United States: The Class Action Fairness Act of 2005

On February 18, 2005 the President signed into law the Class Action Fairness Act of 2005 (the "Act" or "CAFA"). The Act, whose stated purpose is "to amend the procedures that apply to consideration of interstate class actions to assure fairer outcomes for class members and defendants," represents the culmination of years of efforts to address the recent dramatic increase in practices widely viewed as abusive in interstate class actions brought in state courts.

The Act has implications for all defendants in class actions filed after the date of the Act’s passage. Passage of the Act is a welcome development for defendants, reducing the risk of prejudicial and inconsistent treatment in state court. Various issues remain to be worked out as the Act is implemented in the courts, however, and a proper understanding of what the Act does and does not accomplish will be essential to navigating this early litigation.

The Act has two basic components, which reflect the convergence of consumer and business interests that led to the Act’s passage after over seven years of deliberation by Congress.

Federal Jurisdiction over Class Actions. First, the Act modifies a longstanding, much-criticized characteristic of the federal diversity jurisdiction statute whereby large interstate class actions have been kept out of federal courts because of the existence of a single, nominal defendant in the forum state or because of amount-in-controversy requirements based on individual class members rather than the entire class. The Act amends the diversity statute to allow federal courts to hear more interstate class actions and modifies the federal removal statutes to ensure that qualifying interstate class actions initially brought in state courts may be heard by federal courts if any defendant so desires.

Consumer Class Action Bill of Rights. Second, the Act includes a "consumer class action bill of rights" designed to eliminate certain of the more flagrant perceived abuses of the class action device by the plaintiffs’ bar. The bill of rights limits the amount of attorneys’ fees that may be awarded on the basis of "coupon" settlements, imposes additional fairness determination requirements prior to approval of "coupon" or "net loss" settlements, and requires that notice of class action settlements be sent to specified state and federal officials, so that they may object if they believe that the class action settlement is not in the best interest of class members.

Asummary of the Act follows, together with comments on the likely implications of various of the Act’s provisions. As will be seen, some areas of significant uncertainty remain, largely because the Act makes use of several undefined terms and does not spell out a number of procedural points. Some guidance on these questions is provided by the Act’s legislative history—in particular, a colloquy that took place between the Act’s sponsors in the House of Representatives on the day of passage and a report on a prior version of the bill that was issued by the Senate Judiciary Committee in 2003. It remains unclear how authoritative the courts will understand this history to be.

Section 2 of the Act sets out Congress’ findings and purposes. The findings state that class actions are "an important and valuable part of our legal system when they permit the fair and efficient resolution of legitimate claims of numerous parties." However, the findings note that over the last decade class actions have been subject to a number of abuses that injure both consumer plaintiffs and defendants, adversely affect interstate commerce, and undermine public respect for the judicial system. For example, the findings state that class members "often receive little or no benefit from class actions, and are sometimes harmed," such as where counsel receive large fees while class members receive awards of little or no value. In particular, the findings state that such abuses in state and local courts undermine the national judicial system, the free flow of interstate commerce, and fundamental principles of diversity jurisdiction, and that cases that are of national importance, that are subject to local bias, or that will have extraterritorial effect should be heard in federal courts.

The stated purposes of the Act are to assure "fair and prompt recoveries for class members with legitimate claims;" to "restore the intent of the Framers with regard to diversity jurisdiction by creating federal jurisdiction over interstate class actions;" and to encourage innovation and lower consumer prices.

Sections 4 and 5 of the Act fundamentally alter the federal jurisdictional rules applicable to class actions. Based on the Act’s changes to the diversity jurisdiction rules, most significant interstate class actions previously brought in state courts would, if brought in the future, be subject to federal diversity jurisdiction (under Section 4) and removable (under Section 5) from state to federal court upon the motion of any defendant.

The diversity jurisdiction principle set forth in Article III of the Constitution, which provides that the federal judicial power "shall extend…to Controversies…between a State and citizens of another State [and] between citizens of different States," protects out-of-state litigants against the potential prejudice of local courts by allowing for federal diversity jurisdiction where plaintiffs and defendants are citizens of different states. Under the federal diversity jurisdiction statute, 28 U.S.C. 1332, however, rules evolved in such a manner that plaintiffs’ lawyers could easily structure class actions so as to evade federal diversity jurisdiction, even when almost all of the parties involved are of diverse citizenship and the case is overwhelmingly interstate in character.

