Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. 1091-VCL (Del. Ch. Feb. 6, 2013).

Issue addressed: Whether the court would allow objectors to the settlement of a derivative suit to guarantee the amount of the settlement and “take a chance” at pursuing a higher recovery at trial or in a later, new settlement, in the nature of a “market test” of the settlement.  Short answer: In a prior decision the Court of Chancery entertained the idea on a conceptual level, but the court now explains in this decision why it would not allow a litigation finance company to pursue a “better deal”,  based on the record presented. Thus, the original settlement was finally approved.

Several prior Chancery decisions in this matter have been highlighted on these pages and are available here. Tom Hals of Thomson Reuters provides a helpful overview of the case here

Short Overview

In its May 2012 decision in this case, highlighted on these pages here,  the Court of Chancery provisionally approved the settlement in this derivative case as “within the range of fairness, albeit at the low end.” Due to the closeness of the call, the court gave the objectors the opportunity to present a superior alternative and take over the case. The objectors failed to “convert” that opportunity and thus the court formally and finally approved the original settlement and dismissed the case.

This pithy opinion is rich with extended footnotes that constitute a large portion of the decision which includes citations to scholarly writings on the public policy and doctrinal issues raised in this case. For example, the court observes that in the context of the requirement that it approve derivative settlements, it plays the role of a fiduciary in reviewing the final resolution of the case, and it stands in the oxymoronic position of exercising its business judgment to determine if the settlement is fair. See, e.g., footnote 1.

The Court reasoned that in its fiduciary capacity, it must be concerned with more than economic rationality. On one level, objectively one might think that it should not matter what the financing terms are if a greater settlement is obtained. For example, if the proposed financiers were to receive a fee of 99 cents for every additional dollar that the settlement were increased, why should it matter to them what the financier is receiving? The answer is similar to the reason why the court rarely approves legal fees beyond one-third of the fund created in a derivative case.

That is,  for public policy reasons, the law eschews the notion that “anything for the client is better than nothing.” Slip op. at 9-10. The Court explained the terms of the proposed financing and observed that the proposed litigation finance company, Burford Capital, made its proposal based in part on “business development considerations” which led the court to conclude that “the market therefore does not support continuing the litigation.”  Thus, this “market test” experiment will need to wait for another day and another case.


Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091-VCL (Del. Ch. May 9, 2012).

Issue Addressed

Whether the settlement of a derivative action that the Court considered fair should be approved despite the objections of the named plaintiffs. 

Short Answer

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.

Brief Background

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.

Legal Analysis

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.

Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091-VCL (Del. Ch. August 11, 2010),  read opinion here. Among the five prior opinions in this case (all listed at footnote 1 of the decision), highlights of three are available here.

Brief Overview
This is the latest in a long-running dispute involving claims by the investors of an investment fund formed as a limited partnership. Procedurally, the Court makes its analysis in the context of a Motion for Summary Judgment. The Court recognized many factual issues that prevented a ruling on many of the claims but nonetheless, granted in part and denied in part a Motion for Summary Judgment regarding the various claims of the parties against the managers of the fund. Most of the claims were governed by the terms of the agreement among the parties.


The key agreement among the parties contained an exculpatory provision that limited the liability of the general partner, special limited partner and investment advisor. The exculpation clause, in essence, only allowed the recovery of damages if the following could be established: “Bad faith, willful misconduct, gross negligence or material breach of the [agreement].” The detailed factual background provided by the Court takes up about the first 19-pages of the decision. For purposes of this brief and cursory highlight of the key parts of the decision, there were several affiliated funds that worked “side-by-side” with other funds. The overlapping and interfacing among the affiliated funds created some of the raw material for the claims. Of course, one of the reasons why the litigation began is because of the substantial losses suffered by the investors. Although the returns eventually “got back into the black,” the returns generated were “approximately $200 million below the returns generated by the lowest quartile of comparable funds.”

Legal Analysis

The Court found material questions of fact as to whether defendants acted in bad faith or with gross negligence. Bad faith was defined as occurring when a “fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties." (citing Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 253 (Del. 2008)). Gross negligence was defined as including “conduct that constitutes a reckless indifference or actions that are without the bounds of reason.” (citing McPadden v. Sidhu, 964 A.2d 1262, 1274 (Del. Ch. 2008)).

