The Seventh Circuit Court of Appeals recently invalidated a nationwide settlement agreement covering six consumer fraud class actions (“Settlement Agreement”) brought against NBTY, Inc., Rexall Sundown, Inc., and Target Corporation (“Defendants”). See Pearson v. NBTY, Inc., No. 14-1198 (decided Nov. 19, 2014). Each case was premised on Defendants’ allegedly deceptive marketing and sale of glucosamine supplements, which are marketed as promoting joint health.

Background

Defendants are in the business of marketing, selling, and distributing a line of joint-health dietary supplements, the active ingredient of which was glucosamine. Plaintiffs sued after they purchased and allegedly used the dietary supplements as directed but did not experience any of the promised health benefits as represented on the packaging. (See Case No. 11-7975 (N.D. Ill.), Jan. 3, 2014 Mem. Op. & Order at 2, Dkt. No. 143). Plaintiffs also claimed that they later learned of several studies which suggested that glucosamine was ineffective at relieving or curing joint related ailments. (Id.) Plaintiffs sought damages in the amount of the purchase price of the products.

On April 15, 2013, the parties executed the Settlement Agreement, which covered approximately 12 million class members and provided for a total fund of $20.2 Million, only $2M of which was guaranteed to be paid to class members. (Id. at 6). On the other hand, $4.5 Million was guaranteed to class counsel for their fees. (Id.)  The balance, less notice and administrative costs, would revert to defendants. Theoretically, each class member could receive $3 for an undocumented purchase and $50 for a documented purchase. (Id.) As is common in consumer class actions with individual relief of small value, however, the settlement resulted in a very low claim rate. (Id. at 14). As of the claims deadline, only 0.25% of the proposed settlement class returned claims, totaling $865,284 (Id. at 14). The remaining $1,134,716 of the guaranteed fund of $2M was to be remitted in cy pres to an educational foundation. (Id.).

When Plaintiffs’ moved for Final Approval, certain class members objected, arguing that the settlement agreement was not “fair, adequate and reasonable” within the meaning of Federal Rule of Civil Procedure 23(h) given that class members was receiving less than $1 Million dollars, approximately 4% of the settlement fund, while class counsel was receiving $4.5 Million. (Id. at 9.)

On January 3, 2014, the District Court for the Northern District of Illinois approved the final settlement but reduced the attorneys’ fees to $1.9 Million. (Id. at 18). The objectors then appealed to the Seventh Circuit.

Appellate Review

The objectors’ opening brief asserts that “[t]he self-dealing here not only included a disproportionate fee, but a clear sailing agreement and a segregated fund for the proposed attorneys’ fees that would revert to the defendant here rather than the class.” (Opening Brief of Appellants at 18.) The objectors argued that this unfairly insulated the fee request from scrutiny and forced them to object to the settlement in order to challenge the fee award. (Id.) Appellants maintained that, while in hindsight the fee award exceeded the benefit to the class, that did not make the settlement per se unfair or show collusion or self-dealing. (Response Brief at 20-23.)

During oral argument, the Panel made clear that they had grave concerns about the $4.5 million in fees requested by plaintiffs’ attorneys and whether there was collusion. Judge Posner commented that the settlement claim form and informational website were “extremely confusing” for a $3 refund on a product that averaged around $20 per bottle and suggested that the forms were clearly designed “to discourage people from applying.” Similarly, Judge Rovner questioned the propriety of making class members attest, under penalty of perjury, as to what month they bought a bottle of pills years after their purchase of the product.

As expected, on November 19, 2014, the Seventh Circuit reversed the district court’s confirmation of the settlement, which it described as a “selfish deal between class counsel and the defendants.” (Slip Op. at 18). Judge Posner mocked class counsel for shedding “crocodile tears over Rexall’s misrepresentations” to class members and then turning around and agreeing to a settlement that actually “disserves the class” in order to maximize their award of attorneys’ fees. (Id.)

Taking a brutal view of class settlement negotiations, the court explained how counsel for both sides often has an incentive to make the claim forms as burdensome as possible to minimize the claims rate. Like all defendants, Rexall had “no reason to care about the allocation of its cost of settlement between class counsel and class members; all it cares about as a rational maximizer of its net worth is the bottom line – how much the settlement is likely to cost.” (Id. at 10). The problem in this case was that class counsel too had an incentive to minimize class claims and therefore were agreeable to a more burdensome claims process, “because the fewer the claims, the more money Rexall would be willing to give class counsel to induce settlement.” (Id.).

The Court also took aim at the Settlement Agreement’s reversion or “kicker clause” which provided that if the judge were to reduce the attorneys’ fees award, the savings would “enure not to the class but to the defendant.” (Id. at 16). The Seventh Circuit ruled that such a clause was “a gimmick for defeating objectors” and presumptively invalid. (Id.)

The Court concluded that, “Class Counsel could have done much better by the class had they been willing to accept lower fees in their negotiation with Rexall. But realism requires recognition that probably all that class counsel really care about is their fees — for $865,284 spread over 12 million class members is only 7 cents apiece.” (Id. at 10).

In order to mitigate the effect of such dynamics in the future, the Court ruled that the reasonableness of the attorneys’ fees allowed to class counsel should be judged against the “actual or at least reasonably foreseeable benefits to the class,” not the mere potential benefit. (Id.).

Implications

The Seventh Circuit was unequivocal in its opinion that the settlement in this case did not come close to comporting with the fairness requirements of Fed. R. Civ. P. 23(h) due to the disparity between the plaintiffs’ attorneys’ fees award and the actual benefit to the class. This and other recent federal court decisions indicate that judicial scrutiny of consumer class action settlements is growing. Both defense and class counsel are encouraged to be mindful of the actual benefit to the class when negotiating the attorneys’ fee award and reversion provisions in class action settlements, or face the risk that the fairness of the settlement will be challenged.