Class Action Year in Review: Courts Continue Close Scrutiny of Class Action Settlements

In this alert, we discuss three significant issues relating to class action settlements:

• First, the continuing debate over class representative incentive awards in the wake of the Eighth Circuit’s decision in Johnson v. NPAS Solutions, LLC that such awards are per se unlawful.
• Second, the use of cy pres awards in class action settlements — i.e., payments to third parties, typically charitable, consumer, and legal aid organizations, when there are “residual” funds that have not been or cannot be distributed to class members.
• Finally, the use of “coupon” settlements in cases subject to the Class Action Fairness Act of 2005 (CAFA), including how attorneys’ fees should be calculated in such settlements.

Class Representative Incentive Awards

Class action settlements often include incentive awards for the class representative. These awards provide additional compensation beyond that to which the class representative may be entitled as a class member. In theory, incentive awards compensate the class representative for the costs and burdens incurred in representing the class, such as spending time learning about the case, answering discovery requests, and participating in a deposition.

Until recently, courts did not question the propriety of incentive awards generally; the issue was whether an incentive award was appropriate in a particular case and, if so, the amount. In making these determinations, courts typically analyzed factors like the amount of effort and risk to which the class representative was exposed and the benefits conferred on other class members.

As we previously discussed, in September 2020 a divided Eleventh Circuit panel held that incentive awards for class representatives are per se prohibited by two 19th-century U.S. Supreme Court cases that did not involve class actions.[1] Johnson v. NPAS Sols., LLC, 975 F.3d 1244 (11th Cir. 2020). In August 2022, the Eleventh Circuit denied rehearing en banc.[2] The case left many wondering if the decision signaled the beginning of the end of incentive awards for class representatives. Others went further, predicting the end of class actions — or at least consumer class actions. Indeed, in her lengthy dissent to the denial of rehearing en banc, Judge Pryor wrote that the Johnson decision was a threat to “the very viability of class actions in this circuit. This is particularly so in small-dollar-value class actions, where incentive awards help to encourage potential plaintiffs to serve as class representatives, despite having to take on significant additional responsibilities while receiving the same modest recovery as other class members.”

Currently, the Eleventh Circuit stands alone among the federal courts of appeals in barring incentive awards outright. For example, last month the First Circuit rejected the Johnson analysis, including its reliance on the two 19th-century Supreme Court cases: “Courts have blessed incentive payments for named plaintiffs in class actions for nearly a half century, despite Greenough and Pettus.”[3] The First Circuit found additional support for incentive awards in Federal Rule of Civil Procedure 23(e), which “ensures that incentive payments will not result in unfair settlements” by requiring that the settlement be “fair, reasonable, and adequate”; that class representatives adequately represent the class; and that the settlement treat class members “equitably relative to each other.” The Second and Ninth Circuits likewise expressly rejected the Johnson analysis.[4] And the Sixth Circuit rejected the argument that the incentive awards in that case were a “bounty,” finding that “those payments correlate[d] to the substantial amount of time that the named plaintiffs actually spent producing documents and otherwise advancing the litigation of the case.”[5]

According to the dissent in Johnson, the decision “place[s] this circuit at odds with more than 50 years of class action law and decisions from every other federal court in the country.” Nevertheless, some courts have noted that the Eleventh Circuit raised legitimate concerns that need to be addressed by the Supreme Court or Congress.[6] Until then, the Eleventh Circuit’s decision will continue to generate controversy.

Cy Pres Awards

Class action settlements often do not distribute the full amount of the settlement funds to class members, resulting in “residual” or “unclaimed” funds. For example, in “claims-made” settlements, some class members will not submit a claim form, and therefore will not receive a payment. In other cases, a settlement check that was sent to a class member may not have been cashed by its stale date. In still others, it may be administratively infeasible or cost-prohibitive to distribute payments to some or all class members.

The court then must decide how to dispose of these funds. Some possibilities include a reversion to the defendant, an additional pro rata distribution to class members who already received settlement payments, escheat to the government, or a cy pres distribution to a third party.

The cy pres doctrine authorizes courts to distribute such funds to their “next best use,” typically a charitable organization with a mission aligned with the issues of the case. Many states enthusiastically have embraced cy pres awards in class action settlements, with unclaimed funds often going to legal aid organizations. Indeed, many of these organizations depend to a significant degree on cy pres awards for their annual budgets. These state cy pres laws vary widely, including on what constitutes a “residue.”[7]

Many courts, however, have expressed a growing concern over cy pres awards. Such awards may divert funds from class members — the ostensible beneficiaries of the settlement — to third parties without a sufficient connection to the issues in the case. Furthermore, class counsel may receive substantial attorneys’ fees based on a payment that did not directly benefit the class. The U.S. Supreme Court has not squarely addressed the issue, although several justices have expressed the need to clarify these issues. For example, Chief Justice Roberts identified the potentially problematic aspects of cy pres awards in class settlements, including “when, if ever, such relief should be considered,” “how to assess its fairness as a general matter,” and “how closely the goals of any enlisted organization must correspond to the interests of the class.”[8]

