NY Court of Appeals applies additional scrutiny to opt-out of clauses in mergers.

The Court of Appeals recently held in Jiannaris v. Alfant, 2016 Slip Op 03548 (May 5th, 2016) that a settlement that would deprive out-of-state class members of a cognizable property interest to opt-out should be rejected.

On August 4th, 2009, Google and On2 entered into a merger agreement.  A class action was commenced by plaintiff alleging that the On2’s board of directors had breached its fiduciary duty to its shareholders.  Another group of shareholders commenced similar actions in the Delaware Court of Chancery.

A settlement was reached between plaintiffs in both actions with the directors of On2.  The stipulation of settlement was filed in Supreme Court that provided for, inter alia, “the dismissal of the New York and Delaware actions in their entirety with prejudice” and a “release of of any and all merger related claims.” However, the settlement failed to state any opt-out rights.  The Supreme Court certified the proposed class pursuant to CPLR Article 9 subject to a fairness hearing.

The Supreme Court found the settlement to be fair ,but rejected it ultimately as there was no opt-out clause for out of state class members.  The Appellate Divison upheld the Supreme Court’s judgment, see 124 A.D.3d 582 (2nd Dep., 2015).  Leave of appeal was granted by the Court of Appeals.

The Court began its analysis with a review of the Philips Petroleum Co. v. Shutts, 472 US 797 (1985), which held that due process requires opt-out rights in actions “wholly or predominately for monetary damages.”  The Court of Appeals affirmed this decision in Matter of Colt Indus. Shareholder Litig., 77 N.Y.2d 185 (1991).  In Matter of Colt, a Missouri corporation wanted to opt-out of a New York class action that seeked equitable relief.  The Court held that “there was no due process right to opt out of a class that seeks…equitable relief.”   Nevertheless, the settlement still violated due process since it precluded class members to pursue an action for damages in another jurisdiction (internal citations omitted).  

Similarly, the settlement proposed between Google and On2 also contained a provision whereby out-of-state class members could not pursue non-equitable claims.  The defendants distinguished Colt by stating that the scope of the release was different in that Colt also related to claims prior to the buyout in addition to the merger-related claims.  However, the Court emphasized that the holding based on the damage claims that could not be pursued because of the merger.  Thus, for the purpose of the opt-out analysis, the case was not distinguishable.

In addition, the defendants sought to distinguish the different types of damages claims such as incidental damages and individualized damage claims.  To this effect, the defendants cited Wal-Mart Stores, Inc. v. Dukes, 131 S.Ct.  2541 (2014) where the Supreme Court held that legal damage claims incidental to equitable relief may be bound on out-of-class members.

The Court distinguished Wal-mart by indicating that it applies to federal class actions whereas the current case is a New York class action suit.   Under FRCP 23(b)(2), there is no right to opt out of class actions where equitbale relief is sought.

Since the current class action was brought under CPLR 9, the Court stated that Wal-Mart did not apply here.  Furthermore, pursuant to Colt, a judge has discretion “to permit a class member to opt out of a class”, particularly where a settlement may violate due process rights.

The takeaway from this case is the differentiation of right of out-of-state class members in New York state class actions versus federal ones.  The lack of opt-out clauses for out-of-state class members are likely to be scrutinized further in New York state class actions.