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self-study / Class Actions

Class actions require heightened scrutiny

Polly J. Estes

Estes Law Group

1005 Northgate Dr # 504
San Rafael , CA 94903

Phone: (415) 448-5905

Email: polly@appellateattorney.com

University of Texas SOL; Austin TX

Savannah Blackwell

Estes Law Group

Shutterstock

Both trial and appellate courts review settlements in class actions with "heightened scrutiny" for good reason. Class actions are both a blessing and a curse. They provide a much-needed means for efficiently handling multiple claims that are virtually identical but not worth pursuing individually. Tackling more than one claim at a time, however, presents its own unique set of problems and adverse incentives. And because there is so much money at stake, "[a]n inherent danger in class-action settlements is the defendant (who cares only about the total amount of the settlement, not how it is distributed) will agree to a settlement in which most of the recovery flows to class counsel, with only modest benefits to the class members (none of whom individually has enough at stake to have an incentive to object). That danger is particularly acute when the benefits to the class come in the form of coupons for the defendant's products." McKinney-Drobnis v. Oreshack (Massage Envy Franchising, LLC), 2021 DJDAR 10906 (9th Cir. Oct. 20, 2021).

Sometimes counsel for the putative class seeks only to right a wrong, and has a large war chest at their disposal. But there is also an incentive to settle cases quickly, especially because class actions can take years and they cost a fortune to finance along the way. Defendants know this and take full advantage of these incentives for class counsel. For their part, defendants want to minimize their actual output for any wrong they may have committed. They love to offer coupons to class members because although the face value of a coupon makes it look like they are giving up a large sum of money, the reality is that only a very, very small percentage of the coupons are ever redeemed. In McKinney-Drobnis, the expert testimony established that only 6.2% of the eligible class members had even filed a claim to receive a coupon and, of course, even fewer would actually ever use that coupon.

Class actions are supposed to incentivize defendants to act in accordance with the law, but these cheap settlements do just the opposite. Knowing that very few coupons will ever be redeemed creates the wrong incentive for defendants. If defendants know that they can break contracts, fix prices, and even break the law and the only price they will pay if they get caught is to lose 6.2% of their ill-gotten gains, then why wouldn't they cheat the system?

Class counsel love coupons too because it looks like they have done a lot of good for a vast number of people, and they ask that their attorney fees be calculated as a percentage of the amount of good they have done for the class. So, a coupon good for "$2 off your next purchase" really only costs the defendants a few pennies per class member, but gets the class counsel a nice large fee. The only people who lose in this scenario are the absent class members, who frequently are unaware the suit is even happening.

Recognizing this problem, Congress enacted 28 U.S.C. Section 1712 to deal with coupon settlements. This section provides that any contingency fee has to be based on "the value to class members of the coupons that are redeemed." 28 U.S.C. Section 1712(a). When a class member claims the right to a coupon within the notice period, the coupon is "claimed." To be "redeemed," a coupon must actually have been used by the consumer, not merely claimed.

Alternatively, when a contingency fee method is not used, Section 1712 also provides for using the lodestar method, possibly with a multiplier, though what that multiplier should be is not specified. Id. at Section 1712(b). The 9th U.S. Circuit Court of Appeals has held that the Class Action Fairness Act mandates the use of a percentage-of-value calculation for any portion of a fee award "attributable to the award of the coupons." In re HP Inkjet Printer Litig., 716 F.3d 1173, 1177, 1180-81 (9th Cir. 2013) (quoting 28 U.S.C. Section 1712(a)). The court clarified that the lodestar methodology may be used in a "mixed" settlement involving coupon and non-coupon relief, but only if the lodestar calculation does not consider the coupon portion of the settlement or take into account the coupon redemption value. In re EasySaver Rewards Litig., 906 F.3d 747, 759 (9th Cir. 2018); see also Chambers v. Whirlpool Corp., 980 F.3d 645, 654 (9th Cir. 2020). In Chambers, the court held that attorney fees based on the "lodestar plus a multiplier" method must also be compared to the actual redemption value of coupons, not the face value. The court held it was an abuse of discretion to award $14.8 million in attorney fees to a coupon settlement where the face value of the coupons was $116.7 million, but a potential redemption value of just $4.2 million. Id.

