Diversity, Choice-of-Law and Fee Awards in Class Action Settlements

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In an opinion authored by Chief Justice Sandra Lynch that could, and should, find its way into civil procedure casebooks, the First Circuit charted a course through the complexities of the Erie doctrine and state choice-of-law principles in determining which law governed the award of attorneys' fees to be paid under a class action settlement agreement, reached in a federal MDL proceeding, where subject matter jurisdiction was based on diversity of citizenship.  The decision brings remarkable clarity to an often murky area of law.

In re:  Volkswagen and Audi Warranty Extension Litigation was an MDL proceeding pending in the District of Massachusetts.  Plaintiffs alleged that engine defects in certain vechicles caused the build up of damaging sludge unless certain types of motor oil were used.  They asserted claims of consumer fraud and unfair and deceptive trade practices under various state laws.  Putative class actions were filed in five district courts, and the Judicial Panel on Multidistrict Litigation ordered them transferred to the District of Massachusetts and consolidated for pretrial proceedings.  Subject matter jurisdiction was based on diversity under the Class Action Fairness Act.

The parties arrived at a proposed settlement agreement in September 2010.  They agreed to a claims-made settlement that included both monetary and non-monetary components (including payment for repair and replacement costs, warranty extensions for certain vehicles, one-time oil change discounts, and an education and information program.)  Although defendants agreed to pay attorneys' fees, the settlement agreement expressly separated the benefits to be awarded class members from the anticipated application for attorneys' fees and costs.  It contained no agreement concerning the amount of the fees or how they would be determined, and specified that any attorneys' fee award would be over and above the benefits to be paid to the class.  Another section of the agreement provided that the parties had not agreed to any choice of state or federal law with respect to the construction of the agreement, “including but not limited to attorney fees and costs.”

Class counsel asked the court to award $37.5 million in attorneys' fees, and argued that the fee award was governed by federal law.  They contended that the percentage-of-the-fund methodology should apply, and that the settlement value was at least $414 million.  They also argued that an award of $37.5 million was reasonable under the lodestar method.  Defendants argued that state, not federal, law should apply, that their expert valued the settlement at $50 million, and that the requested fees were excessive.

The district court awarded $30 million in fees.  The court held that, where the fee award is the result of a private agreement, federal law governs, and that application of state fee-shifting statutes would not be appropriate because plaintiffs were not prevailing parties.  The court opined that, in the settlement context, fees may be awarded as part of the court's equitable powers over the fund created to benefit the class.  The court further determined that $30 million was reasonable under both the percentage-of-the-fund method and the lodestar approach.

Defendants appealed from the fee award.  The First Circuit vacated the award and remanded for re-determination of the fees.  

First, the court of appeals determined that state law governed the attorneys' fee award.  It noted that, in general, state contract law governs the interpretation of agreements, and that the issue of attorneys' fees “has long been considered for Erie purposes to be substantive and not procedural.”  Class counsel argued that the determination of fee awards is procedural because Rule 23(h) of the Federal Rules of Civil Procedure expressly provides for them.  The court rejected this argument, relying on the language of the rule (permitting courts to award attorneys' fees and costs “that are authorized by law or by the parties' agreement”), and the Advisory Committee's notes (stating that Rule 23(h) “does not undertake to create new grounds for an award of attorney fees or nontaxable costs.”)  The court also rejected class counsel's Shady Grove argument because there was no conflict between Rule 23(h) and the application of state-law principles.    

Next, the court held that “the district court erred in finding that it had inherent federal equitable powers to fashion an attorneys' fee award.”  The cases used to support that argument, the court noted, were based on federal question jurisdiction, not diversity.  Because the basis for the fee award in the MDL proceeding was the agreement itself, it was based on state contract law principles, not federal law.  Additionally, the settlement did not create a common fund from which the fees would be paid, and the common benefit method did not apply “because this is not a case in which the cost of the fees is being 'spread around' among the parties benefitted; the fees are on top of the class-wide benefits.”

Having established that state law governed the determination of the fee award, the court then turned to the question of which state's law applied.  The court first determined that, in an MDL proceeding where jurisdiction is based on diversity, the relevant choice-of-law rules are those of the states where the transferor courts sit.  Next, analyzing the choice-of-law rules of each state in which the lawsuits were originally filed, the court concluded that Massachusetts law applied.  The court then determined that Massachusetts follows two approaches to determining attorneys' fees under a contractual agreement (the lodestar method and a multi-factor approach), and remanded the case to the district court to select one of these two methods and award an appropriate fee.