In Jinnaras v. Alfant, decided on May 5, 2016, the New York Court of Appeals rejected a proposed settlement of a shareholder class action, where the proposed settlement would have deprived out-of-state class members of a “cognizable property interest” by failing to provide a mechanism for class members residing outside of New York to opt out of the settlement.

The Jinnaras case arose from a 2009 merger agreement between Google and On2 Technologies, a Delaware corporation domiciled in New York.  On2’s shareholders commenced class action litigation in both New York and Delaware courts alleging that On2’s directors breached their fiduciary obligations to the shareholders by failing to ensure that they would receive the maximum value for their shares and favoring the interests of certain “insider” shareholders, among other allegations.  The Complaint demanded rescission of the merger agreement and an injunction prohibiting the proposed merger unless certain conditions were satisfied.

Shortly thereafter, the parties to the litigation reached a settlement under which On2 agreed to make supplemental disclosures in the proxy statement and related materials provided to shareholders to solicit their votes in connection with the merger.  In addition, although the proposed settlement contained broad releases under which class members gave up their right to sue for damages, it did not contain any provision permitting class members to opt out of the settlement to pursue individual actions.

A number of shareholders objected to the settlement, and the Supreme Court held an evidentiary hearing on the issue of fairness.  In its memorandum decision, the court rejected the non-opt out provision of the settlement, ruling that shareholders who were not residents of New York must be afforded an opportunity to opt out of the agreement.   With that modification, the court otherwise approved the settlement.

An appeal to the Appellate Division ensued, and a divided panel affirmed the Supreme Court decision.  The dissenting Justice, however, would have approved the settlement without requiring an opportunity for non-residents to opt out.  The dissent reasoned that the damages at issue were merely incidental to the equitable relief that was sought, and New York law permitted non-opt out settlements in actions where the primary relief sought was equitable.  The dissent also found no basis for treating non-residents of New York any differently than residents of the State, as to whom opt-outs were foreclosed.

The Court of Appeals rejected the reasoning of the dissent and affirmed.  Writing for a unanimous Court, Judge Pigott reasoned that opt-out rights ensure that class members will have the option of pursuing individual rights for redress.  The Court explained that, for actions that are “wholly or predominantly” for monetary damages, opt-out rights are required by the Due Process Clause of the United States Constitution.  While New York courts may have the power under the Constitution and New York law to approve non-opt out settlements in matters that are “predominately equitable,” the Court held that power should not be exercised to bind class members with no ties to New York to a settlement that extinguished their rights to bring an action for damages in another jurisdiction.

The Court noted that the settlement at issue extinguished the right of out-of-state class members to pursue any and all claims for damages related to the merger, not only the claims that may be considered “incidental” to the equitable claims.  Accordingly, it may remain an open question in New York as to whether a court may approve a non-opt out settlement for both residents and non-residents that contains a limited release of monetary damages that are truly incidental to equitable relief.