No. 6 August 2002
Anatomy of a Madison County (Illinois) Class Action: A Study of Pathology
Visiting Scholar, Manhattan Institute for Policy Research
ABOUT THE AUTHOR
Professor Lester Brickman teaches at the Yeshiva University Benjamin N. Cardozo School of Law. He is a leading expert on lawyers’ fees and, in particular, contingency fees. He has published articles on lawyers’ ethics, delivery of legal services, legal paraprofessionals, clinical legal education, nonrefundable retainers, fee arbitration, contingency fees and their effect on the tort system, attorney discipline, asbestos litigation, tobacco litigation fees, fiduciary obligation, tort reform and class actions. His published writings have been cited in treatises, casebooks, restatements of the law, scholarly journals and judicial opinions (including the United States Supreme Court, United States Circuit Courts of Appeals, state supreme courts and federal and state appellate and trial courts).
He is widely cited in the press and has published “op-eds” in the New York Times, Wall Street Journal, Washington Post, Los Angeles Times, and USA Today. His writings on nonrefundable retainers have been instrumental in the banning of their use by several state supreme courts. A proposal that he co-authored to realign the contingency fee system with its policy roots and ethical underpinnings was the subject of a front page story in the New York Times and has received extensive coverage in both the media and scholarly publications.
He has been a consultant to the U.S. Office of Education, the U.S. Civil Service Commission, National Science Foundation, Ford Foundation, Administrative Conference of the United States, the American Bar Association, the U.S. Office of Legal Services, and others.
If per-capita class action filing rates were the same nationwide as they are in Madison County, Illinois, there would have been over 42,000 class action filings in 2000. One reason for the county’s popularity among class action lawyers is its reputation for the propensity of its judges to accommodate class action lawyers’ interests.
In this monograph, I focus on a single class action (Schuppert et al. v. Down et al.) filed in Madison County on behalf of hundreds of thousands of mostly elderly Americans who were the victims of a vast mass-marketing scheme conducted by James Blair Down (“Down”), a Canadian citizen. Ironically, if not tragically, the elderly victims of the scheme appear poised to become victims a second time—of “class action” justice in Madison County. A provisional settlement agreement is so abusive of the class’s rights that it can only gain final judicial approbation from a court oblivious to the need to protect class members from self-interested behavior by its self-appointed class lawyers. Indeed, if there were an award for the most abusive class action settlement of the decade, if not the century, this settlement would be an odds-on favorite to gain the prize. The only possible impediment is a unique confluence of events that is permitting public scrutiny of the settlement—scrutiny that has already had some effect on the judicial proceedings in Madison County.
Various of Down’s enterprises sold “prize award certificates” and interests in lottery pools, yielding gross receipts of upward of $150 million. Millions of direct mail solicitations were sent and tens of thousands of phone calls were made from boiler rooms in Barbados and Canada. Hundreds of thousands of victims were tricked into paying amounts up to hundreds of thousands of dollars—in some cases, their entire life savings.
In June 1997, Down was indicted, and in August 1998, he pled guilty to a single count of criminal conspiracy to transport gaming paraphernalia in violation of the laws of the United States. Though he was imprisoned for a term of six months and forfeited $12 million in partial restitution to victims, he nonetheless struck an excellent bargain, knowing, in the words of a Canadian judge, that he would leave prison as a “very wealthy man.” The government’s failure to seek higher penalties and greater redress for Down’s victims reflected the difficulties it faced in investigating criminal activity intentionally fragmented by Down across national boundaries, the proceeds of which had been concealed in offshore asset-holding structures.
In June 1998, frustrated by its inability to recover even a modest percentage of the amount obtained from the victims, the F.B.I. and the U.S. Attorney’s Office in Seattle sought assistance from the Interclaim group of companies, a private asset-recovery group located in the Republic of Ireland, in obtaining fuller relief. Interclaim located over $100 million of Down’s assets scattered all over the world, commenced an intensive set of complex legal proceedings in Canada, obtained a freeze of Down’s assets, and incurred several million dollars in costs, which it hoped to recoup by sharing in the proceeds. Initially, it met with success, but when the complexity of the case turned the legal tide against Interclaim in Canada, it sought an American class action law firm to institute proceedings in the U.S.
In February 2000, Interclaim entered into an agreement with the Charleston, South Carolina, law firm of Ness, Motley, Loadholt, Richardson & Poole (“Ness Motley”) to bring a class action proceeding on behalf of the victims of Down’s enterprises. Interclaim was instrumental in providing Ness Motley with essential information. Ness Motley selected Madison County to bring the action seeking certification of a nationwide class consisting of the victims of Down’s enterprises. Shortly afterward, Down initiated settlement negotiations but made it a condition of any talks that Interclaim, and the victims who had been working with Interclaim in an attempt to recover their losses, be excluded from the negotiations and from benefiting from any ensuing settlement. Although Ness Motley owed a fiduciary obligation to Interclaim and to the specific victims Interclaim had been working with, it agreed to Down’s conditions and reached a settlement with Down.
The settlement purports to amount to $6 million for the victims, a lawyers’ fee of $2 million, plus approximately $2 million in notice and administration costs—totaling approximately $10 million. This announced amount is woefully inadequate, given the compelling case against Down: his guilty plea, numerous cease-and-desist orders issued by U.S. Postal authorities, and the freezing of $100 million of his assets so that they could be reached by judicial process. The case had all the appearances of a “slam dunk.”
Beyond “woefully inadequate,” the settlement is intentionally misleading as to the amount to be paid to victims of Down’s enterprises. In fact, instead of paying $6 million plus expenses, Down can actually expect to pay only a small fraction of that sum because of the way in which Ness Motley and Down structured the settlement.
The Plan of Notice
The provisionally approved plan to notify victims of the settlement is an elaborate ruse. It deliberately rejects using existing computerized lists containing the names and addresses of hundreds of thousands of “customers” who sent money to Down’s enterprises, including the amounts sent to directly notify victims by mail. Instead, the Plan of Notice provides for the use of newspaper and television advertising that, according to empirical evidence, few victims have seen.
The Proof of Claim Form
The Proof of Claim Form contained in the settlement is simply a compendium of one onerous requirement piled on top of another, apparently for the purpose of further minimizing the number of successful claims. To successfully assert a claim, Down’s mostly elderly victims are required to provide credit-card receipts, money orders, postal receipts, or canceled checks in support of their claim. But how many of the hundreds of thousands of mostly elderly victims who actually become aware of the settlement and take steps to obtain a claim form are likely to have retained receipts for transactions that took place five to ten years earlier? In addition, those who sent money to Down on multiple occasions, as many did, are required to correctly list each amount sent and the date of each such “purchase.” If a claimant correctly identifies four “purchases” but errs as to a fifth, his entire claim is subject to rejection. Also, claimants have to correctly identify the exact name of the lottery company or puzzle contest to which they sent money. Down had used 57 different company and trade names to do his dirty work. Once again, a mistake as to a single name could invalidate an entire claim, even if all the other names were correctly listed. It is hard to imagine a claiming process more deliberately designed to prevent filing of claims than this one.
