In a class action arising from a data breach at a retailer that resulted in the theft of millions of consumers’ credit card information, the U.S Court of Appeals for the Eleventh Circuit recently held that the fee arrangement included as part of the settlement was a fee-shifting contract and the constructive common fund doctrine did not apply, reversing as an abuse of discretion the trial court’s use of a fee multiplier in a fee-shifting case.

A copy of the opinion in Northeastern Engineers Federal Credit Union, et al. v. Home Depot, Inc., et al. is available at: Link to Opinion.

A class of banks sued a retailer after a data breach in 2014 to recover their losses resulting from the theft of the credit card information for “tens of millions” of consumers.

The case settled and as part of the settlement, the retailer agreed that the reasonable attorney’s fees of the class counsel “would be paid separate from and in addition to the class fund, but the parties left the amount of those fees undetermined.”

The trial court awarded $15.2 million in fees using the lodestar method, finding the class counsel’s hours to be reasonable and applying a multiplier of 1.3 to account for the risk the case presented. The trial court also compared this amount to an award using the percentage method “as a cross-check to ensure the amount of fees was reasonable.”

The retailer appealed, arguing that the trial court “abused its discretion by applying a multiplier and by compensating Class Counsel for certain time spent … litigating about a private dispute resolution process.” The class counsel cross-appealed, arguing that the trial court incorrectly “conducted the percentage cross-check.”

The Eleventh Circuit began by explaining that the “main issue underlying the appeal is whether the fee arrangement outlined in the settlement should be characterized as a constructive common fund or as a fee-shifting contract. We hold that this is a contractual fee-shifting case, and the constructive common-fund doctrine does not apply.”

The Court then engaged in a “thorough review of the facts” because “[d]isputes over attorney’s fees are fact-intensive inquiries.”

The data breach occurred in 2014 when hackers installed malware on the retailer’s self-checkout kiosks. The hackers then offered the credit card information “for sale on a black-market website.” Soon thereafter consumers began reporting fraudulent transactions on their credit cards.

Consumers and banks “filed over 50 class actions” which were consolidated in the U.S. District Court for the Northern District of Georgia, “where the District Court split the litigation into two tracks: one for consumers and one for the banks.” This appeal before the Eleventh Circuit arose from the bank track.

The banks’ consolidated complaint included claims for negligence, negligence per se, and “for violations of state consumer-protection statutes on behalf of eight state-specific subclasses[,]” alleging that as a result of the retailer’s failure to “secure its data[,]” the banks were “forced to cancel and reissue the compromised cards, investigate claims of fraudulent activity, and reimburse customers for fraudulent charges (among other things).” The bank class sought monetary damages for the cost of these responses, as well as declaratory and injunctive relief to force the retailer to improve its security measures.

After denying in part the retailer’s motion to dismiss the complaint, the parties engaged in discovery. While the case progressed, the banks, the retailer, and the credit card brands (e.g., Visa and Mastercard) entered into “the card-brand recovery process[,] which the Court described as essentially a private dispute resolution arrangement based on contracts with merchants (like the retailer) that outline the terms for accepting credit and debit cards as payment.

The Court described the card-brand recovery process as follows: Visa and Mastercard contract with banks “that issue their branded cards to customers. In turn, the banks have contracts with the merchants who accept cards as payment. These contracts include regulations for protecting payment-card data against the threat of a data breach [and] also establish procedures for merchants to reimburse the banks for losses in the event that card information is compromised in a data breach.”

After going through the process, Visa and Mastercard together assessed $120 million against the retailer to be paid to banks. The retailer agreed “to pay the full amount plus a premium … in exchange for the banks releasing their claims against” the retailer.

The larger banks, the retailer, Visa and Mastercard achieved a settlement where the retailer would pay the full amount of the assessment, plus about a 10 percent premium payable to the banks that release their claims.

The class counsel objected to the proposed deal, accusing the retailer of improperly offering “misleading and coercive” releases without the court’s permission. “Specifically, the offers did not say how much the banks would receive from the settlement or whether the banks would still receive their share of the assessments even if they did not agree to the settlement.” Accordingly, the class counsel filed a motion “to vacate the releases, to send curative notices to class members, and to protect class members from misleading settlement attempts going forward.”

The trial court found “that the release offers were misleading and coercive[,]” but did not vacate the releases, instead allowing “Class Counsel to pursue discovery relating to the release offers.”

After a flurry of discovery disputes and motions, the trial court “stayed discovery pending settlement negotiations.”

Eventually, most of the larger banks representing 70 to 80 percent of the compromised payment cards accepted the releases, and the retailer “paid these banks a total of $14.5 million (a premium on top of the $120 million in assessments).”

The parties returned to the litigation and engaged in three rounds of mediation, which resulted in a proposed settlement agreement that was presented for the trial court’s approval.

The proposed class definition excluded “those banks that released their claims against [the retailer] by accepting the release offers[,]” but included “smaller banks who did not contract directly with the card brands[.]” The smaller banks were not excluded from the class “because Class Counsel contest[ed] the validity of their releases….”

