Recent Amendments to Rule 23
Federal Rule of Civil Procedure 23 governs class actions brought in federal court, and Rule 23(e) specifically discusses the process and procedures for class settlements. Prior to December 1, 2018, subsection (e) set out very general principles surrounding the approval of class settlements, which required that the settlement be “fair, reasonable, and adequate.” This left courts with extensive discretion in evaluating class settlements, and appellate courts around the country had thereby developed a patchwork of varying factors intended to guide the district courts—some more stringent and some less.
However, in December 2018, Rule 23(e) was amended such that the rule itself now contains a specific set of criteria a district court must consider in assessing a class settlement. These criteria place more scrutiny on what constitutes a “fair, reasonable, and adequate” class settlement. For instance, Rule 23(e) directs district courts to consider the effectiveness of any proposed method for distributing relief to the class, including the method of processing class members’ claims. The advisory committee notes state that this may require the district court to direct the parties to report back about the actual claims experience, something district courts often do not do. Further, Rule 23(e) now requires the district court to consider how the contents of any agreement made in connection with the proposed settlement bear on the adequacy of the settlement, particularly as it relates to the equitable treatment of all members of the class. And Rule 23(e) now places specific emphasis on the terms of the attorney fee awards, and the advisory committee notes emphasize that the relief actually delivered to class is a significant factor in determining the appropriate fee award.
In sum, Rule 23(e) underwent significant revisions in December 2018. These revisions now provide concrete guidance to district courts on how to analyze class settlements—guidance that, in some cases, will be more rigorous than what district courts had applied in the past.
Class Representative Incentive Payments
It has been a long-standing practice for class action settlements to include incentive payments for the named plaintiffs. Indeed, this is often how plaintiffs’ attorneys are able to attract named plaintiffs to participate in low-value class actions. These payments are designed to compensate named plaintiffs for their time and trouble in representing the class, which often includes sitting for deposition and collecting responsive documents. Incentive awards are usually a very small percentage of the overall settlement payout and typically do not exceed a few thousand dollars. As such, both the parties and the courts have typically paid little attention to them in the process of negotiating and analyzing the settlement.
Despite this long-standing practice, an appellate court recently determined that class incentive awards are not permissible and it broadly condemned their future use in class settlements. In particular, in Johnson v. NPAS Solutions LLC, 975 F.3d 1244 (11th Cir. 2020), the Eleventh Circuit observed that the commonplace use of incentive awards is simply “a product of inertia and inattention, not adherence to the law,” and it faulted the judiciary for failing to pause to consider the legal propriety of these awards. The Eleventh Circuit then went on to consider two centuries-old Supreme Court decisions in which the Supreme Court had held that a representative plaintiff who initiated litigation on behalf of himself and other similarly situated creditors could not be compensated for “personal services and private expenses.” Based on these decisions, the Eleventh Circuit held that while a class representative could be reimbursed for any attorney fees and expenses, he or she cannot be “paid a salary or be reimbursed for his [or her] personal expenses.” The court reasoned that the incentive award is analogous to a salary, or payment for “personal services,” and noted that incentive awards present an even greater risk than the reimbursement disapproved of by the Supreme Court because they “promote litigation by providing a prize to be won.” In reaching the decision, the Eleventh Circuit outright rejected the argument that incentive awards are routine in class actions, finding that it was “not at liberty to sanction a device or practice, however widespread, that is foreclosed by Supreme Court precedent.”
Given the recency of the Johnson decision, the ultimate implications and consequences of this landmark ruling are yet to be determined. While no other appellate court has outright rejected incentive awards, there are courts that have—at the very least—looked at them with increasing scrutiny. In particular, at least two appellate courts have both rejected class incentive awards where there was too great a disparity between the class fund and the incentive award. Roes v. SFBSC Mgmt., LLC, 944 F.3d 1035 (9th Cir. 2019); Vassalle v. Midland Funding LLC, 708 F. 3d 747 (6th Cir. 2013)While it is too early to tell whether other appellate courts will adopt the reasoning in Johnson, the decision is at least likely to spur similar challenges in courts across the country—raising doubts for named plaintiffs as to whether they will ever be eligible for an incentive award. See Somogyi v. Freedom Mortg. Corp., 2020 WL 6146875, at *9 (D.N.J. Oct. 20, 2020) (declining to follow Johnson).
This development may not only make it more difficult for plaintiffs’ attorneys to locate willing named plaintiffs, but it may very well deter named plaintiffs from agreeing to very low value class settlements that fail to provide any real, tangible benefit to all class members. Given that the named plaintiffs will no longer stand to benefit from the additional several thousand dollars they ordinarily receive in a class settlement (money to which other class members are not entitled), they may refuse a class settlement that does not provide them—and therefore all other class members—with material benefits. This, in and of itself, may create significant obstacles for the future of class settlements as it may require the defendant to provide additional compensation to the entire class than would otherwise be the case. Thus, the sheer uncertainty surrounding the future of these incentive awards may present challenges to a mutually agreeable—and approvable—class settlement.
