A recent Law 360 article by Michael McTigue, Meredith Slawe, and Max Kaplan of Cozen O’Connor, “7th Circ. Ruling Should Deter Class Objector Side Deals,” report on a recent Seventh Circuit ruling on class action fee objectors. This article was posted with permission. The article reads:
On Aug. 6, the U.S. Court of Appeals for the Seventh Circuit issued an opinion addressing exploitation of the class action settlement process by individual objectors. The first sentence of U.S. Circuit Judge David F. Hamilton's opinion in Pearson v. Target Corp. frames the issue: "We address here a recurring problem in class-action litigation known colloquially as 'objector blackmail.'"
This practice, in which objectors threaten to delay and unravel negotiated class resolutions absent payments to them, has occurred with greater frequency over the past few years. Concerns with coercive objector side deals even prompted a change to the Federal Rules of Civil Procedure in 2018.
Background
The underlying action, which challenged supplement labeling practices, was litigated over several years. In March 2013, the parties reached a class settlement, which was approved by the U.S. District Court for the Northern District of Illinois over concerns raised by "serial objector" and activist Theodore Frank, among others.
Frank appealed and the Seventh Circuit reversed the district court's final approval order, finding the settlement plagued by "fatal weaknesses," amounting to a "selfish deal" between class counsel and defendants that "disserve[d] the class." Frank was subsequently awarded $180,000 in attorney fees.
The parties renegotiated the settlement in April 2015, and proposed the creation of a $7.5 million common fund accompanied by permanent injunctive relief. The district court approved the revised settlement over the objections of three individuals.
These objectors submitted brief statements to the district court, "light on citations to law and fact." One submission contained irrelevant assertions regarding the defendant's failure to acknowledge liability under the Telephone Consumer Protection Act, a statute not at issue in the litigation.
The objectors challenged the district court's final approval order, but abandoned their appeals prior to briefing and after negotiating side payments with the settling parties. On May 19, 2017, Frank moved to reopen the case and disgorge the funds paid to those objectors because, "with no benefit to the absent class," the objectors "received unjust payments for appeals that plaintiffs called 'vexatious' and 'bad faith.'”
The district court denied Frank's motion for lack of jurisdiction. He again appealed, and the Seventh Circuit again reversed, finding that the district court had jurisdiction over Frank's motion.
On remand, the parties disclosed that they had paid a total of $130,000 to the objectors in exchange for the dismissal of their appeals. The district court rejected Frank's motion for disgorgement of those funds, concluding that the objectors' actions: (1) did not constitute criminal blackmail and (2) otherwise did not harm the class. Frank appealed a third time, and the Seventh Circuit reversed once again.
Seventh Circuit Emphasizes the Fiduciary Role of Objectors
The Seventh Circuit ruled that equity required the disgorgement of all funds paid to these objectors. The court characterized the objectors' conduct as "[f]alsely flying the class's colors," to extract substantial monetary benefits for themselves with no benefit to the class. Specifically, the court 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."
In reaching this conclusion, the court primarily relied on a 1945 U.S. Supreme Court case — Young v. Higbee Co. In Young, the Supreme Court held an accounting of profits was appropriate where a bankrupt entity purchased preferred stock from two of its shareholders at a premium in exchange for the shareholders abandoning their appeal from approval of the rehabilitation plan.
By appealing as they did, the Supreme Court reasoned, these shareholders purported to act on behalf of all preferred shareholders, to reshape the company's rehabilitation to better their common fate. "This control of the common rights of all the preferred stockholders imposed on [appellants] a duty fairly to represent those common rights," and it was therefore a breach of this duty to "trade in the rights of others for their own aggrandizement." Any profits individually gained thus belonged in equity to benefit all preferred shareholders.
The Seventh Circuit characterized the payments to the three objectors in Pearson as "not meaningfully different" from the transactions in Young. These objectors, like those in Young, raised alleged settlement defects that purportedly injured all class members, and if corrected would benefit all class members; indeed, it was this protection of the common interest that enabled the objectors to bring their appeals under Federal Rule of Civil Procedure 23(e)(5).