The Secret Letter Agreement
The settlement includes a secret “Letter Agreement” that has been filed “under seal,” which allows for Down to defer paying valid claims for three years or more without having to provide any security. This bizarre and unique feature of the settlement appears designed to allow Down to avoid payment of most of the announced amount of the settlement.
Ness Motley’s Fee
The secret Letter Agreement also includes another unique feature: that Down does not have to pay Ness Motley’s $2 million fee (assuming court approval) upon conclusion of the settlement. Instead, Down can pay at some future unspecified time. And if Down fails to pay, Ness Motley would then have to bring an action against Down. To enforce that judgment, it would have to locate Down’s assets—seemingly reposed in complex structures in many countries. Anyone who really believes that Ness Motley accepted a class action settlement in which payment of its fee could be delayed three years or more—and that requires it to rely on the unsecured promise of someone well versed in concealing his assets after he has obtained the benefit of a full release of liability from the underlying class—has obviously been standing out in the Madison County sun for too long. Whatever the reality is with regard to payment of Ness Motley’s fee, it is highly improbable that it is that which is set forth in the Letter Agreement.
Right to Object to the Settlement
As is typical in class action settlements, members of the settlement class are permitted to appear at the “fairness hearing” and object to the settlement and/or the application for legal fees. However, unlike in other class action settlements, in this class action, that right to object is conditioned on the prior provision of the very documentary evidence required for submission of a claim. In “Catch-22” fashion, class members who do not have such documentation and who wish to object to the requirement that to submit a claim, they have to produce one of the listed documents, are excluded from objecting to the settlement and fee request.
Schuppert v. Down: A Case in Progress
Madison County Judge Nicholas Byron’s preliminary approvals of the settlement have recently been the subject of critical media attention. Even though the media attention was modest, it was also unprecedented, and it apparently subjected the local class action bar and the court to unwanted scrutiny. Judge Byron thereafter ordered that, in addition to the newspaper and TV advertising, a postcard be mailed, using one of the lists of Down’s victims, to provide additional notice. In addition, new deadlines and dates have been set as follows for Schuppert v. Down: 1) class members objecting to the settlement must file notice with the court by August 2, 2002; 2) class members seeking to opt out of the settlement must so notice the court by August 2, 2002; 3) class members filing claims must submit them by September 6, 2002; and, most critically, 4) the fairness hearing originally scheduled for June 7, 2002, has been rescheduled to August 14, 2002.
On that date, August 14, 2002, approval by Judge Byron will cast the settlement, including the Plan of Notice, in concrete. It will be impervious to attack—except to direct appeal by an objecting class member to Illinois appellate courts, which have never heretofore disturbed a Madison County class action proceeding.
This monograph begins with a reference to the role of the “rule of law” in our economic system and concludes with the observation that in Madison County, the rule of law has been displaced by the “rule of class action lawyers.”
Even more disturbing than the use of Plan of Notice and Proof of Claim processes designed to minimize the number and amount of claims is the fact that the settlement was agreed to by one of the leading class action law firms, apparently acting in full confidence that it owes no fiduciary obligation to the class members it has undertaken to represent. Moreover, Ness Motley’s filing of the action in Madison County appears to be an expression of confidence that the courts in that county will summarily approve a grossly abusive settlement and fee request, paying only lip service, at best, to the mantra that the court must be the guardian of the interests of class members. While the glare of publicity may subvert the subjecting of the elderly victims of Down’s mass-marketing schemes to a second victimhood—though that remains to be seen—such publicity rarely attends even the most abusive of class action settlements.
Any solution to the lack of due process in state court class action claiming necessarily includes a facilitated process for removing class actions filed in state courts to federal courts. The analysis of the settlement in this monograph adds to the already substantial evidence that respect for the “rule of law” requires that defendants have the opportunity to bypass Madison County and other “class action magnet courts” that stand, like speed traps, astride the nation’s litigation highways.
The American market-based economy is the engine that powers the world’s economic progress. All successful market-based economies are underpinned by a “rule of law,” that is, a civil justice system that provides for a means of enforcement of certain investment-backed expectations. We depend upon maintenance of a “rule of law” for our prosperity. We rely on the courts and the legal professionals to sustain it. The very essence of the “rule of law” is being undermined today by abusive class action litigation. Class actions are a phenomenon with which most Americans have some familiarity. Indeed, most everyone in the United States has been a member of a class action lawsuit. Indeed, virtually everyone who has flown commercially, used long-distance services or a cell phone, or purchased securities, insurance, car repair, or any of hundreds of other goods and services has been inducted into a class action. Class action settlements have generated billions of dollars in payments and fees for lawyers—and enormous controversy as to their social utility.
Class action claiming presents unique opportunities for lawyers to engage in self-interested actions, motivated in part by the practice of “courts routinely overcompensat[ing] attorneys in class actions.” One consequence of that overcompensation is that much class action litigation is purely fee-driven. While ostensibly seeking to capture ill-gotten gains and compensate large numbers of victims, in reality, claims of wrongful conduct may often be pretextual and simply the vehicle for extracting a substantial wealth transfer.
Certification of a class action by a court usually generates enormous pressures on defendants to settle, even if the class includes large numbers of claimants and even if the claims are of dubious merit. Moreover, class action settlements often reflect self-interested behavior on the part of the class lawyers at the expense of the class, particularly in so-called coupon settlements, as well as in settlements where onerous claim procedures are selected, thereby generating “unclaimed funds” that revert to the defendant (so-called reversionary settlements).
Though class action filings have increased substantially in recent years, they are not evenly distributed throughout the country. Instead, class action claiming activity tends to center in a small number of jurisdictions. While some large population centers, such as Los Angeles County (California), Cook County (Illinois), and Dade County (Florida), are the locus for disproportionate numbers of class action filings, other much smaller population centers have relatively higher volumes of class actions filings, including Madison County, Illinois; Jefferson County, Texas (comprising the cities of Beaumont and Port Arthur); and Palm Beach County, Florida (West Palm Beach, Boca Raton). Class action filings in these three counties increased sharply and disproportionately in recent years and were the subject of a study recently published by the Center for Legal Policy of the Manhattan Institute (“the Study”). Of these three counties, Madison County, bordering the Mississippi River in southwest Illinois, is the leading locus for class action filings in the United States on a population-equivalent basis.
