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Class Action Lawsuits and Unethical Settlements


Copyright 2004 by Michael A. S. Guth. All Rights Reserved. No portion of this article, including this web page, may be copied, retransmitted, reposted, or duplicated in significant portion without the express written permission of Dr. Michael Guth. Users are always welcome to establish links to this web page or to quote from it freely.

Modern multiforum litigation creates a conflict of interest environment in which attorneys representing class plaintiffs may be tempted to settle class action lawsuits for the wrong reasons. Instead of rejecting an inadequate settlement offer, the class counsel might recommend settlement so that he can be assured of collecting an attorney fee award and so that the claims of his clients will not become barred by the preclusive effect of a settlement negotiated in another forum. A trend has now developed in which the plaintiff class counsel compete with one another to offer the best and most sweeping settlement terms to defendants, and these settlements generally contain a global release of all claims in other fora. Once these global releases are approved and entered as part of a class action judgment, the releases effectively extinguish or bar related actions by class members in any other forum.

An attorney who wishes to conduct his class action practice in a diligent and ethical manner can be harmed by the unethical behavior of some class counsel who use claims in other fora as a bargaining chip to maximize the settlement terms for their own fee award. The resulting settlements may be contrary to public policy in the sense that (1) injured class members receive little or no recovery, and (2) viable claims in one forum are extinguished by the claim preclusive effect of a less than fair settlement and global release of all claims in another forum.

Unlike ordinary litigation where a defense counsel must bargain with one plaintiffs' counsel to reach a settlement in a single jurisdiction, in multiforum class actions defense counsel can shop from forum to forum to obtain the best settlement terms for their client. The plaintiff class counsel in one forum actually has an incentive to undercut the claims represented by another class counsel in another forum: the class counsel can get a higher settlement, and consequently a higher fee award, if his settlement includes a release of claims beyond his own forum.

Section I of this article describes the legal and ethical environment in which attorneys engaged in multiforum litigation must practice. Section II lists examples of opportunistic behavior by lawyers within this legal environment. In particular, Section II provides cases to illustrate reverse auctions, forum shopping,[1] filing of sham complaints aimed at precluding claims in other fora, meritless class action suits, race to the courthouse, and other conduct that tends to cast the judicial system or the legal profession into disrepute.

At present, neither the federal nor any state judiciary, which are responsible for promulgating rules under which attorneys practice law, has recognized that multiforum class litigation create a unique set of ethical dilemmas for attorneys with respect to settlements, the award of fees, and the law of preclusion. Some of these ethical dilemmas arise from the current state of the substantive law. Section III discusses changes needed in the substantive law of preclusion and rules of civil procedure to prevent abuses within the legal system. Section IV focuses upon the ethical risk that some attorneys may elevate their own self-interests ahead of their clients and recommends that each state should adopt a new Rule of Professional Responsibility specifically tailored to multiforum practice. This new ethical rule should cover attorneys' conduct from the point when they first undertake to represent a client in a potential class action matter to the time when the action is concluded. Finally, the Appendix contains our proposed rule, with a comment that follows the rule.

I. Legal and Ethical Environment of Modern Multiforum Litigation

Although lawyers typically think of their professional responsibilities in terms of representing a single party in litigation in one forum, the class action lawyer faces a different legal and ethical environment. A class action proceeds on behalf of all members defined in the class, and all class members similarly situated will be bound by the terms of any settlement or judgment in the class action. In this environment, the attorney representing the plaintiffs in a class action, usually designated the class counsel, has an ethical duty of loyalty to represent the best interests of all class members. In particular, the class counsel cannot ethically favor any one plaintiff or his own self-interest above those of the absent class members.

A lawyer engaged in mutiforum class action practice also faces a unique environment for negotiating a settlement. Unlike the settlement of a lawsuit between two individual parties in which the court will routinely sign a jointly proposed order by both counsel to settle and thereby dismiss a case, the settlement of a class action lawsuit requires a judicial determination of the fairness of the settlement to absent class members.[2] A court's nondelegable duty to approve the fairness and adequacy of any proposed class action settlement "is not an act of judicial mediation; it is an act of judicial power."[3] The court must administer class proceedings in a way that safeguards the rights of absent class members and comports with the requirements of due process.

Generally, class members will have the legal right to opt out of any proposed settlement of the class action. Those who choose to opt out of the class action will then have the freedom to pursue their claims individually against the defendants. Those who fail to exercise their opt out rights, either because they want their prorata share of the proposed settlement consideration or simply because they ignored the court notification and allowed their opt out rights to lapse, will be bound by any judgment entered by the court. Such a judgment in a class action will generally have claim preclusive effect, under the Full Faith and Credit Act,[4] on either pending or subsequently filed litigation arising from the same transaction. This preclusive effect will extend to any other forum, both state and federal, in which a plaintiff might file claims against the defendants named in the class action.