Thus, the court reasoned, as an objector "temporarily takes 'control of the common rights of all' the class members" by appealing the overruling of an objection, the objector thereby assumes a "limited representative or fiduciary duty ... 'fairly to represent those common rights.'" Here, however, while the objectors "were ... 'bound to protect' the common interests of the class," they "'sacrifice[d] those interests' to their own advantage by selling their appeals without benefit to the class."
The Seventh Circuit made clear that objectors may properly seek a personal benefit, whether in the form of attorney fees or incentive payments, so long as such benefits are earned in bettering the class as a whole. The Pearson objectors, however, abandoned any attempt to better the class — which received nothing as a result of their efforts — for what was in effect a premium worth almost 100 times what other class members could receive.
As the objectors would have received such a benefit had they succeeded in their appeals, the court viewed the abandonment thereof as evidence the objectors either "sold off [a] genuine chance of improving the entire class's recovery" or otherwise asserted meritless objections to leverage the class interest. In either case, the funds obtained should rest with the class and not with the individual objectors.
Given the posture of the settlement, the Seventh Circuit found the most appropriate manner to distribute the ill-gotten gains was to divert the funds to the organization designated by the parties as the cy pres recipient in the settlement agreement.
2018 Amendment to Rule 23(e)(5)
The Pearson objectors predate, and were not subject to, the 2018 amendment to Federal Rule of Civil Procedure 23(e)(5). This amendment addressed the improper use of "objections to obtain benefits for [objectors] rather than assisting in the settlement-review."
To that end, Rule 23(e)(5) now requires objectors to "state with specificity the grounds for the objection" and prohibits an objector from "forgoing, dismissing, or abandoning an appeal" in exchange for "payment or other consideration" without court approval. This change has already proved somewhat effective.
The Seventh Circuit noted that neither its decision nor the 2018 amendment should deter good faith objectors who are compensated for successfully improving the position of the class.
Takeaways
The Seventh Circuit's opinion sends a powerful message to objectors who seek to take advantage of the class action settlement process for personal gain, and should serve to deter such efforts. In this case, the improper activities took the form of frivolous appeals that threatened to delay and disrupt the distribution of settlement benefits to class members and burden the court by multiplying proceedings.
This happens all too often at the expense of all parties, except for the objectors. When a fair settlement is reached and approved, compelling interests support having the proceeds be distributed to the class, which also enables the parties to gain finality.
Further, courts should not be saddled with contrived appeals brought for the sole purpose of benefiting individuals who have no genuine interest in securing additional relief for or otherwise elevating the position of the class as a whole.
The court's opinion in Pearson, along with the 2018 amendment to Rule 23(e)(5), should be instructive for parties that are engaged in the settlement approval process. The parties should consider objectors' motives and actions prior to negotiating separately with them. Objectors should be mindful of their duties to class members.
Finally, courts should be vigilant in addressing illegitimate objector activity and may wish to consult the frank discussion of what it means for objectors to represent the interests of a class in this opinion. Collectively, all parties can combat abuse in connection with class action settlements.
This ruling also highlights increasing awareness in the courts of exploitive conduct in the context of modern class action practice. Indeed, the cottage industry of presuit demand letters — often invisible to federal court judges — threatening class action litigation absent quick stealth payouts bears similarity to the so-called objector blackmail portrayed by the Seventh Circuit.
Additionally, mass litigation tactics by serial plaintiffs and their counsel have prompted some judges to engage in diligence and hold parties and their counsel accountable. As putative class actions continue to flood the court dockets, judicial awareness of incidents of abuse and self-serving conduct become of heightened importance.
Michael W. McTigue Jr. is a partner and co-chair of the class actions practice at Cozen O'Connor. Meredith C. Slawe is a partner and co-chair of the class actions practice at the firm. Max E. Kaplan is an associate at the firm