Referring to the language of the agreement addressed in a prior decision from the Court of Chancery regarding the duties of the general partner, the Court affirmed that the general partner was required to make at least some effort to oversee the fund in order to properly discharge its duties of oversight. See Forsythe, 2007 WL 2982247, at * 7 (referring to the terms of the agreement that impose a duty of oversight on the general partner to take active steps to satisfy itself that the person to whom it delegated its authority actually discharged their powers loyally to the fund and in conformity with the agreement).

The governance structure of the fund based on the applicable agreement allowed for the investment decisions on day-to-day management to be delegated to conflicted representatives of an affiliated fund. That structure required greater vigilance by the general partner. If the general partners acted in a manner analogous to an independent director, that may have validated the actions of a conflicted delegate’s decision, but, as the Court explained, the “general partner’s disappearance from the scene and its studious impersonation of a rubber stamp eliminate my ability to rely on the Individual Defendants as a cleansing device.”

The majority of the 33-page decision focuses on the implications of the controlling terms of the agreements among the parties and the nature of the factual issues precluding a ruling on most of the Motion for Summary Judgment. The Court also devotes a fair amount of time to “clearing out the underbrush so the parties can focus at trial on the major disputes.” At trial, the acts and omissions of the defendants will be measured by the standards defined in the agreements among the parties and whether or not those acts or omissions constituted bad faith, willful misconduct of gross negligence.


Forsythe v. ESC Fund Management Co., C.A. No. 1091-VCL (Apr. 21, 2010), read letter decision here.

This short letter decision emphasized a truism recognized in prior Delaware decisions that the Court of Chancery will not allow an expert to opine on matters of Delaware law, especially including matters related to the fiduciary duties of directors. In this regard, the Court ruled that an expert would not be entitled to testify about the custom and practice in the financial services business in the context of applicable industry standards such as those of the Financial Industry Regulatory Association.

Such proposed testimony, in the view of the Court, would be: “actually . . . opinions concerning legal issues governed by Delaware law.” Thus, to that extent, the Court granted a motion to strike the report and to preclude the testimony of the particular expert that was proposing that testimony. In essence, the Court is saying that it is the final arbiter of what Delaware law is, and no "outside expert" is needed on that topic.


In Forsythe v.  ESC Fund Management Co., 2007 WL 2982247 (Del. Ch., Oct. 9, 2007), read opinion here, the Chancery Court allowed a breach of fiduciary claim to proceed despite the absence of a pre-suit demand. The court discussed both the Caremark standard and common law partnership duties, but determined that the language of the  parties’ partnership agreement provided the applicable standard to measure the behavior of the defendants. The court also applied the Aronson/Rales pre-suit demand analysis in the context of a general partner of a limited partnership. 

The court also discussed those relationships on which fiduciary duties are imposed, and found that the Investment Advisor in this matter had such duties. This is a case where the court’s own summary may be the most pithy overview:

A major bank offered to its most highly paid employees partnership interests
in a fund intended to co-invest with the bank in its proprietary investments. In
accordance with the partnership agreement, the corporate general partner, owned
by its three unaffiliated directors, delegated the responsibility for the fund’s
management to affiliates of the bank. After the fund suffered extreme losses, a
group of limited partners brought suit against, the bank, the general partner, its
directors and the bank’s affiliates for breach of fiduciary duty and breach of the
partnership agreement.
The defendants have moved to dismiss on various grounds, including failure
to make pre-suit demand on the general partner. The issue raised by this aspect of
the motion is whether the general partner’s oversight duty is governed by the
familiar standard of Caremark or by a higher standard rooted in the partnership
agreement itself.
The court concludes the partnership agreement provides the relevant
standard. Particularly in light of the general partner’s full delegation of its
managerial duties to conflicted persons, the residual duty of oversight found in the
agreement imposes a duty upon the general partner to take active steps to satisfy
itself that the conflicted delegates actually discharge their powers loyally to the
fund and in conformity with the partnership agreement. Because the complaint
adequately alleges facts which, if true, show that the general partner did not fulfill
that duty, demand will be excused.

UPDATE: Here is a decision on Oct. 31, denying the Motion for Reconsideration under Rule 59(f).

Three recent Chancery decisions posted on the Court’s website each addressed issues that often arise:
In Mason v. Network of Wilmington, Inc., download pdf file, the court discussed the summary judgment motion standard (prior to the recent adoption of Rule 56(h)), in connection with analyzing the following issues related to efforts to collect a judgement against the sole shareholder of affiliated entities: piercing the corporate veil; fraudulent transfers and successor liability. See below link for remaining 2 cases.

Continue Reading Three Recent Chancery Decisions