Closer Scrutiny for Cy Pres Distributions?

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The Third Circuit’s recent opinion in In re Baby Products Antitrust Litig. is noteworthy for its approach to cy pres distributions in class settlements, a topic that has also garnered recent attention in the First Circuit.  In that case, the Third Circuit held that a district court must determine whether a class settlement incorporating a cy pres fund provides sufficient direct compensation to class members.  The Third Circuit’s opinion suggests the possibility of even closer scrutiny for cy pres distributions and additional challenges for class settlements.

In re Baby Products involved a claim that certain companies involved in the sale of baby products had conspired to set a price floor.  After class certification was granted, the parties entered into a settlement agreement that was approved by the district court.  Under the settlement agreement, the defendants paid over $35.5 million into a common fund.  From that fund, roughly $14 million was allocated to attorneys' fees and expenses.  The remainder was to be distributed via a claims process that would allow claimants who provided proof of purchase to receive higher levels of reimbursement than those who provided no proof of purchase.  A class member who submitted proof of purchase would receive a percentage of the purchase price, while a class member with no proof of purchase would receive a payment of $5.  Any residual funds were first to be redistributed to claimants until their claims had been paid in full, and any funds remaining after redistribution were to go to cy pres recipients to be selected by the district court.  Because many claimants did not have a proof of purchase, the claims process revealed that only about $3 million would be distributed to class members, while approximately $18.5 million would be distributed to cy pres recipients.

On appeal, the Third Circuit held that class settlements may include a cy pres component.  As noted by the Third Circuit, and as previously addressed on this blog, the First Circuit has also approved the use of cy pres distributions in settlement agreements.  However, the Third Circuit vacated the baby products settlement because of what it characterized as the “troubling” and “surprising” allocation of the settlement fund. 

Observing that the district court had been unaware of the amount of the fund that would be distributed to cy pres recipients at the time it approved the settlement, the Third Circuit remanded for the lower court to find whether the settlement provided “sufficient direct benefit” to the class.  According to the Third Circuit, the primary purpose of a settlement is to “compensate the class members,” and, therefore, “direct distributions to the class are preferred over cy pres distributions.”  As such, the Third Circuit observed, “cy pres awards should generally represent a small percentage of total settlement funds.”

In consequence, the Third Circuit held that a district court should consider “the degree of direct benefit provided to the class” in approving a settlement – an analysis that might require a district court “to withhold final approval of a settlement until the actual distribution of funds can be  estimated with reasonable accuracy.”  As an alternative, the Third Circuit observed that a district court “may urge the parties to implement a settlement structure that attempts to maintain an appropriate balance between payments to the class and cy pres awards.” 

The Third Circuit then went on to vacate the attorneys’ fees award because the settlement was no longer in effect.  In so doing, the court declined to impose a rule requiring district courts to discount attorneys’ fees when a portion of an award will be distributed through cy pres, but did state that, “[w]here a district court has reason to believe that counsel has not met its responsibility to seek an award that adequately prioritizes direct benefit to the class, we . . . think it appropriate for the court to decrease the fee award.”

The Third Circuit’s opinion is notable for at least three reasons.  First, the opinion adds the voice of the Third Circuit to that of other courts that have expressed concern about the use of cy pres in class settlements.  Similar criticism has also been heard within the First Circuit.  For instance, in the  Download In re Compact Disc Minimum Advertised Price Litigationin the District of Maine, Judge Hornby took the step of “substantially reduc[ing] the request for attorney fees” because of “the modest benefit” to recipients of the cy pres award.  Second, and perhaps more importantly, the Third Circuit’s reasoning could introduce increased uncertainty into settlement negotiations.  Under the Third Circuit’s approach, final approval of a settlement could be contingent on the results of the claims process – which is not known (and may not reasonably be knowable) at the time of negotiation.  Parties therefore may be left to negotiate a settlement in a vacuum, and could have their settlement agreements rejected despite their efforts to reasonably compensate class members.  Finally, and relatedly, the Third Circuit’s approach also highlights the First Circuit’s admonishment in In re Lupron Marketing & Sales Practices Litigation that, when class members will receive less than 100% compensation under the terms of the settlement, unclaimed funds should be used to augment the class members’ recovery before they are allocated to cy pres distributions.  In re Baby Products is another signal that cy pres distributions will be closely scrutinized.