Claim-Splitting Does Not Require Final Judgment, Unlike Res Judicata — Forced Seller Doctrine Does Not Apply to 1933 Act Claims — Investor Forced to Sell in Squeeze-Out Merger Is Not a Purchaser under 1933 Act

Katz v. Gerardi, 655 F.3d 1212 (10th Cir. 2011):

This case requires us to consider whether a plaintiff can split potential legal claims against a defendant by bringing them in two different lawsuits. We conclude that related claims must be brought in a single cause of action, and the district court properly dismissed the claim-splitting plaintiffs here. We also consider whether an investor who was forced to sell his shares as the result of a merger has standing to sue as a purchaser of securities under the 1933 Act. We find the Act applies only to purchasers of securities and not to forced sales resulting from a merger.

Jack P. Katz and Infinity Clark Street Operating were minority shareholders in a real estate investment trust owned by Archstone Smith Trust, a public company. Archstone entered into a merger agreement in which two investors acquired all of Archstone's outstanding public shares. As part of the merger, Katz and Infinity were squeezed out of the REIT and had the option of receiving either cash or stock in the newly formed entity in exchange for their shares. Katz opted for cash; Infinity chose stock. Claiming the offering documents associated with the merger contained false and misleading statements or omissions, Katz and Infinity separately sued.

In Colorado, Infinity filed a federal class action lawsuit alleging breaches of contract and fiduciary duty relating to the merger. The district court dismissed the complaint with prejudice except as to one claim, and the case was stayed pending arbitration of the surviving claim.

Meanwhile, Katz filed a class action lawsuit in Illinois state court asserting securities law claims arising from the merger. The case was removed to federal court and eventually transferred to Colorado. Katz then filed an amended complaint joining Infinity as a party plaintiff, even though Infinity's case was still waiting the outcome of arbitration. The district court dismissed Katz's complaint, ruling that by joining the case, Infinity was improperly splitting claims that should have been alleged in its earlier action. The court also found Katz lacked standing to bring his securities law claims since he was not a purchaser when he opted to sell his shares. Katz and Infinity challenge the district court's decision on appeal.

A. Infinity

The district court dismissed Infinity from this case because the court concluded Infinity had improperly split its claims between this case and its action already pending in the District of Colorado.

The rule against claim-splitting requires a plaintiff to assert all of its causes of action arising from a common set of facts in one lawsuit. By spreading claims around in multiple lawsuits in other courts or before other judges, parties waste "scarce judicial resources" and undermine "the efficient and comprehensive disposition of cases." Hartsel Springs Ranch of Colo., Inc. v. Bluegreen Corp. 296 F.3d 982, 985 (10th Cir. 2002). ***

Infinity argues the district court erred because no final judgment was entered in the other case. Without a final judgment, Infinity contends the prohibition against claim splitting does not apply. And even if the court did not err in the dismissals, Infinity argues the court should allow it to substitute a different plaintiff to pursue claims on behalf of the investors who elected to receive new units in the merger. We reject each of these arguments.

1. Claim-Splitting

District courts have discretion to control their dockets by dismissing duplicative cases. See Colo. River Water Conservation Dist. v. United States, 424 U.S. 800, 817, 96 S. Ct. 1236, 47 L. Ed. 2d 483 (1976) ("As between federal district courts . . . though no precise rule has evolved, the general principle is to avoid duplicative litigation."). Long ago, the Supreme Court captured the general principle regarding claim-splitting:

When the pendency of a [previously filed] suit is set up to defeat another, the case must be the same. There must be the same parties, or, at least, such as represent the same interests; there must be the same rights asserted and the same relief prayed for; the relief must be founded upon the same facts, and the title, or essential basis, of the relief sought must be the same.

The Haytian Republic, 154 U.S. 118, 124, 14 S. Ct. 992, 38 L. Ed. 930 (1894) (quotation omitted); see also Curtis v. Citibank, N.A., 226 F.3d 133, 139 (2d Cir. 2000) ("[P]laintiffs have no right to maintain two actions on the same subject in the same court, against the same defendant at the same time."). We have noted that "more recent cases analyze claim-splitting as an aspect of res judicata." Hartsel, 296 F.3d at 986 (collecting cases); see also Stone v. Dep't of Aviation, 453 F.3d 1271, 1278 (10th Cir. 2006) ("A plaintiff's obligation to bring all related claims together in the same action arises under the common law rule of claim preclusion prohibiting the splitting of actions.").

