Certain class action settlements—like employment and consumer settlements—will very often draw objections from absent class members. But other types of settlements with more sophisticated absent class members—like antitrust and securities—will often draw no objections at all.

Without any objectors, and thus no one contesting approval of the settlement, a district judge with busy docket will sometimes choose to dispense with the formality of a fairness hearing on an uncontested motion for settlement approval.  While more efficient for the court, this approach is problematic under Rule 23(e)(2), which states that “[i]f the proposal would bind class members, the court may approve it only after a hearing . . . .” This requirement originated in the 2003 amendments to Rule 23. The advisory committee note to that amendment explained that the provision “confirms and mandates the already common practice of holding hearings as a part of the process of approving settlement . . . that would bind members of a class.”

To be sure, district courts enjoy “wide latitude” on the scope of a hearing necessary to “reach[] an informed, just and reasoned decision.” UAW v. Gen. Motors Corp., 497 F.3d 615, 635 (6th Cir. 2007) (citation omitted). So if the class notice required written objection as a prerequisite to participation at the fairness hearing, and the court receives no written objections, then a fairness hearing could theoretically be a one-minute exercise in taking appearances, acknowledging the lack of objectors, and accepting the motion for approval for consideration on the papers. As empty as such an exercise may be, Rule 23(e)(2) does appear to require it.

For defense attorneys, a judge’s sua sponte cancellation of a fairness hearing for an uncontested settlement raises practical questions. The trigger for a mandatory fairness hearing is if the settlement “would bind class members.” Could the failure to hold a fairness hearing risk an appeal, a collateral attack on the settlement, or a new action from an absent class member? Or would the failure to object in writing waive such a challenge? And if a failure to object in writing would lead to waiver, then why does Rule 23 require a fairness hearing even when no class members have objected to the proposed settlement?

It does not appear that this issue has ever been litigated. Indeed, it is admittedly improbable that a non-objecting class member would seek to disturb a class settlement post-approval. But defense attorneys seeking to ensure the enforceability of a release may still want to avoid such risk altogether by pushing to ensure that a fairness hearing take place, even if just as a formality. At times, this may include pushing back (or at least making a record) when a judge sua sponte adjourns a fairness hearing over an uncontested application for final approval.

Cross-posted with permission from American Bar Association Class Actions & Derivative Suits Committee Practice Points.

The U.S. House Committee on Financial Services (Committee) met last Wednesday[1] to discuss the rapidly growing cryptocurrency market exchange and the regulatory landscape that currently governs it.

Executives from six major crypto asset companies, including Coinbase and Circle, testified at the hearing, calling for clearer standards and guidance from regulators. Among other things, the witnesses raised concerns about the current regulatory framework used to determine whether digital assets should be regulated as securities under the federal securities laws. They also discussed the need for oversight by a centralized body capable of taking a flexible approach to regulating the crypto assets industry in light of its complex, dynamic nature. Specifically, Coinbase CEO Alesia Haas expressed a need for regulation by “a nimble group that is constantly looking at the changes in crypto.”[2]

The Committee’s hearing memorandum reflects its concern that investments in digital assets are thus “vulnerable to fraud, manipulation, and abuse.”[3] As a result, and “[g]iven the digital asset sector’s growth and evolution, several questions have arisen as to how regulators can ensure investor protections, ensure consumer protections, and maintain market integrity.”[4] Some, but not all, digital market exchanges and issuers have obtained national charters and/or state money transmitter and sale of checks licenses from various states.[5]

The U.S. Securities and Exchange Commission (SEC) has sought to protect investors by requiring the registration and disclosure of any offerings of digital assets that fall under the definition of securities as set forth in the Securities Act of 1933,[6] which encompasses a variety of enumerated terms, including “investment contracts.” Securities are broadly defined under the statute, and courts liberally construe that definition.

To determine whether an offering, including one involving cryptocurrency, constitutes an “investment contract” under the federal securities statute, courts apply the U.S. Supreme Court’s “Howey test.”[7] Under the Howey test, courts analyze whether the offering is (a) an investment of money (b) in a common enterprise and (c) with an expectation of profits to be derived solely from the efforts of others.[8] As the SEC has explained, the Howey test not only requires a fact-specific analysis of “the form and terms of the instrument itself,” but also focuses “on the circumstances surrounding the digital asset [or other instrument or offering] and the manner in which it is offered, sold, or resold.”[9]

Howey, decided in 1946, focused on whether an offering of citrus groves, along with management services, constituted an “investment contract” under the statute.[10]

The SEC has offered some guidance on the application of Howey in the digital asset context but has acknowledged that the outcome of the test depends on the specific facts and circumstances in each case.[11] At Wednesday’s hearing, former U.S. banking regulator and current CEO of bitcoin mining company Bitfury Brian Brooks stated that the uncertain classification of digital assets was “the most important issue in the short-term for the industry.”[12] Brooks emphasized that the Howey test is a “balancing test” rather than a clear rule.[13]

The witnesses also answered questions from the Committee on a range of topics, such as the demographic differences between cryptocurrency investors and investors in traditional instruments and the extent to which the growth of digital assets and decentralized finance can drive financial inclusion and benefit underserved communities.[14] These questions reflect the Committee’s awareness of the potential benefits that the ever-evolving digital asset industry may offer–not only in the United States, but also on a global scale.


