The Seventh Circuit confronts “objector blackmail” and limits the extraction of “rents from the litigation process simply by showing up and objecting to consummation of the settlement.”

On August 6, 2020, the Seventh Circuit Court of Appeals addressed the thorny “problem in class-action litigation known colloquially as ‘objector blackmail.’” The court confronted a situation in which three objectors filed an appeal after their objections were denied. But they dismissed their appeal in exchange for payments. Back in the district court, another class member challenged those payments and sought disgorgement. In turn, the district court decided that it did not have the equitable power to rectify the situation. The Seventh Circuit thought otherwise and reversed.

We reverse. Falsely flying the class’s colors, these three objectors extracted $130,000 in what economists would call rents from the litigation process simply by showing up and objecting to consummation of the settlement to slow things down until they were paid. We hold that settling an objection that asserts the class’s rights in return for a private payment to the objector is inequitable and that disgorgement is the most appropriate remedy.

The court based its decision on long-standing principles in equity. In particular, it found Young v. Higbee Co. to be particularly instructive. Its choice to root its analysis in this Supreme Court case from 75 years ago is a strong reminder of the dearth of modern authority on this precise issue.

Young was a bankruptcy case. As the Seventh Circuit panel explained, “Potts and Boag, two preferred shareholders of the bankrupt Higbee Company, objected to confirmation of the company’s bankruptcy plan. They argued that the company’s preferred shareholders should have been given priority over a junior debt held by Bradley and Murphy, two of the company’s directors.” Potts and Boag appealed the district court’s confirmation of the bankruptcy plan over their objections. Yet, “[w]hile their appeal was pending, they sold their preferred shares along with the appeal to Bradley and Murphy for seven times the shares’ market value.”

The Supreme Court in Young ruled that the district court had the equitable power to order an accounting in those circumstances. The Supreme Court explained that “control of the common rights of all the preferred stockholders imposed on Potts and Boag a duty fairly to represent those common rights” and that Potts and Boag could not “trade in the rights of others for their own aggrandizement.” The Seventh Circuit recognized that this bankruptcy situation was analogous to the circumstances of the case at hand. Indeed, it observed:

[I]n one important respect the facts here are even more egregious than in Young. There, the Court observed that the purposes of the bankruptcy laws would be flouted if Potts and Boag, by selling out for seven times the market value of their preferred shares, were allowed to receive “$7.00 for every $1.00 paid to other preferred stockholders.” Even less could the “fair, reasonable, and adequate” settlement demanded by Rule 23(e)(2) be achieved in this case. Sweeney’s settlement gave him $96, and Nunez and Buckley $577, for every $1 received by other class members — in exchange for absolutely nothing.

. . . .

What the objectors did, however, was to advance these superficially plausible objections in the space of four pages each, light on citations to law and fact, and to sell them — before speaking a word in their defense — at discounts from face value ranging from 94 percent (Buckley) to 99.2 percent (Nunez). For his part, Sweeney could not even correctly identify the subject matter of the litigation. The objectors’ conduct testifies that, whatever merit their objections might have had, the objectors themselves did not believe them or take them seriously, from the day they were filed to the day they were settled.

Having identified the wrongful conduct, the Seventh Circuit then had to wrestle with determining the proper remedy. This analysis was complicated by the fact that the parties apparently agreed there was no practical way to distribute the disgorged funds to the class members at this point. Therefore, the court determined that “the appropriate remedial framework here is the constructive trust.” Thus, “that would mean ordering payment to the Orthopedic Research and Education Foundation,” which organization was provided for in the class settlement.

Finally, the court took pains to emphasize that its decision should not dissuade good faith objectors. “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.” The court also cautioned, anticipating potential strategies to circumvent this opinion, that “we trust no district court will be misled by the facile expedient of dressing a class-based objection in individual clothing to avoid scrutiny under Young and our decision here.”

This is a groundbreaking decision for class action litigators. As the court noted, “[t]he scenario is familiar to class-action litigators on both offense and defense.” This decision provides guidance on this important issue to class counsel and defense counsel alike.

Frank v. Target Corp., No. 19-3095 (7th Cir. Aug. 6, 2020).