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Testimony

May 18, 2010


Testimony of Theodore H. Frank at Opponent Hearing before the

Ohio House Civil & Commercial Law Committee

 

Testimony by Ted Frank, Adjunct Fellow, The Manhattan Institute

Thank you, Mr. Chairman and members of this Committee, for allowing me to testify today about House Bill 427, a proposal to require unpaid moneys in class action settlements to be awarded to charities name by plaintiff’s attorneys.

I am the President of the Center for Class Action Fairness and an Adjunct Fellow at the Manhattan Institute for Policy Research, but I am not testifying here on their behalf. I have been invited to testify as an expert on this topic by the Ohio Alliance for Civil Justice. The views that I am sharing today are my own. I conclude that the pending legislation exacerbates existing problems of conflicts of interest in class action representation. I believe existing Ohio law is sufficient to handle the issue of unclaimed settlement amounts, but, if the legislature wishes to act, it should modify House Bill 427 to ensure that class action attorneys’ incentives are aligned with those of their clients, and that potential conflicts of interest are eliminated in cy pres awards.

The idea of cy pres (pronounced “see pray” or “sigh pray,” from the French cy pres comme possible—“as near as possible”) originated in the trust context, where courts would reinterpret the terms of a charitable trust when literal application of those terms resulted in the dissolution of the trust because of impossibility or illegality.[1] In a classic 19th-century example, a court repurposed a trust that had been created to abolish slavery in the United States to instead provide charity to poor African-Americans.[2] The California Supreme Court endorsed the use of cy pres or “fluid recovery” mechanism in class action settlements in 1986, to distribute proceeds to a “next best” class of consumers, and many other courts have gradually adopted the procedure.[3] Cy pres settlements arise in one of three circumstances:

  • There is a fixed settlement fund that exceeds the amount paid out because only a few class members have registered to be claimants;
  • The court (often at the parties’ behest) decides that administering a settlement by paying class members directly would be too expensive;
  • The parties otherwise agree that a case shall be settled by paying a third party.

While original cy pres class action settlements provided that left-over money be distributed to a different set of consumers who may or may not coincide with the class, in recent years, left-over, or specifically earmarked, funds are typically given directly to a third-party charity.

The problem with cy pres is that it exacerbates existing conflicts of interest in the class action settlement context. When a class attorney settles a class action, he or she is not only negotiating class recovery, but is also negotiating his or her own fee. A defendant may be willing to spend a certain amount of money to settle a class action to avoid the expense and risk of litigation, but that money must be divided between the class and their attorneys. Every dollar going to the attorneys does not go to the class, and vice versa. At the same time, a class action settlement must be approved by the court. Attorneys who do not adhere to their fiduciary responsibility to the class have an incentive to exaggerate class recovery to a court to maximize their fees.

The possibility of cy pres awards gives an additional incentive to class action attorneys to breach their fiduciary duties to the class. Every dollar that a class member does not recover can now be spent by the attorney himself to the charity of the attorney’s choice. Attorneys essentially get free advertising: witness the existence of websites like “lawyersgiveback.com” where lawyers are using their clients’ money to advertise themselves. At best this is mildly unethical; at worst, it is a breach of the attorneys’ fiduciary duty to put the interests of their clients first. If cy pres is codified, then attorneys have an incentive to make it difficult for their own putative clients to recover, because then they can maximize the amount of money that goes to charity in the attorneys’ names. The legislature should not codify this conflict of interest.

Judge Richard Posner has argued that cy pres is a misnomer in the class action context:

[Cy pres] doctrine is based on the idea that the settlor would have preferred a modest alteration in the terms of the trust to having the corpus revert to his residuary legatees. So there is an indirect benefit to the settlor. In the class action context the reason for appealing to cy pres is to prevent the defendant from walking away from the litigation scot-free because of the infeasibility of distributing the proceeds of the settlement (or the judgment, in the rare case in which a class action goes to judgment) to the class members. There is no indirect benefit to the class from the defendant's giving the money to someone else. In such a case the “cy pres ” remedy (badly misnamed, but the alternative term—“fluid recovery”—is no less misleading) is purely punitive.[4]

But sometimes cy pres is less a matter of being punitive and more a matter of disguising the true cost of a settlement to the defendant to maximize the share of the actual recovery received by the plaintiffs’ attorneys. If the beneficiary is related to the defendant, or the defendant otherwise benefits from the payout, then the contingent attorneys’ fee can be exaggerated by claiming that the value to the class is equal to nominal value of the payment to the beneficiary; the defendant is willing to make a larger nominal contribution to settle the case than the actual cost to the defendant. For example, a California state court settlement of a derivative action against Larry Ellison alleging insider trading settled when Ellison agreed to pay $100 million to a charity chosen by Oracle—even though the billionaire has previously stated that his fortune would go to charity.[5] The only real expense to Ellison was the $22 million attorneys’ fee.