Infinity claims that there can be no claim splitting as long as there is no final judgment in the other case. We disagree. While it is correct that a final judgment is necessary for traditional claim preclusion analysis, it is not required for the purposes of claim splitting. The doctrine of claim preclusion, or res judicata, requires as one element a valid, final judgment on the merits. See Pelt v. Utah, 539 F.3d 1271, 1281 (10th Cir. 2008); Wright & Miller, 18A Federal Practice & Procedure Jurisdiction § 4432 (2d ed. 2011). While we analyze claim splitting as an aspect of res judicata, the claim-splitting doctrine does not fall within a conventional res judicata analysis. See Curtis, 226 F.3d at 138 ("The rule against duplicative litigation is distinct from but related to the doctrine of claim preclusion or res judicata.").

To be sure, claim splitting and res judicata both serve the same interests of promoting judicial economy and shielding parties from vexatious concurrent or duplicative litigation. But claim splitting is more concerned with the district court's comprehensive management of its docket, whereas res judicata focuses on protecting the finality of judgments. See Wright & Miller, supra § 4406 (considering it an "exaggeration" to describe claim splitting as an aspect of res judicata). The difference also appears in our standards of review for claim splitting (abuse of discretion) and res judicata (de novo). Compare Hartsel, 296 F.3d at 985 (reviewing dismissal for claim splitting for abuse of discretion) with Wilkes v. Wyo. Dep't of Emp't Div. of Labor Standards, 314 F.3d 501, 503 (10th Cir. 2002) (reviewing whether the doctrine of res judicata applies de novo).

With these different interests in mind, we have held that a final judgment is not a necessary component of the claim-splitting analysis:

It is clear that a motion to dismiss based on improper claim-splitting need not — indeed, often cannot — wait until the first suit reaches final judgment. . . . Thus, in the claim-splitting context, the appropriate inquiry is whether, assuming that the first suit were already final, the second suit could be precluded pursuant to claim preclusion.

Hartsel, 296 F.3d at 987 n.1 (emphasis added). Otherwise, a defendant could "lie in wait silently until one of the two actions is brought to judgment to ambush the plaintiff and defeat the other action." Id.; see also Brady v. UBS Fin. Svc., Inc., 538 F.3d 1319, 1327 n.10 (10th Cir. 2008) ("The first suit need not reach final judgment before a motion to dismiss based on improper claim-splitting can be granted."); Wright & Miller, supra § 4406 ("In dealing with simultaneous actions on related theories, courts at times express principles of 'claim splitting' that are similar to claim preclusion, but that do not require a prior judgment.").

Our precedent cannot be clearer: the test for claim splitting is not whether there is finality of judgment, but whether the first suit, assuming it were final, would preclude the second suit. This makes sense, given that the claim-splitting rule exists to allow district courts to manage their docket and dispense with duplicative litigation. If the party challenging a second suit on the basis of claim splitting had to wait until the first suit was final, the rule would be meaningless. The second, duplicative suit would forge ahead until the first suit became final, all the while wasting judicial resources.

Also, different treatment is warranted because of the different results created by a dismissal under res judicata and claim splitting. A dismissal on res judicata grounds can stop a case in its tracks; a plaintiff is precluded from asserting a claim. In such a case, we leave a party without recourse for its claims, and thus we want to be sure such a decision stems from a previous valid, final judgment on the merits. But with a dismissal on claim-splitting grounds, by its nature, the dismissed party is involved in another pending suit regarding the same subject matter against the same defendants. Given the toll on a court's docket, the rule does not impose the more stringent requirement of a final judgment. ***

