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Touch of Class: Reducing the Risk of “Sweetheart Deals” “Competing”
class actions are multiple actions brought against the same defendant,
or group of defendants, all alleging essentially the same misconduct.1 A defendant may face exposure to several
class actions at once, brought by different class representatives
around the country. Some of these actions may seek to certify claims
of members resident in a single state.
Others may seek to certify claims of all class members nationwide. A defendant who is unable to have these cases
transferred to a single forum will be forced to defend itself in several
courts at the same time. A defendant
can turn this situation to its advantage by negotiating a global settlement
that covers every class member who does not opt out.
To get the best deal possible, the defendant negotiates exclusively
with the plaintiff who has the weakest case, the least effectual counsel,
or both. Once a deal is struck,
the settling plaintiff expands his proposed class into a broader “settlement
class” that purports to cover class members in all other pending cases. The defendant thus gets the benefit of a “sweetheart”
deal, and the settling plaintiff and his counsel receive lucrative
attorney fees and incentive awards in exchange for claims that they
may not even have. While
the defendant negotiates with one or more weak plaintiffs’ counsel,
plaintiffs who are frozen out of settlement negotiations have little
recourse but to continue litigating and push their cases toward trial.
As they do so, the pressure builds on the settling parties
to reach a global settlement, before a verdict tilts the litigation
landscape so heavily in favor of class members that a “sweetheart”
deal is no longer possible. Thus, a plaintiff’s litigation successes ultimately
work to his own downfall, by driving weaker plaintiffs to accept a
lowball offer that settles everyone’s claims, particularly those of
the stronger plaintiff, for less than they are worth. For competing
class counsel, the allure of fees can be strong — sometimes so strong
that class counsel engage in a “reverse auction” or a “race to the
bottom” as they bargain against each other and try to entice a defendant
with the best deal. Class members suffer in the end when class counsel
sacrifice class claims for less than they are worth, in the hopes
of garnering a fee. A class member’s only option in such circumstances
is to opt out of the proposed settlement (which usually yields no
cost-effective path to recovery), or object in the hope that the court
will not approve the settlement. Managing
the Problem with CAFA By removing
virtually all class actions to federal court, CAFA will reduce, if
not eliminate, a defendant’s ability to play one plaintiff’s counsel
off another. Once removed, related lawsuits are usually transferred
to a single district court for pretrial proceedings.2 The transferred cases can then be consolidated
for pretrial purposes, and one group of plaintiffs and their counsel
given exclusive authority to negotiate settlement on behalf of all
class members. This effectively
eliminates a defendant’s ability to choose its negotiating partner. Even
with the enactment of CAFA, however, federal courts and practitioners
will continue to grapple with competing class actions. Not all class
actions are suitable for transfer to a single district court.
Even if the suits are transferred to a single forum, plaintiffs
may still be able to avoid consolidation with other transferred cases
and proceed with relative independence in pretrial proceedings. Thus, the opportunity (or temptation) to play
one plaintiff off another in settlement negotiations may still be
present when competing class actions are filed. But even
where related cases are not transferred and consolidated in a single
federal forum, federal courts remain the best venue to protect class
members from lowball settlements.
In Amchem Prods., Inc. v. Windsor,3 the United States
Supreme Court held that a settlement should not be approved if it
does not have the “structural assurance of fair and adequate representation”
that Rule 23 demands. Post-Amchem appellate decisions make clear
that federal courts are to give heightened scrutiny to class action
settlements negotiated exclusively with a weak class representative
that purport to bind competing class members with stronger claims.4
Two recent
decisions by the Court of Appeals for the 7th Circuit illustrate this
trend. In Reynolds v. Beneficial
National Bank,5 a panel of the 7th Circuit reversed a lower court’s approval
of a nationwide settlement of 17 million consumer claims against H
& R Block and Beneficial National Bank.
