United States Court of Appeals
Fifth Circuit
REVISED MAY 12, 2005
F I L E D
April 15, 2005
IN THE UNITED STATES COURT OF APPEALS
Charles R. Fulbruge III
FOR THE FIFTH CIRCUIT Clerk
No. 04-20380
ROBERT F SMITH
Plaintiff - Appellant
v.
WASTE MANAGEMENT INC., a Delaware Corporation
Defendant - Appellee
Appeal from the United States District Court for the
Southern District of Texas, Houston
Before KING, Chief Judge, and JOLLY and DENNIS, Circuit Judges.
KING, Chief Judge:
Plaintiff-Appellant Robert Smith, the former owner of
several million shares of Waste Management, Inc. stock, has sued
Defendant-Appellee Waste Management for fraud and negligent
misrepresentation in connection with losses he sustained when
Waste Management’s share price fell in late 1999. On appeal,
Smith alleges that the district court erred when it found that
his claims were derivative and barred by res judicata. For the
following reasons, we AFFIRM the judgment of the district court.
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I. FACTUAL AND PROCEDURAL BACKGROUND
Robert Smith is a former officer and director of USA Waste
Services, Inc. In July of 1998, USA Waste merged with Waste
Management, Inc. At the time of the merger, Smith held a
substantial number of USA Waste shares. As a result of the
merger, these shares were converted into Waste Management shares.
By June of 1999, Smith owned approximately 2.4 million Waste
Management shares, most of which had been committed by him as
collateral for loans used to pay for his business endeavors. By
pledging Waste Management shares as collateral, Smith had
obtained $54 million in loans from five lenders. He had also
pledged 1.3 million of his Waste Management shares to borrow an
additional $50 million from Merrill Lynch & Co.
In the late spring of 1999, Ed Hayes, an accountant who
served as the chief financial officer for various companies owned
by Smith, allegedly began urging Smith to sell at least some of
his Waste Management stock to reduce his loan balances. Chris
Pakeltis, Smith’s personal accountant, also allegedly recommended
that he sell some of his Waste Management shares during this time
period. Smith, however, chose not to sell his shares. According
to him, his decision to retain his Waste Management shares
resulted from public statements made by Waste Management.
Specifically, on May 6, 1999, Waste Management stated in a press
release that its first-quarter net income had increased 93% from
the previous year and that earnings per share had similarly
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increased by 79%. Likewise, on May 6, 1999, Waste Management
conducted a conference call with investors and analysts, during
which it predicted that its earnings would climb to $3.50 per
share by the next year. Additionally, Waste Management officers
stated at an industry convention that earnings per share would
likely be $3.60 by the next year. According to Smith, he decided
not to sell his Waste Management shares after hearing these
positive representations about Waste Management’s future
earnings.
On July 6, 1999, Waste Management revealed that its second-
quarter earnings would fall $250 million below the levels it had
predicted several weeks before. As a result of this
announcement, Waste Management’s stock price dropped by more than
$20 per share. On August 3, 1999, Waste Management made another
negative adjustment to its projected second-quarter earnings, and
its share price continued to drop. By the end of 1999, Smith’s
Waste Management shares, as a result of the decline in the
company’s share price, had fallen to 40% of their value at the
time of the merger. Furthermore, as a result of this drop in
value, Smith’s Waste Management shares were rendered insufficient
collateral for his various business loans, and the banks that
made the loans foreclosed upon his Waste Management stock.
According to Smith, these foreclosures had a domino effect,
causing his other business loans, which were not secured by Waste
Management shares, to be harmed, since Smith’s sudden need for
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available resources caused him to default on these loans as well.
Ultimately, Smith filed a petition for bankruptcy.
As a result of the decline in Waste Management’s share
price, two derivative actions were brought on behalf of all Waste
Management stockholders in Delaware. On September 20, 2001, a
settlement of the consolidated Delaware actions (the “Delaware
litigation”) was approved by the Delaware Chancery Court, and
final judgment was entered. In re Waste Management, Inc.
Shareholder Derivative Litigation, C.A. No. 17313 NC (Del. Ch.