[1] Hearings, the U.S. House Committee on Financial Services, https://financialservices.house.gov/events/eventsingle.aspx?EventID=408705 (last visited Dec. 10, 2021) (hereinafter, “Hearings”).
[2] Id.
[3] Memorandum: December 8, 2021, Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States, 3 (Dec. 3, 2021), https://financialservices.house.gov/uploadedfiles/hhrg-117-ba00-20211208-sd002.pdf.
[4] Id. at 1.
[5] Id. at 3.
[6] 15 U.S.C. § 77a et seq.
[7] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
[8] Id.
[9] Framework for “Investment Contract” Analysis of Digital Assets, SEC, https://www.sec.gov/files/dlt-framework.pdf (last modified Apr. 3, 2019) (hereinafter, “Framework”).
[10] 328 U.S. 293.
[11] See Framework.
[12] Hearings.
[13] Id.
[14] Id.

It is an old saw that partners, co-venturers, and insiders to closely held businesses owe fiduciary duties of loyalty and due care when dealing with one another. Importantly, these fiduciary duties modify the common law of fraud by imposing an affirmative duty upon the fiduciary to disclose material facts to the beneficiary, which, if breached, renders a material omission unlawful. But this assumes a commonality of interest in the operation of the business. How do these duties operate when a business partner is negotiating the terms of her exit from the business venture, and especially where the departing partner is asked to provide a general release of all known and unknown claims as part of her exit package? In that situation, the business and the remaining partners have interests at odds with those of the departing partner — the departing partner seeks to maximize her compensation, while the business’s interests are best served by minimizing the compensation paid and securing protection against any future potential liability through the general release. But does that mean the business can remain silent about facts that might have induced the departing partner to demand more money or refuse to sign the release, without violating a fiduciary duty and thereby voiding the release?

The answer is yes, provided that care is taken to be clear that the parties understand and agree that the parties’ interests are adverse and no fiduciary duties are owed in these circumstances.

The New York Court of Appeals has recognized that “[w]here a principal and fiduciary are sophisticated parties engaged in negotiations to terminate their relationship … the principal cannot blindly trust the fiduciary’s assertions” or rely on the fiduciary to disclose every particular fact about a transaction. Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V.,17 N.Y.3d 269, 279 (2011). Rather, “[a] sophisticated principal is able to release its fiduciary from claims — at least where … the fiduciary relationship is no longer one of unquestioning trust — so long as the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into.” Id. at 278. As the First Department put it, to hold otherwise would effectively conclude that “a fiduciary can never obtain a valid release without first making a full confession of its sins to the releaser, a proposition that has never been the law.” Arfa v. Zamir, 76 A.D.3d 56, 60–61 (1st Dep’t 2010).

While nothing will preclude a departing partner from later seeking to renegotiate the terms of her separation or vitiate a complete release of claims on grounds that the business failed to disclose important facts in violation of its fiduciary duties, businesses can take steps to ensure maximum protection under Centro and its progeny. A business is well-advised to add provisions into the separation agreement with the departing partner to make clear (i) that everyone understands and agrees that the departing partner and the business are acting in their own separate interests with respect to the separation, (ii) the departing partner has had an opportunity to separately secure whatever legal, financial, or other counsel she feels necessary to advise her on the terms of separation, and that she is not looking to the business for such guidance or advice, and (iii) it is expressly understood and agreed that the business does not stand in fiduciary relationship to the departing partner with respect to the negotiation of the terms of separation or of the release.

Inspection rights in a partnership agreement are frequently ignored until a dispute arises. And by that time, a limited partner’s degree of access may make the difference as to whether a lawsuit is ultimately filed.

Section 17-305 of the Delaware Revised Uniform Limited Partnership Act , 6 Del. C. § 17-101, et seq. (“DRULPA” or the “Act”), grants a limited partner of a Delaware limited partnership the right to demand access to the partnership’s books and records in a summary proceeding analogous to a shareholder’s right to bring a § 220 action. See Del. C. § 220. While Delaware law is clear that a limited partner’s inspection right is not without bounds, it is less clear to what extent it may be contractually limited and, more importantly, whether a limited partner can contract away their information rights entirely.

Section 17-305(a) provides that a limited partner’s right to access information may be “subject to such reasonable standards (including standards governing what information (including books, records and other documents) is to be furnished, at what time and location, and at whose expense) as may be set forth in the partnership agreement.” Delaware courts have held that such reasonable standards should not be used to “deny completely a right granted in the Partnership Agreement,” Parkcentral Glob., L.P. v. Brown Inv. Mgmt., L.P., 1 A.3d 291, 296 (Del. 2010), and that a limited partnership’s adoption of “reasonable standards” should not “substantively reduce the [statutory] right itself.” Madison Ave. Inv. Partners, LLC v. Am. First Real Est. Inv. Partners, L.P., 806 A.2d 165, 171-72 (Del. Ch. 2002).

