The Seventh Circuit Orders Disgorgement of Objectors’ Side Settlements

When a class action settles, class members generally have three options: (1) remain a part of the class, (2) opt-out of the settlement, or (3) object to the settlement. Many courts have bemoaned a perceived rise in the abuse of the third option by class members using a technique commonly referred to as “objector blackmail.” Objector blackmail involves class members filing frivolous objections to a class settlement, appealing decisions approving the settlement over such objections, and then seeking to obtain a side payment from the defendant in exchange for dismissal of their appeals. A recent Seventh Circuit opinion may spell the beginning of the end of this practice.

The issue of objector blackmail was front and center in the case of Pearson v. Target Corp. The plaintiffs in Pearson filed a putative class action alleging that the retailer Target, among others, made false claims about dietary supplements they manufactured and distributed. In March of 2013, the parties reached a settlement and asked the district court to approve it. After the first settlement was thrown out on appeal, the parties then reached a second settlement. Following the district court’s preliminary approval of the second settlement, three class members objected to the settlement. The objections ran the gamut from the number of class counsel’s fees to the failure of the defendants to admit liability under a statute they had not been accused of violating in the case.

The district court ultimately granted final approval to the settlement over the objections of the three-class members. All three objectors appealed the final approval of the settlement. All three later dismissed their appeals before the briefing began. Another class member, intrigued by the dismissal of the appeals, sought to reopen the case in the district court by filing a motion for disgorgement of any payments made to objectors in exchange for the dismissal of their appeals. The district court concluded that there was not sufficient evidence to support disgorgement and denied the motion.

On appeal, the Seventh Circuit found not only that the district court had the ability to consider the motion for disgorgement but that it had applied the wrong legal standard in determining whether to grant the motion. The district court had concluded that a statutory violation was a prerequisite for disgorgement. This is not the case and constituted a reversible abuse of discretion the Seventh Circuit concluded.

The Seventh Circuit’s opinion focused primarily on “long-established principles of equity.” The first step in its analysis focused on establishing that the objecting class members owed a fiduciary duty to the other class members who were similarly situated because the objectors alleged defects that affected all class members alike by binding them all to an inadequate settlement. Having assumed the position of objecting on behalf of the class, the objectors were “bound to protect” the interests of the class by objecting only in “good faith.”

By settling their appeals in a manner that benefitted only themselves and not the class, the Seventh Circuit concluded that the objectors had sacrificed the interests of the class for their own gain. The Seventh Circuit looked at two possible scenarios and found that neither scenario justified the objector’s actions. Either the objectors had meritorious arguments about the settlement’s inadequacy which they sacrificed for their own gain. Alternatively, the objectors’ arguments were meritless and the objectors’ settlements of their appeals traded on the strength of the litigation, which belonged to the entire class, for personal gain, which also did not benefit the class. Either way, the money the objectors received in excess of their interests as class members “was not paid for anything they owned” and thus belonged in equity to the class.

After determining that the objectors’ settlements were subject to disgorgement, the Seventh Circuit turned to the appropriate process for doing so. It identified several possible remedies from undoing the entire settlement to adding the objectors’ settlements to a common fund, to establishing a constructive trust. After assessing the arguments for and against each possible remedy, the Court decided that a constructive trust was best as it allowed for either disbursement to the entire class, or if that proved too costly to provide a real benefit to the class, then an alternative use of the money that accomplished the purpose of the trust, such as a cy pres award, could be pursued.

The Court’s entire opinion is available online here.

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