The retailer also “agreed to pay $25 million into a settlement fund” to “be used to pay any taxes due and to pay any service awards to class representatives,” and the remainder of the fund would be distributed to class members who had not released their claims.” The retailer also “agreed to pay up to $2.25 million to some of the smaller banks,” “to adopt security measures to protect its data[,]” and to “pay the ‘reasonable attorneys’ fees, costs and expenses’ of Class Counsel.” The attorney’s fees would not be paid “from the 25 million set aside for class members.”

The trial court approved the settlement agreement and reserved ruling on the amount of attorney’s fees. The parties then bitterly contested which method should be used, “the percentage method or the lodestar method.” Under the percentage method, “courts award counsel a percentage of the class benefit[,] [which] generally includes any benefits resulting from the litigation that go to the class. In the Eleventh Circuit, “courts typically award between 20-30%, known as the benchmark range.”

“Under the lodestar method, courts determine attorney’s fees based on the product of the reasonable hours spent on the case and a reasonable hourly rate. … The product is known as the lodestar. Sometimes courts apply to the lodestar a multiplier, also known as an enhancement or an upward adjustment, to reward counsel on top of their hourly rates.”

The class counsel argued that the trial court “had discretion to choose either the lodestar or the percentage method” and “requested $18 million in fees.” The retailer on the other hand argued that the trial court “had to use the lodestar method, and based on its calculations, a reasonable fee would be about $5.6 million.”

After a hearing, the trial court adopted the lodestar approach, awarding about $11.7 million, and then applied “the same multiplier used in the consumer-track settlement, 1.3, to arrive at a reasonable fee of $15.2 million.” The trial court also “employed the percentage method as a cross-check on the lodestar.” The parties agreed that “the class benefit should include the $5 million settlement fund, the $2.25 million [the retailer] agreed to pay to some smaller banks”, and $710,000 in expenses.

The trial court agreed with the class counsel’s argument that the class benefit should include the $14.5 million premiums that the retailer paid to banks in exchange for releases as part of the card-brand recovery process, “finding that they were ‘substantially motivated by the pendency of this litigation.’”

The trial court refused to “include any attorney’s fees in the class benefit, because this was not a ‘true common fund analysis.’” In sum, the total “class benefit equaled about $42.5 million.” Because “an attorney’s fee of $15.3 million is slightly more than a third of the class benefit,” the trial court “concluded that the percentage crosscheck supported the reasonableness of the fee award.”

The retailer appealed the attorney’s fee award, arguing first that it was an abuse of discretion for the trial court to apply a multiplier. The retailer also argued that “it was an abuse of discretion to compensate Class Counsel for time spent litigating about the card-brand recovery process.” In addition, the retailer argued that “it was an abuse of discretion to compensate Class Counsel for time spent soliciting class representatives.” Lastly, the retailer argued that the trial court’s order improperly “fails to provide sufficient detail for meaningful appellate review.”

The class counsel cross-appealed, arguing that if the retailer’s appeal was successful and the case remanded, the trial court should “include attorney’s fees in the class benefit when it performs the percentage method—either as a cross-check or in the first instance.”

Before addressing the four arguments raised by the retailer, the Eleventh Circuit addressed the “preliminary question on which much of the subsequent analysis turns: whether this is a common fund or fee-shifting case.”

The Court first explained the so-called traditional “American Rule” under which “[e]ach litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise.” However, “[t]here are three exceptions to the American Rule: (1) when a statute grants courts the authority to direct the losing party to pay attorney’s fees; (2) when the parties agree in a contract that one party will pay attorney’s fees; and (3) when a court orders one party to pay attorney’s fees for acting in bad faith. … These exceptions—when one party pays for the other’s attorney’s fees—describe fee-shifting cases.”

The Court then reasoned that although some courts, including the Eleventh Circuit, “have described common-fund cases as an exception to the American Rule[,] … [t]hat is incorrect.”

“A common-fund case is when ‘a lawyer who recovers a common fund for the benefit of persons other than himself or his client is entitled to a reasonable attorney’s fee from the fund as a whole. … This is typical in class actions … [and] [c]ommon fund cases are consistent with the American Rule, because the attorney’s fees come from the fund, which belongs to the class. In this way, the client, not the losing party, pays the attorney’s fees.”

Thus, the Eleventh Circuit noted, “the key distinction between common-fund and fee-shifting cases is whether the attorney’s fees are paid by the client (as in common-fund cases) or by the other party (as in fee-shifting cases).” After applying this standard, the Court concluded that it was dealing with “a fee-shifting case.”

First, the Eleventh Circuit noted, the settlement agreement provides that the retailer “will pay the attorney’s fees. … Even more explicit, the agreement goes on to state that ‘[a]ny award of attorney’s fees, costs and expenses shall be paid separate from and in addition to the Settlement Fund.’ That sounds like fee shifting.”

The Court rejected the class counsel’s argument that the fee-shifting arrangement in the settlement agreement should be treated “as a constructive common fund[,]” explaining that although “courts will often classify the fee arrangement as a ‘constructive common fund’ that is governed by common-fund principles even when the agreement states that fees will be paid separately[,] … [b]ased on a proper understanding of the doctrine of constructive common funds, we find that it does not apply to this case.”

