In late 2011, SDNY Judge Jed Rakoff rejected a $285 million dollar proposed settlement between the S.E.C. and Citigroup concerning mortgage backed securities fraud.  The ruling grabbed headlines at the time, with commentators citing it as a rebuke of SEC’s practice of settling cases without extracting an admission of wrongdoing by corporate defendants.  In retrospect, it strikes us that courts have shown an increasing willingness to subject proposed settlements to closer scrutiny since Judge Rakoff’s ruling, whether in the class action or public enforcement context.  True, the Second Circuit reversed Judge Rakoff but that does not change the fact that the Sixth Circuit rejected a proposed class action settlement last August on the grounds that it left “unnamed class members with nothing but nearly worthless injunctive relief,” or that a federal court in California rejected a class action settlement this April because incentive awards to the lead plaintiffs undermined the fairness of the settlement.  

And, more recently, the Seventh Circuit pointedly rejected a proposed class action settlement in an opinion penned by Judge Richard Posner.  The decision in Eubank v. Pella Corp., Nos. 13-2091 et al., slip op. (7th Cir. June 2, 2014) has garnered a fair amount of attention, and for good reason: not only does Judge Posner dismiss the settlement as “scandalous,”  he also drubs the plaintiffs’ attorneys for ethical breaches and muses in general about the potential for class actions to be abused.  While addressing a unique set of facts, the Seventh Circuit decision — like the others mentioned above – provides some useful takeaways for defense counsel to consider when negotiating settlements.

First, a bit about the Pella case.  A putative class filed suit in the summer of 2006 against defendant Pella Corporation alleging that its “ProLine Series” casement windows manufactured and sold between 1991 and 2006 had a design defect that allowed water to enter and damage the window’s wooden frame and the house itself.  The plaintiffs alleged that the windows violated the product liability and consumer protection laws of a number of states in which the windows were sold.  The district court certified two classes of plaintiffs, one for customers who had already repaired or replaced their windows, the other for those who hadn’t.  The former class sought damages and was limited to six states.  Pella Corp. v. Saltzman, 606 F.3d 391 (7th Cir. 2010) (per curiam).  Class counsel negotiated a settlement of the class action with Pella in the fall of 2011, and the district judge gave final approval in 2013 over the objections of certain class members.  But here’s where things get really interesting: the son-in-law of the initial lead plaintiff was lead counsel for the class, had sole discretion to allocate the award of attorneys’ fees, and proposed allocating 73 percent of his fees to his own firm.  In addition, the lead plaintiff’s daughter was a partner in that firm, which disintegrated while the litigation was ongoing and spawned a messy series of lawsuits alleging misappropriation of funds.  As if that wasn’t enough to raise red flags, the Illinois Bar recommended that lead plaintiff counsel be suspended for 30 months because of repeated misconduct.  Still, the district court approved the proposed settlement.

Against this backdrop, Judge Posner assailed the “impropriety of allowing [lead plaintiff] to serve as class representative as long as his son-in-law was lead class counsel,”  particularly since four other class representatives all objected to the terms of the settlement that was ultimately approved, which called for Pella to pay $11 million in attorneys’ fees to class counsel but did not specify the amount that class members would receive.  Equally troubling was that class members who opposed the settlement were not eligible to receive “incentive awards” of $5,000 to $10,000.  The judge also attacked the district court’s failure to quantify the benefits of the proposed settlement to class members, much less address any of the objections raised by members of the class who opposed the terms of the settlement, admonishing that a court must “make sure that class counsel are behaving as honest fiduciaries for the class as a whole.”  Finally, Judge Posner raised the ethical problems of lead plaintiff counsel, citing them as a “compelling reason for kicking him and [lead plaintiff] off the case.”   Judge Posner concluded that lead plaintiff and lead plaintiff counsel failed to satisfy FRCP 23(a)(4)’s requirement that the representative parties fairly and adequately represent the interests of the class.  (“Class counsel sold out the class.”)  Judge Posner thus ordered the removal of lead plaintiff and lead plaintiff’s counsel.

The decision is notable for more than just its colorful language.  Indeed, there are some nuggets of wisdom to be gleaned by defense counsel, particularly since Pella and its attorneys did not escape Judge Posner’s wrath, as he all but accused them of pushing a settlement that “is stacked against the class.”  It should not come as a surprise to the judiciary that defense attorneys want to reach a settlement that is as favorable as possible to their client.  It’s not only common sense, it’s an ethical obligation.  That said, when negotiating a settlement it behooves defense counsel to ask whether the terms of the agreement provide any meaningful benefit to the class.  This is not to suggest that the defense needs to do the thinking for the plaintiffs’ lawyers, not at all.  It’s more about being pragmatic; if your client is going to pay a significant sum to settle the case, wouldn’t you rather the money go to remedying the alleged issue rather than to opposing counsel?  Whether intentionally or not, Judge Posner’s opinion suggests that defense counsel should not ignore this consideration when hashing out the terms of a settlement, else the certainty and avoidance of risk that they hoped to obtain may prove illusory.