In particular, the requirements of full diversity and a minimum amount in controversy have served as impediments to federal courts asserting jurisdiction over interstate class actions. Under prevailing law prior to the Act’s passage, federal diversity jurisdiction over a class action generally would not exist unless every representative plaintiff were a citizen of a different state from every defendant, and (depending on the judicial circuit) at least one named plaintiff or every individual member of the purported class sought damages in excess of $75,000. Thus, as the Senate Judiciary Committee noted in a 2003 report, federal courts could assert diversity jurisdiction over "a typical state law claim arising out of an auto accident between a driver from one state and a driver from another," but could not assert diversity jurisdiction over "claims covering large-scale, interstate class actions involving thousands of plaintiffs from multiple states, defendants from many states, the laws of several states, and hundreds of millions of dollars."¹

Section 4 of the Act corrects this problem by expanding the diversity jurisdiction of the federal courts as it relates to class actions such that class actions filed against defendants outside their home state are subject to federal jurisdiction if citizens from different states are on opposing sides and more than $5 million in the aggregate is at issue. At the same time, the Act provides limited exceptions to this rule for certain class actions brought in the defendants’ home state, and for controversies that are local in nature.

Section 4 of the Act provides a new Subsection (d) to be added to the diversity jurisdiction statute, 28 U.S.C. § 1332. The main operative provision is Subparagraph (d)(2), which provides that federal district courts shall have original jurisdiction over any class action with 100 or more class members² in which the aggregate³ matter in controversy exceeds $5,000,000, and in which (A) any member of a class of plaintiffs is a citizen of a state different from any defendant; (B) any member of a class of plaintiffs is a foreign state or a citizen or subject of a foreign state and any defendant is a citizen of a state; or (C) any member of a class of plaintiffs is a citizen of a state and any defendant is a foreign state or a citizen or subject of a foreign state.

This provision has two principal effects on qualifying class actions. First, it replaces the stringent requirement of complete diversity of citizenship between plaintiffs and defendants with the much more permissive requirement that there be any diversity between plaintiffs and defendants. This eliminates the possibility that a single in-state defendant will destroy federal diversity jurisdiction. Second, it allows for the aggregation of the claims of class members in calculating the amount in controversy, so that federal courts will not lack jurisdiction over a huge class action claim simply because the individual claims falls below the $75,000 threshold.

• Note: The House colloquy emphasizes that federal jurisdiction exists if the amount in controversy exceeds $5 million from the perspective of either the plaintiffs or the defendant. It also stresses that, in assessing the value of the dispute, a court should take into account "the value of all relief and benefits that would logically flow from granting" injunctive or declaratory relief.⁴

Having stated the general rule that minimal diversity supports federal jurisdiction, the Act goes on to create exceptions and special rules for actions brought in the home state of a "primary defendant," depending upon the number of plaintiff class members who are citizens of the forum state.

More than Two-Thirds of Class Members in Home State. Subparagraph (d)(4)(B) provides that if two-thirds or more of the class members and "the primary defendants" are citizens of the forum state (a corporation is deemed to be a citizen of both its state of incorporation and the state of its principal place of business), a district court must decline to exercise jurisdiction.

Between One-Third and Two-Thirds of Class Members in Home State. If fewer than two-thirds but more than one-third of the class members and "the primary defendants" are citizens of the forum state, Subparagraph (d)(3) provides that a district court may, "in the interests of justice and looking at the totality of the circumstances," decline to exercise jurisdiction. In making this determination, the district court must consider six enumerated factors:

1. whether the claims asserted involve matters of national or interstate interest;
2. whether the claims asserted will be governed by laws of the forum state or by the laws of other states;
3. whether the class action has been pleaded in a manner that seeks to avoid federal jurisdiction;
4. whether the action was brought in a forum with a distinct nexus with the class members, the alleged harm, or the defendants;
5. whether the number of class members who are citizens of the forum state is substantially larger than the number who are citizens of other states, and whether the citizenship of the other class members is dispersed among a substantial number of states; and
6. whether, during the three-year period preceding the filing of the class action, one or more other class actions asserting the same or similar claims on behalf of the same or other persons have been filed.

Fewer than One-Third of Class Members in Home State. No exception to the general jurisdictional rule is provided for class actions in which the primary defendant and less than one-third of the class members are citizens of the forum state.

