Court Denies Motion to Approve a Shareholders Class Action Settlement, Finding the Plaintiffs to Be Inadequate Class Representatives and the Settlement to Provide No Benefit

• Posted on: Sep 25 2019

As this Blog has noted previously, the courts (in New York and Delaware) have refused to approve the settlement of shareholder litigation where class members receive no financial benefit and are asked to give broad releases to the defendants that are inimical to their rights. The latest court to follow this path is the Supreme Court, New York County, Commercial Division. In Matter of Xerox Corp. Consol. Shareholder Litig., 2019 N.Y. Slip Op. 51467(U) (Sept. 10, 2019), Justice Barry Ostrager denied a motion, among others, to approve a shareholder class action settlement because the putative class received no financial benefit from the settlement and relinquished rights that they could have otherwise asserted in derivative litigation. As explained by Justice Ostrager, the proposed settlement would have released current and former corporate directors from potential liability for, among other things, giving control over the board of directors (the “Board”) of the Xerox Corporation (“Xerox”) to activist investors and potentially exposing Xerox to significant liability in a contract action brought by Fujifilm Holdings Corporation (“Fuji”) concerning termination of the potential merger of the two companies.

Background

On January 30, 2018, Xerox and Fuji agreed to a proposed transaction, whereby Fuji would receive a 50.1% controlling interest in Xerox in exchange for its 75% interest in Fuji-Xerox (the “Transaction”). Xerox shareholders would receive a “special dividend” funded by new company debt. Despite sitting on over $8 billion in cash reserves and getting most of the future benefits of the deal, Fuji would not pay out any cash in the Transaction.

On February 13, 2018, Darwin Deason (“Deason”), the second-largest individual shareholder of Xerox, initiated an action to enjoin the Transaction. Deason v. Fujifilm Holdings, Index No. 650675/2018 (“Deason I”). On March 2, Deason filed a second lawsuit to enjoin Xerox from enforcing the advance notice bylaw deadline for the nomination of directors to be elected at the 2018 Annual Meeting. Deason v. Xerox Corp., Index No. 650988/2018 (“Deason II”). At or about this same period of time, four putative class actions were filed on behalf of pension funds for the Asbestos Workers, the Iron Workers, and Carpenters, as well as by Robert Lowinger, each of which also sought to enjoin the Transaction on the ground that, by approving the Transaction, the Xerox Board had breached its fiduciary duties to the Xerox shareholders. On March 9, 2018, the Court consolidated the four putative class actions under the caption In Re Xerox Corporation Consolidated Shareholder Litigation.

Following expedited discovery, on April 27, 2018, the Court held that the Xerox Board and Jeff Jacobson, the then CEO of Xerox, had breached their fiduciary duties in agreeing to the proposed Transaction. The Court also issued a mandatory injunction that directed the Xerox Board to waive its advance notice bylaw to allow Deason to run a competing slate of directors.

On May 1, 2018, two business days after the Court issued the preliminary injunction, the parties advised the Court that they had reached a potential settlement. In connection with the potential settlement, the parties (i.e., the class plaintiffs, Deason and Xerox) presented the Court with a fully executed Memorandum of Understanding (“MOU”), setting forth the salient terms of their settlement in principle.

On May 13, 2018, Deason and Xerox settled their dispute pursuant to which six directors of the Xerox Board resigned and were replaced by directors nominated by Deason and Carl Icahn (“Icahn”), thereby effectively giving Deason and Icahn control of the Xerox Board. Icahn had supported the Deason action and with Deason was waging a proxy contest to oust the Xerox directors. According to the Court, the language of the settlement agreement indicated that termination of the Transaction was a condition of the Deason/Icahn settlement with Xerox, though neither Deason nor Icahn could be held liable for the decision. The Deason/Icahn/Xerox settlement was private; no release of the class claims was included.

Also, on May 13, 2018, counsel for the putative class resubmitted the Memorandum of Understanding pursuant to which class counsel agreed to the release of all Xerox directors in exchange for no consideration other than the terms of the private Deason settlement. In that regard, the Memorandum of Understanding contemplated the release of all resigning and continuing Xerox directors from any liability relating to the change in control of the Xerox Board and any liability arising out of the termination of the Transaction. The Memorandum of Understanding provided that neither Xerox nor Deason would oppose, and Xerox would fund, an award of attorney’s fees of $7.5 million to counsel for the class plaintiffs, provided the Court approved the class settlement.

On May 24, 2018, Carmen Ribbe (“Ribbe”) commenced a derivative action against the resigning and continuing Xerox directors for breach of fiduciary duty because, among other things, of the possibility that Fuji might sue Xerox over termination of the Transaction. That action was dismissed on December 6, 2018, without prejudice based on issues related to demand futility. Ribbe initiated a second derivative action on April 11, 2019, and is awaiting a response from Xerox on its demand.

On June 18, 2018, Fuji initiated an action against Xerox in the United States District Court for the Southern District of New York seeking $1 billion in damages for breach of the January 31, 2018 Transaction agreement. Fujifilm Holdings Corp. v. Xerox Corp., 1:18-cv-05458. Xerox moved to dismiss the complaint, which was subsequently denied. The case is being actively litigated.

