A Class Act?
A bill could move most class actions to federal court, but will it make reaching lasting settlements more difficult
The American Lawyer and Corporate Counsel
In October 1999 it looked as though H&R Block, Inc., had finally settled a particularly troublesome federal class action suit. Sixteen months earlier, a group of plaintiffs had sued the Kansas City, Mo.-based tax specialist for consumer fraud, claiming that a program that offered customers advances on their income tax refunds contained hidden finance charges. The stakes were high: Originally, the plaintiffs sought unspecified cash damages that could have reached close to $1 billion for a class of close to 17 million individuals. But now, with the settlement, H&R Block and Beneficial National Bank, a co-defendant, could put the mess behind them -- and all for $25 million, a relatively modest cost.
Or so they thought. In the following months, a handful of class members objected to the deal. They argued that the customers would receive too little -- only $15 or $30, depending on how often they'd used Block's services, and their lawyers would get too much -- more than $4 million, plus expenses, to be shared by a half-dozen or so Chicago-based practitioners. Although classes of plaintiffs often settle for compensation other than cash -- like coupons for future services -- the objectors still didn't want any part of the settlement.
In April 2002 the often business-friendly 7th U.S. Circuit Court of Appeals sided with the dissatisfied plaintiffs. Judge Richard Posner, writing for the three-judge panel, ordered the district court to reconsider its approval of the settlement, saying that the original trial court should have looked more closely at the issue of lawyer collusion. When the case went back to the lower court, the judge noted a number of factors that hinted at collusion, including the absence of discovery prior to the settlement and a meeting between lawyers from both sides that took place before the case was even filed. In an opinion issued last June, Judge Elaine Bucklo voided the settlement and removed class counsel from the case.
The upshot? Five years after the suit was filed, the parties are back to square one, filing motions and fighting over discovery and class certification all over again. "It's an absolute mess," says Howard Prossnitz, a Chicago-based solo practitioner and one of the lawyers dismissed from the case. "The plaintiffs had a good deal, and now they're back to the beginning with no promise of getting anything. It was a big waste of time and energy for everyone involved."
Settlements that go up in smoke are just what corporate America doesn't need. But a pending piece of federal legislation strongly backed by the Fortune 1,000 and their lawyers, could, ironically, make the H&R Block scenario a lot more common.
The Class Action Fairness Act -- approved by the U.S. House of Representatives in June, just a full U.S. Senate vote away from becoming law -- would move most nationwide class actions from state courts to federal courts. To a broad patchwork of American industry -- from auto manufacturers to pharmaceutical companies, Big Tobacco to makers of consumer goods -- this jurisdictional shift means big things. Historically, federal courts have been tougher than state courts on granting plaintiffs' class certification motions, the all-important requests to let a united group of individuals bring a single suit against a defendant. And state jurisdictions notorious for favoring class action plaintiffs -- like the courts in Madison County, Ill. -- don't exist in the federal system.
But the Class Action Fairness Act may not turn out to be the panacea corporate America expects. In recent years, federal courts have increasingly followed Judge Posner's lead, rejecting class action settlements at even the barest hint of collusion or unfairness. There are no official statistics on how many of the hundreds of federal class action cases that settled last year had their agreements nullified. In the past three years alone, however, federal district and appellate courts have shot down parts of or entire class settlements in California, Florida, Illinois, Maine, Missouri, Pennsylvania, Tennessee and Washington state. And many district courts have started assuming the role of "class fiduciary" in their review of settlements, which requires them to act in the best interest of the plaintiff class, even if that means voiding a hard-fought deal.
So by putting even more of the biggest class actions in federal court, the Class Action Fairness Act will increase the risk that parties will fight through discovery and long settlement negotiations, only to find their efforts wasted.
"When it comes to settlements, I'm not sure [the act] is going to help class action defendants at all," says Matthew Neumeier, one of H&R Block's current lawyers and a partner at Chicago's Jenner & Block. "Given the way [federal] judges have started listening to objectors, the act could just make it harder to get rid of the worst nuisance suits. And that's a prospect that frightens me."