Madison County’s reputation for being disproportionately receptive to class action filings is well-deserved—50 were filed there in 2001 versus 39 in 2000, about 20 times the national average on a per capita basis . Moreover, no class action in recent memory has ever gone to trial. One reason for the county’s popularity among class action lawyers is its reputation for the propensity of its judges to accommodate class action lawyers’ interests. The importance of such an accommodating stance cannot be overstated. Lawyers who are denied class action status in one jurisdiction can, under our federalist system, simply try again and again to find a receptive judge in another jurisdiction. One judge in a jurisdiction such as Madison County can thus, in effect, “overrule” the decisions of numerous other judges throughout the country to deny certification of a suit seeking class action status. No study of the class action phenomenon can therefore ignore the jurisdictions that have experienced extremely high rates of successful filings. Indeed, no better candidate for study exists than Madison County.
The Center for Legal Policy study focused on a number of class actions pending in Madison County, including those brought against such well-known businesses as Sears, MCI WorldCom, Sprint, Roto-Rooter, State Farm, Prudential, Mattel, Atlantic Richfield, Exxon, Mobil, and Chevron. While these actions involved tens of millions of consumers, only a tiny fraction were residents of Madison County. In criticizing the filing of class actions intended to have nationwide effect in state courts instead of in federal courts, the Study noted that “some state courts have…shown a tendency to approve settlements that generously compensate the class counsel while giving little or nothing to the people on whose behalf the action supposedly was brought—the unnamed class members.”
This monograph seeks to supplement the Study by focusing on a single class action filed in Madison County on behalf of several hundred thousand mostly elderly Americans who were the victims of a vast mass-marketing scheme that yielded gross receipts of upward of $150 million. The swindle has been featured on CBS’s 60 Minutes, yet the case and the perpetrator of the criminal activity at the heart of it, James Blair Down, have received only modest media scrutiny. Ironically, if not tragically, the elderly victims of the scheme appear poised to become victims a second time of “class action” justice in Madison County.
A settlement agreement has been entered into, ostensibly setting aside $10 million to reimburse victims and pay expenses. In reality, however, few are likely to receive any funds. The principal beneficiaries of the settlement agreement appear to be the law firm representing the class and the defendant, Mr. Down. The principal losers appear to be the victims of Down’s enterprises and an Ireland-based entrepreneurial asset-recovery firm, which set in motion the wheels of justice by expending considerable resources to locate Down’s assets and begin the invocation of legal process on behalf of the victims, first in Canada and later in the U.S. When the wheels reached Madison County, however, they went off the track.
Since only a tiny fraction of the victims of Down’s enterprises lived in Madison County, selecting it as the venue for a class action would, at first blush, appear to be incongruous. However, as the Study illustrates, this is characteristic of most class action claiming in Madison County: very few persons who are included in the class action actually live there.
No doubt, plaintiff lawyers, who basically have a choice of filing a class action in virtually any jurisdiction in the U.S., select Madison County and other preferred venues because they anticipate receiving favorable treatment from local judges with regard to certification of the class and, if they ever do go to trial, from local juries as well. Even by that standard, however, selection of Madison County would still appear to have been a strange choice. As will be seen, the case against Down was compelling. He had pled guilty to engaging in an enterprise that violated federal criminal law; as part of that illegal scheme, he appeared to have swindled hundreds of thousands of victims of tens of millions of dollars. In addition, he had been the subject of numerous cease-and-desist orders. The major issue to be adjudicated in the class action would have been the amount of damages to be assessed. An additional concern—whether Down’s extensively laundered assets could be located and preserved by means of judicial process—had been resolved by the efforts of the asset-recovery firm. The case had all the appearances of a “slam dunk.”
However apparently unnecessary it may have appeared to select Madison County as the locus for this class action, the decision to bring the action there instead of in a venue where large numbers of victims resided may prove highly rewarding to the law firm representing the class. This is so because the settlement agreement that has been entered into provisionally is so abusive of the class’s rights that it could only gain final judicial approbation from a court oblivious to the need to protect class members from self-interested behavior by its self-appointed class lawyers.
One feature of class action claiming that both promotes abuse and is protective of lawyers’ interests is the low visibility of most class action litigation. For each class action that gains press coverage, we have good reason to suspect that there may be many other class actions essentially hidden from view, in which collusive settlements that provide, at best, modest—if not mainly illusory—relief for class members are rubber-stamped by compliant, if not complicit, judges. The Down settlement, negotiated by a major class action law firm, fits that mold. But there is one critical difference: A unique confluence of events is permitting intensive public scrutiny of a settlement with terms so bizarre that if there were an award for the most abusive class action settlement of the decade, if not the century, this settlement would be an odds-on favorite to gain the prize. Such unprecedented and unwanted scrutiny has already had an effect on the judicial proceedings in Madison County by influencing the court to reconsider an earlier decision to certify the use of one of the least effective means possible for providing notice of the settlement to class members. This monograph is thus the result of an unparalleled opportunity to pluck an aggressively abusive settlement from its intended obscurity and fully expose it to public view.
To set the stage for this up-close examination, this monograph will briefly survey the class action phenomenon, the potential coercive effects of such litigation, the perverse incentives it creates, and the incidence of forum shopping as a core feature of class action claiming. Attention will then shift to the specific facts underlying the class action brought in Madison County: how the mass-marketing schemes were carried on; the efforts of an Irish company to recover some of the victims’ money by bringing several complex legal actions in Canadian courts, where much of the property belonging to Down had been located; events leading up to the filing of a class action in Madison County, Illinois; the settlement of that action; and an intensive dissection of that settlement.
II. The Class Action Phenomenon
Class action claiming has increased dramatically over the past two decades. Most of the increases have taken place in state courts. Despite the fact that hundreds and perhaps thousands of civil actions seeking class action status are brought every year, we lack knowledge of how many actions are filed, where they are filed, the number of persons asserted to be members of the class, the number of persons ultimately determined to be eligible to receive benefits, the number who actually receive benefits, the quantum of the value of wealth transferred, the fees sought and the amounts approved, the number of hours of work for which class counsel claim compensation, the effective hourly rates being awarded by the courts, the amounts of money or other benefits that are ostensibly generated for class members, the quantum of the value actually received by class members, what proportionate share these amounts constitute of the amounts of damages initially claimed, and the proportion that the attorneys’ fees awarded represent of the value of the benefits actually received by the class. What we do know is that it is in the interests of those who generate substantial fees by filing class actions that as little information as possible be available for public scrutiny. While our dearth of knowledge is a function of inadequate state record keeping, it is not surprising that this gross imperfection in record keeping remains unremedied. Nothing short of federal action mandating uniform record keeping will succeed in closing this critical information gap.
Adding to the effect of this enormous gap in our knowledge of the quantity of class actions is the fact that while it is readily apparent that tens of millions of claimants are inducted annually, for purposes of counting the number of tort actions filed annually in the United States, a certified class action, where there may be 50,000 or even 5 million or more class members, counts as one or two tort actions. This misleading counting system is an essential feature of the empirically based argument advanced by the opponents of tort reform, that there is no ongoing litigation explosion. If the number of class members inducted each year into the civil litigation system were to be counted in the annual totals of tort claims filed, then the use of the term “litigation explosion” would significantly understate the dimensions of the increases in tort claiming that have occurred in the past two decades.
