Opinion
20 Civ. 618 (ALC) GWG)
01-07-2021
REVIVE INVESTING LLC, Plaintiff, v. FBC HOLDINGS S.A.R.L, Defendant. and SPHERE 3D CORP., Nominal Defendant.
REPORT AND RECOMMENDATION
GABRIEL W. GORENSTEIN, UNITED STATES MAGISTRATE JUDGE
Revive Investing LLC (“Revive”), a shareholder of Sphere 3D Corporation (“Sphere”), has sued FBC Holdings S.A.R.L (“FBC”), a 10% beneficial owner of Sphere, alleging that it engaged in short-swing transactions in violation of Section 16(b) of the Securities Exchange Act of 1934. Under Section 16(b), corporate insiders, including 10% beneficial owners of stock, who engage in the purchase and sale, or sale and purchase, of the corporation's stock within a six-month period must disgorge any profit to the corporation. 15 U.S.C. § 78p(b). Revive alleges FBC violated this rule when it sold and purchased Sphere stock within a six-month period between February and May of 2018.
FBC previously settled Section 16(b) claims with Sphere and now moves for summary judgment dismissing the case on the ground that the prior settlement bars Revive's claims. For the reasons stated below, FBC's motion should be granted.
Motion for Summary Judgment, filed July 23, 2020 (Docket #32); Memorandum of Law in Support of Summary Judgment, filed July 23, 2020 (Docket #34) (“Def. Mem.”); Declaration of Douglas A. Rappaport in Support of Summary Judgment, filed July 23, 2020 (Docket #35) (“Rappaport Decl.”); Declaration of Miriam Tauber in Support of Summary Judgment, filed July 23, 2020 (Docket #36) (“Tauber Decl.”); Declaration of David Lopez in Support of Summary Judgment, filed July 23, 2020 (Docket #37) (“Lopez Decl.”); Defendant Local Rule 56.1 Statement of Material Facts, filed July 23, 2020 (Docket #38); Declaration of Daniel E. Doherty in Opposition to Summary Judgment, filed August 27, 2020 (Docket #39) (“Doherty Decl.”); Memorandum in Opposition to Summary Judgment, filed August 27, 2020 (Docket #40) (“Pl. Opp.”); Plaintiff Local Rule 56.1 Reply and Statement of Material Facts, filed August 27, 2020 (Docket #41); Reply Memorandum in Support of Summary Judgment, filed September 15, 2020 (Docket #42) (“Def. Reply Mem.”); Counter Statement to Plaintiff's Local Rule 56.1 Statement of Material Facts, filed September 15, 2020 (Docket #43); Supplemental Memorandum in Opposition to Summary Judgment, filed November 18, 2020 (Docket #46) (“Pl. Supp. Mem.”); Supplemental Memorandum in Support of Summary Judgment, filed November 18, 2020 (Docket #47) (“Def. Supp. Mem.”); Supplemental Reply Memorandum in Opposition to Summary Judgment, filed November 25, 2020 (Docket #48) (“Pl. Supp. Reply Mem.”); Supplemental Reply Memorandum in Support of Summary Judgment, filed November 25, 2020 (Docket #49) (“Def. Supp. Reply Mem.”); Supplement Memorandum re Settlement Payment, filed December 18, 2020 (Docket #52) (“Def. Settl. Payment Mem.”); Supplemental Memorandum re Debt Previously Contracted Exception, filed December 21, 2020 (Docket #53).
I. BACKGROUND
The following facts are either undisputed or constitute facts that have not been contested by means of admissible evidence.
In December 2014, Rappaport Decl. ¶ 15, FBC loaned Sphere $19.5 million through an 8% Senior Secured Convertible Debenture, see 8% Senior Secured Convertible Debenture, annexed as Exhibit I to Rappaport Decl., which was amended at least twice over the course of four years, see Second Amendment to 8% Senior Secured Convertible Debenture, annexed as Exhibit J to Rappaport Decl.; Third Amendment to 8% Senior Secured Convertible Debenture, annexed as Exhibit K to Rappaport Decl. (“Third Amendment”). The last amendment, the Third Amendment, was in March of 2018, Rappaport Decl. ¶ 17, and represented the final amendment of the loan from FBC to Sphere for purposes of this case. See Third Amendment. Payment under the Third Amendment was due on May 31, 2018. Id. § 1.1(a).
As part of the Third Amendment, Sphere was required to pay an extension fee, which was to be paid in installments on dates set out in the Third Amendment. Third Amendment § 2.2. Additionally, Sphere was required to pay interest, consisting of interest that had already accrued and interest on the Third Amendment, the payment dates of which were set out in the Third Amendment. Id. § 2.3. The Third Amendment permitted Sphere “at its option” to pay both the extension fee and interest with shares of common stock in lieu of cash payments. Id. §§ 2.2-2.3. FBC reported acquisitions of Sphere stock through this method four times from March to May 2018. Statement of Changes in Beneficial Ownership filed April 3, 2018, annexed as Exhibit M to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed April 18, 2018, annexed as Exhibit N to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed May 1, 2018, annexed as Exhibit O to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed May 17, 2018, annexed as Exhibit P to Rappaport Decl. Prior to Sphere exercising this option, FBC reported multiple sales of Sphere stock in February 2018. See Statement of Changes in Beneficial Ownership filed February 23, 2018, annexed as Exhibit L to Rappaport Decl. These transactions constitute the alleged violation of Section 16(b)'s short-swing profit rule. See Amended Complaint, filed April 23, 2020 (Docket #20) ¶¶ 29-43 (“Am. Comp.”).
