On June 2, 2014, the Seventh Circuit issued a searing opinion authored by Judge Posner reversing a judgment and rejecting a class action settlement approved by the district court.  Saltzman, etal. v. Pella Corporation and Pella Windows and Doors, Inc., No. 13-2091, 2133, 2162, 2202, 2014 WL 2444388 (7th Cir. June 2, 2014).  This opinion represents the latest example of federal courts applying greater scrutiny to class action settlements. In Pella, the Seventh Circuit determined that the settlement agreement—which was purportedly worth $90 million to the class—was actually only worth $8.5 million at best, and was “inequitable—even scandalous” in light of the $11 million in attorneys’ fees awarded to class counsel, who happened to be the lead class representative’s son-in- law. On the basis of these conflicts of interest and several other considerations, the Court held that the “settlement should have been disapproved on multiple grounds.”

The underlying claims in Pella—which has been pending since 2006—allege violations of product- liability and consumer protection statutes in connection with casement windows sold by defendant Pella Corporation.  Prior to settlement, the district court had certified two classes: one for customers who had already repaired or replaced their defective windows and another for customers who had not.  Though additional named plaintiffs would eventually be added, Leonard Saltzman was the initial named plaintiff, and his son-in-law, Paul M. Weiss, was lead class counsel. Weiss’ wife— Saltzman’s daughter—was a partner in Weiss’ firm.

Weiss negotiated a settlement with Pella in the fall of 2011. Prior to the deadline for class members to file claims, the district court granted final approval of the settlement. The settlement, which ignored the certification of the separate classes and purported to bind a single nationwide class—the first of many red flags the Seventh Circuit spotted—obligated Pella to pay $11 million in attorneys’ fees to class counsel, but did not specify an amount to be received by the class members.  Rather, the agreement detailed a claims process whereby class members could submit a claim directly to Pella with a maximum award of $750, or submit a claim to arbitration with a $6,000 damages cap.  Important to the Seventh Circuit, the agreement gave Pella the right to assert various defenses in arbitration, did not shift a victorious claimant’s fees to Pella, and provided that some claimants would only be entitled to coupons, “a warning sign of a questionable settlement.”  And, some class members were only entitled to an extension of warranty under a program that Pella had adopted before the settlement.

While Weiss argued that the settlement was worth $90 million to the class, the Seventh Circuit noted that Pella itself only estimated the class would recover $22.5 million.  After exhaustively examining the damages cap for each class member, the length and complexity of the claims forms, and the average class member’s unfamiliarity with arbitration, Judge Posner determined that the aggregate value of the settlement was actually only $8.5 million given all the obstacles to recovery the settlement imposed.  This set the stage for an appeal by objecting class members.

Judge Posner detailed several grounds on which the agreement should have been rejected.  First, the fact that lead class counsel was the named plaintiff’s son-in-law created a “grave conflict of interest” because the larger the fee award to class counsel, the better off Saltzman’s daughter and son-in-law would be financially.  This conflict of interest was exacerbated by Weiss’s financial woes: Weiss was the subject of two lawsuits accusing him—and his wife—of misappropriating funds from their former law firm, and Weiss also needed money to finance his new law firm.  This perhaps explains a $2 million advance in attorneys’ fees that Weiss negotiated with Pella before notice of the settlement was even sent to the class members—a payment the Seventh Circuit found suspicious.

Moreover, Weiss was embroiled in a disciplinary proceeding with the Illinois Attorney Registration and Disciplinary Commission at the time the settlement agreement was negotiated.  This should have been enough to remove Weiss as class counsel because, according to Judge Posner, “[i]t was very much in his personal interest, as opposed to the interest of the class members, to get the settlement signed and approved before the disciplinary proceeding culminated in a sanction that might abrogate his right to share in the attorney’s fee award in this case.”  Thus, “Weiss was unfit  to represent the class” and negotiated a settlement that “sold out the class” in order to best serve his needs.

Finally, Judge Posner found that Saltzman and the other class representatives failed to adequately protect the interests of the class under Federal Rule of Civil Procedure 23(a)(4).  In addition to Saltzman, four other class members were subsequently added as named plaintiffs.  After they opposed the settlement in the district court when it was up for preliminary approval, those individuals were replaced by four other class members that joined Saltzman in supporting the agreement, and were granted incentive awards.  Saltzman and these class representatives failed to fairly and adequately represent the interests of the class when they approved a settlement that was “stacked against the class.”

Thus, according to Judge Posner, “almost every danger sign in a class action settlement that [courts] have warned district judges to be on the lookout for was present in this case.”  The “settlement flunked the ‘fairness’ standard by the one-sidedness of its terms and the fatal conflicts of interest on the part of Saltzman and Weiss.”  As a result, the Seventh Circuit ordered that Weiss and Saltzman be replaced as class counsel and class representative, respectively, and reinstated as class representatives the original four named plaintiffs that had been replaced earlier.  The judgment was reversed and the case was then remanded back to the district court.

The Pella decision offers several lessons for companies and counsel when settling consumer class actions.  First, it is a strong reminder that settlement agreements in class actions must balance the interests of the class with the interests of class counsel; a deal that seems too good to be true just might be.  And, to avoid the risk of an appeal overturning a settlement—after the costs of getting the settlement approved and the class notified have been incurred—defense counsel should take steps to ensure that the district court is given an accurate and reasonable estimation of the settlement value to the class.  Finally, Pella should once again remind defense counsel to carefully consider adequacy of representation, both by the named plaintiff(s) and class counsel, when opposing class certification.