One controversial idea for protecting the rights of absent class members would be to limit attorney fees for class counsel to a lodestar (with a multiplier only in extraordinary cases) any time there is a non-cash settlement prior to class certification. The total amount would still need to bear a reasonable relation to the value of the redeemed coupons. In most cases settled pre-certification, that rule would provide a large incentive for class counsel to push for a cash settlement instead. What class member wouldn't prefer cash?

Class counsel hated Section 1712(a), so some of them tried "vouchers" instead of "coupons" as a means of increasing their fees. (Head slap here.)

In McKinney-Drobnis, the 9th Circuit addresses the problem of what level of scrutiny should be applied to class action settlements before the class is certified involving so-called "vouchers." As usual, Judge Ronald Gould writes a logical, thorough opinion that is easy to follow where he sets forth each of the many steps the district court must follow before approving a settlement.

The first step in the court's analysis is to determine whether the settlement involves coupons, in which case 28 U.S.C. Section 1712 applies. Coupons are not defined in the statute. To do that, McKinney-Drobnis noted that the court considers: "(1) whether class members have to hand over more of their money before they can take advantage of' the credit; (2) whether the credit was valid only for select products or services; and (3) how much flexibility the credit provides, including whether it expires or is freely transferrable." (Cleaned up) (quoting In re EasySaver Rewards Litig., 906 F.3d at 755; In re Online DVD-Rental Antitrust Litig., 779 F.3d 934, 951 (9th Cir. 2015).

In his concurrence, Judge Eric Miller suggests the court dismiss this test and adopt the 7th U.S. Circuit Court of Appeals' conclusion that the term voucher is interchangeable with coupon. At first blush, this seems like a sensible suggestion, but the 9th Circuit is correct to focus not on the label, but on the characteristics of a coupon that Congress was trying to guard against in enacting Section 1712. Given how clever counsel can be, it's not always cut and dried as to whether the proposed settlement involves something that essentially amounts to a coupon.

For instance, is a gift card a coupon? If it's for $12 at Walmart, where one can purchase a vast array of products for less than the $12 and that gift card never expires and is freely transferrable, then the gift card is not a coupon. See Online DVD-Rental, 779 F.3d at 956.

How about a credit? Is a credit a coupon? The court ruled a $20 credit was a coupon where the range of products that could be purchased was small and there were several limitations on the use of the credit like a one-year expiration, several blackout periods, and a prohibition on same day online purchases. EasySaver, 906 F.3d at 752-57.

So what about a voucher? In McKinney-Drobnis, the class complained that Massage Envy had periodically increased membership fees in violation of the membership agreement. The 9th Circuit held vouchers that ranged in value from $36.28 to $180.68 were considered coupons where the smallest vouchers were not enough to purchase even one massage, thus requiring class members to spend more of their own money to receive the primary product offered, and the range of products one could purchase was quite small (251 products), even though the vouchers did not expire within one year nor were they otherwise limited. The court focused on the small number of products offered. Interestingly, in Hendricks v. Ference, the court found that vouchers were not coupons because they never expired and were freely transferrable, even though they were good for just one product -- canned tuna. 754 F. App'x 510, 514 (9th Cir. 2018). It is difficult to reconcile McKinney-Drobnis and Hendricks.

One alternative to the analysis set forth in Online DVD-Rental that would simplify everything is set forth in Judge Michelle Friedland's concurrence in Hendricks. She proposed that the court should simply treat "all non-cash discounts, credits, vouchers, and the like as coupons under CAFA." Id. at 514. This is one question Congress should clarify. Did it mean to classify all non-cash settlements as requiring these special considerations? We suspect it did.

