Advisen

Rule 23 under the Microscope: Pending Legislation May Alter the Class Action Landscape

By Daniel H. Simnowitz and Ariel Fliman, QBE North America

Class actions – including securities class actions, employment practices class actions, wage and hour class actions, and antitrust class actions – are among the most significant exposures for insurers in the management and professional liability space. For this reason, recent legislation passed by the U.S. House of Representatives that may change the procedural landscape for federal class actions should be of interest not only to management and professional liability insurers but also to risk managers and brokers.

On March 9, 2017, the House of Representatives passed a bill introduced by the chairman of the House Judiciary Committee, Rep. Bob Goodlatte of Virginia, entitled the Fairness in Class Action Litigation Act of 2017 (the “Act”), which proposes to modify procedures for federal class actions to “assure fairer, more efficient outcomes.” The Act would dramatically alter the landscape for federal class actions by: (1) requiring that all class members suffer the same type and scope of injury; (2) imposing an automatic stay on discovery pending the resolution of a motion to dismiss; (3) capping the amount of fees awarded to class counsel and conditioning payment of fees on complete distribution of settlement proceeds to the class; and (4) requiring the disclosure of any third-party litigation funding. These changes may create hurdles, costs and other disincentives that could make potential lead plaintiffs and their lawyers think twice before initiating a class action. Overall, the Act could result in a decline in both the settlement value and number of class actions filed in federal court.

A week after passing the House, the Act advanced to the Senate Judiciary Committee. Given Washington’s current preoccupation with investigations arising from Russian hacking, healthcare and potentially tax reform, it is unclear when the Senate Judiciary Committee will conduct hearings and a vote on the bill will occur. Nevertheless, many of the Act’s potentially significant reforms merit examination and can be categorized as set forth below.

Limitations on Costs: Provisions of the Act that restrict litigation activity while motions to dismiss  are pending, and that set ceilings on fees awarded to class counsel, could limit plaintiffs’ leverage to negotiate favorable settlements and make plaintiffs rethink the scope of a putative class.

Stay of Discovery: The Act would impose a stay on all discovery while motions to dismiss (and other types of motions, including motions to strike allegations from complaints) are pending in connection with all putative federal class actions. The discovery stay would apply “unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice.” Effectively, the Act would impose a discovery stay similar to the one applicable under the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) pending the resolution of a motion to dismiss in securities class actions.

The imposition of an automatic discovery stay in non-securities class actions could benefit class action defendants by potentially reducing defense costs in connection with discovery before the court issues a ruling on the defendants’ motion to dismiss or motion to strike. And similar to the PSLRA, the Act may discourage the filing of so-called “strike suits” in which class plaintiffs file abusive or non-meritorious lawsuits against defendants, hoping to force a settlement without allowing the defendants the opportunity to fully evaluate and challenge the legal and factual merits of the plaintiffs’ case due to the immediate prospect of onerous discovery costs.

Plaintiffs’ Attorney Fee Awards: The Act would limit both the amount and the timing of the payment of a fee award to plaintiffs’ attorneys. The Act would limit attorneys’ fees to class counsel to a “reasonable percentage of any payments directly distributed to and received by class members,” which would prevent the court from awarding fees that exceed the total amount actually distributed directly to members of the class. And in class actions that result in equitable relief, the Act would similarly require that any award constitute a “reasonable percentage” of the value of any such equitable relief. With respect to timing of any payment of plaintiffs’ attorneys’ fees, the Act provides that “no attorneys’ fees may be determined or paid … until the distribution of any monetary recovery to class members has been completed.”

These provisions, which create uncertainty around the amount and timing of fee payments to class plaintiffs’ counsel, may have a chilling effect on class actions. With regard to the calculation of a fee award, the Act does not address the methodology of assigning a dollar amount to a settlement or judgment that is composed, at least in part, of some form of non-monetary relief. Non-monetary relief is a relatively common component of a settlement or judgment in many class actions that may give rise to coverage under management and professional liability policies, including shareholder derivative actions (corporate therapeutics or enhanced disclosures to shareholders), employment practices class actions (reasonable accommodations for disabled individuals) and antitrust class actions (halting anti-competitive behavior). Placing a monetary value on the non-monetary relief for the purposes of calculating a fee award would be a difficult and potentially expensive task for plaintiffs’ attorneys, potentially involving the use of experts and other third parties. With respect to the timing of payment of plaintiffs’ fee awards, that plaintiffs’ firms may have to wait until a settlement or judgment is completely distributed to the class to receive the fee award may cause cash-flow issues for some smaller and thinly capitalized plaintiffs’ firms, as in some cases it may take years to complete the monetary payout to the class.

