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American Bar Association

ABA Section of Business Law


ABA Section of Business Law
Business Law Today
May/June 1998


Legitimate businesses can behave badly

By DANIEL C. GIRARD

Girard is a partner at Girard & Green, LLP, in San Francisco.

Class action lawyers thrive in the business lawyer's hell, a world of false promises, busted deals and murky, impenetrable statutes. We are the chickens come home to roost, the litigation risk that cautious business lawyers counsel their clients to avoid. Our perspective on the debate over class actions is born of a lifetime lived in a world most business lawyers avoid at all costs.

We see how often "legitimate" businesses behave badly. Poor business ethics and lax management can turn any business into a predator. Some businesses refuse to allocate enough resources to legal compliance. Others condone aggressive "business decisions" in the face of ambiguous laws or regulations. In some cases, prominent brokerage firms unload risky and illiquid limited partnerships on fixed-income retirees, high technology companies cook the books to conceal operating losses, and respected life insurance companies sell overpriced policies to the elderly.

We spend hours on end speaking with despondent investors who demand that we, as representatives of the legal system, explain why the regulators didn't protect them and won't be doing anything to get their money back. We have seen too many government lawyers who are underpaid and outgunned. Government lawyers have told us again and again that they worry about stepping on political toes if they do their jobs too well.

We face off against some of the most dedicated and accomplished lawyers in the country. Simply keeping a meritorious case from being thrown out before trial can be a substantial achievement. When it comes to discovery, extracting the most damaging documents, the ones that show what the defendants were really up to, can take years of effort and expense.

We find, as we sift through the wreckage of various investment schemes or encounter violations of consumer protection laws, that no matter how clear the evidence of wrongdoing, no one involved — promoters, bankers, lawyers, accountants, brokers, anybody — ever accepts responsibility for anything. Instead, hundreds of millions of dollars in settlements, enough to pay an army of lawyers for years, is paid to avoid the "cost of litigation." We bankroll years of litigation to pursue the claims of average people against powerful institutions. We recognize that while the legal profession tolerates, uneasily, the lawyer as entrepreneur, without our investment, there would be no representation for our clients at all.

And while lawyer-funded litigation has its drawbacks, it is equally clear that compensating our adversaries by the hour does little to promote enlightened dispute resolution. Victims of unfair or deceptive trade practices, systemic violations of consumer protection statues, fraud, defective products and industrial disasters will continue finding their way to class action lawyers' doors. The absence of any alternative means to address genuine grievances on a large scale suggests that class action litigation, in some form or another, is here to stay. Here are one class action lawyer's suggestions on how to improve results in meritorious class actions, discourage the filing of weak ones, and why business lawyers should care.

A uniform standard — The law requires, for the class to be certified, that the class representative "adequately" represent the interest of the class. Courts have traditionally held that an adequate class representative is one who understands the role in which he or she serves, agrees to participate in discovery and appear for trial, lacks any disabling conflict of interest with the class and otherwise exhibits the vital signs of a living, breathing litigant. Critics of class actions, however, complain that class representatives are nothing more than figureheads.

One federal judge has concluded that individuals can almost never qualify as adequate representatives in securities cases. He wants institutions to serve as class representatives. He thinks mutual funds and state pension plans will take a more active role in selecting the lawyers and managing the litigation. Congress agreed, and amended the federal securities laws to make it easier for institutions to serve as class representatives in securities cases. Yet these same reforms prohibit class representatives from being paid for taking on the risks and burdens of managing a multimillion dollar lawsuit.

In my experience, named plaintiffs in class actions take their obligations seriously, whether they are institutions or individuals. Class representatives, particularly individuals, need clear guidance as to the scope of their duty to the class, however. If courts or commentators want them to do more, such as comparison shop for lawyers, impose a budget and manage the litigation, class representatives must be given a clear statement of what is expected of them. They must also have the resources and incentives to act.

Differences in expectations imposed on the class representative stem from divergent views of the duties of a representative litigant to the members of the class. Courts and commentators take a different view of the obligations of the class representative and his or her counsel depending on whether they adopt what can be called the "representative" or "enterprise" view of class action litigation. The representative view is the more traditional perspective on class action litigation, rooted in the view that the class action is simply a joinder device. Under the representative view, the representative litigant's obligations to the absent members of the class are delineated by due process. As long as the class representative's interests do not conflict with those of the class, and there is no evidence of collusion, courts that adopt the representative view tend to defer to the judgment of the class representative and the lawyer.

