Ninth Circuit reminds district courts that pre-certification and coupon class action settlements must be subject to heightened scrutiny

In Mckinney-Drobnis v. Oreshack,[1] (hereinafter “McKinney”), the Ninth Circuit instructed a district court that vouchers awarded to Massage Envy Franchising, LLC ("MEF") members in a pre-class certification settlement were “coupons” under the Class Action Fairness Act (“CAFA”), and that the lower court had failed to subject such a settlement to heightened scrutiny, including in particular the class counsel fees that were awarded.

The class action settlement at issue

The complaint in McKinney alleged that MEF began to periodically increase monthly membership fees in violation of its membership agreement. After extensive discovery, but prior to a class certification decision, the case settled. Under the settlement, class members were entitled to submit claims for "vouchers" that could be redeemed for a number of specified MEF products and services. The value of a voucher, which would expire in 18 months, would correspond to the fee increase a class member claimed to have paid. If total class member voucher claims were less than $10 million, the value of each claimant’s voucher would be increased pro rata until the total value reached $10 million. Significantly, MEF agreed not to contest a fee request by class counsel of up to $3.3 million, and if the court awarded a lower fee, the surplus would revert back to MEF rather than to the class. Ultimately, the value of claimed vouchers was lower than $3 million, so voucher values were increased to a range from $36.28 to $180.68.

CAFA provides: “If a proposed settlement in a class action provides for a recovery of coupons to a class member, the portion of any attorney’s fee award to class counsel that is attributable to the award of the coupons shall be based on the value to class members of the coupons that are redeemed.”[2] According to a 2018 Ninth Circuit decision, this is to ensure that class counsel benefit only from coupons that provide actual relief to the class, lessening the incentive to obtain an award of coupons that class members may have little interest in using.[3] However, the term “coupons” is not defined in the statute.

The district court’s acceptance of the settlement

The district court in McKinney determined that the vouchers to be provided to MEF members were not “coupons” subject to CAFA, so class counsel’s fees could be based on the $10 million value of the total settlement fund rather than the less than $3 million value of the vouchers that ultimately had been redeemed. Nevertheless, the district court approved the settlement as “fair, reasonable, and adequate” under Fed. R. Civ. P. 23(e), and awarded the $3.3 million attorneys’ fee that had been requested by class counsel. An objector appealed the ruling to the Ninth Circuit after unsuccessfully claiming in the district court that the vouchers provided under the settlement in fact were “coupons” subject to CAFA, adding that in any event the district court had abused its discretion by disregarding warning signs of class counsel’s self interest that warranted additional judicial scrutiny of the pre-certification settlement.

The Ninth Circuit’s rejection of the settlement

The Ninth Circuit panel initially considered whether the vouchers awarded to the class in fact were “coupons” under CAFA, applying a three-factor test adopted by the court in a 2015 decision.[4] The first factor: whether class members had to hand over money in order to obtain the benefits of the settlement, suggested to the panel that the vouchers were “coupons” under CAFA because smaller class member voucher amounts were not enough to purchase most of the services covered by the settlement The second factor: whether the vouchers only could be used for “select products or services,” also supported the argument that the vouchers were “coupons.” The third factor: the flexibility of the vouchers, favored the vouchers not being considered “coupons” because they did not expire for 18 months. Weighing all three factors, the panel concluded that the vouchers in fact were “coupons” subject to CAFA’s requirements for coupon settlements.[5] Accordingly, the panel vacated the district court’s approval of the attorneys’ fee award, and remanded the case in order for the district court to use the value of the vouchers that were actually redeemed by class members in awarding counsel fees, as required by CAFA.[6]

The Ninth Circuit panel next addressed the Objector’s contention that, independent of CAFA’s applicability to the class counsel’s fee award, the settlement was not “fair, reasonable, and adequate” under Rule 23(e) because it unfairly benefited class counsel over class members. The panel essentially agreed, holding that the district court abused its discretion by failing to apply heightened scrutiny to a pre-class certification settlement.

Specifically, the panel relied on three factors that had been identified in a 2011 Ninth Circuit decision as determinative of a settlement that unfairly benefits class counsel over class members: (i) awarding a disproportionate portion of the settlement award to class counsel; (ii) a so-called “clear sailing” provision under which a defendant agrees not to challenge a fee award to class counsel at or below a specified amount—; and (iii) providing that unawarded attorneys’ fees revert to the defendant rather than to the class—referred to as a “reverter.”[7] As to the first factor, the panel declared that the proportionality of class counsel’s fee could not be determined until it was recalculated by the district court on remand. Considering the second and third factors together, the panel concluded: “when a clear-sailing provision is paired with a reverter, the terms together increase the risk that class counsel will unreasonably raise the amount of requested fees, and the class members will have less incentive to push back because the recovery of any unawarded fees will inure to the defendants, not the class members.”[8] Concluding that the district court had not adequately investigated and analyzed settlement terms that the Ninth Circuit panel considered to be evidence of potential collusion, the panel ruled that the lower court had not conducted the required heightened scrutiny of a pre-certification settlement, thereby abusing its discretion in granting approval of the settlement.

Takeaways

The McKinney decision provides three clear messages to class action litigants as to when settlements will be subject to heightened scrutiny—at least in the Ninth Circuit:

  • when the class action is settled pre-class certification;
  • when the reward to the class involves coupons subject to CAFA; and
  • when a “clear-sailing” provision is accompanied by a “reverter.”          

Footnotes

[1] 2021 WL 4890277 (9th Cir., Oct. 20, 2021).

[2] 28 U.S.C. Section 1712(a)

[3] See In re EasySaver Rewards Litig., 906 F.3d 747, 755 (9th Cir. 2018).

[4] In re Online DVD-Rental Antitrust Litig., 779 F.3d 934 (9th Cir. 2015).

[5] McKinney-Drobnis v. Oreshack, 2021 WL 4890277 at *8-*9.

[6] Id. at *9. 

[7] In re Bluetooth Headset Products Liability Litig., 654 F.3d 935 (9th Cir. 2011).

[8] McKinney-Drobnis v. Oreshack, 2021 WL 4890277 at *13.

*Irving Scher is Senior Counsel in the firm's New York office.