One recurring issue is whether cy pres awards may be distributed if the claiming class members have not been fully compensated by the settlement. In 2022, the Eighth Circuit clarified its precedent that a court may not distribute cy pres awards until “class-member claimants have been fully compensated and further distribution to remaining class members is not feasible.” Jones v. Monsanto Co., 38 F.4th 693, 698–99 (8th Cir. 2022), reh’g and reh’g en banc denied, No. 21-2292, 2022 WL 3365924 (8th Cir. Aug. 16, 2022), pet. for cert. filed, No. 22-554 (U.S. Sup. Ct. Dec. 14, 2022). Jones was a consumer class action against an herbicide manufacturer for allegedly deceptive labeling. The proposed settlement would have paid claimants up to 50% of the product’s purchase price; there was approximately a 2-3% claim-in rate. Of the $39.55 million settlement fund, $9.89 million went for attorneys’ fees, $1.8 million was allocated to settlement administration expenses, and claims payments were estimated to be between $11.72–13.34 million, leaving approximately $14–$16 million to be distributed cy pres to three consumer advocacy organizations. An objector argued that payments to claiming class members should have been increased to 100% of the product’s value before the residual funds could be distributed cy pres.

The Eighth Circuit disagreed. Under Eighth Circuit precedent, when class members have claims for liquidated damages, they are “fully compensated” only when the claims are “100 percent satisfied by the initial distribution” of settlement payments. 38 F.4th at 699. If the claims are unliquidated, however, and the settlement provides for payment of only a portion of the damages sought in the complaint, “then the notion that class members were fully compensated by the settlement is speculative, at best.” Id. (internal quotations omitted). The objector contended that when the claims are unliquidated, class members must first be paid 100% of the damages claimed by the plaintiffs before the court may authorize a cy pres award.

The Eighth Circuit rejected this contention and held that when claims are unliquidated, the district court must make its own assessment of the damages “that would be recoverable” by class members. Id. The district court had conducted just such an analysis, ruling that payments of up to 50% of the average weighted retail price of the items class members they purchased “fully compensated” them, because their damages would need to be reduced from 100% of the price to account for the value they had received from using the product. The class members therefore had no equitable claim to the remaining funds. The Eighth Circuit held that this ruling was not an abuse of discretion.

Another recurring issue is the extent to which the cy pres recipient must advance the aims of the litigation or provide a benefit — even if indirect — to class members.  The Second Circuit recently addressed this issue, albeit in a relatively unusual context in which a monetary payment was made to the cy pres recipient, but not to class members.  In Hyland v. Navient, the Second Circuit approved a settlement on behalf of a class of student loan borrowers who alleged that a for-profit loan servicing company had engaged in deceptive practices. 48 F.4th at 121–24. The settlement provided class members with injunctive relief only, but required the defendant to contribute a cy pres award of $2.25 million to establish a not-for-profit organization that would provide counseling to borrowers, including advice on whether they had viable claims for monetary relief against the defendant. The Second Circuit rejected arguments that the cy pres award was improper: “[C]lass members can benefit — albeit indirectly — from a defendant’s payment of funds to an appropriate third party… . [W]here a cy pres award has a direct and substantial nexus to the interests of the class and account[s] for the nature of the plaintiffs’ lawsuit, … it necessarily prioritizes class members’ interests, even if it also provides a diffuse benefit to society at large.” Id. at 121–22 (emphasis in original; internal quotations omitted).  

Coupon Settlements and Attorneys’ Fees

Congress enacted CAFA in part out of a concern that some class action settlements enriched plaintiffs’ attorneys while providing little or no value to class members. Of particular concern were certain “coupon settlements,” in which class members, instead of receiving a monetary payment, received a “coupon” with which to purchase additional products or services from the defendant. These coupons often went unredeemed. See Pub. L. No. 109-2, § 2(a)(3)(A), 119 Stat. 4 (2005) (noting concern over settlements in which “counsel are awarded large fees, while leaving class members with coupons or other awards of little or no value”).

Under CAFA, Congress did not prohibit “coupon settlements” outright, but instead limited class counsel’s attorneys’ fees in such settlements: “If a proposed settlement in a class action provides for a recovery of coupons to a class member, 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.” 28 U.S.C. § 1712(a). CAFA does not define “coupon,” however, leaving federal courts to devise their own tests.

A recent example is the Ninth Circuit’s decision in McKnight v. Hinojosa, 54 F.4th 1069 (9th Cir. Nov. 30, 2022). The Ninth Circuit affirmed the district court’s conclusion that a class settlement with a ride-sharing company was not a “coupon” settlement subject to CAFA’s restrictions on attorneys’ fees awards to class counsel.

The Ninth Circuit, applying de novo review, analyzed the three factors it had previously set forth in In re Online DVD-Rental Antitrust Litigation, 779 F.3d 934, 950-51 (9th Cir. 2015), to determine whether the settlement qualifies as a coupon settlement: “(1) whether class members have to hand over more of their own money before they can take advantage of a credit, (2) whether the credit is valid only for select products or services, and (3) how much flexibility the credit provides, including whether it expires or is freely transferrable.”

