The topic of potential self-dealing in class action settlements has been written about extensively.  While class counsel may be fully aligned with the class in seeking to maximize the settlement, their interests diverge sharply when it comes to determining the portion of the settlement earmarked for attorney fees.  And unlike the size of the settlement itself, the attorney fee award is likely to be of little concern to the defendant, so long as the total cost of the settlement to the defendant is minimized.

The subject may have been convered extensively, but (at least until now) not exhaustively.  A recent Seventh Circuit opinion—authored, predictably, by Judge Posner—addressed the potential conflicts in detail in chastising what it considered a lower court’s less-than-diligent review of a coupon settlement.  While there is nothing particularly extraordinary about the outcome, the opinion reads like an “A” response to a law-school “issue spotter” exam positing a suspect class action settlement.

In Redman v. RadioShack Corporation, a class action was filed on behalf of RadioShack consumers who made purchases with credit or debit cards and received receipts that showed the card’s expiration date—a violation of the Fair and Accurate Credit Transactions Act.  The lawsuit sought only statutory damages, as there was no evidence that the violation resulted in any actual identity thefts from the plaintiffs.

Class counsel and RadioShack agreed on a proposed settlement that would provide each responding class member with a $10 coupon and class counsel with just under $1 million in fees.  Approximately 83,000 potential class members submitted claims for the $10 coupons.  With an estimated $830,000 in coupons being distributed, and an additional $2.2 million in notice and other administrative costs to RadioShack factored in, the district court estimated the value of the settlement at around $4 million—with 25 percent going to class counsel.  The district court approved the settlement.

Judge Posner, in a detailed analysis of the actual value of the settlement and the incentives to the various parties involved, systematically picked apart various features of the settlement and excoriated the district court judge for failing to address them:

  • The panel held that the district court should not have counted RadioShack’s $2.2 million in administrative costs as part of the settlement.  Such costs, Judge Posner reasoned, are “not part of the value received from the settlement by the members of the class.”  While the class admittedly would “get nothing” if notice were not provided, Judge Posner noted that class counsel likewise would get nothing (since the class would derive no benefit from the settlement), and that “without reliable administration the defendant will not have the benefit of a valid and binding settlement.”  Thus, the district court’s calculation of the attorney fee award as “a respectable-seeming 25 percent” of the total settlement was incorrect, because the total settlement was artificially inflated by the administrative costs.
  • Even excluding the administrative costs, Judge Posner concluced that the district court made “[n]o attempt” to estimate the “actual value” of the coupon settlement.  Although approximately $830,000 in coupons were to be distributed, the settlement could not reasonably be valued at $830,000.  Not everyone who received a coupon could be expected to use it, particularly given the short redemption period and the likelihood that “[s]ome recipients of coupons will use them or forget about them.”  And if the customer used the coupon on an item costing less than $10, the proposed settlement did not allow for a cash refund, thereby diminishing the value of the coupons even for some class members who used them.
  • The district court instead based the fee award on the amount of time expended by class counsel, with a 25 percent increase to reflect the risk of the lawsuit to class counsel. Judge Posner responded that “the reasonableness of a fee cannot be assessed in isolation from what it buys.”  As to the risk premium:  “[A]ttorneys’ fees don’t ride an escalator called risk into the financial stratosphere.  Some cases should not be brought . . . and others are such long shots that prudent counsel will cut his expenditure in litigating them of time, effort, and money to the bone.  Neither course was followed by class counsel in this case.”
  • The district court did not scrutinize the proposed settlement’s “clear-sailing clause,” in which RadioShack agreed not to contest class counsel’s fee request.  Since a defendant ordinarily will not agree to such a clause without a reduction in the portion of the settlement that goes to class members, clear-sailing clauses “illustrate[] the danger of collusion in class actions between class counsel and the defendant, to the detriment of class members.”  Judge Posner added that such clauses are particularly suspect in non-cash settlements, such as coupon settlements, where the value of the settlement to class members is more difficult to ascertain.
  • Class counsel filed its fee request after the deadline for objections to the settlement, thereby violating the requirement in Rule 23(h) that fee requests be directed to class members “in a reasonable manner.”  Athough the proposed settlement placed potential objectors on notice of the amount of attorney fees to be requested, the details regarding class counsel’s hours and expenses—as well as class counsel’s rationale for its fee request—were not submitted until the fee request was made.
  • The lead plaintiff was employed by class counsel’s former law firm.  This was not cited as a basis for overturning the settlement, but Judge Posner used the opportunity “to remind the class action bar of the importance of insisting that named plantiffs be genuine fiduciaries, uninfluenced by family ties . . . or friendships.”

In reversing approval of the settlement, the court urged the parties to renegotiate the settlement in a manner that would “shift some fraction of the exorbitant attorneys’ fee awarded class counsel in the existing settlement that we are disapproving to class members.”  The only alternative, the court noted, would be to increase the value of the settlement to class members while leaving counsel’s fee intact.  As RadioShack “is in terrible financial shape,” the court observed, “[a]dding millions to the cost of the settlement to RadioShack might, if not precipitate the company’s failure, make it more likely—an outcome that might leave very little for class members.  A modest settlement is the prudent course.”

The moral of the story?  We’ve said it before:  While class action defendants may not have a direct interest in the division of settlement proceeds between class members and class counsel, they do have an interest in having their settlement approved.  Settlements weighted too heavily in favor of attorney fees will be suspect.  Settlements with such counsel-friendly provisions as “clear sailing clauses” will be even more suspect, particularly where the named plaintiff appears to be under class counsel’s control.  Avoiding such settlements serves the interests of both sides.