(Mark Lennihan / AP)

A $7.25 billion settlement between millions of merchants and the Visa and MasterCard credit card networks over fees and anti-steering rules that bar retailers from charging different prices based on the means of payment was thrown out Thursday by a federal appeals court.

The U.S. Court of Appeals for the Second Circuit vacated an antitrust settlement approved by a lower court, finding that one class of plaintiffs were inadequately represented in violation of both the rules for certifying a class action and the due process clause.

A big part of the problem for the court was that class counsel, which stood to gain, and now stands to lose, $544.8 million in fees, were representing two certified classes with very different interests.

“Class representatives had interests antagonistic to those of some of the class members they were representing,” the court said in In re Payment Card Interchange Fee and Merchant Discount Litigation, 12-4671-cv. “The fault lines were glaring as to matters of fundamental importance.”

Judges Ralph Winter, Dennis Jacobs and Pierre Leval reversed former Eastern District Judge John Gleeson and sent the case back to Brooklyn, where it is being handled by Judge Margo Brodie. Jacobs wrote the court’s opinion and Leval wrote a concurrence.

Some 12 million merchants filed suit in Brooklyn in 2005 against Visa, MasterCard and their issuing banks claiming Section 1 of the Sherman Act was violated by several rules set by card issuers’ networks that impose artificially inflated fees.

They challenged as anti-competitive the “default interchange fee” that applies to every transaction in the network; the “honor-all-cards” rule that requires all stores to accept all Visa and MasterCards if they accept any of them; and “anti-steering” rules, including “no-surcharge” and “no discount” rules that prohibit merchants from charging different prices depending on the means of payment—such as favoring cash versus credit or favoring one credit card with a lower interchange fee over another.

Jacobs laid out several ways the interests of the two classes collided in the settlement Gleeson accepted as fair and reasonable in 2013.

The first is an opt-out class that accepted Visa and/or MasterCard between January 2004 and November 2012 that would receive the $7.25 billion payout.

The second is for a non-opt-out class that accepted or will accept the cards from November 2012 forward until July 2021. This second class will receive no money, only injunctive relief.

One issue for the Second Circuit was that, in return for the injunction where credit card companies and issuers abandon some of their practices until 2021, the merchants released all claims for past or future conduct related to the defendant’s conduct not covered by the injunction.

Further complicating matters was that some merchants operate in states that ban surcharging—like New York, California and Texas—and some take American Express.

Jacobs said that “procedural deficiencies produced substantive shortcomings in representation” and the settlement was “unreasonable and inadequate.”

“Divided loyalties are rarely divided down the middle,” he said, as there was more than one conflict between the money class Gleeson certified and the injunctive relief class.

“The former would want to maximize cash compensation for past harm, and the latter would want to maximize restraints on network rules to prevent harm in the future,” he said.

Plaintiffs’ counsel, granted $544.8 million in fees, “stood to gain enormously if they got the deal done,” he said, and while counsel got extra money for each dollar they secured for the damages class, they “did not even ask to be compensated based on the size or significance of the injunctive relief.”

The judge made it clear that the court was not impugning class counsel, led by Craig Wildfang of Robins Kaplan in Minneapolis and lawyers with Berger & Montague in Philadelphia and Robbins Geller Rudman & Dowd in San Diego.

Jacobs nonetheless said structural defects “created a fundamental conflict” between the classes “and sapped class counsel of the incentive to zealously represent the latter.”

“Merchants in the (b)(2) class that accept American Express or operate in states that prohibit surcharging gain no appreciable benefit from the settlement, and merchants that begin business after July 20, 2021 gain no benefit at all,” he said. “In exchange, class counsel forced these merchants to release virtually any claims they would ever have against the defendants.”

Mallory Duncan, senior vice president and general counsel at the National Retail Federation, said Thursday his organization was pleased the court saw through “a seriously flawed settlement.”

“It gave one group of merchants 2 or 3 cents on the dollar for serious antitrust violations and it gave another group of merchants virtually nothing, and it bound all merchants from suing Visa and MasterCard for their anticompetitive acts in the future,” Duncan said.

Paul Clement of Bancroft PLLC argued for the settling plaintiffs.

Carter Phillips of Sidley Austin argued for the defendants.

Thomas Goldstein of Goldstein & Russell argued for merchants who objected to the deal.

Jeffrey Shinder, managing partner at Constantine Cannon’s New York office, was also counsel for the merchant objectors. Shinder said Thursday, “Bottom line, this was a total victory for the objectors.”

“This was a settlement that extinguished merchants’ abilities to challenge those rules. It essentially ratified anticompetitive conduct that is harmful, locking in the highest interchange rates in the developed world.” he said.