From the Bench: Are Settlements Sacrosanct?

Vol. 37 No. 4

The author is a U.S. district judge for the Southern District of New York. In 2010, he presided over and rejected the first settlement reached between the SEC and Bank of America. On November 28, 2011, he rejected the settlement between the SEC and Citigroup.

When should a judge turn down a settlement that is presented for the judge’s approval? Some would say never. After all, if the parties to a dispute have reached an amicable resolution of their differences, why should a judge interfere? Doesn’t the judge have better things to do than to muck up an agreement that the parties have labored, often long and hard, to reach?

As with so much in the law, however, the answer to this last question is neither yes nor no, but rather, “it depends.” Even in the case of a purely monetary settlement between two private individual parties where there is no request for any further involvement by the court, a court is required to scrutinize the settlement if it involves an infant or incompetent and may choose to get involved if the settlement smacks of collusion. The reason for the court’s involvement in such cases is the risk that, otherwise, the façade of a legally binding settlement will conceal over-reaching by one or more parties (as when an infant’s recovery is actually going to the benefit of his guardian) or will serve to compromise the rights of third parties (as in the case of a collusive settlement), or the like.

 

One might go further and argue that, at least where the parties to a settlement invoke the power of the court to enforce the settlement, the court has the obligation to review the settlement to make sure it passes minimal standards of fairness. Indeed, Professor Owen Fiss of Yale Law School, in his famous 1984 article entitled “Against Settlement,” argued that settlements are most often the product of unequal bargaining power between the parties and should be carefully scrutinized. My own experience, however, is that such unsolicited involvement by the court is as likely to cause mischief as to promote fairness. For example, while judges may undoubtedly serve a useful function in promoting settlements in cases in which the disputes, on their face, seem more the product of emotion than of rational disagreement, it may be suggested that judges are sometimes too quick to push for settlement when they have little understanding of the basic facts at issue. Too often, the judge’s motivation for pressing for settlement is the judge’s desire to ease an overcrowded docket; but the effect of heavy-handed judicial pressure for settlement may be to coerce a settlement that does not remotely reflect the actual merits of the case. In such circumstances, it is the unequal bargaining power of the court, rather than of any of the parties, that leads to unfairness.

Prudence therefore suggests judicial restraint in pushing private parties to settle, for they and their lawyers are often in a much better position than the court to make the cost-benefit analysis that underlies any agreement to settle. My own suggestion is to push forward, instead, with the case itself: There is nothing that promotes settlement like the imminence of trial.

Having said that, I would add that there are subtle ways in which the legal system’s bias in favor of promoting settlements between private parties perhaps goes too far. For example, it is not uncommon, after a decision has been rendered in favor of one party, for the parties to then settle (and thus avoid further litigation) contingent on the court’s vacating the prior decision. The reason for this is so that the party that lost the case will be able to avoid having the decision cited against it in some future litigation with other parties; and some courts, in the interests of promoting settlements, have been known to go along. But the effect is to rewrite history and pretend that a court that decided a case one way later changed its mind. This might be fodder for an Orwell novel, but it seems to me antithetical to the tenets of a legal system based on precedent.

At the other end of the spectrum—at least in theory—from purely private settlements between parties fully represented are those settlements that a court is required by law to assess for their fairness, reasonableness, and adequacy. Typically, these involve situations where, by the very nature of the case, the settlement affects the rights of absentees. A common example is a class action. Pursuant to Rule 23(e) of the Federal Rules of Civil Procedure, a federal class action may be settled “only with the court’s approval,” which may be given only when, following notice to all class members and a full hearing, the court determines that the settlement “is fair, reasonable, and adequate.” These requirements, both procedural and substantive, are prompted by a recognition that, without such safeguards, there is a genuine danger that the absentee members of the class will not be accorded due process. Congress has recognized, moreover, that these cases tend to be “lawyer-driven,” and for that reason, the court is also given a significant role in the appointment of class counsel and the determination of counsel’s fees.

In reality, however, courts find themselves handicapped in undertaking the considerable scrutiny mandated by these rules, chiefly because the adversarial system does not operate in this context. Once the parties of record have settled, they have no incentive to apprise the court of respects in which the settlement might be argued to be unfair, unreasonable, or inadequate. Defendants’ counsel, for example, having agreed to pay a fixed total of dollars in settlement, could not care less how much of the sum goes to the class members and how much to class counsel; and, indeed, the settlement agreement often contains an express term that defendants will not object to the plaintiffs’ lawyers’ fee application. While absentee class members are given the opportunity to appear (in writing or in person) and make objections, they rarely have a sufficient individual stake to warrant such an appearance, let alone to hire counsel to make their objections legally forceful.

 

Court as Inquiring Magistrate

The result is that, if the court is really to make the kind of factual inquiry necessary to provide a genuine basis for making the findings required by Rule 23(e), the court will have to play the role of inquiring magistrate that, while familiar to courts in civil law systems, is far removed from what Chief Justice Roberts has described as the American model of the “umpire” judge calling “balls and strikes” between contending parties. Few judges are ready to undertake this unfamiliar, sometimes unpleasant, and always time-consuming role of an inquisitor except in exceptional circumstances.

One fellow district judge has suggested that judges might appoint special masters, or even experts, to aid them in such evaluations. But, quite aside from the added costs and delays that this would engender, in my opinion it simply passes the buck. Special masters, and even more so court-appointed experts, bring their own biases to bear, biases that are often shaped by their “day jobs” as private practitioners, law professors, and the like. While no human being is without biases, federal district judges are about as free of external influences as it is possible to be in our contentious world, and it is that comparative objectivity that should be exercised in determining whether a class-action settlement is fair, reasonable, and adequate. But, of course, such objectivity cannot be exercised unless the judge has immersed herself in the underlying facts. There is just no substitute for hard work in such cases—and for judges handling overloaded dockets, that is frequently the rub.