And, in Smith v. Sprint,6 another 7th Circuit panel reversed a trial court’s certification
of a nationwide settlement class that purported to resolve landowner
trespass claims against numerous telecommunications carriers and railroads
in all 50 states. Each of these
proposed settlements was negotiated exclusively with one group of
plaintiffs over other competing plaintiffs.
Using different analytical approaches, the Reynolds and Smith courts
concluded that under the circumstances, the settlements at issue should
not have been approved. Reynolds
v. Beneficial National Bank In Reynolds, the court reviewed a deal that
purported to settle claims for fraud and breach of fiduciary duty
against Beneficial and H & R Block for Block’s “Refund Anticipation
Loan” (“RAL”) program. Over the preceding decade, more than 20 class
action cases had been filed, alleging that that the defendants fraudulently
failed to disclose Block’s interest in loans made to taxpayers pending
their receipt of a refund. Most
of the lawsuits had failed on one ground or another, but a few survived,
including one Texas case that was slated for trial.7 Counsel
for plaintiffs in two of the failed cases met with counsel for Beneficial
and discussed a global resolution of the RAL cases with Beneficial. Beneficial’s counsel
used a range of $24 million to $25 million “for purposes of illustration”
at the meeting. A few months
later, these counsel filed two new cases, with new plaintiffs, against
Beneficial and four Block entities.
The plaintiffs agreed to dismiss the Block defendants from
the cases after Block moved to dismiss for lack of personal jurisdiction. The parties (including Block) then began settlement
negotiations, culminating in a nationwide settlement agreement.8 Under the proposed settlement, Block was to be
added as a defendant for settlement only, apparently for the sole
purpose of protecting Beneficial from a potential indemnification
claim. In exchange for $25 million and unspecified
injunctive relief, the class was to release all claims against Beneficial
and Block “arising out of or in any way relating to the tax refund
anticipation loans (‘RALs,’ sometimes erroneously referred to as Rapid Refunds)”
obtained during a 13-year class period.
Individual claims were capped at $15, and any unclaimed funds
would revert to the defendants.9 While
it reviewed the Reynolds
settlement, the lower court issued an injunction to keep the Texas
case from proceeding to trial.10 Over
numerous objections, the lower court approved the settlement, with
the exception of the $15 cap (which the court insisted be raised to
$30 for class members who had more than one RAL) and the reversion
(which was ultimately rendered moot by the submission of over one
million claims).11 Several
of the objectors appealed, arguing that the settlement was the result
of a “reverse auction.” Although not concluding that “the settlement
was actually collusive in the reverse auction sense,” the Reynolds
court held that the lower court had not adequately scrutinized the
settlement for fairness and adequacy in light of “such questionable
antecedents and circumstances.”12
The theory of recovery in the Two other
objector groups argued that their claims had also been swept into
the settlement without consideration. One group was challenging Block’s
practice of promising (and charging extra for) a “Rapid Refund” to
taxpayers seeking the Earned Income Tax Credit, whose refunds were
almost certain to be delayed by the Government.
The other group challenged Block’s practice of intercepting
taxpayer refunds to pay off RALs previously extended to the taxpayer by Block. The panel found that these claims were “sharply
different from those of the classes represented by the settlement
counsel,” and that the $15 settlement recovery did not appear to compensate
these claims at all, despite broad language that released these claims.15
In sum,
the Reynolds court held that the lower court
had not fulfilled its obligation to protect members of the class from
“lawyers for the class who may, in derogation of their professional
and fiduciary obligations, place their pecuniary self-interest ahead
of that of the class.”16 Despite
evidence indicating a higher range of damages, the lower court conducted
no inquiry into the range and/or likelihood of possible outcomes but
relied upon an unsworn report by an accountant.17
Indeed, the appellate court found that “a pattern of withholding
information emerged” when the lower court enjoined the Texas class
counsel from informing their class members of the status of the Texas
litigation, and encouraged certain settlement counsel to submit their
fee applications in camera
to protect them from the criticism of objectors challenging the fee.18
The Reynolds court thus held that the lower court had abused its discretion
by approving the settlement without sufficient inquiry into its reasonableness,
fairness, and adequacy. Smith
v. Sprint In Smith v. Sprint, another panel of the 7th
Circuit took a different approach when it reversed a trial court’s
certification of a nationwide settlement class that was intended to
bar claims of other plaintiffs with competing, certified classes.