On June 21, 2018, the Court discontinued the Deason I action “on the express condition that the discontinuance of the Deason action in no way, shape or form constitute[d] approval of any elements of any settlement agreement among any parties,” thereby terminating all litigation between Deason and Xerox. The Court also denied class plaintiffs’ motion to stay the litigation as to the Xerox defendants only and to vacate the preliminary injunction as to the Xerox defendants only, notwithstanding class counsel’s representation that “part of the settlement between us and Xerox defendants was that we would move the Court for an order lifting the injunction….”

Nevertheless, on July 13, 2018, the newly constituted Xerox Board approved the settlement of the class litigation on the same basis contemplated by the Memorandum of Understanding.

Shortly after Fuji filed the federal court action, class plaintiffs moved for preliminary approval of the proposed settlement. At a July 16, 2018 hearing on class plaintiffs’ motion, the Court declined to preliminarily approve the proposed settlement. Instead, the Court directed counsel to send notice to the class to apprise them of the status of the proceedings.

On May 23, 2019, the Court approved the form of notice, a finalized copy of which was filed with the Court on June 3, 2019.

On September 6, 2019, the Court heard argument on three motions filed by counsel for the putative class. The motions sought certification of a class for settlement purposes and appointment of class representatives, approval of the class settlement, and an award of attorneys’ fees of $7.5 million. Ribbe opposed the motions and approximately 34 members of the putative class opted out of the settlement. Following extensive oral argument on the motions, the Court found that the class representatives were inadequate, and the proposed settlement was unreasonable and unfair to Xerox shareholders.

The Court’s Decision

The Court held that the proposed class representatives were not adequate representatives of the class because they bound the class to corporate actions that occurred before the settlement had been reached. Slip Op. at *6 (noting that “material terms of the settlement took effect on May 13, 2018, at least insofar as it called for the resignation of certain Board members and the designation of new Board members” notwithstanding the fact that the settlement was reached three months later on July 13, 2018).  “By agreeing to the Memorandum of Understanding, which contained broad releases for the resigning Board members,” said the Court, “the class representatives were potentially shielding the Xerox directors from any potential liability for the subsequently filed Fuji action.” Id.

“Turning to the proposed settlement,” the Court concluded that it was not in the best interests of Xerox shareholders because “it achieve[d] no material benefit for shareholders other than Icahn and Deason.” Id. “On the contrary,” continued the Court, “the proposed settlement releases any claims shareholders may have concerning the change of control orchestrated by Deason and Icahn and any liability for the subsequently filed Fuji case.” Id. In fact, said the Court, “[t]he benefit to Xerox as a company [wa]s also questionable in light of the $1 billion lawsuit by Fuji that remain[ed] pending. Id. The Court concluded as follows:

The purported class members will “get” no financial benefit, and they are being asked to “give” broad releases of any derivative claims they may have. The Memorandum of Understanding contemplated full releases to the directors at a time when this Court had held the directors to be faithless fiduciaries, largely in exchange for fees to the purported class counsel of $7.5 million. There were no exigent circumstances requiring purported class counsel to enter into the Memorandum of Understanding other than the desire of Deason and Icahn to achieve control of the Xerox Board, which purported class counsel facilitated. The purported class counsel had no authority to settle on behalf of the class without having been appointed as counsel for the class, without a class having been certified, and without their clients having been designated as class representatives. The net result of the actions of the purported class representatives and purported class counsel was to transfer control of a public corporation to Messrs. Deason and Icahn via a private agreement that offered no tangible benefit to the interests of the class.

Id. at **6-7.

Finally, the Court denied the request for attorney’s fees, holding that “[s]ince … class counsel conferred no benefit on the Xerox shareholders, there is no basis for any award of counsel fees.” Id. at *7.

Takeaway

In Gordon v. Verizon Communications, Inc., 148 A.D.3d 146 (1st Dept. 2017), on which Justice Ostrager relied, the First Department observed that “[m]uch has been written on the subjects of whether settlements of shareholder class action suits challenging corporate mergers and acquisitions should be rejected in the absence of monetary damage awards, and the propriety of the attorney fee awards attendant to such agreements.” Id. at 148.

The use of nonmonetary settlements has become increasingly disfavored because they provide minimal benefits to shareholders and to their corporations. Id. at 154. The increasingly negative view of nonmonetary settlements was memorialized in recent decisions coming from the courts in both Delaware and New York in which the judges found such lawsuits to amount to “meritless lawsuits filed in order to raise a threat of enjoining or delaying closure of the transaction, and thereby incentivizing settlement.” Id., citing Matter of Trulia, Inc. Stockholder Litig., 129 A.3d 884, 887 (Del. Ch. 2016); Matter of Allied Healthcare Shareholder Litig., 49 Misc. 3d 1210[A], 2015 N.Y. Slip Op. 51552[U], *2 (Sup. Ct., N.Y. County 2015). In Xerox, the Court followed in the footsteps of the foregoing courts.