The rule governing class actions -- Federal Rule of Civil Procedure 23 -- has for decades required judges to approve settlements before parties can put them into effect. Historically, this didn't create much of an obstacle for cases in federal court; judges would typically make sure the parties agreed on the terms before signing an order approving the deal.
But in the late 1990s, the U.S. Supreme Court shot down two separate asbestos class action settlements, holding that the district courts wrongly certified classes that were larger and more "sprawling" than allowed by Rule 23. In its opinions, the Court also addressed collusive settlements, advising lower courts to be wary of deals in which the class attorney fees seemed disproportionate to the relief granted to class members. Such a scenario, said the Court, might be evidence that the class lawyers "colluded" with defense attorneys by cutting a deal favorable to everyone but the class members.
Federal judges got the message. Today, having become increasingly concerned about exorbitant legal fees and relatively small payouts to class members, federal courts are bouncing more settlements. Concurrently, growing numbers of dissident plaintiffs groups are seeking to have settlements voided on those grounds.
In recent years, a handful of enterprising lawyers have made good money representing "objector classes," subsets of classes that object to settlements. These groups challenged the H&R Block settlement as well as one of the more noteworthy recent settlement blowups: the 9th Circuit's rejection late last year of a deal reached between The Boeing Co. and a class of African-American Boeing employees.
In that instance, a class of 15,000 African-American Boeing workers reached a $15 million settlement in 1999 over claims of racial harassment and racial discrimination. Later that year, a federal district court in Seattle approved the settlement, which gave between $3.5 and $4.1 million to three groups: the 237 "named" plaintiffs, the remainder of the class and the plaintiffs lawyers. The rest of the settlement pie, around $3.7 million, went toward the creation of a new diversity training program at various Boeing offices around the country.
But a small group of objectors appealed the decision, claiming that the attorney fees were disproportionately high, and the two-tiered payout to the plaintiffs was unjustified. The 9th Circuit agreed, stating "We are somewhat uneasy ... about whether ... class counsel adequately pursued the interests of the class as a whole," and sent the case back to the lower court. At press time the parties had yet to rekindle any sort of settlement discussion.
Federal district courts are vacating settlements on similar grounds, too. In 2001 a federal district court in Philadelphia voided a settlement between the teams of the National Football League Inc., and a class of almost 2 million football fans who claimed that the teams had packaged pay-per-view television broadcasts in a way that violated antitrust law. The court ruled that the settlement, which merely expanded class members' pay-per-view options but gave their lawyers $3.7 million, was "[in]consistent with sound notions of public policy," and would "diminish public confidence in the class action process." Last February, a federal district court in Memphis shot down a class settlement between the state of Tennessee and residents of a state-run center for developmentally disabled people, ruling that the agreement to close the center was counter to the best interests of the class. And in June a federal district judge in Portland, Maine, invalidated a portion of a deal involving music retailers and a class of CD purchasers, ruling that he "could attach no value" to coupons awarded to class members under the settlement. The court said, a "settlement is not fair where all the cash goes to expenses and lawyers, and the members receive only discounts of dubious value."
Legislative class action reform has a rich history, dating back to the early 1990s. In 1995, over the vociferous objection of the powerful trial lawyer lobby, Congress passed the Private Securities Litigation Reform Act in an effort to stem the surging tide of corporate securities fraud class actions. The PSLRA quieted some of the more vocal pro-business lobby. But it didn't silence the harshest critics of the class action system, like the National Association of Manufacturers and the U.S. Chamber of Commerce; they wanted all types of class action cases to be reformed, not just securities suits.
