Blackmailer Beware: Seventh Circuit Disgorges Class Objectors' Inequitable Settlement Proceeds

11 August 2020 Consumer Class Defense Counsel Blog
Authors: Michael D. Leffel Aaron R. Wegrzyn

The Seventh Circuit held last Thursday that individuals who object to a class action settlement voluntarily assume a limited fiduciary duty to other class members, which they can breach by settling their classwide objections for personal profit. The decision in Frank v. Target Corp., No. 19-3095, 2020 WL 4519053 (7th Cir. Aug. 6, 2020), seeks to put an end to what the court called “objector blackmail.” All attorneys should take heed of this decision when considering how to resolve objections to class action settlements.   

The named plaintiffs filed their lawsuit in 2011, accusing several defendants of making false claims regarding dietary supplements. The parties reached an initial classwide settlement in 2013, to which one of the class members, Theodore Frank, objected. Frank eventually prevailed on his objection in an earlier appeal to the Seventh Circuit. Pearson v. NBTY, Inc., 772 F.3d 778, 787 (7th Cir. 2014). On remand, the named parties reworked their settlement agreement and sought court approval under Federal Rule of Civil Procedure 23(e). Frank did not object to the new settlement, but three other class members (the “New Objectors”) came forward to file short objections. The district court overruled the New Objectors’ protestations to the revised settlement agreement and they appealed. But each voluntarily dismissed his appeal before briefing began in the Seventh Circuit.

Frank, finding these procedural moves suspicious, sought to reopen the case to pursue his theory that the New Objectors had sold out absent class members in exchange for personal side bargains. The Seventh Circuit, noting that “selfish settlements by objectors are a serious problem,” granted Frank permission to pursue his theory in the district court. Pearson v. Target Corp., 893 F.3d 980, 986 (7th Cir. 2018). Discovery then demonstrated that the New Objectors had in fact received payments totaling $130,000 in exchange for dismissing their appeals. Nevertheless, the district court ruled that there was no basis to conclude that the New Objectors’ settlements had harmed class members, as there was no demonstration of any illegal conduct, and it denied Frank’s motion to disgorge (for the benefit of the settlement class) the proceeds of the New Objectors’ private settlements. Frank then filed the latest appeal.

The Seventh Circuit reversed, characterizing the New Objectors’ conduct as classic rent-seeking behavior. Relying on a 75-year-old Supreme Court bankruptcy decision, Young v. Higbee, 324 U.S. 204 (1945), the court held that the New Objectors’ proceeds “belong in equity and good conscience” to the class and therefore need to be disgorged. Judge Hamilton, joined by Judge Rovner and Judge Wood, ruled that the district court erred in requiring evidence of an affirmative statutory violation as a predicate for disgorgement. Instead, based on “long-established principles of equity,” the court concluded that by filing classwide objections to the settlement, the New Objectors voluntarily assumed a limited fiduciary obligation to protect the interests of class members, which they breached by “selling their appeals without benefit to the class.” It pointed out that the New Objectors’ settlements allowed them to personally extract up to $577 for every $1 received by absent class members by temporarily taking control of the common rights of the class. The court also highlighted the fact that class counsel had contributed a portion of their fee award to the settlements with the New Objectors, which it characterized as “savings that ought to have enured to the class.” 

After ruling that the New Objectors’ settlements warranted disgorgement, the Seventh Circuit addressed the practical challenge of executing the remedy. It recognized that distribution of the $130,000 to the class was not practical given the administrative costs associated with such a distribution. The court instead turned to the constructive trust doctrine and cy pres principles in awarding the funds to a charitable foundation named in the class settlement.

Before concluding its opinion, the Seventh Circuit noted that it did not expect its ruling would chill legitimate objections to class action settlements. Judge Hamilton cited the recent amendments to Rule 23(e)(5), which require district court approval of payments made to objectors who withdraw an objection or dismiss an appeal, as an existing check on blackmail activity. And the court reaffirmed that objectors who pursue good-faith objections are entitled to seek payment for their services:

We do not expect any good-faith objector will fail to bring her objection because she is prohibited from selling out the class in exchange for private payment, where she may choose instead not to sell out the class and still receive payment if she brings the class a real benefit.

This decision is the latest in a line of a cases by the Seventh Circuit seeking to check what it deems as questionable practices associated with class action settlements. See also In re Subway Footlong Sandwich Litig., 869 F.3d 551 (7th Cir. 2017); In re Walgreen Co. Stockholder Litig., 832 F.3d 718 (7th Cir. 2016). Its recognition of fiduciary duties owed by objecting class members should help deter frivolous objections and streamline the settlement approval process. However, where a class member does object, named parties will need to account for the objector’s duties before attempting to resolve the objections through individual settlements.    

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