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Posts Tagged ‘reversion’

HarrisMartin’s Data Breach Litigation Conference: The Coming of Age is scheduled for next Wednesday, March 25, 2015, at the Westin San Diego.  I’ll be speaking on a panel titled Creative Approaches to Settling Data Breach Cases with Ben Barnow of Barnow and Associates, P.C., Chicago.  So, the news this week was very timely that Target has reached a settlement in the consumer class actions arising out of its massive payment card breach.  Because a few clients and colleagues on both sides of the bar have asked for my opinion about the settlement, I thought I’d share a few thoughts here.

Settlements in data breach cases have been fairly rare up to this point, as many data breach cases have met their doom at the pleadings stage due to the inability of plaintiffs to show injury-in-fact sufficient to give them standing.  Payment Card cases have been an exception because there are real financial losses to consumers that can flow naturally from a hacking incident.  Importantly, these losses generally do not include the amount of any fraudulent card transactions because federal law limits consumer liability to $50 and the major card brands go further and impose $0 liability requirements on issuing banks.  However, other incidental losses, such as replacement card fees, interest, finance charges by other companies due to missed payments, to name a few, can result from a payment card breach.  For this reason, claims in several payment card class actions, including Target (Target Order on Motion to Dismiss) have survived motions to dismiss, leading many defendants to settle these cases.  Payment card class actions against Heartland Payment Systems, TJ Maxx, Michaels Stores, and others were all resolved by class-wide settlements.

The Target Settlement has been praised and derided by the mainstream and legal trade media with a host of characterizations ranging from “huge” to “affordable” to “tiny.”  In fact, Target’s settlement is not particularly groundbreaking beyond the media attention that it has garnered.  Instead, it shares many of the features of the payment card settlements that came before it, and it is not significantly different in terms of its cost or in terms of the benefits it would provide to consumers, if finally approved.

Here is a summary of some of the key features of the settlement:

Overall Costs to Target

Claims Fund.  Target is to pay $10M to create a fund to pay consumers who claim certain out-of-pocket losses and time spent in connection with those losses (discussed in more detail below).  The fund is non-reversionary, meaning unclaimed funds don’t go back to the defendant.  Instead, the agreement contemplates that the court will decide who unclaimed funds are to be distributed.  (For a discussion of how courts can deal with unclaimed funds, see this February 2010 CAB post.)

Attorneys’ Fees.  The plaintiffs will request court approval of up to $6.75M in fees.  Target may object to the initial request, but it may not appeal any decision by the trial court to award $6.75M or less.  Target must pay the fees awarded in addition to the $10M fund.

Settlement Expenses.  Target must pay for all settlement administrative expenses in addition to claims fund and fees.  This includes the expenses to provide both published and direct notice of the settlement to affected customers and the costs to administer claims and make payments to claimants if the settlement is finally approved.  For a class size as large as Target’s these costs can easily measure in the millions of dollars.

Total Payment by Target.  So, my guess it that the total payout by Target is likely to be closer to $19M, assuming the full amount of fees are approved.

Settlement Benefits to Consumers 

One of the attachments to the Settlement Agreement is a Distribution Plan that generally outlines the benefits available to claimants.  The Distribution Plan doesn’t itemize every conceivable loss that might qualify for compensation, but it attaches sample claim forms that give more insight into the specific benefits that are contemplated.  Most of the categories of reimbursable losses are similar to those provided for in other payment card settlements.  Here’s a summary, with some comments on each category:

