Seventh Circuit Holds Class Action Objectors Can Be Required to Disgorge Private Settlements

King & Spalding

On August 6, the Seventh Circuit held that it is inequitable for a class action objector to settle her objection for an amount in excess of her share as a class member and that disgorgement is the most appropriate remedy.

  • In 2011, several plaintiffs brought a putative class action alleging that defendants had made various false claims about certain dietary supplements they manufactured and distributed. The parties submitted a proposed settlement in March 2013, which the district court approved over an objection from a class member, well-known tort-reform advocate Theodore “Ted” Frank. The Seventh Circuit reversed, finding that the settlement was plagued by “fatal weaknesses” and constituted a “selfish deal” benefiting class counsel and the defendants.
  • In April 2015, the parties negotiated a second settlement and submitted it for approval. The second settlement was approved by the district court over three objections. All three objectors dismissed their appeals before briefing began. Frank, the objector to the original settlement, sought to reopen the case by filing a motion for disgorgement, based on his suspicion that the objectors dismissed their objections in bad faith.
  • Discovery revealed that the three objectors had received side payments in exchange for dismissing their appeals. Nevertheless, the district court held that the record did not contain evidence of blackmail or other wrongdoing and denied the motion for disgorgement. Frank appealed and two of the three objectors appeared to defend their payments.
  • On appeal, the Seventh Circuit held that the district court erred both factually and legally. Specifically, the Seventh Circuit held that the district court mistakenly found that the money paid to the objectors did not harm the class because the money had not been earmarked for the class. Legally, the district court erred by requiring a positive statutory authority for disgorgement.
  • The Seventh Circuit was persuaded by a 1945 case in which the Supreme Court held that shareholders objecting to a company’s bankruptcy plan that later received side payments to drop their objections had violated the shareholders’ fiduciary duty to the company and therefore acted inequitably. The court read this decision “to impose a limited representative or fiduciary duty on the class-based objector who, by appealing the denial of his objection on behalf of the class, temporarily takes control of the common rights of all the class members and thereby assumes a duty fairly to represent those common rights.” Either the objections were meritorious (in which case the objectors sold off a chance to improve the class’s recovery for their own benefit), or they were not (in which case the objectors essentially held the proposed settlement hostage to benefit only themselves).
  • Applying that case to the facts before it, the Seventh Circuit concluded that “merit was a matter of indifference to these objectors” because they advanced their objections in only four pages that were “light on citations to law and fact.” The court also found that the payments had harmed the class because the fees, whether they came from the class fund or from class counsel, were funds that should have gone to the class.
  • Having determined that the objectors received side payments in violation of the rights of the class members, the court then turned to the issue of what remedy to afford. The court agreed with the parties that returning the amounts paid to the objectors to the class fund would create more administrative costs than it would generate in benefits to the class. Thus, the court ordered instead that the funds be disgorged and paid to a research foundation that would benefit members of the class as set forth in the settlement agreement.
  • The court concluded by emphasizing that “reasonable and good-faith objectors” would not be deterred by the court’s holding, as they would be able to state specifically why the class had been deprived of a fair settlement. Such good-faith objectors would be expected to improve the class’s position, and therefore would not be interested in selling out the class for a side payment.
  • Read the Seventh Circuit’s opinion in Pearson v. Target Corp. here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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