This, the Eleventh Circuit held, is because “the rationale for the constructive common fund is that the defendant negotiated the payment to the class and the payment to counsel as a ‘package deal.’.. But this package-deal reasoning does not apply here. Put simply, there was no package: [the retailer] did not negotiate the attorney’s fees simultaneously with the settlement fund. The fees were left entirely to the District Court’s discretion.”

The Court held “that the constructive common fund does not apply when the agreement provides that attorney’s fees will be paid by the defendant separately from the settlement fund, and the amount of those fees is left completely undetermined. We construe the settlement agreement here as a fee-shifting arrangement.”

Turning to the issues raised on appeal by the retailer, first, the Eleventh Circuit agreed with the retailer’s argument “that it was error for the District Court to enhance Class Counsel’s lodestar based on risk.” After reviewing the precedent from the Supreme Court of the United States dealing with statutory fee-shifting cases decreeing that “courts could not use a multiplier in statutory fee-shifting cases to account for risk,” the Court considered whether those precedents applied in “a contractual fee-shifting arrangement”, concluding that the Supreme Court’s “prohibition on enhancements for risk applies to contractual fee-shifting cases when courts use the lodestar method.

Thus, the Eleventh Circuit held that the trial court “abused its discretion in applying a multiplier on the basis of the ‘exceptional risk that class counsel took in litigating this case.’”

Turning to the second issue raised on appeal — whether the trial court “abused its discretion by compensating Class Counsel for the time spent litigating about the card-brand recovery process” — the Court reasoned that because the class counsel’s fees derived from a contract and not a fee-shifting statute with “prevailing party” language, “the question is simply whether the time spent was reasonable, which is the standard set in the agreement.”

“Time spent is reasonable, and thus compensable, if it would be proper to charge the time to a client.” Using this standard, the Court concluded that “it was firmly within the District Court’s discretion to compensate Class Counsel for time spent challenging the release offers.” “To hold otherwise would be to say, as a matter of law, that it is unreasonable for Class Counsel to ever oppose a settlement.”

Turning to the third issue on appeal, the Court held that “it was not an abuse of discretion to pay Class Counsel for their time spent finding and vetting class representatives.” This is because “[s]electing proper class representatives is an important part of what class counsel does. And counsellors should be paid for work reasonably done on behalf of their clients.”

On the fourth issue raised by the retailer — the trial court’s order “does not allow for meaningful review[,]” the Court disagreed, holding that “we are not left in doubt about what the District Court decided and why.”

Having “held that the District Court abused its discretion by applying a multiplier to account for risk,” the Court turned to the class counsel’s cross-appeal challenging “the way the District Court performed the cross-check.”

The Eleventh Circuit held that courts “often use a cross-check to ensure that the fee produced by the chosen method is in the ballpark of an appropriate fee.”

“As the percentage method awards class counsel a percentage of the class benefit, the first step is to determine what constitutes the class benefit.” The class counsel argued that “the District Court should have included the attorney’s fees in the class benefit.” The retailer countered “that the District Court should not have included in the class benefit the $14.5 million premium that [the retailer] paid to banks in exchange for releases as part of the card-brand recovery process.”

The Court reasoned that “[w]hile Class Counsel is correct that attorney’s fees are generally included in the class benefit in common-fund cases, it does not make sense to do so in fee-shifting cases.” This is because “there is no constructive common fund in this case because the parties left the amount of attorney’s fees completely undetermined. Instead, they negotiated a pure fee-shifting arrangement. For this reason, Class Counsel’s argument to include attorney’s fees in the class benefit fails. Conceptually, if the fees are paid separately, they never belonged to the class, so they should not be included in the class benefit.”

Turning to the retailer’s argument that “the District Court should not have included the $14.5 million premiums it paid to banks in exchange for releases[,]” the Court explained that “[c]ounsel is entitled to compensation for its efforts that create, enhance, preserve, or protect a common fund.” Thus, the Eleventh Circuit held, “the question is whether Class Counsel deserves credit for the $14.5 million premiums that [the retailer] paid to putative class members to settle their claims.”

The Court rejected the retailer’s argument “that the releases were unrelated to the class litigation[,]” concluding that the “District Court was well within its discretion to conclude that the release payments were ‘substantially motivated by the pendency of this litigation.’”

The Eleventh Circuit reasoned that “a rule establishing that class counsel can get no credit for settlements with putative class members done before the class as a whole settles would entrench the very unjust enrichment and collective-action problem that class actions are designed to solve. Plus, ‘[t]here is no question … that federal courts may award counsel fees based on benefits resulting from litigation efforts even where adjudication on the merits is never reached, e.g., after a settlement.’”

Therefore, the Eleventh Circuit affirmed the trial court’s ruling “in all respects except one: it was an abuse of discretion to use a multiplier to account for risk in a fee shifting case.” The trial court’s judgment was therefore affirmed in part, vacated in part and remanded for further proceedings.