Class Action Lawsuits and Unethical Settlements
AN INVITATION FOR CLASS ACTION ATTORNEYS TO ENGAGE IN UNPROFESSIONAL CONDUCT © Copyright 2004 by Michael A. S. Guth. All Rights Reserved. No portion of this article, including this web page, may be copied, retransmitted, reposted, or duplicated in significant portion without the express written permission of Dr. Michael Guth. Users are always welcome to establish links to this web page or to quote from it freely. Modern multiforum litigation creates a conflict of interest environment in which attorneys representing class plaintiffs may be tempted to settle class action lawsuits for the wrong reasons. Instead of rejecting an inadequate settlement offer, the class counsel might recommend settlement so that he can be assured of collecting an attorney fee award and so that the claims of his clients will not become barred by the preclusive effect of a settlement negotiated in another forum. A trend has now developed in which the plaintiff class counsel compete with one another to offer the best and most sweeping settlement terms to defendants, and these settlements generally contain a global release of all claims in other fora. Once these global releases are approved and entered as part of a class action judgment, the releases effectively extinguish or bar related actions by class members in any other forum. An attorney who wishes to conduct his class action practice in a diligent and ethical manner can be harmed by the unethical behavior of some class counsel who use claims in other fora as a bargaining chip to maximize the settlement terms for their own fee award. The resulting settlements may be contrary to public policy in the sense that (1) injured class members receive little or no recovery, and (2) viable claims in one forum are extinguished by the claim preclusive effect of a less than fair settlement and global release of all claims in another forum. Unlike ordinary litigation where a defense counsel must bargain with one plaintiffs' counsel to reach a settlement in a single jurisdiction, in multiforum class actions defense counsel can shop from forum to forum to obtain the best settlement terms for their client. The plaintiff class counsel in one forum actually has an incentive to undercut the claims represented by another class counsel in another forum: the class counsel can get a higher settlement, and consequently a higher fee award, if his settlement includes a release of claims beyond his own forum. Section I of this article describes the legal and ethical environment in which attorneys engaged in multiforum litigation must practice. Section II lists examples of opportunistic behavior by lawyers within this legal environment. In particular, Section II provides cases to illustrate reverse auctions, forum shopping,[1] filing of sham complaints aimed at precluding claims in other fora, meritless class action suits, race to the courthouse, and other conduct that tends to cast the judicial system or the legal profession into disrepute. At present, neither the federal nor any state judiciary, which are responsible for promulgating rules under which attorneys practice law, has recognized that multiforum class litigation create a unique set of ethical dilemmas for attorneys with respect to settlements, the award of fees, and the law of preclusion. Some of these ethical dilemmas arise from the current state of the substantive law. Section III discusses changes needed in the substantive law of preclusion and rules of civil procedure to prevent abuses within the legal system. Section IV focuses upon the ethical risk that some attorneys may elevate their own self-interests ahead of their clients and recommends that each state should adopt a new Rule of Professional Responsibility specifically tailored to multiforum practice. This new ethical rule should cover attorneys' conduct from the point when they first undertake to represent a client in a potential class action matter to the time when the action is concluded. Finally, the Appendix contains our proposed rule, with a comment that follows the rule. I. Legal and Ethical Environment of Modern Multiforum Litigation Although lawyers typically think of their professional responsibilities in terms of representing a single party in litigation in one forum, the class action lawyer faces a different legal and ethical environment. A class action proceeds on behalf of all members defined in the class, and all class members similarly situated will be bound by the terms of any settlement or judgment in the class action. In this environment, the attorney representing the plaintiffs in a class action, usually designated the class counsel, has an ethical duty of loyalty to represent the best interests of all class members. In particular, the class counsel cannot ethically favor any one plaintiff or his own self-interest above those of the absent class members. A lawyer engaged in mutiforum class action practice also faces a unique environment for negotiating a settlement. Unlike the settlement of a lawsuit between two individual parties in which the court will routinely sign a jointly proposed order by both counsel to settle and thereby dismiss a case, the settlement of a class action lawsuit requires a judicial determination of the fairness of the settlement to absent class members.