The difference between the representative view and enterprise view is apparent when it comes to courts' consideration of class action settlements. Courts evaluate class action settlements under the "fair, reasonable and adequate" standard. Courts that adhere to the representative view tend to impose a substantial burden on objectors of substantiating claims of "inadequate" representation at the settlement stage.

Courts that adhere to the "enterprise" view of class action litigation take a different view. They give little weight to the judgment of the class representative and emphasize the pecuniary interest of the plaintiff's lawyer in the outcome of the litigation. Adherents to the enterprise view place on the class representative the burden of maximizing the value of the claims asserted. In practice, at the settlement stage, these courts place a relatively light burden on objectors of demonstrating inadequate representation, then effectively shift the burden to the class representative's lawyer of demonstrating that the claims have been pursued to a satisfactory conclusion.

Taken to an extreme, the enterprise view can give passive beneficiaries of the class representative's efforts disproportionate control over the litigation, despite their unwillingness to shoulder its burdens. Objectors to class action settlements traditionally got the cold shoulder from most courts. Recently, however, courts concerned with the chummy atmosphere in class actions at the settlement stage, when former adversaries link arms to secure settlement approval, have given objectors a more favorable reception. An "Objectors' Bar" has developed. These lawyers have no intention of assuming the risk of prosecuting cases. Instead, they probe settlements for weaknesses and evidence of excessive attorneys' fee payments. Their objective is to obtain a fee by pressuring the defendant to sweeten the settlement pot, persuading the court to reduce the fee award to plaintiff's counsel, or, if all else fails, threatening to delay the consummation of the settlement through protracted appeals.

While class members unquestionably have a right to be heard, and objectors help courts evaluate the merits of settlements, the law in many jurisdictions allows a single objector (who can opt-out of the class) to appeal a settlement that is acceptable to the overwhelming majority of the class. Such an appeal can delay the finality of a settlement for years. A number of federal courts have recognized that allowing a single class member to appeal from a judgment that binds others allows an unnamed class member, who is not accountable to the class, to substitute his or her judgment for that of the class representative, who is. A single class member who refuses to formally assume the risks and burdens of serving as a class representative should not be permitted to hold an entire class hostage.

Jurisdictions that permit class members to appeal final judgments approving settlements without requiring them to demonstrate that they are qualified to substitute themselves for the class representative are likely to accept the "enterprise" view of class action litigation. These courts would require a class representative who brings an action on behalf of others to litigate the case to a more favorable conclusion on the say so of a member of the class who refuses to shoulder the burdens assumed by the class representative. Courts adopting this view cite the need to ensure "adequate" settlements. Courts rejecting the view that absent class members should be free to appeal class action settlements are more likely to view settlements as private bargains which, absent evidence of collusion, courts should be reluctant to second guess, provided that the members of the class can make an informed decision to accept the settlement or exclude themselves from the class.

Uncertainties in standards of performance for class representatives can be particularly dangerous for corporate defendants. To secure a release from the class, the defendant must agree that notice of the proposed settlement be sent to every member of the class. Such notice campaigns are costly and leave the defendant vulnerable. Once notice of the claim has been disseminated, the question is no longer whether the defendant will pay but how much. A defendant may negotiate a settlement at arm's length with the class representative, only to find itself confronted with claims that the settlement should be rejected because plaintiff did not conduct sufficient discovery, hire the right expert, plead every potential claim or take a hard enough line in settlement negotiations. These uncertainties can make settlement of class actions more costly and time consuming and less predictable for corporate defendants.

Increase scrutiny — Class action settlements are approved through a two-step process. At the first stage, the court makes a "preliminary fairness evaluation." The idea is for the court to determine if the settlement is one that can be given final approval or whether the settlement instead suffers from obvious deficiencies, such as preferential treatment of a segment of the class or excessive compensation for the class action lawyers. If the court concludes the settlement is one that falls within the range of possible approval, the court authorizes the parties to mail notice of the settlement to the class and schedules the final approval hearing. At the final hearing, the members of the class have their say on the settlement and the attorneys' fees to the lawyers.