1. 1933 Act Claims

Katz brought two substantive claims under §§ 11 and 12(a)(2) of the 1933 Act related to the merger. But both sections provide relief only for purchasers — not sellers — of securities. See 15 U.S.C. § 77k(a) [ § 11] ("any person acquiring such security . . . may . . . sue") (emphasis added); § 77l(a) [ § 12(a)(2)] ("Any person who . . . offers or sells a security . . shall be liable . . . to the person purchasing such security.") (emphasis added); see also Joseph v. Wiles, 223 F.3d 1155, 1159 (10th Cir. 2000) ("[W]e conclude that an aftermarket purchaser has standing to pursue a claim under section 11."); Thomas L. Hazen, 1 Law of Securities Regulation § 1.2 (6th ed.) ("The scope of the Securities Act of 1933 is limited . . . its investor-protection reach extends only to purchasers (and not sellers) of securities."). It is clear only purchasers of securities may assert claims under §§ 11 and 12(a)(2) of the 1933 Act. If Katz cannot demonstrate that he was a purchaser of securities, he lacks standing to bring his claims under the 1933 Act.

In the merger, Katz elected to receive $60.75 in exchange for each of his A-1 Units. That is, he sold each A-1 Unit for $60.75. From a plain view of the transaction, Katz was a seller, not a purchaser. Undeterred, Katz contends that, in fact, he was a purchaser and has standing. He argues that under the so-called fundamental change doctrine, the merger's effect on his A-1 Units caused him to acquire "new" A-1 Units, making him a purchaser and giving him standing to sue under the 1933 Act.

2. Fundamental Change Doctrine

***The fundamental change doctrine — also known as the forced seller doctrine — has been applied in securities fraud cases when "the shareholder is faced with the choice of either holding stock in a nonexistent corporation or exchanging his shares for value as is the case in liquidations and certain types of mergers." Anderson v. Dixon, No. 95-4119, 86 F.3d 1166 [published in full-text format 938 F. Supp. 1419], 1996 WL 276183, at *2 (10th Cir. May 24, 1996) (quotation omitted); see also Hazen, supra § 12.7[3][A] (6th ed.) ("When a shareholder is frozen out of a corporation or otherwise put in the position of a 'forced seller,' Rule 10b-5 standing ordinarily will exist even though there was no voluntary investment decision.").

The doctrine enables a shareholder, whose investment has been fundamentally changed, to meet the causation and reliance requirements of the securities laws even though the shareholder has not made an actual purchase or sale of securities. See Loss & Seligman, Securities Regulation 3740 (3d ed. 2004) ("The forced seller doctrine has been expanded to a variety of transactions . . . where a defendant's fraud results in a fundamental change in the nature of the plaintiff's investment without the plaintiff's consent."). Several circuits have adopted the doctrine,8 though others have questioned its continuing validity. We have previously declined to adopt the doctrine, Anderson, 938 F. Supp. 1419, 1996 WL 276183, at *2, but Katz requests we do so now and apply it here.

As we noted, Katz argues a fundamental change occurred "the minute the Archstone board accepted the Merger, creating de facto new A-1 units" that lacked the advantageous liquidity, dividend, and tax characteristics of the original A-1 units.... He contends his only choice was to either accept the new units, which lacked the same benefits of the A-1 units, or cash out his interest without the tax indemnification the A-1 Units had provided. Katz claims that the "choice," either way, was "irrelevant" because the unitholders were forced to accept inferior new units or cash-out without tax indemnification. ***

We have previously declined to adopt the fundamental change doctrine and we decline to do so again here for several reasons. First, the doctrine only applies to claims under the 1934 Act, where Katz's claims here arise under the 1933 Act. Second, even assuming the doctrine did apply to Katz's 1933 Act claims, the doctrine does not make him a "purchaser" of securities.

3. Fundamental Change/1933 Act Claims

The fundamental change doctrine does not apply to Katz's 1933 Act claims because the doctrine is limited to claims under the 1934 Act. Katz argues the doctrine should apply equally to claims under both Acts. He cites two cases from other circuits that he claims applied the fundamental change doctrine to 1933 Act claims: 7547 Corporation v. Parker & Parsley Development Partners, 38 F.3d 211 (5th Cir. 1994), and In re Union Exploration Partners Securities Litigation, No. 90-3125, 1992 U.S. Dist. LEXIS 9013, 1992 WL 203812 (C.D. Cal. June 18, 1992). But each is distinguishable.