Further ethical problems arise if the beneficiary is related to the judge. The New York Times recently documented the problem of charities soliciting judges for leftover settlement money.[6] In a mass-tort inventory settlement of fen-phen cases in Kentucky, tens of millions of dollars intended for plaintiffs was diverted to a newly created charity, where the judge who approved the settlement and three of the plaintiffs’ attorneys sat as board members, each receiving tens of thousands of dollars for their service. The settlement also provided a million dollars to the alma mater of one of the trial lawyers, which then hired the attorney for a $100,000/year no-show job. (Three of the attorneys are under indictment, and the judge was removed from office.) [7] While this is obviously an extreme case, it does illustrate the ethical problems associated with judges choosing or approving charitable destinations for settlement money. In a case I worked on, currently on appeal to the U. S. Court of Appeals to the Ninth Circuit, the parties proposed a cy pres award to a charity where the judge’s husband served as a board member; the judge rubber-stamped the proposed settlement over an objection regarding the appropriateness of the cy pres award.[8] This appearance of impropriety damages public perceptions of the fairness of the justice system, and is another reason why the legislature should not codify cy pres awards.

More frequently, if the beneficiary is related to the plaintiffs’ attorneys, or the plaintiffs’ attorneys otherwise benefit from the payout, the award rewards trial lawyers twice: first by providing cy pres recovery to an organization that supports the agenda or causes of the trial lawyers bringing the case, and then a second time by basing attorneys fees on the first amount.

In July 2007, Judge Colleen Kollar-Kotelly granted a motion to award $5.1 million of unclaimed antitrust settlement funds to George Washington University to create a “Center for Competition Law ” on the grounds that it would “benefit the plaintiff class and similarly situated parties by creating a Center that will help protect them from future antitrust violations and violations of other competition laws.”[9] The lead plaintiffs’ attorney, Michael Hausfeld, was a GWU Law alumnus.[10] In a Madison County, Illinois settlement where only $20 million of the $60 million award was left unclaimed, plaintiffs’ lawyers Korein Tillery negotiated with Pfizer over the distribution of the remaining $20 million: $5 million each to the Illinois Institute of Technology (for its law school and biomedical research program), University of Chicago Hospitals and the Centers for Disease Control; $3 million to the United Way of Metropolitan Chicago; and $2 million to Lubavitch Chabad of Illinois. Korein Tillery took no discount on its $20 million attorneys’ fee. [11] Such problems go beyond trial lawyers and civil lawsuits; Richard Epstein has criticized a government settlement with Bristol-Myers Squibb requiring them to endow a chair of ethics at the District of New Jersey U. S. Attorney’s alma mater, Seton Hall Law School.[12]

There are several possible responses to the issue of unfettered cy pres awards, which frequently have too little scrutiny from courts, despite the clear conflicts of interest they present between class members and their attorneys. The American Law Institute’s controversial Draft of the Principles of the Law of Aggregate Litigation proposes limiting cy pres to “circumstances in which direct distribution to individual class members is not economically feasible, or where funds remain after class members are given a full opportunity to make a claim.”[13] This would imply that a settlement distribution should go to class members who have filed a claim, although some courts have rejected such a solution as a windfall to class members, especially when the number of class members filing claims is small relative to the size of the class.[14] Another possibility is already part of Ohio law: unclaimed funds escheat to the state treasury.

There is still another possible solution. The federal Class Action Fairness Act bases fee awards in coupon settlements on the actual redeemed value of the coupons; if coupons are donated to charity, those coupons cannot be used to calculate a fee award.[15] The same principle should apply when cash is involved. Contingent-fee attorneys should be rewarded only for benefits going directly to the class. Moreover, if a cy pres settlement benefits the attorneys directly or indirectly, that settlement should offset the attorneys’ fees. A $1 million cy pres award on behalf of lawyersgiveback.com should count as part of the attorneys’ fee award, not as a justification for additional attorneys’ fees. Such a mechanism would give plaintiffs’ attorneys the proper incentive to align their interests with those of the class when devising a settlement: if the class members do not get paid, the attorneys do not get paid. If trial lawyers are truly interested in benefiting charities rather than their own wallets, then this is an appropriate compromise.