In April 2018, Sphere received three letters from counsel for Sphere shareholders alleging short-swing trades by FBC, and demanding that Sphere investigate. The first was from Miriam Tauber and was received on April 18, 2018. Tauber Decl. ¶ 2; Exhibit C to Rappaport Decl.. The second was from David Lopez and was received on April 23, 2018. Lopez Decl. ¶ 2; Exhibit G to Rappaport Decl. The third was from counsel for Revive and was received on April 24, 2018. See Doherty Decl. ¶ 3; Exhibit B to Doherty Decl. Tauber and Lopez decided to work together. Tauber Decl. ¶ 2; Lopez Decl. ¶ 2. Sphere then conducted an investigation into the alleged short-swing transactions. See Sphere Letter, annexed as Exhibit E to Rappaport Decl. (“Sphere Letter”). At the conclusion of its investigation, Sphere notified Tauber it had decided against pursuing litigation for the alleged short-swing profits citing possible defenses by FBC, the cost of litigation, and the amount at issue. See id. at 2. The letter advised Tauber to contact FBC's counsel directly if she still intended to pursue litigation. Id. Tauber then engaged directly with counsel for FBC regarding the demands. Tauber Decl. ¶ 5; Lopez Decl. ¶ 5.
On November 8, 2018, after more than three months of settlement negotiations, FBC, Sphere, Tauber, and Lopez entered into a settlement agreement (“Settlement Agreement”). Rappaport Decl. ¶¶ 2-4; Tauber Decl. ¶¶ 5-6; Lopez Decl. ¶¶ 5-6; see Settlement Agreement, annexed as Exhibit B to Rappaport Decl. (“Settlement Agreement”). The Settlement Agreement purports to settle Sphere's alleged short-swing profit claim against FBC for $300,000, of which 25%, or $75,000, was to be paid to the shareholders' counsel as attorneys fees. Settlement Agreement at 1-2. In the Settlement Agreement, Sphere released FBC “from all liability and damages . . . arising from the Transactions identified in the Shareholder demands, or other Transactions through which [FBC] received [Sphere] shares in connection with the pay-down of loan debt, reported by [FBC] through the date of [the] Agreement” on behalf of itself and all of its shareholders. Id. ¶ 3.
FBC paid the settlement amount by forgiving $300,000 of Sphere's debt owed on the loan. See Declaration of Jennifer M. Pulick, annexed to Def. Settl. Payment Mem. (“Pulick Decl.”) ¶¶ 4, 6-7; Acknowledgment Letter, annexed as Exhibit A to Pulick Decl. § 1.
FBC is managed by Cyrus Capital. Am. Comp. ¶ 19. The Settlement Agreement refers to Cyrus Capital, FBC, and their affiliates as “Cyrus Capital.” Settlement Agreement at 1.
Sphere never responded to the demand letter from Revive. See Doherty Decl. ¶ 7. Revive sent another demand letter on October 17, 2019. See Doherty Decl. ¶ 5; Exhibit D to Doherty Decl. Sphere failed to respond to this letter as well. See Doherty Decl. ¶ 7. Revive then brought the instant action. See Complaint, filed January 23, 2020 (Docket #1).
Before the Court is FBC's motion for summary judgment seeking to dismiss Revive's complaint on the basis of the Settlement Agreement.
II. GOVERNING LAW
A. Summary Judgment Standard
Rule 56(a) of the Federal Rules of Civil Procedure provides that a court shall grant summary judgment when “the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a). A genuine issue of material fact exists “if the evidence is such that a reasonable jury could return a verdict for the nonmoving party.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). In determining whether a genuine issue of material fact exists, “[t]he evidence of the non-movant is to be believed” and the court must draw “all justifiable inferences” in favor of the nonmoving party. Id. at 255 (citing Adickes v. S.H. Kress & Co., 398 U.S. 144, 158-59 (1970) (superceded on other grounds)); accord Morales v. Quintel Entm't, Inc., 249 F.3d 115, 121 (2d Cir. 2001) (“[A]ll reasonable inferences must be drawn against the party whose motion is under consideration.”).
B. Section 16(b)
Section 16(b) of the Securities Exchange Act of 1934 requires directors, officers, and ten percent beneficial owners of stock (commonly referred to as “insiders”) to disgorge any profit realized from a stock transaction within a six-month period. 15 U.S.C. § 78p(a)-(b); see Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 43 (2d Cir. 2012). This is “known as the short-swing profit rule, ” Rubenstein v. Int'l Value Advisers, LLC, 959 F.3d 541, 544 (2d Cir. 2020) (internal quotation marks omitted), and applies to “any profit realized . . . from any purchase and sale, or any sale and purchase, of any equity security . . . within any period of less than six months, ” 15 U.S.C. § 78p(b).