In fairness, however, able counsel in large class actions will often supply to the court, both at the time of the pre-notice “preliminary hearing” on approval of the settlement and again at the time of the ultimate “fairness hearing” on such approval, substantial written submissions detailing the bases on which the parties ask the court to find that the settlement is fair, adequate, and reasonable. This is in stark contrast to the typical submissions from the parties in the third kind of situation to which we now turn: administrative settlements.

 

Administrative Settlements

When a federal administrative agency reaches a settlement of an action brought by the agency in federal court—as opposed to an internal administrative action, which is subject to judicial review (under the Administrative Procedure Act) only if a party seeks review—the agency typically requests injunctive relief to prevent recurrence of the defendant’s alleged misconduct. This invocation of the court’s injunctive and contempt powers requires the court to make a determination that such relief, and more generally the settlement as a whole, is fair, reasonable, adequate, and, according to some authorities, “in the public interest.”

 Indeed, in the case of an antitrust settlement, the terms of the Tunney Act expressly require the court to make the determination that the settlement is in the public interest. Although there is no
similar statute in the case of settlements with the Securities and Exchange Commission (SEC), the SEC has itself repeatedly acknowledged to the courts that it is required to make such a showing, as stated in one recent submission to me by the SEC:

The standard for judicial review and approval of proposed consent judgments in Commission enforcement actions is well-established. Because actions brought by the Commission seek to enforce the federal securities laws, they should serve “the public interest.” To ensure that the public interest is served, the court “need not inquire into the precise legal rights of the parties nor reach and resolve the merits of the claims or controversy, but need only determine that the settlement is fair, adequate, reasonable, and appropriate under the particular facts and that there has been valid consent by the parties.” Stated another way, “[t]his Court has the obligation, within carefully prescribed limits, to determine whether the proposed Consent Judgment settling [a] case is fair, reasonable, adequate, and in the public interest” (citations omitted).

In making such findings, a court is expected to give substantial weight to the views of the government agency that has approved the settlement, although the days of blind deference to administrative agencies are long past—at least in theory. But, as in the case of class actions, actual practice is something else. So confident are some administrative agencies in the automatic approval of their proposed settlements by federal courts that they rarely undertake to make any showing why the settlement is fair, reasonable, or adequate; rather, they simply submit to the court, without any accompanying explanation whatsoever, the proposed consent judgment settling the case and ordering injunctive relief. Such agency confidence is, again, the result of the failure of the adversary system to operate in the context of such settlements. Based on past practice, the agency assumes that, if no party is objecting, a court will not undertake the arduous and unfamiliar task of determining whether the settlement is fair, reasonable, adequate, and in the public interest, when there are a hundred other cases crying for immediate attention. Rather, the agency assumes that the court will be content to rely on the agency’s own determination that the settlement met these standards, without even requiring a word of explanation from the agency itself.

 

Bare-Bones Consent Judgments

This, for example, is the situation that I confronted when, in late August 2009, the SEC submitted to me a bare-bones complaint alleging that Bank of America had defrauded its shareholders in connection with its multibillion-dollar acquisition of Merrill Lynch, together with an equally bare-bones consent judgment stating that the bank, without admitting or denying the allegations, had agreed to pay the SEC $33 million to settle the case. Not one word was offered as to why this settlement was fair, reasonable, adequate, or in the public interest; but so confident was the SEC in its approval that it publicly announced the same day that it had settled with the bank “subject to court approval,” which it clearly expected would be automatic.

I confess that I had signed off on such bare-bone settlements in the past. But I gagged on this one. In violation of what I later learned was the SEC’s own written policy, the commission was allowing the bank’s management to use their shareholders’ money to buy their way out of what the SEC alleged was their fraud on those very same shareholders. The clear implication was that the parties had cut a cynical deal, whereby the SEC got to proclaim publicly that it had taken action in a very high visibility situation, while the bank got to claim that it had bought peace at a cheap price. For these and at least a half-dozen other reasons detailed in my subsequent opinion rejecting the settlement, I found it neither fair, nor reasonable, nor adequate, nor in the public interest.

Perhaps what bothered me most of all is that, in a situation that had occasioned considerable public scrutiny (not least because the U.S. government had lent the bank no less than $40 billion to accomplish the merger), the bare-bones settlement documents guaranteed that the truth would never be known. Perhaps all settlements are to some degree in derogation of disclosing the truth, but this one struck me as extreme. And when, some months later, after very substantial discovery, I finally, albeit reluctantly, approved a substantially different settlement submitted by the parties, it was contingent on their having provided me, and the public, with a 50-page statement of what the underlying facts were.

Having said all this, I was not entirely comfortable at any stage in this process. Any judge must recognize that a standard as broad and vague as “fair, reasonable, and adequate” must be narrowly defined if it is not to become an excuse for the exercise of judicial fiat. Because so few settlements are disapproved for the reasons already mentioned, the contours of the standard have yet to be limned with any precision.

Yet, if there is a danger in failing to delimit such a standard, there is a greater danger in not undertaking in any meaningful way the inquiry of administrative settlements required by law. The effect is to cede one of the judiciary’s most precious powers—its power of contempt—to an arm of the executive. More generally, the effect is to free from even the most modest scrutiny the sometimes too-cozy relationship between administrators and those they supervise, and to deprive the public of any judicial oversight, however modest, of the regulatory state. Such supine deference may give fodder to a novel by Kafka, but it does not inure to the benefit of a free people

 

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