In 7547 Corporation, the Fifth Circuit confined its application of the forced seller doctrine to its analysis of whether plaintiffs had standing to assert claims under § 10(b) and Rule 10b-5 of the 1934 Act. 38 F.3d at 226-29. Notably, the court also considered plaintiff's standing under §§ 11 and 12(a)(2) of the 1933 Act--the same sections Katz asserts here--and made no mention of the forced seller doctrine. Id. at 222-25. The case does not support Katz's argument. Actually, it undermines his position because the court applied the forced seller doctrine only to the 1934 Act claims, even though 1933 Act claims were also at issue in the case.

In Union Exploration Partners, the court cited the forced seller doctrine and concluded plaintiffs could bring their claims under § 10(b). 1992 U.S. Dist. LEXIS 9013, 1992 WL 203812, at *3. It also applied the forced seller doctrine to plaintiff's § 12(a)(2) claims, finding the plaintiffs had satisfied § 12(a)(2)'s causation requirement. 1992 U.S. Dist. LEXIS 9013, [WL] at *5. The court's focus was on whether plaintiffs had demonstrated a causal connection between the fraud and the purchase of securities. Because the argument about causation was "essentially the same" one asserted in connection with the § 10(b) claims, the court decided to apply the forced seller doctrine to the § 12(a)(2) claims as well. Id.

Even though the court applied the forced seller doctrine to claims under the 1933 Act, the case does not help Katz. The court's reasoning was solely focused on the causation requirement of § 12(a)(2), not the purchaser requirement at issue here. Because the causation argument was similar to the causation argument for § 10(b), the court applied the doctrine. There is no such similarity here. Section 12(a)(2)'s strict purchaser requirement has no analogue in the broad provisions of § 10(b) and Rule 10b-5.

Reviewing these two cases with a critical eye reveals they do not support Katz's argument that the fundamental change doctrine should apply to claims under the 1933 Act. We have also located no other cases that apply the doctrine to the 1933 Act. From our review of the case law, courts only apply the fundamental change doctrine in relation to the 1934 Act's anti-fraud provisions (i.e. § 10(b) and Rule 10b-5) and we see no reason to disturb this interpretation.

Katz argues as if the 1933 and 1934 Acts are the same, such that an application of the doctrine to the 1933 Act would not be a significant extension. But this argument ignores the fundamental differences between the 1933 and 1934 Acts. Restricting the doctrine to the 1934 Act comports with § 10(b)'s expansive anti-fraud provision, covering fraud "in connection with the purchase or sale" of a security. 15 U.S.C. § 78j(b). By contrast, the narrow provisions of §§ 11 and 12(a)(2) of the 1933 Act only apply to an individual "purchasing" or "acquiring" a security. See id. §§ 77k(a), 77l(a). This narrower focus weighs heavily against extending the fundamental change doctrine to the 1933 Act.

Ultimately, Katz is simply trying to repackage claims under the 1933 Act that he brought below under the 1934 Act. But the district court dismissed these claims because Katz failed to adequately plead loss causation. See Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 345-46, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005) (holding securities fraud plaintiffs must plead and prove loss causation as an element of claims under § 10(b) and Rule 10b-5). Katz does not appeal the dismissal of his 1934 Act claims and cannot resurrect them through a citation to the fundamental change doctrine. In sum, even if we adopted the fundamental change doctrine, it would not apply to Katz's claims under the 1933 Act.

4. Fundamental Change/Failure to Acquire or Purchase

Further, even if we adopted the fundamental change doctrine and applied it to Katz's 1933 Act claims, it is still no help. In a forced sale, he is still a seller, not a purchaser. To find that Katz has standing, we would still have to assume he purchased the "new" A-1 Units, which he never did. In fact, Katz owned the same A-1 Units both before and after the merger was announced. Nothing can convert the sale of his A-1 units for cash into a purchase of shares he never acquired.

Finally, it is worth noting the Seventh Circuit considered these same arguments during the appeal regarding removal to federal court. Katz v. Gerardi, 552 F.3d 558 (7th Cir. 2009). Like us, the court found the claim unpersuasive***.

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