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Confirming a Settlement That Your Client Hates

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 16, 2012

Representing clients in class or derivative litigation is often tricky when a settlement is on the table. Your duty is to protect the class members or the entities that are your true clients.

But what happens when the class representative or nominal plaintiff does not agree with you? The usual solution to this dilemma, at least when considering a proposed settlement, is to take the dispute to the court for it to resolve. After all, the court will require that the class or other stockholders receive notice of the proposed settlement and will hear and decide any objection to it. What could be simpler?

As with many of life's problems, just transferring the decision to someone else only avoids coming up with a solution. The problem still remains. Moreover, consider what happens if the court, heaven forbid, agrees with the objectors. That will leave you with an unhappy client without a settlement, and with a case that you no longer believe will generate more for the client (and for you in fees) than is already available.

Nor is the court going to be happy with the choice you have forced on it. While all courts favor settlements, forcing a settlement over stockholder or class member objections is not pleasant.

To begin with, the objectors occasionally lack adequate legal representation and make hard-to-understand objections. But even when their objections are well-presented, the court is still faced with the difficult decision of whether to reject a settlement whose benefits may be lost at trial. Then the court will be blamed by the class members or stockholders who did not object to the settlement and who are now deprived of its benefits.

Last week, the Court of Chancery came up with an ingenious solution to this problem in Forsythe v. ESC Fund Management, Del.Ch. C.A. 1091-VCL (May 9, 2012). In Forsythe, the parties agreed to a $10.25 million cash settlement after years of hard-fought litigation. The settlement had much to recommend as a reasonable resolution. Most of the plaintiffs' claims had already been dismissed. The settlement was negotiated before a respected mediator. And, at one point, the named plaintiffs in this derivative action had agreed to the settlement. Only when they had second thoughts did they belatedly object to it. Finally, Vice Chancellor J. Travis Laster, who is no pushover for any hasty settlement, agreed that the settlement fell within a range of fairness that he would approve.

On the other hand, the court also recognized that the objectors had some arguments in their favor that, if accepted, meant the settlement was not enough for the claims they asserted. There were many objectors. Their arguments might generate a much larger recovery, if ultimately successful. The court too was aware that in such matters, the plaintiffs attorneys are incentivized to favor a settlement for the sure fees that will be won.

The court's solution was to let the objectors, in effect, buy the proposed settlement. If the objectors post a bond or similar security for the $10.25 million settlement on the table, the court will permit them to take over the prosecution of the litigation. That way, if the objectors fail to do better after a trial, at least the $10.25 million will be recovered. Will this proposal work?

We will see if a bond is posted. Certainly, as the court itself recognized, there are good reasons why even the most sincere objectors will not post such a bond. For example, if the objectors win after trial, they do not directly benefit from their victory. The recovery in this derivative litigation will first go to the company whose claims they assert. Only later will the recovery trickle down to the objectors, if at all. The cost of the bond may alone outweigh any benefit objectors eventually receive under those circumstances. On the other hand, much of the hard work of litigation has already been done and the possible recovery is quite large.

In some respects, the Forsythe facts present a unique set of circumstances more akin to those found in class action litigation. Unlike most derivative actions, the objectors in Forsythe expected any recovery to be distributed to them. The litigation concerned allegedly improper investments by defendants in controlling an investment fund the objectors invested in and from which they would receive distributions enhanced by any recovery by the fund in the litigation. That is closer to a class action where the class members recover directly in any settlement. This may lead to a "free rider" problem where objectors have little to lose by forcing class counsel to litigate to the bitter end and bear any costs involved. Hence, the court's solution to the balancing of parties' interests in Forsythe seems particularly appropriate.

In short, it remains to be seen if the Forsythe court's solution to the problem of "hated" settlements will actually work. At the least, it should quiet objectors who are unwilling to pay the price to continue litigation.

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