The Smith plaintiffs
were a group of landowners who brought trespass claims in federal
court against telecommunications companies and railroads for laying
fiber optic cable in railroad rights of way without the landowners’
permission. Other groups of landowners had brought similar
cases around the country against some of the same defendants. There had been at least one unsuccessful attempt
to certify a nationwide class in federal court,19
but state courts in When
the Smith parties announced a nationwide settlement,
representatives of the The 7th
Circuit reversed the lower court’s preliminary approval of the settlement. The court began its analysis by acknowledging
that the fact of settlement is relevant to whether a class should
be certified.21 The court also recognized,
however, that settlement is not a “cure-all” for deficiencies that
would otherwise make class certification inappropriate.
The Smith court emphasized that the class certification
requirements are intended to protect absent class members.22 These
protections, which “demand undiluted, even heightened, attention in
the settlement context,”23 include the requirement that a class representative’s
claims be typical of those of the class or subclass that he or she
seeks to represent, and that the class representative adequately represent
the interests of class members.24
The Smith Court determined that the settling
plaintiffs and their counsel did not adequately represent the interests
of class members. The objectors each had certified litigation classes
in their respective state courts, and each of these cases was on the
eve of trial when the lower federal court issued its injunction.
Moreover, In contrast,
a federal appeals court had already determined that the claims of
a nationwide class of landowners against telecommunications companies
could not be certified for trial in federal court.
The consequent lack of any threat of a nationwide trial meant
that the Smith plaintiffs “entered negotiations in what the Amchem court describes
as a ‘disarmed’ state, unable to ‘use the threat of litigation to
press for a better offer’ — not a good position from which to represent
the interests of parties that do wield such a threat.”26 The Smith court further held that this fundamental deficiency was not
cured by having property law experts make adjustments to recovery
based on the relative strengths and weaknesses of each state’s laws. As the court put it, “law professors are no
substitute for proper class representatives.”27 For these reasons, the Smith court vacated both the nationwide
class certification and the injunction.
The dissent
argued that it was wrong to assume that the settling plaintiffs and
class counsel were “disarmed” merely because their settlement class
could not be certified for litigation purposes in federal court. In the dissent’s view, the Smith plaintiffs were not “disarmed,” because
they could still “wield the threat of a disorderly recourse to state
litigation.”28 Litigation
had been pending against the defendants in various state courts for
years, with varying degrees of success. Thus, the alternative to the
proposed settlement was “not the possibility of no
litigation at all,” but “expensive and lengthy chaos in the various
states that the fiber optic cable has traversed.”29
Implications
After CAFA In the
post-CAFA world, the Reynolds
and Smith opinions are a caution to federal
district courts to carefully consider the effect of a proposed settlement
on the interests of class members in other overlapping class actions. If the proposed settlement purports to bind
class members in other cases, the court should closely scrutinize
the prosecutorial efforts by settling class counsel, and view with
suspicion negotiation tactics that excluded competing plaintiffs and
their counsel. The court should reject the settlement if the
court suspects that the settlement is, in reality, a “sweetheart deal”
that undervalues other, more promising litigation. CAFA
has implications for class counsel as well.
Because CAFA makes virtually all class cases removable to federal
court, class counsel can no longer wield the threat of “disorderly”
recourse to state court. This
means that class counsel who are unsuccessful
obtaining a nationwide litigation class, or who have their federal
claims dismissed, may be barred from representing a nationwide settlement
class. As a result, plaintiffs
seeking certification of single-state cases are less vulnerable to
having their claims swept into a nationwide settlement with a disarmed
plaintiff. Even
after CAFA, state courts could theoretically remain a haven for “sweetheart”
deals. For example, a defendant and a settling plaintiff
could agree to refile the plaintiff’s case
in a “friendly” state court and submit their nationwide settlement
for approval there. But courts
have taken a dim view of cases filed solely for the purpose of providing
a vehicle for a class action settlement.30 Moreover, objecting class
members would likely point to the defendant’s waiver of its right
to remove as further evidence of collusion between the settling parties.
