Co-authored by Rodger Eckelberry

Defendants settle class actions to buy peace and put litigation behind them.  Plaintiffs settle class actions to guarantee at least some recovery, and to avoid prolonged litigation.  A settlement benefits no one, though, if the settlement is not approved by the court or if approval is reversed on appeal.  The Ninth Circuit recently reversed approval of a class settlement because of improper application of the cy pres doctrine to unclaimed funds.  Cy pres, meaning “as near as possible,” originally was used to distribute funds from a testator’s charitable gift if the original gift became impossible.  In the class action context, some courts apply this doctrine to unclaimed funds or to direct payment to charities when locating class members is too difficult or members do not claim their share.

In Dennis v. Kellogg Co., No. 11-55674, at 8119 (9th Cir. July 13, 2012), the Ninth Circuit reversed certification of a settlement class, and remanded the case for further proceedings because the settlement provided for a nebulous cy pres award that the Court held was “not sufficiently related to the plaintiff class,” and because the attorneys’ fee award was excessive.  The Dennis plaintiffs alleged that Kellogg falsely advertised the nutritional value of one of its cereals.  The parties’ settlement agreement provided a fund of $2.75 million for distribution to class members on a claims-made basis—with any unclaimed portion being donated to “charities chosen by the parties and approved by the Court.”  Kellogg also agreed to distribute $5.5 million “worth” of food items to charities to feed the indigent, and to pay class counsel’s attorneys’ fees and costs up to $2 million.

The Ninth Circuit’s held the cy pres portion of the settlement was “not sufficiently related to the plaintiff class” because the charities to receive any unclaimed funds were not identified, and because the recipients of the food donation—the indigent—bore no relation to the class members.  The “cy pres distribution was an abuse of discretion because there was no reasonable certainty that any class member would benefit from it, even though the money would go to areas where the class members may live.”  This appeal, and reversal, might have been avoided if the parties had more carefully crafted their settlement agreement to specifically identify the cy pres recipients, and ensured that the recipients were more sufficiently related to the class.

The Fifth Circuit also recently addressed the use of cy pres in another appeal that could possibly have been avoided.  In Klier v. Elf Atochem North America, Inc., 658 F.3d 468 (5th Cir. 2011), the class members were divided into subclasses by their claims for ease of distribution.  The members of one subclass did not claim all of their funds and the settlement agreement did not address what should happen to the unclaimed funds.  The district court ordered the remaining funds to be distributed to a charity under cy pres, and several members of another subclass sued, claiming that the funds should instead be redistributed to them.  The Fifth Circuit concluded that when the terms of a settlement agreement are “insufficient to overcome the presumptions that the settlement provides for further distribution to class members, there is no occasion for charitable gifts, and cy pres must remain offstage.”  Since the funds belonged to the class as a whole, they could not be said to be unclaimed, and had to be returned to the remaining class members.  If parties want unclaimed funds to be distributed to a charity, they need to ensure their agreement properly provides for that.

Though not at issue in Dennis or Klier, parties to a class settlement must also consider the state law implications of unclaimed settlement funds, including unclaimed property laws and, in several states, specific cy pres statutes.  If a settlement creates a property right for each class member, funds left unclaimed may escheat to the state.  And some states, including California, North Carolina, and Illinois, have statutes expressly addressing the use of cy pres in class actions.

Detailed planning for the distribution of funds at the outset of the settlement agreement will greatly reduce later challenges to, and possible reversal of, a class settlement.  It requires more work at the front end, but ensuring your hard-won settlement survives scrutiny is worth the effort.