CLASS MEMBER EXTORTION

MATTHEW WEINER

Overview

Addressing the concerns and solutions raised in a law review article entitled The End of Objector Blackmail? By Brian Fitzpatrick Introduction

Settlement process Implications arising from a 2002 Supreme Court case Define professional objector
Economic incentives created for professional objectors to extort class counsel Attempts made by courts and practitioners to limit professional objectors and objector blackmail Examine the proposed rule by Mr. Fitzpatrick Show how Mr. Fitzpatricks rule is superior, yet still incomplete in fully thwarting professional objectors Mr. Fitzpatricks rule should be adopted, with further standards set by district courts that create a disincentive for professional objectors lodging frivolous objections at a fairness hearings

The Problem

Possible Solutions

Critique

Conclusion

Prevalence of Settlement

Certified class actions were two to five times more likely to settle than cases that contained class allegations but were never certified.

Source: Newberg on Class Actions Appendix XI (4th ed.) Empirical Study of Class Actions in Four Federal District Courts

In a study analyzing the E.D.Pa between years 92-94:

Cases that were certified

Total: 36 (64 not certified) Judgment by Bench Trial: 1 Judgment by Jury Trial: 2 Settlement Approved: 23 (62%)

Thomas E. Willging , Laural L. Hooper , Robert J. Niemic, An Empirical Analysis of Rule 23 to Address the Rulemaking Challenges, 71 N.Y.U. L. Rev. 74, (1996)

Rule 23(e) Settlement, Voluntary Dismissal, or Compromise

(1) The court must direct notice to all class members (2) A court must conduct a fairness hearing

Determine that the settlement is fair, reasonable, and adequate

(3) Disclose any agreements made in connection (4) Afford new opportunity to opt-out (only if b3) (5) Must entertain class members who object

Can only withdraw objection upon approval by court

Who May Object?

Any class member How important is this?

See In re Prudential Ins. Co. of Am. Sales Practices Litig., 278 F.3d 175, 201-03 (3d Cir. 2002) (Rosenn, J., dissenting)

Defendants' counsel and Class Counsel reach a point where they are cooperating in an effort to consummate the settlements. Even the court at this point may be inclined to favor settlement of a huge, complex action, and the general atmosphere becomes largely cooperative. Objections serve a highly useful vehicle for the members of the class and the public generally; they require consideration by the court and its disposition of them usually provides reassurance that the settlement and the fees approved are fair and just. From the conflict of ideas comes crystallization of thought.

General Consensus Concerning Objectors

[T]he least popular parties in the history of civil procedure

Edward Brunet, Class Action Objectors: Extortionist Free Riders or Fairness Guarantors, 2003 U. Chi. Legal F. 403, 438-42 (2003)

Objections may be only an effort to obtain attorneys fees' for the objecting attorney Such claim-jumping attorneys are able to free ride off the efforts of the initial class counsel, who had already identified an alleged legal wrong and spent considerable time procuring a settlement.

Who May Appeal?

Prior to 2002
Circuit Split

Only the formal parties may appeal

Any class member who filed an objection may appeal Circuits 2,3 and 9

Circuits 4,5,6,7, 8, 10 and11

Who May Appeal?

Only the formal parties may appeal Defendant Named Reps Class Counsel (fee awards) Successful Interveners (FRCP 24) Any class member who filed an objection may appeal Defendant Named Reps Class Counsel (fee awards) Successful Interveners (FRCP 24)

Any Class Member Filing an Objection

Devlin v. Scardelleti, 536 U.S. 1 (2002)

Facts

Union pension plan was amended in 1991 to add COLA for retired and active employees Plan could not support such increase In 1997, trustees eliminated COLA for all members by enacting an amendment Trustees filed a class action seeking declaratory judgment that 1997 amendment was binding Petitioner, Devlin, a retired worker, was proposed as class representative for a subclass of retired workers

Devlin v. Scardelleti, 536 U.S. 1 (2002)

Facts

Devlin refused to become named rep Devlin brought his own claim in S.D.N.Y arguing that 1997 amendment violated ADEA Devlins claim was dismissed