[2] A court's nondelegable duty to approve the fairness and adequacy of any proposed class action settlement "is not an act of judicial mediation; it is an act of judicial power."[3] The court must administer class proceedings in a way that safeguards the rights of absent class members and comports with the requirements of due process. Generally, class members will have the legal right to opt out of any proposed settlement of the class action. Those who choose to opt out of the class action will then have the freedom to pursue their claims individually against the defendants. Those who fail to exercise their opt out rights, either because they want their prorata share of the proposed settlement consideration or simply because they ignored the court notification and allowed their opt out rights to lapse, will be bound by any judgment entered by the court. Such a judgment in a class action will generally have claim preclusive effect, under the Full Faith and Credit Act,[4] on either pending or subsequently filed litigation arising from the same transaction. This preclusive effect will extend to any other forum, both state and federal, in which a plaintiff might file claims against the defendants named in the class action. Aside from ethical considerations about undercutting viable claims in another forum, class counsel face no other limitations in receiving court approval to release claims outside their fora and bind class members. Federal courts have entered judgments approving proposed class settlements that released both federal and state law claims. For example, in Class Plaintiffs v. City of Seattle, the Ninth Circuit affirmed a federal district court judgment approving a class settlement and release of federal securities law claims.[5] Also, In re Corrugated Container Antitrust Litig., held a federal district court, in approving a class settlement of federal claims, had jurisdictional competence to extinguish state claims that were not pleaded, but which it had pendent jurisdiction to adjudicate.[6] Similarly, state courts have approved class settlements that released state law, federal law, and even exclusively federal claims.[7] For example, in Kremer v. Chemical Constr. Co., the U.S. Supreme Court held that settlement of federal Title VII employment discrimination claims in a state class proceeding has issue preclusive effect barring subsequent claims raised in federal court.[8] In Nottingham Partners v. Dana, the Delaware Supreme Court affirmed the right of Delaware state courts to enter judgments releasing exclusively federal securities law claims as part of a state court class action settlement.[9] And in Marrese v. American Academy of Orthopaedic Surgeons, the U.S. Supreme Court held "a state court judgment may in some circumstances have preclusive effect in a subsequent action within the exclusive jurisdiction of the federal courts."[10] Until the Supreme Court's recent decision in Matsushita Electrical Industrial Co., Ltd. v. Epstein[11] [hereinafter "Epstein"], the federal courts had placed only one modest limitation on the full faith and credit of state court judgments attempting to release exclusively federal claims: the facts in the underlying state law claims must be identical to those giving rise to claims released or extinguished by the state court judgment. As long as the claims giving jurisdiction to a court arose from the same factual predicate as the claims covered by a settlement, the state courts would have been able to decide the issues on their merits. Consequently, federal courts gave claim preclusive effect to the state court judgment approving the settlement of the action.[12] For example, in Nottingham Partners v. Trans-Lux Corp.,[13] the state class action claims and the released exclusively federal securities law claims both arose from the failure of a corporation to disclose allegedly material facts in a proxy statement. Similarly, the state class claims in Grimes v. Vitalink Communications Corp.,[14] shared a common factual gravamen of nondisclosure of material facts with the federal securities law claims released in the settlement. Yet the Supreme Court's Epstein decision eliminated even this modest limitation on one court's power to extinguish and bar claims in another forum. In Epstein, the Supreme Court affirmed a Delaware state court's approval of a class action settlement that had the effect of releasing exclusively federal securities claims[15] that differed factually from the breach of fiduciary duty state law claims before it. Unlike Nottingham Partners and Grimes, the federal and state law claims in Epstein stemmed from differing factual bases.[16] The gravamen of the Delaware state class action was that the directors of a Delaware corporation had breached their fiduciary duty by failing to (1) implement a market check mechanism to ensure that shareholders received the maximum value for their shares, and (2) disclose key terms of a proposed merger such as the compensation packages that the corporation's top officers would receive.