In 2001, subsection (f) was added to Section 17-305, providing a new avenue for limited partnerships to restrict information rights. That subsection provides: “The rights of a limited partner to obtain information as provided in this section may be expanded or restricted in an original partnership agreement . . .” The stated purpose for adding this subsection was “to permit a partnership agreement to further restrict the rights of a limited partner to obtain information.”  73 Del. Laws, c. 73, § 20 (2001). The legislative history does not address, however, whether a partnership agreement can waive entirely a limited partner’s information rights under the Act.

There are few Delaware cases interpreting Section 17-305 and even fewer that post-date the addition of subsection (f). And no case has considered whether the newly added section permits a wholesale elimination of a limited partner’s statutory information rights. However, there is support for the position that such rights cannot be completely disclaimed in a partnership agreement.

First, Delaware courts have defined the word “restrict” to mean “to restrain within bounds; to limit; to confine.” State ex rel. Lucey et al. v. Terry, 196 A. 163, 167 (Del. Super. 1937). Thus, a natural reading of the word restrict would suggest only limitation, not wholesale elimination of a right. Indeed, a different section of the DRULPA, dealing with fiduciary duties, expressly provides that limited partnership agreements may contractually “expand, restrict, or eliminate any fiduciary duties that a person may owe[,]” 6 Del. C. § 17-1101(d), suggesting that if the legislature intended to permit complete eradication of such information rights in a partnership agreement, they would have added the word “eliminate” to subsection (f). Additionally, the Delaware Chancery Court, in interpreting Section 18-305 of the Delaware Limited Liability Company Act (the analogue to § 17-305 for LLCs), which contains similar language to Section 17-305, determined that Section 18-305 “allows ‘reasonable’ modification of inspection rights[,]” as opposed to total waiver of such rights. Durham v. Grapetree, LLC, No. CV 2018-0174-SG, 2019 WL 413589, at *2 (Del. Ch. Jan. 31, 2019). On the flip side, there is also support for the notion that a partnership agreement can deny access to items to which a limited partner is specifically entitled by statute. See Parkcentral Global, L.P., 1 A.3d at 296 (suggesting that under § 17-305(f), parties can fully eliminate access to certain categories of information to which limited partners are statutorily entitled, such as the names and addresses of partners).

Given the uncertainty over whether, and to what extent, a limited partner can contractually waive their right to information in the partnership agreement, any analysis of a demand for information must include reference to the statute, as well as the relevant partnership agreement, to determine whether the agreement incorporates, expands upon, or disclaims (in whole or in part) the rights available under the Act. Moreover, because a limited partner’s inspection rights can be an important tool for conducting pre-suit discovery, extra consideration should be given to the language used in a limited partnership agreement to define the scope of such a right.

In a recent published decision, the United States Court of Appeals for the Third Circuit clarified the standards that district courts must apply when certifying discrete issues–rather than an entire action–for classwide adjudication under Rule 23(c)(4).

What Is Rule 23(c)(4)?

Rule 23(c)(4) is an obscure part of federal class action practice. It states, simply, “When appropriate, an action may be brought or maintained as a class action with respect to particular issues.”

Because the rule (and its commentary) provide so little guidance, courts have had to fill the gap with criteria for issue certification. The Fifth Circuit, for example, has adopted a narrow holding that issue-class certification is appropriate only when a plaintiff shows that a court should certify an entire action as a class, reasoning that Rule 23(c)(4) “is a housekeeping rule that allows courts to sever the common issues for a class trial.”

But most circuits have rejected this approach and found that issue certification may be appropriate even if full Rule 23(b) certification is impossible. For example, the Sixth Circuit has said that issue-class certification is proper “where common questions predominate within certain issues and where class treatment of those issues is the superior method of resolution.”

The Third Circuit’s Latest Rule 23(c)(4) Decision

The recent case before the Third Circuit–Russell v. Educational Commission for Foreign Medical Graduates–involved a Pennsylvania nonprofit organization that certifies foreign medical school graduates for United States medical-residency programs. The organization certified a particular doctor despite having suspicions that he had misrepresented his identity on his applications. Law enforcement eventually arrested the doctor for possessing fraudulent or altered immigration documents, medical diplomas, medical transcripts, letters of recommendation, and birth certificates. He pleaded guilty to using a fraudulent Social Security number to obtain a medical license.

Following the doctor’s guilty plea, two former patients of the doctor sued the organization that signed off on his participation in a residency program, alleging negligent infliction of emotional distress. The plaintiffs brought their claims as a putative class action on behalf of all the doctor’s former patients.