Sept. 20, 2001). The judgment in the Delaware litigation
disposed of all derivative claims by Waste Management
shareholders that related to, inter alia: (1) Waste Management’s
revenue shortfall for the second quarter of 1999; (2) Waste
Management’s budgeting process for 1998, 1999, and 2000; (3)
public statements by Waste Management or company officials
regarding the company’s actual or projected financial performance
or results (including, without limitation, representations made
in the third quarter of 1999); and (4) the company’s financial
reporting and accounting practices during 1998 and 1999.
Notwithstanding the Delaware litigation, Smith sued Waste
Management in the United States District Court for the Northern
District of Illinois, alleging fraud and negligent
misrepresentation, seeking actual damages of $100 million, and
seeking punitive damages of an additional $100 million. This
case was subsequently transferred to the United States District
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Court for the Southern District of Texas. Waste Management moved
for dismissal under FED. R. CIV. P. 12(b)(6), claiming that
Smith’s claims were derivative in nature and barred by res
judicata because of the September 20, 2001 order and final
judgment in the Delaware litigation. The district court agreed,
holding that Smith’s claims were derivative and barred by res
judicata. Smith now appeals the district court’s dismissal of
his suit.
II. STANDARD OF REVIEW
This court reviews de novo the grant of a motion to dismiss
under FED. R. CIV. P. 12(b)(6). Martin K. Eby Const. Co. v.
Dallas Area Rapid Transit, 369 F.3d 464, 472 (5th Cir. 2004). A
complaint “should not be dismissed for failure to state a claim
unless it appears beyond doubt that the plaintiff can prove no
set of facts in support of his claim which would entitle him to
relief.” Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
III. DISCUSSION
A. Smith’s Claims Are Derivative
The first question before this court is whether Smith’s
claims are direct or derivative. Smith states that because Waste
Management is a Delaware corporation, Delaware law will determine
the answer to this question. He then argues that the district
court erred when, relying on Delaware law, it found that he had
alleged derivative, not direct, claims because he did not allege
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a “special injury” distinct from that suffered by other
shareholders or a wrong involving one of his contractual rights
as a shareholder. According to Smith, he has alleged a special
injury because while other Waste Management shareholders did not
uniformly forego the recommended sale of their shares, he did.
Specifically, Smith argues that, unlike other Waste Management
shareholders, he made a specific decision, contrary to the advice
of his accountants, to hold his Waste Management shares when he
was advised to sell them.
Smith also claims on appeal that the Supreme Court of
Delaware has articulated recently a new standard for determining
whether a claim is derivative or direct in Tooley v. Donaldson,
Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004). According to
Smith, Tooley states that the determination of whether a claim is
derivative or direct will turn solely on who suffered the alleged
injury and who would benefit from any recovery. Smith then
states that his claims are direct because: (1) he relinquished
the opportunity to sell his shares in 1999 and, hence, he
suffered the alleged injury; and (2) he would receive the benefit
of any recovery from his lawsuit.
This court looks to the Delaware law, including the Delaware
Supreme Court’s recent opinion in Tooley, to decide whether
Smith’s claims are direct or derivative.1 In Tooley, the
1
Smith and Waste Management agree, and the district
court correctly concluded, that Delaware law applies to whether
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Delaware Supreme Court discarded the “special injury” test urged
by Smith and in its place articulated the following test for
determining whether a claim is derivative or direct: “The
analysis must be based solely on the following questions: Who
suffered the alleged harm--the corporation or the suing
stockholder individually--and who would receive the benefit of
the recovery or other remedy?” Tooley, 845 A.2d at 1035.
According to the Delaware Supreme Court, this approach is “to be
applied henceforth in determining whether a stockholder’s claim
is derivative or direct.” Id. at 1033. The court then clarified
this test, stating:
The proper analysis has been and should remain that
. . . a court should look to the nature of the wrong and to
whom the relief should go. The stockholder’s claimed direct
injury must be independent of any alleged injury to the
corporation. The stockholder must demonstrate that the duty
breached was owed to the stockholder and that he or she can
prevail without showing an injury to the corporation.
Id. at 1039 (emphasis added).
Smith’s claims are direct or derivative. In a diversity action,
a federal court must apply the choice of law rules of the state
in which it sits. Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S.
