FRIENDLY, Chief Judge:
This appeal raises questions about the settlement of a stockholder's derivative action over the objection of the plaintiff. While we decline to lay down a rule that this may never be done, we hold that the procedures here followed did not adequately protect the right of plaintiff, and of other objecting stockholders, to develop a record which might show that the settlement was improvident.
The transaction here at issue, the two-step sale to Mines Incorporated, in 1951 and 1953, by the Tonopah Mining Company of Nevada (Tonopah) of the stock of Tonopah Nicaragua Company (Tonopah Nicaragua), owner of the Rosita copper mine, is no stranger to the courts of this circuit. The history of an earlier action attacking the sale, Hawkins v. Lindsley, brought in 1957, in the District Court for the Southern District of New York, is recounted in Judge Swan's opinion for this court, 327 F.2d 356 (2 Cir. 1964). It suffices here to say that a second amended complaint in that action charged that the sale violated both state law of fiduciary obligations and the Investment Company Act of 1940; that in September, 1958, Judge Noonan dismissed the claim under the Investment Company Act and required the furnishing of $50,000 of security pursuant to § 61-b of the New York General Corporation Law (McKinney's Consol.Laws, c. 23 Supp. 1971-72); and that when plaintiff failed to post security, Judge Ryan, on July 27, 1961, ordered dismissal with prejudice. Plaintiff failed to take a timely appeal, and other efforts to vacate Judge Ryan's order of dismissal were rejected in the opinion cited.
In February, 1965, plaintiff Saylor began this action, also in the District Court for the Southern District of New York. Federal jurisdiction was based on violations of the federal securities laws, and state claims were alleged merely as pendent. Defendants responded by way of a motion for summary judgment on the basis that this new action was barred by res judicata and by the applicable statute of limitations. Judge Cooper granted the motion and dismissed the complaint on the ground of res judicata; in addition, while not purporting to decide the defense of limitations, he suggested that this presented a question which, if plaintiff appropriately amended his complaint, would create a triable issue of fact, 274 F.Supp. 253 (S.D.N.Y.1967). We reversed on the ground that the dismissal of the Hawkins action for failure to post security was not "on the merits" for purposes of res judicata; we indicated agreement with Judge Cooper's statement as to the defense of limitations and remanded for further proceedings with respect to that issue. 391 F.2d 965 (2 Cir. 1968).
On September 24, 1970, Mr. Markowitz, "attorney for plaintiff," entered into a stipulation of settlement with the attorneys for the various individual and corporate defendants and the attorneys for Tonopah, which had previously been dissolved. This provided for the payment to Wilmington Trust Company, which a Delaware court had appointed to receive and distribute any assets of Tonopah that could not be distributed in liquidation before March 31, 1965, of $250,000 less the costs of notice of the settlement hearing and the fees and disbursements of plaintiff's counsel. Although there is a dispute when agreement on the settlement was actually reached, it is not asserted that plaintiff Saylor at any time authorized it or that Markowitz or anyone else advised him of its terms until November 4, 1970.
On that date Judge Ryan had signed an order setting a hearing on the settlement for December 1, 1970. The notice approved for transmission to stockholders contained no intelligible reference to the most important allegation of the complaint, namely, that defendants had intended the sales to Mines Incorporated to constitute only a step in an ultimate transfer to defendant La Luz Mines, Limited.
At the hearing on December 1, 1970, Mr. Markowitz announced that he appeared "on behalf of the plaintiff." This elicited a response by Lillian Eichman, who had been of counsel in the Hawkins action, that she appeared on behalf of Mr. Saylor in opposition to the settlement. Avrom S. Fischer announced he represented another opposing stockholder, Roseanne Horn, and was of counsel to Mrs. Eichman. Gerard J. O'Brien appeared on behalf of another objecting stockholder, Michael J. McLaughlin. McLaughlin, Saylor, and Fischer, on Miss Horn's behalf, filed affidavits in opposition. Mr. Markowitz made an extended statement in support of the settlement,
As earlier stated, there is a dispute about the time when the settlement was actually reached. McLaughlin's second affidavit stated that Markowitz informed him on June 4, 1969, of a meeting to be held the next day to discuss settlement; that "on Aug. 20, 1969, [Markowitz] informed me of the present offer, which I refused. Mr. Saylor soon thereafter advised me that he had similarly told Mr. Markowitz that he does not agree to any settlement, such as the present proposal." Fischer's second affidavit pointed to a letter to Miss Horn, dated October 29, 1969, from a member of the firm representing defendants, which states in part:
Fischer also relied on the nature of the three depositions taken by Markowitz and filed with the District Court, which, we must say, impress us as designed to justify a settlement rather than as an aggressive effort to ferret out facts helpful to prosecution of the suit, as evidence that a settlement had been agreed upon by the time they were taken. In contrast, Markowitz asserted in his reply affidavit that on August 20, 1969, he did not inform McLaughlin of defendants' offer but essentially of the prospects of negotiations; that on September 27, 1969, he called Saylor to advise him of the negotiations and the weakness of plaintiff's case; that he and counsel for Lindsley did believe on October 28, 1969, they had agreed on a settlement, but this subsequently fell through because there was in fact no agreement on the extent to which Falconbridge as a stockholder of Tonopah should share in the proceeds; that subsequent negotiations foundered; and that on January 15, 1970, he sent McLaughlin a letter which he claims informed McLaughlin that settlement negotiations were halted.
