Eighth Circuit Clarifies Cy Pres Rules for Settlements

The  Eighth Circuit last week issued an opinion with a set of new guidelines regarding "cy pres' disbursements in settlements. See In re BankAmerica Corp. Sec. Litig. (Oetting v. Green Jacobsen P.C.),  No. 13-2620 (8th Cir., 1/8/15).

Following the 1998 merger of NationsBank and BankAmerica to form Bank of America Corporation, shareholders filed multiple class actions around the country alleging violations of federal and state securities laws. The cases were transferred by the Judicial Panel on Multidistrict Litigation to the Eastern District of Missouri.  The transferred cases were resolved when the court approved a $490 million global settlement.  See In re BankAmerica Corp. Sec. Litig., 210 F.R.D. 694, 704-05, 714 (E.D. Mo. 2002), and 227 F. Supp. 2d 1103 (E.D. Mo. 2002). After an initial and then a second distribution, motion was made to distribute cy pres the remainder of the “surplus settlement funds” to three St. Louis area charities suggested by class counsel. The district court granted the motion over various objections. Objectors appealed the cy pres distribution, and the court of appeals reversed in the opinion for today's post.

In recent years, some federal district courts have approved disposed of unclaimed class action settlement funds after distributions to the class by making “cy pres distributions.” The term cy  pres is derived from the Norman French expression "cy pres comme possible," which means "as near as possible." The cy pres doctrine originated as a rule of construction to save a testamentary charitable gift that would otherwise fail, allowing ‘the next best use of the funds to satisfy the testator’s intent as near as possible.’” In re Airline Ticket Comm’n Antitrust Litig., 268 F.3d 619, 625 (8th Cir.2001).

Such distributions “have been controversial in the courts of appeals.” Powell v. Ga. Pac. Corp., 119 F.3d 703, 706 (8th Cir. 1997). Indeed, some courts have criticized or restricted the practice. See, e.g., Ira Holtzman, C.P.A. v. Turza, 728 F.3d 682, 689-90 (7th Cir. 2013); In re Baby Prods. Antitrust Litig., 708 F.3d 163, 172-73 (3d Cir. 2013); In re Lupron, 677 F.3d at 29-33; Nachshin, 663 F.3d at 1038-40; Klier v. Elf Atochem N. Am., Inc., 658 F.3d 468, 473-82 (5th Cir. 2011); In re Katrina Canal Breaches Litig., 628 F.3d 185, 196 (5th Cir. 2010); Masters v. Wilhelmina Model Agency, Inc., 473 F.3d 423, 434-36 (2d Cir. 2007); Wilson v. Sw.Airlines, Inc., 880 F.2d 807, 816 (5th Cir. 1989).  Recently, echoing these views, Chief Justice Roberts noted “fundamental concerns surrounding the use of such remedies in class action litigation” while nonetheless agreeing with the denial of certiorari in Marek v. Lane, 134 S. Ct. 8, 9 (2013).

The American Law Institute addressed the issue of Cy Pres Settlements in § 3.07 of its published Principles of the Law of Aggregate Litigation (2010). The ALI has recommended:

A court may approve a settlement that proposes a cy pres remedy . . . .The court must apply the following criteria in determining whether a cy pres award is appropriate:

(a) If individual class members can be identified through reasonable effort, and the distributions are sufficiently large to make individual distributions economically viable, settlement proceeds should be
distributed directly to individual class members.
(b) If the settlement involves individual distributions to class members and funds remain after distributions (because some class members could not be identified or chose not to participate), the settlement should presumptively provide for further distributions to participating class members unless the amounts involved are too small to make individual distributions economically viable or other specific reasons exist that would make such further distributions impossible or unfair.
(c) If the court finds that individual distributions are not viable based upon the criteria set forth in subsections (a) and (b), the settlement may utilize a cy pres approach. The court, when feasible, should require the parties to identify a recipient whose interests reasonably approximate those being pursued by the class. If, and only if, no recipient whose interest reasonably approximate those being pursued by the class can be identified after thorough investigation and analysis, a court may approve
a recipient that does not reasonably approximate the interests being pursued by the class.

Given what it saw as a substantial history of district courts ignoring and resisting circuit court cy pres concerns and rulings in class action cases, the 8th Circuit then concluded it was time to clarify the legal principles for the doctrine, relying in great measure on the ALI principles.

