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The 3rd U.S. Circuit Court of Appeals says that a family group that owns about $120 million in Cendant Corp. stock can’t opt out of the company’s 1999 class action fraud settlement in an attempt to get a better deal in arbitration. By a 2-1 vote in In re: Cendant Corporation Litigation, No. 00-2185, a three-judge panel ruled that the $2.85 billion class action settlement is binding on the shareholders because they failed to follow court-mandated opt-out procedures. The shareholders are individuals and family trusts associated with Janice and Robert Davidson, who sold their Torrance, Calif., software company, Davidson & Associates Inc., to a Cendant predecessor in return for stock and directorships in 1996. The Davidsons argued that under the Federal Arbitration Act the arbitration clause in that stock deal five years ago took precedence over the settlement and its opt-out rules. U.S. District Judge William Walls in Newark, N.J., to whom the Cendant litigation around the country was assigned, enjoined the arbitration and included the Davidsons in the class after ruling they did not opt out in time. The 3rd Circuit affirmed his decision. “Where a party who desires arbitration fails to timely opt out of the class, the Federal Arbitration Act does not preclude a district court from denying a class member’s request to pursue arbitration,” Judge Thomas Ambro said in an opinion joined by Judge Dolores Sloviter. The Davidsons’ counsel, Gerald Palmer, a partner in the Los Angeles office of Jones, Day, Reavis & Pogue, says he will ask the 3rd Circuit for an en banc review. Palmer declined to comment on his side’s estimate of its benefits as a class member and its potential benefits in arbitration. Cendant’s lawyer, Samuel Kadet, a partner with New York’s Skadden, Arps, Slate, Meagher & Flom, says he hasn’t calculated the difference but adds: “We’re very pleased with the decision. It’s a significant victory for the company.” While rejecting the appellants’ request for arbitration of the fraud claim, the court did agree that claims outside the scope of the class action settlement were arbitrable, a reversal of Walls’ ruling on that issue. The chief issue identified by the appeals court was the value of stock options granted the Davidsons in 1997. Palmer says his side’s win on that point isn’t significant because both sides agreed in the appeal that issues outside the class action were still arbitrable, and Kadet says a relatively small amount of money is involved. Judge Leonard Garth, the dissenter on the panel, says the majority’s reasoning on the main issue was fatally flawed because the arbitration should have taken precedence over the opt-out procedures. He said a class action task force commissioned in January by the circuit’s chief judge, Edward Becker, should study the issues raised by the case. The task force, which heard testimony in March and May, is studying the selection of class action counsel, but Garth said in his dissent: “I suggest that this question of arbitration-class certification is one which in my opinion should assume prominence in the Task Force’s labors.” In the 1996 acquisition of Davidson & Associates by CUC International Inc. for 32 million shares of CUC stock and seats on CUC’s board, both sides agreed that disputes arising from the deal would be arbitrated. Indeed, a dispute over the Davidsons’ employment responsibilities did arise and it was arbitrated to a settlement in May 1997. That year, CUC and HFS Corp. merged to form Cendant. But when accounting irregularities were discovered on the books of pre-merger CUC, Cendant shares lost almost half their value, prompting the class action fraud suits. In 1998, after the lead plaintiffs in those suits sought class certification — but before certification was granted — the Davidsons initiated arbitration in California. And a federal district judge there denied Cendant’s application for an injunction against the arbitration. Cendant eventually took the position that the Davidson group belonged to the class and could avoid receiving its assigned share of the settlement only by following the opt-out procedures in the settlement. Walls enjoined the arbitration and ruled that the Davidsons hadn’t opted out in time, but they argued in the 3rd Circuit that Walls should have extended the opt-out time for them. The Davidsons argued, for instance, that due to a change in their address from California to Nevada they never received the mailed notice of the proposed class action settlement. The 3rd Circuit majority ruled, however, that the Davidsons were aware of the requirements and could have availed themselves of the opt-out provisions. “With sophisticated investors such as the Davidsons, who were assisted by exceptional counsel, it is not a leap of faith to make the logical inference that their failure to file a formal opt-out was a strategic decision,” the court said. In his dissent, however, Garth noted that the arbitration was initiated before the class action certification, making the issue of whether they belonged in the class irrelevant. He said allowing an arbitration of issues peculiar to the Davidsons could not have an imaginable impact on the administration and disposition of other class members’ claims. And he said Walls abused his discretion by enjoining the arbitration decreed by another district judge in California. “The FAA’s clear preference for arbitration over other forms of litigation dictates that an injunction can never be appropriate in a case such as this one,” Garth said.

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