• Note: The term "primary defendant" is not defined in the Act, and will be subject to interpretation by the courts applying these exceptions. Interpretive guidance provided by the Senate Judiciary Committee in its 2003 report indicates that "primary defendants" are intended to be "those defendants who are the real ‘targets’ of the lawsuit—i.e., the defendants that would be expected to incur most of the loss if liability is found."⁵ The Judiciary Committee report goes on to explain that, in a products liability class action, a local retailer should generally not be considered a "primary defendant," but a manufacturer of 20% of the product at issue should be considered a "primary defendant," even if other manufacturer-defendants were responsible for greater proportions of the product at issue.⁶ The House colloquy takes a similar view, adding that a primary defendant typically will be one "that is allegedly liable to the vast majority of the members of the proposed classes, as opposed to simply a few individual class members."⁷
• Note: It is implicit in the language of these exceptions, which refer to the citizenship of "the primary defendants," that all "primary defendants" must be citizens of the forum state in order for the exceptions to apply.
• Note: Subparagraph (d)(7) provides that the citizenship of a proposed class is determined on the date plaintiffs first file a complaint or a subsequent pleading indicating the existence of federal jurisdiction. The Act otherwise provides little guidance for courts in making the threshold determination of what percentage of members of the proposed plaintiff classes are citizens of the forum state. Again, the 2003 Senate Judiciary Committee report provides some guidance, noting that district courts will have to engage in limited factfinding to apply the Act’s jurisdictional provisions, and stating its intention that such determinations be made "largely on the basis of readily available information."⁸ Addressing the question of class member citizenship in particular, the committee stated as follows:

[I]n assessing the citizenship of the various members of a proposed class, it would in most cases be improper for the named plaintiffs to request that the defendant produce a list of all class members (or detailed information that would allow the construction of such a list), in many instances a massive, burdensome undertaking that will not be necessary unless a proposed class is certified. Less burdensome means (e.g., factual stipulations) should be used in creating a record upon which the jurisdictional determinations can be made.⁹

The precise scope of permissible discovery into this question, and the standards for identifying members of proposed classes and determining their citizenship will likely be a subject of early litigation under the Act.

Exception for Local Controversies Subparagraph (d)(4)(A) provides a second exception to the general rule of federal jurisdiction, for certain "local controversies," even where all primary defendants are not citizens of the forum state. Such actions will not be removable to federal court if all of the following conditions are satisfied:

1. more than two-thirds of the proposed class members are citizens of the forum state;
2. at least one defendant is an in-state defendant from whom the plaintiff class seeks "significant" relief and whose conduct forms a significant basis of the claims;
3. the principal injuries resulting from the alleged conduct, or any related conduct, of each defendant occurred in the state where the suit is brought; and
4. no class action has been filed alleging the same claims against any of the defendants in the last three years.

• Note: The Act does not define the term "significant" or explain how (or if) a defendant from whom "significant" relief is sought differs from a "primary" defendant. The House colloquy indicates that, for the local controversy exception to apply, "there must be at least one real local defendant. And by that the drafters meant that the local defendant must be a primary focus of the plaintiffs’ claims, not just a retailer or other peripheral defendant. The defendant must be a target from whom significant relief is sought by the class, as opposed to just a subset of the class membership, as well as being a defendant whose alleged conduct forms a significant basis for the claims asserted by the class."¹⁰ The colloquy offers as another example a case involving alleged insurance fraud, brought against both the insurer and an agent; in such a case, the "agent presumably would not fit this criteria."¹¹
• Note: The requirement that the conduct be "local" in nature is designed to identify acts that are directed at or felt in only a confined geographic area. According to the House colloquy, "[i]f defendants engaged in conduct that allegedly injured consumers throughout the country, the case would not qualify for the local controversy exception, even if it was only brought as a single State class action."¹²

In addition to the above exceptions, the jurisdictional provisions of the Act also exclude class actions in which: (a) the primary defendants are states, state officials, or other governmental entities against whom the district court may be foreclosed from ordering relief; or (b) there are fewer than 100 members of the proposed plaintiff class.

In 1998, a similar class action reform was passed with respect to securities class actions. The passage of the Securities Litigation Uniform Standards Act of l998 ("SLUSA") made the federal courts the sole venue for class action lawsuits involving 50 or more plaintiffs that allege securities fraud by a nationally traded company.