In summary, H.B. 427 addresses a problem that does not exist, and exacerbates the class-action conflict-of-interest problem that is already there. If the Ohio legislature is to act on cy pres awards, it should structure its legislation to eliminate the conflict-of-interest problem that such awards present by (1) requiring attorneys’ fees to be tied to actual class recovery, and (2) taking decision-making about charitable awards out of the hands of attorneys and judges and placing it with the legislature.

Endnotes

  1. Susan Beth Farmer, More Lessons From the Laboratories: Cy Pres Distributions in Parens Patriae Antitrust Actions Brought by State Attorneys General, 68 FORDHAM L. REV. 361, 391-93 (1999); RICHARD POSNER, ECONOMIC ANALYSIS OF LAW 509-10 (4th ed. 1992); BRYAN A. GARNER, BLACK’S LAW DICTIONARY 392 (7th ed. 1999). “Justification for the use of the doctrine [in the middle ages] was laid on the shoulders of the donor, the idea being since the object of the testator in donating the money to charity was to obtain an advantageous position in the kingdom of heaven, he ought not to be frustrated in this desire because of an unexpected or unforeseen failure.” Id. (quoting EDITH L. FISCH, THE CY PRES DOCTRINE IN THE UNITED STATES 4 (1950)).
  2. Jackson v. Phillips, 96 Mass. 539 (1867). But see Evans v. Abney, 396 U.S. 435 (1970) (upholding Georgia Supreme Court’s dissolution of trust providing for segregated municipal park).
  3. State v. Levi Strauss & Co., 41 Cal. 3d 460, 715 P.2d 564, 224 Cal. Rptr. 605 (1986).
  4. Mirfahisi v. Fleet Mortgage Corp., 356 F.3d 781, 784 (7th Cir. 2004).
  5. Ted Frank, “Final update: Oracle settlement,” Point of Law weblog, http://www.pointoflaw.com/archives/001875.php (Nov. 23, 2005) (“That the plaintiffs are settling for pennies on the dollar with no benefit to the corporation on whose behalf they're ostensibly suing, as well as the fact that a Delaware court has already absolved Ellison of the same charges, suggests that even the plaintiffs recognize the suit as meritless.”); Michael Paige, “Judge OKs Ellison's $122M settlement,” MarketWatch, Nov. 22, 2005; Peter Branton, “Wealth of Experience,” IT Weekly (Jul. 9, 2006) (“I think after a certain amount, I’m going to give almost everything I have to charity because what else can you do with it?”).
  6. Adam Liptak, Doling Out Other People’s Money, N.Y. TIMES (Nov. 26, 2007).
  7. Ted Frank, “Fen-Phen Zen, ” American.com (Apr. 4, 2007).
  8. Nathan Koppel, Proposed Facebook Settlement Comes Under Fire, WALL STREET JOURNAL (Mar. 2, 2010).
  9. Diamond Chemical Co. v. Akzo Nobel Chemicals B.V., No. 01-2118 (May 14, 2007) (“Diamond I”); Diamond Chemical Co. v. Akzo Nobel Chemicals B.V., No. 01-2118 (Jul. 10, 2007); George Washington University press release, July 11, 2007.
  10. Ashley Roberts, Law School Gets $5.1 Million to Fund New Center, GW Hatchet (Dec. 3, 2007).
  11. Ameet Sachdev, Charities Reaping Lawsuit Dividends, CHI. TRIBUNE (Sep. 9, 2007).
  12. Richard A. Epstein, The Deferred Prosecution Racket, WALL ST. J. (Nov. 28, 2006).
  13. § 3.08. See also Masters v. Wilhelmina Model Agency, Inc., 473 F.3d 423 (2d Cir. Jan. 4, 2007); Liptak, supra n. 12.
  14. Fears v. Wilhelmina Model Agency, Inc., No. 02 Civ 4911 (S.D.N.Y. Jul. 5, 2007).
  15. 28 U.S.C. § 1712(e).

 

 
 
 

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