Auctioning class settlements.

• Author: Tidmarsh, Jay

Abstract

Although class actions promise better deterrence at a lower cost, they are infected with problems that can keep them from delivering on this promise. One of these problems occurs when the agents for the class--the class representative and class counsel--advance their own interests at the expense of the class. Controlling agency cost, which often manifests itself at the time of settlement, has been the impetus behind a number of class action reform proposals.

This Article develops a proposal that, in conjunction with reforms in fee structure and opt-out rights, controls agency costs at the time of settlement. The idea is to allow the court, once a settlement has been achieved, to put the class's claims up for auction, with the settlement acting as a reserve price. An entity that outbids the settlement becomes owner of the class's claims and may continue to pursue the case against the defendant. A successful auction results in more compensation for the class. On the other hand, if no bids are received, the court has evidence that the settlement was fair. The prospect of a settlement auction also deters class counsel and the defendant from negotiating a sweetheart deal that sells out the class.

The Article works through a series of theoretical and practical issues in settlement auctions, including the standards that a court should use to evaluate bids, the limitations on who may bid, and ways to encourage the emergence of an auction market.

TABLE OF CONTENTS Introduction I. Potential and Pitfalls in Class Litigation II. Ensuring Fair Settlements III. Practical Aspects of Settlement Auctions A. The Auction's Purpose B. Bidding 1. Standards for Bids 2. Partial Bids 3. Settlements with Injunctive Relief 4. Making Payment C. Bidders D. The Emergence of an Auction Market E. The Timing of Opt-Outs F. Apportioning Fees Conclusion Introduction

The cases and literature on class actions contain some radical ideas. Among them are auctioning the class's claims to the highest bidder; (1) auctioning the position of class counsel to the lowest responsible bidder; (2) employing third-party financiers, who take a share of any class settlement in return for providing funds to prosecute the case; (3) and handing over the victims' small-stakes claims to a charity or advocacy group. (4)

All of these ideas have two premises at their foundation. First, class actions are valuable because they can achieve significant deterrence, especially in small-value cases for which individual litigation is not an option. (5) Second, class actions are dangerous because individual plaintiffs have either limited capacity or an insufficient financial stake to monitor the work of their agents--the class representatives and class counsel. (6) Without monitoring, representatives or counsel may engage in self-dealing, reaping a large recovery or fee for themselves while settling the claims of class members for pennies on the dollar. (7)

The trick is to harness the deterrence potential of class actions while slashing agency costs to a minimum. Auctioning the position of class counsel seeks to control agency costs directly by subjecting attorneys' fees to market competition. (8) The other three proposals--auctioning the class's claims, using third-party financing, and giving the right to recover on the class's claims to a charity or advocacy group--control agency costs indirectly by steering the claims into the hands of a single person (a bidder, a financier, or a charity) with a sufficient stake to monitor counsel effectively. (9)

This Article suggests a simple strategy to control agency costs that blends aspects of all four approaches. When the parties in a class action arrive at a settlement, the court should put the settlement up for auction. If third parties bid more for the case than the settlement offer, the proceeds of the highest bid are distributed to the class. Ownership of the class's claims shifts to the winning bidder, who has an incentive to monitor counsel while continuing to press the case against the defendant.

Although the proposal is easy to state, it poses practical difficulties. Part I begins the examination of these issues by framing the problems that a settlement auction is designed to alleviate. Part II outlines the auction process and describes the conditions under which an auction can help to reduce agency costs and to ensure fair settlements. Part III addresses a series of practical concerns that settlement auctions raise and demonstrates how an auction process responsive to these concerns helps class actions to deliver more compensation and provide more deterrence.