The Second Circuit has summarized the statute as follows:
A vital component of the Exchange Act, § 16(b) was designed to prevent an issuer's directors, officers, and principal stockholders “from engaging in speculative transactions on the basis of information not available to others.” Huppe v. WPCS Int'l Inc., 670 F.3d 214, 218 (2d Cir. 2012) . . . Section 16(b) does not itself proscribe trading on inside information. Rather, Congress determined that the “only method . . . effective to curb the evils of insider trading was a flat rule taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great.” Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422, 92 S.Ct. 596, 30 L.Ed.2d 575 (1972); see also Huppe v. WPCS Int'l Inc., 670 F.3d at 218 (stating that “no showing of actual misuse of inside information or of unlawful intent is necessary to compel disgorgement” under § 16(b)). Thus, § 16(b) was crafted as a “blunt instrument, ” Magma Power Co. v. Dow Chem. Co., 136 F.3d 316, 321 (2d Cir. 1998), to “impose[ ] a form of strict liability, ” Credit Suisse Sec. (USA) LLC v. Simmonds, 556 U.S. 221, 132 S.Ct. 1414, 1417, 182 L.Ed.2d 446 (2012) (internal quotation marks omitted), by stating that any profits accruing to a director, officer, or 10% beneficial owner of an issuer “within any period of less than six months . . . shall inure to and be recoverable by the issuer, ” 15 U.S.C. § 78p(b); see Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 43 (2d Cir. 2012) (observing that § 16(b) establishes 10% beneficial owners as “statutory insiders” who, like directors and officers, are required “to disgorge all profits realized from any purchase and sale (or sale and purchase) of the same security made within a six month period”).
In contrast to “most of the federal securities laws, § 16(b) does not confer enforcement authority on the Securities and Exchange Commission.” Gollust v. Mendell, 501 U.S. at 122, 111 S.Ct. 2173. Rather, the statute authorizes two categories of private persons to sue for relief: (1) “the issuer” of the security traded in violation of § 16(b); or (2) “the owner of any security of the issuer in the name and in behalf of the issuer, ” but only “if the issuer shall fail or refuse to bring such suit within sixty days after the request or shall fail diligently to prosecute the same thereafter.” 15 U.S.C. § 78p(b). It has been suggested that the statute thus recruits the issuer (and, if necessary, its security holders) as “‘policemen'” by imbuing them with “‘a private-profit motive'” to enforce the law's prohibition on short-swing trading by insiders. Gollust v. Mendell, 501 U.S. at 124-25, 111 S.Ct. 2173 (quoting Hearings on H.R. 7852 and H.R. 8720 before House Committee on Interstate & Foreign Commerce, 73d Cong., 2d Sess. 136 (1934) (testimony of Thomas G. Corcoran)).Donoghue v. Bulldog Inv'rs Gen. Partn., 696 F.3d 170, 173-74 (2d Cir. 2012).
Section 29(a) of the Securities Exchange Act of 1934 provides that “[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of a self-regulatory organization, shall be void.” 15 U.S.C.A. § 78cc(a). In other words, a corporation is prohibited by Section 29(a) “from waiving compliance with any of the provisions of the Act, including Section 16(b).” Volk v. Zlotoff, 285 F.Supp. 650, 658 (S.D.N.Y. 1968). Section 29(a) therefore prohibits anticipatory waivers or releases claiming to absolve insiders of future liability. See Dresner v. Utility.com, Inc., 371 F.Supp.2d 476, 490 (S.D.N.Y. 2005) (Section 29(a) prohibits courts from enforcing agreements that “prospectively . . . waive plaintiffs' rights to pursue causes of action of which they were not yet aware, ” where it would “bar Exchange Act claims.”).
Nonetheless, “[c]ourts have held that Section 29(a) does not prohibit parties from executing valid releases in connection with securities fraud claims that have already matured.” Id. (citing Korn v. Franchard Corp., 388 F.Supp. 1326, 1328 (S.D.N.Y. 1975) and Mittendorf v. J.R. Williston & Beane Inc., 372 F.Supp. 821, 834 (S.D.N.Y. 1974)); accord Lancer Offshore, Inc. v. Dominion Income Mgmt. Corp., 2002 WL 441309, at *5 (S.D.N.Y. Mar. 20, 2002).
III. DISCUSSION
FBC's motion for summary judgment argues that the release in the Settlement Agreement relieves it of any liability for the transactions alleged in the complaint. See Def. Mem. at 1. Revive challenges the release on two grounds. First, it argues that the release does not cover all of the short-swing transactions alleged in the complaint. Pl. Opp. at 6-9. Second, it argues that the Settlement Agreement could not release FBC from future liability for any transactions because it was “inadequate.” Pl. Opp. at 10. Revive has also requested an accounting “of all transactions in the equity securities of [Sphere] from the date two years preceding the filing of [the] Complaint to the present” from FBC, Am. Compl. ¶¶ 52, which FBC argues must be denied if summary judgment is granted, see Def. Mem. at 24-25.
A. Whether the Release Applies to All Alleged Short-Swing Transactions
“Courts interpret a settlement release under traditional contract principles and must dismiss claims that are precluded by the plain language of the release.” In re Nine W. LBO Sec. Litig., 2020 WL 7090277, at *6 (S.D.N.Y. Dec. 4, 2020) (citation and internal quotation marks omitted). Where a release is valid, it “constitutes a complete bar to an action which is the subject of the release.” Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V., 17 N.Y.3d 269, 276 (2011) (internal quotation marks omitted) (quoting Global Mins. & Metals Corp. v. Holme, 35 A.D.3d 93, 98 (1st Dept. 2006)). Releases may be invalidated where the court finds there is “duress, illegality, fraud, or mutual mistake.” Id. Otherwise, a release that is valid will normally be enforced by the court. See Pampillonia v. RJR Nabisco, Inc., 138 F.3d 459, 463 (2d Cir. 1998).
