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As any litigator will attest, the Erie doctrine and Rule 12(b)(6) of the Federal Rules of Civil Procedure loom large not only in the first-year law school curriculum but also well beyond. On Sept. 3, in a ruling lawyers believe fills a void in Texas Supreme Court precedent, the 5th U.S. Circuit Court of Appeals reversed and remanded a Rule 12(b)(6) dismissal for failure to state a claim upon which relief can be granted. The court noted in Herrmann Holdings Ltd., et al. v. Lucent Technologies Inc. that the Texas Supreme Court never has ruled on the enforceability of “best efforts” clauses in breach of contract actions. Nor had Texas courts considered contractual obligations to use “reasonable best efforts” to file an S-3 registration statement with the Securities and Exchange Commission “as promptly as practicable” and “in the most expeditious manner practicable.” In compliance with the Erie doctrine, which requires federal courts in diversity actions to apply the law of the state in which they sit, the 5th Circuit made an Erie “guess” as to what the Texas Supreme Court most likely would decide. The court concluded that no Texas case precluded recovery for breach of such obligations. Thus, the 5th Circuit concluded that the Texas Supreme Court would decide that the dismissal of the breach of contract claim at the 12(b)(6) stage was premature. “I think this case will be cited with great frequency, because it is a very important decision,” says Geoffrey L. Harrison, a partner in Susman Godfrey in Houston who represents the Herrmann entities. “The case is critically important because it affirms the longstanding concept of Texas law that courts will enforce parties’ contractual agreements as written,” he says. That’s exactly what the 5th Circuit did, he says, adding that the court gave meaning to the negotiated term of requiring action as promptly and expeditiously as practicable. Two of Lucent’s lawyers, Kathleen M. LaValle and Mark R. Steiner, partners in Jackson Walker in Dallas, decline to comment. Bill Price, Lucent’s media relations director, says that although he won’t comment on specifics with regard to the pending litigation, Lucent is confident that the contract claims, like the claims that were dismissed, have no merit. Professor Lonny Hoffman, who teaches civil procedure at the University of Houston Law Center, believes Herrmann Holdings is so significant that he made a point of attending the 5th Circuit oral arguments in New Orleans on June 4. In fact, Hoffman already has used the facts of the case as a teaching tool: He divided his civil procedure class in two and asked students to prepare and present their own oral arguments as to whether a 12(b)(6) dismissal of the case should have been granted. “A 12(b)(6) dismissal is basically the equivalent of ending the game before the first batter is even up, or early in the first inning,” Hoffman says. “They are granted infrequently as compared to other pretrial motions.” As recounted in the Sept. 3 opinion by 5th Circuit Judge Carl E. Stewart and as alleged in Herrmann’s second amended complaint, the dispute arose when Herrmann Holdings Ltd., AnnEm Investments Ltd. and Herrmann Technology Trust, which owned 100 percent of the shares of Dallas-based Herrmann Technology Inc., sold HTI to Lucent, a Delaware corporation with its principal place of business in New Jersey in June 2000 pursuant to a merger agreement. The price: 6.77 million shares of Lucent stock, which, at $60 per share, was worth more than $400 million, according to the opinion. The Herrmann entities couldn’t sell their Lucent stock until Lucent filed, and the SEC declared effective, a Form S-3 registration statement, according to the opinion. Consequently, the merger agreement provided that Lucent “use its reasonable best efforts to prepare, file and cause to become effective, as promptly as practicable” the Form S-3, the opinion noted. But it took Lucent six weeks to do so, and by the time the SEC declared the S-3 effective on Aug. 7, 2000, the stock had dropped to $42 per share, according to the opinion. The Herrmann entities sued, alleging that the delay breached the contract, violated the Texas Securities Act and constituted statutory fraud. Then-U.S. District Judge A. Joe Fish, now chief judge of the Northern District of Texas, dismissed the case on Oct. 5, 2001, on the ground that the contract, Texas Securities Act and fraud allegations failed to state a claim on which relief could be granted. The 5th Circuit affirmed with regard to the Texas Security Act and fraud claims, but held that Fish had dismissed the breach of contract claim prematurely and remanded the case. Among other things, the court rejected Fish’s “narrow reading” of a Texas appeals court case — 1991′s CKB & Associates Inc. v. Moore McCormack Petroleum Inc. — in which the 5th Court of Appeals in Dallas interpreted enforceability of best efforts clauses in breach of contract actions to process crude oil as requiring “some kind of goal or guideline” against which best efforts could be measured. “Requiring contracting parties to fix a date certain in order to set a temporal guideline in which to complete a certain task demands more definiteness than Texas law requires,” wrote Stewart, joined by Judges W. Eugene Davis and Harold R. DeMoss Jr. This language in the merger agreement was not mere boilerplate, Harrison says. It was specifically negotiated to impose a specific obligation on Lucent, and the Herrmann entities allege that Lucent breached that obligation, he says. Consequently, the Herrmann entities seek actual damages of more than $120 million, roughly calculated by multiplying 6.77 million shares by the difference between $60 and $42, Harrison says. Lucent contended in its appellate brief that the district court correctly applied the laws of Texas and the 5th Circuit to the allegations contained in the Herrmann entities’ second amended complaint and that no further proceedings are warranted. With regard to the contract action, Lucent contended in its brief: “The district court held that, in the absence of any specific date in the contract by which filing or registration was to be accomplished, the ‘as soon as practicable’ language of the Agreement was not a suitably objective goal to form the basis of recovery in damages.” Lucent added: “This decision — denial of money damages in the absence of an allegation that an objective ‘best efforts’ registration goal was missed — is entirely consistent both with Texas common law as applied in damage suits and with the great bulk of best efforts stock registration cases.” A REAFFIRMATION John Roberson, an appellate specialist and partner in Houston’s Hill, Parker & Roberson, says Herrmann Holdings will fill a void in Texas state jurisprudence. Roberson, who is not involved in the case, says he found it surprising that there was no Texas Supreme Court case directly on point. Even so, he believes the 5th Circuit opinion is in line with the general flow of case law over the years in Texas. “I think it will govern future cases on this point in the federal courts that are within the 5th Circuit’s realm and will be influential in Texas state court decisions,” he adds. As for the Erie doctrine “guess,” Roberson says he believes the 5th Circuit’s analysis is consistent with general contract law principles in Texas over the years, which is to seek to identify what the parties’ intent was in drafting the contract and to enforce that intent as stated in the contract. The problem here, Roberson says, arose from the imprecise language of the best efforts clause in the Herrmann-Lucent contract — that, arguably, it may be hard to measure whether Lucent used its best efforts. “But my take on it is that if the parties decide among themselves that they want to measure their own contract performance by an imprecise standard, it should hardly be up to the court to use that imprecision as an excuse not to enforce the contract,” Roberson says. Granted, this might become a tricky fact-finding process in a given case, Roberson concedes, but no trickier than the kinds of questions courts routinely answer — such as “what is negligence” in a given scenario — the answer to which depends on the facts and on what a jury thinks is reasonable. “I’m not sure this case broke any new ground or made any new law, but what I think is important is that it reaffirms that Rule 12(b)(6) dismissals should be granted only in rare exceptional circumstances,” Hoffman says. “Here there were sufficient allegations, the 5th Circuit held, to support the breach of contract claim that the [appellants/plaintiffs] had brought, so the court ruled — rightly in my view — that the plaintiffs’ case should not have been ended as unceremoniously as it was.” Once the case returns to Judge Fish’s court, the parties likely will engage in discovery, says Harrison, who says that he hopes the case will proceed to trial next summer.

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