487, 496 (1941). “Where a transferee court presides over [a]
diversity action[] . . . under the multidistrict rules,” the
governing law comes from the “jurisdiction in which the
transferred” case originated. In re Air Disaster, 81 F.3d 570,
576 (5th Cir. 1996). Because Smith originally filed suit in
Illinois, Illinois conflict rules apply. Under Illinois law, the
determination of whether a plaintiff’s claims are direct or
derivative depends upon the law of the company’s state of
incorporation. Lipman v. Batterson, 738 N.E.2d 623, 626 (Ill.
App. Ct. 2000); Spillyards v. Abboud, 662 N.E.2d 1358, 1361 (Ill.
App. Ct. 1996). Because Waste Management is incorporated in
Delaware, Delaware law will determine whether Smith’s claims are
direct or derivative.
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Applying the principles set forth in Tooley to the present
case, it is clear that Smith’s claims are derivative, not direct.
The misrepresentations that allegedly caused Smith’s losses
injured not just Smith but the corporation as a whole. In Manzo
v. Rite Aid, No. Civ. A. 18451-NC, 2002 WL 31926606, at *5 (Del.
Ch. 2002) (unpublished), aff’d, 825 A.2d 239 (Del. 2003), the
Delaware Chancery Court, relying on Kramer v. Western Pacific
Industries, Inc., 546 A.2d 348 (Del. 1988), found that a
plaintiff’s claims were derivative, not direct.2 Explaining its
holding, the court stated that “[t]o the extent that plaintiff
was deprived of accurate information upon which to base
investment decisions and, as a result, received a poor rate of
return on her Rite Aid shares, she experienced an injury suffered
by all Rite Aid shareholders in proportion to their pro rata
share ownership.” Manzo, 2002 WL 31926606, at *5. Thus, when a
corporation, through its officers, misstates its financial
condition, thereby causing a decline in the company’s share price
when the truth is revealed, the corporation itself has been
injured. Here, the harm that befell Smith--the drop in share
price caused by the untimely disclosure of unfavorable financial
data--was a harm that befell all of Waste Management’s
2
Tooley explicitly endorsed Kramer’s approach of looking
at the nature of the wrong and to whom the relief should go in
order to determine if a suit is derivative or direct. Tooley,
845 A.2d at 1038. Thus, even though Manzo was decided before
Tooley, it applied the correct test, and there is no reason to
think it is no longer good law.
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stockholders equally. Stated differently, the misconduct alleged
by Smith did not injure Smith or any other shareholders directly,
but instead only injured them indirectly as a result of their
ownership of Waste Management shares. As such, Smith cannot
prove his injury without also simultaneously proving an injury to
the corporation. Accordingly, in light of Tooley, we find that
Smith’s claims are derivative under Delaware law. See Tooley,
845 A.2d at 1033, 1035, 1039.
Our conclusion is reinforced by the fact that if Smith’s
claims were construed as direct rather than derivative, Smith
would be allowed to benefit (by obtaining a judgment against
Waste Management) at the expense of all other shareholders who
are similarly situated. That is, Smith would be allowed to
recover the full amount of his losses from the diminished assets
of Waste Management, while similarly situated shareholders would
not. By finding that Smith’s claims are derivative, we ensure
that Smith will not incur a benefit at the expense of other
shareholders similarly situated. See Cowin v. Bresler, 741 F.2d
410, 414 (D.C. Cir. 1984) (“Requiring derivative enforcement of
claims belonging in the first instance to the corporation also
prevents an individual shareholder from incurring a benefit at
the expense of other shareholders similarly situated.”).
Our conclusion that Smith’s claims are derivative is similar
to the Texas Court of Appeal’s recent holding in Shirvanian v.
DeFrates, No. 14-02-00447-CV, 2004 WL 2610509, at *1 (Tex. App.--
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Hous. [14 Dist.] Nov. 18, 2004) (Shirvanian II). In this case,
certain Waste Management shareholders, whose shares declined in
value as a result of the decline in Waste Management’s share
price in the summer of 1999, sued the corporation for fraud,
intentional misrepresentation, negligent and grossly negligent
misrepresentation, and conspiracy, arising from alleged oral
inducements not to sell their Waste Management shares. On
January 8, 2004, the Texas Court of Appeals issued an opinion in
favor of the plaintiffs, holding that their lawsuit was a direct
action, not a derivative action. Shirvanian v. DeFrates, No.