  • Payment for unreimbursed, out-of-pocket expenses, with a $10,000 cap per claim – Note that due to the zero consumer liability rules on fraud losses, combined with the fact that payment card information cannot be used to commit other forms of identity theft, it is extremely unlikely that any individual person will have a claim for an amount near the cap.  If it were otherwise, then the fund would only be sufficient to pay 1000 claims.  Other payment card settlements have included individual caps for the most typical types of expenses, which rarely exceed $200 or so, with a separate fund available for extraordinary claims.  The Target settlement omits this smaller cap, perhaps because experience has shown that it is generally unnecessary to control unreasonable or fraudulent claims.
  • Payment for 2 hours of time at $10/hour associated with each type of actual loss claimed – Payments for time are an interesting feature of payment card settlements.  Because of the zero consumer liability for fraud loss imposed by the card brands, mere lost time and aggravation make up the vast majority of consumer impact in a payment card breach.  However, time and inconvenience are generally not considered injuries for which damages can be recovered, so by agreeing to pay for lost time, the defendant is agreeing to pay for something that the plaintiffs probably couldn’t recover if the case went to trial.  Nonetheless, there is nothing preventing defendants from offering these benefits in a class action settlement setting, and it has become common for defendants to offer payments for lost time.  Because claims for time are susceptible to fraud and abuse and are difficult to document, the amounts available tend to be limited to 1-3 hours.  Based on the sample claim form, the Target settlement seems to allow claims for time spent correcting fraudulent charges, but it doesn’t appear to allow claims for lost time resulting from card replacement (for example, having to change the number on automatic or recurring payments), which is something that affects far more consumers than fraud itself in the aftermath of a payment card breach.  Other payment card settlements have allowed claims for lost time for either fraud or for dealing with replacement card issues.
  • Two different types of claim forms – The settlement contemplates the ability to elect either a documented or undocumented claim.  Documented claims get priority in payment.  From a defendant’s perspective, undocumented claims are problematic, because they are susceptible to fraud and abuse.  From a consumer’s perspective, having to document claims is an added aggravation, on top of the aggravation  of having had to deal with the impact of the breach in the first place.  This structure offers a compromise that permits undocumented claims, but ensures that those claims that are documented will be paid first.

As a practical matter, given the size of the fund, it is likely that there will be plenty of money to pay all documented claims and all plausible undocumented claims.  In fact, in view of past settlements, it is extraordinarily unlikely that the amount of all legitimate claims will get even close to the $10 million available in the fund.  In the Heartland Payment Systems settlement, for example, arising out of an incident that impacted 130 million card holder accounts, the number of claims for reimbursement amounted to a grand total of $1925.  (See Judge Rosenthal’s Order in Heartland Payment Systems).  This miniscule claims amount was due undoubtedly to a lack of public familiarity with Heartland (a payment processor) as a brand and with the incident itself, two things that are certainly not true of Target, and claims rates in other settlements have certainly been higher despite having much smaller numbers of potential class members.  However, various media outlets have quoted a RAND Corporation researcher as estimating that less than $1 million of the $10 million fund will be claimed (see, for example, this article by Jason Abbruzzese at Mashable).

If he’s right, expect a fight ahead on what should happen with the $9M in unclaimed funds which, according to the agreement, “shall be distributed by the Settlement Administrator as directed by the Court.”  Cy pres anyone?

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Editor’s Note: The following is a post that I contributed to the Baker Hostetler Class Action Lawsuit Defense Blog.  Please be sure to visit the firm’s blog for more great class-action related content!

What to do with unclaimed settlement funds is a common problem facing class action litigants.  There are at least four methods of distributing unclaimed settlement funds:  (1) reversion of unclaimed funds back to the defendant; (2) payment to those claimants who did make claims on a pro rata basis; (3) letting the funds escheat to the state; and (4) a cy pres award to a charitable organization.  All of these methods have been the subject of criticism, but the practical reality is that something has to be done with funds from a class action settlement that are not claimed by class members.

Recently, the First Circuit Court of Appeals issued a decision that outlines the circumstances under which a court may approve a cy pres distribution of unclaimed settlement funds.  In In re: Lupron Marketing and Sales Practices Litigation, Case Nos. 10-2494, 11-1329 (1st Cir., Apr. 24, 2012), the parties had agreed to a provision that gave the trial court discretion on the distribution of any unclaimed funds from a settlement of claims alleging overcharging for the medication Lupron.  The Court had ordered that $11.4 million in unclaimed funds be distributed to a non-profit cancer center for the purpose of treating diseases for which Lupron was commonly prescribed.  Although the First Circuit expressed “unease with federal judges being put in the role of distributing cy pres funds at their discretion,” it found that the trial court had not abused its discretion.

