Bank of America Corp directors, who were sued by shareholders for allegedly paying too much for Merrill Lynch & Co in 2008, must defend a proposed $20 million settlement of the claims in federal court in New York, court papers show.

Calling the settlement grossly inadequate, lawyers in a similar Delaware case have asked P. Kevin Castel, the judge overseeing the New York matter, to order the parties agreeing to the deal to justify its terms.

Castel directed that parties submit necessary documents by May 4.

The New York Times first reported that the Delaware plaintiffs objected to the settlement in New York as inadequate.

Damages in the case could reach $5 billion, according to the plaintiffs in the case being handled in Delaware Chancery Court, the paper said.

Larry Grayson, spokesman for BofA, declined to comment on the matter.

Lawyers in the Delaware case complained that if the settlement in New York were approved, their clients' damages claims would be wiped out ahead of a scheduled October trial, the newspaper said.

Court papers show the settlement was struck on April 12 by lawyers representing two public employee pension funds that had sued the directors of Bank of America for breach of fiduciary duty. The funds are the Louisiana Municipal Police Employees' Retirement System and the Hollywood Police Officers' Retirement System in Florida.

Bank of America has been the subject of much litigation over Merrill, including its failure to more quickly disclose that Merrill was on its way to losing $15.8 billion in the fourth quarter of 2008 and was also paying out $3.6 billion in bonuses to employees.

Castel's colleague in New York, Judge Jed Rakoff, grudgingly approved a $150 million settlement by the bank of U.S. Securities and Exchange Commission civil charges over the Merrill takeover, after earlier rejecting a $33 million accord as inadequate.

(Nivedita Bhattacharjee in Chicago and Jon Stempel in New York; Editing by Vicki Allen)