Because there were clear individualized issues of injury, causation, and damages, the district court could not certify the class for full adjudication. But it did find that issues of duty and breach could be decided as to the entire class under Rule 23(c)(4), with injury, causation, and damages reserved for individual proceedings.

Addressing the issue-class certification in the case before it, the Third Circuit (in an opinion written by Judge Restrepo and joined by Judges Bibas and Porter) held that the district court abused its discretion when certifying the duty-and-breach issue class.

The Circuit held that a court resolving a motion to certify an issue class must make three determinations:

(1) Whether the proposed issue class satisfies Rule 23(a)’s numerosity, commonality, typicality, and adequacy requirements;

(2) Whether the proposed issue class “fit[s] within one of Rule 23(b)’s categories”; and

(3) Whether it is “appropriate” to certify these issues as a class.

Applying this standard, the Third Circuit reversed for two reasons. First, the Circuit found that the district court abused its discretion by failing to analyze whether the duty and breach elements satisfied Rule 23(b)(3). Second, the Circuit also held that the district court abused its discretion by certifying a class without considering all nine issue certification factors that the Court had earlier announced in Gates v. Rohm and Haas Co.

Although the Third Circuit vacated the district court’s class certification order, it explicitly declined to adopt the Fifth Circuit’s rule that issue classes are appropriate only when an entire case is suitable for class certification.

Practical Considerations for Rule 23(c)(4)

Rule 23(c)(4) has been on the books for more than 50 years, but only recently have plaintiffs’ attorneys started paying attention to it as an alternative to traditional class certification. As more circuits weigh in, it is likely to garner more attention and attract putative class actions that attorneys might not have considered traditionally strong candidates for classwide adjudication. In particular, claims that have clear individualized injury, causation, and damages questions might now find new life as issue-class cases.

Because the question has never been before the Supreme Court, each circuit’s law has different and important variations in how to analyze motions for issue-class certification. Companies and practitioners should be familiar with their home Circuit’s requirements when assessing a putative class action’s changes at certification.

In the wake of COVID-19, litigants have increasingly sought to excuse contractual performance by invoking force majeure clauses. In the early stages of the pandemic, there were few reported decisions on these matters, and the substance of these rulings echoed the principles that were applied in the pre-COVID era: force majeure clauses are strictly and narrowly construed. See, e.g., Lantino v. Clay LLC, 2020 WL 2239957, (S.D.N.Y. May 8, 2020) (rejecting a gym owner’s force majeure/impossibility argument that COVID-19 and the state’s shutdown order destroyed his business and ability to pay because the gym owner established financial difficulty but not a set of circumstances that made performance genuinely impossible).

Other recent opinions, however, have trended toward a more lenient standard. See, e.g., In re Hitz Restaurant Group, No. BR 20 B 05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020) (excusing a restaurant owner and tenant’s performance under a lease due to force majeure where the owner argued that Illinois’ stay-at-home order precluded performance and the language in the lease’s force majeure clause that explicitly mentioned “laws and other government action”); Richards Clearview, LLC. v. Bed Bath & Beyond, Inc., 2020 WL 5229494 (E.D. La. September 2, 2020) (excusing a tenant’s failure to pay rent on force majeure grounds, even though the operative force majeure clause did not mention pandemics, COVID-19, or related government shutdowns).

Still, the varying authority on this topic has left litigants uncertain regarding whether they have a viable force majeure argument. But a recent opinion from the Eastern District of New York — Banco Santander (Brasil), S.A. v. American Airlines Inc., No. 20CV3098RPKRER, 2021 WL 4820646, at *3 (E.D.N.Y. October 15, 2021) — suggests that a related argument, “frustration of purpose,” may carry the day, even though it is based on the same facts and circumstances as an unsuccessful force majeure argument.

In Banco Santander, when the COVID-19 pandemic struck, American Airlines (“American”) suspended flights between Brazil and the United States. Prior to the pandemic, however, Banco Santander (“the Bank”) contracted with American to offer a credit card program, co-branded with American. Under the terms of the contract, cardholders would earn miles with their purchases, and the Bank would, in turn, pay American for those miles. But the Bank was required to purchase a minimum number of miles each year — regardless of how many miles cardholders would earn through their spending.

Because of the pandemic, the Bank sought to terminate the contract due to a force majeure event, and, in the alternative, the Bank argued that it should be excused from performance based on the common-law doctrine of frustration of purpose. The Court gave short shrift to the Bank’s force majeure argument. Particularly, it held that while the pandemic could, in theory, qualify as a force majeure event, the parties’ contract foreclosed the application of the doctrine to American because the force majeure provision applied only if American “delays performance or fails to perform due to a Force Majeure Event” for at least 90 days. However, the contract did not state that flying between Brazil and the United States was among the duties expressly assumed by American. Thus, the Bank’s force majeure argument was rejected.

