In a case of first impression, the U.S. Court of Appeals for the Third Circuit approved the use of cy pres distributions in class action settlements but cautioned that such awards should generally represent a small percentage of the settlement funds. Cy pres refers to the distribution of residual class funds to a nonprofit organization that indirectly benefits the class in cases where the settlement proceeds are not completely distributed to class members. This precedential decision carries significant implications for all parties considering a class action settlement in which the direct benefit to class members may be limited.

While the court sanctioned the use of at least a limited cy pres distribution, it clarified that in approving a settlement and class counsel fees, district courts should remain primarily concerned with the direct benefit to the class. In some cases, this could mean reducing the counsel fee when a substantial portion of the class fund is distributed cy pres. In addition, the practical impact of accounting for this additional factor in many cases may be to delay not only approval of the settlement, but also the award of a counsel fee.

In In re Baby Products Antitrust Litigation, plaintiffs filed suit in the Eastern District of Pennsylvania alleging that retailers and several baby product manufacturers conspired to set a price floor for the sale of certain baby products, resulting in higher prices. The district court certified the class in 2011 and later approved a proposed $35.5 million settlement. The settlement terms included a counsel fee of $14 million and a cy pres provision whereby unclaimed funds would be distributed to appropriate charities. Ultimately, only $3 million was distributed to the class, contrary to the district court’s prediction of $8 million. An objector to the settlement appealed the court's approval, focusing on the cy pres provisions. 

The Third Circuit held that a district court may approve class settlements containing cy pres provisions. The court cautioned, however, that direct distributions to the class are preferred over cy pres distributions and may create a conflict of interest between counsel and the class. As a result, cy pres distributions should generally represent a small percentage of the settlement funds.

To ensure that settlements with cy pres distributions remain fair, reasonable, and adequate from the perspective of the class, the Third Circuit added another factor that district courts must consider when deciding whether to approve a class settlement—the degree of direct benefit to the class—to those set forth in the court’s prior opinions in Girsh v. Jepson and In re Prudential Ins. Co. of Am. Sales Practices Litig. In doing so, the opinion acknowledged that district courts may need to withhold final settlement approval until the actual distribution of funds can be estimated with reasonable accuracy. As the district court in Baby Products did not have a sufficient factual basis to assess the direct benefit to the class, the Third Circuit vacated settlement approval and remanded the case.

The court also provided guidance to district courts on how to assess a reasonable counsel fee in the context of a cy pres provision. Although it declined to require courts to discount counsel fees in that context, the court held that district courts, in their discretion, may do so if class counsel failed to prioritize adequately the direct benefit to the class. This portion of the opinion, in particular, could have significant implications for settlement negotiations.