Aside from ethical considerations about undercutting viable claims in another forum, class counsel face no other limitations in receiving court approval to release claims outside their fora and bind class members. Federal courts have entered judgments approving proposed class settlements that released both federal and state law claims. For example, in Class Plaintiffs v. City of Seattle, the Ninth Circuit affirmed a federal district court judgment approving a class settlement and release of federal securities law claims.[5] Also, In re Corrugated Container Antitrust Litig., held a federal district court, in approving a class settlement of federal claims, had jurisdictional competence to extinguish state claims that were not pleaded, but which it had pendent jurisdiction to adjudicate.[6]

Similarly, state courts have approved class settlements that released state law, federal law, and even exclusively federal claims.[7] For example, in Kremer v. Chemical Constr. Co., the U.S. Supreme Court held that settlement of federal Title VII employment discrimination claims in a state class proceeding has issue preclusive effect barring subsequent claims raised in federal court.[8] In Nottingham Partners v. Dana, the Delaware Supreme Court affirmed the right of Delaware state courts to enter judgments releasing exclusively federal securities law claims as part of a state court class action settlement.[9] And in Marrese v. American Academy of Orthopaedic Surgeons, the U.S. Supreme Court held "a state court judgment may in some circumstances have preclusive effect in a subsequent action within the exclusive jurisdiction of the federal courts."[10]

Until the Supreme Court's recent decision in Matsushita Electrical Industrial Co., Ltd. v. Epstein[11] [hereinafter "Epstein"], the federal courts had placed only one modest limitation on the full faith and credit of state court judgments attempting to release exclusively federal claims: the facts in the underlying state law claims must be identical to those giving rise to claims released or extinguished by the state court judgment. As long as the claims giving jurisdiction to a court arose from the same factual predicate as the claims covered by a settlement, the state courts would have been able to decide the issues on their merits. Consequently, federal courts gave claim preclusive effect to the state court judgment approving the settlement of the action.[12] For example, in Nottingham Partners v. Trans-Lux Corp.,[13] the state class action claims and the released exclusively federal securities law claims both arose from the failure of a corporation to disclose allegedly material facts in a proxy statement. Similarly, the state class claims in Grimes v. Vitalink Communications Corp.,[14] shared a common factual gravamen of nondisclosure of material facts with the federal securities law claims released in the settlement.

Yet the Supreme Court's Epstein decision eliminated even this modest limitation on one court's power to extinguish and bar claims in another forum. In Epstein, the Supreme Court affirmed a Delaware state court's approval of a class action settlement that had the effect of releasing exclusively federal securities claims[15] that differed factually from the breach of fiduciary duty state law claims before it. Unlike Nottingham Partners and Grimes, the federal and state law claims in Epstein stemmed from differing factual bases.[16] The gravamen of the Delaware state class action was that the directors of a Delaware corporation had breached their fiduciary duty by failing to (1) implement a market check mechanism to ensure that shareholders received the maximum value for their shares, and (2) disclose key terms of a proposed merger such as the compensation packages that the corporation's top officers would receive.[17]

In contrast, the federal securities law class action filed in California in Epstein focused on the acquiring corporation's behavior: whether the Japanese acquiring firm violated federal securities law by offering either more consideration for the shares of some shareholders than the tender offer,[18] or by offering these select shareholders a different form of consideration than that offered to other shareholders.[19]

By upholding the Delaware class settlement and reversing the U.S. Court of Appeals for the Ninth Circuit, the Supreme Court eliminated the same factual predicate test previously used by the U.S. Courts of Appeal to limit the preclusive effect of class action settlements. The Court instead used the much broader same transaction test.[20] The Court effectively gave every lower court ─ state or federal ─ the ability to enter a judgment approving a (dubious) settlement that could prevent class members from further litigating claims in other fora.

The Supreme Court could have decided Epstein largely as a matter of forum shopping, which placed state courts in the precarious position of having to value factually unrelated, exclusively federal claims.[21] Yet the Court never even addressed the central forum shopping issue at the heart of Epstein: fair representation to the class. In the aftermath of Epstein, state and federal court judges seemed to have unfettered discretion to approve class action settlements subject only to meeting some minimal, poorly defined due process standards of fairness. Because the Supreme Court offered no guidance on what due process means for the approval of class action settlements, we can anticipate that courts will apply differing levels of scrutiny of settlement terms from forum to forum.[22]

Multiforum class actions thus afford unique opportunities for forum shopping and questionable settlements unlike any opportunistic behavior faced by lawyers representing individual clients in single forum cases. The state Boards of Professional Responsibility, which administer the rules of conduct for practicing attorneys, have paid little attention to class action practice. The nature of class actions and recent decisions on claim preclusion, however, create problems for lawyers who wish to conduct their class representation in an ethical manner. These lawyers face the dilemma that other less scrupulous attorneys in other fora can extinguish their cases. Soon the counsel begin to compete to see who can settle first and thereby bind the class members in other fora. The system creates incentives for lawyers to join in the frenzy of bargaining away the class members' interests before counsel in another forum undercuts the claims that form the basis for their own class representation.

