February 14, 2013
'Judicial Business Judgment' and the Art of Evaluating Derivative Settlements
By Stephen B. Brauerman
With limited exceptions, the Court of Chancery must approve the settlement of derivative actions to ensure that a representative plaintiff has fairly obtained a just outcome for the class he or she represents. In performing this review, the court must "exercise its business judgment to determine whether the settlement is fair and reasonable in light of the factual and legal circumstances of the case," as the court held in In re Resorts International Shareholders Litigation Appeals, 570 A.2d 259, 266 (Del. 1991). Exercising business judgment — a task Delaware courts recognize is best left to corporate fiduciaries — presents unique challenges for the court, which is necessarily limited in its review by the record the parties before it develop. Vice Chancellor J. Travis Laster's February 6 decision in Forsythe v. ESC Fund Management, C.A. No. 1091-VCL (Del. Ch. Feb. 6, 2013), highlights this difficulty and provides useful guidance for litigants hoping to obtain court approval of (or to challenge) good, but not great, derivative settlements.
The Forsythe litigation began years ago and, hotly contested, has now generated eight written opinions. The dispute relates to an investment fund (nominal defendant CIBC Employee Private Equity Fund) created to allow senior employees of the Canadian Imperial Bank of Commerce to pursue private equity opportunities alongside the bank. As a result of the fund's lackluster performance, the plaintiffs brought derivative claims for breach of fiduciary against the fund's general partner, the members of the board of the fund's general partner, the fund's investment adviser and the fund's special limited partner.
The February 6 decision is the second time the court considered the fairness of the Forsythe settlement. On May 9, 2012, over the objections of the named plaintiffs and other fund members, the court, in Forsythe v. ESC Fund Management, C.A. No. 1091-VCL (Del. Ch. May 9, 2012), approved a settlement in which the fund would receive a settlement payment in the amount of $10.25 million in cash and the defendants would waive their claims against the fund for indemnification, valued at $3 million. In the May opinion, the court had considered the pros and cons of approving the settlement. Favoring approval, the parties negotiated a settlement at arm's length, with the benefit of an experienced and respected mediator. The settlement provided for a significant cash payment, with ample information about the case developed after trial and a number of rulings that helped the parties evaluate the merits of their respective claims. Considering factors that counseled against approval, the court noted the large number of objectors with significant holdings (including the named plaintiffs) and the objectors' meaningful concerns about the adequacy of the settlement. Nonetheless, after considering the economic incentives of the interested parties, including the plaintiffs, plaintiffs counsel, the objectors, the defendants and the fund, the court found the settlement fell "within a range of fairness, albeit at the low end."
As a result of its finding that the settlement was at the low end of the range of fairness, the court took a unique approach in determining reasonableness by allowing the objectors the opportunity to pursue the case and seek a higher recovery. The court gave the objecting members 60 days to lodge a "secured bond, letter of credit or similar security for the benefit of the fund in the amount of the settlement consideration." If successful, the fund would benefit from their efforts. If their efforts failed, the fund would have the right to execute on the security to collect the difference between the ultimate recovery and the secured settlement value.
Rather than acce
With limited exceptions, the Court of Chancery must approve the settlement of derivative actions to ensure that a representative plaintiff has fairly obtained a just outcome for the class he or she represents. In performing this review, the court must "exercise its business judgment to determine whether the settlement is fair and reasonable in light of the factual and legal circumstances of the case," as the court held in In re Resorts International Shareholders Litigation Appeals, 570 A.2d 259, 266 (Del. 1991). Exercising business judgment — a task Delaware courts recognize is best left to corporate fiduciaries — presents unique challenges for the court, which is necessarily limited in its review by the record the parties before it develop. Vice Chancellor J. Travis Laster's February 6 decision in Forsythe v. ESC Fund Management, C.A. No. 1091-VCL (Del. Ch. Feb. 6, 2013), highlights this difficulty and provides useful guidance for litigants hoping to obtain court approval of (or to challenge) good, but not great, derivative settlements.
The Forsythe litigation began years ago and, hotly contested, has now generated eight written opinions. The dispute relates to an investment fund (nominal defendant CIBC Employee Private Equity Fund) created to allow senior employees of the Canadian Imperial Bank of Commerce to pursue private equity opportunities alongside the bank. As a result of the fund's lackluster performance, the plaintiffs brought derivative claims for breach of fiduciary against the fund's general partner, the members of the board of the fund's general partner, the fund's investment adviser and the fund's special limited partner.
The February 6 decision is the second time the court considered the fairness of the Forsythe settlement. On May 9, 2012, over the objections of the named plaintiffs and other fund members, the court, in Forsythe v. ESC Fund Management, C.A. No. 1091-VCL (Del. Ch. May 9, 2012), approved a settlement in which the fund would receive a settlement payment in the amount of $10.25 million in cash and the defendants would waive their claims against the fund for indemnification, valued at $3 million. In the May opinion, the court had considered the pros and cons of approving the settlement. Favoring approval, the parties negotiated a settlement at arm's length, with the benefit of an experienced and respected mediator. The settlement provided for a significant cash payment, with ample information about the case developed after trial and a number of rulings that helped the parties evaluate the merits of their respective claims. Considering factors that counseled against approval, the court noted the large number of objectors with significant holdings (including the named plaintiffs) and the objectors' meaningful concerns about the adequacy of the settlement. Nonetheless, after considering the economic incentives of the interested parties, including the plaintiffs, plaintiffs counsel, the objectors, the defendants and the fund, the court found the settlement fell "within a range of fairness, albeit at the low end."
As a result of its finding that the settlement was at the low end of the range of fairness, the court took a unique approach in determining reasonableness by allowing the objectors the opportunity to pursue the case and seek a higher recovery. The court gave the objecting members 60 days to lodge a "secured bond, letter of credit or similar security for the benefit of the fund in the amount of the settlement consideration." If successful, the fund would benefit from their efforts. If their efforts failed, the fund would have the right to execute on the security to collect the difference between the ultimate recovery and the secured settlement value.
Rather than acce