The other day, a colleague tipped me off to a December 2009 blog posting by Oakland, California employment and civil rights attorney Bryan Schwartz entitled Death to the Reversionary, “Claims-Made” Settlement, a thoughtful, well-written article with which I completely disagree and to which I felt compelled to respond. Schwartz is critical of what he alternatively calls “reversionary” or “claims-made” settlements and proposes that plaintiffs’ firms adopt strict policy of refusing to enter into them. His critique may be best summarized in the following excerpt, although I would encourage reading the entire article:
The idea of a reversionary, claims-made settlement is that the defendants will actually be paying “up to” the amount indicated, depending on the number and value of the claims that are submitted. So, if only 50% of eligible claims are submitted, then defendants may wind up paying only half of the agreed-upon amount, with the rest reverting to defendants, though the plaintiffs’ attorneys still collect fees on the full settlement amount. Though many courts no longer permit this practice, defendants still frequently try to offer claims-made (aka reversionary) settlements (which can be easy to sell to the corporate client – “I know X sounds bad, but you’re really only paying Y, so don’t worry!”). Some plaintiffs’ counsel may still agree to claims-made/reversionary settlements, too – but I urge you not to do so!
Schwartz’s critique has surface appeal, and is no doubt shared by many plaintiffs’ lawyers and even judges. However, I would respectfully urge lawyers and judges alike not be too quick to dismiss the possible benefits of these settlement structures for all parties and the courts. If done properly, claims-made settlements provide a unique mechanism for resolving disputes that is both fair to all parties and reduces unnecessary burdens on the court system.
I wrote an article for ProductLiabilityLaw360 in 2008 in which I summarized different possible class action settlement structures and discussed the benefits of claims-made settlements over various alternatives (See full article here). In that article, I drew a distinction between a true “claims-made” settlement and a settlement that involves a pre-determined capped fund with a reversion to the defendant. The quoted section from Schwartz’s article above appears to refer to the latter structure. By contrast, what I would consider a true “claims-made” settlement would be a settlement in which each class member is given the right to make a claim in a predetermined amount or based on a predetermined formula, but the total amount of the potential payments are not capped, and attorney’s fees and costs are paid separately and not taken out of any fund used to pay claims. Unlike the structure described by Schwartz, the Defendant in this type of claims-made settlement takes on the risk, at least theoretically, that it will have to pay 100% of all claims submitted, plus fees and costs. Typically, if the settlement involves a set fund with a reversion, fees and costs are taken out of the fund first, and benefits to class members are reduced pro-rata if there is not enough money left in the fund to pay 100% to all claimants. Any unclaimed amounts revert to the defendant if, after paying all fees and costs and 100% of money claimed by class members, there is still money left over. Despite these technical differences, however, both structures are subject to many of the same criticisms as outlined in Schwartz’s article, and I will not dwell on the differences in the discussion that follows but will rather refer to them both as “claims-made” settlements.
One of the main ideas in my 2008 article was that claims-made settlements can be beneficial to all of the true stakeholders. By true stakeholders, I mean the named plaintiffs, their counsel, the defendant, the courts, and all class members who can be reached and who care to participate. The main factor in making a claims-made settlement fair is in doing everything possible to ensure the best notice practicable, so that all class members have a fair opportunity to participate in the settlement. In my view, this should be the primary goal, not forcing class members to benefit from a settlement or forcing a defendant to pay whether or not class members benefit. Class members who receive notice may choose not to participate in claiming settlement benefits for any number of completely legitimate reasons, including that they don’t want to be bothered, they disagree with class actions generally, or they don’t feel strongly that the defendant did anything wrong. In some cases, it is impossible to reach a portion of the class, so there is no way to benefit class members directly even assuming that they would have wanted to participate.
With these principles in mind, I have outlined below a few of the key criticisms leveled at claims-made settlements, with a brief response to each. Whether my responses carry the day will obviously be left to the individual reader, but I would hope that anyone predisposed to think that claims-made settlements are generally a sham to benefit corporate America at the expense of the public will at least read them with an open mind.
