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F5 Investors Can Sue Without Board OK: Wash. Court

Former CEO Scrushy had complained the settlement was unfair because it cut off his legal defense funds and other benefits

June 18, 2009
Alyson M. Palmer
© 2009 Fulton County Daily Report

The federal appeals court in Atlanta has rejected objections to the settlement of a securities fraud suit against HealthSouth.

Former HealthSouth Chief Executive Officer Richard Scrushy, who is serving a prison sentence for an unrelated bribery charge, had complained that the settlement was unfair to him because it cut off his legal defense funds and other benefits. AIG Global Investment Group, a division of the embattled insurance giant, had argued that it should have been allowed to opt out of the class of plaintiffs in the case.

Absent further appeals, Wednesday's rulings against Scrushy and AIG appear to remove all impediments to the $445 million settlement, which resolves massive securities fraud claims against HealthSouth, its insurance carriers and some of its directors and officers -- but not Scrushy.

Appearing in January at the 11th U.S. Circuit Court of Appeals, Scott B. Smith of Bradley Arant Boult Cummings' office in Huntsville, Ala., defended the settlement on behalf of HealthSouth, which operates rehabilitation centers as well as providing home health services. Smith on Wednesday provided a statement on the rulings from HealthSouth's general counsel, John P. Whittington.

"We are gratified that the 11th Circuit Court of Appeals has resolved these two impediments to the company's 2006 settlement of the federal securities class action," said Whittington. "This is another milestone in the company's efforts to put the past behind it and focus on the future of its business."

Patrick J. Coughlin, who represents the plaintiff class, said Wednesday's decision on Scrushy's appeal addresses situations where a key company officer or two hold settlement discussions hostage.

"It allows us to go into an egregious situation where a few bad guys are holding up the works and settle around them and continue to pursue them," said Coughlin, of the San Diego office of Coughlin Stoia Geller Rudman & Robbins.

Lawyers for the company have acknowledged that between 1996 and 2002, HealthSouth overstated its corporate revenues by $2.7 billion. Several directors and officers of the company pleaded guilty to criminal charges. Scrushy, who is serving an 82-month prison sentence on a federal conviction of bribing Alabama's former governor, was acquitted in a trial over fraud charges involving HealthSouth.

But in authoring the opinion for the three-judge panel, Senior Judge R. Lanier Anderson emphasized that "the underlying plaintiffs perceive Scrushy as a central figure in the violations" and "that Scrushy made no showing in the district court that he was merely an innocent bystander with respect to the violations at issue here."

Represented by David G. Russell of Atlanta's Parker, Hudson, Rainer & Dobbs, Scrushy had argued that the settlement between HealthSouth and a class of plaintiffs impermissibly cuts off contractual obligations the company owes him -- the company's duties to advance Scrushy his legal defense fees and reimburse him for settlement monies when he has acted in good faith -- even though he is not a party to the settlement.

The 11th Circuit panel ruled that the settlement provides Scrushy benefits that make the deal sufficiently fair to pass muster, especially in light of the court's interest in fostering settlements of class actions.

Joined by 11th Circuit Judge Stanley Marcus and visiting 7th Circuit Senior Judge Richard D. Cudahy, Anderson began his opinion by explaining in a footnote that settlement agreements frequently include a provision extinguishing future claims by both settling and nonsettling parties, in order to facilitate the settlement.

The panel rejected Scrushy's complaints about the settlement provision that forbids Scrushy from recouping from HealthSouth whatever he might pay in settlement to the plaintiffs.

Anderson emphasized that the settlement states that plaintiffs can collect on a judgment against Scrushy personally only to the extent that the verdict exceeds $445 million.

Scrushy's lawyers argued that wasn't a fair trade because the credit wouldn't come into play if Scrushy settled with the plaintiffs ahead of trial. But Anderson wrote that Scrushy could use the possibility of the offset "as a very significant bargaining chip in negotiating a settlement with the underlying plaintiffs."

Anderson's opinion also rejected Scrushy's argument that HealthSouth's contractual obligation to advance his attorney fees was too far removed from any liability he might have to the plaintiffs to be eliminated by the settlement.

Although the settlement allows Scrushy to claim reimbursement of fees if he wins in the class action, Anderson acknowledged that "in the absence of fee advancement, an innocent officer or director might have difficulty proving his innocence, and thus might have difficulty realizing a prevailing status."

However, wrote Anderson, that argument has to be balanced against public policy in favor of settlements and against indemnification in the securities litigation context.

"HealthSouth might well have been reluctant to contribute $215 million for the settlement if it thought it would continue to be liable for endless legal fees to fund Scrushy's individual defense against the same violations, especially as HealthSouth and the underlying plaintiffs perceive Scrushy as a central figure in the violations," wrote Anderson, noting insurance carriers had chipped in an additional $230 million to the settlement. "In other words, absent a bar of any claim by Scrushy for advancement of legal fees, HealthSouth would have bought only a limited peace."

Russell, Scrushy's lawyer, left open the possibility of asking the full 11th Circuit or the U.S. Supreme Court to look at the case. He noted Anderson's observation that the decision on the attorney fees advancement bar involved a matter of first impression for a federal court of appeals.

"It seems like the 11th Circuit was heavily guided by not wanting to upset the settlement that HealthSouth had reached with the plaintiffs," said Russell, "and that was the greater good in its mind. ... In their view, Scrushy's contractual rights had to yield to that greater cause."

In a separate, unsigned opinion, the same panel rejected the arguments of AIG Global, which has said that as an investment manager it purchased approximately $180 million of HealthSouth debt securities during the time period covered by the class action. AIG had argued that it should have been allowed to opt out of the class action.

U.S. District Judge Karon O. Bowdre in Birmingham, Ala., told AIG Global it missed a deadline to opt out of the deal, but the company said it got notice of the settlement too late. AIG also argued that HealthSouth and the class counsel hid a provision that would exclude from AIG's recovery approximately 65 percent of the debt instruments it purchased.

But the appellate judges ruled that Bowdre didn't abuse her discretion in denying AIG's opt-out request.

"AIG Global is a sophisticated party with extensive holdings at issue in this litigation," said the panel in its opinion, "and counsel's failure to opt out before the deadline was inexcusable."

Barry A. Ragsdale of Sirote & Permutt in Birmingham, who argued the appeal for AIG, couldn't be reached for comment Wednesday afternoon.

The case is In re: HealthSouth Corporation Securities Litigation, Nos. 07-10701 and 07-11908.

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