III. Class Actions: Uses and Abuses
Class actions today may be likened to the little girl in the Longfellow poem who “when she was good, was very good indeed, but when she was bad she was horrid.” When properly done, class actions—one of several forms of aggregative litigation that provide economies of scale that can improve judicial efficiency by reducing repetitive litigation—perform a useful, if not essential, public purpose, including supplementing the law-enforcement efforts of the public sector. However, certification of a class can also result in the sacrifice of both procedural and substantive fairness. Moreover, all too often, abusive practices deprive class members of their rights and generate a horridly negative image not only of the legal profession but also of legal institutions. Public confidence in the legal profession is exceedingly low—at or near the bottom in most surveys, not least because too many lawyers are perceived as greedy and as acting in their own self-interest at the expense of their clients. Opinion surveys focusing on class actions indicate that the public believes that class members are, at best, incidental beneficiaries of class actions and that, overwhelmingly, the principal beneficiaries are class lawyers; the second most benefited category, according to an opinion survey, are lawyers who represent the defendant! Widespread class action abuses are destroying public respect for the legal system. It is essential for the integrity of the legal profession and for public confidence in the civil justice system that the abusive practices be identified and rooted out by judicial and legislative action.
Federal Rule of Civil Procedure 23 provides that civil actions can be certified as class actions if (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the named plaintiffs are typical of those of the class, and (4) the named plaintiffs will fairly and adequately protect the interests of the class. Prior to 1966, those seeking to be a part of a class action had to affirmatively opt-in to do so. In 1966, however, Rule 23 was amended to allow lawyers to seek certification of a class of claimants whose rights are then determined by the outcome of the litigation if the court certifies the class, unless they affirmatively choose to opt-out . This change has yielded profound—and, at least, as applicable to mass tort litigation—unintended consequences. Most consumers who receive notices that they have been conscripted into a class action have only a slight awareness of the nature of the proceedings. This is so because (1) the notices are written in unintelligible legalese and often omit precisely the kind of information that class members who are concerned that class actions are an abuse might find most objectionable; and (2) most of the conscriptees have only a very small stake in the litigation, and therefore fail to give the notices serious consideration. For these reasons, few people exercise their right to opt-out. Thus, the inherent inertial influences of the opt-out procedure strongly favor the interests of class action lawyers seeking to maximize the size of class memberships. Having very large numbers of claimants included in a class gives the lawyers who organize the class and obtain certification enormous leverage to compel defendants to settle claims, irrespective of their merits.
Even if a defendant perceives that it has a substantial likelihood of prevailing, if the size of the class is large enough, a corporate CEO, motivated by the short-term consideration of avoiding bankruptcy, will often agree to settle such claims even if they have little merit and the long-term interests of the corporation are to litigate them fully. These considerations prevail when the aggregated claims, which usually include a demand for punitive damages, potentially exceed the combined assets of the corporation and any available insurance. The resulting “bet-the-company” scenario is accentuated by the fact that if the claims are tried to verdict and yield a huge judgment, they become, in reality, essentially unappealable because of the typical requirement of having to post a cash bond of at least the amount of the verdict in order to stay execution of the judgment during appeal. Few companies, on short notice, have the liquidity to be able to write a check for a few billion dollars. Thus, plaintiff lawyers have an incentive to generate a number of claims sufficient to achieve a bet-the-company threat level that will compel settlement. This is often done by including, in the putative class, persons without any demonstrable injury or loss.
Only relatively recently have many courts begun to comprehend the extortive effects of class action certification. In In re Rhone-Poulenc Rorer, Inc. and Szabo v. Bridgeport Machines, Inc., Seventh Circuit Court of Appeals Judges Richard Posner and Frank Easterbrook, respectively, recognized that class certification creates a bet-the-company scenario that compels settlement, thus depriving defendants of the rights to contest a claim on its merits and of appealing the outcome of the litigation to an appellate court.
Other jurists have also come to realize that certifying class actions, especially in the area of mass tort litigation, is often a perverse solution to crowded dockets in that it simply generates enormous financial incentives for plaintiffs’ lawyers to seek out new possibilities for class action claiming and engage in new recruitment efforts to seek out claimants. As a consequence, the propensity of federal court judges to certify class actions has considerably diminished in recent years. Plaintiffs’ lawyers have countered this tendency, however, by forum shopping, that is, by filing their would-be class actions in state court jurisdictions where judges are known or believed to be likely to act favorably toward plaintiffs’ counsel and where juries have a high propensity for favoring claimants over out-of-state “big business” defendants. While states’ venue laws typically limit the bringing of civil actions in that state to the county where either the plaintiff or defendant resides or where the event giving rise to the cause of action arose, under federalized class action law, plaintiffs’ lawyers have the almost unfettered right to select any of the thousands of jurisdictions in the country in which to file an action against a major corporation. All that is required is that the lawyer locate a single resident of the chosen county who is a member of the putative class. The incentives to resort to such forum shopping are inordinately high, because no matter how many state or federal court judges have previously rejected plaintiffs’ lawyers’ attempts to seek class action status, a single state court judge, even one located in a county with a population only a small fraction of the size of the putative class, can, in effect, overrule all the other judges and certify a nationwide class action.
State court class action claiming also benefits from a core feature of our constitutional scheme: that actions brought in one state’s courts must be given “full faith and credit” by the courts of other states. The underlying purpose of the requirement that each state must enforce the laws and judgments rendered by other states is to tie the states together into a federal entity while, at the same time, ensuring that each state shall be the master of its own policies and laws. This fundamental right of the states that was carefully protected in our Constitution is often degraded, if not utterly vitiated, by class action law. Under prevailing U.S. Supreme Court doctrine, a class action brought in one state court can have nationwide effect so long as there is an opt-out right, however chimerical in reality. Plaintiffs’ lawyers have availed themselves of this opportunity to bring class actions in one state based upon that state’s laws, which has the effect of nullifying the laws of other states pertaining to such issues as standards for fraud, choice of law, and punitive damages, applicable to the citizens of these other states swept up in the nationwide class. Thus, instead of allowing each state to decide upon its own laws and policies, a nationwide state court class action displaces the laws of many states and substitutes a uniformity of law in the same manner as if the Congress had enacted legislation to that effect with the intent of preempting state law. Consider, for example, the case of Avery v. State Farm Mutual Automobile Ins. Co., which effectively ordered State Farm to pay for original equipment manufacturer (OEM) replacement auto parts for its insureds involved in auto accidents, overruling State Farm’s implementation of the language in its policies to provide replacement parts “of like kind and quality,” by limiting payment usually to less expensive auto parts manufactured by non-original equipment manufacturers (non-OEM). While Congress has the authority to so require, it has not chosen to do so. Each state legislature and state insurance commission also has the authority to do so with regard to insureds residing in that state. None has so mandated. Indeed, some states specifically allow or even require that insurance companies mainly use non-OEM parts, because use of OEM parts increases the cost of accidents and therefore of auto insurance without any commensurate gain with regard to safety. For these reasons, most state legislatures and insurance regulators have largely consigned the issue of OEM versus non-OEM auto parts replacement to the highly competitive marketplace for auto insurance. Nonetheless, in Avery, a jury in a rural area of Illinois has displaced both the market and the laws and policies of all other states, including Illinois, by mandating the use of OEM auto parts. Such attempts to, in effect, federalize tort law through the use of nationwide class actions are being rejected when brought in federal court, but find fertile soil in many state courts.
