Seventh Circuit Slams “Objector Blackmail” in Class Settlement, Orders Repayment of Side Deal

The U.S. Court of Appeals for the Seventh Circuit has ordered three class action objectors to repay $130,000 they received in a “side deal” in exchange for abandoning their appeal of a class settlement. Pearson v. Target Corp., No. 19-3095, ___ F.3d ___, 2020 WL 4519053 (7th Cir. Aug. 6, 2020).

The Seventh Court previously had decried the recurring problem of “objector blackmail,” in which class members object to a proposed settlement not to benefit the class, but to be paid to drop their objections. This time, however, the court did more than dismiss the objections: it ordered disgorgement of the objectors’ payments. The court held that the objectors (whom the court called “selfish holdouts”) had violated their “limited representative or fiduciary duty” to represent the interests of class members; the court ruled that their payments “belonged in equity and good conscience” to the class members.

The Seventh Circuit’s decision should serve to deter bad-faith objections to class settlements, which the court acknowledged are “familiar to class-action litigators on both offense and defense.”

The District Court Proceedings 

The plaintiffs alleged that the defendant manufacturers and retailers had made false claims about the efficacy of a dietary supplement. The district court approved a class action settlement, and the objectors appealed. Before briefing, however, the objectors dismissed their appeal. Another class member—whose objections to an earlier version of the settlement the Seventh Circuit had upheld in a prior appeal—was suspicious of the dismissal. That class member asked the district court to reopen the case and order disgorgement of any payments the objectors received in exchange for dismissing their appeal.

The district court found that the objectors had indeed received side payments—totaling $130,000—but the court declined to order disgorgement, finding that “the record failed to confirm suspicions of blackmail or other wrongdoing.” The class member who sought disgorgement appealed. The only other parties to the appeal were the objectors who received the side payments; the class representatives and defendants did not participate in the appeal.

The Seventh Circuit’s Ruling

The Seventh Circuit held that the district court had abused its discretion in failing to order disgorgement. The Seventh Circuit surveyed “long-established principles of equity,” including the principle that a fiduciary’s self-dealing is treated as a constructive fraud. The court concluded: “We have little difficulty applying these principles to a private payment made to an objector in exchange for withdrawing the appeal of an objection asserting the interests of the class.”

Although class members normally do not owe each other fiduciary duties, the Seventh Circuit held that, under these circumstances, the objectors were obligated to protect the interests of the class. The court imposed a “limited representative or fiduciary duty on the class-based objector who, by appealing the denial of his objection on behalf of the class, temporarily takes control over the common rights of all the class members and thereby assumes a duty fairly to represent those common rights.”   

The Seventh Circuit concluded that the objectors had “sacrifice[d] those interests [of the class] to their own advantage by selling their appeals without benefit to the class. Equity does not permit them to keep that gain.” The court summarily dismissed arguments regarding the “merit” of the objections. While holding that proof of a crime or statutory violation was not required for disgorgement, the court found that the merit of the objections in this case “was a matter of indifference to these objectors,” who simply advanced “superficially plausible” objections only to “sell them” without defending them on appeal. The Seventh Circuit also found it irrelevant whether class counsel or the defendants paid the objectors: the objectors “held what was not theirs to hold.” 

The Seventh Circuit next turned to the proper form of the disgorgement remedy. The court concluded that “the best remedy” would have been for the objectors’ payments to be returned to the common fund for distribution to class members. Here, though, the administrative costs of attempting to pay class members would have swallowed the benefits. Accordingly, the court concluded that the appropriate remedial framework was the “constructive trust,” with a cy pres award to the research and education foundation designated in the settlement as the cy pres recipient.

Finally, the Seventh Circuit dismissed any suggestion that its opinion would have a chilling effect on good-faith objections to class settlements. The court cited the 2018 amendments to Federal Rule of Civil Procedure 23(e), which require objectors to state their objections with specificity (Rule 23(e)(5)(A)) and require district court approval for “forgoing, dismissing, or abandoning an appeal” (Rule 23(e)(5)(B)(ii)). The court concluded: “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.”