In a recent decision, the Second Circuit determined that in a class action settlement that capped total compensation, separate categories of claims must each have separate class representatives and separate counsel.

In In re Literary Works in Electronic Databases Copyright Litigation, 654 F.3d 242 (2d Cir. 2011), the Second Circuit found representation in a class action settlement to be inadequate as a subset of class members’ interests were not represented by the class representatives.  Class plaintiffs were freelance authors who sold their written works for publication in print periodicals.  These articles were later reproduced electronically on publications’ websites and in electronic databases such as LexisNexis.  Plaintiffs brought suit in three separate lawsuits that were later consolidated, alleging that  these electronic publications violated their copyright.  With the assistance of mediators, the authors and publishers reached a global settlement agreement that divided claims into three categories based upon the copyright registration status of the underlying written works.  The category—named Category C—of unregistered works comprised more than 99% of authors’ total claims.  Under the settlement agreement, Category C claims were paid the least and also would be reduced pro rata if the total settlement amount exceeded an $18 million ceiling (the so-called “C reduction”).  The settlement was approved by the district court over several objections, and the objectors appealed to the Second Circuit.  The Second Circuit vacated the decision and remanded for further proceedings.

Relying heavily on the Supreme Court’s Amchem and Ortiz decisions, the court determined that the interests of authors holding Category C claims were not adequately represented by class counsel.  See Amchem Products, Inc. v. Windsor, 521 U.S. 591 (1997); Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999).  The court found that “[t]he selling out of one category of claim for another is not improbable here.”  Because the settlement was capped, the claims in each of the three categories were pitted against one another to receive a larger share of the total settlement funds – an increase in the value of one category’s claims would come directly from the value of claims in another category.  The Second Circuit held that the only way to adequately represent these interests would be to have separate class counsel representing each category.

The court acknowledged that the mediated settlement negotiations had protections for all plaintiffs that were not present in Amchem, including competent mediators and the inclusion of certain authors’ associations that presumably represented the interests of all authors in the negotiations.  However, it reasoned these protections were inadequate to satisfy Federal Rule of Civil Procedure 23(a)(4)’s requirement that “the representative parties will fairly and adequately protect the interests of the class.”  The court found a sufficient divergence of interests between the holders of the category C claims and the other categories of claims that even despite such protections, the holders of the category C claims could not be adequately represented by counsel for the other categories of claims.  Specifically, the court found that the “’C reduction’ places the risk that the total claims and fees exceed the $18 million cap exclusively on Category C. . . . The ‘C reduction’ cannot be justified as a reflection of Category C’s lower value, because the Settlement’s recovery formulae already account for that difference. The ‘C reduction’ is not designed to reflect the claims’ value at all, but rather is a safety valve meant to preserve the integrity of the Settlement in the event the cap is exceeded.” 

Because the named plaintiffs did not adequately represent the interests of Category C claims, the Second Circuit vacated the approval of the settlement and remanded to the district court.