Procedural Hurdles for Class Certification: To the extent that plaintiffs remain incentivized to pursue class action litigation, the Act would impose additional burdens that may prevent courts from certifying putative classes. These hurdles set a relatively high bar to achieve class certification and may result in fewer classes actually proceeding to the stages of substantive litigation.

Uniform Damages Requirement: The Act’s requirement that “each proposed class member suffered the same type and scope of injury” in order to grant class certification could strike a significant blow to class actions. Demonstrating that each class member suffered a particular type and scope of injury could prove particularly problematic in many types of class actions, including securities class actions where class plaintiffs may have suffered different amounts of damages depending on the timing of their stock purchases. Similarly, it may be difficult to establish a uniform type and scope of injuries in antitrust class actions, where plaintiffs’ injuries may differ depending on the particular context in which a plaintiff was affected by alleged price-fixing or anti-competitive conduct. And in data breach class actions, where every class member’s personally identifiable information is compromised by a breach but only some class members’ information is actually misused, a class may be smaller and more difficult to certify.

The uniformity-of-damages requirement would potentially overrule existing Supreme Court precedent holding that the inquiry is not necessary at the class certification stage. Indeed, the Act’s scope-of-injury standard would exceed the standard set forth in the Supreme Court’s 2016 decision in Tyson Foods, Inc. v. Bouaphakeo. In that case, the Court declined to reject class certification where the plaintiff could not demonstrate that every class member had suffered an injury, and thereby treated the inquiry into class members’ injuries as one properly handled while assessing the disbursement of damages. By imposing a stricter damages requirement in this regard, the Act would significantly expand plaintiffs’ burden at the class certification stage.

Enhanced Disclosures for Conflicts of Interest: With the exception of securities class actions, the Act would require a putative class and its counsel to disclose any personal, employment, contractual or prior client relationships between the class and its counsel unrelated to the action at hand. Where the named plaintiff or class representative “is a relative or employee of class counsel,” the Act prohibits the court from granting class certification. Further, the Act would obligate non-securities plaintiffs to disclose the identity of any third parties involved in funding the class action litigation.

Interestingly, the initial draft of the Act introduced in the House of Representatives included broad prohibitions on certifying classes in all types of class actions, including securities class actions, if the above-described conflicts of interest existed. Subsequent amendments to the Act resulted in a version under consideration in the Senate that includes narrower conflict of interest provisions. In particular, the current version of the Act eliminates previous versions’ prohibition on counsel representing lead plaintiffs in multiple class actions. Moreover, the current version of the Act excludes securities class actions from all conflict of interest disclosure rules, ensuring that the Act remains consistent with the purpose and impact of the PSLRA to encourage institutional investors (who are often represented by the same counsel in multiple class actions) to serve as lead plaintiffs.

Greater Access to Appellate Review: In those instances where trial courts determine that the Act’s requirements have been satisfied and certify plaintiffs’ putative classes, passage of the Act would increase the availability of appellate review of any certification decision. The Act would replace Circuit Courts of Appeals’ current discretion to review class certification orders with a provision stating that circuit courts “shall permit an appeal from an order granting or denying class-action certification under Rule 23.” Given that circuit courts currently grant such review only in rare instances, the Act would likely increase scrutiny of orders granting class certification and ensure strict compliance with new certification requirements. 

Overall, even if the Senate adopts the Act with amendments that change its current scope, the Act likely would still constitute a profound change in the procedures that currently control federal class actions. If the Act ultimately renders federal court a less attractive or viable forum for class actions, plaintiffs’ lawyers would most likely resort to state courts to bring class actions (with the exception of securities class actions, which may not be brought in state court under the Securities Litigation Uniform Standards Act), where judges and juries might be tasked with the complex assignment of interpreting and applying intricate fact patterns to complex federal laws. Given the Act’s significant potential impact on class action procedures, all parties with an interest in lowering defendants’ exposures and businesses’ risks of onerous litigation should monitor developments concerning the Act closely.

About the authors: Daniel H. Simnowitz is vice president, Product Development at QBE North America. Ariel Fliman is assistant vice president, Product Development at QBE North America.

This article is for general informational purposes only and is not legal advice and should not be construed as legal advice.