Originally published February 11, 2005
On February 10, 2005, the U.S. Senate passed Senate Bill 5, the Class Action Fairness Act of 2005 (the "Class Action Fairness Act" or the "Act"), which likely will take effect after swift approval by the House and the President. The Act effects a sweeping overhaul of the current class action litigation system by providing a federal forum for oversight of many class actions and increased judicial scrutiny of settlements and plaintiffs’ counsel fees in such cases. The Act provides important procedural protections for companies targeted by the plaintiffs’ bar in nationwide class action litigation and certain mass litigations consolidated in state court for joint trial, and creates a substantial advantage for companies facing class action litigation. As a result, companies should be poised to take full advantage of the new laws.
As many companies are painfully aware, the risks and costs of defending a nationwide class action lawsuit can be substantial. Defendants are often forced to litigate these "betthe- company" cases in state court jurisdictions hand selected by the plaintiffs’ bar. Some state court jurisdictions preferred by the plaintiffs’ bar are well-known for a lack of standards in certifying, overseeing and settling class actions. In addition, many of the state court venues are tied indirectly, if at all, to the transactions or alleged violations at issue. Under the current system, plaintiffs’ class counsel also receive substantial legal fees unrelated to the value of the settlement to the class members as a whole or the conduct challenged. Together these issues create a strong incentive for the plaintiffs’ bar to bring class actions against large corporations in state court and provide little protection to those corporations so targeted.
This article examines the new protections afforded by the Act and analyzes the changes to existing law. The most significant provisions of the Act are as follows:
Expansion of Federal Jurisdiction
The Act greatly expands the definition of federal diversity jurisdiction for class actions, thereby protecting corporations from risky plaintiff-friendly state courts that have no relationship to the case. Generally, corporate defendants prefer federal court because of more consistent standards and oversight with respect to class action certification and settlement and greater safeguards against abuses. Under prior law, a class action was restricted to state court unless (1) each class member sought damages of at least $75,000 (although some courts modified this requirement to apply only to the named plaintiffs) and (2) all named plaintiffs were citizens of states different from all named defendants.
Under the Act, federal jurisdiction will exist when (i) any defendant is a citizen of a state different from any member of the plaintiff class, and (ii) the aggregate amount of the claims of all class members exceeds $5 million. For example, under the old rules, if a Delaware corporation was sued in New York and at least one of the class members was a Delaware resident, then the case could not be brought in federal court because the corporation and one of the class members were from the same state. Under the Act, however, federal jurisdiction will exist as long as even one class member is not from Delaware. While certain securities and corporate governance class actions are excluded from the Act, this definition nonetheless greatly expands the number of class actions that may be heard in federal court.
Expansion of a Defendant’s Removal Rights
The Act also greatly expands the ability of a single defendant to remove a class action to federal court. Under prior law, to remove a case to federal court, all defendants had to consent to removal, and a defendant that was a citizen of the state in which the state court action was filed could not remove the case at all. These restrictions created problems for corporate defendants given the tight time limitations for removal and the difficulty gaining the consent and cooperation of multiple defendants at such an early stage of the litigation. The Act changes this and allows any defendant that otherwise meets the Act’s diversity requirements to remove an interstate class action to federal court "without the consent of all defendants" and "without regard to whether any defendant is a citizen of the state in which the action is brought." The Act also shuts down one of the plaintiffs’ favorite ways around the strictures of a class action – joining hundreds of unrelated plaintiffs together in one case but not calling it a class action. As such, the Act permits these "mass actions" to be removed from federal to state court to the same extent as a class action under the Act.
The Act also provides for broader and expedited federal appellate review of orders granting or denying remand of removed cases. Prior to the Act, defendants had no access to appellate review of an order granting remand and sending the case back to state court, forcing defendants to litigate the case in state court with no review of a potentially erroneous remand order. Under the Act, however, federal appellate courts may accept an appeal of an order granting remand, thereby providing defendants with immediate review of an erroneous remand order and potentially saving defendants from years of costly litigation in state court.
The Act does not mean, however, that all bet-the-company class actions will end up in federal court, as it does not apply to purely intrastate class actions. A case may not be removed when two-thirds of the class members and the primary defendants are from the state in which the action is brought, and other conditions are met. Likewise, federal jurisdiction is discretionary if a certain portion of the class and the defendants are from the state in which the action is brought.
Judicial Scrutiny of Coupon Settlements and Resulting Attorneys’ Fees
In cases in which the proposed settlement involves coupons to class members, the bill requires heightened judicial scrutiny. Nominal settlement amounts often are offered in the form of coupons to class members to resolve a dispute, while plaintiffs’ class counsel cash in on hugely disproportionate fee awards. For example, class members in a dispute involving a product may receive a coupon of a few dollars off that product, while the fees awarded to plaintiffs’ class counsel can reach into the multiple millions of dollars. The Act curtails these coupon settlements, with the anticipated result that fewer class actions will be filed where the value to the consumer is nominal. Under the Act, the court must conduct a hearing and approve a coupon settlement only after it makes written findings that the settlement is fair, reasonable and adequate for class members. Moreover, the fees of plaintiffs’ counsel must be based on the value of the settlement to class members. The court may also require that unclaimed coupons be distributed to charitable or governmental organizations. The Act also bars settlements that favor plaintiff class members based solely on their geographic proximity to the court hearing the case.
What This Means for Corporate Defendants
We anticipate that the Class Action Fairness Act will go into effect relatively soon. Reportedly, an agreement already exists with House leadership to approve the bill as passed by the Senate. The Act will apply only to class actions and mass actions filed after the effective date of the new law. The Act will change the dynamics of litigating class actions and mass actions to the benefit of corporate defendants. More class actions will be heard in federal court, with the protection of the Federal Rules of Procedure, the Federal Rules of Evidence, and greater federal appellate oversight. Going forward, more class actions or mass actions filed in state court will be removable to federal court with potential appellate review of an erroneous remand decision available if necessary. Additional discovery regarding the citizenship of all class members may be necessary to determine whether the new jurisdictional rules apply. We anticipate substantial appellate review on the issues of diversity jurisdiction and remand in the class action context, so companies should be prepared to litigate these issues in the early stages of the case. In addition, companies must work closely with their in-house and outside counsel to carefully structure settlements before they are presented to the court for approval to ensure that the proposed settlement complies with the provisions of the Act.
Goodwin Procter LLP is one of the nation's leading law firms, with a team of 650 attorneys and offices in Boston, New York and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.
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