After years of hard-fought litigation and months of settlement negotiations, you finally reach an agreement on the monetary terms of a class action settlement in federal court. Your client immediately begins to celebrate that this entire mess is behind it. But the work is not done quite yet. In this article, which focuses on settlement agreements relating to class actions pending in federal court, we highlight two particular provisions defense counsel should focus on and considerations to keep in mind with respect to future exposure when drafting and negotiating the settlement agreement itself.
Find an Appropriate Balance in the Release Provision
The first of these provisions—perhaps unsurprisingly—is the scope of release: what your client is buying through this settlement. As defense counsel, your instinct may be that the broadest release possible best serves your client’s interests. And class counsel may have a similar interest at this stage in releasing the broadest scope of conduct to increase the size of the class. Thus, a defendant’s desire to protect itself from future claims, when coupled with class counsel’s non-objection, often produces an expansive release.
As a general matter, courts permit releases encompassing a broader set of claims than those asserted in the class complaint. Berry v. Schulman, 807 F.3d 600, 616 (4th Cir. 2015). Without some limitation on liability and exposure, defendants “would otherwise face nearly limitless liability from related lawsuits in jurisdictions throughout the country.” Wal-Mart Stores, Inc. v. Visa, U.S.A., Inc., 396 F.3d 96, 106 (2d Cir. 2005) (“Broad class action settlements are common, since defendants and their cohorts would otherwise face nearly limitless liability from related lawsuits in jurisdictions throughout the country. Practically speaking, ‘[c]lass action settlements simply will not occur if the parties cannot set definitive limits on defendants’ liability.’”).
But rather than reflexively draft the broadest release possible, defense counsel should think strategically about the scope and language of the proposed release. A class settlement release will preclude subsequent claims only if the released conduct arises out of the “identical factual predicate” as the claims at issue in the underlying class litigation. Wal-Mart Stores, 396 F.3d at 106–7. The Supreme Court has not expressly weighed in on the scope of the identical factual predicate doctrine, but nearly every court of appeals (the Fifth Circuit appears to be the exception) has considered the scope of the doctrine in the context of a class action settlement release.
Such limitations are not hypothetical arguments that could only come up years down the road if your client seeks to use this settlement agreement affirmatively against a new separate lawsuit. At least one court sua sponte denied a motion for preliminary approval of a class action settlement because the release included “all encompassing ‘including without limitation’ language,” which made it
unclear whether there is any real limitation on the release of claims “of any and every kind” against the Defendant, whether known or unknown, “from the beginning of the world until today.” (Id. (emphasis added).) In short, because the release does not appropriately track the extent and breadth of Plaintiff’s allegations in the Complaint, the Court finds that the settlement agreement “suffers from an obvious deficiency” that precludes preliminary approval. See Christensen v. Hillyard, Inc., No. 13-cv-04389, 2014 WL 3749523, at *4 (N.D. Cal. July 30, 2014) (denying preliminary approval of a class action settlement in part because the proposed release “does not ‘directly track the allegations in the complaint.’” (citation omitted)).
Munday v. Navy Fed. Credit Union, No. 8:15-cv-01629, slip. op. at 7 (C.D. Cal. May 26, 2016), ECF No. 37 (order denying joint motion for preliminary approval of settlement).
Likewise, the Department of Justice lodged a high-profile objection to a proposed class action settlement between the Authors Guild and Association of American Publishers and Google, relying in part on the identical factual predicate doctrine and arguing that the settlement was “an attempt to use the class action mechanism to implement forward-looking business arrangements that go far beyond the dispute before the Court in this litigation.” Statement of Interest of the United States of America Regarding Proposed Amended Settlement Agreement at 6, Authors Guild v. Google, Inc., No. 05-civ-8136 (S.D.N.Y. Feb. 4, 2010), ECF No. 922. The district court did not approve the settlement. Even in less publicized settlements, objectors are often standing by to challenge arguably excessive releases.
Thus, particularly if your settlement involves injunctive or forward-looking relief or if the scope of the release you have bargained for expressly relates to future claims, pay special attention to the release provision and consider the implications of the identical factual predicate doctrine to ensure your settlement is approved.