Nonetheless, the Court refused to dismiss the Bank’s claim for frustration of purpose. The Court explained that under New York law, the frustration-of-purpose doctrine permits a party to stop performing under a contract when a “wholly unforeseeable event renders the contract valueless” to that party. Axginc Corp. v. Plaza Automall, Ltd., 759 F. App’x 26, 29 (2d Cir. 2018); cf. PPF Safeguard, LLC v. BCR Safeguard Holding, LLC, 85 A.D.3d 506, 508 (N.Y. App. Div. 2011) (frustration of purpose applies when “a change in circumstances makes one party’s performance virtually worthless to the other, frustrating his purpose in making the contract”). To that end, the Bank essentially realleged its force majeure argument — that the COVID-19 pandemic was an event unforeseen by the parties that both disrupted all air travel worldwide and led American to cease all air travel between the United States and Brazil. The Bank further claimed that the pandemic had a “fundamental” impact on the desirability of air travel between the United States and Brazil because it led to government travel restrictions, reductions in airline capacity, and a general reluctance to travel. Thus, the Bank concluded that the consequences of the unforeseeable global pandemic rendered the contract valueless to the Bank.

Notably, in refusing to dismiss the Bank’s claim, the Court explained that:

[F]airly read, the complaint argues that a confluence of factors stemming from the COVID-19 pandemic rendered the contract valueless — including not just the suspension of flights, Compl. ¶¶ 47-48, but also a broader decimation of air-travel demand, id. ¶ 49. Even if one link in the chain of events on which the bank relies was foreseen by the parties — the suspension of flights — it would be inappropriate to dismiss a frustration-of-purpose claim that also relies in substantial inm part on other, assertedly [sic] unprecedented events.

2021 WL 4820646, at *5. The Court then held that these are plausible factual issues that were not appropriate to resolve on a motion to dismiss.

There are several takeaways from this holding and the evolution of force majeure litigation in a post-pandemic era:

  • Careful attention should be paid to the evolving force majeure/COVID jurisprudence in the relevant jurisdiction.
  • Practitioners should be mindful of both (i) a contract’s force majeure language (namely, whether it identifies COVID-19, pandemics, or government shutdown orders as force majeure events) and (ii) the particular facts and circumstances that led to a client’s frustrated performance, with the understanding that some courts may require a thorough argument demonstrating that performance was not merely frustrated but impossible.
  • Despite the uncertainty of successful force majeure arguments, however, practitioners should consider arguing the common law doctrine of frustration of purpose as an alternative form of relief, as the same facts that constitute an unsuccessful force majeure argument may nonetheless state a viable frustration-of-purpose claim.

The common train of thought when litigating as an out-of-state defendant is that it is best to be venued in federal court so as to eliminate any advantage an in-state plaintiff might have with a local jury. Typically, foreign companies will seek to remove state court actions filed by local plaintiffs to federal court under 28 U.S.C. § 1332 on the basis that there is diversity of citizenship between the parties–i.e., the parties on opposite sides of the lawsuit are citizens of different states. But what happens when a local stakeholder sues a limited liability company (LLC) in which he or she has an interest that neither was formed nor operates in the forum?

While at first glance there would appear to be diversity of citizenship between the parties, the unique character of LLCs necessitates further analysis. Unlike corporations, which are considered citizens of the state where they are incorporated and the state where they maintain their principal place of business, LLCs, and other unincorporated entities, are considered citizens of every state where their members reside. Thus, when an LLC member names the company itself as one of several defendants in a lawsuit, there may not be grounds for removal because “diversity jurisdiction in a suit by or against [an unincorporated] entity depends on the citizenship of all the members.” Carden v. Arkoma Assocs., 494 U.S. 185, 195 (1990) (internal quotation mark omitted).  The plaintiff member’s residence would supply the state of citizenship for both him/herself and the company.

At present, the U.S. Supreme Court has not weighed in on the analysis to be applied when an LLC member and the company are on opposite sides of a lawsuit and diversity jurisdiction is challenged. District courts, however, have applied a “nominal defendant” test when evaluating whether complete diversity exists. That is, a court will decide whether the LLC’s presence impacts the jurisdictional analysis by examining whether the company is essential to the lawsuit. Under this test, the company’s citizenship will be evaluated if the plaintiff member has an independent cause of action against the company. If, on the other hand, the member is really asserting claims against the LLC’s other interest holders and the company was named in the lawsuit purely for the purpose of affecting any remedy granted to the plaintiff member, the company’s presence does not factor into the citizenship analysis. See, e.g., S. Lavon Evans, Jr. Drilling Venture, LLC v. Laredo Energy Holdings, LLC, No. 2:11-CV-12, 2011 WL 1104150 (S.D. Miss. Mar. 23, 2011); J2 Enterprises, LLC v. Fields, No. CIV-14-781, 2014 WL 4957300 (W.D. Okla. Oct. 3, 2014); Kroupa v. Garbus, 583 F. Supp. 2d 949 (N.D. Ill. 2008).