[17] In contrast, the federal securities law class action filed in California in Epstein focused on the acquiring corporation's behavior: whether the Japanese acquiring firm violated federal securities law by offering either more consideration for the shares of some shareholders than the tender offer,[18] or by offering these select shareholders a different form of consideration than that offered to other shareholders.[19] By upholding the Delaware class settlement and reversing the U.S. Court of Appeals for the Ninth Circuit, the Supreme Court eliminated the same factual predicate test previously used by the U.S. Courts of Appeal to limit the preclusive effect of class action settlements. The Court instead used the much broader same transaction test.[20] The Court effectively gave every lower court ─ state or federal ─ the ability to enter a judgment approving a (dubious) settlement that could prevent class members from further litigating claims in other fora. The Supreme Court could have decided Epstein largely as a matter of forum shopping, which placed state courts in the precarious position of having to value factually unrelated, exclusively federal claims.[21] Yet the Court never even addressed the central forum shopping issue at the heart of Epstein: fair representation to the class. In the aftermath of Epstein, state and federal court judges seemed to have unfettered discretion to approve class action settlements subject only to meeting some minimal, poorly defined due process standards of fairness. Because the Supreme Court offered no guidance on what due process means for the approval of class action settlements, we can anticipate that courts will apply differing levels of scrutiny of settlement terms from forum to forum.[22] Multiforum class actions thus afford unique opportunities for forum shopping and questionable settlements unlike any opportunistic behavior faced by lawyers representing individual clients in single forum cases. The state Boards of Professional Responsibility, which administer the rules of conduct for practicing attorneys, have paid little attention to class action practice. The nature of class actions and recent decisions on claim preclusion, however, create problems for lawyers who wish to conduct their class representation in an ethical manner. These lawyers face the dilemma that other less scrupulous attorneys in other fora can extinguish their cases. Soon the counsel begin to compete to see who can settle first and thereby bind the class members in other fora. The system creates incentives for lawyers to join in the frenzy of bargaining away the class members' interests before counsel in another forum undercuts the claims that form the basis for their own class representation. II. Examples of Opportunistic Behavior that Illustrate the Need for Greater Regulation of Multiforum Litigation In Section I, we described a general environment that creates incentives for lawyers engaged in multiforum, class action practice to exhibit unprofessional behavior. This section illustrates specific instances of undesirable behavior resulting from the incentive problems in the modern class action practice. Types of undesirable behavior include reverse auctions, in which plaintiffs counsel keep trying undercutting the value of their clients claims in order to propose the winning (and generally lowest value) settlement to the defendants, forum shopping for unsophisticated judges, filing nuisance suits, structuring complaints with an eye towards the preclusive effect on claims in another forum, a race to the courthouse to be the first class counsel to file suit, courts racing to judgment so that another court does not extinguish the claims before them, and due process concerns associated with class member apathy. A. The Reverse Auction The first consequence of the multiforum environment we shall examine is the reverse auction of plaintiffs' counsel lowering their settlement bids in an effort to induce defendants to settle in their forum. In a multiforum class action, defendants generally have two or more forums in which they have been sued to find the most favorable settlement terms. If class counsel in one forum will not accept an offer, both the counsel and the defendants know that class counsel in another forum may well accept it. The counsel who negotiates the settlement offer usually collects the lion's share of any payment for plaintiffs' attorney fees, which gives class counsel in each forum a powerful incentive to offer the most favorable deal to the defendants. "Whoever settles first with the defendant wins because any of these courts can grant a fully preclusive settlement covering all possible claims. . . . [D]efendants can force rival teams of plaintiffs' attorneys in to a `reverse auction' under which the defendants will settle with the lowest bidder among them."[23] The likely winner in such a reverse auction should be one of the state class counsel. Counsel for the state court plaintiffs cannot litigate federal securities claims and sometimes not even the state law claims of another state in their own forum. The primary settlement value of their claims will often lie in their ability to preclude the more ominous action in some other forum. Defendants are aware that plaintiffs' counsel in state court are willing to bargain away exclusively federal claims, which they cannot argue on the merits and for which they can derive no attorney fee. The Delaware Chancery Court, which hears a disproportionate number of class action suits based on the number of corporations that choose to incorporate in Delaware, acknowledged the potential for this kind of abuse with class action proceedings: using a settlement in one forum to extinguish the prosecution of a similar class action in another forum.