Plaintiff in Putative Securities Class Action Lacks Standing to Opt-Out of Plan Release
By Diane Davis
A bankruptcy court correctly concluded that the appellant, who is the lead plaintiff in a separate putative securities class action suit against former directors and officers of the debtor, lacked standing to opt-out of or object to the debtor’s Chapter 11 plan’s release of claims against non-debtor third parties on behalf of the putative class, the U.S. District Court for the Southern District of New York held June 4 (Lucas v. Dynegy Inc. (In re Dynegy Inc.), S.D.N.Y., No. 1:12-cv-08908-JGK, 6/4/13).
Dismissing the appeal, Judge John G. Koeltl concluded that because the appellant has opted out of the release and therefore is unaffected by a determination whether the release is valid, he lacked standing to pursue an objection on appeal.
The appellant, Stephen Lucas, opted out of the release, the court noted, and therefore, regardless of a judicial determination of the validity of the release, the appellant may continue with his claims against the defendants in the securities litigation. Because the appellant opted out of the release and may pursue his claims, he was not directly affected in any pecuniary way by the order of the bankruptcy court that the release was valid, and lacked standing to appeal the order of the bankruptcy court, the court said.
“The appellant is attempting to use his status as lead plaintiff in the securities litigation to have his cake and eat it too–to opt out of the Release personally but also to challenge its validity in the separate bankruptcy proceeding. There is no authority supporting this position and it is at odds with standing doctrine,” the court said
According to the court, the appellant lacked standing to opt out of or object to the release on behalf of the putative class and to object to the release individually.
Settlement of Claims
Debtor Dynegy Holdings LLC and certain of its indirect subsidiaries filed for Chapter 11 protection on Nov. 7, 2011. The bankruptcy court appointed an independent examiner to investigate allegations of fraud and fraudulent transfers between Dynegy Holdings LLC, Dynegy Inc., and other subsidiaries. The examiner concluded that the debtors’ board of directors breached their fiduciary duties by approving and carrying out fraudulent transfers between Dynegy Inc. and certain of its subsidiaries.
The debtors and major stakeholders later reached an agreement settling claims stemming from the investigation. Under the settlement agreement, shareholders of Dynegy Inc. received one percent of the equity in the entity that would emerge from the bankruptcy of Dynegy Inc. as well as certain warrants.
Subsequently, Charles Silsby filed a securities class action complaint in the district court against Dynegy Inc. and several of Dynegy Inc.’s controlling shareholders, Carl C. Icahn, Robert C. Flexon, and Clint C. Freeland. The complaint alleged that the defendants violated various provisions of section 10(b) of the Exchange Act of 1934, and Rule 10b-5, by falsely disseminating false and misleading information and failing to disclose material facts with respect to Dynegy’s financial performance and prospects. The putative class included investors who purchased or otherwise acquired Dynegy Inc. common stock on the New York Stock Exchange between Sept. 2, 2011, and March 9, 2012.
On July 6, 2012, debtor Dynegy Inc. filed for Chapter 11 protection, and the bankruptcy court entered an order under Bankruptcy Code Section 362(a) staying the securities litigation as to Dynegy Inc., but it was not stayed against the individual defendants.
The bankruptcy court approved the debtor’s disclosure statement in an order providing that the proponents of the plan were “not required to distribute or serve copies of the Plan, Ballots, Confirmation Hearing Notice, … Stakeholder Notice, … to any holder of a claim or interest in the Non-Voting Classes.” The disclosure statement ordered that a “Confirmation Hearing Notice” be published in the national editions of The New York Times and The Wall Street Journal. In addition, the plan included third-party releases that would be binding unless a party opted-out.
The debtor’s Chapter 11 plan also included a release provision that releases from liability non-debtor third parties who are defendants in the putative securities class action. The parties agreed that the individual defendants in the securities litigation are within the scope of the release.
The release has two exceptions. First, it does not cover “intentional fraud, willful misconduct, gross negligence, or criminal conduct as determined by a Final Order….” The parties agreed that the appellant’s claim is a claim that is not within the scope of the release. Second, the exception applies to “any holder of a Claim or Equity Interest … that elects to ‘opt out’ of such releases by making such election on its timely submitted ballot (to the extent it receives a ballot) or in a written notice submitted to the Solicitation Agent on or before the Plan Objection Deadline.”
The plan also contains an injunction that precludes litigation against non-debtor third parties.
Objection to Confirmation of Plan
On July 13, 2012, the appellant was appointed lead plaintiff in the securities litigation and Levi & Korsinky LLP was appointed lead counsel. The securities litigation is at a preliminary stage and no class has been certified.
Lead counsel later submitted a letter to the bankruptcy court requesting that the lead plaintiff order be modified to clarify that the lead plaintiff had the authority to opt-out of the release on behalf of the class. The appellant subsequently timely submitted an opt-out election to the court on behalf of himself and the putative class he represents in the putative securities litigation. The appellant also submitted a timely objection to confirmation of the plan on behalf of himself and of the putative securities class, arguing that the release was impermissible.
