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COLAN v. MONUMENTAL CORP.

October 5, 1981

DAVID COLAN, PLAINTIFF,
v.
MONUMENTAL CORPORATION, KAUFMAN AND BROAD, INC., SUN LIFE GROUP, INC., AND SUN LIFE INSURANCE COMPANY OF AMERICA, DEFENDANTS.



The opinion of the court was delivered by: Aspen, District Judge:

MEMORANDUM OPINION AND ORDER

Plaintiff David Colan instituted this derivative action on behalf of Monumental Corporation ("Monumental") against defendants Kaufman and Broad, Inc., Sun Life Group, Inc., and Sun Life Insurance Co. of America ("the K & B Defendants") pursuant to Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) ["Section 16(b)"]. This suit seeks recovery of "short-swing profits" which plaintiff alleges were realized through a series of purchases and sales of securities within a six-month period during which defendants beneficially owned more than ten percent of Monumental common stock.

This matter is presently before the Court on the K & B Defendants' motion to dismiss the complaint on the grounds that (1) a prior shareholder derivative action filed against these defendants is res judicata with regard to the instant claims and (2) plaintiff failed to make a proper demand on Monumental prior to bringing this action as required by Rule 23.1 of the Federal Rules of Civil Procedure and Section 16(b). For the reasons set forth herein, the motion is denied in its entirety.*fn1

RES JUDICATA

The K & B Defendants contend that the doctrine of res judicata bars this action by virtue of the dismissal on the merits of a prior derivative suit in Coran v. Kaufman & Broad, Inc., 79 Civ. 4958 (S.D.N.Y., March 21, 1980) (the "First Derivative Action"). There is no dispute here that the First Derivative Action was brought by a different shareholder of Monumental against the same defendants, alleging the same wrong, and involving the same factual context as the current suit. The plaintiff herein argues that res judicata should not be applied in the instant case because the plaintiff in the First Derivative Action failed "diligently to prosecute" the corporation's claim as required by Section 16(b).

In general, the doctrine of res judicata provides that a valid final judgment rendered on the merits bars absolutely a subsequent action between the same parties, or those in privity with them, upon the same claim. Res judicata binds the parties both as to issues which were actually litigated and decided in the initial action as well as those issues which could have been, but were not, raised and resolved. E. g., Saylor v. Lindsley, 391 F.2d 965, 968 (2d Cir. 1968). As such, the doctrine serves important functions of judicial economy and of fairness to defendants. Parties are given one chance to fully litigate a claim. After that claim has been decided, res judicata relieves the courts of the necessity of hearing the same dispute once again. The rule promotes finality and stability of judgments, and protects defendants from vexatious lawsuits and multiple recovery. These virtues outweigh the danger that, occasionally, the operation of the doctrine will result in injustice to a particular plaintiff. See generally, Note, Res Judicata in the Derivative Action: Adequacy of Representation and the Inadequate Plaintiff, 71 Mich.L.Rev. 1042, 1058 (1973).

In the special context of derivative suits, the doctrine of res judicata has both compelling applications and limitations. The doctrine protects a corporate defendant from exposure to a series of suits by different shareholders all alleging the same wrong. Successive suits would result in a number of detriments to the corporation, including loss of reputation and good will, financial hardship from constant litigation, erosion of company morale, and disruption and inconvenience for directors and officers and other employees who must divert their attentions from the normal conduct of business to the business of defending against lawsuits. Note, Res Judicata in the Derivative Action, supra at 1058.

Res Judicata nonetheless poses particular dangers in the derivative suit context. Because the corporation, and not the shareholder-plaintiff, is the real party in interest in a derivative action, Ross v. Bernhard, 396 U.S. 531, 538, 90 S.Ct. 733, 738, 24 L.Ed.2d 729 (1970), an adjudication on the merits in one shareholder derivative suit will operate to bind all shareholders to the judgment in that case. See, e. g., Cramer v. General Telephone & Electronics Corp., 582 F.2d 259, 267 (3d Cir. 1978). Since the first shareholder whose claim becomes final binds the rest, there is a special danger that a plaintiff suing derivatively will not, as Rule 23.1 requires, "fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association," thus losing for the corporation forever the opportunity for a more favorable disposition of its claim. To protect the corporation against the loss of a valid claim by a plaintiff who is incompetent, in collusion with the wrongdoers, or who simply grows "faint-hearted" at the prospect of continued litigation, Rule 23.1 requires that a derivative action not be "dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders in such manner as the court directs." Fed.R. Civ.P. 23.1. Thus, the court and other shareholders are given the opportunity to supervise to some extent the first plaintiff's conduct of the suit before the settlement or judgment becomes final and binding on the corporation.

