On June 2, 2014, the United States Court of Appeals for the Seventh Circuit rejected a class action settlement in Eubank v. Pella Corp., Nos. 13-2091, -2133, 2136, -2162, 2202 (7th Cir., June 2, 2014) that the Court labeled “inequitable – even scandalous.”  The Opinion, written by Judge Posner, identified a myriad of warning signs that demonstrated that the settlement “flunked the ‘fairness’ standard,” and should have been rejected by the district court.

1.  The Class Representative’s “Palpable” and “Grave” Conflict of Interest:  Class representatives are fiduciaries of the class.  The core class representative, however, had divided loyalties – his son-in-law was lead counsel for the class and his daughter, who was married to class counsel, was a partner in her husband’s firm.

2.  Class Counsel’s Financial and Ethical Woes Rendered Him Inadequate To Serve As Class Counsel:  Class counsel serves as a fiduciary for the class as a whole; however, there were numerous indications that lead counsel in this case could not serve that role.  Lead counsel and his wife were embroiled in a lawsuit over the alleged misappropriation of the assets of their former law firm, which apparently dissolved and descended into “open warfare” between its former partners.  The Court noted that the “articulated financial needs” of class counsel may have driven settlement of the class action.

Moreover, lead counsel was also involved in a serious ethical proceeding, and was ultimately recommended for disbarment by the Supreme Court of Illinois due to “repeated misconduct.”  Lead counsel’s pending ethics case, in and of itself, was a “compelling reason to kick class counsel off the case.”  But the ethical and financial problems together gave class counsel a powerful incentive to act in his own interest; instead of that of the class.  Class counsel “may have been desperate to settle the case and obtain a large attorneys’ fee in this case before the financial roof fell in on him.”

3.  Four Out Of The Five Original Class Members Objected To The Settlement:  When the settlement agreement was presented to the Court, class counsel’s son-in-law was the only class member who supported the settlement.  The remaining class members opposed it.  The objecting class members were replaced; the replacements, selected by class counsel, supported the settlement.

4.  The Settlement Agreement Did Not Provide Incentive Awards To Class Representatives That Opposed The Settlement:  This created a conflict of interest because any representative that opposed the settlement would be stripped of compensation.

5.  Attorneys’ Fees Versus Value To The Class:  Class counsel was to receive $11 million in attorneys’ fees under the settlement.  In fact, the settlement provided that $2 million in fees were to be paid before notice was sent to class.  And any reduction of the attorney fee award would revert to Pella, not the class members.

The benefit to class counsel was clear, however, the benefit to the class was not.  Class counsel estimated the value of the settlement as $90 million, and Pella estimated the value of the settlement at $22.5 million.  But after examining the settlement and the submitted claims, Judge Posner put the settlement value at about $1 million.  Judge Posner noted that the district court should have made some responsible prediction of the settlement’s value to the class members before approving the settlement.

6.  Overcomplicated Claims Process To Obtain Modest Relief:   While class counsel received their fees up front, class members obtained the right to make claims under a process “bristling [with] technicalities.”  In order to receive compensation, or coupons, class representatives had to complete a claim form that was 12–13 pages long and also submit a “slew of arcane data.”  Pella could reject the forms if they were not filled out completely and correctly.

Class members could fill out a “simple” claim to receive a maximum of $750; however, the claim process was rife with conditions that made a maximum recovery unlikely.  Alternatively, class members could opt to run the “gauntlet” of arbitration and receive up to $6,000.  But the arbitration process was burdensome, and allowed Pella to assert numerous defenses such that, even on a valid claim, it could reduce any recovery by 75%.  And the class member would have to bear the cost of arbitration.

7.  Class Notice Was Incomplete And Misleading:  Class notice was 27-pages long, yet failed to mention numerous key facts.  For example, it did not state that four of the five original class members objected to the settlement and were subsequently replaced, it did not mention the conflicts of interest of the class representative and lead counsel, or that lead counsel was in “financial trouble and ethically challenged,” and it did not mention that up to half of those that received notice would, if they filed a claim (and it was approved), receive a coupon for the purchase of a new Pella window.  Of the 225,000 claim forms issued, 5% of the claim forms were returned to Pella.

8.  The Objections Were Ignored:  Judge Posner noted that “district judges presiding over [class action settlements] . . . are expected to give careful scrutiny to the terms of the proposed settlement to make sure that class counsel are behaving as honest fiduciaries for the class as a whole.”  But despite the issues with the settlement, and the objections of the former class representatives, the district court’s approval of the settlement was squeezed into two two-page orders” and the objections of the former class members were “virtually ignored.”

9.  Adversity amongst subgroups:  Prior to the settlement, two main subclasses were certified – one for customers that already replaced or repaired their windows, and a second that sought only declaratory relief.  The damages class was limited to six states, with a subclass for each state; the declaratory relief class was nationwide.  The settlement agreement, however, purported to bind a single nationwide class consisting of all window owners.  The different remedies indicated that there was “adversity among subgroups,” which meant that all members of each subgroup [could not] be bound to [the] settlement except by consents given by those who understand that their role is to represent solely the members of their respective subgroups.”

Between the “one-sidedness of its terms and the fatal conflicts of interest” it was clear to the Court that “[c]lass counsel sold out the class.”  As a result, the Court not only rejected the settlement, but stated that the class representatives and class counsel must be replaced, and that the objectors should be reinstated as the class representatives.

Many valid settlements contain elements analogous to those in Eubanks (e.g., requiring class members to return a claim form to obtain benefits), but the facts in Eubanks are extreme.  Thus it is uncertain how Eubanks may inform district courts’ scrutiny of class action settlements.  At a minimum, however, Eubanks provides a warning that settlement terms cannot be one sided, and that a district court must do more than a rubber stamp class action settlements.