On June 2, 2014, the U.S. Court of Appeal for the Seventh Circuit overturned approval of a class action settlement that it described as “inequitable” and “even scandalous.” The decision, Eubank v. Pella, Nos. 13-2091, 13-2133, 13-2136, 13-2162 & 13-2202 (7th Cir. June 2, 2014), is a laundry list of what not to do when settling class actions and serves as a good reminder that a settlement will not necessarily pass scrutiny merely because the parties agree to the terms. Although it arose outside of the employment context, this case provides a road map of factors that employers facing class actions should keep in mind when approaching the negotiating table.

Background

In 2006, Pella, a leading manufacturer of windows, was sued on the basis that its “ProLine Series” of casement windows allowed water to enter and cause damage to the window frame and the house itself. It was alleged that Pella’s sale of the defective windows violated product-liability and consumer-protection laws of a number of states in which the windows were sold.

The district court certified two separate classes, including one for customers who had already replaced or repaired their defective windows, the other for those who had not. The first class sought damages and was limited to customers in six states, with a separate sub-class for each state. The latter class sought only declaratory relief and was nationwide in scope. The Seventh Circuit, over Pella’s objection, upheld the orders of class certification in Pella Corp. v. Saltzman, 606 F.3d 391 (7th Cir. 2010).  Class counsel subsequently negotiated a settlement with Pella in fall of 2011.

Initially the case had only one named plaintiff, a dentist named Leonard E. Saltzman. His son-in-law,  Paul M. Weiss, was lead counsel for the class. Weiss’ firm was also lead class counsel. Mr. Weiss’ wife – Saltzman’s daughter – was also a lawyer, and a partner in her husband’s firm. Both Mr. and Mrs. Weiss were defendants in a lawsuit charging them with misappropriation of the assets of their  firm. Further, Mr. Weiss was the subject of an additional lawsuit that resulted in a disciplinary committee recommendation that he be suspended from practicing law for 30 months.

Early in the litigation, four class members were added as plaintiffs, in addition to Saltzman. When the settlement was presented to the district court for preliminary approval, the four class members who had also been named as plaintiffs opposed it.   These four members were subsequently removed and replaced with members who supported Saltzman.

The final settlement directed Pella to pay $11 million in attorney’s fees to class counsel. The basis for this figure was plaintiffs’ claim that the settlement was worth $90 million to the class. However, the settlement did not specify an amount of money to be received by the class members, as distinct from class counsel. Instead, it specified a procedure by which class members could claim damages.

The Seventh Circuit Opinion

Judge Richard Posner, issuing the opinion for the Seventh Circuit, found no reason to affirm the class settlement and ruled that the settlement contained “every danger sign in a class action settlement” that the Seventh Circuit had previously “warned district judges to be on the lookout for. . . .” Id. at 21. In stern language, he asserted that the objectors in this litigation were right because they “smell[ed] a rat…” Id. at 5.

The Seventh Circuit’s opinion is essentially a recitation of what went wrong. The Seventh Circuit identified that lack of an adversarial presentation as a primary reason why a district court would approve such an unfair settlement: “This is a case in which he lawyers support the settlement to get fees; the defendants support it to evade liability; the court can’t vindicate the class’s rights because the friendly presentation means that it lacks essential information.” Id. at 22.

The Seventh Circuit also ticked off the wide array of “danger sign(s)” that, nevertheless, should have signaled to the district court that the settlement was insufficient. Id. at 21. The key read flags were numerous: (i) the settlement agreement ignored that two classes had been certified and purported to bind a single nationwide class consisting of all owners of Pella ProLine windows containing the defect, whether or not the owners have already replaced the windows; (ii) the family relationship between lead class counsel and the named representative raised significant concerns; (iii) the lawsuits, disciplinary hearings, and ethical troubles that embroiled class counsel, and the likely financial hardship that resulted and further incentivized plaintiff’s counsel to reach a settlement, signaled further problems; (iv) the procedural maneuver the resulted in the replacement of all class representatives that disagreed with the settlement further exacerbated these problems; (v) the fact that the settlement did not specify how much was to be received by class and instead replaced it with a procedure by which class members had to execute complex and arcane forms in order to receive payment simply would not be fair; (vi) Plaintiff’s overall estimate of the value of the settlement was not credible, as Plaintiff,  and subsequently the district court judge, estimated that it was worth $90 million, clearly in an effort to make their $11 million payout in attorney’s fees appear reasonable (in doing the math, it became clear that it was valued at significantly less than that, as Judge Posner found that the class could not reasonably expect to receive more than $8.5 million from the settlement); and (vii) the settlement agreement gave lead class counsel “sole discretion” to allocate the award of attorneys’ fees to which the parties had agreed among the class counsel. Id.at 7.

Based on these factors, the Seventh Circuit rejected Plaintiffs’ argument that the settlement must have been fair because the notice to class resulted in very few objections to the settlement. The Seventh Circuit recognized that not only was the notice designed as to avoid objection, but also that “[i]t was not neutral and it did not provide a truthful basis for deciding whether to opt out.” Id. at 20. Additionally, opting-out of a class is extremely rare. An individual who opts out is “unlikely to hire a lawyer and litigate over a window.” Id. at 21. Overall, the Seventh Circuit found that “[t]he settlement flunked the fairness standard by the one-sideness of its terms and the fatal conflicts of interest on the part of Saltzman and Weiss.” Id.at 22.

Implications For Employers

Employers can learn from Eubank v. Saltzman, even though it is not an employment-related class action. In settling a class action, it is important to recognize that frequently at the settlement phase, the interests of defendants and class counsel are aligned. Because of this – especially in light of this ruling – just because the parties agree, that does not mean that the settlement is proper or will be affirmed by the district court (or on appeal).