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503 F.Supp. 802 

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        Edward Slovick, and James S. Gordon, J. Samuel Tenenbaum, and Theodore M. Becker, Becker & Tenenbaum, Chicago, Ill., for plaintiffs.

        Max E. Wildman, Wildman, Harrold, Allen & Dixon, William A. Montgomery, Allen Horwich, and John Adams, Schiff, Hardin & Waite, Chicago, Ill., for defendant Heizer Corp.

        Harold A. Lipton, Kaplan, Livingston, Goodwin, Berkovitz & Selvin, Beverly Hills,

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Cal., John B. Simon, and Russ M. Strobel, Friedman & Koven, Chicago, Ill., for defendant International Digisonics Corp.

        MARSHALL, District Judge.

        We have four issues to resolve in this shareholder derivative suit brought on behalf of International Digisonics Corporation (IDC) against defendant Heizer Corporation (Heizer). Plaintiffs alleged that Heizer defrauded IDC in a series of five transactions in which Heizer purchased IDC preferred stock and made loans in exchange for both demand notes and stock warrants. After we rendered our decision, 411 F.Supp. 23 (D.C.Ill.), the Court of Appeals affirmed in part and vacated in part, with directions to modify. Wright v. Heizer Corp., 560 F.2d 236 (7th Cir. 1977). The issues now awaiting resolution are (1) the adjustment of the maturities of the demand notes held by Heizer, (2) the amount of attorney's fees, if any, to be awarded to plaintiffs, (3) whether those fees should be assessed against Heizer and (4) whether IDC should be compelled to redeem the preferred stock held by Heizer.

        The facts underlying plaintiffs' complaint were set forth in great detail in our original memorandum decision and in the Court of Appeals decision. Thus we will limit our description of the facts to those necessary to provide an understanding of the remaining issues.

        In a series of five transactions beginning in November, 1969, Heizer invested in IDC through the purchase of IDC preferred stock and the exchange of demand loans in return for stock warrants. In the first transaction, in November, 1969, Heizer purchased 100,000 shares of newly created Class A common stock at $10 per share. In addition, IDC gave Heizer a warrant to purchase 155,000 shares of IDC common stock at $8.50 per share. The warrant contained an antidilution clause which reduced the price to Heizer in the event IDC issued or sold common stock at less than $8.50. Heizer agreed to lend IDC up to $500,000 with interest at 2% over prime. This $500,000 sum was loaned to IDC in May, 1970.

        In September, 1970, IDC and Heizer consummated the second transaction. IDC amended its certificate of incorporation to authorize 350,000 shares of a new class of preferred stock, carrying a weighted vote of 4.4 votes per share on all shareholder votes. Heizer exchanged the 100,000 shares of Class A common issued in the first transaction for 100,000 shares of the new preferred and purchased 200,000 additional shares at $10 per share in two takedowns of $1,000,000 each. After the second takedown, IDC issued an additional warrant to purchase 400,000 shares of IDC common at $6 per share, with an antidilution clause identical to the one employed in the first transaction.

        The third transaction occurred in May, 1971. IDC amended its certificate of incorporation to increase the authorized common stock to 3,000,000 shares. IDC sold Heizer a twenty-year senior note in the principal amount of $1.7 million and issued additional warrants to purchase 472,222 shares of IDC common at $3.60 per share. The purchase price in the warrants issued in the first two transactions was adjusted to $3.60 per share and the number of shares purchasable under the warrants was increased to 276,223 for the first transaction and 555,555 for the second transaction. Thus by the conclusion of the third transaction Heizer could purchase 1,304,000 shares of common stock at $3.60 per share.

        The fourth transaction, consummated in November, 1971, provided for loans of up to $600,000 by Heizer to IDC through sale of a note by IDC to Heizer payable on demand after March 31, 1972. If the entire $600,000 was loaned but not timely paid, Heizer could convert it into common stock at $1.00 per share. If the note became convertible, then the prices on the warrants from the first three transactions would be decreased from $3.60 per share to $1.00 per share and the number of shares purchasable would increase from 1,304,000 to 4,694,400. IDC amended its certificate of incorporation increasing

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the number of authorized common shares from 3,000,000 to 7,000,000.

        On March 13, 1972, the November, 1971 agreement was amended to provide for an additional loan from Heizer to IDC of an amount up to $250,000. On March 13, Heizer loaned $105,000 of this amount to IDC. In addition, IDC issued a demand note in the amount of $114,508 to cover management services Heizer had performed for IDC. IDC was unable to repay any of the fourth transaction loans by March 31, 1972 and thus all warrants held by Heizer became exercisable at $1.00 per share. This gave Heizer the right to purchase 5,513,000 shares of IDC common stock, representing 87% of IDC's pro forma common stock equity. Between April 14, 1972 and April 19, 1973, Heizer loaned IDC an additional $2,015,000 in demand loans.

        On October 11, 1972 the plaintiffs brought this action seeking to enjoin Heizer's exercise of the stock warrants and to obtain rescission of the first four transactions. Then on June 8, 1973, in the fifth transaction, Heizer agreed to refrain from demanding payment on the notes totalling $819,508 issued pursuant to the fourth transaction and demand notes totalling $2,015,000 issued between April 14, 1972 and April 19, 1973. In addition, Heizer agreed to make further demand loans to IDC in the maximum amount of $1,181,700 and a minimum of $460,400. IDC pledged all of the stock of its wholly owned subsidiary Talent and Residuals, Inc. (TR) to Heizer as security for the demand note loans made after April 14, 1972. Plaintiffs amended their complaint to challenge the fifth transaction as well as the first four.

        In our memorandum decision of December 3, 1975, following a bench trial, we held that plaintiffs, as shareholders of IDC, could maintain the action derivatively on behalf of IDC, but not on their own behalf. We then held that plaintiffs had not proved a 10b-5 violation with respect to the first three transactions. We concluded that although Heizer had driven a hard bargain, IDC was badly in need of cash, and IDC's directors, counsel, and shareholders had been fully informed and that the directors were independent of Heizer's control.

        We held, however, that Heizer had violated Rule 10b-5 in the fourth and fifth transactions. Because by the fourth transaction Heizer's agents were on IDC's board and held votes essential to the consummation of these transactions, we held that Heizer had a heavy burden of proving the fairness of these transactions. We noted that in the fourth transaction, Heizer, for an additional investment of only $600,000, had increased its claim on IDC's common equity from 1,304,000 shares at $3.60 per share to 4,694,000 (and after additional demand loans 5,513,000) shares at $1.00 per share. We also found that Heizer's valuation of IDC stock at $1.00 per share was inadequate and that Heizer had dealt unfairly with IDC. We held that the fifth transaction was also unfair. After the fourth transaction, Heizer could, through the warrants and convertible notes, capture 87% of IDC's equity and the profitable TR. Thus Heizer, by obtaining the pledge of TR stock in the fifth transaction, was attempting to protect itself from the outcome of this litigation. We noted that "[i]t is difficult to conjure a more blatant breach of trust." Wright v. Heizer Corp., 411 F.Supp. at 37.

        We ordered the notes from the fourth and fifth transactions declared nonconvertible, and we voided any provision in the fourth transaction which permitted an increase of issuable common shares of IDC in excess of 1,304,000 or which permitted the exercise of a warrant at a price less than $3.60 per share. We also voided the pledge of TR stock to Heizer.

        Prior to the Court of Appeals' consideration of our decision, Heizer presented a recapitalization plan to IDC's shareholders and in a proxy solicitation noted that IDC did not have the financial resources necessary to repay Heizer. Heizer threatened to institute bankruptcy proceedings for IDC if the plan was not approved. We enjoined consummation of the plan pending appeal. We also enjoined Heizer from collecting interest or principal on its loans to IDC. In a petition for supplemental relief, the plaintiffs

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urged that the demand loans held by Heizer were unfair and should be cancelled or reformed into common stock. We denied this petition for supplemental relief as untimely.

        The Court of Appeals affirmed in part and vacated in part, with directions to modify. The plaintiffs filed but dismissed an appeal with respect to the first three transactions. The Court of Appeals held in light of the Supreme Court's intervening decision Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), that our conclusion that a breach of fiduciary duty by majority shareholders in itself violates rule 10b-5 was incorrect and that proof of a 10b-5 violation here would depend upon showings of nondisclosure, materiality, reliance and scienter. The court went on to find that all such elements had been proved on both the fourth and fifth transactions.

        As for the fourth transaction, the court found lacking a full disclosure of a critical and material element, the charter amendment increasing the number of authorized shares of common stock from three to seven million. Because the shareholders, under applicable Delaware law, had the power to veto the transaction entirely, proof of materiality established reliance. The court also found the failure to disclose details of the controversial fourth transaction was highly unreasonable and constituted proof of "an extreme departure from the standards of ordinary care" as required by Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976).

