GavelRecently, a District Court approved a class action settlement of an action against a manufacturer of allegedly defective windows.  The class representative was lead class counsel’s father-in-law; class counsel was embroiled in separate litigation and a state bar investigation over misappropriation of fees; the proposed settlement awarded class counsel $11 million in attorney’s fees without any reliable valuation of the class’s claims; and the claim procedure built into the settlement was so burdensome and prohibitive that the likelihood of any real class recovery was minimal at best.  On June 2, 2014, the Seventh Circuit emphatically rejected the settlement, which may seem unremarkable based on these facts.  What is noteworthy is the Court’s specific recognition of the risks of abuse associated with class actions and emphasis of the importance of close judicial scrutiny of class action settlements, which too often is undermined where both parties — the plaintiffs and their lawyers who want attorneys’ fees, and the defendant who just wants to cut its losses and avoid risk — jointly urge the court to approve a settlement and get a case off its docket.  The case is Eubank v. Pella Corporation, Seventh Circuit Case Nos. 12-2091, -2133, -2136, -2165 and -2202 (7th Cir. June 2, 2014).

Judge Posner’s opinion starts with a discussion of the benefits of the class action mechanism, but then recognizes the various risks of abuse seen frequently in these cases.  “Class actions are the brainchildren of lawyers who specialize in prosecuting such actions, and in picking class representatives they have no incentive to select persons capable or desirous of monitoring the lawyers’ conduct in the litigation.”  (Op. at 3.)  A “high percentage” of such lawsuits is settled, because aggregating individual claims multiplies potential liability to the point where many defendants are unwilling to bear the risk of trial, and “class counsel, ungoverned as a practical matter by either the named plaintiffs or the other members of the class, have an opportunity to maximize their attorneys’ fees ….”  (Id. at 3-4.)

“Fortunately the settlement, including the amount of attorneys’ fees to award to class counsel, must be approved by the district judge presiding over the case; unfortunately, American judges are accustomed to presiding over adversary proceedings [and] expect the clash of the adversaries to generate the information that the judge needs to decide the case.”  (Id. at 4-5.)  “And so when a judge is being urged by both adversaries to approve the class-action settlement that they’ve negotiated, he’s at a disadvantage in evaluating the fairness of the settlement to the class.”  (Id. at 5.)  “In this case, despite the presence of objectors, the district court approved a class action settlement that is inequitable – even scandalous.”  (Id.)  “The case underscores the importance of both objectors (for they are the appellants in this case – without them there would have been no appellate challenge to the settlement) and of intense judicial scrutiny of proposed class action settlements.”  (Id.)

The case alleged a design defect as to one of the defendant window manufacturer’s windows.  The district court approved a class settlement that would award $11 million to class counsel, based on counsel’s conclusion that the settlement was worth $90 million to the class.  “Were that so, … the fee award, equal to 12 percent of the amount of the settlement earmarked for the class members, would have been defensible.”  (Id. at 9-10.)  But lacking was the requisite close judicial scrutiny, a job the Seventh Circuit undertook, finding:

  • The first named plaintiff was the father-in-law of lead class counsel.
  • Four other named plaintiffs were added, but they objected to the settlement and were promptly replaced by four new, acquiescing class representatives.
  • Lead class counsel’s wife – the daughter of the named plaintiff – was a partner in the same law firm, and this relationship “created a grave conflict of interest; for the larger the fee award to class counsel, the better off [plaintiff’s] daughter and son-in-law would be financially – and (which sharpened the conflict of interest) by a lot.”  (Id. at 11.)
  • Both spouses are defendants in litigation accusing them of misappropriating assets of their former firm.
  • The Hearing Board of the Illinois Attorney Registration and Disciplinary Commission recommended that lead class counsel be suspended from practicing law due to “repeated misconduct[,]” (id. at 8) and this “ethical embroilment was another compelling reason for kicking him and [his father-in-law plaintiff] off the case.  …  It was very much in his personal interest, as opposed to the interest of the class members, to get the settlement signed and approved before the disciplinary proceeding culminated in a sanction that might abrogate his right to share in the attorneys’ fee award in this case.”  (Id. at 12, emphasis in original.).
  • Despite the conclusory $90 million valuation of the class claims, the settlement specified a burdensome, if not prohibitive, procedure to claim damages, including claim forms over 12-pages long, while the $11 million attorney fee award was to be awarded up front.
  • The judge approved the settlement before the deadline for filing claims, and “made no attempt to estimate how many claims were likely to be filed, though without such an estimate no responsible prediction of the value of the settlement to the members of the class could be made.”  (Id. at 11.)
  • Closer scrutiny of the case and claims process showed that the class “could not expect to receive more than $8.5 million from the settlement, … [a]nd even that figure seems too high.”  (Id. at 17.)

Thus, “[u]nheeded was our warning that because class actions are rife with potential conflicts of interest between class counsel and class members, district judges presiding over such actions are expected to give careful scrutiny to the terms of proposed settlements in order to make sure that class counsel are behaving as honest fiduciaries for the class as a whole.”  (Id. at 11, citation and internal quotation marks omitted.)

“In sum, almost every danger sign in a class action settlement that our court and other courts have warned district judges to be on the lookout for was present in this case.”  (Id. at 21.)  “After eight largely wasted years,” the Court reversed the order approving the settlement and ordered that the plaintiff and his son-in-law counsel be replaced.

While this case may be an extreme example of class action abuse, it highlights the importance of examining conflicts of interest between class counsel and their often hand-picked plaintiffs, and the value of class recovery as compared to attorney fee recovery, the latter of which so often drives this kind of litigation from the outset.