The court concluded that the first factor weighed against finding a coupon settlement because, although most class members’ settlement awards were too small to purchase a ride without paying more out of pocket, class members could claim their reward up-front in cash and could also receive cash if they did not use their credit with the defendant. The second factor weighed in favor of finding a coupon settlement because the settlement credit was valid only for the defendant’s services. And the third factor weighed against finding a coupon settlement because the credits would become cash after one year without further action by class members. Because two of the three Online DVD factors weighed against finding a coupon settlement, the Ninth Circuit found that the district court did not err in concluding the settlement was not a coupon settlement under CAFA.

Because the settlement was not a coupon settlement, it was not subject to the heightened scrutiny applied to coupon settlements under CAFA. Nonetheless, the Ninth Circuit also found that the district court did not abuse its discretion in reducing class counsel’s attorneys’ fee award. The district court reduced the award from the requested $8.125 million (25% of the settlement fund and 4.14 times class counsel’s lodestar of $1.96 million) to $5.69 million (about 17.5% of the fund and 2.9 times the lodestar). The Ninth Circuit noted that the district court had reduced the fee award below the presumptively reasonable 25% benchmark “because of the modest degree of success” and because it would have overcompensated class counsel compared to their lodestar.

Another issue federal courts must consider in settlements that do involve coupons is how to calculate attorneys’ fees. The Fourth Circuit recently noted CAFA’s confusing statutory provisions in this regard, which variously state that fees should be based on the value of the coupons actually redeemed (the “percentage of the fund” method), or on class counsel’s actual time reasonably expended working on the matter (the “lodestar” method), or on a combination of the two methods. In re Lumber Liquidators Chinese-Manufactured Flooring Prod. Mktg., Sales Pracs. & Prods. Liab. Litig., 27 F.4th 291, 302 (4th Cir. 2022) (CAFA’s settlement provisions in §§ 1712(a), (b), and (c) “may not represent the height of artful drafting”).

The Fourth Circuit concluded that a fair reading of CAFA “reveals that the statute is permissive in nature” and provides courts with discretion to use the lodestar or percentage-of-the-fund method. The Fourth Circuit noted that the Ninth Circuit stands alone in requiring district courts to use the lodestar method in coupon settlements that provide injunctive relief, and that other circuits (including the Sixth, Seventh, and Eighth) have all concluded that CAFA’s settlement provisions are permissive structure and allow for the use of the lodestar method even in coupon settlements.

_{[1] Trustees v. Greenough, 105 US 527 (1881); Cent. R.R. & Banking Co. v. Pettus, 113 U.S. 116 (1885).}

_{[2] Johnson v. NPAS Sols., LLC, 43 F.4th 1138 (11th Cir. 2022). Plaintiff filed a petition for a writ of certiorari in October 2022.}

_{[3] Murray v. Grocery Delivery E-Servs. USA Inc., ___ F.4th ___, No. 21-1931, 2022 WL 17729630, at *9 (1st Cir. Dec. 16, 2022).}

_{[4] Hyland v. Navient Corp., 48 F.4th 110, 124 (2d Cir. 2022) (Greenough and Pettus were decided “decades before the adoption of Rule 23” and were “inapposite”), petition for cert. filed, Dkt. No. 22-566 (U.S. Sup. Ct. Dec. 16, 2022); In re Apple Inc. Device Performance Litig., 50 F.4th 769, 785 & n.13 (9th Cir. 2021) (“[W]e have previously considered this nineteenth century caselaw in the context of incentive awards and found nothing discordant.”).}

_{[5] Shane Grp., Inc. v. Blue Cross Blue Shield, 833 F. App’x 430, 431 (6th Cir. 2021).}

_{[6] See, e.g., Hunter v. CC Gaming, No. 19-cv-01979, 2020 WL 13444208, at *7 (D. Colo. Dec. 16, 2020) (“[M]uch of the reasoning in Johnson [is] persuasive, particularly to the extent it rejects ‘incentive’ payments that function as a ‘bounty’ for suing.”); Hart v. BHH, No. 15-cv-4804, 2020 WL 5645984, at *5 (S.D.N.Y. Sept. 22, 2020) (approving incentive awards while highlighting that “this issue is deserving of congressional attention”).}

_{[7] See, e.g., Cal. C.C.P. § 384(a) (“It is the policy of the State of California to ensure that the unpaid cash residue and unclaimed or abandoned funds in class action litigation are distributed, to the fullest extent possible, in a manner designed either to further the purposes of the underlying class action or causes of action, or to promote justice for all Californians.”); 735 ILCS 5/2-807 (addressing “[r]esidual funds in a common fund created in a class action”); Wash. Super. Ct. R. 23(f) (addressing “residual funds” but noting that rule did not prohibit settlements that do not create residual funds).}

_{[8] Marek v. Lane, 571 U.S. 1003, 1003 (2017) (concurring in denial of certiorari, but noting that Court may need to “clarify the limits” of cy pres awards).}