The parties did not brief the issue of choice of law but FBC's moving brief cited to New York law as to principles of contract interpretation, see Def. Mem. at 14, and Revive interposed no objection. Thus, we assume New York law applies in this case. See, e.g., Krumme v. WestPoint Stevens Inc., 238 F.3d 133, 138 (2d Cir. 2000) (“The parties' briefs assume that New York law controls, and such implied consent is sufficient to establish choice of law” (citation and internal quotation marks omitted)).
Revive argues that the release in the Settlement Agreement does not cover some or all of the alleged short-swing transactions. Pl. Opp. at 6-9. The release provision in the Settlement Agreement releases FBC from any liability “arising from the Transactions identified in the Shareholder demands, or other Transactions through which [FBC] received Sphere 3D shares in connection with the pay-down of loan debt, reported by [FBC] through the date of this Agreement.” Settlement Agreement ¶ 3. Revive contends that the phrase “arising from the Transactions identified in the Shareholder demands” means only the transactions named in Tauber's April 18 demand letter. Pl. Opp. at 7. Revive points to other transactions that were not included in Tauber's demand. Id. Specifically, FBC acquired Sphere stock as reported on SEC forms filed on May 1, Rappaport Decl. ¶ 21; Statement of Changes in Beneficial Ownership filed May 1, 2018, annexed as Exhibit O to Rappaport Decl., and May 17, 2018, Rappaport Decl. ¶ 22; Statement of Changes in Beneficial Ownership filed May 17, 2018, annexed as Exhibit P to Rappaport Decl., which were acquired in lieu of cash payments for interest and the extension fee on the Third Amendment, see Statement of Changes in Beneficial Ownership filed May 1, 2018, annexed as Exhibit O to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed May 17, 2018, annexed as Exhibit P to Rappaport Decl.
The problem with this argument is that, while the Settlement Agreement refers to demand letters from Tauber and Lopez as prompting the settlement, Settlement Agreement at 1, the release is far broader, encompassing claims relating not only to “the Transactions identified in the Shareholder demands” but also to “other Transactions through which [FBC] received Sphere 3D shares in connection with the pay-down of loan debt, reported by [FBC] through the date of” the Settlement Agreement, id. ¶ 3.
Revive counters by pointing out that all of the FBC's transactions at issue are “related either to the payment of interest or to the payment of a fee in consideration for FBC's extension of the [loan] maturity date.” Pl. Opp. at 7. These transactions, Revive argues, do not constitute a “pay-down of loan debt” and thus the transactions are not in fact within the release language. Id. at 7-8. Revive argues that to “pay-down” a debt means only to “reduce its balance and result in a reduction of the principal amount outstanding.” Id. It cites to dictionary definitions of “pay down” suggesting that the phrase means to “reduce” a debt. Id. at 8. n.27. FBC responds that to “pay-down” a debt includes paying fees and interest as well as the principal and cites to a definition that defines “pay-down” as including a payment of “interest.” Def. Reply Mem. at 6.
Here, the phrase at issue is not the term “pay-down” by itself but rather a much broader phrase: specifically, “[t]ransactions through which [FBC] received Sphere 3D shares in connection with the pay-down of loan debt[.]” Settlement Agreement ¶ 3. While we believe the term “pay-down” encompasses payments of interest and fees, the broadness of the actual language in the release leaves no doubt that the parties intended to include them. The use of the phrase “in connection with, ” Settlement Agreement ¶ 3, particularly supports this view as it contemplates payments other than those that directly reduce the principal of the debt. Moreover, the parties' intent is further indicated by the fact that the Agreement states that the “shareholders' theory of liability in this matter is based on [FBC]'s reported transactions in Sphere 3D securities as of the date of execution of this Settlement[.]” Settlement Agreement at 1. In other words, the parties intention was to encompass FBC's “reported transactions” generally. The Settlement Agreement was reached on November 8, 2018, Settlement Agreement at 6; Tauber Decl. ¶ 6; Lopez Decl. ¶ 6; Rappaport Decl. ¶ 4, well after the date the last alleged short-swing transactions were reported on May 17, 2018, see Rappaport Decl. ¶ 22; Statement of Changes in Beneficial Ownership filed May 17, 2018, annexed as Exhibit P to Rappaport Decl. Thus, it was obviously the intent of the parties in drafting this language to release transactions consisting of payments of fees and interest up to the date of the Settlement Agreement. See Collins v. Harrison-Bode, 303 F.3d 429, 433 (2d Cir. 2002) (“particular words should be considered, not as if isolated from the context, but in light of the obligation as a whole and the intention of the parties manifested thereby” (quoting Kass v. Kass, 91 N.Y.2d 554, 566 (1998))). The Settlement Agreement therefore unambiguously covers all of the transactions at issue in Revive's Amended Complaint.
In light of the unambiguity of the release, it is unnecessary to rely on any extrinsic evidence, which confirms this conclusion. See, e.g., Tauber Decl. ¶ 6; Lopez Decl. ¶ 6.