Subsection (d)(9) of Section 4 of the CAFA excepts from the general jurisdictional rule any class action that solely involves a claim (A) concerning a "covered security" as defined in the "limitation on remedies" provisions added to the federal securities statutes by [SLUSA]; (B) that relates to the internal affairs or governance of a corporation or other form of business enterprise and that arises under or by virtue of the laws of the State in which such corporation or business enterprise is incorporated or organized; or (C) that relates to the rights, duties (including fiduciary duties), and obligations relating to or created by or pursuant to any security (as defined under section 2(a)(1) of the Securities Act of 1933 (15 U.S.C. 77b(a)(1)) and the regulations issued thereunder).

These exceptions are intended to "avoid disturbing in any way the federal versus state court jurisdictional lines already drawn in the securities litigation class action context by the enactment of [SLUSA]."¹³

• Note: In seeking to preserve wholesale the jurisdictional lines previously drawn with respect to "covered securities," the drafters of the Act may allow certain categories of securities class actions to remain outside federal jurisdiction. For example, while SLUSA requires that actions alleging untrue statements, omissions, or use of manipulative or deceptive devices "in connection with the purchase or sale of a covered security,"¹⁴ be brought in federal court, Subsection (d)(9) of Section 4 of CAFAexcepts from its grant of federal jurisdiction a broader category of claims: every action that involves a claim "concerning a covered security." Thus, under the Act and SLUSA taken together, a class action that solely involves a claim concerning a covered security, but does not involve allegations of untrue statements, omissions, or use of manipulative or deceptive devices in connection with the purchase or sale of a covered security, would not fall within federal jurisdiction. One particularly significant type of case that might fall into this category is the state-law securities "holder" action, in which class members seek damages caused by their retention of securities in reliance on alleged misrepresentations and omissions during the class period.¹⁵ On January 11, 2005, the Second Circuit joined the Eighth, Ninth and Eleventh Circuits in holding that SLUSA does not apply to "holder" actions.¹⁶ The jurisdictional provisions of the Act also do not reach such actions. Thus it appears that state law "holder" class actions may continue to evade federal jurisdiction under the Act.

Subparagraph (d)(11) of the jurisdictional provision enacted by Section 4 of the Act expands federal jurisdiction to cover certain mass actions—suits that are brought on behalf of numerous named plaintiffs (i.e., not as a representative action by named plaintiffs on behalf of a class) who claim that their suits present common questions of law or fact that should be aggregated and tried together. Mass actions, which are particularly common in jurisdictions such as Mississippi that have not adopted class action rules analogous to Federal Rule of Civil Procedure 23, function very much like class actions.

Subparagraph (d)(11) provides that any civil action in which 100 or more named parties seek to try their claims for monetary relief together will be treated as a class action for jurisdictional purposes. Significantly, however, a federal court’s jurisdiction extends only to those plaintiffs in a mass action whose claims meet the individual amount-in-controversy threshold under 28 U.S.C. 1332(a)—currently $75,000. The claims of plaintiffs seeking lesser recoveries will remain in state court. The state law statutory limitation period for any claims asserted in a mass action are tolled while the mass action is pending in federal court.

The mass action provision also includes certain exceptions. A mass action will not be considered a class action for purposes of determining federal jurisdiction if it falls under any one of the following exceptions:

In addition to the above exceptions, the jurisdictional provisions of the Act also exclude class actions in which: (a) the primary defendants are states, state officials, or other governmental entities against whom the district court may be foreclosed from ordering relief; or (b) there are fewer than 100 members of the proposed plaintiff class.

Exception for Securities Litigation In 1998, a similar class action reform was passed with respect to securities class actions. The passage of the Securities Litigation Uniform Standards Act of l998 ("SLUSA") made the federal courts the sole venue for class action lawsuits involving 50 or more plaintiffs that allege securities fraud by a nationally traded company.

Subsection (d)(9) of Section 4 of the CAFA excepts from the general jurisdictional rule any class action that solely involves a claim (A) concerning a "covered security" as defined in the "limitation on remedies" provisions added to the federal securities statutes by [SLUSA]; (B) that relates to the internal affairs or governance of a corporation or other form of business enterprise and that arises under or by virtue of the laws of the State in which such corporation or business enterprise is incorporated or organized; or (C) that relates to the rights, duties (including fiduciary duties), and obligations relating to or created by or pursuant to any security (as defined under section 2(a)(1) of the Securities Act of 1933 (15 U.S.C. 77b(a)(1)) and the regulations issued thereunder).