In reaching this decision, the First Circuit adopted the “reasonable approximation” test for evaluating whether a district court’s cy pres award constitutes an abuse of discretion.  Under the “reasonable approximation” test, which had previously been applied by the Seventh, Eighth, and Ninth Circuits, the Court looks to whether the cy pres distribution is to a recipient that reasonably approximates the interests being pursued by the members of the class.  The Court listed a number of non-exclusive factors to be considered in making this determination:

(1)        the purposes underlying statutes claimed to have been violated;

(2)        the nature of the injury to the class members;

(3)        the characteristics and interests of the class members;

(4)        the geographic scope of the class;

(5)        the reasons why the settlement funds have gone unclaimed; and

(6)        the closeness of the fit between the class and the cy pres recipient.

The opinion more generally has an interesting discussion of some of the policy arguments for and against each potential alternative method of disposing of unclaimed funds.  Relying on the American Law Institute’s Principles of the Law of Aggregate Litigation, the First Circuit rejected the presumption suggested by the concurrence in Klier v. Elf Atochem North America, Inc., 658 F.3d 468 (5th Cir. 2011), that any residual funds in a class action settlement should be returned to the defendant.  The Court also cited the ALI Principles in rejecting escheat to the state as the preferred option of disposing of unclaimed settlement funds.  The opinion lists a variety of policy reasons why unclaimed funds should not be given pro-rata to the claimants who do participate, including that this method creates a windfall and leads to perverse incentives to prevent participation in a settlement by absent class members.

Like the Fifth Circuit’s decision in Klier last year, the First Circuit’s decision in In re: Lupron Marketing and Sales Practices Litigation illustrates the need for parties to be specific in the settlement agreement about the means of distributing unclaimed settlement funds.  Failure to take care in specifying how unclaimed funds are to be distributed can lead to additional unwanted and expensive litigation with objectors, and can force the court to make a public policy-driven decision that may be inconsistent with the desires of both parties to the settlement.

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Recently, I have commented on two types of objectors in class action settlements.  This March 31 entry discusses the problem of so-called “professional” objectors.  And this April 12 entry addresses objections raised by government officials.  There is at least one other type of organized objectors to class action settlements: public interest organizations.  (I use the term “organized objectors” to distinguish these types of objections from objections that may be sent in by individual class members who are not represented by separate counsel).  Mechanically, objections by public interest organizations may be accomplished in a manner similar to that used by professional objectors: through the representation of one or more settlement class members by lawyers employed by or cooperating with the organization.  However, unlike with professional objectors lawyers, the representation is usually pro bono.  Alternatively. as with objections by government officials, public interest objections to a settlement may be accomplished through amicus briefs to the court.

There are a variety of public interest organizations that file objections to proposed class action settlements.  These organizations have widely differing purposes and political agendas.  For example, the Center for Class Action Fairness (CCAF) was founded by attorney and leading tort and class action reform advocate (and contributor to the popular law blog, Overlawyered), Ted Frank.  CCAF is a nonprofit organization formed for the stated purpose of providing “pro bono representation to consumers and shareholders aggrieved by class action attorneys who negotiate settlements that benefit themselves at the expense of their putative clients.”  In this April 18, 2011 press release, Frank summarizes various cases in which his organization successfully objected to class action settlements that “will result in class members receiving over $5 million more than what their class attorneys were willing to negotiate.” 

At the other end of the political spectrum (at least from the perspective of tort reform) from CCAF, is Public Justice, an organization founded by leading trial lawyers that describes itself as “America’s public interest law firm.”  A stated objective of Public Justice is to fight interests aimed at “closing the courthouse doors so victims can’t hold the powerful accountable,” including fighting “class action bans and abuses.”  Like CCAF, Public Justice has successfully objected to or intervened in a variety of class action settlements.  Some of its work in this area is summarized in the article “Fighting Class Action Abuse,” which is available on its website.