  The importance of the notice requirement in lessening the
special danger posed by the application of res judicata in the
derivative context has been recognized by a number of courts.
As the Second Circuit wrote in Papilsky v. Berndt, 466 F.2d 251
(2d Cir. 1972), cert. denied, 409 U.S. 1077, 93 S.Ct. 689, 34
L.Ed.2d 665 (1972),

   . . caution [in according res judicata effect to
  a prior action in which the present
  plaintiff-shareholder was absent] is warranted in
  the context of derivative actions in view of the
  fact that the plaintiff-shareholder is affecting a
  right which belongs to the corporation. To
  discourage the plaintiff from sacrificing the
  corporate cause of action to further his own
  self-interest, notice to nonparty stockholders of
  proposed dismissals is required in a variety of
  situations. Where notice is a prerequisite to
  dismissal of a derivative action, a judgment of
  dismissal will not be accorded res judicata effect
  unless such notice was given.

Id. at 257 (citations omitted).

As the Papilsky court noted, courts have required notice of proposed dismissals in a variety of situations where the corporate claim could otherwise be lost through the operation of res judicata. An examination of some of these precedents is helpful in evaluating the K & B Defendants' argument for the application of res judicata in the instant case. In Certain-Teed Products Corp. v. Topping, 171 F.2d 241 (2d Cir. 1948), the notice requirement of Rule 23(c) (now Rule 23.1) was held applicable where the plaintiff-shareholder consented to the entry of summary judgment against him. Similarly, in Brendle v. Smith, 7 F.R.D. 119 (S.D.N.Y. 1946), the plaintiff-shareholder stipulated to the dismissal of his suit without costs and did not oppose the defendant's motion for summary judgment. The court held that the notice requirement of Rule 23(c) applied. Saylor v. Lindsley, 391 F.2d 965 (2d Cir. 1968) (failure to answer interrogatories) and Papilsky, supra (failure to post bond-for-cost) were both cases in which the court explicitly refused to accord res judicata effect to an involuntary dismissal of a plaintiff-shareholder's derivative action without notice to nonparty shareholders, even though Rule 41(b) dismissals are expressly said to operate as adjudications on the merits.*fn2 Fed.R.Civ.P. 41(b). Finally, this Court notes that in Cramer v. General Telephone & Electronics Corp., supra, cited by the K & B Defendants in support of the application of res judicata, the Third Circuit interpreted the notice requirement of Rule 23.1 as extending to voluntary dismissals under Rule 41(a), and held that nonparty shareholders could not be bound by the judgment in a derivative action voluntarily dismissed without notice to other shareholders.

Read together, these cases support a general rule, endorsed by Professor Moore, that notice should be a precondition to the application of res judicata following any dismissal of a derivative suit: "unless the dismissal can be analogized to a dismissal for lack of jurisdiction, or to dismissal on the merits with adequate representation, then no exception should be recognized and notice should be required." J. Moore, Federal Practice ¶ 23.1.24[2] at 23.1-131.

Applying these principles and precedents to the facts of the instant case, it is apparent that the policies supporting the denial of res judicata effect to a prior derivative action should govern here as well. The First Derivative Action was dismissed on defendants' motion pursuant to Fed.R. Civ.P. 12(b)(6). In its memorandum granting the defendants' motion, the district court relied on the responsive affidavit filed by the plaintiff's attorney in which the attorney concedes that the complaint was mistaken as to the critical fact of whether the K & B Defendants were ten percent shareholders at the relevant times. Coran v. Kaufman & Broad, Inc., 79 Civ. 4958 (S.D.N.Y. March 21, 1980).*fn3 The affidavit concedes that, based on information contained in the defendants' motion to dismiss and on Coran's attorney's subsequent research, at no time during a six-month period did the defendants make a purchase and sale or sale and purchase while beneficially owning ten percent of Monumental common stock. In concluding, Coran's attorney expressed his belief that "the facts overtly support defendants' application of § 16(b) case law in this action" and that he "knows of no viable defense to the [defendants' motion] and asks that the Court make its determination accordingly." Bronzaft Affidavit at 7.

Irrespective of the merits of the underlying complaint, it can hardly be said that the plaintiff's prosecution of the corporation's claim in the First Derivative Action led to the kind of adjudication on the merits after full adversarial presentations by opposing counsel which would guarantee that the validity of the corporation's claim has been fairly determined and would justify binding result. While there is no suggestion made here of fraud or collusion, none is necessary. Because the only substantive filing made by the plaintiff in the First Derivative Action was the affidavit of plaintiff's attorney admitting that he had no case and inviting the Court to act accordingly, the disposition of that case was most closely analogous to a voluntary dismissal or a consent to the entry of summary judgment. Thus, the policies and precedents supporting the requirement of notice to nonparty shareholders as a precondition to according res judicata effect to a dismissal of a derivative suit are applicable here. Since there is nothing in the memoranda submitted by the parties here, or in the Court's order or opinion in the First Derivative Action, to indicate that any notice of that action's dismissal was provided to nonparty ...


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