These exceptions are intended to "avoid disturbing in any way the federal versus state court jurisdictional lines already drawn in the securities litigation class action context by the enactment of [SLUSA]."13

• Note: In seeking to preserve wholesale the jurisdictional lines previously drawn with respect to "covered securities," the drafters of the Act may allow certain categories of securities class actions to remain outside federal jurisdiction. For example, while SLUSA requires that actions alleging untrue statements, omissions, or use of manipulative or deceptive devices "in connection with the purchase or sale of a covered security,"14 be brought in federal court, Subsection (d)(9) of Section 4 of CAFAexcepts from its grant of federal jurisdiction a broader category of claims: every action that involves a claim "concerning a covered security." Thus, under the Act and SLUSA taken together, a class action that solely involves a claim concerning a covered security, but does not involve allegations of untrue statements, omissions, or use of manipulative or deceptive devices in connection with the purchase or sale of a covered security, would not fall within federal jurisdiction. One particularly significant type of case that might fall into this category is the state-law securities "holder" action, in which class members seek damages caused by their retention of securities in reliance on alleged misrepresentations and omissions during the class period.15 On January 11, 2005, the Second Circuit joined the Eighth, Ninth and Eleventh Circuits in holding that SLUSA does not apply to "holder" actions.16 The jurisdictional provisions of the Act also do not reach such actions. Thus it appears that state law "holder" class actions may continue to evade federal jurisdiction under the Act.

Subparagraph (d)(11) of the jurisdictional provision enacted by Section 4 of the Act expands federal jurisdiction to cover certain mass actions—suits that are brought on behalf of numerous named plaintiffs (i.e., not as a representative action by named plaintiffs on behalf of a class) who claim that their suits present common questions of law or fact that should be aggregated and tried together. Mass actions, which are particularly common in jurisdictions such as Mississippi that have not adopted class action rules analogous to Federal Rule of Civil Procedure 23, function very much like class actions.

Subparagraph (d)(11) provides that any civil action in which 100 or more named parties seek to try their claims for monetary relief together will be treated as a class action for jurisdictional purposes. Significantly, however, a federal court’s jurisdiction extends only to those plaintiffs in a mass action whose claims meet the individual amount-in-controversy threshold under 28 U.S.C. 1332(a)—currently $75,000. The claims of plaintiffs seeking lesser recoveries will remain in state court. The state law statutory limitation period for any claims asserted in a mass action are tolled while the mass action is pending in federal court.

The mass action provision also includes certain exceptions. A mass action will not be considered a class action for purposes of determining federal jurisdiction if it falls under any one of the following exceptions:

(I) all of the claims in the action arise from an event or occurrence in the forum state that allegedly resulted in injuries in the forum state or in states contiguous to the forum state;

(II) the claims are joined upon motion of a defendant;

(III) all of the claims in the action are asserted on behalf of the general public (and not on behalf of individual claimants or members of a purported class) pursuant to a state statute specifically authorizing such action; or

(IV) the claims have been consolidated or coordinated solely for pretrial proceedings.

• Note: The exception for events occurring in the forum state is directed at local controversies that do not have significant interstate consequences. The House colloquy emphasizes that "[t]he purpose of this exception is to allow cases involving environmental torts, such as a chemical spill, to remain in State court if both the event and the injuries were truly local, even though there were some out of state defendants. By contrast, this exception would not apply to a product liability or insurance case. The sale of a product to different people does not qualify as an event, and the alleged injuries in such a case would be spread out over more than one State or contiguous States even if all the plaintiffs in a particular case came from one single State."¹⁷

A mass action removed to a federal court under this provision may not be transferred to another federal court under the multidistrict litigation (MDL) statute, 28 U.S.C. § 1407, unless a majority of the plaintiffs request such a transfer.

Section 5 of the Act addresses removal of interstate class actions to federal court by the addition of a new Section 1453 to Title 28 of the U.S. Code. As with the jurisdictional provisions, the Act’s removal provisions reflect a policy preference for establishing federal jurisdiction over class actions, and modify— for purposes of class actions only—aspects of prior removal law that have prevented the removal of class actions.