Rather than risk ending up locked in an unfavorable state court due to the absence of federal jurisdiction, LLCs can, to a certain degree, preempt the issue by including broad forum selection clauses in their operating agreements. Thus, by contract, an LLC can control where its members file lawsuits relating to company operations.  Li v. loanDepot.com, LLC, No. CV 2019-0026-JTL, 2019 WL 1792307 (Del. Ch. Apr. 24, 2019); KTV Media Int’l, Inc. v. Galaxy Grp., LA LLC, 812 F. Supp. 2d 377 (S.D.N.Y. 2011); Marth v. Innomark Commc’ns LLC, No. CV 16-8136, 2017 WL 3081684 (C.D. Cal. Apr. 19, 2017).  And even though the forum selection clause itself will not create diversity jurisdiction to provide an avenue into federal court (which depends on the citizenship of the company’s members), the company can use the clause to select a favorable or neutral state for resolving company disputes—for example, the state under whose laws the LLC was formed.

On Sept. 23, the Delaware Supreme Court endorsed a new universal three-part demand-futility test in United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, et al. (Zuckerberg).[1] This universal test combines the traditional demand-futility tests established in Aronson v. Lewis[2] and Rales v. Blasband.[3]

Background: the Zuckerberg case

The Zuckerberg case arose after the board of directors of Facebook Inc. voted in favor of a stock reclassification (reclassification) that would allow Facebook’s controller, chairman, and chief executive officer, Mark Zuckerberg, to sell most of his Facebook stock while maintaining voting control of the company. Facebook’s stockholders, with Zuckerberg casting the deciding votes, approved the reclassification. However, not long after, numerous stockholders filed lawsuits alleging that Facebook’s board of directors violated its fiduciary duties by approving a purportedly one-sided deal. The lawsuits were consolidated into a single class action. Facebook ultimately withdrew the reclassification and mooted the class action. In total, the company spent about $21.8 million defending the class action and $68.7 million in attorneys’ fees paid to plaintiffs’ counsel under the corporate benefit doctrine.

Another stockholder, the United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund (Tri-State), filed a derivative complaint in the Court of Chancery seeking compensation for the money Facebook spent in connection with the class action. Tri-State did not make a demand under Court of Chancery Rule 23.1 and instead argued that demand would be futile.

The Aronson and Rales tests

Derivative suits seek to “deprive the board of control over a corporation’s litigation asset.”[4] “In order for a stockholder to divest the directors of their authority to control the litigation asset and bring a derivative action on behalf of the corporation, the stockholder must” either (1) make a demand on the board or (2) demonstrate that demand would be futile.[5] The Aronson and Rales tests were used by Delaware courts to determine whether demand was futile. The Aronson test applied where the complaint challenged a decision made by the same board considering a litigation demand.[6] Under the Aronson test, demand was excused as futile if the complaint alleged particularized facts that raised a reasonable doubt that “(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid business judgment.”[7]

The Rales test applies in all other situations.[8] Under the Rales test, demand was excused as futile if the complaint alleged particularized facts that created a “reasonable doubt that, as of the time the complaint is filed,” a majority of the board “could have properly exercised its independent and disinterested business judgment in responding to a demand.”[9] Ultimately, these tests address the same question, “‘whether the board can exercise its business judgment on the corporat[ion]’s behalf’ in considering demand.”[10]

The Delaware Supreme Court’s reasoning in Zuckerberg and the new universal demand-futility test

On appeal to the Delaware Supreme Court, Tri-State argued that the Court of Chancery erred in holding that exculpated duty-of-care violations do not satisfy the second prong of Aronson.[11] At issue was that Facebook’s charter contained a Section 102(b)(7) (of the Delaware General Corporation Law) clause, thereby insulating its directors from duty-of-care claims such that they faced no risk of personal liability. The Delaware Supreme Court disagreed with Tri-State’s argument and affirmed the Court of Chancery’s decision. The Aronson case was decided before Section 102(b)(7) was adopted in 1995; thus, the court noted:

When Aronson was decided, raising a reasonable doubt that directors breached their duty of care exposed them to a substantial likelihood of liability and protracted litigation, raising doubt as to their ability to impartially consider demand. The ground has since shifted, and exculpated breach of care claims no longer pose a threat that neutralizes director discretion. These developments must be factored into demand-futility analysis, and Tri-State has failed to provide a reasoned explanation of why rebutting the business judgment rule should automatically render directors incapable of impartially considering a litigation demand given the current landscape.[12]

Further, the court rejected Tri-State’s argument that because the entire fairness standard or review applies ab initio to a conflicted-controller transaction (like the one at issue in Zuckerberg), demand is automatically excused under Aronson’s second prong.[13]

Most importantly, the Delaware Supreme Court adopted a three-part universal test, which blends elements of the Aronson and Rales tests. This test requires courts to assess the following on a director-by-director basis:

(i) Whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand

(ii) Whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand

(iii) Whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand[14]