Paradoxically, even as plaintiffs’ lawyers have succeeded in many instances in thus effectively federalizing state tort law through forum shopping and the use of nationwide class actions, attempts to counter such abusive class action claiming through congressional legislation have been resisted on the grounds that such attempts would federalize state tort law.
The ability of class action lawyers to forum-shop is materially augmented by several systemic abuses of federal civil procedure. Under the federal constitution, the judicial power of the federal courts extends to all cases in which there is a controversy “between citizens of different states”; this is referred to as “diversity of citizenship.” This provision recognizes that litigants sued in one state who are domiciled in another state may be subjected to prejudicial treatment in the away-from-home state court. Federal law implementing this constitutional provision permits the removal of a case filed in state court to federal court on the grounds of diversity of citizenship, but only if the parties are “completely” diverse, that is, where each and every defendant is not a citizen of the same state as one of the plaintiffs. In addition, for removal on the basis of diversity of citizenship, each plaintiff’s claim must be reasonably substantial; currently, that requirement is that it be in excess of $75,000.
To thwart removal of a class action filed in state court to federal court, which is often a critical factor in the ability of the plaintiff lawyer to succeed in the litigation, class action lawyers use a number of strategies. One is to add a codefendant who is a citizen of the state in which the action is filed, thus destroying “complete” diversity. That codefendant can be, for example, a doctor or a pharmacy (in a suit against a drug company) or a local hardware store or other local retailer (in a suit against a product manufacturer). After the expiration of the one-year time limit on removal to federal court, that codefendant, who was never an intended target of the litigation, is dropped.
Another device to preclude removal is to plead that each class member’s damages are $75,000 or less. Under the statute regulating removal, even if there is complete diversity of citizenship and the total amount of damages sought in the class action is in the billions of dollars, the case is not removable from state court unless damages sought are in excess of $75,000 per class member. Moreover, if the complaint states that the damages sought for each class member is $75,000 or under and the class lawyers intend to later amend their pleadings to increase the damages claimed, after the expiration of the one-year period for removal to federal court—and actually do so—then that class action cannot thereafter be removed to federal court.
In addition to the foregoing systemic abuses, class action claiming has created a new set of client abuses that current ethical rules are ill-equipped to address. Many of these abuses are a function of the financial incentives that motivate the litigation. For example, plaintiffs’ counsel have intrinsic incentives to seek excessive fees and at the time of settlement to compromise the interests of the class in exchange for a defendant’s agreement to support (or not to oppose) such a fee request. Lawyers may also structure a class action settlement in order to maximize their fees. Or they may seek to avoid the even meager quantum of attorneys’ fee superintendence, often provided by courts in class actions, by aggregating hundreds and even thousands of individual cases into a single proceeding and then settling those claims en masse. Lawyers are then able to charge retail prices—standard contingency fees of 33–40 percent and higher—against wholesale settlements, insulated from any ethical oversight.
In addition to promoting systemic abuses and self-interested behavior, class actions invite large-scale deviations from the standards of care and conduct owed by the lawyer to the client, such as breaches of ethical duties, breaches of fiduciary obligation—including the duty not to represent clients with conflicting interests, and engaging in conduct that constitutes malpractice. While individual clients have the right to seek redress from their attorneys for such breaches, in class actions where the lawyer conscripts the client, such client rights have been effectively eviscerated. Even class lawyers who engage in clear self-dealing at their clients expense are virtually immune from the traditional disciplinary systems. This is so because “[c]ourt approval of a settlement…insulates class counsel from collateral attack by clients aggrieved by an apparent sell-out of their claims by lawyers laden with conflicts of interest.” Clients who have had their pockets picked by their lawyers are thus denied the right, for example, to seek redress by invoking the same tort system that their ostensible lawyers are invoking to generate multimillion-dollar fees for themselves.
The principal impetus for lawyers to bring actions seeking class certification and to engage in these various abuses are the fees. While courts have the duty to protect class members from lawyers who put their pecuniary self-interest ahead of the interests of the class, in reality, they often fail to fulfill their self-imposed duty to act as fiduciary for the class with regard to approval of both the settlement and the class lawyers’ fee request. Instead, plaintiffs’ lawyers, charging contingency fees, are routinely overcompensated by courts and are often able to obtain substantial—indeed, enormous—fees, sometimes a product of inflating the number of hours claimed, which are rarely commensurate with the effort required, the risks assumed, or ethical limitations on the reasonableness of fees. These fees frequently amount to tens of thousands of dollars an hour and can be as much as hundreds of thousands of dollars an hour. Judges justify the fees awarded by noting that attorneys must be provided with sufficient compensation to yield the necessary incentives to undertake the risk of litigation in order to effectuate client rights in an era when legislatures are stymied by special interests and administrative agencies are shackled by budgetary constraints. Even if all elements of that proposition were accepted, the differences between actual compensation and “sufficient compensation” remain disturbingly high. A principal consequence of such overcompensation is the proliferation of class action litigation, often irrespective of merit and yielding net subtractions from social welfare.
One of the more pernicious fee-setting devices that courts have permitted is the basing of the class action fee as a percentage of an artificially inflated settlement value when the reality is that the actual payments to the class will be a small fraction of the “announced” settlement value. This is what frequently occurs in the reversionary settlement (as opposed to the pro-rata), where, as noted earlier, any funds unclaimed by the class revert to the defendant. This provides an incentive to class counsel and defendant to act collusively to raise the stated amount of the settlement; the fee, which is usually a percentage of that amount, is thereby increased, thus paying off class counsel. In exchange, class counsel agrees to an especially arduous claiming process for class members in order to minimize the actual number of claims asserted against the notional value of the settlement fund, thereby maximizing the amount that will revert to the defendant. In such cases, class counsels’ fees can easily amount to 200 percent or more of the amount actually paid to class members.