Subsection (b) of Section 5 provides that class actions may be removed to federal court in accordance with the federal removal statute, 29 U.S.C. 1446, with the following key modifications applicable to class actions:

No In-State Defendant Exception to Removal Right Consistent with the elimination of the complete diversity requirement for class actions under the Act’s jurisdictional provisions, Subsection (b) of Section 5 provides that in a class action defendants may remove to federal court without regard to whether any defendant is a citizen of the state in which the action was filed. So long as the jurisdictional provisions of Section 4 provide for federal jurisdiction, the existence of an in-state defendant will not preclude removal of a class action (as it would have under the removal statute prior to this modification).

Subsection (b) also provides, contrary to the rule for removal generally, that any defendant may remove a class action to federal court without the consent of all defendants. This is intended to prevent the collusive tactic of naming a defendant friendly to plaintiffs to object to removal and prevent removal of the action.

• Note: Prior draft versions of the Act provided that class actions could also be removed by unnamed plaintiff class members.¹⁸ This provision is not in the Act as enacted.

Section 1446(b) of the federal removal statute provides that where a case becomes removable at some time after the filing of the initial complaint, it may be removed within thirty days after such event, but may in no event be removed more than one year following service of the initial complaint in the case. Subsection (b) of Section 5 of the Act specifies that this oneyear limitation will not apply to class actions. The Act’s invalidation of the one-year limitation on removal for class actions prevents "gaming" of the rule whereby, for example, "diverse" defendants or an increased damages amount, which would otherwise give rise to a right of removal, are added to an action by way of an amended complaint after the one-year time period has expired.¹⁹ The thirty-day deadline for removal remains in effect for class actions.

Expedited, Discretionary Appeals of Remand Orders Section 1446(b) of the federal removal statute provides that orders remanding removed cases to state court are generally not appealable. In contrast, Subsection (c) of Section 5 of the Act allows for discretionary review by the federal courts of appeals of district court orders granting or denying motions to remand class actions that have been removed to federal court. The party appealing such an order must file an application for review within seven days after the order is issued. The appeals court must issue a final decision on the appeal within sixty days (with provision for one ten-day extension for good cause), unless the parties agree otherwise.

• Note: There is a peculiarity in the language of the appeal provision. It states that an application for leave to appeal must be made "not less than 7 days after entry of the [remand] order." Given the provision’s emphasis on speed, the drafters presumably meant to say that applications must be filed not more than seven days after entry of the order. Until the courts offer a definitive reading, caution might suggest filing protective applications both before and after the running of the seven-day period.

Subsection (d) parallels Section 4 in excepting from the class action removal rules the same cases concerning securities and corporate governance that are excepted from the Act’s jurisdictional provisions, and discussed in more detail in Part II above.

Section 3 of the Act sets forth a "Consumer Class Action Bill of Rights" designed to "help ensure that class actions do not hurt their intended beneficiaries," and intended to address a number of "common abuses" and to "encourage greater judicial scrutiny of proposed class action settlements."²⁰ The provisions of Section 3 consist of five sections, Sections 1711 through 1715, to be added to the United States Code as a new Chapter of Title 28 of the United States Code.

Subsection 1711 defines the term "class action" to include representative actions filed in federal district court under Rule 23 of the Federal Rules of Civil Procedure, as well as actions filed under similar rules in state courts that have been removed to federal court. It also defines the following terms: class counsel, class members, plaintiff class action and proposed settlement.

• Note: The Consumer Class Action Bill of Rights applies only to class actions in federal court. It does not apply to mass actions. Also, unlike the jurisdictional and removal provisions of the Act, it does not contain an exception for securities class actions.

Subsection 1712 is designed to correct the perceived inequity of plaintiffs’ class counsel negotiating settlements that provide class members with "nothing more than promotional coupons to purchase more products from the defendants,"²¹ while class counsel receives fees calculated based upon the full potential value of the coupons. The most widely reported such case, which was noted by the Senate Judiciary Committee in its 2003 report, involved the settlement of a state court class action against Blockbuster alleging excessive late fees. In that case, the class members received $1 coupons for future rentals, while class counsel received a $9.25 million fee award. Experts predicted that at most only 20 percent of the class members would redeem the coupons, and the settlement allowed Blockbuster to continue the challenged late-fee practice.²²

To address the perceived unfairness to plaintiff class members of such coupon settlements, Section 1712(a) pegs class counsel fees to the value of coupons actually redeemed by class members. It provides that, in a coupon settlement, the "portion of any attorney’s fee award to class counsel that is attributable to the award of the coupons shall be based on the value to class members of the coupons that are redeemed." Thus, class counsel will no longer be able to claim percentage contingency fees based on the nominal value of coupons that will never be redeemed. And even those coupons that are redeemed might not be valued at full face value for purposes of calculating class counsel’s fees: Section 1712(d) provides that a court may hear expert testimony on "the actual value to the class members of the coupons that are redeemed."