II. Examples of Opportunistic Behavior that Illustrate the Need for Greater Regulation of Multiforum Litigation

In Section I, we described a general environment that creates incentives for lawyers engaged in multiforum, class action practice to exhibit unprofessional behavior. This section illustrates specific instances of undesirable behavior resulting from the incentive problems in the modern class action practice. Types of undesirable behavior include reverse auctions, in which plaintiffs counsel keep trying undercutting the value of their clients claims in order to propose the winning (and generally lowest value) settlement to the defendants, forum shopping for unsophisticated judges, filing nuisance suits, structuring complaints with an eye towards the preclusive effect on claims in another forum, a race to the courthouse to be the first class counsel to file suit, courts racing to judgment so that another court does not extinguish the claims before them, and due process concerns associated with class member apathy.

A. The Reverse Auction

The first consequence of the multiforum environment we shall examine is the reverse auction of plaintiffs' counsel lowering their settlement bids in an effort to induce defendants to settle in their forum. In a multiforum class action, defendants generally have two or more forums in which they have been sued to find the most favorable settlement terms. If class counsel in one forum will not accept an offer, both the counsel and the defendants know that class counsel in another forum may well accept it. The counsel who negotiates the settlement offer usually collects the lion's share of any payment for plaintiffs' attorney fees, which gives class counsel in each forum a powerful incentive to offer the most favorable deal to the defendants. "Whoever settles first with the defendant wins because any of these courts can grant a fully preclusive settlement covering all possible claims. . . . [D]efendants can force rival teams of plaintiffs' attorneys in to a `reverse auction' under which the defendants will settle with the lowest bidder among them."[23]

The likely winner in such a reverse auction should be one of the state class counsel. Counsel for the state court plaintiffs cannot litigate federal securities claims and sometimes not even the state law claims of another state in their own forum. The primary settlement value of their claims will often lie in their ability to preclude the more ominous action in some other forum. Defendants are aware that plaintiffs' counsel in state court are willing to bargain away exclusively federal claims, which they cannot argue on the merits and for which they can derive no attorney fee.

The Delaware Chancery Court, which hears a disproportionate number of class action suits based on the number of corporations that choose to incorporate in Delaware, acknowledged the potential for this kind of abuse with class action proceedings: using a settlement in one forum to extinguish the prosecution of a similar class action in another forum.[24] Yet the defendants' end run around the Epstein plaintiffs ─ going across the country to Delaware in an effort to extinguish the federal class action appeal, rather than defending that suit on its merits in California ─ illustrates a general pattern that is likely to recur in the current legal and ethical environment for multiforum litigation. We believe the ethical standards imposed on defense counsel should limit the benefit of employing a divide and conquer reverse auction strategy, rather than opposing a claim on its merits.[25]

B. Forum Shopping by Plaintiffs' Counsel for a Judge Who Will Approve a Settlement

Defense counsel are not the only source of forum shopping in the modern multiforum litigation practice. Plaintiffs' counsel also engage in forum shopping. In multiforum litigation, the class counsel's forum shopping is not the usual choice of a state court or federal court within a given state jurisdiction; that choice of fora remains a legitimate exercise of the counsel's discretion to maximize his clients' recovery. Instead, with multiforum class actions, we see plaintiff class forum shopping for a jurisdiction most likely to approve any dubious settlement terms that counsel submits. Clearly, selecting a forum based on its settlement acceptance behavior and its treatment for the award of attorney fees poses no direct benefit to class members. To the contrary, that form of forum shopping may exacerbate the conflicts of interest between the class members and the recovery of a fee award by their counsel.