Under this test, demand is excused as futile if the answer to any of the questions is “yes” for at least half of the members of the demand board.[15] As the court noted, “The purpose of the demand-futility analysis is to assess whether the board should be deprived of its decision-making authority because there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand.”[16] This universal test now “refocuses the inquiry on the decision regarding the litigation demand, rather than the decision being challenged.”[17]

The court stressed that Aronson, Rales, and their progeny remain good law because the new three-part test is consistent with and enhances these cases.[18]

Conclusion

Going forward, the new test will be applied, eliminating the need to determine whether the Aronson test or the Rales test governs a complaint’s demand-futility allegations. The court’s ruling in Zuckerberg affirms that “the demand requirement is not excused lightly because derivative litigation upsets the balance of power that the [Delaware General Corporation Law] establishes between a corporation’s directors and its stockholders.”[19]


[1] No. 404, 2020, 2021 WL 4344361 (Del. Sept. 23, 2021).

[2] 473 A.2d 805 (Del. 1984).

[3] 634 A.2d 927 (Del. 1993).

[4] Aronson, 473 A.2d at 811.

[5] Lenois v. Lawal, 2017 WL 5289611, at *9 (Del. Ch. Nov. 7, 2021).

[6] Zuckerberg, 2021 WL 4344361, at *7 (citing Rales, 634 A.2d at 933).

[7] Aronson, 473 A.2d at 814.

[8] Zuckerberg, 2021 WL 4344361, at *7.

[9] Rales, 634 A.2d at 934.

[10] Lenois, 2017 WL 5289611, at *9 (quoting Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988)).

[11] Zuckerberg, 2021 WL 4344361, at *8.

[12] Id. at *12.

[13] Id. at *13.

[14] Id. at *17 (internal citation omitted).

[15] Id.

[16]Zuckerberg, 2021 WL 4344361, at *16.

[17]Id. (internal citation omitted).

[18] Id. at *17.

[19] Id. at *7.

Today, the United States Supreme Court resolved a circuit split regarding what constitutes an “autodialer” under the Telephone Consumer Protection Act (TCPA). In a blow to the plaintiffs’ bar, the Supreme Court ruled in favor of defendant Facebook, establishing a narrower, nationwide standard for what type of dialing equipment constitutes an “autodialer.”

The TCPA prohibits auto-dialed calls and texts to cellphones without prior express consent. Statutory penalties under the TCPA are severe: $500 per call in violation of the statute, or $1,500 per call for willful violations. 47 U.S.C. § 227(b)(3). The key issue in the Facebook appeal was whether a computer that simply stores and then dials a list of numbers qualifies as an “autodialer,” or whether the “autodialer” must itself randomly generate the list of numbers to be called.

In Facebook, Inc. v. Duguid, et al., No. 19-511, a unanimous Court overturned a Ninth Circuit ruling that held that dialing equipment that dials numbers from a stored list (as opposed to a randomly generated list) can qualify as an autodialer under the TCPA. The high court held, instead, that “Congress’ definition of an autodialer requires that in all cases, whether storing or producing numbers to be called, the equipment in question must use a random or sequential number generator.” The Second, Sixth, and Ninth Circuits had previously held that equipment that merely dials numbers from a stored list can qualify as an autodialer under the TCPA.

The TCPA defines “automatic telephone dialing system” as “equipment which has the capacity to store or produce telephone numbers to be called, using a random or sequential number generator, and, to dial such numbers.” 47 U.S.C. § 227(a)(1). In the case below, Duguid filed a putative class action over text messages he received from Facebook in 2014, alleging that Facebook violated the TCPA by sending automated text messages to his cellphone using an autodialer. Facebook argued that the TCPA did not apply, saying the technology it used to send Duguid text messages was not an autodialer because it did not send him text messages using a “random or sequential number generator.” The district court agreed and the plaintiff appealed to the Ninth Circuit, which reversed.

Before the Supreme Court, Facebook argued that the phrase “using a random or sequential number generator” modified both “store” and “produce,” while the plaintiff urged that the phrase only modified “produce,” such that an autodialer would encompass any equipment that can simply store and dial numbers, such as your average smartphone. The Supreme Court held that Facebook’s reading provided the most natural construction and, further, that it more closely aligned with Congress’ intent in enacting the TCPA, which arose–in part–from concerns that autodialers could randomly dial emergency lines, creating a threat to public safety, or “tie up all the lines of any business with sequentially numbered phone lines.”

The Supreme Court also appeared to recognize the potentially crippling effect the plaintiff’s reading would have on businesses that use telemarketing, stating that “[e]xpanding the definition of an autodialer to encompass any equipment that merely stores and dials telephone numbers would take a chainsaw to these nuanced problems when Congress meant to use a scalpel.”

While today’s ruling is a significant victory for the TCPA defense bar, businesses should continue to ensure compliance with the TCPA’s other requirements and prohibitions, including those relating to prerecorded calls.