[24] Yet the defendants' end run around the Epstein plaintiffs ─ going across the country to Delaware in an effort to extinguish the federal class action appeal, rather than defending that suit on its merits in California ─ illustrates a general pattern that is likely to recur in the current legal and ethical environment for multiforum litigation. We believe the ethical standards imposed on defense counsel should limit the benefit of employing a divide and conquer reverse auction strategy, rather than opposing a claim on its merits.[25] B. Forum Shopping by Plaintiffs' Counsel for a Judge Who Will Approve a Settlement Defense counsel are not the only source of forum shopping in the modern multiforum litigation practice. Plaintiffs' counsel also engage in forum shopping. In multiforum litigation, the class counsel's forum shopping is not the usual choice of a state court or federal court within a given state jurisdiction; that choice of fora remains a legitimate exercise of the counsel's discretion to maximize his clients' recovery. Instead, with multiforum class actions, we see plaintiff class forum shopping for a jurisdiction most likely to approve any dubious settlement terms that counsel submits. Clearly, selecting a forum based on its settlement acceptance behavior and its treatment for the award of attorney fees poses no direct benefit to class members. To the contrary, that form of forum shopping may exacerbate the conflicts of interest between the class members and the recovery of a fee award by their counsel. Forum shopping by plaintiff class counsel is typified by the polybutylene plumbing case, which involved a multi-billion dollar settlement and a defined class of more than six million current homeowners and additional unknown class members who will own the homes in the future.[26] Plaintiff class counsel first filed a settlement of that nationwide class action suit in a Texas state court. When the judge refused to approved the settlement because it was unfair to class members, the class counsel refiled the class lawsuit in a federal district court in Texas. Again, the settlement was not approved. The plaintiffs' class counsel then moved the lawsuit to Union City, Tennessee, where he located a Chancellor who ultimately approved the class action settlement.[27] Obviously, one would not ordinarily expect the largest property-damage class action suit in America to be resolved in a small town forum like Union City, Tennessee.[28] But the legal machinations in the polybutylene plumbing case did not stop in Tennessee. It turns out another group of plaintiffs' attorneys had filed a similar class action suit in an Alabama state court.[29] For a time, like dueling banjos, the two teams of plaintiff's attorneys competed for clients, trading accusations of misconduct and running rival newspaper and TV ads. The result was both to confuse eligible homeowners and to create a competition that defendants could exploit. Eventually, a state court judge in California negotiated a truce between the warring factions. . . . [T]he revised settlement . . . did little to improve the benefits for the class. Rather, it mainly assured both groups of plaintiff's attorneys that they would receive court-awarded fees.[30] No ethical rule prevents the plaintiff class counsel from settling multiforum litigation in locations far removed from the state of incorporation or the principal place of business of the corporate defendants. However, when class counsel deliberately selects a forum to submit his proposed class settlement, based on on the fact that judges in that forum are less sophisticated in corporate and class action litigation, the counsel appears to be violating his ethical duty of diligent representation. The general public may perceive that plaintiffs' class counsel are taking advantage of less sophisticated judges in a way they could not with judges more familiar with class action cases. C. Filing Cases that are Known to Cost the Class Plaintiffs Much More Than They Receive While obtaining judicial approval of a dubious class action settlement would fail to redress the harm class members have sustained, other forms of unethical attorney conduct actually harm class members further. One example of harmful attorney conduct is filing suits that will reasonably cost class members more than they could expect to gain. Such suits only exacerbate the losses of injured class members. The Bank of Boston's January 1994 settlement of a class action illustrates this point concisely. The class action suit accused the bank of keeping excess amounts of mortgage customers' funds in non-interest-bearing escrow accounts and involved a nationwide class of some 750,000 current and former mortgage holders.