Forum shopping by plaintiff class counsel is typified by the polybutylene plumbing case, which involved a multi-billion dollar settlement and a defined class of more than six million current homeowners and additional unknown class members who will own the homes in the future.[26] Plaintiff class counsel first filed a settlement of that nationwide class action suit in a Texas state court. When the judge refused to approved the settlement because it was unfair to class members, the class counsel refiled the class lawsuit in a federal district court in Texas. Again, the settlement was not approved. The plaintiffs' class counsel then moved the lawsuit to Union City, Tennessee, where he located a Chancellor who ultimately approved the class action settlement.[27] Obviously, one would not ordinarily expect the largest property-damage class action suit in America to be resolved in a small town forum like Union City, Tennessee.[28]

But the legal machinations in the polybutylene plumbing case did not stop in Tennessee. It turns out another group of plaintiffs' attorneys had filed a similar class action suit in an Alabama state court.[29]

For a time, like dueling banjos, the two teams of plaintiff's attorneys competed for clients, trading accusations of misconduct and running rival newspaper and TV ads. The result was both to confuse eligible homeowners and to create a competition that defendants could exploit. Eventually, a state court judge in California negotiated a truce between the warring factions. . . . [T]he revised settlement . . . did little to improve the benefits for the class. Rather, it mainly assured both groups of plaintiff's attorneys that they would receive court-awarded fees.[30]

No ethical rule prevents the plaintiff class counsel from settling multiforum litigation in locations far removed from the state of incorporation or the principal place of business of the corporate defendants. However, when class counsel deliberately selects a forum to submit his proposed class settlement, based on on the fact that judges in that forum are less sophisticated in corporate and class action litigation, the counsel appears to be violating his ethical duty of diligent representation. The general public may perceive that plaintiffs' class counsel are taking advantage of less sophisticated judges in a way they could not with judges more familiar with class action cases.

C. Filing Cases that are Known to Cost the Class Plaintiffs Much More Than They Receive

While obtaining judicial approval of a dubious class action settlement would fail to redress the harm class members have sustained, other forms of unethical attorney conduct actually harm class members further. One example of harmful attorney conduct is filing suits that will reasonably cost class members more than they could expect to gain. Such suits only exacerbate the losses of injured class members. The Bank of Boston's January 1994 settlement of a class action illustrates this point concisely. The class action suit accused the bank of keeping excess amounts of mortgage customers' funds in non-interest-bearing escrow accounts and involved a nationwide class of some 750,000 current and former mortgage holders.[31] The 300,000 current mortgage holders were charged for the cost of the attorney fee award, which totaled $8.5 million.[32] The terms of the settlement, approved by an Alabama state court, called for the Bank of Boston to reimburse each class member's account up to $8.76 as compensation for lost interest "and then deduct upward of $100 from many of those accounts to pay the [class representative's] attorney fees."[33]

Dexter Kamilewicz was typical of the Bank of Boston customers so affected. The bank credited his account for $2.19 in back interest and deducted $91.33 from his account to pay the attorney fee award.[34] Like other current mortgage holders, Kamilewicz lost far more in the class action lawsuit than he gained. Once again, the attorney fees dwarfed the damages awarded to individual class members. Ironically, aside from the few dollars in back interest, the recovery consisted of a refund of the plaintiffs' own money held in escrow, "which would have been returned sooner or later even without the [class action] suit."[35] As a result in the fall of 1995, Kamilewicz, his wife, and a third bank customer filed a new class action lawsuit in federal district court in Chicago alleging fraud in the terms of the settlement against the Bank of Boston, its attorneys in Alabama and Chicago, and the Alabama law firm representing the class plaintiffs.[36]

In the Bank of Boston case, the plaintiff attorneys should have had an ethical duty to advise their clients that the costs of litigation would exceed any recovery the class members might attain. Furthermore, counsel had an ethical duty to advise class members of these material facts at the outset of the litigation, and give class members an opportunity to opt out at that time. Where counsel accumulates litigation fees per class member that are nearly ten times the recovery for each individual class member, questions about whether the suit should have been filed will naturally arise.

At a bare minimum, the Due Process Clause would seem to require that class members be given the opportunity to opt out of that settlement. The class counsel is better able to bear the risk of nonpayment of attorney fees than individual class members, who have no way of curtailing counsel once it appears he is merely piling up billable hours without having any tangible effect on recovery for class members. Moreover, even from the outset, the Bank of Boston class counsel should have reasonably known their litigation costs would exceed the likely recovery to class members. The Rules of Professional Conduct should have prevented the counsel from proceeding with these class action claims on an hourly fee basis.

D. Structuring Complaints to Maximize the Preclusive Effect of a Settlement on Claims in Another Forum

Yet another form of unethical, or at least unseemly, conduct involves drafting (amended) complaints so as to maximize the preclusive effect of any settlement in that forum on claims in other fora. The pristine example of this phenomenon concerned the amended complaint and proposed settlement filed in the Delaware state court in Epstein. The Epstein plaintiffs tried to persuade the U.S. Supreme Court that the Delaware settlement was nothing more than a carefully crafted ploy to extinguish their suit, by calling forth the following facts from the record.[37] The Delaware class counsel filed the amended complaint just one day after the Epstein class action was filed, and the amended complaint sought to comprise issues covered in the Epstein securities fraud action. For example, the amended complaint contained a bogus, nonexistent state law claim that the board of directors of MCA, Inc., had violated SEC Rule 14d-10.[38] The Ninth Circuit agreed that the Delaware class counsel had manipulated the Delaware amended complaint in an effort to add claims that if settled, would preclude the pending federal class action:

There is, to state the obvious, no cause of action in Delaware for violating the federal securities laws, and there would thus be no issue preclusion if these claims were litigated on the merits in Delaware. . . . The fact that the lawyers for the Delaware plaintiffs inserted such a claim into their amended complaint (not to mention that they did so the day after the Epstein action was filed) does little more than make readily apparent the extent to which the state suit was structured with an eye toward the preclusive effect it might have on the federal claims pending in the Central District of California.[39]

The record shows that Delaware class counsel named Matsushita as a defendant, even though Delaware had no personal jurisdiction over Matsushita, and Matsushita acquiesced to personal jurisdiction to preserve settlement opportunities in that forum.[40] The Delaware class counsel stated he had no evidence to prove the claims in the amended complaint, which immediately raised ethical questions about why he filed the amended pleading. He further downplayed the importance of the exclusively federal claims in the California portion of the class action, which counsel intended to release, as "frivolous, . . . distracting in the main litigation, and . . . a waste of our time and resources."[41] The Supreme Court's decision in Epstein will only exacerbate the general problem of attorneys using suits filed in one forum not as a vehicle for vigorous prosecution of claims, but primarily as a device to preclude litigation in another forum.

E. Potential for Collusion in Temporary Settlement Classes

Another feature of class action practice that can spur unprofessional conduct leading to unfair settlements is the use of the temporary settlement class procedure. In 1994, the Delaware Supreme Court expressed its concerns that this procedure might foster collusion between attorneys for the plaintiff class and the defendants:

The principle criticism of the temporary settlement class procedure is that it facilitates premature, inadequate, and perhaps collusive settlements because plaintiffs' counsel is under strong pressure to conform to the defendants' wishes at the early stages of the litigation. . . . These concerns reflect the unique character of class actions, in which the financial interests of the individual class members are frequently small while those of the class lawyers are great. When competition among different sets of plaintiffs' counsel exists, as it does here, there is the ever present danger that unscrupulous counsel may `sell out' the class in order to receive a fee.[42]

The temporary class procedure exacerbates the ethical tensions a class counsel faces to settle out of court, because the class counsel knows that a court has certified his class and his position as counsel for that class solely for settlement discussions. If the discussions break down, counsel knows that he may face an uphill battle to have the class certified to litigate the claims on the merits. Defense counsel in multiforum litigation, by contrast, know they have the upper hand in the settlement negotiation. If defense counsel informs the court that the settlement discussions have become fruitless, he may succeed in terminating both the representative class and that class's representation by the class counsel. With such unequal bargaining positions, the class counsel is practically guaranteed to strike a less than favorable settlement for class members, particularly when compared to the deal he could negotiate if he had authority to prosecute the claims on the merit. An ethical class counsel would not squander the legitimate claims of class members solely for purposes of strike a deal, any deal, with the defense counsel before his status is terminated.

F. Race to the Courthouse

Modern multiforum litigation also fosters a race to the courthouse mentality among plaintiffs' attorneys viaing for the coveted position of class counsel. In Epstein, attorneys raced to the courthouse to file class action suits against MCA, Inc., one day after The Wall Street Journal broke a story about the potential merger with Matsushita. The speed with which the plaintiffs' attorneys filed their lawsuits, before the corporations had even reached agreement on the terms of the merger, merely reflects the attorneys' keen desire to be the first attorney on record to file suit. The plaintiffs' attorneys seem to believe that being first to file will improve their chances of being named lead counsel for the plaintiff class.

Yet it is rather unseemly that attorneys would file suit against MCA and its officers before the terms of the merger were even negotiated, so that their complaints would have to be repeatedly amended as the terms of the merger were revealed. In particular, the MCA shareholder plaintiff class defined at that time could not have had any federal securities law claims, because these did not arise until after Matsushita had paid MCA's two top officers for their block of shares. No doubt due in part to the haste with which the complaints were written, the Delaware Vice Chancellor ruled that the state law causes of action were extremely weak. In essence, plaintiffs' counsel rushed to file meritless (borderline frivolous) lawsuits just to exploit any nuisance settlement fund that MCA/Matsushita might create.

The Private Securities Litigation Reform Act of 1995[43] curb some of these abuses, at least as far as claims involving the federal securities law. The Act contains a lead plaintiff provision, which presumes that the shareholder who has the greatest economic stake in the litigation, i.e., owns the most shares in the company, should generally be named lead plaintiff in federal securities class action suits.[44] Under the Private Securities Litigation Reform Act, it would not matter which plaintiff counsel filed suit first, and that should remove the incentive for racing to the courthouse to file securities lawsuits.

