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Court of Chancery Investigates Potential For Collusive Settlements in Multi-Fora Litigation

March 30, 2011
Peter B. Ladig
Delaware Business Court Insider

It is not uncommon for the announcement of a business combination to be followed shortly thereafter by the filing of multiple lawsuits seeking to enjoin the consummation of that transaction. It is also not uncommon for those lawsuits to be filed in more than one forum. While responding to lawsuits arising from the same transaction in multiple jurisdictions can be costly and time-consuming for defendants, it also presents an opportunity for defendants to leverage the different plaintiffs groups against each other to construct a form of reverse auction to obtain the lowest possible settlement, recognizing the settlement of one action will extinguish all other actions. Recently, the Court of Chancery appointed special counsel to determine whether an improper collusive settlement occurred in the settlement of class actions arising from the merger of Nighthawk Radiology Holdings, Inc. (“Nighthawk”). The report of the special counsel addressed the concerns of the Court and provided helpful guidance to litigators facing similar issues in the future.

Background To The Nighthawk Settlement

After the announcement of the merger of Nighthawk with Virtual Radiologic Corporation, seven lawsuits challenging the merger were filed in Arizona, and one, later-filed action, was filed in Delaware. In Delaware the plaintiff filed a motion to expedite based on disclosure claims. Vice Chancellor J. Travis Laster denied that motion, finding the disclosure claims to be not only not colorable but also unlikely to serve as the sole basis for a settlement of the entire action. The Vice Chancellor reached that conclusion, in part, because he believed that the plaintiffs had overlooked certain process-based claims related to the merger that had more merit to them and could have provided a proper basis for a motion to expedite.

After the denial of the motion to expedite in Delaware, counsel for Nighthawk entered into settlement discussions with counsel for one of the Arizona plaintiffs. Nighthawk initially agreed to produce a limited set of documents for settlement purposes only, negotiated with one set of plaintiff’s attorneys with whom counsel for Nighthawk was familiar, and affirmatively chose not to negotiate any terms of the settlement with Delaware plaintiff’s counsel. These discussions resulted in a “disclosure only” settlement, providing additional disclosure by Nighthawk to “correct” disclosure issues that the Vice Chancellor had previously held were not colorable, along with the payment of attorneys’ fees to the Arizona plaintiff’s counsel. Most importantly, the parties agreed to present the settlement for approval to the Arizona court, notwithstanding the fact that no meaningful activity had occurred in the Arizona litigation prior to that point.

Plaintiff’s Delaware counsel then informed the Vice Chancellor that the parties had agreed to the settlement and that it would be presented to the Arizona court for approval. This news prompted the Vice Chancellor to order the parties in Delaware to provide him with a written report on the settlement negotiations and to attend a status conference. At the status conference, the Vice Chancellor informed the parties that based on the limited record before him, he believed that there was a prima facie case that the settlement was collusive. The Vice Chancellor found it very troubling that the defendants, who had initially indicated a desire to litigate the case in Delaware, changed their mind when the Court advised the parties of its doubt that a disclosure-only settlement would be approved and then sought to negotiate a disclosure-only settlement with a familiar opponent that would be presented to a different court for approval. The Vice Chancellor asked that the parties provide him with briefing on whether a wrong was committed and, if so, what the remedy should be.

The Vice Chancellor also appointed a “special counsel” to “represent the interests of the State of Delaware and to provide specific input on the interests of the State and the judicial system as a whole.” The Court asked the special counsel to answer five questions:

1. is forum shopping for purposes of securing an advantageous settlement a wrong under Delaware law?

2. what role, if any, should the “non-settlement” forum have when it receives notice of what appears to be a collusive settlement?

3. is it a valid concern that the court being presented with the settlement would not have reason to know of adverse rulings or commentary from the non-settlement forum?

4. what remedy, if any, should there be for counsel if the Court finds they engaged in a collusive settlement, such as revocation of pro hac vice status?

5. how should the answers to these questions be applied to the Nighthawk settlement?

The Special Counsel’s Report and Recommendations

The special counsel delivered his report to the Court on March 11, 2011. The special counsel ultimately concluded that no wrongdoing had occurred in connection with the settlement of the Nighthawk litigation, but in answering the Court’s other questions, special counsel provided valuable insight into management of future multi-jurisdictional litigation.

The special counsel concluded that forum shopping for the purposes of securing an advantageous settlement was not the equivalent of a collusive settlement, and therefore was not an independent wrong under Delaware law. A collusive settlement, on the other hand, is usually marked by an early settlement with counsel not actively involved in litigating the claims on the merits with evidence of a reverse auction. Special counsel recommended that the court be particularly alert in these instances.

Special counsel also made several recommendations to address the concerns raised by the Court regarding information available to settlement courts and potential remedies if a court finds counsel engaged in a collusive settlement. As an initial matter, special counsel noted that early class certification has consequences for other competing class actions and may end the reverse auction phenomenon, but did not affirmatively recommend that the Court address class action certification earlier than it currently does. Special counsel agreed that informational gaps between jurisdictions can exist, but the gaps could be closed by mandating that the settling forum be made aware of events in the non-settling forum, particularly adverse rulings or commentary from the judge in the non-settling forum. Special counsel suggested that changes to the Court of Chancery Rules, or in individual orders of the Court could accomplish this goal. Special counsel also recommended that the Court could also require that the parties provide the Court with contact information of the judge who will be asked to approve the settlement and copies of any settlement papers filed in the other forum.

The special counsel found that the potential remedies available to a Court if it finds the parties engaged in a collusive settlement are a mixture of Court rules, disciplinary action and market forces. Pursuant to the authority exercised under Rule 23, courts have at times declined to approve settlements or award attorneys’ fees or even remove class counsel when the settlement was not the product of arm’s length negotiations. Special counsel noted that while defense counsel are not subject to the fiduciary concerns found in Rule 23, they must answer to their own clients for the failure to obtain approval of the settlement, can be liable potentially for aiding and abetting a fiduciary breach by plaintiffs’ counsel, and can be disciplined by the Court for misrepresentations or dishonesty to the Court. Revocation of admission pro hac vice, for either plaintiff’s or defense counsel, is also available under the Court’s inherent authority to “preserve the integrity of judicial proceedings” although that power is exercised rarely.

While the issues parties and courts face in multi-jurisdictional litigation are not new, a court appointing special counsel to determine whether a collusive settlement occurred is a new development. If nothing else, this development indicates that the Court of Chancery is paying heightened attention to representative litigation to ensure that the Court’s rules and expectations are being met.