Against this backdrop, Representative Henry Hyde, R-Ill., in 1998 introduced an earlier version of the current bill. The House passed the Hyde bill, but the then-Democratic controlled Senate never voted on it. Similar bills were introduced in subsequent Congresses, but the lobbying community didn't get serious about class action reform until the Republicans gained control of the Senate in early 2001. At that point, each side drew their swords. The Association of Trial Lawyers of America hired Patton Boggs, one of Washington, D.C.'s preeminent lobbying firms, while nearly every conceivable industry group put its own team of lobbyists into action. (Ralph Nader's watchdog group Public Citizen estimates that since 2000, nearly 500 lobbyists have registered to promote class action reform.)
Starting the day the Hyde bill was introduced, the most heated debate has concerned a section of the legislation that changes the diversity requirement for federal court removal. Under current law, a defendant can remove a class action from state to federal court on diversity grounds only when every class member resides in a different state from every defendant. Of course, this makes removal impossible in "nationwide" class actions, which often include members from all 50 states. But under the act, federal removal in big cases becomes nearly automatic. The House bill, for example, requires class actions involving more than $2 million in claims to be heard in federal court unless a "substantial majority" of the plaintiffs hail from the same state as the defendants.
Supporters of the bill insist that federal court is the proper place for these suits. After all, class actions increasingly involve collections of individuals from Boston and Bakersfield, Dallas and Dubuque. "Nationwide class actions are nationwide problems and need to be in federal court," says Robert Weber, chairman of the product liability practice at Cleveland-based Jones Day. Weber says that too often state judges' decisions in class actions are governed by parochial interests, such as, he says, "getting re-elected."
Those opposed to the act -- chiefly trial lawyers and consumer groups -- say that pushing more matters of state law to federal courts will overwhelm the already backlogged federal courts and trample fundamental tenets of federalism. "It's going to delay a lot of corporate America's cases," says Richard Seymour, a partner in the Washington, D.C., office of San Francisco-based Lieff, Cabraser, Heimann & Bernstein. "ERISA matters, intellectual property matters -- if the law passes, these are all headed straight to the back burner of the federal bench." The "clog-the-courts" bit isn't just a trial lawyer scare tactic. Supreme Court chief justice William Rehnquist also opposes the legislation for fear of what it will do to trial courts' dockets.
The bill's opponents also argue that lawyer collusion could become an even bigger problem under the act. If a settlement is going to come under more intense judicial scrutiny, lawyers on both sides will go to even greater lengths to keep class members from challenging it. And this, say experts, could establish a strange dynamic. "[The act] may well set up a tension among defense lawyers who handle class actions," says professor Geoffrey Miller of New York University law school, an expert on class action litigation. "They may well [be inclined] to keep an eye out for the plaintiff class while, at the same time, trying to get the best deal for their own client. That's a hard line to walk."
The act's supporters say the law will only keep things honest. One of tort reform's most outspoken proponents, Shook, Hardy & Bacon's Victor Schwartz, says the legislation will check the backroom bargaining that goes into hammering out a settlement. "The act should separate the valid settlements from the bogus ones, the ones where there's a 'wink, wink' between the attorneys [on both sides]," says Schwartz. "Frankly, if I have to work harder on a settlement because it's in federal court, so be it. The act is good public policy."
But what happens when all that hard work fails and a settlement still dies? "It's not fun," says Sonnenschein Nath & Rosenthal's Reid Ashinoff. "But you typically go right back to the table and start again."
The thing is, often the defendants return to their seat only to find that, well, the table has turned. "At that point, the plaintiffs have the upper hand," says David Harvin, the cochair of the litigation department at Houston's Vinson & Elkins. "They know that [your client] is willing to shell it out."
According to Jenner's Neumeier, a rejected settlement presents defense counsel with a tough choice: start fighting all over again, or rekindle settlement discussions at an inflated starting point. "It's not unusual to find yourself getting asked for more money in a case where the vast majority of [the plaintiff class] didn't even complain," he says with a sigh. "Honestly, it's a scenario I wouldn't wish on anyone. It's a nightmare."
Unfortunately, it's a scenario that could soon become much more common. And if it does, the defense bar will have no one to blame but themselves -- and their clients.