The Third Circuit has vacated an order approving settlement for the second time in In Re Community Bank of Northern Virginia, a consolidated national class action. The Court’s decision highlights the role that the doctrine of equitable tolling can play in class actions and its relationship with the adequacy requirement under Federal Rule of Civil Procedure 23(a).

The plaintiffs alleged an illegal lending scheme against two banks and a company that acquired second mortgage loans from those banks in the secondary market. The complaints filed in the litigation asserted, inter alia, violations of the Real Estate Settlement Procedures Act of 1974 (“RESPA”), but did not assert causes of action under the Truth in Lending Act (“TILA”) or the Home Ownership and Equity Protection Act (“HOEPA”). Plaintiffs justified their failure to bring TILA or HOEPA claims by invoking the statute of limitations defense, as the applicable limitations periods had lapsed for most of the class, including all of the named plaintiffs.

First Settlement and Appeal

The first proposed settlement included a broad release of all claims that had been or could have been asserted in the litigation, including claims under TILA and HOEPA. The district court consolidated the cases and certified the class for settlement purposes only. Certain class members objected, claiming that there was inadequate consideration for the release of the TILA and HOEPA claims. Nonetheless, the district court entered a final order approving settlement.

On appeal, Third Circuit vacated and remanded, citing concerns about the adequacy of the class representatives under Rule 23(a), namely, whether the named plaintiffs and class counsel had sufficient incentive to establish TILA and HOEPA violations and to maximize the potential overall recovery.

Second Settlement

On remand, the settling parties reached a modified settlement agreement that purported to consider possible damages that could have been sought under TILA and HOEPA. The settlement was structured such that class members could only obtain such damages if they established some basis to rely on equitable tolling.

In reviewing the proposed modified settlement, the district court attempted to undertake a bifurcated analysis that first addressed the viability of potential TILA/HOEPA claims and then addressed adequacy and the other Rule 23 elements. The court reasoned that if the claims were unsound, the failure to bring them did not render the class representatives inadequate. The court purported to examine the claims under a motion to dismiss standard.

In the end, the court concluded that no class member could bring a timely claim under TILA or HOEPA and entered a final order approving the modified settlement. It held that no such amended pleading could satisfy the requirements of Fed. R. Civ. P. 15(c), and thus could not relate back to any earlier complaint in the litigation. The court also concluded that class members could not establish the “active misleading” by the defendants that would be necessary to support equitable tolling based on a fraudulent concealment theory.

The objectors once again appealed, arguing that the court erred in evaluating the merits of defendants’ statute-of-limitations defense.

Result on Appeal

On appeal for the second time, the Third Circuit began by stating that district courts are not categorically prohibited from evaluating the merits of a class claim at the class certification stage. Nonetheless, it held that the district court’s analysis was flawed.

The Third Circuit noted, without deciding the issue, that it was unconvinced by the district court’s Rule 15(c) relation-back analysis. More troubling was the equitable tolling analysis: the district court abused its discretion in concluding, under a motion to dismiss standard, that no member of the class could rely on equitable tolling to save an otherwise untimely TILA/HOEPA claim. Because the question whether a particular party is eligible for equitable tolling generally requires consideration of evidence beyond the pleadings, such tolling is not generally amenable to Rule 12(b)(6) treatment. In particular, whether class members could establish fraudulent concealment was an improper merits inquiry in the context of making a determination as to class certification.

Based on the foregoing, the Third Circuit also identified serious unanswered questions about the adequacy of class representation, including with respect to potential intra-class conflicts of interest and the justification for class counsel’s decision not to bring TILA/HOEPA claims.

The Court vacated and remanded with instructions for the district court to consider: (1) whether a subclass of class members with timely RESPA and/or TILA/HOEPA claims should be created; and (2) whether class counsel were adequate representatives in light of counsel’s justifications given for their decision not to bring TILA/HOEPA claims on behalf of the class.

This decision may serve to expand the leverage that the equitable tolling doctrine has in the class action context and make it more difficult to reach settlement. On a more practical level, it suggests that settling parties that face similar objections should weigh the possibility of creating subclasses.