B. Whether the Settlement Agreement is a Valid Bar to Revive's Claim
1. Section 16(b) Settlement Standards
An insider may be found to be released from liability by a valid settlement agreement, even if the agreement was not the product of a settlement of litigation. See Lewis v. Levinson, 1978 WL 1087, at *1 (S.D.N.Y. May 8, 1978). The initial question before the Court is whether, upon subsequent suit by a shareholder or issuer seeking to challenge that settlement, the prior agreement must be scrutinized by the Court. In the first round of briefing in this case, FBC took the remarkable position that “there is no need to explore the credible defenses raised by FBC during settlement negotiations” simply because any claims on behalf of Sphere had been released. Def. Reply Mem. at 10 n.3; accord Def. Mem. at 4 (“good faith out-of-court settlements are not subject to judicial review”); id. at 18 (settlement could be challenged only if it was the product of “fraud, duress, illegality or mutual mistake”). Revive's brief was confusing as to the standard of the Court's review. Accordingly, the Court requested that the parties provide further briefing as to “what standard a court should use to evaluate a settlement agreement that is offered as bar to a shareholder action under Section 16(b).” Order, filed November 9, 2020 (Docket #45) at 2. In response, FBC advocated for the standard articulated in Donoghue v. Bohemian Invs. LLC, 2016 WL 9738103 (D. Colo. Sept. 30, 2016). See Def.
Supp. Mem. at 3-4. In Donoghue, the court found a settlement agreement served as a bar to the plaintiff's claim because the claim was “mature” when settled, and the claim was “genuinely disputed and uncertain.” 2016 WL 9738103, *3. Revive appeared to argue for the application of the factors set out in City of Detroit v. Grinnell Corp. for evaluating settlements under Fed.R.Civ.P. 23(e)(2), see Pl. Supp. Mem. at 6-13, “with an eye kept on the congressional purpose of promoting full disgorgement, ” id. at 16; see id. at 13-15.
Section 16(b) itself provides no standard for making this evaluation. But some kind of scrutiny must be required when a settlement agreement is challenged so that Section 16(b)'s intent to incentivize stockholders to be true enforcers of the short-swing rule may be implemented. See Donoghue, 696 F.3d at 174. In the absence of scrutiny of purported settlements, Congress's intent that the enforcement be real and not illusory could not be implemented. To locate the requirement for an evaluation more precisely in the statutory language, we note that the statute authorizes suit to be brought only where there has been a prior request that the issuer bring suit that has not been acted upon or the issuer “fail[s] diligently to prosecute” a Section 16(b) suit. 15 U.S.C. § 78p(b). A court's review of a Section 16(b) settlement thus may be viewed as an assessment of the “diligen[ce]” of the corporation's pursuit of the Section 16(b) profits.
In keeping with this analysis, the case of Chechelev. Elsztain, 2012 WL 12358221, at *2 (S.D.N.Y. Aug. 1, 2012), approved the settlement because it was “a diligent prosecution of the Company's Section 16(b) rights.” Chechele, however, fails to say how the analysis of “diligen[ce]” was conducted. In a footnote, however, id. at 2 n.11, the court notes the settlement would have satisfied the factors laid out in City of Detroit v. Grinnell Corp., 495 F.2d 448, 463 (2d Cir. 1974), which sets forth the standard for assessing whether the settlement of a class action is appropriate.
Not surprisingly, courts have almost universally recognized that agreements purporting to resolve Section 16(b) proceedings must be scrutinized. Courts in this circuit have often used the “fair, reasonable and adequate” standard of Fed.R.Civ.P. 23(e)(2), or some version thereof, to conduct the analysis even though the 16(b) settlement was not the result of a class action. See Levy v. General Elec. Capital Corp., 2002 WL 1225542, at *2 (S.D.N.Y. June 4, 2002) (settlement of a Section 16(b) claim was approved as “fair and reasonable”); Lewis v. Anderson, 81 F.R.D. 436, 438 (S.D.N.Y. 1978) (“fair, reasonable and adequate”); Lewis v. Chapman, 416 F.Supp. 855, 857 (S.D.N.Y. 1976) (“Approval should be given if the settlement offered is fair, reasonable and adequate” (citation and internal quotation marks omitted)); Morales v. Holiday Inns, Inc., 366 F.Supp. 760, 762 (S.D.N.Y. 1973) (“the criteria for assessing the fairness of a settlement under Rule 23 seem to apply”).
This standard accords to some degree with the standard a court must use to decide whether the settlement of a derivative action should be approved. See Fed.R.Civ.P. 23.1. While the Federal Rules of Civil Procedure do not contain a standard for approval of a derivative action, case law holds that a court must inquire into whether the settlement “fairly and adequately serves the interests of the corporation on whose behalf the derivative action was instituted.” Milliken on behalf of Hosp. Inv'rs Tr., Inc. v. Am. Realty Capital Hosp. Advisors, LLC, 2020 WL 3402816, at *1 (S.D.N.Y. June 19, 2020) (citation and internal quotation marks omitted). And some courts simply frame the standard as whether the settlement in the derivative action was “fair, reasonable, and adequate.” Mautner v. Hirsch, 1992 WL 106318, at *3 (S.D.N.Y. May 4, 1992).
While Fed.R.Civ.P. 23.1(c) states that “[n]otice of a proposed settlement, voluntary dismissal, or compromise [of a derivative action] must be given to shareholders or members in the manner that the court orders[, ]” case law is equally clear that a Section 16(b) suit does not qualify as a derivative action and thus notice need not be provided. See, e.g., Chechele v. Elsztain, 2012 WL 12358221, at *2 (S.D.N.Y. Aug. 1, 2012); Rosen v. Price, 1998 WL 337896, at *1 (S.D.N.Y. June 23, 1998).
