The Sixth Circuit Court of Appelas recently vacated a class action settlement that had resolved no fewer than three separate class lawsuits involving more than 1.4 million class members across the country. Though the settlement resembled many that have sailed through fairness hearings before, the Sixth Circuit took exception to several aspects of the agreement and made new law in the process.

The Cases

Vassalle v. Midland Funding LLC, __ F3d __, 2013 U.S. App. LEXIS 3914 (6th Cir. February 26, 2013) was one of three separate cases involving a “debt buyer” that had engaged in “robo-signing” in connection with its debt collection lawsuits.

Midland Funding, an affiliate of a billion-dollar publicly traded entity called Encore Capital Group, is not a traditional lender. Instead, it purchases debt from the original lenders who, for various reasons, write off the accounts and sell them at a discount to Midland. Midland then sues on the debt, but does not possess the original contracts or any of the underlying account documentation to support the obligation.

Midland was accused of filing debt collection actions based on affidavits signed by employees claiming personal knowledge of the debts, when, in fact, they did not possess any such knowledge. Id. at *4. It turned out that Midland’s employees were producing between 200 and 400 of these computer-generated affidavits each day. Id. ss actions as

In the oldest of the three cases, Midland Funding v. Brent, the district court eventually ruled that the robo-signed affidavits violated the FDCPA, certified a nationwide class and denied the defendant’s request for actual damages under the FDCPA. The court must have thought that the defendant really did owe the money after all, and thus found that there were no actual damages — just claims for statutory damages and attorneys’ fees. Id. at *4-5.

The Settlement

Perhaps because of the rulings, the parties decided it was time to settle. They stipulated to a class defined as those who had been sued by Midland “in any debt collection lawsuit in any court . . . where an affidavit attesting to facts about the underlying debt was used by Midland in connection with the debt collection lawsuit.” Id. at *6.

The key elements of the settlement were:

  • $5.2 million paid into a common fund;
  • $1.5 million in attorneys’ fees and costs of claims administration paid from the fund;
  • $2,000 in incentive awards to each of the four class representatives;
  • Individual class claims worth $17.38;
  • Broad releases to class representatives absolving them from any liability for their underlying debts;
  • Narrow releases for unnamed class members reserving Midland’s right to continue suit for the underlying debt and prohibiting the class members from raising the robo-signed affidavit as a defense to the suit; and
  • A one-year injunction ordering Midland to develop practices to avoid the misconduct in the future, supervised by a retired federal judge.

Id. at *6-9.

Under one form of the release, the class representatives’ debts were fully released. Id. at *7-8.

Class members, on the other hand, were required to release Midland from all claims “arising out of or relating to the Released Parties’ use of affidavits in debt collection lawsuits.” Id.

According to the claim notice approved by the parties and the court, the release meant “you can’t sue or be part of any other lawsuit against [Midland] about the claims or issues in this lawsuit, or any other claims arising out of affidavits attached or executed in support of collection complaints filed against” class members. Id. at *25-26 (emphasis added).

Midland thus reserved the right to continue collecting the debts of these class members, while the class members were barred from raising the bona fides of the supporting affidavits as claims or defenses.

Following approval of the settlement, only 9.2 percent of eligible class members (133,000 of 1.4 million) actually submitted claims. Only 0.3 percent opted out. Id. at *8.

The Problems

The Sixth Circuit’s first issue with the settlement was basic fairness: the court found that the settlement favored the class representatives to the detriment of the other 1.4 million class members. In doing so, the court made new law.

The Sixth Circuit first recited the familiar factors to be considered by a district court in assessing the fairness of a class settlement:

  • The risk of fraud or collusion;
  • The complexity, expense and likely duration of the litigation;
  • The amount of discovery engaged in by the parties;
  • The likelihood of success on the merits;
  • The opinions of class counsel and class representatives;
  • The reaction of absent class members; and
  • The public interest.

Id. at *11-12 (quoting UAW v. Gen. Motors Corp., 497 F.3d 615, 631 (6th Cir. 2007)).

The court found that each of these factors was satisfied. Id. at *14.

But the court then looked to an eighth factor “not included in the seven UAW factors”: “whether the settlement ‘gives preferential treatment to the named plaintiffs while only perfunctory relief to unnamed class members.’” Id. at *12-13 (quoting Williams v. Vukovich, 720 F.2d 909, 925 n.11 (6th Cir. 1983)). In so doing, the Sixth Circuit joined two other circuits that recognize this factor. Id. at *13.

