 356 (Revised Ed.). Such a policy would urge one in the absence of contrary factors to characterize claims for ...

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