First, said the court, because the settlement funds are the property of the class, a cy pres distribution to a third party of unclaimed settlement funds is permissible only when it is not feasible to make further distributions to class members, except where an additional distribution would provide a windfall to class members with liquidated-damages claims that were 100 percent satisfied by the initial distribution. Here, said the court, from the perspective of administrative cost, a further distribution to the class was in fact feasible. The district court thus erred in finding that further distributions would be so “costly and difficult” as to preclude a further distribution; that type of inquiry must be based primarily on whether “the amounts involved are too small to make individual distributions economically viable.” ALI § 3.07(a).

Second, a cy pres distribution is not authorized by declaring, as class counsel did in this case, that all class members submitting claims have been satisfied in full. It is not true that class members with unliquidated damage claims in the underlying litigation are “fully compensated” by payment of the amounts allocated to their claims in the settlement. In this case, the district court approved (not atypically) a global settlement in which plaintiffs would recover only a percentage of the damages that they sought.  The settlement notice to the class stated: “the settling parties disagree as to both liability and damages, and do not agree on the average amount of damages per share that would be recoverable by any of the Classes.” Thus, the notion that class members were fully compensated by the settlement  was speculative, at best, said the court of appeals.

Third, the court rejected any contention that the cy pres distribution must be affirmed because the district court is bound by language in the settlement agreement, such as a clause stating that the balance in the settlement fund “shall be contributed” to non-profit organizations “determined by the court in its sole discretion.” Distribution of funds at the discretion of the court is not a traditional Article III function. More importantly, a proposed cy pres distribution must meet the standards governing cy pres awards regardless of whether the award was fashioned by the settling parties or the trial court.

Fourth, the court held that, unless the amount of funds to be distributed cy pres is de minimis, a district court should make a cy pres proposal publicly available and allow class members to object or suggest alternative recipients before the court selects a cy pres recipient. This gives class members a voice in choosing a “next best” third party and minimizes any appearance of judicial overreaching. See In re Baby Prods., 708 F.3d at 180; ALI § 3.07(c), cmt b (encouraging courts to “solicit input from the parties” regarding cy pres recipients).

Fifth, when a district court concludes that a cy pres distribution is appropriate after applying the foregoing rigorous standards, such a distribution must be for the next best use, for indirect class benefit, and for uses consistent with the nature of the underlying action and with the judicial function. Any unclaimed funds should be distributed for a purpose as near as possible to the legitimate objectives underlying the lawsuit, the interests of class members, and the interests of those similarly situated. Applying this standard here, the court of appeals concluded that while the recipient here was unquestionably a worthy charity, it was not necessarily the “next best” recipient of unclaimed settlement funds in this nationwide class action. A district court must carefully weigh all considerations, including the geographic scope of the underlying litigation, and make a thorough investigation to determine whether a recipient can be found that most closely approximates the interests of the class.

The order was thus vacated. On remand, if any settlement funds remain after an additional distribution to the class, and if the district court concludes after proper inquiry that a cy pres award is still appropriate, the district court was directed to select next best cy pres recipient(s) more closely tailored to the interests of the class and the purposes of the underlying litigation.

 

Seventh Circuit Rejects Another Class Settlement

The Seventh Circuit is one of the appeals courts that tends to examine very closely proposed class action settlements.  In a recent case, the court rejected a proposed settlement, finding the distribution to members of a class challenging dietary supplement labeling didn't justify the attorneys' fee award. See Pearson v. NBTY Inc., No. 14-1198 (7th Cir. 11/19/14).

Judge Posner opined for the panel about several class action settlement issues.  Defendants manufactured vitamins and nutritional supplements, including glucosamine pills, which are dietary supplements designed to help people with joint disorders, such as osteoarthritis. Several class action suits were filed in federal district courts across the country alleging violation of several states’ consumer protection laws by making allegedly false claims for glucosamine’s efficacy.  The district court had jurisdiction of this case under the Class Action Fairness Act, 28 U.S.C. § 1332(d)(2).

About eight months after the plaintiffs filed this suit in federal district court in Illinois, class counsel in all the cases negotiated a nationwide settlement and submitted it to that court for approval. Judge Posner noted it is typical in class action cases of this sort—cases in which class counsel want to maximize the settlement and the defendants don’t want to settle except for “global” peace—for the class counsel to negotiate a single nationwide settlement and agree to submit it for approval to just one of the district courts in which the multiple actions had been filed.

Here, the district judge approved the settlement, though with significant modifications. As approved, the settlement required payment of $1.93 million in fees to class counsel, plus an additional $179,676 in attorney expenses (attorneys' fees cover billable time and overhead expenses such as office space); $1.5 million in class notice and administration costs, $1.13 million to the Orthopedic Research and Education Foundation, $865,284 to the 30,245 class members who submitted claims, and $30,000 to the six named plaintiffs ($5,000 apiece) as compensation for their role as the class representatives. There had been a stipulation that defendants wouldn’t challenge any attorney fee requests by class counsel up to the agreed amount. Such a stipulation is sometimes called a “clear-sailing” agreement.