        As for the fifth transaction, the Court of Appeals found that because IDC's Board of Directors was virtually controlled by Heizer, which was self-dealing, only the independent shareholders could represent the corporation. Such independent shareholders are entitled to full disclosure.¹ See Dasho v. Susquehanna Corp., 461 F.2d 11 (7th Cir.), cert. denied, 408 U.S. 925, 92 S.Ct. 2496, 33 L.Ed.2d 336 (1972). The Court of Appeals found that this disclosure was missing here, inasmuch as the shareholders were first informed of the pledge two months after the transaction. Because under Delaware law the minority shareholders would have had the right to obtain a judicial determination of the fairness of the pledge transaction, the materiality requirement was fulfilled if the controlling shareholder, Heizer, could not demonstrate the fairness of the pledge transaction. The Court of Appeals held that the presumption of unfairness that we applied was appropriate because of Heizer's attempt to divorce its role as creditor from its role as fiduciary. The Court of Appeals found unpersuasive Heizer's arguments in support of the fairness of the pledge transaction. Heizer's first explanation, that the pledge was a device to discourage the "nuisance" suit filed by plaintiffs, was inconsistent with the duty to deal fairly with the minority. The second explanation, that in light of the possible result of plaintiffs' suit the pledge was necessary to preserve Heizer's flexibility of choosing between maintaining its senior position or converting its holdings into common stock, bore no relation to IDC's welfare. Finally, the Court of Appeals found that the failure to disclose was reckless because Heizer must have known that the pledge was for its own benefit and thus would arouse a great deal of opposition.

        The Court of Appeals affirmed our nullification of the pledge transaction, the cancellation of the conversion feature, price adjustment, and charter amendment in the fourth transaction. The court, however, reversed our determination that the petition for supplemental relief with respect to the demand loans was untimely. The court held that the loans constituted a "heads-I-win-tails-you-lose" series of transactions, inasmuch as Heizer could obtain a controlling share of IDC's equity if IDC's monitoring effort was successful but could call in its loans and put IDC into bankruptcy if the

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monitoring venture failed. Thus the court held that

        [I]n order to unravel in an equitable manner the transactions resulting from Heizer's wrongful conduct, the maturities of the loans should be adjusted to make them commensurate with IDC's ability to pay. On remand the District Court should make the necessary determinations and modify the terms of the loans accordingly.

        560 F.2d at 254.

        Thus the mandate of the Court of Appeals requires us to modify the maturities of the loans commensurate with IDC's ability to pay. Plaintiffs, Heizer, and IDC's management have all submitted proposals for scheduling this repayment. Before we determine which proposal to adopt, however, we must resolve other issues. Plaintiffs have moved for attorney's fees and have sought to compel IDC to redeem the preferred stock held by Heizer. If we decide that plaintiffs are entitled to attorney's fees, and that the fees should be assessed against IDC and not Heizer, we will have to adjust the repayment schedule to reflect the attorney's fees.² Similarly, if we hold that IDC should redeem the preferred stock now, IDC's ability to repay the demand loans will be affected and the schedule for repayment will require modification. Thus we will determine first whether IDC must redeem the preferred stock held by Heizer. We will then determine whether plaintiffs are entitled to attorney's fees and who should pay them. Finally, we will consider which of the three repayment plans is best.

        Heizer owns 209,048 shares of preferred stock.³ Although 350,000 shares are authorized, Heizer owns the only preferred stock outstanding. Each preferred share carries 4.4 votes. Plaintiffs seek an injunction requiring IDC to redeem this preferred stock.

        Both IDC and Heizer oppose redemption. They claim first that because the issue is governed by state law and is not within the Court of Appeals mandate, we have no jurisdiction to hear the claim. Further, IDC and Heizer argue that even if we do have jurisdiction, IDC is barred by Delaware law from redeeming any preferred stock at this time. Delaware law prohibits a corporation from redeeming stock when the corporation's capital is impaired or would be impaired by redemption. Del.Code Tit. 8, § 160. Section 160 also contains an exception which permits redemption of preferred stock out of capital. IDC and Heizer contend that IDC's capital would be impaired by redemption and that IDC does not have sufficient capital to redeem the preferred stock by resort to the exception.

        Plaintiffs contend in response that the redemption issue is encompassed within the Court of Appeals mandate, because before we can determine how to adjust the maturities of the demand loans, we must determine what other obligations IDC must fulfill. One such obligation, according to plaintiffs, is the redemption of the preferred stock. Plaintiffs further contend that the statutory limitations contained in Delaware law are inapplicable because the Delaware law is designed to protect shareholders and creditors, but no common stockholder opposes redemption and IDC has no creditors other than Heizer who might be affected by the redemption. Even if Delaware law does apply, plaintiffs contend that "additional paid-in capital" should be included with capital to trigger the exception in § 160.

        Before proceeding to the merits of plaintiffs' motion, we must determine whether we have jurisdiction to hear it. When a district court enters a final judgment in a case, and an appeal is filed, the district court loses jurisdiction over the case. The only further action that the district court may take is action that will aid

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the appeal or correct clerical errors. 9 Moore's Federal Practice 203.11 at 738-39; Lloyd v. Lawrence, 60 F.R.D. 116, 117-18 (D.C.Tex.1973). Then if the Court of Appeals decides the appeal and remands, issues determined by the appellate court cannot be reconsidered by the district court upon remand. United States v. Parke, Davis & Co., 365 U.S. 125, 81 S.Ct. 433, 5 L.Ed.2d 457 (1961). Thus the district court on remand may consider issues raised below but left open by the Court of Appeals, issues ancillary or pendent to those left open, issues for which an independent basis of jurisdiction exists, and issues ancillary to the mandate.

        Applying these general principles to the instant case, we find that our memorandum decision addressed all five transactions challenged by plaintiffs. Upon appeal, plaintiffs chose not to contest our rulings with respect to the first three transactions. They are, therefore, precluded from asserting, either here or in the Court of Appeals, that defendants violated Rule 10b-5 in those transactions. The Court of Appeals ruled on the 10b-5 contentions with respect to the fourth and fifth transactions. The only issue left open by the Court of Appeals was the maturities of the demand notes. Our remand jurisdiction now extends only to the determination of the modification of the demand notes. Thus unless an independent basis for federal jurisdiction exists or unless the redemption issue is ancillary to the Court of Appeals mandate to reform the demand notes, we have no jurisdiction to hear it.

        Even if plaintiffs were to amend their complaint or bring a related action seeking to compel redemption, we cannot conceive of a federal law, nor have plaintiffs suggested any, that would require redemption here and that would convey a basis for federal jurisdiction.⁴ Rule 10b-5 applies only to the purchase or sale of securities. Inasmuch as we held that the sale of the preferred stock to Heizer was not a violation of 10b-5, then the redemption issue does not present a 10b-5 question. Moreover, Delaware law does contain a detailed provision regarding redemption, and the issue is one which is "traditionally relegated to state law." See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 478, 97 S.Ct. 1292, 1303, 51 L.Ed.2d 480 (1977). Thus no independent federal jurisdiction exists.

        Plaintiffs contend that even if state law is applicable, the redemption issue is ancillary to the mandate. According to the plaintiffs, the mandate requires us to determine IDC's ability to repay the demand notes. IDC's ability to repay is dependent upon its other obligations, one of which is the obligation to redeem the preferred stock held by Heizer. Therefore, in order to determine what obligations will affect IDC's ability to repay the loans, we must determine whether IDC must first redeem the preferred stock. Plaintiffs also claim that Heizer has refused to permit IDC to redeem the preferred stock "in flagrant violation of the ruling of the Court of Appeals in this case that Heizer cannot use its power over the corporate machinery to maintain its control over the corporation." Plaintiffs' Motion for Preliminary and Permanent Injunction, at 3.

        We agree with plaintiffs that we should consider IDC's obligations in determining how to schedule repayment of the loans commensurate with IDC's ability to pay. We do not agree, however, that such consideration could result in an order compelling redemption of the stock. The mandate empowers us to formulate a schedule for repayment of the demand notes. We could, ancillary to the mandate, enjoin any action that would frustrate the mandate. We do not believe, however, that the redemption or nonredemption of the preferred stock would carry any potential for frustrating the mandate. The mandate requires only that we reform the demand notes commensurate

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with IDC's ability to pay. Findings of fact resulting from a determination of what obligations, such as redemption, affect IDC's ability to pay are within the scope of the mandate. Enforcement of those obligations is not. Thus we must make findings with respect to whether Delaware requires redemption, but we are not empowered to order redemption.

        As a practical matter, it makes little difference whether we have the power to order redemption, because we conclude that Delaware law prohibits redemption of the preferred stock owned by Heizer at this time. The Delaware law governing redemption, Del.Code Tit. 8, § 160, is designed for the benefit of both creditors and shareholders. See Propp v. Sadacca, 40 Del.Ch. 113, 175 A.2d 33, 38 (1961), modified, 41 Del.Ch. 14, 187 A.2d 405 (1962). Moreover, plaintiffs have offered no support for the contention that no common stock owners oppose redemption, and IDC has creditors other than Heizer. Transcript (Tr.) at 283. Thus we conclude that plaintiffs' assertion that Delaware law governing redemption should not apply because no one here is deserving of its protection is incorrect.

        Section 160 of the Delaware General Corporation Law (DGCL) provides that a corporation may not redeem its own shares

        [W]hen the capital of the corporation is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation, except that a corporation may purchase or redeem out of capital any of its own shares which are entitled upon any distribution of its assets, whether by dividend or in liquidation, to a preference over another class or series of its stock if such shares will be retired upon their acquisition and the capital of the corporation reduced in accordance with §§ 243 and 244 of this title.