Under the Act, the lead plaintiff will be reponsible for selecting an attorney to act as class counsel, and this lead plaintiff bears responsibility for supervising the counsel and approving any proposed out-of-court settlements. When a large institutional holder serves as the class representative and instructs the class counsel on terms of a potential settlement, it appears less likely that class members' claims will be sold out in favor of a high fee award to the class counsel.

Congress intended to eliminate figurehead plaintiffs who exercised no meaningful supervision of the litigation ─ or even the decision to file suit ─ by attempting to encourage, but not require, institutional shareholders to supervise this litigation, and to select their own counsel whom these institutions would monitor and supervise.[45]

The Private Securities Litigation Reform Act only applies to federal securities law claims. Thus, the race to the courthouse environment would still exist in cases such as Epstein, that are based on state law breach of fiduciary duty claims. Nothing in the Epstein decision would curtail premature filing of pleadings that often require multiple amendments as the facts of the case unfold. We are left with the unsatisfactory situation that the ethical plaintiffs' attorney who waits for the terms of a transaction to be clarified may be strategically disadvantaged compared to the unethical attorney who hastily files suit in the hopes of being considered first as class counsel.

G. Race to Judgment Scenario

Race to the courthouse situations arise in many contexts in the law, e.g., in the filing of deeds on property, and are not limited to multiforum class action practice. But the latter practice area may be unique for fostering a similar race to judgment behavior among the judges hearing these multiforum cases. Again, we see a pristine example of this novel racing behavior by judges in the Epstein case.

In Epstein, the Delaware state court faced a race to judgment with the U.S. Court of Appeals for the Ninth Circuit. In order to issue a judgment that could be interposed in the Ninth Circuit to preclude further review of the Epstein case, the Delaware Chancery Court had to enter judgment before the Ninth Circuit handed down its opinion. Otherwise, the Ninth Circuit's judgment most likely would have been interposed as a strong objection to block consideration of the undervalued Delaware class settlement. The issue of which court precluded the other all came down to which court handed down its decision first.

It appears unseemly for a federal and state court to compete with each other to see which can render a judgment before the other. We would expect courts to take as long as necessary to analyze a case. In modern multiforum litigation, no court can take its time to render an opinion, unless it is prepared to have its pending decision completely eradicated by the claim preclusive effect of a settlement of the class action in another forum. Again, we are left with an unsatisfactory situation in which unethical attorneys have incentives to block unfavorable judicial decisions through negotiations in other fora. To our knowledge, aside from multiforum litigation, no other practice area permits attorneys to circumvent appellate and trial judgments this way.

H. Defense Counsel Tactics in Light of Little Class Member Response

Another institutional feature of the multiforum litigation environment that gives rise to unfair settlements is the burden placed on class members to respond to notices. The courts have placed the burden on class members to sign and return to the court various documents to preserve their rights. While this procedural posture poses the least amount of work for the courts, it does little to safeguard the rights of inattentive class members. The general public has apathy towards many interests, and the issues at stake in a class action are no different. Most members of a class will not respond to any notice that is sent to them. The courts are aware of this apathetic response. Reasonable minds could differ on whether principles of due process should require the courts to receive an affirmative response from class members before they can be bound by out of court settlements or simply rely on silence as implying consent.

However, reasonable minds cannot disagree that defense counsel have recognized this pattern of very low response rates from class members and used this apathy to their advantage. Defense counsel are taking advantage of the opt out provision plus notice requirement in class actions as a means of getting questionable settlements approved by the courts. People rarely respond to these notices, counsel know that, and they are emboldened by such low response rates to propose even grossly unfair settlement terms. Furthermore, once the statute of limitations has passed on a claim ─ and most litigation drags on for years before a settlement notice is mailed to the plaintiff class ─ members of that class often have no choice but to accept the settlement terms, because it is too late for them to file individual lawsuits.

Finally, the informational costs as well as the actual costs of hiring an attorney often preclude most class members from pursuing their individual claims. Class action litigation represents an area where class member apathy has created an opportunity for clever defense counsel to terminate the claims of class members with dubious settlement terms.

III. Changes Needed in Substantive Law to Prevent Abuses in Settling Multiforum Litigation

The previous section presented examples of opportunistic behavior by attorneys practicing in the area of multiforum class action litigation. Recall that some of the opportunistic behavior, such as forum shopping for a judge who will approve a settlement or forum shopping for the best settlement terms, are not per se violations of ethical conduct. Rather this behavior stems from incentives inherent to the procedures for filing, prosecuting, and settling a class action lawsuit.

