Settlement Insurance Shows Need for Court Skepticism in Class Actions

A plaintiffs’ attorney and an insurance executive have created a business, Risk Settlements, that offers a “post-lawsuit settlement insurance product specifically designed to manage settlement risk, cap exposure and provide certainty to the uncertain world of class action settlements.” That this business model is viable—and that it purports to save class-action defendants millions of dollars in claims-made settlements—demonstrates the need for courts to provide scrutiny of what class-action settlements actually provide consumers, and to structure incentives for class counsel to minimize conflicts of interest.

Under Risk Settlements’ class action settlement insurance, “in exchange for a fixed premium payment, the insurer covers all valid claims made pursuant to the settlement agreement.” The policy “is tailored to each individual settlement agreement.” What’s remarkable is the forthright acknowledgement that a “well-designed claims-made settlement can help a settling defendant recoup or save money” over the standard common-fund settlement, making it possible “to bridge the gap between what a plaintiff wants and what a defendant is willing to offer.” Thus, for example, a TCPA defendant who was considering a $15 million common fund instead, under the advice of Risk Settlement, structured a claims-made settlement that eventually cost the defendant only $7.5 million—and presumably paid the class even less than that because that was what it paid Risk Settlement, which in turn surely made a profit.

Why a defendant would purchase settlement insurance is obvious: by passing on the risk of the ultimate expense of the class action to the insurer, a defendant can reduce contingent uncertainty on its books, because it might take years of litigation even after a settlement is agreed to before all payments are finally resolved. And, of course, a defendant is interested only in the total cost of settlement, not who gets the money. (If anything, a defendant will prefer that as few of its customers learn about the litigation as possible, because agreeing to pay money for alleged wrongdoing may hurt its reputation.)

But why would class counsel prefer a claims-made settlement that saves a defendant so much money to the larger lump-sum common fund? The shocking answer is that attorneys have persuaded courts to adopt rules that treat these unambiguously worse settlements as “better” for the class than ones that actually pay the class more money.

Imagine a hypothetical class action settlement where the parties settle for a fraction of the total alleged liability, creating a $4 million settlement fund where class counsel gets 60% of the settlement fund ($2.4 million) and the 600,000 class members are left with only $1.6 million, paid with $2.75 checks mailed out to each class member. Courts normally would not countenance such a result: if there is a common fund, class counsel is typically awarded 25%, rather than 60%, and a court would and should reallocate the $4 million to reach that ratio, and the class members would get $5 each rather than $2.75.

But in a “claims-made” settlement, the defendant pays every class member who makes a claim, but has no liability to the ones who fail to do so—and the parties can structure the claims process so that under 10% or even under 1% of the class never make a claim and get nothing. (Risk Settlement is sufficiently confident of these figures that they agree to take on the risk that claims rates will be much higher.) The attorneys’ fees are paid separately from what the class receives, and are often accompanied by a “clear sailing” agreement that the defendant will be barred from arguing that the fee request should be reduced or denied in any way.

Such a settlement is plainly worse for the class than the first settlement and fee request universally understood to be problematic, because now any reduction in the fee will go to the defendant, and the district court is left only with the decision to give the settlement a thumbs-up or a thumbs-down. If the court approves the settlement and the excessive fee request, no one will have legal standing to challenge solely an excessive fee awarded by the district court. Because the only purpose of these “clear-sailing” and “kicker” clauses is to shield attorneys’ fees from scrutiny at the economic expense of their clients, Cardozo professor Lester Brickman proposed that these clauses should be considered a per se unethical breach of a plaintiffs’ attorney’s fiduciary duties to her class clients. Sadly, courts have yet to adopt such a rule; though some have been critical of the clauses, none have been willing to reject a settlement or penalize class counsel simply because of their presence.

But more importantly, many of the same courts that would reject the first division of $2.4 million to the attorneys and $1.6 million to the class in the common-fund context will accept it so long as it’s structured as a claims-made settlement. Why? Because class counsel will argue that the settlement should be valued as if every class member made a claim would have been paid, because every class member could have hypothetically been paid—even though it’s close enough to an actuarial certainty (based on a “comprehensive historical database and risk assessment”) that the vast majority of the class will receive nothing.

Thus, in Poertner v. Gillette Co., an all-too-typical example of the claims-made settlement, a settlement paying class members who made claims $6 each was reported in the press as a “$50 million settlement,” even though only 0.5% of the class made claims and actually received only $345,000. The attorneys made $5.7 million. They actually defended this result in the district court by presenting a study of hundreds of class-action settlements that showed that the median settlement pays only 0.23% of the class. But “everybody does it” is an argument for reform of systemic corruption rather than letting attorneys collect 1800% of what their clients do.

In Pearson v. NBTY, Inc., glucosamine buyers received only $0.8 million, but the district court valued this amount at $14.2 million “based on the contrary-to-fact assumption that every one of the 4.72 million class members who had received postcard rather than publication notice of the class action would file a $3 claim” and awarded $2.1 million to the attorneys. CEI won reversal in a Seventh Circuit opinion authored by Judge Posner, correctly holding that a settlement must be valued at the amount the class members actually receive.

But CEI recently lost Gascho v. Global Fitness in a 2-1 decision in the Sixth Circuit, which expressly rejected Judge Posner’s ruling in Pearson. Gascho approved a claims-made settlement with precisely the $2.4 million and $1.6 million ratio discussed a few paragraphs earlier—even with the attorneys presenting testimony that they expected less than 10% of the class to make a claim. Its rule of decision creates extraordinarily perverse incentives for attorneys. If class counsel can receive only $1 million if they win $3 million for class members in a common fund, but more than double their fees by agreeing to a “claims-made” settlement that pays less than 10% of the class a total of $1.6 million, of course class counsel is going to prefer to treat their clients worse. And there will be businesses like Risk Settlement that can help class counsel profit from the breach of fiduciary duty by figuring out how to reduce the number of claims made, because they make a dollar for every dollar not paid out to class members.

On remand in Pearson, the parties agreed to a new settlement, recently approved by the district court, which paid class members millions of dollars more. Similarly, after our Baby Products Antitrust Litigation victory in the Third Circuit, the settling parties on remand somehow figured out how to make distributions directly to class members, who received nearly $15 million more than the original claims-made settlement that paid them only $2.8 million. Unsurprisingly, when courts create rules that pay attorneys based on what class members actually receive rather than based on fiction, the attorneys have the incentive to ensure the class members actually get the money rather than the incentive to create imaginary benefits where no one gets paid.

If parties want to create claims-made settlements, there’s no reason to create a per se rule against them. Perhaps a case is low in merit, and must be settled for only pennies on the dollar. The problem comes when attorneys take a litigation that’s worth $6 million in settlement value and then deliberately structure it to receive 94% of the benefit for themselves.

CEI’s client in Gascho, law professor Josh Blackman, will be filing a certiorari petition with the Supreme Court in September asking them to resolve the circuit split between the Sixth and Seventh Circuits. One hopes the Supreme Court sides with reality over fiction, ends this abuse of the class-action system, and holds class counsel to their fiduciary duty to put their clients ahead of themselves.