Courts should be encouraged to focus on the merits of class action settlements at the preliminary approval hearing. Often, because settlements are submitted for preliminary approval without opposition, courts give proposed settlements only limited scrutiny. Settlements that have been criticized by commentators as class action abuses could have been weeded out at the preliminary approval stage. Defendants, in particular, benefit from increased scrutiny at the preliminary approval stage, as they may otherwise be required to fund expensive notice campaigns, only to find a proposed settlement rejected.

In many cases, notice of a settlement may trigger the filing of additional litigation that may ultimately make settlement more costly than doing it right the first time. Moreover, because in practice some courts apply more vigorous standards than others in evaluating settlements, the parties are better off knowing at the outset what the judge thinks of their deal. A court should never allow notice of a settlement to be mailed to class members if the court is not likely to ultimately approve the settlement, as the result is confusion and increased cynicism on the part of class members and greater expense to the settling parties.

Develop standards — At present, only cases filed in the federal court system can be coordinated and transferred to a single court. While some states have procedures for coordination of cases filed in multiple counties, there is no procedure to coordinate related cases in different states or in federal and state courts. The results can be chaotic. When cases are pending in multiple states, defendants can search for the most willing plaintiff's lawyer with which to negotiate a cheap settlement. On the other hand, defendants can be whipsawed by plaintiffs who file cases in concert with other lawyers in multiple jurisdictions.

There should be a protocol for coordination of related interstate cases or cases in federal and state courts. Criteria for determining which court should take the lead in adjudicating class actions that arise out of similar transactions or occurrences could be established. While constitutional limitations might preclude compulsory procedures to coordinate class actions in courts of different states, development of voluntary standards for the coordination and efficient management of related cases in multiple courts would provide guidance where none currently exists.

Establish a fee structure — Anyone familiar with class action litigation will recognize the impact of lawyer compensation on outcome and timing. In the litigation arising out of the collapse of ACC/Lincoln Savings and Loan, the court fixed the compensation for the class action lawyers at the outset of the litigation. The defrauded investors recovered their losses in full as a result of outstanding work by a number of top lawyers. The lawyers were willing to invest in the case because they knew what to expect in return for their efforts. Similarly, in the Exxon Valdez oil spill litigation, the judge entered an order fixing attorneys' fees before trial. The case was tried to a record-setting judgment. In contrast, in the litigation arising out of bond defaults by the Washington Public Power System, the plaintiffs' lawyers toiled for seven years and recovered more than $600 million in settlements. The lawyers expected to be paid a straight percentage of the recovery. The court saw their fee demands as excessive and compensated them based on the hours they spent on the case. Whether one agrees with the court or the plaintiffs' lawyers, it is unlikely the bond investors would have enjoyed such a sizable recovery if the lawyers who agreed to pursue their claims had known the risks they assumed would not be compensated at the level they had anticipated.

Courts should be encouraged to spell out early on the standards by which the plaintiff's lawyers will be compensated. Marginal settlements prompt criticism of class actions. Many of these settlements would never see the light of day if a benchmark were established that provided only modest compensation for so-so results and adequate incentives for improvement. Existing standards that give courts discretion to set the fee at the end of the day based on the result achieved, the risk assumed, delay in payment and other factors generally result in fair compensation. These standards can be applied very differently from one court to the next, however. Courts should be encouraged to solicit proposals for compensation of plaintiff's counsel early in the litigation and to consider retaining experts, where necessary, to evaluate the proposals.

While Rule 23 and state class action procedures may see amendments in the next few years, group litigation is unlikely to disappear from the business landscape. In the future, we can expect to see many changes, including:

  • increased demands for greater accountability from all participants in class action litigation,
  • increasingly sophisticated settlement structures and fee setting arrangements,
  • simplified procedures for communications with class members and submission of claims,
  • increasing calls for formal procedures to coordinate related cases outside the federal court system,
  • more appearances by public pension funds as class representatives in securities litigation, and
  • increasingly sophisticated use of class certification by defendants to forestall fragmentation of the class, influence forum selection and facilitate early resolution.
Our American economic and social system is the most dynamic and efficient in the world. We cannot afford to have regulators fly-speck every financial transaction or new product introduction. Inevitably, promoters overreach and products fail. As lawyers, we should use our insights to advocate for a system that adequately deters wrongdoing and compensates deserving victims without stifling enterprise or innovation.

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