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When a failed corporate merger results in a flurry of shareholder lawsuits, the federal courts shouldn’t take a back seat and defer to the state courts — even corporate-law-savvy courts from Delaware — a federal appeals panel ruled Thursday. The decision in McMurray v. DeVink reverses a ruling by U.S. District Judge Katherine Sweeney Hayden of the District of New Jersey that stayed all federal litigation filed in the wake of the failed merger of Warner Lambert Co. and American Home Products Corp. to await the outcome of litigation in the Delaware courts. The appellate court found that while Hayden correctly refused to “abstain” from the case, her decision to stay the litigation would have the same effect. And Hayden’s rationale for issuing the stay was flawed, the appellate panel found, since there is nothing in the law that prohibits the federal courts from exercising jurisdiction over a dispute that is being litigated at the same time in a state court. Defense lawyers argued that Hayden’s decision was sound because the issues were all controlled by Delaware law and the courts of Delaware have an expertise in resolving corporate law and shareholders’ rights cases. But the 3rd Circuit said the federal courts cannot relinquish jurisdiction simply because a state court is up to the task. “We share the appellees’ high regard for the courts and jurists of Delaware, and we are well aware of the unique stature of corporate law in Delaware. However, that is not a sufficient reason for a federal court to refrain from exercising jurisdiction,” Circuit Judge Theodore A. McKee wrote. The litigation began soon after Warner-Lambert announced in November 1999 that it had agreed to merge with AHP in a $70 billion deal that valued Warner’s stock at about $83. Later the same day, Pfizer Inc. made a hostile bid to take over Warner for $82.4 billion, paying more than $96 per share. Although the Pfizer deal was clearly better for shareholders, the AHP deal was better for the Warner executives. It included a governance clause that said the new company would have 20 directors — 10 each from Warner and AHP — and that Warner’s CEO would jointly run the company for 18 months with AHP’s CEO who would then step aside. The Warner/AHP merger agreement also contained a “break-up fee” that required Warner to pay $2 billion to AHP if Warner terminated the agreement. In a spate of lawsuits, Warner shareholders accused the company’s directors of breaching their fiduciary duty by failing to pursue Pfizer’s higher offers; by rebuffing Pfizer’s previous attempts to enter into merger talks; and by agreeing to the $2 billion break-up fee. Two of the lawsuits were filed in U.S. District Court in New Jersey by attorneys Richard B. Brualdi of New York and David J. Manogue of Specter Specter in Pittsburgh. More than 30 suits were filed in the Delaware state courts, including a derivative action. Defense lawyers set out to secure a single forum and urged Judge Hayden to abstain or stay the federal cases. Hayden refused to abstain, but agreed to issue a stay and to “administratively terminate” the cases pending the outcome of the Delaware litigation. On appeal, Warner’s and AHP’s lawyers — Dennis J. Block of Cadwalader Wickersham in New York and Elizabeth J. Sher of Pitney Hardin in Morristown, N.J. — argued that the 3rd Circuit should dismiss the appeal for lack of jurisdiction since Hayden’s stay was not a “final order.” The 3rd Circuit disagreed, saying Hayden’s stay was “equivalent to a dismissal” because she had effectively surrendered jurisdiction to the state courts whose judgments would be res judicata. “A decision on the merits in the state court will have a preclusive effect on the stayed federal case, putting the shareholders effectively out of federal court,” McKee wrote in an opinion joined by Chief Circuit Judge Edward R. Becker and Circuit Judge Marjorie O. Rendell. Plaintiffs’ lawyers argued that Hayden’s stay should be lifted because it amounted to an abstention that violated the U.S. Supreme Court’s 1976 decision in Colorado River Water Conserv. Dist. v. United States. McKee agreed, saying Hayden erred by relying on Tabas v. Mullane, a 1985 decision from the District of New Jersey, to support her decision to stay the litigation despite refusing to abstain. “The district court erred in concluding that, by staying the case, it was not abstaining. The stay that was entered was nothing more than the procedural mechanism for abstaining in favor of concurrent state litigation,” McKee wrote. “We reject any motion that Tabas could properly establish a separate test for abstention. The relevant inquiry must be guided by Colorado River and its progeny, not Tabas or principles extrapolated from it,” McKee wrote. In 1997, McKee said, the 3rd Circuit interpreted and expounded on Colorado River with its decision in Ryan v. Johnson. McKee said Ryan “cautioned that if the presence of concurrent litigation itself becomes the threshold test for meeting Colorado River’s piecemeal litigation factor, then the test becomes so broad that it swallows up the century-old principle that the pendency of an action in the state court is no bar to proceedings concerning the same matter in the federal court having jurisdiction.” Hayden erred, McKee said, by not following Ryan. “There is no credible allegation that this litigation involves anything more than garden-variety state corporate law issues,” McKee wrote.

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