And, even if the state court were to approve the settlement,
federal courts presiding over competing, certified class actions may
be able to enjoin the state court proceedings,31 or refuse to give
binding effect to the state court judgment.32
Conclusion With
the enactment of CAFA, almost all competing class action cases will
go to federal court. Federal
courts closely scrutinize settlements with relatively weak class representatives
that purport to bind stronger, competing classes.
Thus, if the competing cases are not consolidated in one court,
the defendant will have to deal with each viable, competing class
case on its own terms. The good news for class members is that their
claims are less likely to be swept into global settlements that have
more to do with protecting certain class counsels’ fees than with
fairly compensating class members’ claims.
2 See
generally General Rules for Multidistrict Litigation, 28 U.S.C. §1407. 3
521 4 This
was not always the case. Before
Amchem, federal courts generally assumed the absence of any
ill motive or misconduct in classwide settlement
negotiations, even in the face of evidence that the settlement was
negotiated over the objection of class members with competing cases. See e.g,
DeBoer v. Mellon Mortgage Co., 64 F.2d 1171,
1176-77 (8th Cir. 1995); In re Corrugated Container Antitrust Litig.,
1980-1 Trade Cas. (cch) ¶ 63,163 at 77,788 n.10, 1979 wl 1751 (S.D. Tex. 1979), aff’d, 643 F.2d 195 (5th Cir. 1981). See also In re General
Motors Corp. Pick-Up Truck Fuel Tank Products Liability Litig.,
55 F.3d 768, 799 & n.20 (3d Cir. 1995). 5
288 F.3d 277, 282-83 (7th Cir. 2002). 6
387 F.3d 612 (7th Cir. 2004), rehearing and en banc review denied. 7
288 F.3d at 280. 8
288 F.3d at 280-81. 9
288 F.3d at 281-82. 10 The
lower court issued the injunction under the All-Writs Act, 28 U.S.C.
§1651, and the Anti-Injunction Act, 28 U.S.C. §2883, both of which
authorize federal courts to issue writs and injunctions in aid of
the federal court’s jurisdiction. See 288 F.3d at 283. 11 288
F.3d at 282 . 12
288 F.3d at 283. 13
14
288 F.3d at 283-84.
15
288 F.3d at 285-86.
16
288 F.3d at 279.
17
288 F.3d at 282. 18
288 F.3d at 284.
19 387
F.3d at 613 (citing Isaacs v. Sprint Corp., 261 F.3d 679 (7th Cir.
2001). 20 The
Smith case was originally filed in the United States District Court
for the Northern District of Illinois. It was subsequently withdrawn
and submitted to the United States District Court for the District
of Oregon, which refused to entertain the settlement on grounds of
“judge shopping,” so the Smith parties went back to 21 For
example, a settlement class presents no issue of whether a class is
manageable for trial, because it is proposed that there be no trial. 387 F.3d at 614 (citing Amchem
Prods., Inc. v. Windsor, 521 22
387 F.3d at 614. 23
387 F.2d at 614 (citing Amchem, 521 24
387 F.3d at 614 (citing Fed.
R. Civ. P. 12(a)(3),
(4)). 25
387 F.2d at 614 (citations omitted). 26 27 28
387 F.3d at 618 (dissent). 29
387 F.3d at 616 (dissent). 30 See
e.g. Amchem, 521 31 A
federal court can issue writs and injunctions in aid of the court’s
jurisdiction. See 28 U.S.C. §§1651; 2883. 32 See
e.g. Romstadt v. Apple Computer, 948 F. Supp. 701 (N.D. Ohio 1996). |