Consider Strategies for Managing Opt-Out Risk
Another important provision of any settlement agreement that involves opt-out rights (as in damages classes governed by Federal Rule of Civil Procedure 23(b)(3)) is the allocation of opt-out risk. With increasing frequency, absent class members—often sophisticated and well-counseled institutions—“opt out” of a settlement class and initiate a stand-alone “direct action” lawsuit. Cornerstone Research, Opt-Out Cases in Securities Class Action Settlements: 2014–2018 Update (2019) (finding that out of 382 securities class action settlements between 2014 and 2018, the 8.9 percent opt-out rate during this period was more than double the 3.4 percent rate of opt-outs prior to 2014).
Give Thought to a Blow Provision or Takedown Mechanism
Settling parties have devised different approaches to sharing the risk that high opt-out rates would deprive the settling defendant of the benefit of its bargain. One common approach is a “blow” or “blow up” provision, whereby the parties may agree that, if opt-outs reach a certain threshold, then the defendant has the option to terminate—or blow up—the settlement. For a settling defendant, the benefit is readily apparent. If too many class members opt out of the settlement (ostensibly to file an individual suit to recover for the same underlying conduct), any settlement with the class quickly loses value, both in terms of prospective global peace from litigation and exposure. Blow provisions appear frequently in antitrust and securities class action settlements.
Alternatively, the parties could agree that, depending on the extent of opt-outs, part of the settlement payment will be refunded to the defendant—thereby taking down or reducing the funds distributed to the class members who remain in the settlement and file claims. Such takedown or reduction mechanisms can be particularly appealing when class members with large claims are likely to opt out, presenting acute risk to the settling defendant. A takedown provision can help to assure a defendant that it will not overpay to settle with a class that brings it little peace from continuing litigation. Because a reduction mechanism is less binary than a blow provision, it is generally a structure that defendants prefer. By contrast, blow provisions, while more common, are rarely exercised because defendants are not often willing to walk away from settlements.
Consider Carefully How to Document and Disclose this Provision
If you have successfully negotiated a blow or takedown provision, strategically consider how to publicize this aspect of the settlement agreement. Frequently, the parties may agree to execute a supplemental agreement that sets forth their arrangements for sharing opt-out risk, which courts often allow to remain confidential. See HealthSouth Corp. Sec. Litig., 334 F. App’x 248, 250 n.4 (11th Cir. 2009) (“The threshold number of opt outs required to trigger the blow provision is typically not disclosed and is kept confidential to encourage settlement and discourage third parties from soliciting class members to opt out.”); see also In re Citigroup Inc. Sec. Litig., 965 F. Supp. 2d 369, 401 (S.D.N.Y. 2013) (approving settlement with confidential blow-up provision); In re Warfarin Sodium Antitrust Litig., 212 F.R.D. 231, 253 (D. Del. 2002) (finding that the notice to class members did not need to include “the confidential ‘opt-out’ threshold beyond which defendant reserved the right to withdraw from the settlement (irrelevant to members’ opt-out decision)”), aff’d, 391 F.3d 516 (3d Cir. 2004).
Although many courts have allowed such arrangements be kept confidential, the degree of disclosure required can vary. In Martin v. FedEx Ground Package System, the court denied preliminary approval based on its concerns with the proposed notice. Specifically, the court noted that one of the “major shortcomings” of the proposed settlement was that the “proposed form of notice omitted a material term of the settlement, the number of opt-outs that triggered the defendant’s right to withdraw from the settlement.” Martin v. FedEx Ground Package Sys., Inc., No. C 06-6883 VRW, 2008 WL 5478576, at *1 (N.D. Cal. Dec. 31, 2008) (granting preliminary approval of class action settlement in part because the revised notice to class members provided sufficient detail about the blow-up provision and the triggering threshold).
Finally, regardless of whether the terms of a blow or takedown provision are disclosed in a public filing, it can be important for the provision to provide for important contingencies. The parties should specify, for example, what happens if they disagree about whether the “blow” or takedown threshold was triggered, who resolves such a dispute, and the timeline for doing so. Consideration should also be given to circumstances when one of the parties—typically, class counsel—has much more extensive information than the other about the true size and scope of opt-outs. In those situations, procedures for sharing information may be necessary, and it may benefit your client to have such procedures included in the enforceable and public settlement agreement.
A Closing Thought
In conclusion, resist the temptation to let the drafting of a settlement agreement become a hasty afterthought. Strategic drafting can help protect your client in both the near and long term.
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