The U.S. Supreme Court will hear arguments on March 30, 2021, in a case that will help clarify when an intangible, nonmonetary injury is sufficiently “concrete and particularized” to give rise to Article III standing.1 The Supreme Court’s decision will likely provide guidance for class-action plaintiffs seeking to bring (and class-action defendants looking to defend against) claims for civil penalties in the wake of the Supreme Court’s 2016 decision in Spokeo, Inc. v. Robins.2 The case could have profound consequences for any company that is potentially subject to a claim for statutory civil penalties in a federal class action lawsuit.

The Ninth Circuit’s Decision in Ramirez v. TransUnion LLC

Sergio Ramirez tried to buy a car with his wife. The dealership obtained a credit report, which incorrectly identified Ramirez as appearing on a list of Specially Designated Nationals (“SDNs”)–that is, people prohibited from doing business in the United States for national security reasons. It is essentially a terrorist watch list.

Ramirez contacted the credit reporting agency, TransUnion, to fix the error. In response, he received two letters. The first letter contained his ordinary credit report with a summary-of-rights form and instructions on how to submit proposed corrections. The second letter (“SDN Letter”) disclosed that Ramirez’s name was a “potential match” for names on the Treasury Department’s SDN list, but it lacked a summary-of-rights form or instructions on corrections. As it turns out, TransUnion included SDN references in credit reports based on information supplied by a third-party vendor that used software dependent on comparing first and last names. The assessment thus did not consider addresses, Social Security numbers, or any other identifying information.

Ramirez sued, alleging that TransUnion violated the Fair Credit Reporting Act (“FCRA”) when it willfully failed to follow reasonable procedures to ensure accuracy of the alerts, willfully failed to disclose full credit reports by sending the SDN Letter separately from the balance of the credit report, and willfully failed to provide a summary of rights with the SDN Letter.

Ramirez’s suit was brought individually and also on behalf of all 8,185 individuals who received the SDN Letter in a seven-month period. The trial court certified that class, and the jury returned a verdict of $60 million in favor of the class, including $8 million in statutory civil penalties and $52 million in punitive damages. (The Ninth Circuit later reduced the punitive damages to $32 million.)

In a 2-1 decision, the Ninth Circuit affirmed class certification and the verdict.3 The majority opinion, written by Judge Murguia and joined by Judge Fletcher, applied a two-part test to determine “whether the violation of a statutory right constitutes a concrete injury.” The court first asked “whether the statutory provisions at issue were established to protect [the plaintiff’s] concrete interests (as opposed to purely procedural rights).” And then, if they were, “whether the specific procedural violations alleged actually harm, or present a material risk of harm to, such interests.”

The majority had little difficulty finding the answer to both questions to be yes, since the protective purposes of FCRA are clear, as is the risk of harm from a false accusation that a person is an SDN. In her dissent, Judge McKeown explained that the class consisted of anyone who received the SDN Letter rather than anyone who had the false SDN accusation distributed to third parties. There was therefore no guarantee that every class member even opened the mailing, let alone that the incorrect credit report confused, distressed, or otherwise affected the absent class members.

The Ramirez argument comes one month after a similar case in which the Eleventh Circuit held that data breach victims must show more than a heightened risk of future injury or costs incurred to mitigate potential harm in order to establish Article III standing.

The Upcoming Argument

The question before the Supreme Court is whether the absent class members in Ramirez sustained a concrete injury sustaining Article III standing.

TransUnion’s argument focuses on the record at trial, which definitively established only that a quarter of the absent class members had the incorrect information distributed to third parties. As a result, as much as three-quarters of the class never suffered any harm as a result of the incorrect information. TransUnion argues that the trial court therefore should have never certified the class because its membership (all persons who received the SDN Letter in a seven-month period) is untethered from the alleged harm–that is, dissemination of the false SDN identification.

Ramirez turns this on its head and points out that there is no dispute that a quarter of the class suffered a concrete injury through dissemination of the SDN Letters. As for the rest, Ramirez argues that TransUnion must have also disseminated the incorrect SDN allegation of the third-party vendor that printed the SDN Letters, which suffices for an FCRA violation. And in any event, under Spokeo, there need only be a “risk of real harm,” which Ramirez argues is present when TransUnion prepares an incorrect credit report that exists solely so that TransUnion can distribute it to its customers on demand.

The Supreme Court’s decision will likely turn on how speculative or inference-driven a predicate for Article III standing can be. The outcome will affect not only FCRA litigation but also virtually any claim in which a plaintiff sues only for civil penalties because of a statutory violation. Such claims are ubiquitous in consumer fraud statutes, such as the Fair and Accurate Credit Transactions Act, the Stored Communications Act, and the Telephone Consumer Protection Act.

 

1 TransUnion LLC v. Ramirez, No. 20-297.

2 578 U.S. 330.

3 Ramirez v. TransUnion LLC, 951 F.3d 1008 (9th Cir. 2020), reh’g denied (Apr. 8, 2020).