Second Circuit thought it appropriate that the district court holding the class-action (Maryland) should handle all of these claims

Maryland had already certified a class under 23(b)(1) By the time Devlin formally sought intervention, motions were already filed for the court to approve settlement

Intervention was absolutely untimely and thus denied Devlin appeals motion ruling, as well as settlement approval Fourth Circuit: Devlin lacks standing not a formal party Cert granted

Devlin v. Scardelleti, 536 U.S. 1 (2002)

Supreme Court

Issue:

[W]hether nonnamed class members who fail to properly intervene may bring an appeal of the approval of a settlement.

Is Devlin a party for the purposes of appeal Only parties to a lawsuit, or those that properly become parties, may appeal an adverse judgment. Marino v. Ortiz, 484 U.S. 301 (1988)

Devlin v. Scardelleti, 536 U.S. 1 (2002)

Supreme Court

Holding:

Any class member objecting to approval of settlement at fairness hearing may bring an appeal without intervening Although nonmembers are not considered a party for some instances (e.g. conducting discovery and moving for SJ), they may be considered a party for appeal because the settlement binds them
This will come as news to law students everywhere The rule that only parties may appeal an adverse judgment is one well-settled rule that, thankfully, the Court leaves intact. Other chapters in the hornbooks are not so lucky.

Dissent (Scalia):

Practical Implications Arising from Devlin

Economic Incentives

Court

Appeals would be few because, like the objections on which appeals are based, they are irrational to pursue Cost of Appeal > Expected Marginal Recovery from Appeal This surely suggests the triumph of hope over experience.

Dissent

Who is correct?

Practical Implications Arising from Devlin

The dissent is pointing to the problem of Objector Blackmail

To say the substance of an objection is irrational is not to say that it is irrational to make the objection and file the appeal. C < (pR) or (pB) Appeal

Where:

C = Marginal cost for objector to pursue appeal P = Probability R = Expected Marginal Recovery from Appellate Court B = Expected Blackmail Payment from Counsel

Practical Implications Arising from Devlin

C < (pR) or (pB) Appeal Why would counsel pay party to withdraw appeal?

Time Value of Money: A dollar now is worth more than a dollar tomorrow C + (PVft PVfa) > B Payoff appeal

Where:

C = Marginal cost for class counsel to defend appeal (include opportunity costs) PVft = Present value of counsel fee after initial trial court approval of settlement Pvfa = Present value of counsel fee after appellate determination B = Payment to settle appeal

There is a lot of money on the line

PVft PVfa > B Payoff appeal Example: Shaw v. Toshiba, 91 F.Supp2d 942 (E.D.Tex. 2000)

Class settlement: $2.1B

Not all cash - warranty remedies, hardware replacements, software patches, and coupons

Counsel fee: $147.5M Objector counsel fee: $6M

Doubled amount of time class members could redeem coupons:

6 months to 1 year

Frivolous Objectors: $0

[F]iled by professional objectors who seek out class actions to simply extract a fee by lodging generic, unhelpful protests.

What Devlin now allows

The Frivolous Objectors now have the right to appeal their ruling, thereby delaying class counsels fee Using Shaws numbers: C + (PVft Pvfa) > B Payoff appeal

C + $145.5 - $138.5* > B Therefore, it is economically rational for the class counsel in Shaw to payoff the frivolous objectors appeal at any amount less than $7M Furthermore, despite what the Court stated in Devlin, it is not irrational for the frivolous objectors to pursue appeal (as long as appeal would cost less than $7M)

* Assumes a 5% rate and an appeal that gets denied in 1 year (very conservative assumptions)

What comprises such a frivolous objection?

Perhaps the district court was wrong in dismissing the objector and calling the objection frivolous

Objector argued: It is abundantly clear that Sears will enjoy increased floor traffic in its stores from those class members who actually use the coupon thereby benefitting Sears even further. SEARS HAS NOTHING TO DO WITH THIS LAWSUIT! This Court would venture to say this particular language has previously been filed in another class-action lawsuit involving Sears. Perhaps that's where it should have stayed.