IV. Down’s Enterprises
Beginning at least as early as 1989 and continuing to about March 1998, James Blair Down (“Down”), a Canadian citizen, conducted numerous mass-marketing schemes from Canada and Barbados, aimed principally at swindling elderly American citizens. Using many different direct mail solicitation companies that he controlled and multiple names, Down targeted the elderly and other vulnerable groups with direct mail solicitations in the form of prize-award notices, sometimes coupled with “puzzle contests,” designed to convince the addressees that they were entitled to receive a $10,000 prize, provided they sent in $5–20 as “administrative fees” for judging the puzzles. In fact, the mailings were misleading and deceptive; no such entitlements actually existed, and little money was ever received by those who responded. Instead, consumers who responded were inundated with more mailings, promising larger prizes and soliciting additional amounts of money. Several of those solicited who responded positively became frequent targets, sending in dozens of checks amounting to hundreds of dollars.
In addition to the “puzzle contest” enterprises, Down sold interests in “lottery pools” in Canadian and Australian lotteries, in contravention of U.S. law prohibiting the use of the mails to promote or market lotteries and anti-racketeering laws related to gambling. Down’s agents represented to potential customers that by participating in such pools, they would be receiving chances in foreign lotteries; moreover, by virtue of Down’s expertise in picking “special numbers” and the opportunity afforded to Down’s “customers” to buy larger shares in the pools, they were assured of a significant win. In fact, these claims were either misleading or false. The chance of winning any sum of money was very remote, and the chance of winning any large sum—as claimed in the marketing campaigns—was virtually nil. The lottery enterprise generated huge profits for Down because the prices charged to consumers greatly exceeded the actual costs of any lottery tickets purchased. The United States attempted to stop this activity by seizing the solicitations and other lottery materials. Down responded by frequently changing the names of his promotions, shifting part of his business from Canada to Barbados, disguising his mailings, and expanding his operations. In furtherance of his enterprise, Down sent out hundreds of mailings from various locations throughout the world, each consisting of 5,000 to 300,000 individual mail solicitations.
In addition to mail solicitations, Down also undertook a deceptive and predatory telemarketing scheme to sell lottery participations to targeted victims and gain access to their credit-card numbers. Millions of letters were sent and thousands of calls were made to U.S. residents from boiler rooms manned by approximately 500 telemarketers. The phone callers were insistent and persistent, gaining the confidence of the elderly victims by befriending them and calling again and again to procure additional checks and credit-card charges. Thousands of individuals, many of them elderly, were tricked into paying out amounts ranging from hundreds of dollars to several hundred thousand dollars. In many cases, these sums represented the victims’ entire life savings. Among one group of 192 victims whose losses exceeded $10,000 each, the average loss was over $50,000; one individual lost $329,000. Major victims, characterized as “VIP customers” by Down’s enterprises, were mollified by personal visits designed to demonstrate Down’s concern for their plight. These visits included presenting victims who had spent large sums of money (usually more than $100,000) with $5,000 in traveler’s checks or cash to reduce the likelihood that they would report the scheme to authorities.
A. Cease-and-Desist Orders
Between 1992 and 1996, Down’s enterprises were the subject of at least 22 different U.S. Postal Inspection Service enforcement proceedings. These enforcement efforts resulted in three agreements between Down and the postal authorities whereby Down agreed to “cease and desist” engaging in his lottery promotion enterprises. In one such consent order involving the lottery enterprises, Down, on behalf of himself and his marketing companies, agreed “to cease and desist immediately from falsely representing, directly or indirectly, in substance and effect, whether by affirmative statements, implications or omissions, that:
(1) a lottery winning system has been devised;
(2) an individual will win lotteries and become wealthy by using a lottery winning system;
(3) individuals have become wealthy (e.g., millionaires) by using a lottery winning system;
(4) an entity provides numbers of a combination of numbers that will win lotteries;
(5) numbers or a combination of numbers were specially selected for an individual and/or will win the lottery for the individual;
(6) an individual has won something of value;
(7) an entity is in possession of something of value (i.e., lottery entries) on behalf of an individual;
(8) an individual was especially selected to receive something of value;
(9) an entity will obtain, process and validate lottery tickets for the consumer for free;
(10) a fee solicited from consumers is merely an administrative fee to cover the costs of validation and processing; [and]
(11) any fee solicited from consumers is not the purchase price of the product.
Respondents are further ordered to cease and desist immediately from obtaining money or property through the mail for the purposes of conducting or participating in a lottery.”
In addition, between April 1991 and September 1993, the U.S. Customs Service effected ten seizures of lottery tickets and other illegal material that Down caused to be mailed into the United States. Down’s “response to this enforcement activity was to continue and expand his illegal operations by changing the names of his promotions and operating companies, by shifting the operation of part of his business from Canada to Barbados, by disguising his mailings or using alternative couriers to avoid detection and by relying increasingly on telemarketing to avoid detection.”
In 1998, Down was prosecuted by the U.S. Attorney and the U.S. Postal Service in a civil fraud action in New Jersey for operating an illegal direct mail marketing business that solicited money mainly from elderly Americans. The New Jersey civil proceedings were settled in December 1998 with a consent judgment compelling Down to forfeit $400,000 to repay victims of his enterprises.
One of Down’s Barbados companies was also the subject of a consumer fraud complaint filed in 1997 by the Attorney General of Illinois, alleging that it had violated the Illinois Consumer Fraud and Deceptive Practices Act. This resulted in a consent judgment in which Down’s company agreed to permanently discontinue its “prize” marketing scheme.
B. The Criminal Prosecution
In early 1992, the U.S. Attorney’s Office in Seattle, Washington, the U.S. Postal Inspection Service, and the U.S. Customs Office started a joint investigation into Down’s enterprises. In June 1997, Down was indicted by the United States for using the mails and other facilities in interstate and foreign commence to illegally sell chances in lotteries and to carry on an unlawful business enterprise involving gambling. In the indictment, it was alleged that $118,640,327 had been collected from victims and sent to Down in Canada. A more detailed and fuller estimate of the aggregate value of the proceeds of Down’s criminal enterprises pegs the total receipts from the puzzle contests and lottery sales between 1989 and 1998 as in excess of $150 million. On August 19, 1998, Down pled guilty to a single count of criminal conspiracy to transport gaming paraphernalia in violation of the laws of the United States. As part of the Plea Agreement, Down admitted that he established, controlled, and directed entities forming the enterprise and that his criminal activity was the cause of the victims’ delivery of monies to his agents. He further agreed to forfeit any interest in funds that had been seized as part of the prosecution amounting to over $12 million, to be used primarily to make partial restitution to victims. Finally, Down agreed to incarceration and was imprisoned in Oregon for a term of six months.
Nonetheless, Down struck an excellent bargain, knowing that, in the words of a Canadian judge, he would leave prison as a “very wealthy man.” He avoided up to 20 years incarceration under U.S. Bureau of Prison minimum mandatory sentencing guidelines and was forced to disgorge a very small percentage of the gross “take” of his criminal enterprises. The agreement by the U.S. government to settle for six months in a minimum-security prison and the forfeiture of $12 million reflected the difficulties faced by the government in investigating criminal activity intentionally fragmented by Down across national boundaries, the proceeds of which had been concealed in offshore asset holding structures. Frustrated by its inability to recover even a modest percentage of the amount obtained from the victims, in June 1998, representatives of the F.B.I. and the U.S. Attorney’s Office in Seattle sought assistance from the Interclaim group of companies, including Interclaim Holdings Limited, located in the Republic of Ireland, in obtaining fuller relief for Down’s victims.