        A corporation redeeming its own shares would impair its capital within the meaning of § 160 unless it redeems shares out of "surplus." In Re International Radiator Co., 10 Del.Ch. 358, 92 A. 255 (1914). Section 154 of the DGCL defines "surplus" as "the excess, if any, at any given time, of the net assets of the corporation over the amount ... determined to be capital." Section 154 defines "net assets" as "the amount by which total assets exceed total liabilities." Del.Code Tit. 8, § 154. The most recent IDC balance sheet which is part of the record shows that IDC has assets of $10,278,746 and liabilities of $15,863,161. See Plaintiffs' Exhibit 4, IDC Consolidated Balance Sheet as of December 31, 1977. Under Delaware law, IDC has a negative surplus and its capital would be impaired by redemption.

        Section 160 provides an exception to the impairment of capital rule. The corporation may redeem preferred stock out of capital if the shares are retired and the capital reduced. Section 154 defines "capital" as "an amount equal to aggregate par value of such shares." The par value of the 300,000 IDC preferred shares is $3,000,000. Although § 154 provides that a corporation may designate an amount in excess of par value to be "capital," the IDC Board of Directors made no such designation. In fact, the Certificate of Amendment of Incorporation of IDC specifically provides that the corporation will not classify as capital the excess of the consideration received for preferred stock over the aggregate par value of the preferred shares. See Certificate of Amendment of Certificate of Incorporation of International Digisonics Corp., Exhibit B to Appendix C to Post Hearing Brief of Heizer Corp.

        Plaintiffs argue, however, that the item on IDC's balance sheet designated as "paid-in capital" indicates the amount of IDC's "capital" for the purpose of redemption under § 160. We agree with defendants, however, that "paid-in capital" is merely a descriptive accounting term and certainly cannot be taken as a corporate designation of "capital" in excess of par value as defined by § 154. See G. Dick & R. Rickert, Accounting Trends & Techniques (31st ed. 1977). Therefore, § 160 of the DGCL prohibits redemption of IDC preferred stock at this time.

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        1. Assessment of Fees Against Heizer Corp.

        Plaintiffs seek attorney's fees from Heizer or IDC. They first seek fees from Heizer under the "bad faith" exception to the "American rule" that a winning litigant cannot recover attorney's fees from the loser. If plaintiffs' counsel (hereinafter petitioners) cannot recover fees from Heizer, they seek to be paid by IDC on the grounds that plaintiffs' derivative suit substantially benefited the corporation. Petitioners Edward Slovick and James S. Gordon seek fees of $90 per hour for 3,965 hours, $95 per hour for 498.5 hours, and $100 per hour for 1,091.75 hours, for a total of $489,082.50. They also seek a multiplier of 3.5 imposed on the 3,695 hours at $90 per hour (or $315 per hour) and a multiplier of 2.0 imposed on the remaining hours (or $190-200 per hour), for a total fee of $1,476,990. A. Bradley Eben and Michael Rosenhouse, who assisted Slovick and Gordon at various times, seek $6,656.00 and $2,952.00 respectively. Additionally, J. Samuel Tenenbaum and Theodore Becker, who assisted Slovick and Gordon on the appeal, have filed a petition for fees at the rate of $75 per hour for 350.05 hours, with a multiplier of 3, and $75 per hour for 73 hours, with a multiplier of 2, for a total of $89,711.25. On April 5, 1978, April 16, 1979 and November 16, 1979, we entered orders awarding Slovick and Gordon interim fees in the amounts of $230,000, $70,000, and $75,000 respectively, which have been paid.⁵

        Before proceeding to the specifics of the determination of the proper amount of fees, we will first determine whether IDC or Heizer is liable for any of plaintiffs' attorney's fees. Both IDC and petitioners contend that Heizer should be liable for fees under the "bad faith" exception to the American rule. The American rule provides that a losing party is not liable for the prevailing party's fees. Under the "bad faith" exception, however, the prevailing party is entitled to fees from the losing party if that party "has acted in bad faith, vexatiously, wantonly, or for oppressive reasons." F. D. Rich Co. v. Industrial Lumber Co., 417 U.S. 116, 129, 94 S.Ct. 2157, 2165, 40 L.Ed.2d 703 (1974). IDC has sought to assess petitioners' fees and its own fees against Heizer. We will consider fees for petitioners first, separate from the fees incurred by IDC.

        Petitioners and IDC point to alleged bad faith conduct of Heizer before and during the suit and after trial. Before suit, Heizer allegedly acted in bad faith by entering into the fourth transaction in which Heizer obtained 87% of the pro forma equity of IDC at an inadequate price. As for conduct occurring during the pendency of the action, petitioners and IDC point to the fifth,

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or pledge, transaction, which we found, and the Court of Appeals agreed, to be an attempt by Heizer to discourage this litigation and to protect itself from the results of the litigation. As evidence of bad faith after trial but before appeal, plaintiffs and IDC focus on Heizer's proposed recapitalization plan which Heizer attempted to force upon IDC's shareholders by threatening to put IDC into bankruptcy unless the plan were approved.

        Heizer responds first by contending that bad faith attorney's fees, which are punitive in nature, cannot be awarded in 10b-5 cases, because the Securities Exchange Act of 1934 does not permit awards of punitive damages for violations of § 10(b). Even if bad faith attorney's fees could be awarded here, Heizer argues that it did not act in bad faith and attempts to introduce a legitimate purpose for all of its allegedly bad faith action.

        We must apply the test for awarding bad faith attorney's fees stringently. See Satoskar v. Indiana Real Estate Commission, 517 F.2d 696 (7th Cir. 1975). Only in "exceptional cases and for dominating reasons of justice" can such an award be justified. 8 Moore's Federal Practice, 54.77[2] at 1709-11. The Seventh Circuit has held, however, that the conduct justifying an award of attorney's fees under the bad faith doctrine may be part of the conduct necessitating the action or conduct occurring during the course of the litigation. Bond v. Stanton, 528 F.2d 688, 690 (7th Cir.), vacated on other grounds, 429 U.S. 973, 97 S.Ct. 479, 50 L.Ed.2d 581 (1976). Hall v. Cole, 412 U.S. 1, 5, 15, 93 S.Ct. 1943, 1946, 1951, 36 L.Ed.2d 702 (1973).

        Therefore, two possible bases underlie an award for bad faith: conduct occurring during the litigation having an impact on the litigation process, and conduct inherent in the substantive violation. Petitioners and IDC allege that the fourth transaction is in the latter category and the fifth transaction and the proposed recapitalization plan fall in both categories. In the context of this case, however, we conclude that only bad faith conduct occurring during the course of this litigation, and not conduct necessitating the action, may be the basis for an award of fees. Straub v. Vaisman & Co., Inc., 540 F.2d 591 (3d Cir. 1976), the Third Circuit reversed a district court's award of bad faith fees in a 10b-5 action. The district court had based its award on the "wilful and wanton fraud" of the defendants in selling stock to plaintiffs. The court noted that the Securities Exchange Act prohibits a recovery in excess of actual damages, and that therefore punitive damages are prohibited. See 15 U.S.C. § 78bb(a); Gould v. American-Hawaiian Steamship Co., 535 F.2d 761 (3d Cir. 1976). The fees that the district court awarded in Straub resulted not from conduct occurring during the litigation process but from bad faith conduct "inherent in the fraudulent acts which constituted the cause of action itself." 540 F.2d at 599. Inasmuch as bad faith attorney's fees are punitive in nature, see Hall v. Cole, supra at 5, 93 S.Ct. at 1946, the Straub court held that an award of bad faith attorney's fees for the fraudulent acts would violate the Exchange Act's proscription of punitive damages.⁶

        Petitioners and IDC argue that Straub is logically unsound because courts will often award punitive damages under a state law claim for conduct which violates both state law and rule 10b-5. See, e. g., Flaks v. Koegel, 504 F.2d 702, 706-07 (2d Cir. 1974). Thus plaintiffs and IDC argue that attorney's fees for defendants' bad faith conduct would be a punitive award under a claim other than the 10b-5 claim. We are inclined to agree with IDC that the holding in Straub is overly strict in prohibiting attorney's fees in all 10b-5 cases in which the alleged bad faith conduct is inherent in the 10b-5 claim. In the context of this case, however, we do not believe that the prelitigation alleged bad faith conduct, which was inherent in the 10b-5 claim underlying the fourth transaction, supports an award of fees on a bad faith theory.

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        Petitioners and IDC argue that "not only" was the fourth transaction a violation of 10b-5, but it was also "reckless" and "highly unreasonable."⁷ The recklessness or unreasonableness was an element of the 10b-5 claim. The plaintiffs could not prove a violation of 10b-5 without showing scienter as required by Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). If proof of such recklessness alone were enough to constitute bad faith sufficient to justify an award of attorney's fees, every derivative plaintiff prevailing in a 10b-5 cause of action would be entitled to attorney's fees. We do not believe that such a rule would comport with the stringent requirements of the bad faith exception, and we decline to apply such a rule here.

        Presumably, the petitioners and IDC would argue that the degree of recklessness is relevant in determining bad faith and that some reckless conduct would be sufficient to prove a 10b-5 violation but not sufficient to justify a bad faith fee award. Although such lines are difficult to draw, we should not foreclose the possibility that a 10b-5 plaintiff could prove that a defendant's behavior in the conduct giving rise to the cause of action was so outrageous as to justify an award of bad faith fees. Heizer's conduct in the fourth transaction is not such a case.

