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FISCHER v. CF&I STEEL CORP.

December 20, 1984

ETHEL FISCHER and HERBERT BONIME, Plaintiffs,
v.
CF&I STEEL CORPORATION, THOMAS M. EVANS, SOUTHERN PACIFIC COMPANY and SOUTHERN PACIFIC TRANSPORTATION COMPANY, Defendants; MARY MAYER, Plaintiff, v. CF&I STEEL CORPORATION, THOMAS M. EVANS, SOUTHERN PACIFIC COMPANY and SOUTHERN PACIFIC TRANSPORTATION COMPANY, Defendants.



The opinion of the court was delivered by: LASKER

LASKER, D.J.

I.

 These shareholder double-derivative suits are brought on behalf of the Southern Pacific Transportation Company ("SPTC"), a subsidiary of the Southern Pacific Company ("Southern Pacific"), a Delaware corporation, against defendant Thomas M. Evans, a former Southern Pacific and SPTC director and the owner of a "substantial interest" in defendant CF&I Steel Corp. ("CF&I"). The shareholder plaintiffs allege that defendants violated Section 10 of the Clayton Anti-Trust Act, 15 U.S.C. § 20 (1982), by failing to employ statutorily required competitive bidding procedures for purchases between 1978 and 1981 of over $70 million in rails and rail products by SPTC and CF&I. Section 10 requires common carriers such as SPTC to receive competitive bids from potential vendors if any of its directors held a "Substantial interest" in the vendor. *fn1"

 Defendants initially moved to dismiss the amended complaints for failure to make a demand upon the directors of Southern Pacific or SPTC to bring or prosecute an action as required under Federal Rule of Civil Procedure 23.1.Plaintiffs cross-moved for summary judgment and to establish defendants' liability under Section 10 of the Clayton Act. *fn2" Due to the merger of Southern Pacific and Santa Fe Industries ("Santa Fe") creating a new holding company, Santa Fe Southern Pacific Corporation ("SFSP"), defendants subsequently moved to dismiss the complaint on the ground that plaintiffs lack standing to continue these actions. Under the terms of the combination agreement, Santa Fe and Southern Pacific shareholders exchanged their stock for SFSP shares and the two companies became wholly-owned subsidiaries of the new entity. We have reviewed the parties' submissions and arguments and now hold that plaintiffs no longer have standing to assert their claims due to the Santa Fe-Southern Pacific merger. *fn3"

 II.

 Under the terms of the October, 1983 Combination Agreement and Plan of Reorganization, Southern Pacific became a wholly-owned subsidiary of SFSP through a procedure in which SFSP created a wholly-owned subsidiary, SPC (Delaware) Inc., which merged into Southern Pacific which survived. Each share of outstanding Southern Pacific common stock at the time of the merger was converted into 1.543 shares of SFSP common stock. See Combination Agreement and Plan of Reorganization, art. I, para. 2, at 3, reprinted in, Notice of Motion, filed Mar. 8, 1984, at Exhibit A. *fn4" The Agreement further stated that it was the contracting parties' intent that the Santa Fe and Southern Pacific SFSP subsidiaries "each continue (so far as practicable and consistent with the basic purposes of [the] Agreement) the separate operations of their respective enterprises" and it provided for an SFSP board of directors composed of pre-merger directors of both Santa Fe and Southern Pacific. See id., art. 5, at 8-9.

 III.

 Defendants assert that plaintiffs have lost their standing to continue these double-derivative actions because they are no longer shareholders in Southern Pacific. They contend that plaintiffs have lost their proprietary interest in Southern Pacific because SFSP is now the sole shareholder of Southern Pacific stock, and it makes no difference that this state of affairs came about due to a merger transaction instead of a voluntary sale of stock by the plaintiffs. Defendants rely primarily upon Delaware law to argue that even in situations in which shareholders lose their stock through the merger process, a plaintiff continues to have standing in a derivative action only by owning stock in the relevant corporation throughout the litigation. *fn5" SFSP, in defendants' view, is now the shareholder beneficiary of any claims which Southern Pacific or SPTC previously had against the defendants. They assert that plaintiffs' proper course of conduct as SFSP shareholders is to bring a triple-derivative action on behalf of SFSP after they make a proper demand upon SFSP's board of directors.