1. Potential and Pitfalls in Class Litigation

   Aggregating similar claims in a single lawsuit can create significant benefits. Principal among them are forcing defendants to internalize the full costs of their wrongdoing, (10) equalizing the incentives for plaintiffs and defendants to invest in litigation, (11) lowering per-claim transaction costs, (12) providing compensation to victims, (13) and ensuring the like treatment of like claimants. (14) But aggregation also creates the risk of substantial costs. Among these are aggregation's potential to overdeter behavior, (15) deprive individuals of their right to a "day in court," (16) and increase transaction costs.

   The most significant transaction costs derive from three sources. The first transaction costs are the additional costs of litigation. In cases in which individual losses are very small, which are often referred to as "negative-value cases," (17) the parties and the court incur no litigation expenses, absent the plaintiffs' capacity to aggregate their claims, because the cases are too expensive to bring individually. (18) In addition, class actions and other aggregate litigation often involve other expenses--such as notice to the class (19) and additional judicial management (20)--that ordinary cases do not. The second set of transaction costs are error costs. The aggregation of claims may distort both the likelihood of recovery and the amount of recovery in relation to individual litigation, thus generating a litigation premium that defendants must pay. (21)

   Third, aggregate litigation may generate agency costs, which can arise when an asset owned by a principal is placed in the hands of an agent. The agent may have an incentive to maximize personal profit rather than the profit of the principal. (22) The consequence is agency cost, which has three components: the principal's costs of monitoring the agent, the principal's costs of providing incentives that ensure the fidelity of the agent, and any difference between the asset's value in the hands of a faithful agent and the actual value realized by a self-interested agent. (23)

   In aggregate litigation, little monitoring occurs, (24) so the most significant agency costs arise from loss in claim value due to self-serving representation. Loss in claim value arises from two sources. First, the class representatives, or other individuals that lead the group, may use the group's claims to leverage more favorable treatment for their own claims relative to the claims of others in the group. (25) Second, class counsel may sell out the entire group's claims in return for a hefty fee. (26) Agency costs do not occur in every case, but the inevitability of conflicts among group members and between the group and counsel makes these costs a constant risk. (27)

   As litigation, error, and agency costs rise in relation to benefits, aggregation by class action or other means becomes less attractive. (28) Therefore, considerable attention has been paid to keeping these costs at their minimum. With regard to agency costs, Rule 23--the federal class action rule--created structural safeguards that can reduce these costs. (29) First, a court must find that both the class representative(s) and class counsel are adequate. (30) Second, a court must approve all class settlements and can do so only when it finds that the settlement is "fair, reasonable, and adequate." (31)

   But these safeguards do not end the concern about agency costs. At a legal level, the present law on "adequate representation" is too broad in some ways and too narrow in others to sufficiently ferret out all self-dealing behavior by representatives and counsel. (32) Nor do these safeguards presently pertain to nonclass aggregate litigation. (33) At a practical level, these protections have not eliminated self-regarding behavior. There are enough examples of such behavior--Dexter Kamilewicz's settlement; (34) settlements in which class members received nearly worthless coupons and class counsel walked away with large fees; (35) settlements in which class counsel's own clients received greater benefits than those afforded class members under the settlement; (36) and other settlements in which class members stood to receive nothing of value, but class counsel stood to profit handsomely (37)--to dispel any notion that the doctrine of adequate representation eliminated self-dealing. Likewise, courts' lack of knowledge about the strength of the claims, as well as many courts' desire to move big cases off their dockets, renders the "fair, reasonable, and adequate" check on settlements an imperfect mechanism to avoid agency costs. (38)

   A number of proposals designed to cut down on agency costs have stepped into this gap. (39) To start, there are the ideas discussed at the beginning of this Article. (40) In addition, some commentators have suggested creative uses of attorneys' fees to give counsel less incentive to sell out the class. (41) Others have recommended that members of the group be allowed a free right to opt out of a settlement once its terms become known. (42) Broadly, these proposals seek to control agency costs in one of three ways. One is to transfer ownership of, or at least a significant stake in, the claims to an entity with a sufficient financial interest to monitor the counsel's...