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Class Action Defense Cases–In re HealthSouth: Eleventh Circuit Affirms Class Action Settlement Of Securities Fraud Class Action Including Bar Order Impacting CEO’s Indemnity Agreement With Company

Class Action Settlement Calling for Bar Order, Wiping Out Corporate Officer’s Indemnification Agreement and Advancement of Attorney Fees from Company Properly Approved by District Court Eleventh Circuit Holds

Plaintiffs filed a class action against HealthSouth Corporation and others, including its former chairman and CEO Richard M. Scrushy, alleging securities fraud; the class action complaint was filed in March 2003, after “HealthSouth acknowledged that its previous financial statements had substantially overstated its income and assets.” In re HealthSouth Corp. Sec. Litig., 572 F.3d 854, 2009 WL 1675398, *1 (11th Cir. 2009). According to the several class action complaints that were filed, defendants violated the Securities Act of 1933 and the Securities Exchange Act of 1934. Id. Ultimately, the class actions were consolidated in the Northern District of Alabama, and a partial settlement was reached between HealthSouth and the lead plaintiffs whereby HealthSouth would pay $445 million in settlement. Id. Scrushy was not a party to the settlement (having been prohibited from the mediation as the alleged mastermind of the fraud), and the district court approved the settlement over his objections, id. In part, the settlement included a bar order that extinguished “[Scrushy’s] contractual claims against HealthSouth for indemnification of settlement payments he might make to the underlying plaintiffs and extinguishes his claims for advancement of legal defense costs.” Id.

The basis of the appeal is that, in 1994, “Scrushy and HealthSouth executed an agreement requiring HealthSouth to indemnify Scrushy to the fullest extent permitted by law.” In re HealthSouth, at *1. Specifically, the indemnity agreement “require[d] HealthSouth to indemnify Scrushy for any judgment or settlement in any action in which he is sued for actions taken as a director or officer of the company, if he acted in good faith and reasonably believed he was acting in the best interest of the company.” Id. The bar order, however, wiped out any indemnity obligations, id. Scrushy’s objection was premised on the fact that the bar order “extinguished valuable and enforceable rights to which Scrushy was entitled under his indemnification agreement with HealthSouth.” Id., at *2. But “[t]he Bar Order is reciprocal, extinguishing similar claims by the settling defendants.” Id., at *2 (footnote omitted). The Eleventh Circuit reviewed Scrushy’s challenges to the settlement bar order for an abuse of discretion, id., at *3.

The Circuit Court first addressed the bar order’s impact on Scrushy’s claim for indemnification against HealthSouth. In re HealthSouth, at *3. Scrushy claimed that the PSLRA’s “mandatory contribution bar” is “exclusive,” and therefore prohibits the contribution bar approved by the district court, id. The Circuit Court held that “the mandatory contribution bar in the PSLRA does not preclude a bar order containing a provision like the instant one – i.e., barring Scrushy’s potential claim against the Released Persons for indemnification of any amounts he might pay in settlement of actual or threatened liability to the underlying plaintiffs.” Id., at *4. The Eleventh Circuit rejected Scrushy’s claim that contractual claims may be barred only to the extent that they concern potential liability of the plaintiffs. Id., at *5. Scrushy claimed that his claims were “truly independent,” but the Circuit Court rejected this claim, following a Second Circuit decision on the very point. Id. The Court rejected also Scrushy’s public policy argument for indemnification of corporate officers “sued for actions taken within the scope of their employment,” id., at *6. The Eleventh Circuit held that the bar order “is neither inconsistent with the mandatory contribution bar in the PSLRA, nor with public policy,” and therefore the district court did not err in rejecting Scrushy’s objections to the settlement. Id.

The Eleventh Circuit then turned to Scrushy’s challenge to the bar order’s extinguishment of his contractual claim for the advancement of attorney fees in the securities fraud class action. See In re HealthSouth, at *7. Yet again, the Circuit Court rejected Scrushy’s claim that bar orders may only “preclude claims by non-settling defendants against settling defendants where the injury to the non-settling defendant was its liability to the underlying plaintiffs.” Id. (citations omitted). Here, however, Scrushy’s claim is “a truly independent claim” because it is unrelated to liability to the plaintiffs in the class action. Id. While recognizing no circuit court authority on the subject, the Eleventh Circuit rejected Scrushy’s argument, concluding that “Scrushy’s claim for attorneys’ fees clearly cannot be considered to be independent of his liability to the underlying plaintiffs.” Id., at *8. The Court rejected also Scrushy’s public policy argument “that Delaware law supports advancement of litigation fees for officers and directors to ensure that they will resist unjustified claims, and to encourage qualified individuals to serve.” Id. (citation omitted). The Circuit Court recognized that it may be difficult for an innocent officer or director to prove innocence without the advancement of attorney fees, id., but held that “policy arguments supporting advancement of legal fees must be balanced against countervailing policies in favor of settlements and against indemnification in the securities litigation context,” id., at *9. This is particularly true given HealthSouth’s substantial contribution to the class action settlement, id. In sum, because the Circuit Court found that the settlement was “fair, adequate and reasonable,” it held that the district court did not abuse its discretion in approving it and in barring “Scrushy’s claims against HealthSouth for advancement of legal fees.” Id., at *11. Accordingly, the Eleventh Circuit affirmed the approval of the class action settlement. Id.

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