In determining whether a Section 16(b) settlement is fair, reasonable and adequate, some courts in this circuit have applied certain of the factors originally laid out in City of Detroit v. Grinnell Corp., 495 F.2d 448, 463 (2d Cir. 1974), for evaluating the substantive fairness of a settlement agreement - specifically:
(1) risks of establishing liability; (2) risks of proving damages; (3) complexity, expense and likely duration of the litigation; (4) stage of proceeding and the amount of discovery completed; (5) ability of defendants to withstand a greater judgment; (6) range of reasonableness in light of the maximum possible recovery and range of reasonableness in light of all the attendant risks of the litigation; and (7) reaction of other shareholders to the settlement.FTR Consulting Group, Inc. ex rel. Cel-Sci Corp. v. Advantage Fund II Ltd., 2005 WL 2234039, at *2 (S.D.N.Y. Sept. 14, 2005) (citing Levy ex rel. Mktg. Servs. Grp., Inc. v. General Elec. Cap. Corp., 2001 WL 987873, at *5 (S.D.N.Y. Aug. 30, 2001)); accord Anderson, 81 F.R.D. at 438 (considering the Grinnell factors in approving a settlement agreement of multiple claims, including a Section 16(b) claim). A potential eighth factor has also been mentioned for Section 16(b) settlements: “ ‘the congressional purpose to cause disgorgement of short-swing trading profits by corporate insiders . . . even when the corporation is unwilling to prosecute such a suit and a derivative plaintiff brings suit instead.'” FTR Consulting Group, 2005 WL 2234039, at *2 (quoting Levy ex rel., 2001 WL 987873, at * 5).
The standard proposed by FBC is that laid out in Donoghue, 2016 WL 9738103, at *3, which asks whether the claim (assuming it was “matured”) was “genuinely disputed and uncertain.” Donoghue provides no source for this standard, however, other than a citation to the brief of one of the parties. Id. Donoghue also provides no insight into how the standard should be applied. Because this standard appears to be without precedent and because no court has to date ever cited it, we decline to follow Donoghue. We note that, in any event, we do not see how the standard of “genuineness” can be applied without at least some consideration of the fairness, reasonableness and adequacy of the settlement, which brings us back to the class action standard anyway.
We therefore conclude that any evaluation of a settlement under Section 16(b) must seek to determine if it is fair, reasonable and adequate. We also reject FBC's argument that such a standard must not be adopted in cases of suits that follow private settlements because it would dissuade issuers from entering into private settlements, see Def. Supp. Reply Mem. at 1-2, 6-7; accord Def. Mem. at 3-4 (arguing that there should be no scrutiny at all of good faith private settlements). There is no reason why a private settlement should be accorded any greater deference than settlements presented to a court. As for whether issuers will be dissuaded from entering into private settlements, issuers are free to enter into private settlements on the understanding that if the settlement is later challenged, it must pass the same scrutiny that would have been applied to the settlement had it been presented to a court at the time it was effectuated.
In applying Grinnell, we note that “[a] court need not find every factor militates in favor of a finding of fairness; rather, a court considers the totality of [the] factors in light of the particular circumstances.” In re Merrill Lynch & Co., Inc. Research Reports Securities Litig., 246 F.R.D. 156, 167 (S.D.N.Y. 2007). We believe the primary concern for assessing a settlement under Section 16(b) is the same as for approval of a class action: “the need to compare the terms of the compromise with the likely rewards of litigation.” Maywalt v. Parker & Parsley Petroleum Co., 67 F.3d 1072, 1079 (2d Cir. 1995) (citation and internal punctuation omitted); accord Gwozdzinnsky v. Sandler Assocs., 1998 WL 538064, at *1-2 (2d Cir. Mar. 13, 15 1998) (approving application of Grinnell factors to assessment of the settlement of a Section 16(b) action) (unpublished decision).
Apart from examining the substantive fairness of the settlement, we also think it important to examine “the negotiating process by which the settlement was reached to ensure that the settlement is the result of arm's-length negotiations rather than collusion and that all interests have been effectively represented.” In re Metro. Life Derivative Litig., 935 F.Supp. 286, 291 (S.D.N.Y. 1996) (citation and internal quotation marks omitted) (addressing standard applicable to class actions and derivative actions).
In practice, courts reviewing a Section 16(b) settlement will favor “settlements where the plaintiff's right to recover is subject to serious questions of fact or law.” Schimmel v. Goldman, 57 F.R.D. 481, 484 (S.D.N.Y. 1973); accord Lewis v. Levinson, 1978 WL 1087, at *1 (S.D.N.Y. 1978) (“[w]here there is a question of whether there is liability at all . . . there is authority for upholding compromises reached in good faith negotiations.”); Chapman, 416 F.Supp. at 857 (settlement approved where claim involved “novel issues of law”). Thus, Levy v. Gen. Elec. Capital Corp., 2002 WL 1225542 (S.D.N.Y. June 4, 2002), recounted approving a settlement that amounted to 46% of one measure of recovery because “the risk of judgment in defendant's favor was high.” Id. at *2; see also Goldman, 57 F.R.D. at 487 (approving settlement of 72% of potential liability where issuer's arguments opposing the suit were “substantial and, if successful, would defeat any recovery by the corporation”); Plaskow v. Clausing Corp., 1983 WL 1320, at *1 (S.D.N.Y. June 1, 1983) (approving settlement of 70% of claim because “[t]his discount is fair, in recognizing that certain questions exist as to the merits of the case, and, if the case went to trial, further expenses would be incurred.”).