Criticism 1: Claims-made settlements allow the defendant to get away with its misconduct. The defense attorney’s easy retort to this argument is that class actions generally allow greedy plaintiffs’ lawyers to extort money out of innocent companies by filing frivolous lawsuits. In most class actions, however, the defendant’s conduct was not clearly improper, nor was the lawsuit clearly frivolous. That is one reason why most class actions are resolved by settlement in the first place. The point is that a settlement is a compromise resolution of a dispute, not punishment for a corporate wrongdoer. It is no more fair to call a defendant in a class action settlement a wrongdoer than it is to call the case frivolous.
Criticism 2: Leftover money should be given to charity, not returned to greedy corporate executives. Aside from the previous observation that a defendant hasn’t been found to have done anything wrong in a class action settlement, this criticism also often rests on another flawed premise; that is, that any money saved by a corporation in settling a lawsuit goes to a select few corporate executives who use the money to buy a new private jet or vacation home. This is a misconception of how large companies operate. Every dollar paid out by a corporate defendant impacts a variety of groups of people who had nothing to do with whatever the alleged misconduct was. When a company pays a settlement or a judgment in a class action, it is not required to specify where the money is going to come from. So, every dollar paid in settlement negatively impacts the company’s shareholders, most of whom (at least in the case of a public company) clearly had nothing to do with whatever malfeasance the company is accused of. Paying a settlement may require the company to increase the cost of its goods or services, which negatively impacts consumers. In the case of an insurance company, the cost of settling a lawsuit is also borne by the company’s policyholders in the form of higher premiums. The cost of settling a lawsuit may also impact the job security of the company’s employees. When these other stakeholders are taken into account, it becomes far less clear that it is more just to have any unclaimed funds be paid to a charity, which had nothing at all to do with the subject of the dispute, rather than returned to the company, where the funds might benefit certain executives but will also benefit innocent shareholders, consumers, policyholders, and employees. There are a variety of other criticisms of cy pres awards in class action settlements. (See CAB entries dated October 11, 2009, October 28, 2009, and December 17, 2009 discussing cy pres awards).
Criticism 3: Claims-made settlements create perverse incentives for defendants. In many cases, claims-made structures provide the only possible way to bridge the gap between what the Defendant is willing to pay, short of going to trial, and what the plaintiffs’ attorneys are willing to accept in fees, short of going to trial (In my experience, the named plaintiff does not play much of a role in this process, but then again, I’ve never been in the room when settlement was discussed with a named plaintiff). The defendant doesn’t think it did anything wrong, and certainly doesn’t think that whatever it might have done wrong impacted everyone in the class (or would-be class), and it isn’t willing to pay 100% of what the plaintiff is claiming on behalf of the class. In order to settle the suit, it will only agree to pay far less than what would take to make the entire class whole. On the other side, the plaintiffs’ attorneys fee expectation, which is based on an assumed 1/3 share of a recovery on behalf of the class as a whole, becomes a key obstacle for resolution of the dispute, whether or not the actual class members would ever hope to benefit from the relief that the attorney is seeking. So, it can be argued that claims-made settlements create perverse incentives for both defendants and plaintiffs’ class action lawyers.
But incentives don’t necessarily have to translate into abuses. There are checks in place to prevent abuses on both sides. The perverse incentive for a defendant is to create artificial roadblocks to participation, such as making the claim form confusing or burdensome to complete. This can be avoided by following strict plain notice guidelines and hiring a competent settlement administrator and notice expert. The perverse incentive for a plaintiff is to trade class benefits for higher fees. However, the potential for this abuse is limited by the requirement that the court approve any fee award.
Perhaps abolishing claims-made settlements would cause more consumers, shareholders, or employees to reap higher returns in class action lawsuits, but it would just as likely reduce the fee expectations created within the plaintiffs’ bar for settling suits for what they are actually worth both in terms of litigation risk and public benefit. These are public policy matters that in my view are best left to the state legislatures and Congress to correct if they need to be corrected. Removing claims-made settlement as an option, stated simply, means less class action settlements. From the perspective of critics of the class action device generally, this may sound like a positive reform, but I can’t imagine that it would ultimately be a positive development for the plaintiffs’ bar. Fewer class action settlements means a greater burden on the court system and lower fee expectations for plaintiffs’ lawyers generally, resulting in less people willing to pursue class actions, and less opportunity for the victims of alleged wrongdoing to recover any benefits.