[31] The 300,000 current mortgage holders were charged for the cost of the attorney fee award, which totaled $8.5 million.[32] The terms of the settlement, approved by an Alabama state court, called for the Bank of Boston to reimburse each class member's account up to $8.76 as compensation for lost interest "and then deduct upward of $100 from many of those accounts to pay the [class representative's] attorney fees."[33] Dexter Kamilewicz was typical of the Bank of Boston customers so affected. The bank credited his account for $2.19 in back interest and deducted $91.33 from his account to pay the attorney fee award.[34] Like other current mortgage holders, Kamilewicz lost far more in the class action lawsuit than he gained. Once again, the attorney fees dwarfed the damages awarded to individual class members. Ironically, aside from the few dollars in back interest, the recovery consisted of a refund of the plaintiffs' own money held in escrow, "which would have been returned sooner or later even without the [class action] suit."[35] As a result in the fall of 1995, Kamilewicz, his wife, and a third bank customer filed a new class action lawsuit in federal district court in Chicago alleging fraud in the terms of the settlement against the Bank of Boston, its attorneys in Alabama and Chicago, and the Alabama law firm representing the class plaintiffs.[36] In the Bank of Boston case, the plaintiff attorneys should have had an ethical duty to advise their clients that the costs of litigation would exceed any recovery the class members might attain. Furthermore, counsel had an ethical duty to advise class members of these material facts at the outset of the litigation, and give class members an opportunity to opt out at that time. Where counsel accumulates litigation fees per class member that are nearly ten times the recovery for each individual class member, questions about whether the suit should have been filed will naturally arise. At a bare minimum, the Due Process Clause would seem to require that class members be given the opportunity to opt out of that settlement. The class counsel is better able to bear the risk of nonpayment of attorney fees than individual class members, who have no way of curtailing counsel once it appears he is merely piling up billable hours without having any tangible effect on recovery for class members. Moreover, even from the outset, the Bank of Boston class counsel should have reasonably known their litigation costs would exceed the likely recovery to class members. The Rules of Professional Conduct should have prevented the counsel from proceeding with these class action claims on an hourly fee basis. D. Structuring Complaints to Maximize the Preclusive Effect of a Settlement on Claims in Another Forum Yet another form of unethical, or at least unseemly, conduct involves drafting (amended) complaints so as to maximize the preclusive effect of any settlement in that forum on claims in other fora. The pristine example of this phenomenon concerned the amended complaint and proposed settlement filed in the Delaware state court in Epstein. The Epstein plaintiffs tried to persuade the U.S. Supreme Court that the Delaware settlement was nothing more than a carefully crafted ploy to extinguish their suit, by calling forth the following facts from the record.[37] The Delaware class counsel filed the amended complaint just one day after the Epstein class action was filed, and the amended complaint sought to comprise issues covered in the Epstein securities fraud action. For example, the amended complaint contained a bogus, nonexistent state law claim that the board of directors of MCA, Inc., had violated SEC Rule 14d-10.[38] The Ninth Circuit agreed that the Delaware class counsel had manipulated the Delaware amended complaint in an effort to add claims that if settled, would preclude the pending federal class action: There is, to state the obvious, no cause of action in Delaware for violating the federal securities laws, and there would thus be no issue preclusion if these claims were litigated on the merits in Delaware. . . . The fact that the lawyers for the Delaware plaintiffs inserted such a claim into their amended complaint (not to mention that they did so the day after the Epstein action was filed) does little more than make readily apparent the extent to which the state suit was structured with an eye toward the preclusive effect it might have on the federal claims pending in the Central District of California.[39] The record shows that Delaware class counsel named Matsushita as a defendant, even though Delaware had no personal jurisdiction over Matsushita, and Matsushita acquiesced to personal jurisdiction to preserve settlement opportunities in that forum.[40] The Delaware class counsel stated he had no evidence to prove the claims in the amended complaint, which immediately raised ethical questions about why he filed the amended pleading. He further downplayed the importance of the exclusively federal claims in the California portion of the class action, which counsel intended to release, as "frivolous, . . . distracting in the main litigation, and . . . a waste of our time and resources."