Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091-VCL (Del. Ch. May 9, 2012).
Whether the settlement of a derivative action that the Court considered fair should be approved despite the objections of the named plaintiffs.
The Court explained that the settlement could still be approved even if the named plaintiffs objected to it but in light of the potential merits of the objectors’ arguments, the Court would approve the settlement provisionally – – unless the objectors posted a secured bond or letter of credit in the full amount of the settlement consideration of $13.25 million, at which time they could apply to the Court for approval to take over the case.
Several prior opinions in this case have been highlighted on these pages here.
This is the 7th opinion by the Court of Chancery in this long running derivative action. The case involves a derivative claim against a fund that was formed for senior employees of the Canadian Imperial Bank of Commerce to co-invest with the bank in private equity opportunities. Shortly before trial in early 2011, a mediation resulted in a settlement that the named plaintiffs initially agreed to, but they subsequently joined with other objectors in opposing the settlement.
The Court reviewed the fundamentals of Delaware law applicable to this situation. Namely, settlements of a derivative action require Court approval, and also require the Court to determine the intrinsic fairness of the settlement. Although the Court does not perform its own evaluation of the case on the merits, it must apply its own business judgment in deciding whether the settlement is reasonable.
The Court emphasized that it was not necessary for the named plaintiffs to support the settlement in order for the Court to approve it. The Court explained that by suing a representative capacity, “the named plaintiffs gave up the right to dictate the outcome of the action unilaterally.” Moreover, the Court emphasized that “counsel in a derivative and/or class action may present a proposed settlement over the objections of the named plaintiffs. The mere fact that the counsel takes a different view on the advisability of a settlement than the named clients, does not, in itself, constitute grounds for disqualification.”
The Court recited the reasons why it believed that the settlement proposal was reasonable even if it was on the “low end” of reasonableness.
The Court, however, recognized that it “is not infallible,” and wanted to allow for the possibility that the objectors may be right in their analysis that the potential damages could exceed $200 million, far more than the approximately $13 million value of the settlement.
The Court recited several quotations from law review articles and other decisions of several federal courts to address the competing interests which raise the concern, in general, that the interests of counsel for the class may diverge from the interests of their clients, and that the requirement of judicial approval for settlements in representative litigation must take those factors into account. Moreover, the Court observed that there may be concern that the interests of the objectors to the settlement may also diverge from the interest of the company, or in this case the fund, against whom the claims were made.
Balancing of Risk
In order to balance the risk of losing the certainty of the settlement against the possibility that the settlement consideration may by inadequate, the Court fashioned a somewhat Solomonic remedy which provided that it would enter an order approving the settlement, as well as the counsel fees for the plaintiff – – unless the objectors or their counsel provided the Court within 60 days with a secured bond or letter of credit or similar security in the amount of the settlement consideration. If the objectors pursue the case and ultimately recover less than the current settlement, the fund will have the right to execute on the security to collect the difference. If however the objectors in the future were to receive more than the current cash settlement, they would be entitled to the benefits of the larger settlement.
The Court recognized that even though this approach addresses the agency costs and the inherent problems with representative actions, through an auctioning process, it was imperfect because the objectors and their counsel would not be entitled to the entire amount of any increased recovery even though they were providing a bond for the entire amount of the settlement.
The Court conducts a careful weighing of the public policy concerns that are at work due to the different interests and different perspectives of the parties that are presenting a settlement of this type to it for approval. The citations to various law review articles and federal court opinions provide a basis for deep thought about these issues that have a substantial impact on society.
In sum, the Court explained that it would approve the settlement and the fee request by the plaintiffs’ attorneys unless the objectors posted security and applied to take over the case within 60 days. The Court then went on to explain the basis for approving the amount of fees requested by the plaintiffs, as well as a request for payment to the named plaintiffs for their substantial contributions to the case over several years.