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Bankruptcy and class action litigation have been seen as similar. In both, the aggrieved parties, in a presumably organized fashion, are proceeding on behalf of others similarly situated, in an attempt to maximize recovery. In bankruptcy, this group is the unsecured creditors’ committee and in the class action context, it is the class action plaintiffs. Interestingly, one of the questions with which class action lawyers have often grappled — that of to whom do causes of action belong, the shareholders or the company — is also faced by creditors and committees. The lines of demarcation between bankruptcy and class action litigation have often been less than clear, with the parties being uncertain over what happens to pending class action litigation when a bankruptcy is filed, and debtors and creditors being unclear whether shareholder plaintiffs can proceed, and under what rules, following the commencement of Chapter 11 proceedings. Creditors have taken the position that there is no need for class action litigation to proceed once a Chapter 11 case has been filed because the claims will be pursued by the debtor and/or the committee. Of course, that analysis is somewhat complicated by the fact that there is often insurance coverage for defendants which is only available when parties other than the corporate insured, or a committee suing on its behalf, is the plaintiff. As the anticipated returns for aggrieved creditors and shareholders in bankruptcy cases shrink, those parties are pushed to be ever-more creative in pursuing recovery. A recent opinion has provided important guidance for those trying to navigate the bankruptcy/class action quagmire. In In re Enron Corp., 2002 U.S. Dist. LEXIS 19987, decided on Oct. 22, the U.S. District Court for the Southern District of New York found that the Enron shareholder plaintiffs were free to proceed with their action against Dynegy despite the Enron bankruptcy and debtor’s independent prosecution of claims against the same defendant. In the fall of 2001, as Enron was beginning its public slide into financial ruin, the thinking was that it could salvage its future by signing a merger agreement with Dynegy. Under the proposed merger, Enron’s debts would be assumed by Dynegy, and Dynegy would invest $1.5 billion in Enron. Additionally, Enron’s shareholders were to be issued shares in Dynegy in an amount that would have given them 36 percent of the combined company. However, before the merger was consummated, Dynegy alleged that there had developed “a materially adverse condition in Enron’s financial affairs” and withdrew from the agreement with Enron. In fact, Enron blamed its bankruptcy filing in large part on the botched merger and the downgrade to “junk” status. In addition to terminating the merger, Dynegy also sought to exercise a provision in the merger agreement that was to give it control of Enron’s Northern Pipeline assets, among Enron’s most valuable assets. Following the filing of Enron Chapter 11 on Dec. 2, 2001, Enron’s shareholders sought to enforce their rights as shareholders against Dynegy under the merger agreement. Those shareholders filed suits in federal district court in the Southern District of New York and in the Texas state courts. The suits sought specific performance by Dynegy in the merger agreement and/or money damages, claiming that they were third-party beneficiaries under the agreement. However, immediately after the cases were filed, the bankruptcy court for the Southern District of New York enjoined the suit, finding that “the shareholders [did] not have standing to sue [because] their claims are derivative and belong to Enron.” Specifically, Bankruptcy Judge Arthur Gonzalez entered an order dated April 19, 2002, “providing that the stay should be enforced and directing dismissal of the shareholder actions.” At the same time Enron filed bankruptcy, it filed an adversary proceeding in the bankruptcy court seeking damages of more than $10 billion from Dynegy. That litigation was ultimately settled by Dynegy agreeing to pay Enron $92 million. The disappointed shareholders appealed the opinion of the bankruptcy court to the U.S. District Court for the Southern District of New York. District Court Judge Alvin K. Hellerstein reversed the opinion of the bankruptcy court, holding that “the Enron shareholders have a separate and independent right of action under the merger agreement and may therefore proceed with their claims against Dynegy.” In reviewing the opinion of the bankruptcy court, the district court noted that the automatic stay of � 362(a) of the Bankruptcy Code stays “any action to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” The court also noted � 541(a) of the code, which “provides that the commencement of a bankruptcy case creates an estate comprised of ‘all legal or equitable interests of the debtor in property as of the commencement of the case.’” Obviously, the outcome of the dispute depended on whether the shareholders’ claims against Dynegy were “derivative and thereby possessed by Enron” or were “separate and independent, so that only the shareholders may vindicate the rights provided to them.” Additionally, the court noted that state law determines which claims belong to the estate, and hence can be pursued by the trustee. The merger agreement stated that it was governed by Texas law. Under Texas law “if a corporation suffers damages, the corporation, and not its shareholders, has the right to sue.” However, a “corporate shareholder may have an action for personal damages ‘where the wrongdoer violates a duty arising from contract or otherwise and owing directly by him to the stockholder.’” This independent right of a corporate shareholder “is permitted only when the wrongs are such as to give to the stockholder personally a right of action. If the injuries complained of are such as to give to the corporation a cause of action upon damages … , the stockholder has no right to bring suit.” The court needed to determine whether there was an independent “cause of action” by the plaintiff shareholders and found that “if Dynegy repudiated the merger agreement, shareholders have a right to sue in order to enforce those provisions of the contract that benefit them.” In fact, in addition to specifically providing for issuance of Dynegy stock to Enron shareholders, the merger agreement “explicitly state[d] that the third-party provisions in the contract may be enforced by third parties.” Thus, the court found that “Dynegy’s withdrawal from the merger agreement … triggered the shareholders’ right as third party beneficiaries to claim damages for breach of the provisions of the agreement that benefited them.” Further, the court found that the nature of the alleged misconduct by Dynegy “cause[d] an injury to the plaintiff distinct from any injury to [Enron]” because although Enron was having its debts assumed, the shareholders were to obtain equity in the merged corporation. In fact, the court found additional support in its conclusion that there were separate and distinct claims of Enron and its shareholders by looking to the Dynegy/Enron settlement agreement that released Dynegy from claims made by Enron, but did not release the shareholders’ claims. Among the other lessons from the opinion of Hellerstein is the reminder that agreements which give specific rights to shareholders, directly, will add another layer of complexity for counterparties attempting to settle cases, but similarly empower the shareholders who have direct claims for injury. Interestingly, shortly after the Enron decision, practitioners received further guidance on the interplay of bankruptcy and class action. On Nov. 19, the 11th U.S. Circuit Court of Appeals in Chrysler Financial Corporation v. Powe, 2002 U.S. App. LEXIS 23881, addressed, for the first time, the question of whether a party may appeal directly to the court of appeals an order by the bankruptcy court granting class certification. In the Chryslercase, Chrysler Financial and other defendants were subject to numerous adversary proceedings in the bankruptcy court for the Southern District of Alabama. In those cases, the plaintiffs alleged that the defendants had violated the bankruptcy code when they asserted and collected on claims for attorney fees from debtors. The bankruptcy court granted class certification under Fed.R.Civ.P. 23(f) and Fed.R.Bank.P. 7023(f). As most attorneys know, when a bankruptcy court enters an order, the district court, or bankruptcy appellate panel, sits, in essence, as the court of appeals. In this case, the defendants argued that because this was an order dealing with a class action, they should be able to “skip” the district court level and proceed directly to the court of appeals. The 11th Circuit rejected that argument and, accordingly, the defendants would have to argue their class certification issues in the district court. Paul J. Brenman is a partner at Wolf Block Schorr & Solis-Cohen ( www.wolfblock.com) in Philadelphia and chairs the firm’s bankruptcy practice group. If you are interested in submitting an article to law.com, please click herefor our submission guidelines.

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