[41] The Supreme Court's decision in Epstein will only exacerbate the general problem of attorneys using suits filed in one forum not as a vehicle for vigorous prosecution of claims, but primarily as a device to preclude litigation in another forum. E. Potential for Collusion in Temporary Settlement Classes Another feature of class action practice that can spur unprofessional conduct leading to unfair settlements is the use of the temporary settlement class procedure. In 1994, the Delaware Supreme Court expressed its concerns that this procedure might foster collusion between attorneys for the plaintiff class and the defendants: The principle criticism of the temporary settlement class procedure is that it facilitates premature, inadequate, and perhaps collusive settlements because plaintiffs' counsel is under strong pressure to conform to the defendants' wishes at the early stages of the litigation. . . . These concerns reflect the unique character of class actions, in which the financial interests of the individual class members are frequently small while those of the class lawyers are great. When competition among different sets of plaintiffs' counsel exists, as it does here, there is the ever present danger that unscrupulous counsel may `sell out' the class in order to receive a fee.[42] The temporary class procedure exacerbates the ethical tensions a class counsel faces to settle out of court, because the class counsel knows that a court has certified his class and his position as counsel for that class solely for settlement discussions. If the discussions break down, counsel knows that he may face an uphill battle to have the class certified to litigate the claims on the merits. Defense counsel in multiforum litigation, by contrast, know they have the upper hand in the settlement negotiation. If defense counsel informs the court that the settlement discussions have become fruitless, he may succeed in terminating both the representative class and that class's representation by the class counsel. With such unequal bargaining positions, the class counsel is practically guaranteed to strike a less than favorable settlement for class members, particularly when compared to the deal he could negotiate if he had authority to prosecute the claims on the merit. An ethical class counsel would not squander the legitimate claims of class members solely for purposes of strike a deal, any deal, with the defense counsel before his status is terminated. F. Race to the Courthouse Modern multiforum litigation also fosters a race to the courthouse mentality among plaintiffs' attorneys viaing for the coveted position of class counsel. In Epstein, attorneys raced to the courthouse to file class action suits against MCA, Inc., one day after The Wall Street Journal broke a story about the potential merger with Matsushita. The speed with which the plaintiffs' attorneys filed their lawsuits, before the corporations had even reached agreement on the terms of the merger, merely reflects the attorneys' keen desire to be the first attorney on record to file suit. The plaintiffs' attorneys seem to believe that being first to file will improve their chances of being named lead counsel for the plaintiff class. Yet it is rather unseemly that attorneys would file suit against MCA and its officers before the terms of the merger were even negotiated, so that their complaints would have to be repeatedly amended as the terms of the merger were revealed. In particular, the MCA shareholder plaintiff class defined at that time could not have had any federal securities law claims, because these did not arise until after Matsushita had paid MCA's two top officers for their block of shares. No doubt due in part to the haste with which the complaints were written, the Delaware Vice Chancellor ruled that the state law causes of action were extremely weak. In essence, plaintiffs' counsel rushed to file meritless (borderline frivolous) lawsuits just to exploit any nuisance settlement fund that MCA/Matsushita might create. The Private Securities Litigation Reform Act of 1995[43] curb some of these abuses, at least as far as claims involving the federal securities law. The Act contains a lead plaintiff provision, which presumes that the shareholder who has the greatest economic stake in the litigation, i.e., owns the most shares in the company, should generally be named lead plaintiff in federal securities class action suits.[44] Under the Private Securities Litigation Reform Act, it would not matter which plaintiff counsel filed suit first, and that should remove the incentive for racing to the courthouse to file securities lawsuits. Under the Act, the lead plaintiff will be reponsible for selecting an attorney to act as class counsel, and this lead plaintiff bears responsibility for supervising the counsel and approving any proposed out-of-court settlements. When a large institutional holder serves as the class representative and instructs the class counsel on terms of a potential settlement, it appears less likely that class members' claims will be sold out in favor of a high fee award to the class counsel. Congress intended to eliminate figurehead plaintiffs who exercised no meaningful supervision of the litigation ─ or even the decision to file suit ─ by attempting to encoura
