In a case of first impression, the U.S. Court of Appeals for the Third Circuit has vacated a $35.5 million antitrust settlement involving baby product manufacturers because $18.5 million of that settlement was allocated as cy pres distributions.

The Third Circuit also hinted that the lower court may want to revisit the $14 million in attorney fees and expenses that were awarded, but ultimately left that to the district court’s discretion.

In the consolidated cases of In re Baby Products Antitrust Litigation, the court addressed for the first time whether cy pres awards are appropriate in a class action settlement. Cy pres awards take the excess money left over from a class action settlement once the attorneys and class members have been paid and distribute that to entities that bear some relation to thwarting the conduct that resulted in the settlement in the first place.

"We join other courts of appeals in holding that a district court does not abuse its discretion by approving a class action settlement agreement that includes a cy pres component directing the distribution of excess settlement funds to a third party to be used for a purpose related to the class injury," Judge Thomas L. Ambro said in his opinion.

The inclusion of a cy pres provision in and of itself does not render a settlement unfair or inadequate, Ambro noted. He said such provisions are warranted when, in looking at the settlement as a whole, the court finds it "fair, reasonable and adequate."

"We caution, however, that direct distributions to the class are preferred over cy pres distributions," Ambro said. "The private causes of action aggregated in this class action — as in many others — were created by Congress to allow plaintiffs to recover compensatory damages for their injuries. Cy pres distributions imperfectly serve that purpose by substituting for that direct compensation an indirect benefit that is at best attenuated and at worst illusory."

Ambro further noted that cy pres awards present a potential conflict of interest between class counsel and their clients because the inclusion of such awards might increase a settlement fund, and therefore increase attorney fees without increasing the direct benefit to the class. If a court is concerned about such conflict, it should subject the settlement to increased scrutiny, Ambro said.

When weighing the approval of a class settlement that includes a cy pres award, the cy pres provision should be given the same consideration given to other aspects of the settlement, Ambro said. But the court added an additional inquiry that should be taken into account when dealing with cy pres distributions. Ambro noted a court may consider, among other things, the number of awards given to class members compared to the number of claims and estimated number of class members as well as the size of the individual class member awards compared to their estimated damages.

"Barring sufficient justification, cy pres awards should generally represent a small percentage of total settlement funds," Ambro said.

As an example, Ambro said a court could withhold settlement approval until a mechanism is created to provide additional payouts to class members if the initial payouts don’t sufficiently deplete a "significant portion" of the total settlement fund.

The settlement in In re Baby Products Antitrust Litigation provided three tiers of payouts to class members, all of whom purchased various baby products from Toys R Us and Babies R Us. It was only the third tier, in which customers who couldn’t provide proof of their purchases would receive $5, that was objected to by class member Kevin Young. He argued that the class members in the third tier would not be fully compensated while the attorneys and cy pres awardees would get the bulk of the settlement. According to the opinion, class counsel expected $3 million of the settlement to go to class members given a large portion of them fell into the third category.

Ambro said the court is vacating the settlement because the Eastern District of Pennsylvania judge did not have the factual basis to determine whether the settlement was fair. Particularly, Ambro noted, the lower court didn’t know the amount of compensation going directly to the class. While about $21.5 million less the costs of claims administration was designated for the class, only $3 million was actually going to the class, Ambro said.

The judge instructed the lower court on remand to address the fairness of the settlement. Ambro said the parties may want to increase the $5 limit or lower the evidentiary bar for class members to get into a tier that provides higher payouts.

A Fair Fee?

In addition to addressing the cy pres award, Ambro said the court had to vacate the award of attorney fees and expenses because they were based on a settlement that is no longer in effect. Ambro said that while the Third Circuit wouldn’t address the reasonableness of the attorney fees, it wanted to note that Young raised an issue worthy of discussion.

Young argued the court should not consider the cy pres award as a class benefit for purposes of calculating attorney fees, or at least discount the benefit attached to the cy pres award.

"We think it unwise to impose, as Young requests, a rule requiring district courts to discount attorney fees when a portion of an award will be distributed cy pres," Ambro said. "There are a variety of reasons that settlement funds may remain even after an exhaustive claims process — including if the class members’ individual damages are simply too small to motivate them to submit claims."

But Ambro said the court appreciates the conflict created between absent class members and their counsel when attorney fee awards are based on an entire settlement amount rather than that portion that goes to the class. When a district court finds counsel has not met its responsibility to seek an award that adequately prioritizes the direct benefit to the class, the judge should reduce the fee award, Ambro said.

"In this case, class counsel, and not their client, may be the foremost beneficiaries of the settlement," Ambro said.

While this settlement had the ability to compensate members "significantly," Ambro said the current distribution "arguably overcompensates class counsel at the expense of the class."

Ambro said he recognized the difficulty district courts face in deciding whether attorney fees should be reduced on this basis. He said courts may want to use the lodestar test as a cross-check, but ultimately Ambro left that determination to the district court. Third Circuit Judge Joseph A. Greenaway Jr. and Judge Kathleen O’Malley of the U.S. Court of Appeals for the Federal Circuit joined Ambro in the decision.

Young was represented in the appeal by Theodore Frank of the Center for Class Action Fairness, a nonprofit that has filed a number of similar suits across the country challenging various aspects of the fairness of class action settlements. Frank said the issue of cy pres awards and attorney fees outweighing the amount of money class members get is not unique.

"It’s another victory for the principle that class actions are supposed to benefit consumers rather than attorneys," Frank said of the Third Circuit’s ruling.

Eugene Spector of Spector, Roseman, Kodroff & Willis in Philadelphia argued the case on behalf of the class members and Mark L. Weyman of Reed Smith in New York argued on behalf of Toys R Us and Babies R Us. Weyman said it was his client’s policy not to comment on pending litigation.

Spector said the ruling created an "awkward situation" in that the court found the settlement notice to the class was acceptable "yet it seemed as if the problem was not enough class members made claims and so under those circumstances, what are we supposed to do?"

Spector said the parties will go back before the district court and perhaps look for ways to increase the payouts to those class members who didn’t receive maximum payouts. Spector said that no matter how the settlement changes, he would expect it to still include some form of cy pres distribution. The court’s ruling, Spector said, essentially requires courts to look more carefully at settlements involving cy pres distributions, which he said could delay the settlement approval process by several months.

Gina Passarella can be contacted at 215-557-2494 or at gpassarella@alm.com. Follow her on Twitter @GPassarellaTLI.

(Copies of the 34-page opinion in In re Baby Products Antitrust Litigation, PICS No. 13-0386, are available from The Legal Intelligencer. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.) •