Fee Awards and Valuing the Class Settlement
It goes without saying that the attorney fee award is a key component of any class settlement analysis. In fact, the fee award typically draws the most scrutiny in the class settlement analysis. Fee awards are typically calculated in one of two ways: (1) the lodestar method, which is based on the number of hours worked multiplied by a reasonable hourly fee, or (2) the percentage method, which attempts to approximate the value of the settlement for the class and then calculates the fee as a percentage of the class members’ recovery.
The lodestar method is far more straightforward and typically bears less scrutiny, particularly because there is less incentive to hyperinflate the value of the class settlement in relation to the value of the fee award. That is not to say it is never scrutinized. For instance, one appellate court reversed the approval of a settlement based on the lodestar method because the district court made no effort to compare the fee award with the overall benefit to the class, and the fee award turned out to be 83 percent of the total amount that the defendant was required to spend to settle the case. In re Bluetooth Headset Prods. Liab. Litig., 654 F.3d 935 (9th Cir. 2011). And at least one appellate court has reversed the use of the lodestar method in the context of “coupon” or “voucher” settlements, holding that there must be a cross-check against the actual value of the coupons redeemed before the district court can approve of the lodestar-based fee. Chambers v. Whirlpool Corp., 980 F.3d 645 (9th Cir. 2020). Thus, while lodestar-based settlements typically involve a less complicated and rigorous analysis, practitioners need to be cognizant that such settlements may not always be subject to a rubberstamp approval.
As to the percentage method, which is more frequently used in high-value settlements, courts are much more careful in assessing the reasonableness of the fee award, the reason being that attorneys can come up with numerous ways to hyperinflate the value of the class award in order to justify their fees. In recent years, courts have become increasingly wary of the methods by which attorneys attempt to value the settlement in order to justify their fee award. This creates challenges for practitioners who attempt to invoke creative methods for class settlements that are agreeable to both the parties and the courts.
For instance, practitioners often attempt to use claims-made settlements to inflate the value of a settlement in order to justify their fee, while simultaneously enabling the defendant to pay far less than the total value against which the fee award is compared. Because these types of settlements are vulnerable to abuse, they have recently become the subject of heightened judicial scrutiny. Indeed, several appellate courts (although certainly not all) have recently disavowed the practice of valuing a claims-based settlement based solely on the total amount that could potentially be recovered if all class members filed a claim. Rather, courts have held that the fee award must at least take into consideration the claims rate or total amount of funds that are actually distributed or both. Vargas v. Lott, 787 F. App’x 372 (9th Cir. 2019); In re Baby Prods. Antitrust Litig., 708 F.3d 163 (3d Cir. 2013). And given the recent amendments to Rule 23(e) discussed above, this is likely to become a widely accepted rule in courts across the country.
Similar scrutiny is applied in cases involving “coupon” settlements. While attorneys had, in the past, tried to value the settlement based on the total face value of the coupons to which class members are entitled, Congress unequivocally prohibited that practice through the Class Action Fairness Act (CAFA). 28 U.S.C.A. § 1712. Rather, in valuing the settlement in relation to the fee, district courts must determine the value of the coupons that class members actually redeem. While this law has been in place since 2005, appellate courts have more recently made clear that a “voucher” settlement—one that permits a class member to purchase an entire product (rather than providing a simple discount)—is likewise subject to the CAFA’s restrictions and is to be treated no differently than coupons in the evaluation of a class settlement. E.g., Redman v. RadioShack Corp., 768 F.3d 622 (7th Cir. 2014).
Another type of settlement that has brought with it heightened scrutiny when applying the percentage method is one that attempts to value an injunctive relief component as part of the fee calculation. Because of the danger that parties will overestimate the value of the injunctive relief in order to inflate fees, several district courts have recently reinforced the principle that courts must be particularly careful when ascribing value to injunctive relief for purposes of determining attorney fees. In fact, one appellate court has held that only in the unusual instance where the value of the injunctive relief can be accurately ascertained may courts include that relief as part of the value of the fund for purposes of determining fees. Farrell v. Bank of Am. Corp., N.A., 827 F. App’x 628 (9th Cir. 2020). Not all circuits are so wary of valuing the injunctive relief in this manner, but it is certainly something that will always bear scrutiny by the district court.
And yet another wrinkle in the fee award issue is the existence of “clear sailing” agreements. These are agreements by defendants not to contest class counsel’s petition for fees up to a specified maximum value. Although clear sailing agreements are not per se prohibited, they are disfavored and have more recently led to greater scrutiny of the negotiation process and increased need to justify the fee award. And when a clear sailing agreement is coupled with a reversionary provision—that is, a provision in the agreement that any unclaimed funds revert to the defendant at the end of the class period—some courts have held that this raises a presumption of unfairness in the settlement.
In sum, there is no question that class settlements have come under heightened scrutiny in recent years. No longer may parties come up with creative ways to benefit class counsel, the defendant, and the named plaintiff—while simultaneously providing little to no material benefit to the members of the class. Practitioners should be aware of these developments and govern themselves accordingly.