Section 1712(c) provides that if a proposed settlement includes both coupons and equitable relief, then any portion of the award that is a contingent fee based on the value of the coupons must be calculated based on the value of redeemed coupons, and any portion not based on the value of the coupons must be based on the time reasonably spent by class counsel on the case.

Finally, Section 1712(e) states that a federal judge may not approve a coupon settlement without first conducting a hearing and determining that the settlement terms are fair, reasonable, and adequate for class members. In making that determination, the judge should consider, among other things, the real monetary value and likely utilization rate of the coupons provided by the settlement. The Senate Judiciary Committee stated in its 2003 report that "the fairness of the settlement should be seriously questioned by the reviewing court where the attorneys’ fees demand is disproportionate to the level of tangible, non-speculative benefit to the class members." Section 1712(e) also provides that a court may, in its discretion, require that a proposed settlement provide for the distribution of a portion of the value of unclaimed coupons to a charitable organization or government entity; any such distribution shall not be used as the basis for the award of attorneys’ fees.

• Note: This Section does not prohibit coupon settlements. Indeed, the Senate Judiciary Committee in 2003 expressly recognized the potential value of such settlements, stating that "[t]he Committee wishes to make clear that it does not intend to forbid all non-cash settlements. Such settlements may be appropriate where they provide real benefits to consumer class members (e.g., where coupons entitle class members to receive something of actual value free of charge) or where the claims being resolved appear to be of marginal merit."²³

• Note: The term "coupon" is widely used, but never defined in Section 1712. While Congress’s general intention to avoid compensating plaintiffs’ lawyers on the basis of theoretical benefit not actually accruing to the plaintiff class is evident, the specific limiting provision of Section 1712(a) is addressed only to "coupons."
• Note: The timing of coupon value determinations under Section 1712 is not clear on the face of the statute, and will likely need to be developed as settlements arise under the Act. The general rule set forth in Section 1712(a), by providing that contingency fees in coupon class actions must be "based on the value to class members of the coupons that are redeemed," appears to require that plaintiffs’ lawyers await actual redemption of the coupons prior to being paid. An argument might be made that plaintiffs’ lawyers could seek at the time of settlement to introduce—and be paid on the basis of—expert testimony under Section 1712(d) relating to the expected rate of redemption of the coupons. Such an argument appears unlikely to prevail, based on both the text and the legislative history of the Section 1712(d), which suggest that Section 1712(d) is not intended to authorize a prediction of the future coupon redemptions, but rather is designed to enable a finding that the actual value of redeemed coupons falls below their face value. Absent a mechanism for advance payment of plaintiffs’ legal fees, it is possible that courts will implement some method of rolling fee payment, whereby contingency fees are paid periodically on the basis of actual coupon redemption.

Under Section 1712(b), if class counsel’s fees in a coupon settlement are not to be based on the value of the coupons, the award must be based on the amount of time class counsel reasonably expended working on the action. Any such fee must be approved by the court and may include a fee for obtaining equitable relief, such as an injunction. The provision states that it does not prohibit application of a lodestar using a multiplier method.

Subsection 1713 states that a federal judge may not approve a class action settlement in which "any class member is obligated to pay sums to class counsel that would result in a net loss to the class member" unless the court makes a written finding that the benefits to the class members "substantially outweigh" the monetary loss.

This rule is intended to address anomalous situations like that arising in the Bank of Boston settlement,²⁴ in which the settlement resulted in class members having small amounts added to their bank accounts, while larger amounts were deducted to pay the fees of class counsel.²⁵

Subsection 1714 states that a federal court settlement may not award some class members a larger recovery than others simply because the favored members of the class live closer to the courthouse in which the settlement is filed than do the disfavored class members. The provision, which responds to cases in which settlements have discriminated on the basis of geography, provides assurance that out-of-state class members are not discriminated against by local judges.