14-02-00447-CV, 2004 WL 35987 (Tex.App.--Hous. [14 Dist.] Jan.
08, 2004) (Shirvanian I). In his briefs to this court, Smith
cites this decision in support of his claims. After the briefs
had been filed in the present case, however, the Texas Court of
Appeals withdrew its opinion in Shirvanian I and granted
rehearing in light of Tooley. On November 8, 2004, the Court of
Appeals, on rehearing, held that under Tooley, the plaintiffs’
claims were derivative and barred by res judicata. Shirvanian
II, 2004 WL 2610509, at *6-7. In the words of the Court of
Appeals:
To decide if the harm was to the corporation or to the
stockholder individually, the [Delaware Supreme Court
in Tooley] suggested the most relevant question is
whether the stockholder can prevail without showing an
injury to the corporation. . . . The stockholder must
demonstrate that the duty breached was owed to the
stockholder and that he or she can prevail without
showing a corresponding injury to the corporation.
Applying those principles here leads to the conclusion
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that the Shirvanians’ complaints are derivative, not
direct, and could be asserted only on behalf of the
corporation. The misrepresentations the Shirvanians
allege caused their injury were based on mismanagement
of the corporation’s assets. The Shirvanians cannot
prove their injury without proving an injury to the
corporation. We hold, therefore, that the Shirvanians’
suit is derivative under Delaware law.
Id. at *6. Accordingly, Shirvanian II supports this court’s
determination that Smith’s claims are derivative, not direct.3
B. Res Judicata Bars Smith’s Claims
Because Smith’s claims are derivative, they are barred by
res judicata. Res judicata prevents the relitigation of claims
that have already been finally adjudicated or that should have
been litigated in the prior lawsuit. United States ex rel. Laird
v. Lockheed Martin Eng’g and Sci. Servs., 336 F.3d 346, 357 (5th
Cir. 2003). Res judicata applies when: (1) there was a previous
final judgment on the merits; (2) the prior judgment was between
identical parties or those in privity with them; and (3) there is
a second action based on the same claims as were raised or could
3
While no court in this circuit has yet addressed
Tooley, the Delaware Chancery Court has relied on Tooley in
several cases to hold, as the Texas Court of Appeals held in
Shirvanian, that a claim is derivative, not direct. See, e.g.,
In re Syncor Int’l Corp. S’holders Litig., 857 A.2d 994, 995-98
(Del. Ch. 2004); Dieterich v. Harrer, 857 A.2d 1017, 1025-28
(Del. Ch. 2004); FS Parallel Fund L.P. v. Ergen, No. Civ. A
19853, 2004 WL 3048751, at *3 (Del. Ch. Nov. 03, 2004)
(unpublished); see also Gaia Offshore Master Fund, Ltd. v.
Hawkins, No. C03-3657, 2004 WL 2496142, at *3-4 (N.D. Cal. Nov.
5, 2004); Schuster v. Gardner, 25 Cal. Rptr. 3d 468, 476-78
(2005).
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have been raised in the first action. See id. Smith himself
admits that if his claims are derivative, they are barred by res
judicata. This follows from the fact that the September 20, 2001
final judgment in the Delaware litigation against Waste
Management is a final judgment that: (1) disposes of all
derivative claims by Waste Management shareholders against the
company pertaining to misrepresentations about Waste Management’s
projected earnings and the sudden fall in its share price in
1999; and (2) is between parties identical to, or in privity
with, those now before this court. Accordingly, because Smith’s
claims are derivative, they are barred by res judicata and the
dismissal of his complaint was proper.4
IV. CONCLUSION
For the foregoing reasons, we AFFIRM the judgment of the
district court.
4
Because Smith’s claims are barred by res judicata, the
court need not address Waste Management’s further argument that
holder claims are not cognizable under this court’s decision in
Crocker v. FDIC, 826 F.2d 347 (5th Cir. 1987), or under the
Supreme Court’s decision in Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723 (1975).
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