This section focuses on the need for changes in the substantive law governing the rules of civil procedure and the law of preclusion. In particular, courts need to view with heightened scrutiny any proposed settlement of a class action lawsuits that releases claims in other fora. The next two changes amount to greater judicial adherence to the existing requirements of procedural due process. Finally, we echo the call of many commentators that the Federal Judicial Panel on Multidistrict Litigation be authorized to consolidate state law and federal law claims in one forum, so as to avoid forum shopping and related problems.

A. Heightened Scrutiny of State Court Proceedings That Can Preclude Exclusively Federal Claims

State courts do not have experience judging the merits of exclusively federal claims. Whenever a state court judgment has the effect of releasing exclusively federal claims in another forum, the state court should employ heightened scrutiny of the terms of the settlement. The court should scrutinize whether viable claims in another forum will be extinguished by the court's entering a judgment approving a settlement. If so, the state court should be loathe to enter the judgment until the fair value of those claims have been determined by the reviewing court. In particular, a state court should not substitute its own valuation of those exclusively federal claims for the value determined by a U. S. Court of Appeals.

In reviewing proposed settlements that will have claim preclusive effect on other fora, a court must look for signs that the litigation in its forum is being used to manipulate the results of and extinguish the litigation in another forum. For example, in Epstein, either Matsushita or MCA should have moved to dismiss the Delaware class action. Afterall, the Delaware class counsel admitted that he lacked evidence to substantiate the claims in the amended complaint, and the Vice Chancellor even characterized these state law claims as weak.[46] Yet rather than moving to dismiss the Delaware complaint, Matsushita appeared to preserve its opportunity to negotiate a settlement in a state forum. Matsushita understood that the Delaware class counsel would collect no fee if the Delaware class action was dismissed. One might even say knowledge of the Delaware class counsel's weakened bargaining position with respect prospects for receiving a fee could be imputed to Matsushita.

What evidence, then, shows when defendants' counsel has sufficient knowledge to merit imputation to it of plaintiff's counsel's inadequacy? [Epstein] supplies a road map of likely warning signals. They include phantom litigation that lay dormant for more than a year, until the federal action threatened to result in a judgment; a clearly illusory settlement that offered the class members only non-pecuniary relief; the structuring of the state settlement to preclude the federal action, even though they involved fundamentally different claims; and the curious fact that the statute of limitations under Rule 10b-5 had run on the state claimants, so that at the time they settled they were powerless to assert the federal securities law claims anywhere.[47]

Matsushita's primary goal in negotiating in Delaware was to obtain a release of the securities law claims in the Epstein California securities class action, not a release of the meritless Delaware state law claims. The Delaware class counsel might have honestly felt that he bargained in good faith to reach a settlement with Matsushita,[48] but he bargained away the federal securities law claims for only about two cents a share.[49] In contrast, the Ninth Circuit calculated that if the Epstein plaintiffs prevailed on just one of their causes of action, the damages to each tendering MCA shareholder would amount to $17.80/share:[50] nearly one thousand times the recovery per share secured by the Delaware counsel. The Epstein case illustrates an example of a state court improperly substituting its own misconceptions about the value of exclusively federal claims for those of a federal appellate court.

This pattern of minimal use of a forum for prosecution and maximum use for blocking litigation in another forum should automatically trigger heightened scrutiny prior to any approval of a proposed class settlement. In particular, to receive full faith and credit in another forum, the approving court should justify why the class settlement that seeks to preclude claims in another forum was not proposed and approved in that forum where the issues could have been adjudicated on their merits. In the Epstein case, Matsushita had no reason to justify to a Delaware court why it settled the case in Delaware, rather than in California where the class plaintiffs had a much stronger case.

The current state and federal Rules of Civil Procedure leave open the possibility that attorneys will destroy meritorious claims in another forum.

[Epstein] is not, however, the typical case that will arise in the future. While the state class action there preceded the federal action, the more common pattern will be for the weaker action - state or federal - to follow well after the stronger, original action. Often, the weaker action will be filed as a settlement class action, with the settlement being struck just as the trial date for the original action is approaching. In these cases, collusion will be more difficult to prove because there seldom will be a period of feigned litigation to reveal the non-adversarial relationship between the parties.[51]

Judge Friendly reasoned that a court's jurisdiction to extinguish claims by class settlement should not exceed its jurisdiction to extinguish claims by adjudication. Although Epstein has given state courts permission to settle exclusively federal claims, they would be wise to exercise judicial restraint and only rarely approve settlements containing issues beyond their subject matter jurisdiction. By exercising caution and self-restraint, state courts can limit forum shopping opportunities for class action defendants and thereby aid the negotiation of fair settlements.