        Although Heizer's conduct during the fourth transaction violated Rule 10b-5, we do not believe that the conduct was so egregious as to constitute bad faith. This is not a case in which the defendant defrauded the corporation. See Straub, supra. Rather, Heizer imposed an unfair transaction on a corporation badly in need of funds, and Heizer violated Rule 10b-5 by failing to properly disclose all of the facts regarding the transaction. Therefore, although Heizer behaved recklessly, its actions were at least in part the product of market considerations. Therefore the fourth transaction cannot be the basis for an award of fees under the bad faith exception.

        We come to the same conclusion with respect to the recapitalization proposal. Although we enjoined implementation of the proposal, we made no findings as to the fairness of the plan. Moreover, as with the fourth transaction, we cannot now say that the plan was so egregiously unfair as to justify an award simply by virtue of its unfairness. Thus unless the proposal was designed to impact on the litigation process, we will not assess fees against Heizer for proposing the plan.

        We do not believe that the recapitalization plan had sufficient potential to frustrate the litigation so as to constitute bad faith. As Heizer notes, prior to the proposal, we had denied supplemental relief as to the demand notes. Because the notes remained obligations of IDC, recapitalization may have been desirable and even necessary. See Crossett testimony, Tr. 463, 492-94. Furthermore, Heizer gave plaintiffs notice of the plan sufficient to prevent its implementation, and the plan as proposed could have been adjusted, by cancelling the preferred stock, were the Court of Appeals to grant relief as to the demand notes. Thus although the notice to the shareholders appeared to be coercive, we do not believe that the recapitalization had sufficient potential to frustrate the litigation so as to warrant an award of fees on a bad faith theory.

        We come to a different conclusion, however with respect to the fifth, or pledge, transaction. Although the pledge transaction itself constituted a 10b-5 violation, it occurred during the course of the litigation. Moreover, unlike the fourth transaction, the

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fifth transaction contained elements directly related to the litigation process. We found that Heizer blatantly breached its trust by taking the pledge to protect itself from the outcome of this pending litigation. 411 F.Supp. at 37. The Court of Appeals agreed, characterizing the pledge transaction at least in part as "a device to discourage what [Heizer] considered to be a nuisance suit." 560 F.2d 251.⁸

        Thus the pledge transaction was an attempt by Heizer to frustrate the litigation by rendering useless any relief plaintiffs could obtain. The pledge is therefore analogous to a frivolous defense or counterclaim, presented solely to harass a plaintiff and delay his recovery, for which bad faith attorney's fees are clearly available. Indeed, the pledge had the potential for even more impact on the litigation than a frivolous defense. A frivolous defense only delays ultimate recovery, but the pledge here could have rendered any recovery meaningless. As conduct occurring during litigation, and as action taken in response to that litigation, even the Straub court would not preclude attorney's fees on a bad faith theory here. Thus we hold that petitioners are entitled to fees from Heizer for its bad faith conduct in the fifth transaction.

        Petitioners and IDC have also argued that Heizer should be liable for fees by virtue of its violation of fiduciary duties owed to IDC. Relying on the Court of Appeals' determination that Heizer acted in a fiduciary capacity to IDC, plaintiffs and IDC cite state law cases indicating that a fiduciary violating its duties is liable for the plaintiff's attorney's fees. See, e. g. Wilmington Trust Co. v. Coulter, 42 Del.Ch. 253, 208 A.2d 677, 682-83 (1965). Further, petitioners and IDC argue that even if federal law controls, a fee award for violation of fiduciary duties is an exception to the American rule, either as a separate exception or as a subset of the bad faith exception.

        Because we have held that Heizer is liable for fees with respect to the fifth transaction, we need only consider Heizer's liability for fees on a breach of fiduciary duty theory with respect to the fourth transaction and the recapitalization plan. Federal law governs this issue. Plaintiff's complaint did not allege that Heizer violated state law either in the fourth transaction or in the attempt to effect a recapitalization plan. Although the Court of Appeals considered Heizer's position as a fiduciary in determining what disclosure obligations Heizer had under 10b-5, petitioners cannot boost this discussion into a finding on a state law claim. Plaintiffs' action sought to redress a violation of federal law; federal law will determine whether attorney's fees will be awarded.

        Unless an exception to the American rule applies, the plaintiff in a derivative suit is not entitled to fees from a losing defendant. See Bailey v. Meister Brau, 535 F.2d 982 (7th Cir. 1976). Although petitioners have argued that a breach of fiduciary duties qualifies as an exception to the American rule, the cases petitioners and IDC have cited in support of the proposition that a violation of fiduciary duties justifies a fee award either as part of the bad faith exception or as a separate exception do not support an award of fees in the instant case. The cases relied upon by petitioners and IDC and other cases in which court assessed fees against a fiduciary, involve fiduciaries in substantially different positions from Heizer's relationship to IDC. Wolff v. Calla, 288 F.Supp. 891 (E.D.Pa.1969), for example, the defendant had refused to pay money he held in trust to the intended beneficiary. Kiser v. Miller, 364 F.Supp. 1311 (D.D.C.1973), aff'd in part and remanded in part, 517 F.2d 1275 (D.C.Cir. 1975), the defendants were trustees of the United Mine Workers of America Welfare and Retirement Fund, who had violated fiduciary duties owed to union members.⁹

Page 815

Similarly, Richardson v. Communications Workers of America, 530 F.2d 126 (8th Cir.) cert. denied, 429 U.S. 824, 97 S.Ct. 77, 50 L.Ed.2d 86 (1976), the defendant was a union which had violated its fiduciary duty by failing to pursue the plaintiff's employment rights and actually lobbying for his discharge. In re Johnson, 518 F.2d 246 (10th Cir.), cert. denied, 423 U.S. 893, 96 S.Ct. 191, 46 L.Ed.2d 125 (1975) (fees assessed against trustee of a creditor's trust).

        In all of these cases, the defendant-fiduciary had an obligation to its beneficiaries which should have remained unclouded by any personal interests or obligations. In making this distinction, we do not mean to deprecate the fiduciary duty owed by Heizer to IDC and its minority shareholders. We cannot be unmindful, however, of the fact that Heizer had its own interests and the interests of its shareholders to protect. Therefore, the nature of the fiduciary duty in the cited cases is sufficiently distinguishable from Heizer's fiduciary duty to induce us to decline to award fees because of Heizer's violation of that duty.

        Therefore, Heizer is liable to pay petitioners' fees on a bad faith theory only for the fifth transaction. And this liability does not extend to fees for all of the charged hours. If a defendant in a protracted proceeding submits a frivolous defense which consumes one day of plaintiff's time the plaintiff is certainly not entitled to all of its fees on a bad faith theory. Rather, the bad faith defendant should be required only to recompense the prevailing plaintiff for the time spent to meet the bad faith defense. See Browning Debenture Holders' Committee v. Dasa Corp., 560 F.2d 1078, 1089 (2d Cir. 1977). In the instant case, however, we believe that an award of fees limited to the amount of time spent by petitioners on the fifth transaction would not be fair. Unlike most frivolous defenses, the effects of which are limited in time or scope, the effects of the pledge permeated the entire litigation. Because the determination of bad faith is based on Heizer's attempt to frustrate the entire litigation and render useless any relief plaintiffs might obtain, Heizer's liability for plaintiffs' attorneys' fees should be for a percentage greater than the percentage of hours spent on the fifth transaction.

        Defendants claim that 9% of petitioners' time may be attributed to the fifth transaction. They base this figure on the amount of time devoted to the pledge transaction at trial. See Post Trial Brief of Heizer Corporation at 126. We have examined petitioners' fee petition, and with a few exceptions, we cannot determine with any specificity the amount of time devoted to the fifth transaction. Moreover, we assume that any reconstruction at this point would be inaccurate and speculative. But because we believe that petitioners are entitled to an award of fees greater than that which would represent actual hours spent, a determination of the exact number of hours is not crucial. Therefore, we hold that Heizer is liable for fees awarded for 25% of the hours that we find petitioners have reasonably spent on the case.¹⁰

        To the extent that IDC's motion seeks to assess against Heizer the fees incurred by IDC's counsel, the motion is denied. We have no doubt, contrary to plaintiffs' assertions, that IDC exercised independent judgment, separate from Heizer's, with respect to this litigation. Nevertheless, IDC either opposed plaintiff's efforts or remained neutral throughout the litigation. Given IDC's refusal to oppose any of Heizer's illegal conduct, an order forcing Heizer to pay IDC's fees on either a bad faith or violation of fiduciary duty theory would be inappropriate.

        2. Assessment of Fees Against IDC Corp.

        In a derivative suit brought on behalf of a corporation, the plaintiffs are entitled to reimbursement of their costs, including

Page 816

attorney's fees, from the corporation if the suit confers a substantial benefit on the corporation. Mills v. Electric Auto-Lite, 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970). This rule applies regardless of whether the plaintiffs have produced a fund for the corporation from which the fees may be paid. 7A C. Wright & A. Miller, Federal Practice & Procedure, § 1841 at 444 (1972). Thus the first question in determining whether IDC is liable for fees is whether the litigation benefited IDC.