A third organization, Public Citizen, is a consumer advocacy group that has the stated goal of preserving the right of consumers to seek relief through class actions.  However, according to its website, “[a]t the same time, we recognize that on occasion class action settlements may not be in the interest of all class members, and in such cases we have often represented class members in objecting to and seeking to improve the terms of such settlements.”

Although the political motivations of these organizations might be different, there are several key similarities between these groups.  First, their interest in objecting to a settlement is based on a sincerely held belief that their involvement is necessary to protect the public interest.  This means that they are not motivated by profit, but rather by a conviction that the settlement (or the system itself) is unfair.  Like government objectors, their goal is to gain disapproval of or modification to the settlement, not to extort a portion of the fee.

Second, regardless of the ultimate motivating philosophy, even public interest groups with drastically different political agendas can find the same kinds of settlements or settlement terms objectionable.  Not surprisingly, many of their objections are the same as those that a government official might make.  Coupon settlements are a natural target.  A conservative group formed to combat class action abuse might object to a coupon settlement because the fact that a coupon settlement was the best the plaintiffs’ could do for the putative class reflects that he case was a frivolous, lawyer-driven case that had no societal value in the first place.  A consumer advocacy group might object to the same settlement because of a perception that it is unfair for a defendant to profit from its own wrongdoing.  Where both groups might agree is that the court should not approve a settlement that includes little or no benefit to class members and a large payout to the plaintiffs’ lawyers.

One area in which right-leaning and left-leaning public interest groups may diverge is in their view of cy pres provisions in class action settlements, that is, distribution of any unclaimed funds to a charity.  Class action reform advocates object to cy pres distributions because they don’t benefit the members of the class, and are sometimes simply a tool used by trial lawyers to raise funds for their own pet causes.  Trial lawyers in turn, argue that cy pres is the best way to deal with unclaimed funds, because the alternative would be to let the money revert back to the defendant, which would allow the defendant to profit from its wrongdoing.  (Although I want to stay neutral, as a defense lawyer, I am compelled to point out that the fallacy in this reasoning is the class action settlement context, the defendant hasn’t been found to have done anything wrong.  Rather it has voluntarily agreed to provide some compensation in exchange for peace from further litigation).

As with objections by government actors, objections to class action settlements by public interest groups are rare, but they present a significant risk to approval of a settlement if they do occur.   There are a variety of steps that counsel can make to avoid these types of objections, including:

  • Ensure that the settlement notice is in plain English, understandable, and contains all information required by Rule 23(c)(2)(B).  The Federal Judicial Center guidelines for plain English notice provide an excellent template, but the template obviously must be tailored to each case in order to provide effective notice.  Hiring a qualified notice expert (not simply a settlement administrator) to help draft the notice and testify about the fairness of the notice plan can protect against possible objections to the fairness of the notice.
  • Make sure that the notice is delivered in a way that makes it truly the best notice practicable.  Intentionally using a method of notice that is unlikely to be read and appreciated by class members, in the hopes of reducing the response rate, is folly.  If you don’t do everything reasonable possible to give class members adequate notice of a settlement, you risk having the entire settlement disapproved after you have incurred the significant notice costs. In many cases, direct mail is still considered the best way of distributing notice.  Technology has made direct mail possible even in cases where the last known addresses of class members are a few years old.  Old addresses can be updated through the post office change of address system, as well as through various private databases.  Again, having a qualified notice expert can help.  If it is truly impossible to reach a sufficient number of class members through direct mail, then a published notice can be used as a supplement, but it is better to think of published notice as a last resort. 
  • Avoid settlement terms or arguments that exaggerate the true value of a benefit to be given to the class.  A settlement does not have to give class members 100% of the claimed damages in order to be fair.  It is, after all, the result of a compromise.  However, exaggerating the value of benefits, especially non-monetary benefits, is one of the surest ways to draw objections and skepticism from the Court.
  • Avoid unnecessary publicity.  Unnecessary publicity (by either the plaintiffs or the defendant) raises the risk that public interest groups will scrutinize it.  This is another reason to use direct mail when possible. 
  • If the settlement does include a cy pres component, try to find an organization that is likely to benefit some or all of the class members directly.  Distribution to any organization in which one of the lawyers has a personal affiliation or stake will raise a red flag.  Donations to a victim’s assistance fund, for example, are less likely to receive scrutiny than a donation to a lawyer’s law school.
  • In any settlement that may include unclaimed funds (whether those funds revert to the defendant, are distributed pro rata to other class members, or are distributed to a charity),  above all else, do whatever you can to ensure that class members have a fair opportunity to participate in the settlement.  You often can’t force class members to claim benefits, but you do have the power to make sure that there are no artificial barriers to participation.

