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Forsythe v. ESC Fund Management: Court of Chancery Resolves Objections to Settlement by Giving Objectors Option to Continue Litigation Subject to Posting Secured Bond in Amount of Settlement Consideration

June 5, 2012

In Forsythe v. ESC Fund Management Co. (U.S.), Inc., C.A. No. 1091-VCL (Del. Ch. May 9, 2012), the Court of Chancery implemented a novel form of relief in resolving an objection to the adequacy of the consideration received in the settlement of representative litigation. Although the Court was prepared to approve the proposed $13.25 million settlement, the Court gave the objectors the option of continuing the case in pursuit of a larger recovery if they agreed to post a secured bond that would ensure that the partnership would, at a minimum, receive the full amount of the proposed settlement consideration once the litigation had ultimately been resolved.

The parties’ long-running dispute involved the performance of the CIBC Employee Private Equity Fund (U.S.) I, L.P. (the “Fund”), which was formed in 1999 by Canadian Imperial Bank of Commerce (“CIBC”) to give senior CIBC employees the opportunity to coinvest with CIBC in private equity opportunities. The Fund performed poorly, generating approximately $200 million less than the returns generated by the lowest quartile of comparable funds during the first nine years of its existence. In 2005, the plaintiffs filed a derivative action on behalf of the Fund against the Fund’s general partner, the individual directors of the Fund’s general partner, the Fund’s investment advisor, the Fund’s special limited partners, and CIBC, claiming breaches of fiduciary duties in connection with the management and oversight of the Fund, and asserting claims for losses suffered in each of the Fund’s investment categories.

In August 2010, the Court entered summary judgment in favor of the defendants with respect to the largest portion of the plaintiff’s damages claims. The parties then engaged in a pretrial mediation session in March 2011 that resulted in the proposed settlement. In exchange for a global release from liability, the defendants agreed to pay the Fund $10.25 million in cash and forgo claims for indemnification from the Fund in the amount of approximately $3 million. The named plaintiffs initially agreed to the settlement, but by January 2012, they had joined a group of 57 objectors in opposing the proposed settlement.

In assessing the reasonableness of the proposed settlement, the Court noted that several significant factors weighed in favor of approval: the parties negotiated at arm’s length with the assistance of a mediator, the plaintiffs had settled on the eve of trial after completing discovery, and the settlement consideration included a cash component and was not composed of merely intangible or therapeutic benefits. On the other hand, the Court also indicated that a number of factors weighed against approval: a large number of objectors with a significant stake in the litigation (including the named plaintiffs) opposed the settlement, the objectors had hired separate counsel, and the objectors had advanced an argument for reviving the largest portion of the plaintiffs’ damages claims that, if successful, could result in a significantly larger recovery for the Fund. After weighing the various factors, the Court concluded that the settlement consideration was within the range of fairness, albeit at the low end of that range. Nevertheless, the Court recognized that if the objectors were able to revive part of the damages claims, the settlement consideration would be inadequate.

The Court discussed the potentially divergent interests of counsel and objecting clients at the settlement stage of representative litigation. The Court noted that counsel, who has at this stage invested substantial resources in the case, may be inclined to settle rather than pursue a case to the end, particularly in a situation where a significant increase in recovery would involve the uncertainties inherent in trial and a potentially costly appeal process. The objectors, who to this point have not been directly burdened with the costs of litigating the action, rationally could prefer to continue the case in an attempt to secure a larger recovery.

In an effort to resolve these potentially conflicting interests, the Court devised a method to protect the interests of the non-objecting plaintiffs while providing the objectors the opportunity to continue the litigation in pursuit of a larger recovery for the Fund as a whole. If the objectors posted a secured bond, letter of credit, or similar security for the benefit of the Fund in the amount of the full $13.25 million settlement consideration, the Court would allow the objectors to take over the case. If the objectors were successful in recovering more than the proposed settlement, the increased consideration would inure to the benefit of the Fund. If the objectors ultimately recovered less than the proposed settlement, the Fund would have the right to execute on the security to collect the difference. The Court indicated that if no secured bond had been posted by the objecting plaintiffs within 60 days, the proposed $13.25 million settlement would be approved.