        Petitioners argue that the relief obtained produced several benefits. First, the cancellation of the convertibility features of the notes issued in the fourth transaction and the cancellation of Heizer's right to purchase 5,513,908 shares of IDC common stock at $1.00 per share benefited the corporation because the $1.00 per share price was and is below the true value of IDC stock. Second, the cancellation of the pledge of TR stock to Heizer prevented Heizer from foreclosing on its loans and thereby seizing IDC's most profitable asset. Third, by obtaining an injunction against the 1976 Plan of Recapitalization, plaintiffs prevented defendants from mooting the relief and attendant benefits resulting from our decision on the fourth transaction. Further, consummation of the plan would have been detrimentally unfair to IDC. Fourth, the prospective relief granted by this court and the Court of Appeals requires Heizer to deal fairly with IDC and to obtain approval from the common stockholders other than Heizer before entering into securities transactions with IDC. This relief benefits IDC by preventing, in the future, the types of securities law violations Heizer inflicted on IDC in the past. The final benefit is the supplemental relief granted by the Court of Appeals, pursuant to which Heizer is enjoined from enforcing the demand notes and IDC is permitted to repay the loans commensurate with its ability to pay. This relief benefits IDC by preventing Heizer from forcing IDC into bankruptcy in order to collect on the loans. The supplemental relief also benefits IDC by allowing IDC to repay the loans only as it is able to do so.

        In a nonfund case, the benefit a derivative suit provides to a corporation is difficult to quantify.¹¹ Nevertheless, a corporation may be benefited by a nonfund case, and an award of fees is not precluded by the difficulty or even impossibility of assigning a specific monetary value to the benefit received. See Ramey v. Cincinnati Enquirer, Inc., 508 F.2d 1188 (6th Cir. 1974); Merola v. Atlantic Richfield Co., 515 F.2d 165 (3d Cir. 1975). In fact, the Mills v. Electric Auto-Lite Court noted that a non-pecuniary benefit may justify an award of fees. 396 U.S. at 396, 90 S.Ct. at 627. Reiser v. Del Monte Properties Co., 605 F.2d 1135 (9th Cir. 1979). The Mills Court reasoned that a plaintiff, by vindicating an important statutory policy, may render substantial service to the corporation.

        Although plaintiffs here vindicated an important statutory policy by challenging Heizer's violations of Rule 10b-5, we would not be inclined to award substantial fees on that basis alone. Moreover, the Supreme Court's decision Alyeska Pipeline Service Co. v. Wilderness Society, 421 U.S. 240, 95 S.Ct. 1612, 44 L.Ed.2d 141 (1975), which laid to rest the private attorney general theory as a basis for awarding attorney's fees, casts doubt upon the propriety of awarding fees solely for the vindication of a statutory policy, even if the corporation can be said to have been benefited. Therefore we will focus on the pecuniary benefit that IDC received from this litigation, keeping in mind that this benefit need not be proved with specificity.

        Heizer contends that IDC received no benefit from the cancellation of the convertibility features of the fourth transaction notes as well as the cancellation of the $1.00 stock warrants, because the fact that plaintiffs reduced Heizer's pro forma equity

Page 817

in IDC from 87% to 61% is of no real economic value to IDC. More importantly, IDC stock is not worth $1.00 per share and would not have been worth $1.00 prior to the expiration of the warrants in 1981. Thus Heizer claims that it would not have wanted to exercise the warrants, and even if it had, IDC would have received more for the warrants than its stock is worth. Heizer attacks petitioners' contention that IDC stock is worth considerably more than $1.00 per share and questions the reliability of Fred Holubow, plaintiffs' expert, whose projections guided plaintiffs' evaluation of the value of IDC shares.

        Petitioners respond that if the stock is worth less than $1.00 now, it must have also been worth less than $1.00 in 1971, when the warrants were issued, because in 1971 IDC was suffering substantial losses, while it is currently earning substantial profits. These profits, according to Heizer's expert, should continue. Plaintiffs question Heizer's vigorous defense of the fourth transaction warrants if they are, and continue to be, worth less than $1.00. Moreover, according to the projections, by 1981, when the warrants would have expired, IDC would have earned substantial income and the stock would be worth more than $1.00.

        As we noted earlier, we cannot precisely quantify the benefit realized by IDC. With respect to the fourth transaction, we believe that a determination of benefit is governed by the value of IDC stock. If by exercising the warrants Heizer could have received shares of IDC common stock for less than their value, then IDC has realized a benefit through cancellation of the warrants. We will concentrate here on the present and future value of IDC stock, because the parties have based their arguments on that value, and because past value becomes less significant if the value of the stock has now fallen below the warrant price. Moreover, as petitioners note, IDC is in a constantly improving financial position, so it is unlikely that the value of its stock would now be worth less than in 1971. Because of the speculative nature of the benefit conferred in a nonfund case, however, we believe that in addition to present value the potential value of IDC stock in 1981, when the warrants would have expired, is relevant.¹²

        Plaintiffs and Heizer have presented two widely differing views on the value of IDC stock. On the one hand, Heizer's experts, Hendrick and Browning opined that IDC stock is worth $0.55 per share and the corporation is worth $5.5 million, substantially less than the debt owed to Heizer. On the other hand, plaintiffs' expert, Holubow, testified that in his opinion, based on Browning's projections, IDC is worth between $14,000,000 and $20,000,000, a figure which would indicate that IDC's common stock is worth substantially more than $1.00 per share. We suspect, as is the case with most expert testimony advocacy, that the true value of IDC lies somewhere between the two extremes. For purposes of determining benefit to IDC, we need not determine which opinion is correct. We need decide now only whether a probability exists that at any time prior to 1981 a purchaser of IDC stock would be willing to pay more than $1.00 per share. To make this determination, a consideration of the valuation methods the various experts used is instructive.

        Browning, Heizer's expert, valued the corporation at $5.5 million. He purported to value IDC as a going concern and calculated the price a purchaser would be willing to pay for the assets and liabilities needed to continue the business as a going concern. Tr. 618. The assets would consist largely of accounts receivable, and the liabilities would consist of accounts payable, the obligation to Burroughs Corporation for a computer, and the indebtedness to acquired companies. The liabilities, however, would not include the debt to Heizer. Tr. 618-619. See Heizer Exhibits 21-A, 21-B, 21-C. The parties have referred to this entity

Page 818

as "IDC Adjusted." Browning compared IDC Adjusted to a group of advertising companies, selected for the similarity of their business to IDC's business. Tr. 626-27. He derived the price/earnings ratio for each company and determined, on the basis of 1978 projected earnings, that a price/earnings ratio of 6.6 would be the ratio at which a purchaser would be willing to invest in IDC. Tr. 630. By multiplying 1978 projected earnings by the 6.6 figure, Browning arrived at a value of $5.5 million. This figure would reward an investor with a 15% return on his investment. Browning admitted on cross examination that for the purposes of valuing IDC, he had not considered the $18,000,000 in earnings by 1986 that he had projected for purposes of reconstructing the demand debt. Tr. 671-74.

        Heizer's other expert, Hendrick, testified that in his opinion IDC stock is currently worth $0.55. He arrived at this figure by comparing IDC to a composite of nine publicly held companies involved in specialized data processing services for corporate clients. He derived a composite price/earnings ratio of 8.6 and a composite price/net worth ratio of 2.3. He then calculated a mean earnings figure of $0.16 per share for IDC for 1976 and 1977, and a net worth for 1977 of $271,000 or $0.35 per share. Next he constructed a "theoretical net earnings evaluation" of $1.38 by multiplying the $0.16 mean earnings by the composite price/earnings ratio of 8.6. He also multiplied the estimated net worth per share of $0.35 by the composite price/net worth ratio to arrive at a "theoretical net worth evaluation" of $0.81. He then took the mean of the two abstract figures, $1.38 and $0.81, to arrive at a $1.09 figure as the price that IDC stock would bring in the over-the-counter market. Given several uncertainties facing the company, however, such as the effects of this litigation and the lack of a public market, Hendrick applied a 50% discount to the $1.09 figure to arrive at a $0.55 per share figure. See Heizer Exhibit 37 at 14-23. Hendrick, like Browning, did not consider the projections for future earnings, because he did not believe that the projections were certain enough to be reliable. Tr. 1418.

        In contrast, plaintiffs' expert, Holubow, relied heavily on the earnings projected by Browning. Holubow took the projected earnings through 1986, used the construct for "IDC Adjusted" as created by Browning and determined the projected stream of cash available for dividends to a purchaser through 1986. See Plaintiffs' Exhibit 22. Using a 15% discount figure provided by plaintiffs' counsel, Holubow calculated the present value of these dividends as $7,352,000. Plaintiffs' Exhibit 23. He then calculated two separate market values for IDC Adjusted. The lower value was computed by taking the projected net income of IDC in 1986 and multiplying that by the price/earnings ratio, 6.6, found to be appropriate for IDC by Browning. This product, $6,771,000, discounted to present value by a 15% factor, was added to the present value of cash dividends available to IDC to yield a lower value of $14,123,000. The upper value was the sum of (1) the present value of cash dividends and (2) the product of the 1986 value and a 13 price/earnings ratio, the composite of price/earnings ratios for the computer companies that Heizer used for comparison in valuing IDC. See Plaintiffs' Exhibits 12 and 24. This computation yielded an upper value of $20,568,000. Either value would indicate a value for IDC stock far greater than $1.00 per share. Holubow testified that the method of valuation he used was accepted and used in the financial community. Tr. 1088, 1089.