Nevertheless, because of Devlin, the objector can now appeal from this denied frivolous objection

Side Note: Average fee/cost ratio

Analyzing 346 cases between 1993 2002 (adjusted for $2002):

Average attorneys fees $8,870,101. In 252 cases, the average attorneys costs and expenses $1,061,172.

Theodore Eisenberg , Geoffrey P. Miller, Incentive Awards to Class Action Plaintiffs: An Empirical Study, 53 UCLA L. Rev. 1303 (2006)

Proposals to Eliminate Blackmail

Sanctions Bond Posting Undo Devlin Quick-Pay Provisions Inalienability

Sanctions

Rule:

Sanction class members whose objections are insubstantial Eliminates frivolous objections (such as what we saw in Shaw) What is insubstantial? Can chill potentially legitimate objectors Legitimate objectors may still blackmail

Pros:

Cons:

Bond Posting

Rule:

Under Rule 7 of Appellate Procedure, court may require objectors to post bonds to cover for attorneys fees

In re Cardizem CD Antitrust Litig., 391 F.3d 812, 815, 817 (6th Cir. 2004) In re Pharm. Indus. Average Wholesale Price Litig., 520 F. Supp. 2d 274, 279 (D. Mass. 2007)

Pros:

Bond can be high enough to successfully thwart objectors who do not have enough capital and pay for administrative costs attributable to delay in [settlement] distribution
Judges now have authority to limit appeals from their own decisions Blackmailers can still appeal from the decision to post bond, creating more delay Does not directly stop blackmailers if objector has enough capital to post bond, then blackmailers may still prevail

Cons:

Undo Devlin

Rule:

Congress may override Devlin by enacting a statute Drastically reduces potential appeals to only formal party members Savvy blackmailers could simply intervene Still allows for appeal from an order denying intervention

Pros:

Cons:

Quick-Pay Provisions

Rule:

Wording inserted into settlement agreement (with consent by defendants) that allows counsel to receive fees after trial court approval of settlement Counsel agrees to return fee if appeal is lost Blackmailers less inclined to appeal

Pros:

Coc < (pR) or (pB)

Appeal

B would only equal Ccc (i.e. the marginal cost for class counsel to defend appeal)

Counsel will be less inclined to payoff blackmailers

Ccc + (PVft PVfa)> B

Payoff appeal

PVft Pvfa = 0

Prevalence:

35% of settlement agreements contain quick-pay provisions in 2006 80% of security fraud cases contain quick-pay provisions

Quick-Pay Provisions

Cons:
1) There is still opportunity, albeit a considerably smaller one, for blackmailers to prevail

If counsel is risk averse to losing appeal

C + pL > B

payoff objector

Where: C = Costs of appeal (including opportunity costs) P = probability of losing appeal L = expected marginal loss to counsel fee B = objector payoff amount

Persuasive?

Remember, objector must find it rational to pursue appeal

Coc < (pR) or (pB) Appeal B is considerably smaller because there is no time-value of money loss to class counsel

Quick-Pay Provisions

Cons:
2) Defendants might still be inclined to pay objectors to obtain case closure

A pending class action hurts Defendants stock price

Persuasive?

3) Defendant inclined to bargain for quick-pay provision

Quid pro quo Decreases class settlement amount

Inalienability

Rule:

Once appeal is filed, it may only be withdrawn if the settlement of the appeal benefits the entire class Similar to rule 23(e)(5) objection at settlement fairness hearing may not be withdrawn without court approval Prohibit objectors from extracting rents from a class counsel who is eager to avoid delay, risk, and litigation costs No legitimate objector would be discouraged from having their appeals heard

Pros:

Cons?

Potential Critiques of Inalienability Rule

Where do we typically see inalienability rules?