V. The Interclaim Group
The Interclaim group (“Interclaim”) formed in 1996, consists of several related companies that are in the business of contracting with financial institutions, sovereign governments, and individuals to locate illegally obtained or laundered assets worldwide and to acquire and enforce complex, multi-jurisdictional judgments, claims, and debts.
Interclaim receives either fixed fees for its efforts or enters into contingency-fee agreements with the institutions or others that hired it to recover assets. Where it is impractical for Interclaim to enter into recovery agreements with each claim holder because of numerosity or the limited amount of individual claims, Interclaim makes innovative use of legal process to seek the recovery of assets.
In response to the request from the F.B.I. and the U.S. Attorney’s Office, Interclaim, upon investigation, concluded that the $12 million that Down paid in restitution as part of the Plea Agreement represented only a small fraction of the proceeds of Down’s enterprises. It further concluded that it could profitably participate in securing additional redress for Down’s victims and, to that end, devised an entrepreneurial strategy to intervene on behalf of the victims. Interclaim, with the help of the U.S. Attorney’s Office, which introduced Interclaim to 18 victims who had expressed interest in having Interclaim help them recover their loss, devised a plan to locate and recover Down’s concealed assets. As a part of this plan, Interclaim sought to gain a legal basis to participate in several judicial proceedings that it contemplated instituting. It did so by entering into written agreements with 15 of the lottery-ticket purchasers, paying each between $2,500 and $5,000 from its own funds as a nonrefundable advance against any monies that Interclaim would recover from Down, in exchange for which these victims appointed Interclaim to be their attorney in fact to prosecute their claims against Down.
To give it a further legally cognizable interest in pursuing Down, Interclaim bought up approximately $670,000 of outstanding trade debts of Down-owned enterprises, paying approximately $87,500 to a printer, a data processor and mailer, and a telephone company that Down acquired services from in furtherance of his schemes but for which he had failed to pay. In the process, Interclaim acquired a list of 418,846 names and addresses of individuals who paid approximately $28.5 million with regard to the “puzzle business” swindle operated by Down. Many, if not most, of these puzzle-contest participants were also solicited by Down’s lottery enterprises and sent in monies to the latter.
VI. The Canadian Litigations
A. The Bankruptcy Action
Employing a novel and complex legal strategy, on December 22, 1998, Interclaim commenced a bankruptcy proceeding against Down in the Supreme Court of British Columbia, in its own name (as owner of Down-related trade debt) and in the names of 15 lottery-ticket purchasers as co-petitioners. Down’s liability was premised on the theory that, as the operator of an illegal enterprise (whose business was ostensibly involved in the unlawful resale of foreign lottery tickets), Down was not legally entitled to keep the proceeds of what were hundreds of thousands of illegal contracts. Accordingly, each and every one of Down’s “customers” or contractual counterparties was a creditor entitled to the return of whatever monies Down received from them. As such, Down was a debtor to each of these creditors in an amount equal to the liquidated sum received from his victims. Interclaim further alleged that: (a) Down had attempted to secrete his assets with the intent to defeat his creditors (Interclaim and the lottery-ticket purchasers); (b) Down was insolvent because his debts exceeded his assets, thus creating a need for a process of ratably distributing his assets among the creditors; and (c) these facts and circumstances constituted acts of bankruptcy under Canadian law.
However, merely petitioning Down into involuntary bankruptcy proceedings was in no way sufficient to ensure that Down’s creditors would be compensated. As a result of many years of evading and avoiding criminal prosecution from various law-enforcement agencies in the United States, Down had placed his assets beyond traditional means of recovery available to ordinary creditors, through the creation of complex asset protection mechanisms across multiple jurisdictions. Accordingly, merely placing Down into involuntary bankruptcy would not result in compensation to creditors. Rather, Down’s laundering of the proceeds of his crime would merely frustrate those seeking restitution, as one could not expect Down to be forthright in the disclosure of his worldwide assets. To deal with the complexity of the issue, Interclaim conceived of a plan to allow for the orderly compensation of Down’s victims while at the same time earning a profit for itself. The plan was to: (1) locate Down’s assets; (2) collect evidence of the manner and means of ownership of those assets; (3) collect the evidence necessary to convince a court that these assets were truly owned by Down and that unless these assets were placed under the control of the court, they would be dissipated in order to frustrate creditors; and (4) simultaneously petition Down into involuntary bankruptcy and have the bankruptcy court appoint an interim receiver to seize Down’s assets, pending resolution of the issue of whether Down was a “debtor” and his victims “creditors” within the meaning of the Canadian Bankruptcy and Insolvency Act and, therefore, should be adjudicated a bankrupt.
In furtherance of its plan, Interclaim had entered into an agreement with Arthur Andersen, Inc., whereby Andersen would, if appointed by the court, serve as interim receiver (“Interim Receiver”) of Down’s assets and of the assets of two of Down’s former senior executives. In addition, Interclaim was authorized thereunder to search out Down’s assets and provide up to CAD$3 million of its own funds to do so, including posting any security for cross-undertakings in costs or damages required to preemptively freeze Down’s assets. Finally, the agreement provided that Interclaim was entitled to recover its outlays and 50 percent of any proved claims realized in bankruptcy.
At an ex parte hearing on December 18, 1998, the Bankruptcy Court approved the appointment of the Interim Receiver and the marketing of an International Claims Enforcement Agreement between it and Interclaim, authorizing Interclaim to support the Interim Receiver’s efforts to locate and preserve assets of Down, in exchange for receiving payment of certain expenses plus a 50 percent share of the net proceeds of any recovery as its total compensation for its efforts. Interclaim then set about the task of assisting the Interim Receiver to commence extensive proceedings to locate and preserve assets acquired with the proceeds of Down’s enterprises, in bank accounts and investments in Switzerland, the Cayman Islands, the United States, the Bailiwicks of Jersey and Guernsey in the Channel Islands, the British Virgin Islands, Barbados, Papua New Guinea, and Canada.
Acting as agent for the Interim Receiver, Interclaim located and assisted the Interim Receiver in preserving approximately CAD$100 million of assets throughout the world that were beneficially owned by Down, of which it projected that $50–60 million would be recoverable under the bankruptcy proceeding.
