Eichenholtz v. Brennan

Court of Appeals for the Third Circuit
52 F.3d 478 (1995)

ELI5:

Rule of Law:

Under federal securities law, indemnification agreements for underwriters are unenforceable as a violation of public policy. A partial settlement agreement may bar a non-settling defendant's right to contribution, provided the non-settling defendant's ultimate liability is reduced by the settling defendant's proportionate share of fault as determined by a trier of fact.

Facts:

International Thoroughbred Breeders (“ITB”) sought to purchase and rebuild the Garden State Racetrack, funding the project through four public offerings of securities between 1983 and 1986.
Broker-dealers, including First Jersey Securities, Inc. (“First Jersey”), served as underwriters for these offerings.
First Jersey's underwriting agreements with ITB contained clauses where ITB agreed to indemnify First Jersey for any losses arising from material misstatements or omissions in the offering materials.
Paulette Eichenholtz and Larry Salberg purchased ITB securities and later alleged that the offering documents contained material misstatements and omissions, constituting a scheme to inflate the value of the securities.
The defendants included the underwriters (First Jersey, Rooney Pace, Inc., and First Philadelphia Corporation), ITB itself, and various ITB directors and officers.
The plaintiff class reached a partial settlement agreement with ITB, its directors, and their insurer, but not with the underwriter defendants.

Procedural Posture:

Paulette Eichenholtz and Larry Salberg filed separate class action lawsuits in federal district courts, which were later consolidated in the District of New Jersey.
The plaintiffs alleged violations of federal securities laws and RICO against ITB, its directors, and its underwriters.
Defendants moved to dismiss, and the district court granted the motion in part, but left most of the claims intact.
The district court certified the plaintiffs' proposed class.
The plaintiff class and a group of defendants (ITB, its directors, and their insurer) negotiated a proposed partial settlement agreement.
The proposed agreement included a 'bar order' to extinguish claims for contribution and indemnification by the non-settling defendants against the settling defendants, and a 'proportionate fault judgment reduction' provision.
The district court approved the partial settlement agreement and entered it as a final judgment pursuant to Federal Rule of Civil Procedure 54(b).
The non-settling underwriter defendants (appellants) appealed the district court's approval of the settlement to the United States Court of Appeals for the Third Circuit.

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Issue:

Does a partial settlement in a federal securities case that bars non-settling defendants' claims for contribution and indemnification against settling defendants unfairly prejudice the non-settling defendants when the settlement also provides for a proportionate fault judgment reduction?

Opinions:

Majority - Seitz, Circuit Judge

No. A partial settlement that bars non-settling defendants' claims for contribution and indemnification does not unfairly prejudice them when it includes a proportionate fault judgment reduction. There is no right to indemnification under federal securities laws, as it runs counter to the public policy of encouraging underwriter diligence. While there is a right to contribution, it can be extinguished by a settlement bar order if, in exchange, the non-settling defendants' liability at trial is limited to their proportionate share of the fault. The court reasoned that indemnification, whether contractual or implied, undermines the deterrent effect of the securities laws by allowing culpable parties, like underwriters, to shift their liability, thereby reducing their incentive to conduct thorough investigations. In contrast, contribution promotes fairness among defendants. To harmonize the right of contribution with the policy of encouraging settlement, a bar order is permissible if coupled with a proportionate judgment reduction. This method ensures non-settling defendants pay only their share of the total damages as determined by the jury, effectively serving the same purpose as a contribution claim and placing the risk of a low settlement on the plaintiffs.

Analysis:

This decision solidifies the Third Circuit's position on two crucial issues in multi-defendant securities litigation. First, it unequivocally voids underwriter indemnification agreements as contrary to the public policy of ensuring investor protection through diligent investigation. This reinforces the gatekeeper role of underwriters and prevents them from contractually avoiding liability. Second, the court formally adopts the proportionate fault judgment reduction rule as the appropriate mechanism for balancing the strong policy favoring settlement with the statutory contribution rights of non-settling defendants. This provides a clear and fair framework for structuring partial settlements in complex class actions, influencing litigation strategy by giving settling defendants finality while protecting non-settlers from inequitable liability.

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