We are willing to go along with appellees and hold, despite the seeming incongruity, that the assent of the plaintiff (or plaintiffs) who brought a derivative stockholder's action is not essential to a settlement;
There can be no blinking at the fact that the interests of the plaintiff in a stockholder's derivative suit and of his attorney are by no means congruent. While, in a general sense, both are interested in maximizing the recovery this is only a half-truth. Even apart from special considerations which, as has been noted, may cause special divergence of interest in cases where extremely large amounts are at stake, see Haudek, supra, 23 Sw.L.J. at 768 & n. 166, there is a difference in every case. The plaintiff's financial interest is in his share of the total recovery less what may be awarded to counsel, simpliciter; counsel's financial interest is in the amount of the award to him less the time and effort needed to produce it. A relatively small settlement may well produce an allowance bearing a higher ratio to the cost of the work than a much larger recovery obtained only after extensive discovery, a long trial and an appeal. The risks in proceeding to trial vary even more essentially. For the plaintiff, a defendant's judgment may mean simply the defeat of an expectation, often of relatively small
In many suits which have been prepared almost to the point of trial, the pretrial discovery, conducted when the objective of plaintiff's attorney was still to develop the strongest possible basis for a recovery, may be entirely adequate to that end. But that is not the case here. Two of the defendants, La Luz and Falconbridge,
Despite all this, we ought not to take up the time of the district court and the parties with a remand if, on the basis of undisputed facts, a substantial recovery here was hopeless or nearly so. We do not think, however, this can fairly be said on the record before us. We shall limit our discussion to what we consider plaintiff's most promising theory—that the defendants, or at least some of them, in obtaining the SEC exemptions from § 17(a) of the Investment Company Act of 1940 which were required for the sale of the stock of Tonopah Nicaragua to Mines Incorporated, had concealed that the true beneficiary of the transfers was always intended to be La Luz,
In order to understand the problem, some knowledge of the intricate intercorporate relations is needed. Plaintiff's complaint alleges the following facts in this respect: In 1950 Ventures, Limited, owned 13.48% of the voting stock of Tonopah, a registered investment company; by 1953 the proportion had increased to 26.25%, presumptively control under § 2(a)(9) of the 1940 Act. Defendant Lindsley, individually and through defendant Northfield Mines, Inc., owned more than 34% of the voting stock of Ventures. That company owned in excess of 54% of the voting stock of Frobisher Ltd., of which Mines Incorporated was a wholly owned subsidiary. Also Ventures owned more than 69% of the voting stock of La Luz, which owned and operated a gold and silver mine in Nicaragua only thirty miles away from Tonopah Nicaragua's Rosita copper mine and had developed a hydro-electric power plant at a site which was apparently the
In November, 1950, Tonopah applied, pursuant to § 17(b) of the 1940 Act, for an exemption permitting the sale of 60% of the stock of Tonopah Nicaragua to Mines for $210,000. This was necessary because Ventures' ownership, then 13.48%, of the voting stock of Tonopah and of some 54% of the voting stock of Frobisher made Tonopah and Mines affiliated persons within § 2(a)(3). The application recited unsuccessful efforts in 1948-49 to sell the Rosita mine at a net price of $297,000, and a similarly unsuccessful effort early in 1950 to sell it for $275,000. There appears never to have been doubt that the Rosita mine possessed very substantial copper reserves; the problem was the cost of mining and refining, due to the mine's remote jungle location and the complex nature of the Rosita copper ore. The application was twice amended, apparently on the insistence of the SEC, to incorporate further detail, including a report by an engineering firm, Singmaster & Breyer, bringing up to date a 1943 report by A. Wheeler, which showed that the cost of producing a pound of refined copper by a process involving the use of a flotation concentrator, a reverberatory furnace, and converters would be 31.6 cents as against a domestic copper price, as of February 21, 1951, of 24.5 cents, and would require investment of $12,000,000, several times Tonopah's total resources. On April 16, 1951, the SEC granted the exemption.