Defined as something of yours that you cannot lose by specified means

Examples:

Body Organs, Sex, Heroin, Children, and Human Rights

General Rule: Prohibitions on transfers are economically inefficient because they prevent people from getting what they want

Inalienability rests on conventional morality and political philosophies that stress values other than economic efficiency

Robert Cooter and Thomas Ulen, LAW & ECONOMICS 161 (Pearson 6th ed. 2011)

Scholars have actually attacked many inalienability rules on economic efficiency grounds

See Landes & Posner, The Economics of the Baby Shortage, 7 J. LEGAL STUD. 323 (1978) See Richard Epstein, Why Restrain Alienation?, 85 COLUM. L. REV. 970 (1985)

Do General Critiques on Inalienability Apply Here?

The inalienability rule does prevent people from getting what they want

But those people are objector blackmailers By having an inalienability rule and thus depriving blackmailers of their ability to extract a fee by settling an appeal, there is a benefit to the class as a whole and furthermore to class counsel

Inalienability vs. Other Proposals

Better than sanctions, bonds, or undoing Devlin?

Yes only means by which a legitimate objector is not thwarted The only limitation to a quick-pay provision that I find persuasive is the ability for defendant to bargain Nevertheless, inalienability rule still far better alternative

What about quick-pay provisions?

Does Inalienability Achieve Desirable Goals

To class members Yes To class counsel Not enough

Professional objectors still file borderline frivolous objections for which courts award fees

Fee Awards for Objectors

General Rule:

Objectors are only awarded fees when:

They expended large amounts of time, money and resources, They aided the court considerably in its consideration of proposed settlements and fee awards, and The class members were ultimately benefitted as a result of the objectors' efforts.

See Sparks v. MBNA Corp., 289 F.Supp.2d 510 (D.Del 2003) (Noting that objector fees are few and far between.)

Fee Awards for Objectors

Objectors are sometimes awarded fees even when they lose

Many courts allow objector fees when they sharpen the focus of the court

Mostly in the Second Circuit

Frankenstein v. McCrory Corp., 425 F. Supp. 762, 767 (S.D.N.Y. 1977); In re MetLife Demutualization Litig., 689 F. Supp. 2d 297, 367-68 (E.D.N.Y. 2010); Park v. Thomson Corp., 633 F. Supp. 2d 8, 11 (S.D.N.Y. 2009); In re Domestic Air Transp. Antitrust Litig., 148 F.R.D. 297, 358 (N.D. Ga. 1993) But see Martin v. Foster Wheeler Energy Corp., 2008 WL 906472 at *10 (M.D.Pa 2008) (The district courts in the Third Circuit have not adopted a view like that of the Southern District of New York)

Fee Awards for Objectors

Furthermore, courts have become more lenient in granting fee awards to objectors, whose value added to the settlement is questionable

See In re Riverstone Networks, Inc., 256 Fed.Appx. 168 (9th Cir. 2007) (upholding objector attorney fee award even when the objection lodged was essentially the same thing as previous objectors) See generally Bruce D. Greenberg, Keeping the Flies out of the Ointment: Restricting Objectors to Class Action Settlement, 84 St. Johns L. Rev. 949 (2010) (Advocating for stricter standards on allowing objectors to obtain fee)

Inalienability Does Not Fully Prevent Blackmailers

The rule should create a disincentive for professional objectors to lodge meritless objections from the very beginning

Inalienability does not prevent professional objectors from poking their heads into a settlement hearing and attempting to extract a fee

The rule only prevents them from settling the appeal Incentivizes collusion earlier in the settlement process

E.g. The counsel for the objector agrees to allow the settlement to proceed, in exchange for a piece of the settlement pot. See Brunet, supra, at 425-435.

Settlement Negotiation

Fairness Hearing

Court Approval

What Should Be Done?

Strike a balance

Must not create a disincentive for legitimate objectors But also must stop as many extortionist as possible Objector Counsel as well as class member report history and outcomes of prior objections Objector counsel submit fee schedule Only allow objecting counsel fee when, (1) objection is successful, and (2) it is clearly shown that objection benefited entire class

Stricter standards

Whats the solution?

Two-fold
1)

2)

Create an inalienability rule that only allows a party to withdraw their appeal if settling the appeal benefits the entire class Enforce stricter rules on district courts for granting fees to objectors