Forsythe, et al. v. ESC Fund Mgmt. Co. (U.S.) I, L.P., et al., C.A. No. 1091-VCL (Del. Ch. May 9, 2012) (Laster, V.C.)
In this memorandum opinion concerning a proposed derivative settlement, the Court of Chancery determined that it would enter a final order approving the settlement and the plaintiffs’ fee award in 60 days unless the objectors to the settlement “make the equivalent of a topping bid.” In order to forestall the Court’s approval of the settlement, the objectors must post a secured bond or letter of credit for the benefit of the nominal defendant, CIBC Employee Private Equity Fund (U.S.) I, LP (the “Co-Invest Fund”), for the full amount of the settlement consideration — valued at $13.25 million — and apply to take over the litigation. Should the objectors pursue the derivative claims and ultimately recover less than the settlement consideration, the Co-Invest Fund will have the right to execute on the posted security to collect any shortfall between the settlement consideration and the ultimate recovery.
The underlying derivative lawsuit was filed in February 2005. In March 2011, one week before the scheduled trial, the parties reached agreement on a proposed settlement during a mediation session with former Vice Chancellor Stephen P. Lamb, who presided over the litigation until retiring from the Court in 2009. The settlement consideration is comprised of a $10.25 million cash payment to the Co-Invest Fund and the defendants’ agreement to forgo claims for indemnification from the Co-Invest Fund, valued at approximately $3 million. More than 50 of the Co-Invest Fund’s limited partners objected to the settlement. Although the named plaintiffs negotiated, agreed to and initially supported the settlement, they subsequently had “second thoughts” and aligned themselves with the objectors opposing the settlement. The objectors challenged the settlement consideration as inadequate and argued that they could “resurrect” certain claims on which the Court had granted summary judgment.
As a threshold matter, the Court held that the named plaintiffs’ objection to their own settlement would not preclude approval. The Court cited Delaware authority holding that a representative plaintiff cannot “unilaterally” thwart a settlement and that a settlement may be submitted for approval over a representative plaintiff’s objection. Turning to the merits of the settlement, the Court noted that it had various indicia of fairness. The parties negotiated at arm's length with ample information and the benefit of an experienced and respected mediator. The plaintiffs’ counsel invested significant resources in the case and “did not seek an early settlement to harvest a fee.” Further, the plaintiffs’ counsel obtained “actual cash consideration” rather than intangible or therapeutic benefits. Evaluating the record, the Court determined that the settlement consideration “falls within a range of fairness, albeit at the low end.” The Court noted, however, that the settlement consideration may drop below the range of fairness “[i]f the objectors achieve the difficult but not impossible task of resurrecting [certain] claims.”
To balance the risk of forgoing the settlement against the possibility of additional recovery, and drawing upon academic literature advocating the “auctioning” of claims, the Court ruled that it would enter an order approving the settlement in 60 days “unless some combination of objectors or their counsel lodge with the Register in Chancery a secured bond, letter of credit, or similar security for the benefit of the [Co-Invest] Fund in the amount of the settlement consideration.” The Co-Invest Fund would be able to execute on the security and collect the difference if the objectors pursue the litigation but ultimately recover less than the settlement consideration. Such approach “establishes a floor for the [Co-Invest] Fund’s recovery” while requiring the objectors to “put real money on the table” and effectively “outbid” the defendants. The Court noted that the objectors are well-positioned to make an informed decision on whether to proceed in light of the thoroughly developed factual record.
The Court recognized that this “bonding approach” is “admittedly imperfect,” as the objectors would be required to bond the entire amount of the settlement consideration notwithstanding that any recovery would flow to the Co-Invest Fund and would be further reduced by fee awards to the objectors’ counsel and the original plaintiffs’ counsel. The Court nevertheless held that “erring on the side of a higher bond” is the most feasible and appropriate option under the facts presented, despite the cost to the objectors and their counsel, because the settlement consideration falls within the range of fairness.
The Court further held that its final order, if entered, would approve the plaintiffs’ fee application, which fell within a “reasonable range” in relation to the benefits conferred. The Court indicated that such order would also approve incentive payments totaling $62,500 to the named plaintiffs and another limited partner in recognition of their substantial contributions to the case.