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.