The issues of fairness and class counsel's fees come up in every class action settlement. Just two months before McKinney-Drobnis, another panel of the 9th Circuit handed down a similar decision in Kim v. Allison (Tinder, Inc.), 8 F.4th 1170 (9th Cir. 2021). And there have been a couple of others over the past year. Briseno v. Henderson (ConAgra Foods, Inc.), 998 F.3d 1014 (9th Cir. 2021); Chambers.

After determining whether coupons are involved, the district court must evaluate whether the settlement is fair, reasonable and adequate. 28 U.S.C. Section 1712(e); Fed. R. Civ. P. 23(e)(2). Rule 23 provides a laundry list of factors for the district court to consider and McKinney-Drobnis sets forth even more considerations and procedures for the district court.

As part of the inquiry into whether the settlement is fair, reasonable and adequate, the court must consider the three signs there may be implicit collusion between the defense and the class counsel at the expense of the absent class members: "(1) when counsel receives a disproportionate distribution of the settlement; (2) when the parties negotiate a clear-sailing arrangement, under which the defendant agrees not to challenge a request for an agreed-upon attorney's fee; and (3) when the agreement contains a kicker or reverter clause that returns unawarded fees to the defendant, rather than the class." McKinney-Drobnis; In re Bluetooth Headset Products Liability Litig., 654 F.3d 935 (9th Cir. 2011). These types of arrangements illustrate that class counsel may have "allowed pursuit of their own self-interests ... to infect the negotiations." McKinney-Drobnis; Roes, 1-2 v. SFBSC Mgmt., LLC, 944 F.3d 1035, 946, 47, 1050-51 (9th Cir. 2019). This list will, no doubt, have to be expanded in future cases as new schemes are thought up that benefit defendants and class counsel at the expense of the absent class members.

It is particularly important for the district court to scrutinize any settlements that occur prior to the class being certified. As anyone who has ever tried a class action can tell you, having the class certified is the ballgame. Once a class is certified, settlement is inevitable in almost all cases. But to get a class certified requires a ton of work, often taking years. So if class counsel is just out to make a quick buck, they will try to settle the case early on.

One thing that is odd is that while the 9th Circuit reviews the district court's determination of whether the settlement involves coupons de novo, McKinney-Drobnis, it reviews the district court's approval of a settlement overall for abuse of discretion. Id. The two tests involve many of the same types of determinations. In both tests, the court must evaluate a series of factual determinations in order to perform its statutory analysis, but the facts that must be determined are usually presented by motion without live testimony. In other words, both the district court and the appellate court have the same access to the evidence presented to make these factual determinations.

Two things come to mind. First, when the review of a matter involves a multi-factor test, why should only one standard of review by used? Often the factors being reviewed are a mix of legal and factual decisions. The more logical way would be for all legal decisions to be reviewed de novo and for all factual determinations that "'immerse courts in case-specific factual issues' such as weighing evidence and making credibility judgments" to be reviewed for abuse of discretion. U.S. Bank Nat'l Ass'n ex rel. CWCapital Asset Mgmt. LLC, v. Vill. At Lakeridge, LLC, 138 S. Ct. 960, 967 (2018). If a multi-factor tests logically involves some legal and some factual determinations, there is no reason why only one standard of review needs to apply to every decision being reviewed in that test. But what about factual determinations where the facts are presented solely on paper and there is no live testimony? Then it would seem that the district and appellate courts are equally suited to making the decision, with the appellate court perhaps making better decisions, not because it is a so-called "higher" court, but because it has three judges evaluating the evidence instead of just one. And what about when the evidence is undisputed? Both of these scenarios would seem to imply that a de novo standard of review should apply. If, however, any of the witnesses had testified live previously, then the district court would have the upper hand, making an abuse of discretion standard more appropriate. As technology improves, the video-taping of evidence may change all this so this too may be an issue that will change over time.

With so much money at stake, the issue of fairness to absent class members will continue to evolve, requiring new rules by both Congress and the courts and the courts will have to remain ever vigilant in their protection of the absent class members. 

#1091

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