By Gerald L. Maatman, Jr., Jennifer A. Riley, and Alex S. Oxyer

Seyfarth Synopsis: “Objector blackmail” occurs in the class settlement approval process when a few class members object to a proposed settlement and, after the district court has overruled their objections, pursue appeals with the goal of obtaining “side” settlement payments to dismiss the appeal.  In Pearson v. Target Corp., No. 19-3095, 2020 WL 4519053 (7th Cir. Aug. 6, 2020), the U.S. Court of Appeals for the Seventh Circuit addressed issues caused by these objectors.  Recognizing the difficulties these objectors cause, the Seventh Circuit held that, where district courts find the settlements inequitable, district courts may order the objectors to disgorge the private settlements upon motion of another class member. As it gives district courts more power in handling delays and disruptions caused by such “blackmail,” the Pearson ruling is a must-read for employers facing class claims

Case Background

In Pearson, the named plaintiffs filed a putative class action alleging that the defendants made false claims about dietary supplements they manufactured and distributed. The parties eventually reached a settlement and requested that the district court approve the settlement terms. Following the district court’s preliminary approval of the settlement, three class members objected to the settlement. One of the objecting class members had filed his own putative class action, which had been stayed pending the result of the settlement of the Pearson matter. The class member then attempted to intervene in the Pearson matter and, although his request to intervene was denied, he was invited to object to the Pearson settlement. The two other objectors raised issues relative to the attorneys’ fees accorded in the settlement agreement and the settlement distribution process.

Despite the objections, the district court approved the Pearson settlement, and all three objectors appealed. However, all three then dismissed their appeals before briefing began at the appellate level. The dismissals of the appeals caught the attention of another class member, who subsequently 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 denied the motion for lack of jurisdiction, and the moving class member appealed. The Seventh Circuit found on appeal that the district court had jurisdiction to consider the motion for disgorgement and remanded the case.

On remand, it was discovered that all three objectors had received side settlement payments in exchange for dismissing their appeals totaling $130,000, while the class itself received nothing in such settlements. However, the district court held that the record did not substantiate any suspicions of blackmail or any other wrongdoing, so it denied the motion for disgorgement. The moving class member then appealed again.

The Seventh Circuit’s Decision

Reviewing the district court’s decision using an abuse of discretion standard, the Seventh Circuit looked to see whether the district court applied an incorrect legal standard or reached a clearly erroneous conclusion of fact by denying the motion for disgorgement and determining that a statutory violation was a prerequisite for disgorgement. The Seventh Circuit’s opinion focused primarily on principles of equity to assess whether there was sufficient cause to grant the motion for disgorgement.

The Seventh Circuit found that the district court erred in denying the motion for disgorgement.  The Seventh Circuit held that the objecting class members took on a fiduciary duty to the other class members who were similarly situated because the objectors alleged defects that would have injured every member of the class by binding them all to an inadequate settlement. The Seventh Circuit concluded that the objectors were “bound to protect” the interests of the class and that they had a duty to object only in “good faith.”  Id. at *4.  Ultimately, it imposed a limited representative or fiduciary duty on the class-based objector who, by appealing the denial of his objection, “temporarily takes control of the common rights of all the class members and thereby assumes a duty fairly to represent those common rights.” Id. at *5 (internal quotations omitted).

The Seventh Circuit found that the objectors had sacrificed the interests of the class for their own gain by selling their appeals without benefit to the class. In reaching its decision, it reasoned that, if the objections the objectors made had enough merit to stand a genuine chance of improving the entire class’s recovery, the objectors sold the genuine chance, which belonged to the entire class, for their own advantage. However, if the objections were meritless, the objectors’ settlements of such claims traded on the strength of the litigation, which was also the property of the entire class, in order to leverage the parties’ desire for settlement to their own gain. Either way, the Seventh Circuit determined that the payments the objectors received in excess of their interests as class members “w[ere] not paid for anything they owned” and belonged in equity to the class. Id. Thus, it found that disgorgement is appropriate in such a situation.

In reaching its holding, the Seventh Circuit dismissed the arguments made by the objectors on appeal – chiefly, that one also had settled his independent claims raised in a separate case, and so had not traded solely on the property of the class in order to reach a settlement, and that the class member moving for disgorgement lacked standing to do so. It first found that the objector’s independent claims lacked any value in light of the Pearson settlement and so did not provide independent consideration to his private settlement. The Seventh Circuit then determined that the moving class member had standing because class members have standing to defend the class, whose interest they share, against representatives who control the interests of the class as a whole.

The Seventh Circuit then turned to the appropriate process for disgorgement of the funds. It acknowledged that, in theory, the best remedy would be for the objectors to pay the settlement sums into the common fund for direct distribution to all class members. However, the case posed a practical issue because the distribution of the $130,000 in settlement proceeds would be “self-defeating” because the administration costs would consume the benefits. Id. at *8. Accordingly, the Seventh Circuit ordered that the funds be put in a constructive trust.

Finally, the Seventh Circuit addressed the anticipated effect of its ruling on good-faith objections to class settlements. It opined that it did not expect its holding to have a chilling effect on good-faith objections, as objectors should be able to say specifically why the class has been deprived of the fair, reasonable, and adequate settlement and, where objections may be able to improve the class’s position, equitable compensation is available to the objector.

Implications For Employers

The ruling in Pearson gives district courts the ability to deal with a systemic issue in the class action settlement process – “objector blackmail.” The Seventh Circuit’s opinion allows district courts to require disgorgement of private objector settlements where the objector is acting for his own benefit, against the interests of the class.  The availability of such a tool should dissuade opportunistic objectors from holding up a settlement process in order to secure a private resolution. Ultimately, the holding in Pearson will remove a significant nuisance in class settlements and may provide for a more streamlined route for resolving class claims.