        Our task is not to determine with exactitude the present value of IDC stock. If it were, we might be more inclined to ignore or at least discount the projected future earnings and the figures Holubow derived from them. In addition, we recognize the manipulation of figures that both sides have used to arrive at figures most favorable to them. But inasmuch as we are concerned with determining future as well as present value of IDC stock, we believe that the projected earnings are relevant. This conclusion is tempered by the fact that the projections extend through 1986, and the warrants would have been exercisable

Page 819

only through 1981. Nevertheless, we are convinced that a potential investor in 1981 would be influenced by the possibilities for growth exhibited by Browning's projections. See Tr. 1098.

        Moreover, we believe that the Browning projections, although necessarily speculative, are sufficiently certain to warrant our consideration. Browning, after a careful study of IDC, based the projections on IDC's 1978 Business Plan, which all parties concede reflected IDC management's considerable skill in predicting IDC's future The conclusion that the Browning projections are relevant to a determination of value would not be inconsistent with a determination that IDC's proposed repayment plan, which discounts projected earnings by 35%, is preferable to Browning's plan. In light of the Court of Appeals holding, we must be certain that any repayment schedule is certain to guard against unforeseen circumstances and to be commensurate with IDC's ability to pay. Given our conclusion with respect to the speculative nature of a determination of benefit, we need not be so certain in determining the value of IDC stock.

        Furthermore, we find that the 15% rate of return counsel instructed Holubow to use is reasonable, given IDC's projected future earnings. See Tr. 1093-94. Moreover, Browning concluded that his valuation would yield a 15% return, which he thought was "appropriate." Tr. 630.

        Neither Browning nor Hendrick considered the Browning projections in valuing IDC. Holubow, using the projections, arrived at a substantially greater value for IDC. Given our conclusion with respect to the projections, we find that a reasonable likelihood exists that by 1981 the $1.00 stock warrants would have been exercisable at a price which would be less than the value of IDC stock. We recognize the speculation inherent in this conclusion, but the speculative nature of the benefit is best addressed in this case in the determination of what multiplier, if any, to impose on petitioners' fees.

        The second benefit to IDC which plaintiffs claim is the cancellation of the pledge of TR stock consummated in the fifth transaction. We have already indicated that one of Heizer's purposes in seeking this pledge was to blunt the effects of this litigation. Thus plaintiffs, by obtaining a cancellation, protected whatever other benefits the litigation produced. Moreover, the TR stock was IDC's only valuable asset, and Heizer could have recouped its losses by foreclosing on the TR stock. Although Heizer contends that it never intended to foreclose on the pledge, this assertion is inconsistent with the Court of Appeals' finding that the purpose of the pledge was to protect its investment in IDC by threatening foreclosure on the pledge. 560 F.2d at 251. Moreover, Heizer could have foreclosed on the TR pledge and still maintained IDC as a going concern. Again, the question of whether Heizer would have forced IDC into bankruptcy or foreclosed on the TR stock is speculative. Given our findings and the Court of Appeals' finding with respect to Heizer's purpose in entering the pledge transaction, however, we believe that plaintiffs were entirely justified in attempting to cancel the pledge transaction and rendered substantial benefit to IDC in doing so.

        The third alleged benefit is the injunction against the recapitalization plan that Heizer proposed in 1976. Under the recapitalization plan, all of the demand notes would have been converted to preferred stock, at $1.00 per share. The preferred stock would have carried mandatory dividend and redemption requirements to be met out of IDC's earnings in excess of $300,000 per year. Failure to meet these requirements would have resulted in the acceleration of the full principal amount of the outstanding preferred stock. The plan also would have given Heizer an additional six million warrants exercisable until 1986 at $1.00 per share. See Heizer Exhibit 24-B.

        Given our conclusion that IDC stock probably would have been worth more than $1.00 in 1981, the benefit from preventing Heizer from obtaining six million $1.00 warrants exercisable until 1986 is obvious.

Page 820

Moreover, the plan required redemption, on a rigorous schedule, of the preferred stock issued in exchange for the demand notes. Now, however, IDC may repay the demand notes on a schedule commensurate with its ability to do so. Thus IDC is in a better position with respect to the repayment of the demand notes than it would have been with respect to the equivalent redemption of the preferred stock issued pursuant to the plan. Heizer's argument in response to this reasoning seems to be that all agree that a recapitalization would be in IDC's best interest, and that plaintiffs' efforts have frustrated a recapitalization. Only a fair recapitalization, however, is in IDC's best interests, and given our conclusion with respect to the value of IDC stock and the rigorous requirements with respect to redemption of preferred stock that would have been placed on IDC by virtue of the plan, we have serious doubts about the fairness of the 1976 plan. Thus we find that IDC has realized benefit from plaintiffs' efforts with respect to the recapitalization plan.

        The next benefit alleged is the reformation of the demand notes ordered by the Court of Appeals. We agree with plaintiffs that IDC has benefited from this relief. Not only has IDC received an extension on the loans, but it has received an extension that, according to the mandate, cannot unduly tax IDC's resources. In addition, Heizer's claim that their intentions with respect to bankruptcy proceedings were only to institute Chapter XI proceedings is difficult to credit at this late date. Heizer's counsel indicated in 1976 that Heizer had "every intention of taking [IDC] into bankruptcy ..." if it could not collect the debt. Tr. of Proceedings, June 18, 1976.

        Even if by saying "bankruptcy," Heizer meant Chapter XI proceedings, IDC would not now be in the same or better position under a Chapter XI plan than it would be under the mandate. IDC would not have been able to implement a Chapter XI plan without prior approval from Heizer. Under the old Bankruptcy Act, which was in effect until October 1, 1979, and under which IDC and Heizer would have proceeded, a Chapter XI plan could not be confirmed unless the plan was accepted by a majority, in both number and amount, of all creditors with proved and allowed claims. 52 Stat. 911, § 1 (formerly at 11 U.S.C. § 762). Heizer, which held the majority of the amount of claims against IDC, thus could have blocked any plan proposed by IDC. IDC does not have to face this obstacle under the mandate. Moreover, given the disparity between IDC's and Heizer's view of IDC's ability to repay the loans, and given our choice infra regarding the repayment schedule, IDC has achieved a substantial benefit by not having to obtain Heizer's approval of the repayment plan.

        The final benefit is the injunction requiring Heizer to obtain shareholder approval for any Heizer transaction with IDC and to disclose any future transaction involving securities of IDC. As plaintiffs note, this goes beyond the requirements of the securities laws. Given Heizer's previous violations of the securities laws, such an injunction is of obvious benefit to IDC.

        Therefore, we hold that IDC has been benefited in all of the ways alleged by plaintiffs. We must caution, however, that we recognize an element of speculation inherent in finding benefit in every instance. Although we do not believe that this uncertainty warrants a denial of fees, we do believe that it justifies consideration in assessing a multiplier.

        The next step in assessing attorney's fees is determining the base fee, computed by multiplying a reasonable hourly rate by the number of hours expended. Neither Heizer nor IDC have challenged the rates charged by Messrs. Slovick and Gordon. Thus we will approve their rates of $90 per hour prior to March, 1978, $95 per hour prior to September 1, 1978, and $100 per hour after September 1, 1978.

        IDC has objected to the adequacy of time records submitted by petitioners. IDC also claims that some of the hours are noncompensable. A ruling that IDC is correct with regard to these claims will obviate the need to determine the adequacy of the time records

Page 821

with respect to these hours. Therefore, we will consider first the claim that petitioners are not entitled to fees for hours spent on unsuccessful claims and for hours spent on the issue of attorney's fees.

        Defendants claim that hours spent litigating unsuccessful claims are not compensable. Specifically, they point to the 10b-5 claims regarding the first three transactions, the motion to compel redemption of the preferred stock, the motion for an appointment of a receiver for IDC, the motions to enjoin IDC shareholders' meetings, and the motion to vacate our order of May 28, 1976. According to defendants, the hours spent litigating these unsuccessful claims did not benefit IDC and so IDC should not be forced to pay for them. The petitioners respond to this by arguing that these claims resulted in an indirect benefit to IDC and litigation on these claims was necessary to achieve the desired results with respect to the claims on which plaintiffs were successful.

        The issue with respect to unsuccessful claims is whether the hours spent on those claims benefited the corporation in any way, directly or indirectly. If to achieve success on some claims, proof relating to the other claims was necessary, then the hours are compensable. Or if litigation on a particular claim indirectly leads to some beneficial relief, the hours are compensable. See Stanford Daily v. Zurcher, 64 F.R.D. 680 (N.D.Cal.1974). This test should be a broad one, because we should not force plaintiffs' attorneys to predict precisely the extent of a violation or the relief obtainable. See id. at 684. Considerations relevant to these determinations are whether the unsuccessful claims were tangential to the primary cause of action or relief sought, Swanson v. American Consumer Industries, Inc., 517 F.2d 555 (7th Cir. 1975), whether the claims were "extravagant" or "unfounded," id. at 564, or were "manufactured," Locklin v. Day-Glo Color Corporation, 429 F.2d 873 (7th Cir. 1970). Thus if the hours spent litigating unsuccessful claims are reasonably related to the primary thrust of the plaintiffs' cause of action, we will not deny fees for these hours. We will, however, take into account unsuccessful claims in setting the total amount of fees. See Swanson, supra at 563.