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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.

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Cy pres awards continue to be a hot topic both in the news and in academia.  The latest contribution comes from Columbia law student Sam Yospe, whose article entitled Cy Pres Distributions in Class Action Settlements (Columbia Business Law Review, forthcoming) examines judicial discretion in choosing cy pres awards and makes practical suggestions for reform.  Yospe’s article is an excellent secondary research source for anyone looking at issues relating to cy pres awards in class action settlements.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1492105

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Over the past week, I have received two separate requests for comment on cy pres awards to charity in class action settlements.  Evidently it’s on readers’ minds, so I thought I’d give some thoughts on the subject here.

Cy pres distributions to charity are one of several ways of dealing with a common problem in class action settlements: unclaimed proceeds from a common fund.  Class settlement proceeds may go unclaimed for any number of reasons, but for the sake of simplicity, I’ll limit the discussion to funds that cannot be claimed because not all class members can be located or given notice of the availability of the settlement amount.  Amount the other possible ways to distribute these unclaimed amounts are 1) allow the funds to revert back to the defendant; 2) pay the unclaimed amounts pro rata to the plaintiffs who did participate in the settlement; or 3) allow the funds to escheat to the state.

An argument commonly made in favor or a cy pres distribution over the other possible methods is that it provides a social benefit that arguably counteracts the wrong alleged to have been done by the defendant and prevents the defendant from reaping the benefits of its misconduct.  The fallacy in this reasoning is that in the settlement context, the defendant hasn’t been found liable for anything.  It is simply agreeing to resolve the case by paying money rather than face the uncertainty, cost, and risk of litigation and trial.  As long as plaintiffs are given a full and fair opportunity to participate (a topic for another day), there is no reason that cy pres distributions are a superior way of dealing with unclaimed funds to allowing the defendant to retain the funds for the benefit of its shareholders, employees, policyholders, creditors, or other stakeholders. 

On the other hand, because a defendant agrees to a settlement willingly, it really can’t be argued that cy pres provisions are unfair to defendants.  So, from a purely practical point of view, there is little to criticize in the use of cy pres in class action settlements.  Cy pres provides one of several options for settlement structures that may be available to resolve a dispute without having to resort to a trial. Plaintiffs lawyers like cy pres provisions because they may justify a higher attorney’s fee percentage and because they can make the plaintiff’s lawyer look like Robin Hood.  A defendant may agree to the distribution because it wants the certainty of fund that limits its settlement exposure and because it may be able to take advantage of the PR benefits of having donated money to charity in resolving a lawsuit.

From a societal or public policy point of view, however, cy pres is open to serious criticism.  The civil justice system is intended to provide a forum for remedying private wrongs.  If those injured by an unfair or unlawful practice cannot be located to provide them a remedy, then why should the money be forfeited to others who have not suffered injury at all?  Given the high cost of litigation, cy pres is not a particularly efficient way of redistributing wealth.  Policing and punishing misconduct and consumer protection are functions that are probably more appropriately handled by regulatory and criminal authorities.  While cy pres distributions may provide a societal benefit, it might be more beneficial, and less costly to businesses, just to impose a tax on all large companies rather than allowing plaintiffs’ attorneys to pursue these benefits in the civil courts.

For the time being, however, cy pres has become an accepted procedure for dealing with unclaimed class action funds.  As long as it is allowed, class action lawyers and litigants should continue to consider it as one option among many in resolving class actions.

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