In a recent decision, In re Baby Products Antitrust Litigation, 2013 U.S. App. LEXIS 3379 (3d Cir. Feb. 19, 2013), the Third Circuit vacated the district court’s order approving a $35.5 million class action settlement which provided for the distribution of remaining settlement funds, after individual distributions were made to claimants and costs and attorneys’ fees paid, to charitable organizations pursuant to the cy pres doctrine (which is frequently used in class action settlements where it is difficult to identify and distribute payments directly to class members).  The court found that the settlement resulted in a “surprising allocation of the settlement fund,” in which $14 million would go to attorneys’ fees and expenses, $3 million to class members, and the remaining $18.5 million to cy pres recipients.  The court found that “[c]y pres distributions, while in our view permissible, are inferior to direct distributions to the class because they only imperfectly serve the purpose of the underlying causes of action – to compensate class members.” 

The consolidated class action where the settlement arose involved allegations that the defendants, including Toys “R” Us, Babies “R” Us, and Baby Bjorn conspired to set a price floor for the sale of certain baby products, which caused consumers to pay increased prices (an average 18% overcharge) for these products, which cost up to $300.  In outlining the settlement reached in that litigation, the Third Circuit noted that the distribution to class members involved three different compensation levels:  (1) class members who submitted valid documentary proof of purchase and proof of the actual price paid were eligible to receive 20% of the actual purchase price of each product; (2) class members who submitted valid documentary proof of purchase, but not proof of the actual price paid were eligible to receive 20% of the estimated retail price of each product purchased; and (3) class members who did not submit any proof of purchase were eligible to receive a payment of $5.  Claims in the first two categories were subject to pro rata enhancements.  The court noted that at the time of the final fairness hearing, which occurred before the deadline for claims submission, the district court estimated that approximately $8.1 million would be distributed to class members (assuming 20% of a $300 baby product on 45,000 claims since 41,000 had already been submitted).  However, the Third Circuit found that the district court did not know at the time it approved the settlement that the vast majority of claims fell into the $5 category, resulting in a distribution of only $3 million to class members, and therefore, did not have the necessary factual information to determine whether the settlement “was fair to the entire class.”

The Third Circuit declined to find that cy pres distributions were only appropriate “where further individual distributions are economically feasible,” but stated that “[b]arring sufficient justification, cy pres awards should generally represent a small percentage of the total settlement funds.”  The court noted that the class members in the first two categories were fully compensated for their losses, but that those class members in the third category who received $5 were not.  The court stated that on remand, “[w]e place no absolute requirement on the amount of direct compensation the third category of claimants must receive,” and “do not limit cy pres distributions to instances where all claimants have received 100% of their estimated damages.”  However, the court said it was “concerned” that the district court “approved the settlement without being made aware that almost all claimants would fall into the $5 compensation category, resulting in minimal (and we doubt sufficient) compensation going directly to class members,” given that the baby products at issue cost up to $300, which at an 18% overcharge, resulted in damages of over $50.

The Third Circuit also vacated the district court’s order awarding $14 million in attorneys’ fees and costs because that award was based on the vacated settlement.  The court declined to resolve whether the awarded fees were reasonable, but noted that district courts have the discretion on a case by case basis to determine whether an attorneys’ fee award should be reduced where a settlement includes a cy pres distribution.  The court stated “that awarding attorneys’ fees based on the entire settlement amount rather than individual distributions creates a potential conflict of interest between absent class members and their counsel” because class counsel may be motivated to settle lawsuits in a manner that is detrimental to the class.  The court noted that there is a concern that some class actions are brought primarily for the benefit of class counsel and that “[c]y pres awards – by ensuring that a settlement fund is sufficiently large to command a substantial attorneys’ fee – can exacerbate this problem.”  Thus, “[w]here a district court has reason to believe that counsel has not met its responsibility to seek an award that adequately prioritizes direct benefit to the class, we therefore think it appropriate for the court to decrease the fee award.”  With respect to the case at hand, the court noted that “the current distribution of settlement funds arguably overcompensates class counsel at the expense of the class.”

This decision follows the Ninth Circuit’s decision in Dennis v. Kellogg Company, 697 F.3d 858 (9th Cir. 2012) (previously discussed on this blog here and here), in which the Ninth Circuit vacated a $10.6 million settlement providing for a cy pres donation of $5.5 million worth of products to charities that feed the indigent (the settlement established a $2.75 million fund to distribute to class members who could each receive $5 per box of cereal purchased, up to $15).  The Ninth Circuit found that the cy pres distribution had an insufficient connection to the suit’s class members and claims, which involved allegations that Kellogg falsely advertised that its Frosted Mini-Wheats cereal improved attentiveness in children.  Accordingly, the Ninth Circuit reversed the district court’s order approving the settlement. 

Taken together, these decisions make it clear that courts, particularly in cases involving the purchase of consumer products, are increasingly scrutinizing any class action settlements that provide for distributions to charitable organizations pursuant to the cy pres doctrine, and may either decline to approve such settlements at the district court level or potentially reverse approval of such settlements at the circuit court level.  Even outside these circuits, parties should carefully craft any cy pres distribution to account for the expected claims rates in the case and to consider whether any cy pres funds will be used for purposes sufficiently connected to the claims in the case.