        Under the foregoing test, we believe that all of the hours challenged by IDC are compensable. We agree with IDC that plaintiffs did not obtain any relief on the first three transactions. Nevertheless, time spent on the first three transactions was clearly related to the relief plaintiffs sought with respect to the fourth and fifth transactions. Moreover, an understanding of the first three transactions aided our resolution of the claims relating to the fourth and fifth transactions. Although we would be inclined to apply no multiplier to hours spent on the first three transactions, Swanson, supra at 563, we cannot determine from the present record how many hours were spent on those transactions. Furthermore, we do not believe that subtracting three-fifths of the hours from the hours eligible for a multiplier would be appropriate, because we have no basis for concluding that the time was divided equally among the five transactions. See Hughes v. Repko, 578 F.2d 483 (3d Cir. 1978). Thus rather than apply no multiplier to the hours on unsuccessful claims and a full multiplier on the remaining hours, we will apply a reduced multiplier to all of petitioners' hours devoted to the action prior to the appeal.

        As for the hours spent on the motion for the redemption of preferred stock, we have denied the motion. But as we noted, a consideration of the redemption problem is relevant to the issue of reformation of the demand notes. Given the limited nature of the benefit from these hours, however, we will take these hours into account, along with those spent on the first three transactions, in reducing the multiplier.

        As for the other hours challenged by IDC, we agree with petitioners that these hours had some indirect benefit to IDC. The hours spent on the motion for a temporary receiver may have had the effect of reducing IDC's opposition to plaintiffs' efforts.

Page 822

The time consumed by motions to enjoin shareholders' meetings in 1976 and 1978 provided benefits related to the injunction against the 1976 reorganization proposal and the election of directors for IDC in 1978. Finally, because our denial of supplemental relief was reversed by the Court of Appeals, petitioners clearly should be compensated for the time spent on that motion before us.

        IDC contends that hours spent by petitioners on the issue of fees are not compensable, because that time was spent solely on behalf of petitioners and in no way benefited IDC. Because the greater part of the fee award is to be assessed against IDC on the theory that plaintiffs' suit benefited IDC, IDC should not be forced to pay for hours devoted only to counsel's benefit. Analogizing this case to a fund recovery case IDC contends that petitioners here have a conflict of interest with the corporation they sought to benefit, just as attorneys who seek fees from a common fund have a conflict with the recipients of the fund.¹³

        Petitioners respond that the weight of authority supports an award of fees for hours spent litigating the fee issue. Petitioners agree that the funds will come from the corporation that has been benefited. They contend, however, that this case is distinguishable from a fund case, because the relief here was equitable, and the value of the relief IDC received will not be diminished by an award to petitioners. In a fund case, according to petitioners, payment of fees results in an absolute and final reduction of funds available to the class or corporation. Here, however, the relief plaintiffs obtained will continue to benefit IDC and the value of the stock will continue to grow solely as a result of petitioners' efforts. Petitioners also assert that the number of hours spent on the fee petition was inflated solely because of Heizer's and IDC's obstinacy in contesting fees. Petitioners contend that they should not be penalized for opposing counsel's "unconscionable" attempts to deny fees to petitioners.

        We must first emphasize that petitioners are incorrect in their assertion that the weight of authority supports an award of fees for hours spent litigating the fee issue under the facts in this case. Of the seven circuit court decisions petitioners cite, all seven were civil rights cases. See Hairston v. R & R Apartments, 510 F.2d 1090, 1093 (7th Cir. 1975); Souza v. Southworth, 564 F.2d 609, 614 (1st Cir. 1977); Miller v. Amusement Enterprises, Inc., 426 F.2d 534, 539 (5th Cir. 1970); Rosenfeld v. Southern Pacific Co., 519 F.2d 527, 530 (9th Cir. 1975); Torres v. Sachs, 538 F.2d 10 (2d Cir. 1976); Gagne v. Maher, 594 F.2d 336 (2d Cir. 1979); Prandini v. National Tea Co., 585 F.2d 47 (3d Cir. 1978). Of the six district court cases petitioners cited, two were civil rights cases, Aumiller v. University of Delaware, 455 F.Supp. 676, 688 (D.Del.1978); Stanford Daily v. Zurcher, 64 F.R.D. 680, 683-84 (N.D.Cal.), aff'd, 550 F.2d 464 (9th Cir. 1977), and one was a non-class action antitrust case in which the court assessed fees against the defendant. See Pitchford Scientific Inst. Conf. v. Pepi, Inc., 440 F.Supp. 1175, 1179-80 (W.D.Pa.1977).¹⁴ In all of these cases, the fees were to be assessed against a wrongdoing defendant, not against the party benefited by the litigation. Like the courts in the cited cases, we have in a civil rights context awarded fees

Page 823

to counsel for time spent seeking their fees. See Urbina v. Quern, 482 F.Supp. 1013, 1016 (N.D.Ill.1980). Civil rights and antitrust cases, however, are inapposite to the question of whether counsel has a conflict of interest with the party sought to be benefited by the litigation and against whom fees are to be assessed. See id. at 1016 n.1. An award of fees in a civil rights case in no way diminishes the plaintiff's recovery.

        In a fund case, however, an award of attorney's fees will reduce the fund and therefore the relief to the derivative plaintiff. See Lindy Bros. Builders, Inc. v. American Radiator & Standard Sanitary Corp., 540 F.2d 102, 110-11 (3d Cir. 1976). If time spent litigating the fee issue is solely for the attorney's benefit, then the attorney is in conflict with the corporation, the party that the derivative suit seeks to benefit. The theory underlying an award of fees in a derivative suit is that the corporation should compensate the attorneys for benefits the corporation received through the suit. Thus unless the corporation can be deemed to have received a benefit from hours spent seeking attorney's fees, the corporation should not be assessed fees for those hours.

        Petitioners claim that the benefits they have obtained for IDC will continue to grow and continue to benefit IDC, but that the benefit in a fund case is more finite. We fail to see how this argument addresses the question of whether hours spent on attorney's fees issues benefited IDC. Petitioners' argument, if true, merely shows that the relief they have obtained for IDC is of long-lasting duration and may be difficult to quantify. The only inference we can draw from this fact, however, is that fees awarded for hours spent on fees here may take a smaller proportional bite from the corporation's recovery than in a fund case. The bites may be of the same size, however, inasmuch as a corporation can find may uses for a fund recovered through litigation, and the corporation may receive through such a fund a benefit equally as significant or long-lasting as the relief obtained here. Even if petitioners' assertion is true, however, we do not see it as a feature which distinguishes the fund cases from the instant case. In both cases, the effect of the corporation's recovery is diminished by a fee award. The proportion of the decrease and whether the fees come from the actual funds recovered in the litigation or from the corporate coffers are not relevant.

        Hours spent litigating the issue of fees confer no direct benefit on the corporation. We can postulate an indirect benefit, however, because an obstinate defendant or an obstinate derivative plaintiff can, by vigorous and unjustified opposition to counsel's quest for fees, dilute the effect of any fee award. This would have the effect of discouraging representation in derivative suits. The danger of such a dilution is greater in a case such as this one in which the relief is equitable. Because the benefit from the relief obtained in such a case may be speculative, the defendant and the corporation may have more of a basis for challenging the benefit than in a fund case. Indeed, in the instant case petitioners have had to spend considerable time establishing their right to fees.

        Our examination of petitioners' affidavits indicates that they clearly devoted 395 hours to the issue of fees. For an additional 271.75 hours, which IDC refers to as "unapportioned" hours, the entries indicate that some, but not all, of the listed hours were spent on the fee issue. Although IDC argues that none of the 271.75 hours are compensable, it would be unreasonable to deny petitioners fees for all of these hours. Moreover, although IDC claims that hours petitioners spent on the issue of assessing fees against Heizer were clearly delineated as such, we cannot be so certain. Thus even some of the 395 hours may have been consumed by the clearly compensable task of assessing fees against Heizer. In any event, plaintiffs have devoted at the most 666.75 hours to the issue of fees. Thus the dilution by total fees resulting from a denial of fees for attorney's fees issues would be approximately 12.6%. In litigation of this scope and complexity, the need to spend an uncompensated 12.6% of the total hours on

Page 824

attorney's fees would probably not be a disincentive to undertaking the suit.

        We conclude, however, under the facts of this case, that the hours spent on attorney's fees should be included in the total number of hours. In assessing fees for those hours the 666.75 hours will be a part of the 25% of the total that we have found Heizer obligated to pay. We reach this conclusion in part because much of the dilution which would result from a denial of fees on the attorney's fee issue is a result of Heizer's efforts. The battle as to the benefit to IDC was waged primarily by Heizer. More importantly, petitioners do not have the same conflict of interest with respect to the fees assessed against Heizer as they do with respect to IDC, because fees paid by Heizer do not come from the party petitioners sought to benefit with this litigation. The civil rights cases cited by petitioners are more analogous here, inasmuch in both situations a wrongdoing defendant is liable for fees. We have found that Heizer acted in bad faith and did so in a method calculated to frustrate the entire litigation. We believe it fair that Heizer pay for petitioners' costs in seeking their fees.