Preferential Treatment

Applying the “preferential treatment” test, the court concluded that the settlement was not fair because of “the disparity in the relief afforded under the settlement to the named plaintiffs, on the one hand, and the unnamed class members, on the other hand.” Id. at *14. Two factors drove this conclusion:

  • The class representatives’ debts were extinguished, but the class members’ debts were not; and
  • The class representatives received $2,000 in incentive payments, while the class members received only $17.38.

Id. at *15-16.

The first concern is fair enough. It is difficult to accept a “release” that permits the underlying claim to proceed while stripping the class members of defenses based on the very act declared to have been deceptive in the first place. In effect, the $17.38 award was nothing more than an offset to Midland’s underlying claims.

The second issue is far more significant. Incentive awards are routinely given to class representatives, and $2,000 is not unusual. And a $17.38 payment for class members is better than other settlements that courts have previously approved. But the court suggested that incentive awards may not be appropriate in any form. Observing that the Sixth Circuit — unlike some sister circuits — has never “explicitly passed judgment on the appropriateness of incentive awards,” the court stopped short of addressing the question directly because it found the settlement to be so unfair on its face. Id. at *15-16. Indeed, it was the “exoneration of the named plaintiffs’ debts” that obviated the need for the court to expressly address the “appropriateness of incentive awards.” Id. at *15.

But the fact that the issue surfaced at all in connection with a $2,000 award strongly suggests that anything other than a truly nominal incentive award — at least in the absence of “some justification” for the inequity — may not pass muster in the Sixth Circuit. See id at *13, n.1.

Perfunctory Relief

The court also described the class award as “perfunctory.” Why? Because the $17.38 award was “de minimis,” and the injunction was neither long enough nor tough enough. Id. at *16.

The court described $17.38 payment as “de minimis . . . in comparison to the now-forgiven debt of $4,516.57 owed by” the named plaintiff, and “assume[d] that many of the 1.44 million class members’ debts are in the thousands or at least hundreds of dollars.” Id.

Although the decision never said so, it appears that the $17.38 payment resulted from dividing the number of claims by the amount remaining in the common fund following payment of attorneys’ fees and administrative costs. The court did not suggest that the fees were too high or that they should not have been paid from the settlement fund.

The striking thing about the court’s analysis is its categorical rejection of a $17.38 payment as fair to class members. Its comparison of the payment to the forgiven debt is made only as a secondary point, thus suggesting that the court was uncomfortable with the amount of the payment itself.

The court was also critical of the “one-year injunction” because “it does not actually prohibit Midland from creating false affidavits,” and because “Midland is free to resume its predatory practices should it choose to do so” following expiration of the injunction. Id. at *17.

The court’s first concern could easily have been addressed. The injunction could be modified to mandate a prohibition on creating false affidavits. Moreover, between the court rules prohibiting robo-signed affidavits and the precedent of this case, there are lots of “prohibitions” on creating “false affidavits.”

The more interesting issue is the court’s suggestion that the injunction wasn’t long enough: “the injunction only lasts one year, after which Midland is free to resume its predatory practices should it choose to do so.” Id.

What difference does the length of the injunction make? Even if it were subject to a 10-year injunction, Midland could still “resume its predatory practices should it choose to do so.” What’s more, an injunction that purports to enforce lawful behavior accomplishes nothing that isn’t already required of any litigant. Why single out Midland? And why squander the equitable power of the court?

The Sixth Circuit offered no guidance as to the appropriate length or form of an injunction, nor did it acknowledge the changes in Midland’s practices implemented prior the settlement. Instead, the court leaves the parties — and the district court — to guess as to how best comply with the decision.

Lessons Learned

Here are the lessons from the Midland Funding case:

  • The fairness of a class settlement must now take into account the new “preferential treatment” test: whether there is a significant disparity between the relief afforded the class representative and other class members, and whether the relief afforded to unnamed class members is merely “perfunctory.”
  • Incentive awards to class representatives in any amount may be subject to heightened scrutiny and may render the entire settlement unfair to class members.
  • Be wary of including any type of structural injunction in a class settlement. And if you do, the Midland case suggests that one year will be too short, no matter what corrective policies have been implemented during the litigation. Unpopular defendants may not get credit for “time served.”