However, where settlement for less than the full amount of liability is not sufficiently explained or where an asserted defense to the Section 16(b) claim does not apply, courts will decline to approve the settlement agreement. See Morales v. Holiday Inns, Inc., 366 F.Supp. 760, 763 (S.D.N.Y. 1973) (finding settlement did not bar plaintiff's Section 16(b) claim where the asserted defense “could not be sustained”); Levy ex rel., 2001 WL 987873, at *7 (declining to approve settlement that was not “shown to create one dollar of real value to” the issuer).
We will now consider whether the Settlement Agreement is fair, reasonable and adequate to justify serving as a bar to Revive's Section 16(b) claim here. We note that the settlement here of $300,000 equaled only about 30% of FBC's potential liability. See Pl. Opp. at 9 (the total amount of the profits at issue was in the range of $1,051,288.63 to 1, 071, 466.87); Def. Supp. Reply Mem. at 9 n.4.
2. Analysis
As to the procedural fairness of the settlement, we note that the settlement was the product of arms-length negotiations between FBC and experienced Section 16(b) counsel. See Pl. Supp. Mem. at 8 (“Plaintiff does not question the arms-length nature of the negotiations, nor the competence of counsel.”). While Revive does question whether there was truly “substantive discussions between [FBC] and shareholder counsel, ” Pl. Supp. Mem. at 8, both FBC and shareholder counsel have described the months of negotiation that ultimately resulted in the Settlement Agreement, Tauber Decl. ¶¶ 5-6; Lopez Decl. ¶ 5; Rappaport Decl. ¶¶ 2-3. The shareholders were represented by counsel well known to be active in the plaintiff's bar in pursuing Section 16(b) claims. Def. Mem. At 6-7, 17. Revive supplies nothing except skepticism to refute FBC and shareholder counsel's recounting of the negotiations. See Pl. Supp. Mem. at 8. The Settlement Agreement therefore “‘enjoys a presumption of fairness.'” FTR Consulting Group, 2005 WL 2234039, at *3 (quoting In re Austrian and German Bank Holocaust Litig., 80 F.Supp.2d 164, 173-74 (S.D.N.Y. 2000)).
To justify the settlement for 30 cents on the dollar, FBC points to two separate defenses to the Section 16(b) claim: the “debt exception defense” and what it terms the “forced transaction doctrine.” See Def. Mem. at 8. We begin by considering the first, second, and sixth Grinnell factors together to determine the appropriateness of FBC's reliance on these defenses inasmuch as these factors capture the most important question we must decide: “the need to compare the terms of the compromise with the likely rewards of litigation.” Maywalt, 67 F.3d at 1079. In order to find that these factors weigh in favor of finding the Settlement Agreement is fair, reasonable and adequate, we need not determine whether FBC would have prevailed on these defenses; rather we must determine whether the defenses raise substantial enough questions to justify the relatively low settlement amount. See Schimmel, 57 F.R.D. at 484; Levinson, 1978 WL 1087, at *1; Chapman, 416 F.Supp. at 857. And because we find that the “debt exception defense” justifies the settlement amount, we do not address the “forced transaction doctrine.”
This defense - more commonly known as the “borderline” or “unorthodox” transaction defense - arose from the Supreme Court decision of Kern Cnty Land Co. v. Occidental Petroleum Corp. 411 U.S. 582 (1973).
The debt exception defense raised by FBC refers to a statutory exception to Section 16(b) liability. Section 16(b) states that its prohibition does not apply to transactions involving a security that “was acquired in good faith in connection with a debt previously contracted[.]” 15 U.S.C. § 78p(b). To qualify for the debt exception, “the debt at issue must constitute an obligation to pay a fixed sum certainly and at all events, and be a matured debt which existed apart from any existing obligation to transfer securities[.]” Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 43-44 (2d Cir. 2012) (citation and internal quotation marks omitted).
FBC argues the debt exception is a viable defense because it acquired the shares at issue as a result of the payments due under the Third Amendment. See Def. Mem. at 8. Per the Third Amendment, Sphere was required to pay fees for the extension of the debt's maturity date, as well as interest on the debt. See Third Amendment § 2.2-2.3. The Amendment set out dates by which the fees and interest had to be paid and allowed Sphere - at Sphere's option, not FBC's - to pay with either shares or cash. Id. While the maturity date on the principal of the loan was extended by the Third Amendment, see id. § 1.1(a), payments were due prior to this maturity date for the interest and fees, id. § 2.2-2.3.
