ClassAction Settlements If Its Too Good to be True

Class-Action Settlements: If It's Too Good to be True…

July 28, 2014
If a settlement is 'too good to be true' from the defendant’s perspective, then it probably is.

Even as recent Supreme Court decisions have made it more difficult for plaintiffs to successfully pursue class action lawsuits, corporate decision-makers must remain concerned about the risks they pose.

One risk often going overlooked by defendants, however, is the settlement that appears too good to be true.

In a class action case, a small number of “representative” plaintiffs seek to pursue the claims of a class of absent plaintiffs. Often numbering in the thousands, these absent plaintiffs would be entitled to recover damages if the representative plaintiffs prevail at trial. 

If a class-action case cannot be defeated in its early stages, defendants often settle rather than risk a blow-out verdict at trial.

A settlement often makes sense for the lawyers representing the class, too. They are able to guarantee the receipt of a healthy legal fee without the time, effort and risk of taking the case to trial.

To prevent the class’s lawyers striking a bargain benefiting only themselves, the court must approve the terms of the settlement and the amount of the legal fees awarded to the class’s lawyers. 

Typically, the defendant does not care how its money is divided between the lawyers and the class. Instead, the defendant’s incentive is to pay as little as possible in return for the broadest possible release. 

Indeed, a defendant may view a settlement as a blessing in disguise, ridding itself of future headaches in return for a relatively modest payment. 

Eubank v. Pella

But a recent decision in Eubank v. Pella Corporation by the United States Court of Appeals for the Seventh Circuit should have defendants paying closer attention to how a settlement is distributed.

The ruling also illustrates the limits on defendants’ ability to settle class action litigation on advantageous terms.

In Pella, a three-judge panel overturned a class action settlement it deemed “inequitable – even scandalous.” Building owners claimed Pella’s windows had a design defect allowing water to enter behind the window frame causing damage to the frame and the building.

The proposed settlement gave $11 million to the class’s lawyers and created a claims process to compensate class members. The lawyers claimed this process was worth $90 million.   

The appeals court decided the claims process was “stacked against the class” because, among other things, it included lengthy, convoluted claims forms, modest caps on individual recovery, non-monetary benefits such as “coupons” (i.e., discounts on future purchases) and a complicated and expensive arbitration process. It also allowed Pella to contest claims with a host of legal arguments.

For many class members, the deal effectively became less of a settlement and more of an agreement to arbitrate.  As a result, few class members submitted claims at all. The appeals court estimated class members would end up recovering less than $8.5 million. 

The appeals court also noted other “danger sign[s]” including: (a) the lead lawyer for the class was a close relative of the lead representative plaintiff; (b) the same lawyer faced ethical charges at the time of the action; and (c) the familial relationship, ethical charges and defects of the settlement were not disclosed in the notice sent to class members.

The appeals court threw out the settlement and ordered the representative plaintiffs and their lawyers be replaced. The case was sent back to the lower court.  

'Too Good to be True'

The Pella case is a good illustration of how not to structure a settlement.  Earmarks of a settlement a court is likely to approve include:

Substantially more benefit to class members than to their lawyers. A 2-1 ratio is sometimes approved but more commonly it is better than a 4-1 ratio.

Guaranteed benefits pay-out. Rewarding the defendant for successfully contesting a claim troubles many courts. A common solution is to provide that any unclaimed settlement funds go to charity.

Simple for class members. If there is a claims process, it should be straightforward and use plain, readable forms. Simply sending a check to each class member is even better.

The lesson is that if a settlement is “too good to be true” from the defendant’s perspective, then it probably is. There is a real risk the settlement will not withstand review.

The defendant has an interest in undertaking an analysis ensuring the settlement value is defensible in light of the fees awarded to the class’s lawyer.

Even if the defendant is indifferent to how its settlement dollars are spent, the defendant cannot be indifferent to the possibility the court will undo the settlement if a reasonable balance is not struck.

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