Lacks Standing Because Opted Out
On Sept. 10, 2012, the bankruptcy court confirmed the debtors’ plan subject to a full reservation of rights with respect to the objection. After unsuccessful settlement negotiations, the court overruled the appellant’s objection. The bankruptcy court held that it had subject matter jurisdiction to grant the release because it affects the res of the bankruptcy estate. According to the court, the lead plaintiff lacked standing on his own behalf and on behalf of the class because he had timely opted out of the release and therefore a decision whether the release was permissible would not affect his rights.
The bankruptcy court held that the lead plaintiff lacked standing to opt-out of or object to the release on behalf of the class because he had no authority to represent the putative securities class outside of the securities litigation. The court also determined that the release was permissible based on implied consent because the affected parties had received notice but had not opted-out of the release.
The lead plaintiff appealed to the district court, arguing that the lead plaintiff order and his status as lead plaintiff in the securities class action provided him with standing in the bankruptcy court to opt-out and to object to the release on behalf of the putative class.
Failure to Seek Application of Class Action
Because the appellant/lead plaintiff failed to move for the application of the class action rule before the bankruptcy court, he lacked standing to opt-out of or to object to the release on behalf of the putative securities class, the district court concluded. The appellant must assert his own legal rights and interest, the court said, and cannot rest his claim to relief on the legal rights or interests of third parties.
Rule 23 of the Federal Rules of Civil Procedure govern class actions in federal cases, the court explained. Rule 7023 of the Federal Rules of Bankruptcy Procedure provides that Rule 23 applies in adversary proceedings, the court said. Bankruptcy Rule 9014 provides that in a “contested matter” the court “may at any stage in a particular matter direct that one or more of the other rules in Part VII shall apply,” the court noted. According to the court, the objection to the confirmation of a Chapter 11 plan is a “contested matter.”
According to the court, the appellant’s failure to seek the application of a class action rendered him unable to represent a class that had never been designated by the bankruptcy court, much less assume the role of representative of such an undesignated class. Therefore, the appellant could not opt out of the release or object to it on behalf of a class, the court said. The burden is on the claimant to obtain application of Rule 7023 and to satisfy the requirements of Rule 23 itself, the court explained. Rule 23 requires that a class action determination must be made at “an early practicable time,” the court noted.
The appellant’s counsel had been aware of the bankruptcy proceedings since the hearing before the bankruptcy court that counsel attended on July 9, 2012, and the appellant failed to move under Rule 9014 to make Rule 23 applicable to this bankruptcy case, the court said. Therefore, because the appellant never attempted to initiate class proceedings in the bankruptcy court, he represented no one but himself before the bankruptcy court, the court said.
According to the court, the designation of the appellant as “lead plaintiff” in the putative securities class action would not bind the bankruptcy court to allow the appellant to represent the same putative class in the bankruptcy court. The designation of class status in a bankruptcy case raises distinct issues from other litigation, the court said. Even if the appellant had been the lead plaintiff of a certified class action in the district court, he still would have had to move for the application of Rule 7023 in the bankruptcy court to represent the putative securities class in that forum, the court noted. Thus, the court concluded that the appellant’s failure to move for the invocation of Rule 7023 results in his lack of standing to represent the class in the bankruptcy proceeding.
For all practical purposes, the court said, the appellant is a “lone plaintiff attempting to exercise the rights of nonparties by attempting to opt out of or object to the release on their behalf. Such action runs afoul of the prohibition against third party standing,” the court said.
Not a ‘Person Aggrieved.’
The district court also found that because the appellant has opted out of the release and is unaffected by a determination whether the release is valid, he lacks standing to pursue the objection on appeal. In order to have standing to appeal from a bankruptcy court ruling, an appellant must be “a person aggrieved,” the court noted, or a person “directly and adversely affected pecuniarily” by the challenged order of the bankruptcy court. The appellant opted out of the release. Thus, regardless of a judicial determination of the validity of the release, the appellant may continue with his claims against the defendants in the securities litigation, the court noted. Because the appellant opted out of the release and may pursue his claims, he was not directly affected in any pecuniary way by the order of the bankruptcy court that the release was valid, and he lacks standing to appeal the order of the bankruptcy court, the district court said.
It is clear, the court said, that the appellant had no remaining economic stake in objecting to the release because he is not bound by its terms and his individual claims may proceed in this court regardless of the validity of the release. “The appellant is attempting to use his status as lead plaintiff in the securities litigation to have his cake and eat it too–to opt out of the Release personally but also to challenge its validity in the separate bankruptcy proceeding,” the court said. “There is no authority supporting this position and it is at odds with standing doctrine,” the court added.