In January, 1953, Tonopah filed an application with the SEC for a § 17(b) exemption for the sale of the remaining 40% of the stock of Tonopah Nicaragua to Mines for $65,000 plus 10,000 shares of common stock of Falconbridge Nickel Mines Limited having a market value of some $200,000, more or less, in Canadian funds. Defendant Lindsley was president of Falconbridge, and Ventures owned 61.1% of its stock. Just how Mines came into ownership of the 10,000 shares was not explained. This application, too, was twice amended. One amendment included a new report from Singmaster & Breyer showing that "the most feasible process," still the flotation concentrator, reverberatory furnace and converters recommended by Wheeler a decade before, would now require a capital investment in excess of $13,500,000 and would result in a cost per pound well above current copper prices. The SEC granted the exemption in November, 1953.
All of the Tonopah Nicaragua stock was transferred from Mines to its parent, Frobisher, on February 11, 1954. Frobisher then entered into agreement, dated September 21, 1954, to sell the Tonopah Nicaragua stock—and thus the Rosita mine—to La Luz for $515,907.65. Evidently an agreement in principle had been made much earlier, since the minutes of a La Luz shareholders' meeting on May 26, 1954, recited that half the price had already been paid. The mine was conveyed in January, 1955. The refining method evaluated by Wheeler and by Singmaster and Breyer being economically impracticable, La Luz apparently devoted considerable effort to the development of an electrolytic refining process for the Rosita ore. That process, however, was also eventually rejected because of excessive capital requirements and too narrow a profit margin. Ultimately, it was decided not to smelt and refine the ore at the mine site, but rather to use a leach precipitation flotation process to produce a copper concentrate which was then shipped overseas for smelting and refining. The operating cost of producing a pound of refined copper by this process was estimated to be 22 cents by H. S. McGowan in 1957, and the capital cost to La Luz was in fact only some $7,500,000. Acquisition of the mine was hugely profitable to La Luz; objector McLaughlin asserts that La Luz realized net operating profits from it of $38,660,000 between 1959 and 1969.
Although the 1950-51 exemption application to the SEC contained no reference to La Luz, that company's report to stockholders for the fiscal year ended September 30, 1951, issued on March 12, 1952, stated, in explanation of a small balance sheet item entitled "Rosita property
None of this history explicitly refutes defendants' claim that, at the time the SEC granted the first exemption application in April, 1951, there was no thought that La Luz, also an "affiliated person" of Tonopah within § 2(a)(3), would become the owner of the Rosita mine, although La Luz' statement of joint ownership in its 1951 annual report at least creates some basis for scepticism. In any event, some explanation would surely seem required why no mention was made of La Luz in the application of January, 1953, and why it was characterized merely as a prospective operator in the amendment of July 7, 1953. What puts a somewhat sinister color on what may have been merely an innocent mistake, if even that, is the possibility that La Luz ownership of a nearby hydroelectric power plant may have invalidated the calculations submitted to convince the SEC that the Rosita mine could not be profitably operated at that time, and that some of the directors of Tonopah or other persons having responsibility for the applications knew not only this but also the actual extent of development of an economically feasible refining process for the Rosita ore.
We do not mean any of this to be taken either as indicating that plaintiff in fact has a winning case on the theory here discussed or that others of his theories may not have promise, at least as against some of the defendants. We have felt compelled to go this far into the merits only to show that the settlement should not have been approved over his opposition when there is such doubt whether there had been truly adversary discovery prior to the stipulation of settlement and he was afforded no opportunity for any thereafter.
We recognize that since "[t]he very purpose of a compromise is to avoid the trial of sharply disputed issues and to dispense with wasteful litigation", the court must not turn the settlement hearing "into a trial or a rehearsal of the trial"; and that the court "is concerned with the likelihood of success or failure and ought, therefore, to avoid any actual determination of the merits." See Haudek, supra, 23 Sw.L.J. at 795 (footnotes omitted). Still, in passing on the settlement of a derivative suit, as on a compromise in a proceeding under Ch. X of the Bankruptcy Act, the judge must have "apprised himself of all facts necessary for an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated." Protective Committee for Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424-425, 88 S.Ct. 1157, 1163, 20 L.Ed.2d 1 (1968). We cannot say that, particularly in light of the reasoned objections of the plaintiff, as well as of other stockholders, the court did that here. No one would think of applying to the presentation of plaintiff's former attorney at the hearing in this case the characterization of "thoroughness, thoughtfulness and disinterested judgment," which Judge Wyzanski used in approving the settlement in Cherner v. Transitron Electronic Corp., 221 F.Supp. 48, 51 (D.Mass.1963).
The order is reversed and the cause remanded for further consistent proceedings.
Everything turns on the meaning of "concluded." Plaintiff says it means "finished." Markowitz, relying on the reference to "pre-trial proceedings", contends it means "broken off". Plaintiff counters that the October 29 letter of defendants' counsel quoted in the text contemplated the taking of depositions prior to a hearing on a settlement.