Revive mounts a confusing argument as to why FBC cannot rely on the debt exception. In its initial briefing, Revive argued Sphere's debt was not “mature” and therefore FBC could not rely on the debt exception. Pl. Opp. at 11-12. FBC correctly refuted this argument in its supplemental brief, noting that while the principal of the loan was not mature, the extension fees and the interest on the loan were mature. Def. Supp. Mem. at 8-9. And Analytical Surveys does not bar such an interpretation of the maturity requirement. In Analytical Surveys, the Second Circuit rejected the application of the debt exception where the debt had not reached its maturity, and the defendant had not exercised its right to accelerate the debt. 684 F.3d at 44-45. Here, while payment was not due as to the principal of the loan, payment was due for the interest and extension fees on the loan. See Third Amendment § 2.2-2.3 (setting out dates for Sphere's payments to FBC). And these payments are the only amounts that were actually paid to FBC in stock. See Statement of Changes in Beneficial Ownership filed April 3, 2018, annexed as Exhibit M to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed April 18, 2018, annexed as Exhibit N to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed May 1, 2018, annexed as Exhibit O to Rappaport Decl.; Statement of Changes in Beneficial Ownership filed May 17, 2018, annexed as Exhibit P to Rappaport Decl.
Revive responds by arguing that Sphere's obligation to pay interest and an extension fee under the Third Amendment “does not meet the ‘independence requirement'” of the debt exception. Pl. Supp. Reply Mem. at 5. But the independence requirement articulated in Analytical Surveys - that is, the requirement that the debt “exist[] apart from any existing obligation to transfer securities” - does not preclude FBC's reliance on the debt exception. There was no “existing” obligation to transfer securities. Indeed, there was no such obligation at all. See Third Amendment § 2.2-2.3 (“[Sphere] may pay in cash or, at its option, by issuing and delivering to [FBC] that number of Common Shares . . .” (emphasis added)).
In arguing that Sphere's payment of the interest and fees is not “independent, ” Revive cites to two cases from outside this circuit. See Pl. Supp. Reply Mem. at 4-5. But in these cases, either the defendant had opted to convert debentures into stock, see Heli-Coil Corp. v. Webster, 352 F.2d 156, 159-61 (3d Cir. 1965), or the “debt previously contracted” was literally for the sale of the stock, Booth v. Varian Assocs., 334 F.2d 1, 5 (1st Cir. 1964) cert. denied 379 U.S. 961 (1965).
Neither circumstance applies here. Rather, it was Sphere that had the option to pay FBC in either cash or shares for the extension fee and the interest payments. See Third Amendment § 2.2-2.3. Thus, the extension fee and the interest payments were not contracts to buy stock, as Revive is apparently implying. The debt previously contracted was the loan from FBC to Sphere. Sphere was required to make payments, including the payments of interest and fees, to FBC in connection with that loan, see Third Amendment § 2.2-2.3, thus satisfying the independence requirement of the debt exception. See Rheem Mfg Co. v. Rheem, 295 F.2d 473, 20 476-77 (9th Cir. 1961) (stock acquired in connection with an employee bonus plan was independent for purposes of the debt exception).
Of course, our task is not to definitively decide if FBC would prevail under this exception. It is enough to conclude that the defense was strong enough that FBC could view the Section 16(b) claim as having minimal value - in this case no more than 30% of the profit - in light of the strength of this defense.
As noted, in determining whether a proposed settlement is fair, reasonable, and adequate, the “primary concern is with the substantive terms of the settlement” and to assess this we “compare the terms of the compromise with the likely rewards of litigation.” Maywalt, 67 F.3d at 1079. While it does not seem necessary to address any of the other Grinnell factors unrelated to this point, we note that the third and fourth factors, “the complexity of the case and its continued expense, ” Levy ex rel., 2001 WL 987873, at *6, also favor finding the settlement was appropriate. It was entirely possible that, notwithstanding Revive's assertion that “[t]his case involves a discrete set of transactions, the terms of which are not in serious dispute[, ]” Pl. Supp. Mem. at 11, it would have sought to have FBC engage in significant and expensive discovery regarding the origin of the terms in the Third Amendment.
In sum, we find the Settlement Agreement was fair, reasonable and adequate. Thus, it bars Revive's claims.
C. Revive's Request for an Accounting
FBC argues, and Revive does not contest, that if summary judgment is granted as to Revive's Section 16(b) claim, Revive's claim for an accounting must be dismissed as well. Def. Mem. at 24-25. Because Revive's Section 16(b) claim against FBC has been settled and summary judgment should be granted, Revive's claim for an accounting should be dismissed.
IV. Conclusion
For the foregoing reasons, FBC's Motion for Summary Judgment (Docket # 32) should be granted and the complaint should be dismissed.
PROCEDURE FOR FILING OBJECTIONS TO THIS REPORT AND RECOMMENDATION
Pursuant to 28 U.S.C. § 636(b)(1) and Rule 72(b) of the Federal Rules of Civil Procedure, the parties have fourteen (14) days (including weekends and holidays) from service of this Report and Recommendation to file any objections. See also Fed.R.Civ.P. 6(a), (b), (d). A party may respond to any objections within 14 days after being served. Any objections and responses shall be filed with the Clerk of the Court, with copies sent to the Hon. Andrew L. Carter, Jr. at 40 Foley Square, New York, New York 10007. Any request for an extension of time to file objections or responses must be directed to Judge Carter. If a party fails to file timely objections, that party will not be permitted to raise any objections to this Report and Recommendation on appeal. See Thomas v. Arn, 474 U.S. 140 (1985); Wagner & Wagner, LLP v. Atkinson, Haskins, Nellis, Brittingham, Gladd & Carwile, P.C., 596 F.3d 84, 92 (2d Cir. 2010).