After extensive proceedings before the Canadian Bankruptcy Court, the judge, on August 4, 1999, expressed great sympathy for the victims of Down’s enterprises but held that Interclaim’s arrangements with the trade creditors and the 15 lottery victims violated the ancient proscription against champerty. Champerty occurs when one undertakes to carry on a litigation to which he is not a party, in exchange for a share of the proceeds of the litigation. The laws regarding champerty in the United States vary widely: some states never adopted the common law doctrine; some that did have repealed those laws; others that did have created specific exceptions such as for lawyers’ contingency fees, which are, by definition, champertous; and some few still maintain prohibitions against champerty. On the basis of that holding, Justice Brenner dismissed the bankruptcy petition on August 4, 1999.
Justice Brenner’s conclusion that Interclaim’s agreements with the 15 lottery victims were champertous was wrong, both under American and Canadian law. In January 2001, the Court of Appeal for British Columbia overturned Justice Brenner’s dismissal based upon champerty (calling the issue a “red herring”), reinstated the bankruptcy petitions, and instructed the bankruptcy court to dispositively rule on the principal issue in the case—whether the liquidated claims of restitution of the victims of Down’s enterprises were “debts” under the Canadian Bankruptcy and Insolvency Act. The other issues before the bankruptcy court (with respect to Down’s interlocutory application to set aside the appointment of the Interim Receiver) had not been ruled upon in consequence of Justice Brenner’s August 4, 1999, finding of champerty.
B. The Alberta Representative Action
Shortly after the December 15, 1998, institution of the bankruptcy proceedings in Vancouver, British Columbia, Interclaim and the 15 individual co-petitioners to the bankruptcy proceeding commenced the Canadian form of a class action, known as a “representative action” in Calgary, Alberta, where much of Down’s wealth was held in the name of Down’s sister-in-law. This somewhat duplicative action appears to have been motivated by a concern that the Alberta court might otherwise have some reluctance to “freeze” ex parte approximately 30 commercial properties located in Calgary that were on their face owned by corporations under the control of Down’s sister-in-law, who was not a debtor in the British Columbia bankruptcy proceedings. The commencement and prosecution of the representative action against Down and his brother and sister-in-law, as co-conspirators, gave the Alberta court a second and more “local” basis for “freezing” the title to these properties. Shortly after these assets were frozen by ex parte order on January 29, 1999, and after a fiercely contested hearing to dislodge the freeze order, the interim receivership was substantially maintained in Alberta, and that court ordered Interclaim to post bonds totaling Can$4 million to secure the payment of Down’s costs and damages, if any.
In November 1999, the Alberta court struck the class action portion of Interclaim’s representative proceeding. Though the court allowed the claim of the 16 co-plaintiffs to go forward, it declined to allow them to act as representatives on behalf on an estimated 800,000 to 1 million victims of Down’s criminal enterprises, holding that “Alberta does not have modern class action legislation.” The Alberta court’s November 23, 1999, decision in the Interclaim case is on appeal to the Court of Appeal for Alberta.
C. The Asset Freezes
From the very outset of its efforts to secure redress from Down’s victims and compensation for its efforts if successful, Interclaim understood that, even if it won the litigation battles, it would still lose the war unless it could locate Down’s assets and prevent him from selling off those assets and putting the proceeds beyond reach. Accordingly, Interclaim devoted substantial resources and efforts first to locate and then to judicially enjoin Down and all relevant third parties from disposing of those assets.
Initially, the efforts to “arrest, preserve, and protect” Down’s assets were undertaken under the terms of the agreement appointing Interclaim as agent of the Interim Receiver, as approved by the British Columbia Bankruptcy Court in December 1998. Assets belonging to Down, including over 200 bank accounts and 150 “shell” entities, were located in Switzerland, Jersey, Guernsey, Barbados, the British Virgin Islands, and Canada. Using the authority vested in the Interim Receiver by the court, a number of these properties were made subject to the court’s jurisdiction. In subsequent months, additional orders of protection were enforced against other properties that had been located. In March 1999, Down moved to set aside the various ex parte orders. Justice Brenner ordered Interclaim Holdings Limited, to either post a bond of CAD$400,000 or to deliver the undertaking of its corporate parent, Interclaim (Bermuda) Ltd., to guarantee payment of any adverse costs or damage awards. Interclaim elected to do the latter.
On January 29, 1999, the Interim Receiver, with the assistance of Interclaim, froze over $100 million of Down’s assets located in eight jurisdictions. On April 1, 1999, Madam Justice Adel Kent of the Court of Queen’s Bench of Alberta held that 27 of 29 commercial properties previously frozen ex parte by Justice Hawco of the same court on January 29, 1999, were to remain frozen. However, after determining on November 23, 1999, that the representative action could not go forward, Justice Kent effectively released 27 of the 29 properties from the clutches of the Alberta representative action freeze order. Immediately thereafter, the Alberta Court of Appeal issued an order that 26 of the referenced 27 Alberta properties were to remain frozen, pending the outcome of the British Columbia bankruptcy proceeding and the representative action.
On July 28, 2000, as directed to do so by the Court of Appeal, the British Columbia Bankruptcy Court issued supplementary interlocutory rulings on issues raised by Down regarding the December 18, 1988, ex parte interim receivership freeze order. Interclaim prevailed on all the material issues save one, but it was a crucial issue. The court ruled that since the litigants’ expert witnesses disagreed about a critical question of foreign law (i.e., the legal consequences to Down and the victims of his enterprises of the illegality of each of the contracts between them under U.S. law), the court could not conclude that the bankruptcy petitioners had made out a “strong prima facie” case that Down was a “debtor” and the victims of his enterprises, “creditors,” under the Canadian Bankruptcy Act. As a consequence, the chief justice ruled that the Interim Receivership should be dissolved and the assets unfrozen. In August 2000, the Court of Appeal refused to stay the bankruptcy judge’s order dissolving the asset freeze, pending hearing of the consolidated “champerty/debt” appeal in November 2000.
The dissolution of most of the asset freezes posed a mortal danger to Interclaim’s strategy. Even if Interclaim on behalf of itself and its 29 represented victims were to prevail in the appeals in Canada, the victory would be a pyrrhic one. Assets with which to pay the claims would not be available. Indeed, it was a reasonable certainty that Down would take advantage of the unfreezing of his assets to reconceal them in ways that would render them unreachable.
Interclaim therefore had to explore new avenues to effect recovery against the Down group on behalf of Interclaim, Interclaim’s 29 represented victims, and the victim class generally by, in particular, preserving or reinstituting asset freezes. Accordingly, Interclaim decided to retain counsel to commence class action proceedings in the United States with the goal of getting a judgment from an American court, filing it with the British Columbia bankruptcy court as an enforceable debt, facilitating the liquidation of Down’s assets for the benefit of the bankruptcy estate, securing the victim class members’ share by way of a “dividend” from the bankruptcy court, and returning this dividend to the American court to disburse the available funds to the victim class. As will be related below, an asset freeze was obtained from a U.S. court on August 7, 2000, prior to the dissolution of the Canadian asset freezes. But would that be in time and sufficient to allow payment of the victims’ claims?