Approval of the proposed settlement involved an assessment of the value of the settlement to the class. The district judge valued the settlement at the maximum potential payment that class members could receive, which came to $20.2 million. That valuation, which played a critical role in the judge’s decision as to how much to award class counsel in attorneys’ fees, comprised $14.2 million for class members (based on the contrary-to-fact assumption that every one of the 4.7 million class members who had received postcard rather than publication notice of the class action would file a $3 claim), $1.5 million for the cost of notice to the class, and the fees to class counsel.  The $20.2 million figure had "barely any connection to the settlement’s value to the class," said Judge Posner.  Notice and fees, which together account for $6 million of the $20.2 million, are costs, not benefits. The attorneys’ fees are of course not paid to the class members; and as stated in Redman v. RadioShack Corp., 768 F.3d 622, 630 (7th Cir. 2014), “administrative costs should not have been included in calculating the division of the spoils between class counsel and class members. Those costs are part of the settlement but not part of the value received from the settlement by the members of the class. The costs therefore shed no light on the fairness of the division of the settlement pie between class counsel and class members.”

The $14.2 million “benefit” to the class members was a fiction too, said the panel, since only 30,245 claims were filed, yielding total compensation for the class members of less than $1 million.  Because the amount of the attorneys’ fees that the judge wanted to award class counsel—$1.93 million—was only 9.6 percent of $20.2 million, he thought the amount reasonable. But Judge Posner explained that was not relevant;  the ratio that is relevant is the ratio of the fee to the fee plus what the class members received. Basing the award of attorneys’ fees on this ratio, which shows how the aggregate value of the settlement is being split between class counsel and the class, gives class counsel an incentive to design the claims process in such a way as will maximize the settlement benefits actually received by the class. Here, said the court, the class received a "meager" $865,284. This means the attorneys’ fees represented not 9.6 percent of the aggregate value but an "outlandish" 69 percent.

Although appellate review of approval of class action settlements is limited, Williams v. Rohm & Haas Pension Plan, 658 F.3d 629, 634 (7th Cir. 2011), it is far from pro forma, because the district judge as “a fiduciary of the class, who is subject therefore to the high duty of care that the law requires of fiduciaries.” Reynolds v. Beneficial National Bank, 288 F.3d 277, 280 (7th Cir. 2002).

Judge Posner also took issue with the claim forms.  As experienced class action lawyers, class counsel in the present case must have known, said the panel, that the notice and claim forms, and the very modest monetary award that the average claimant would receive, were bound to discourage filings. The postcard sent to each of 4.7 million class members informed the recipient that to file a claim he must click on a website or call a toll-free phone number. A long and detailed process was not enticing for a $3 reward.

The panel also rejected the $1.13 million cy pres award in this case. A cy pres award is supposed to be limited to money that can’t feasibly be awarded to the intended beneficiaries, here consisting of the class members. Notice costing $1.5 million reached 4.7 million class members. Granted, doubling the expenditure would not have doubled the number of class members notified. But there could have been more notice, or the claims process could have been simplified to generate more returns.  The Orthopedic Research and Education Foundation was entitled to receive money intended to compensate victims of consumer fraud only if it was infeasible to provide that compensation to the class—which had not been demonstrated.

An economically rational defendant will be indifferent to the allocation of dollars between class members and class counsel. Caring only about his total liability, the defendant will not agree to class benefits so generous that when added to a reasonable attorneys’ fee award for class counsel they will render the total cost of settlement unacceptable to the defendant.  Judges have learned that class action settlements are often quite different from settlements of other types of cases, which indeed are bargained exchanges between the opposing litigants. Class counsel rarely have clients to whom they are responsive. The named plaintiffs in a class action, though supposed to be the representatives of the class, are typically chosen by class counsel; the other class members are not parties and have no control over class counsel. The result is an acute conflict of interest between class counsel, whose pecuniary interest is in their fees, and class members, whose pecuniary interest is in the award to the class. Defendants, said Judge Posner, are interested only in the total costs of the settlement to them, and not in the division of the costs between attorneys’ fees and payment to class members.   See Eubank v. Pella Corp., 753 F.3d 718, 720 (7th Cir. 2014).

The panel concluded that the district judge made significant modifications in the settlement, but not enough. The settlement, a "selfish deal" between class counsel and the defendant, dis-served the class. Only one-fourth of one percent of the class members would receive even modest compensation, and for these "meager benefits," the court said, class counsel should not receive almost $2 million.