The Seventh Circuit Clears a Roadblock to Settlement

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As I have discussed in earlier posts, there are multiple stakeholders to class action settlements, including named plaintiffs, absent class members, class counsel, defendants, and the courts. Conflicts can arise within some of these groups, and perhaps most often arise among the class members themselves. A settlement that looks good to one named plaintiff or their counsel, for example, might not look good to another member of the class or their counsel. The ability of dissenting class members to object to a proposed settlement is one safeguard that can assist a court in determining whether a class action settlement satisfies Rule 23(e)(2)’s “fair, reasonable, and adequate” standard.

When an objection is brought in good faith and has merit, it can result in a better deal for the class. Unfortunately, not all objections are made in good faith. Rather, some are made with the sole objective of enriching the objector and the objector’s counsel, with no accompanying benefit to the settlement class. And often parties and their lawyers eager to avoid delays caused by lengthy objector appeals reluctantly succumb to the objectors’ demands.

So what, if any, power do federal courts have to police objector misconduct and prevent bad faith objections from slowing down and, in some cases, diminishing the value of class action settlements? Plenty, said the Seventh Circuit in an important decision issued last week.

Pearson v. Target Corp. involved a settlement that had received final approval over several objections, after which the objectors appealed the approval order. Before the appeals were briefed, the objectors dismissed them voluntarily, thus arousing the suspicion of a successful objector to an earlier settlement proposal in the same case. That original objector filed a motion in the district court, seeking disgorgement of any payments made to the new objectors in exchange for dismissing their appeals. The district court denied the motion for lack of jurisdiction, the original objector appealed, and the Seventh Circuit reversed, finding that the district court did indeed have jurisdiction to entertain the motion.

On remand, discovery revealed that the objectors had been paid off for dismissing their appeals. However, the district court found that there was nothing illegal about, and no wrongdoing involved in, the payments to the objectors, and denied the motion for disgorgement.

On the second appeal, the Seventh Circuit reversed again. It held “that settling an objection that asserts the class’s rights in return for a private payment to the objector is inequitable and that disgorgement is the most appropriate remedy.” The district court had mistakenly concluded that the moving party must show “some positive statutory violation as a predicate for disgorgement.” In fact, the appellate court held, disgorgement is an equitable remedy, and longstanding principles of equity required disgorgement here.

The court’s holding was premised on its conclusion that, by asserting the interests of the class in their objections to the settlement, the objectors had assumed a fiduciary role. And, because they resolved the objections in a manner that benefited only themselves and not the class members, they had engaged in self-dealing amounting to “constructive” fraud, which allows for the equitable remedy of disgorgement. After discussing a 1945 Supreme Court decision involving a shareholder class, Young v. Higbee Co., which it found fully applicable, the court then summed up its reasoning as follows:

This case turns on a simple either/or proposition whose logic flows directly from Young. These objectors made sweeping claims of general defects in the Pearson II settlement. Either those objections had enough merit to stand a genuine chance of improving the entire class’s recovery, or they did not. If they did, the objectors sold off that genuine chance, which was the property of the entire class, for their own, strictly private, advantage. If they did not, the objectors’ settlements of meritless claims traded only on the strength of the underlying litigation, also the property of the entire class, to leverage defendants’ and class counsel’s desire to brig it to a close. Either way, the money the objectors received in excess of their interests as class members ‘was not paid for anything they owned,’ . . . and thus belongs in equity to the class.

The court rejected the objectors’ arguments that disgorgement was not appropriate because the amounts they were paid did not come out of the common fund established by the settlement. The objectors acknowledged that some of their payoffs came from class counsel, and were paid from the fees class counsel were awarded as part of the settlement. The court held that “[m]oney that class counsel were willing to part with to finally resolve the litigation consisted of savings that ought to have enured to the class–not to defendants, the three objectors, or their lawyers.”

After concluding that disgorgement was an appropriate remedy, the court addressed the practical problem that the cost of distributing the payoff amounts to the class would exceed the amounts themselves. In that circumstance, the court held, it would be appropriate to adopt the remedial framework of the constructive trust, the purpose of which could be accomplished through a cy pres payment. That payment would be straightforward because the settlement already identified a cy pres beneficiary.

Finally, the court addressed the concern that its decision might deter good-faith objectors from asserting their objections. The court emphasized the important role good-faith objectors play in the settlement process, particularly because the settling parties, by virtue of the settlement, no longer occupy the adversarial relationship on which our system of justice depends. In that setting, the court held, “[g]enuine adversary presentation is supplied, if at all, only by objecting class members.” To that end, the court pointed to the 2018 amendments to Rule 23, and particularly to the provisions of Rule 23(e)(5) requiring objectors to specify the grounds for their objections at the time they assert them, and requiring district court approval for dismissing an appeal in exchange for payment or other consideration.

The Seventh Circuit’s decision represents an important step in the evolution of federal court class action settlements. Like the 2003 and 2018 amendments to Rule 23, it emphasizes the important role federal courts have in scrutinizing settlements and the entire settlement process, including objections and objector appeals. And, by adopting the remedy of disgorgement, the court’s decision should deter the filing of bad faith objections whose only purpose is to enrich the objectors, and that offer no benefit to the class on whose behalf they purport to act.