        This beings us to the issue of petitioners' recordkeeping. IDC claims that some of the hours are improperly documented. Petitioners need not list their hours with "mathematical precision." See Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974). Rather, plaintiffs have satisfied their burden of proof if they demonstrate that "the hours claimed by counsel in their affidavits are a rational reflection of the services performed." Cruz v. Beto, 453 F.Supp. 905, 908 (S.D.Tex.1977). Lindy Bros. Builders of Philadelphia v. American Radiator & Standard Sanitary Corp., 487 F.2d 161, 167 (3d Cir. 1973); City of Detroit v. Grinnell Corp., 495 F.2d 448, 473 (2d Cir. 1974); Moreover, one method that the court may employ in determining fees is its own observation of petitioners' efforts. Cruz, supra.

        Under this standard, we believe petitioners have satisfied their burden of proof on this issue. Petitioners have justified, either through contemporaneous time records or independent recollection, the various hours they claim. When these methods of calculating hours are buttressed by our independent observation of petitioners' efforts in this protracted litigation, we believe that no more is required of them. Although petitioners could avoid disputes regarding hours and make our job easier by keeping more accurate records, we will not, at least in this case, deny them fees for failing to do so. We will not lengthen an already lengthy opinion by considering separately each diary entry challenged by IDC. Petitioners have sought to justify each group of hours questioned by IDC. We have reviewed petitioners' justifications and we credit them. Moreover, we have reviewed the time spent by petitioners and find the number of hours devoted to this case to be reasonable. Therefore, petitioners are entitled to fees for 3,695 hours at $90 per hour, 498.5 hours at $95 per hour, and 1,091.75 hours at $100 per hour, for a total of 5,285.25 hours and a lodestar of $489,082.50.

        We must now determine whether a multiplier should be applied to the lodestar. We will first decide whether IDC will pay a multiplier and then whether the fees Heizer owes will be subject to a multiplier. Two broad issues govern the determination of whether a multiplier is appropriate: the contingent nature of the litigation and the quality of the attorneys' services. City of Detroit v. Grinnell Corp., 495 F.2d 448 (2d Cir. 1974). Within these broad issues are subissues. Relevant to a determination of the contingent nature of the case are the risk of litigation and the delay in receipt of payment. Lindy Bros. Builders, Inc. v. American Radiator & Standard Sanitary Corp., 540 F.2d 102 (3d Cir. 1976) (Lindy II). The quality of the attorneys' services is an even broader issue and is measured by the benefit conferred upon the corporation, the magnitude of the case, the skill and experience necessary to succeed in the litigation, and the efficiency of the attorney's efforts. See id. at 117-18.

        In the instant case, we have already noted that the benefit conferred on IDC is

Page 825

speculative and that although this uncertainty does not warrant a denial of fees, the extent of the multiplier should reflect the speculative nature of the benefit. We are therefore reluctant to impose any multiplier on the basis of benefit conferred on IDC. Moreover we have also recognized that no multiplier should be imposed on hours spent on unsuccessful claims. Because we could not isolate those hours, we held that the multiplier for all hours should be reduced. We also agree with IDC that this is not a case of great magnitude. The suit benefits a privately-held corporation, with relatively few stockholders. This is not a case in which petitioners recovered a huge fund for the benefit of a large class of injured parties. See, e. g. In re Equity Funding Corp. of America, Securities Litigation, 438 F.Supp. 1303 (C.D.Cal.1977) (involving $60,000,000 settlement fund).

        In assessing the skill and efficiency demonstrated by plaintiffs' counsel, we note first that to a great extent petitioners' skill and experience are reflected in their hourly rate. Unless petitioners demonstrated quality work above that common for lawyers who charge their hourly rate, then no multiplier on that basis is appropriate. Thus only exceptional services justify a multiplier. See Lindy II, supra, 540 F.2d at 117-18.

        Petitioners' hourly rate already bespeaks considerable skill and experience. They did excellent legal work in this case, but we would expect that from attorneys billing $90 to $100 per hour. Moreover, plaintiffs were unsuccessful as to the first three transactions, and although the Court of Appeals decision revealed a novel theory of liability, we are not certain that petitioners can take credit for that theory. Thus we are not inclined to award a multiplier solely on the basis of petitioners' skill.

        As for efficiency, we note that petitioners did perform many tasks which could have been performed by other attorneys with less experience and a consequent lower hourly rate. See Equity Funding, supra at 1330. Although we are not inclined to reduce for this reason petitioners' hourly rate for those tasks, as IDC urges, we do believe this use of time is relevant in determining whether petitioners' efficient prosecution of the case warrants a multiplier. In light of all of the circumstances, we will not increase petitioners' award on the basis of quality of services.

        The other issue is the contingent nature of the case, and here the petitioners have a much better argument. Because attorneys are never guaranteed success in a particular case, despite vigorous and competent efforts, the normal hourly rate may not be adequate compensation. The complexity of the case, the probability of defendant's liability, the difficulty of proof, the risks inherent in developing the case, and the delay in receipt of payment are all factors impacting on the contingency. See Lindy II, 540 F.2d at 117. To a certain extent, the contingency factor reflects the fact that counsel must receive a premium to allow them to continue to undertake representation in contingency cases, in some of which they will be unsuccessful and receive no fees.

        This is a complex case. Plaintiffs had to introduce evidence on a complicated series of transactions and to prove 10b-5 violations in the face of constantly changing law. For this same reason, the probability of Heizer's liability was dubious, and the plaintiffs were not assured of obtaining any relief for IDC. No prior proceedings shed any light on Heizer's liability, and the case law revealed no clear answers. Finally, petitioners had to wait over six years to receive any portion of their fees and have seen the value of the dollar decline in the process.¹⁵

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        In light of these factors, we believe that the contingency factor justifies a multiplier. Although plaintiffs' success became more certain after appeal, we will nevertheless award a multiplier to petitioners for post-appeal hours. The delay factor is still significant for these hours. Furthermore, the contingency factor impacts upon counsel's decision to undertake representation. Representation may include substantial expenditures of time even after success is assured, but counsel cannot know that prior to his decision to take the case. Therefore although petitioners are not entitled to the same multiplier for post-appeal hours, they will receive some multiplier to compensate for the contingency factor. We hold that a 1.75 multiplier would be appropriate for pre-appeal hours assessed against IDC, which we will reduce to 1.5 to take into account petitioners' lack of success on the first three transactions. For post-appeal hours we will award a 1.33 multiplier. This figure does not have to be reduced inasmuch as plaintiffs did not appeal our rulings with respect to the first three transactions.

        Heizer contends that even if petitioners are entitled to fees from Heizer, no multiplier on those fees would be appropriate. Heizer found no cases, nor did we, that indicate that application of a multiplier is appropriate in a bad faith case. We see no reason, however, why we cannot award a multiplier against Heizer here simply because the fee award is premised on a theory of bad faith. The factor justifying a multiplier in the instant case, the contingency factor, does not vary with the identity of the party liable for fees. Moreover, courts have awarded multiplied fees in cases in which a wrongdoing defendant, and not a benefited class or corporation, is liable for the fees. See e. g. Commonwealth of Pennsylvania v. O'Neill, 431 F.Supp. 700 (E.D.Pa. 1977) (suit under § 1981 and Title VII). Furthermore, if Heizer were not liable for any fees, IDC would be forced to pay all of petitioners' fees, with a multiplier.¹⁶ Petitioners should not suffer a loss by virtue of their successful efforts to assess fees against Heizer.

        However, a multiplier should not be applied to the hours spent on the attorney's fee issue. Given the fact that these hours were in significant part devoted to petitioners' interest, straight compensation for those hours is sufficient.¹⁷

        Thus the fees will be assessed as follows: Heizer is liable for $153,719.31. To arrive at this figure, we began with the premise that Heizer is liable for 25% of the hours spent at each of the three hourly rates: 923.75 at $90 per hour, 124.5 at $95 per hour and 272.9 at $100 per hour. Because only Heizer is liable for the hours spent on attorney's fee issues, we then determined how many hours at each hourly rate were devoted to the fee issues. We found that petitioners spent 61.5 hours at $90 per hour, 104 hours at $95 per hour and 501.25 hours at $100 per hour on the fee issue. Because petitioners spent far more time in the latter stages of the litigation on the fee issue, a straight 25% apportionment in the three hourly rates would not work. Therefore, we subtracted 228.35 hours from the 923.75 hours in the $90 per hour group and added 228.35 hours in the $100 per hour group to raise the number of hours in the $100 per hour group to the required 501.25. We then had a total of 695.4 hours at $90 per hour, with 61.5 spent on the fee question, 124.6 at $95 per hour with 104 devoted to the fee issue, and 501.25 at $100 per hour, all devoted to the fee issue. The final figure is computed as follows:

Page 827

        IDC's liability is determined by taking the hours remaining for each hourly rate and multiplying these by the hourly rate and the appropriate multiplier:

         498.5  (hours)
     -   124.6
      ________
         373.9      $ 95  =   $ 35,520.50     1.33 (multiplier)  = $ 47,242.26

       1,091.75  (hours)
     -   501.25
      _________
         590.50     $100  =   $ 59,050.00     1.33  (multiplier) = $ 78,536.50
                                                                     ___________
                                                          Total      $530,724.76

        IDC has already paid $375,000 to petitioners and is now liable only for $155,724.76.

        3. Other Fee Petit