 Plaintiffs argue that the Santa Fe-Southern Pacific merger does not deprive them of standing because its only effect upon this litigation was to convert the case from a double-derivative to a triple-derivative law suit.They claim that as SFSP shareholders they retain their proprietary interest in SPTC because Southern Pacific survived as a corporate entity after the merger and continues to own its claims against the defendants.

 This case, plaintiffs contend, is gooverned by federal as opposed to state law because it is founded upon a federal claim. They argue that federal cases denying standing to derivative shareholder plaintiffs are distinguishable because in those cases the plaintiffs had sold their shares and thereby surrendered their equity interests in the corporations on whose behalf they had sued. Plaintiffs point out that, in contrast, this case involves an exchange of stock for a new third-tier parent, which at least one court in this District has found does not eliminate derivative plaintiff standing because it is not the same as a sale of stock. *fn6"

 Plaintiffs go on to argue that the Delaware cases relied upon by the defendants are also distinguishable because in those cases the plaintiffs were denied standing to represent corporations that were merged out of existence.They note that here, southern Pacific survived as a corporation after its merger with Santa Fe. In addition, plaintiffs assert that Delaaware law permits their actions to go forward because the merger here was, in effect, a nominal reorganization of Southern Pacific which merely led to the creation of a holding company.They note that the composition of Southern Pacific's board of directors and officers within SFSP remains unchanged since the merger and contend that the liability of the Southern Pacific directors is not removed merely because of a change of hats. Moreover, plaintiffs contend that because of the substantial control which former Southern Pacific officers and directors exert over SFSP and its board, a demand upon the SFSP board of directors to prosecute these actions would be futile. Finally, plaintiffs ask in supplemental letters that they be allowed to continue their suits as a class action on behalf of southern Pacific shareholders owning stock at the time of the company's combination with Santa Fe, in the event their amended complaints are dismissed for lack of standing.

 IV.

 The amended complaints allege that jurisdiction is based upon 28 U.S.C. § 1337 (1982), which grants original jurisdiction to the federal courts in any action arising under the federal antitrust laaws. Since plaintiffs assert causes of action based solely upon violations of the Clayton Anti-Trust Act, it appears that for the reasons set forth in Drachman v. Harvey, 453 F.2d 722, 725-30 (2d Cir. 1974), the question of derivative shareholder standing under Federal Rule of Civil Procedure 23.1 is controlled by federal law. See also Orenstein v. Compusamp, Inc., 29 Fed. R. Serv. 2d (Callaghan) 466, 467 (S.D.N.Y. 1974). *fn7" Plaintiffs seek to vindicate federally-created rights through derivative actions which were within the historic equity jurisdiction of the federal courts. See Drachman v. Harvey, supra, 453 F.2d at 728-29, citing, Dodge v. Woolsey, 59 U.S. (18 How.) 331, 15 L. Ed. 401 (1855); Hawes v. City of Oakland, 104 U.S. 450, 26 L. Ed. 827 (1882). It is appropriate for the federal courts to apply a uniform standard for determining shareholder standing in derivative suits founded upon federal claims. See Drachman v. Harvey, supra, 453 F.2d at 729; Arnett v. Gerber Scientific, Inc., 566 F. Supp. 1270, 1272-73 (S.D.N.Y. 1983). Accordingly, the issue to be resolved is how does federal law view the standing of shareholders who, through no action on their part, no longer own the stock of the corporation on whose behalf they sue. *fn8"

 The application of the Drachman rule does not fully answer the question posed by defendants' motion. Defendants point out that in Rothernberg v. United Brands Co., [1977-78 Transfer Binder] Fed. Sec. L. Rep. (CCH) P96,045 (S.D.N.Y.), aff'd mem., 573 F.2d 1295 (2d Cir. 1977), Judge Brieant found that a plaintiff who received cash for his stock from a tender offer lacked standing under Rule 23.1 to bring a shareholder derivative suit alleging violations of Section 16(b) of the Exchange Act. 15 U.S.C. § 78p(b) (1982). He noted that while Rule 23.1 does not specifically require a shareholder to retain his or her ...


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