• Note: This provision does not—and is not intended to— prohibit consideration of geographic factors that have a legitimate legal relationship to the proper amount of a claimant’s recovery. As the Senate Judiciary Committee noted in emphasizing this point in its 2003 report, "[f]or example, it is perfectly appropriate for a settlement of an environmental class action to differentiate settlement payment amounts based on a claimant’s proximity to an alleged chemical spill."²⁶ Rather, the provision is intended to address those situations where "putative class members’ claims are legally and factually indistinguishable," and one class member receives extra settlement benefits "merely because he or she resides in (or closer to) the county where the court sits."²⁷

Subsection 1715 sets forth requirements for notification to appropriate federal and state officials of proposed class action settlements. It ensures that a responsible state and/or federal official receives information about proposed class action settlements and is in a position to react prior to final approval of the settlement if the settlement appears unfair to some or all class members or inconsistent with applicable regulatory policies. As the Senate Judiciary Committee noted in its 2003 report, this provision is expected to "provide a check against inequitable settlements" and "deter collusion between class counsel and defendants to craft settlements that do not benefit the injured parties."²⁸ Section 1715(b) requires each defendant, within ten days after a proposed class action settlement is filed in federal court, to provide notice of the proposed settlement to (1) the U.S. Attorney General (or for banks and thrifts, the entity with primary regulatory or supervisory responsibility over the defendant); and (2) the state official that has "primary regulatory or supervisory responsibility with respect to the defendant, or who licenses or otherwise authorizes the defendant to conduct business in the State, if some or all of the matters alleged in the class action are subject to regulation by that person. For state depository institutions, notice must be given to the state bank supervisor in the state in which the defendant is incorporated or chartered. If there is no state official that meets the requirements set forth in the Act, notice must be provided to the state attorney general.

The notice must include (1) a copy of the complaint and attached materials; (2) the date and time of any scheduled judicial hearing; (3) proposed or final notification to the class members; (4) the proposed settlement; (5) any other agreement between class counsel and the defendant; (6) any final judgment or notice of dismissal; (7) the names of class members who reside in each state and their proportional share of the settlement, or if that is not feasible, a reasonable estimate of the number of class members in the state and their share of the settlement; and (8) any written judicial opinion related to the proposed settlement.

A federal court may not issue a final order approving a settlement until 90 days after the appropriate federal and state officials are served. If the defendants do not comply with this provision, a class member can refuse to comply with or be bound by a settlement agreement.

• Note: The notice provision is a potentially significant trap for unwary or sloppy defendants. It is the defendant’s obligation to provide timely notice; a failure to do so may result in absent class members not being bound by the settlement, even after payment has been made.
• Note: Notice to state and federal officials must be provided in securities class actions. This provision also states that it should not be construed to impose any obligations, duties or responsibilities on the federal and state officials who receive notice of a class action settlement pursuant to this provision. Thus, federal and state officials will be notified about proposed settlements and will have an opportunity to object, but will not be required to take any action.
• Note: Congress has omitted from the Act several provisions that appeared in earlier drafts of the Consumer Class Action Bill of Rights, including a provision requiring class notices to be in plain English and easily understandable, and a provision requiring special scrutiny of settlements in which the named plaintiffs receive special compensation (or "bounties") beyond that being given to the other class members.

Report On Class Action Settlements Section 6 of the Act requires the Federal Judicial Conference to prepare a report for the House and Senate Judiciary Committees on class action settlements within 12 months of the Act’s enactment. The report is to include recommendations on the best practices courts can use to ensure the fairness to class members of proposed class action settlements and to ensure the appropriateness of attorneys’ fees and expenses, as well as a report on any actions taken or planned by the Judicial Conference to implement the recommendations in the report.

Effective Date Section 9 of the Act provides that the legislation applies to "any civil action commenced on or after the date of enactment" of the Act.

• Note: The most important implication of this provision is clear: the Act is intended to have prospective effect only, and as such it does not render existing class actions in state court subject to federal jurisdiction and removable to federal court. Nor do the provisions of the consumer class action bill of rights apply to existing class actions in federal court.
• Note: Because Section 9 refers to the "commencement" of an "action" and not the date upon which a case becomes removable to federal court, it appears that the Act’s provisions will not apply to actions that have been commenced as of the date of enactment and are subsequently modified so as to fall within the jurisdictional and removal provisions of the Act. Thus, various post-filing jurisdictional "gaming" strategies (such as waiting until the end of the one-year time limitation for removal prior to adding additional defendants, dismissing non-diverse parties, or increasing the amount demanded above the amount-in-controversy threshold) remain available to plaintiffs’ lawyers in pending state court class actions.

Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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