B. Burden of Proof on Adequacy of Representation

One of the most troubling aspects of the Epstein case history is that members of the plaintiff class did not merely remain silent and thereby acquiesce to the paultry settlement negotiated by the Delaware class counsel. Instead, objectors actually appeared in person before the Delaware state court. The objectors characterized the Delaware class action settlement as "a cut deal" and the product of collusion between Matsushita and the Delaware class counsel to extinguish valid claims pending in California.[52] The Delaware Chancery Court even went so far as to say that "suspicions abound" when "the settling parties have previously proposed a patently inadequate settlement in which the class would receive no monetary benefit but the attorneys would have received $1 million in fees."[53] The Delaware Chancery Court nevertheless concluded that "[s]uspicion . . . is not enough and the Objectors have offered no evidence of any collusion."[54] In short, the Delaware state court completely misapplied the law on which party bore the burden of demonstrating adequacy of representation.

Contrary to the Delaware Chancery Court's holding, the objectors had no legal duty to provide evidence of collusion. The objectors argued that the Delaware class counsel was inadequate and that the Delaware class representative had never proved the adequacy of its proposed class counsel. The Delaware Chancery court improperly shifted the burden of proof onto the objectors to show that the class counsel was inadequate. In fact, Fed. R. Civ. Pro. 23 requires the class plaintiff to prove the adequacy of its selected counsel. As a general matter, a proposal to settle a class action with practically no relief for class members but a disproportionately high attorney fee would seem to be prima facie evidence of collusion.

Therefore, one urgent need for change in the substantive law is for judges to adhere to the requirements of Fed. R. Civ. Pro. 23, and the overwhelming majority of state class action civil procedure rules patterned after it. Judges must place the burden of proving adequacy of representation on the plaintiff class representative and his counsel, not on objectors or dissenting class members.

C. Court's Duty to Ensure Adequacy of Representation

Even when the plaintiff class representative meets its initial burden of proving the adequacy of counsel, the court has an ongoing constitutional duty to monitor the counsel's behavior. For class action litigation, the Due Process Clause requires "that the named plaintiff at all times adequately represent the interests of the absent class members."[55] In particular, notice to class members and the ability to opt out cannot substitute for inadequate class representation.[56]

Notice is no substitute for extensive document examination, depositions of adverse witnesses, securing expert advice on complicated issues, and aggressive negotiation at arms-length. The same holds true for opt-out rights, which are infrequently utilized and usually economically impracticable. Due process requires notice, the opportunity to be heard and to participate in the litigation, the right to opt-out, and adequate representation before an absent class member can be bound by a settlement in a class action predominantly for money damages.[57]

Nor can heightened judicial scrutiny of the merits of a proposed settlement substitute for inadequate class representation.[58] A court will evaluate the merits of a proposed settlement based on the record in a case. The record comprises pleadings and other papers filed by the class counsel, and an inadequate representative would generate a poor or suspect record. This suspect nature follows because "an adequate representative, vigorously prosecuting an action without conflict and bargaining at arms-length, may present different facts and a different settlement proposal to the court than would an inadequate representative."[59] If the record before the court is suspect, then the court would have an improper foundation on which to judge the fairness of any settlement offer. In fact, the entire settlement process may be compromised.[60]

Class action settlements pose the danger "that representative plaintiffs and their lawyers will `endeavor to obtain a better settlement by sacrificing the claims of others at no cost to themselves.'"[61] To guard against settlements with large payments for attorney fees and little or no recovery for the class, courts must ensure that the class representative adequately protects the interests of absent class members and must review the fairness of any proposed settlement.[62] The court protects these interests by playing a far more active role in class action litigation than it would in traditional lawsuits. In essence, a class action suit resembles an individual lawsuit less than it does "a quasi-administrative proceeding, conducted by the judge."[63]

A court will exercise its duty to ensure the adequacy of class representation when it denies a class counsel with weak underlying claims to use the forum as a means of precluding or extinguishing stronger claims in another forum. At a bare minimum, the court should require counsel to explain why that forum was selected for settlement.[64] In particular,

when the state courts cannot hear the federal claims, and when these claims both have value and will be precluded by the state court settlement, this is the suspicious context in which courts must examine the adequacy of the plaintiffs' representation with greater skepticism. The rationale for this closer scrutiny should be that adequate representation requires a representative who can assert - and indeed, has asserted - the strongest claims available to the class members; a representative who must litigate with one arm tied behind his or her back is by definition not an adequate representative.[65]

D. Authorize the Federal Judicial Panel on Multidistrict Litigation to Consolidate Competing State or State-Federal Class Actions as well

In addition to changes in heightened scrutiny of any proposed multiforum settlement and safeguarding the constitutional protections of procedural due process, the substantive law should be amended to permit greater authority for the federal Judicial Panel on Multidistrict Litigation to consolidate combined state and federal cases. At present, the panel can consolidate similar actions filed in separate federal district courts. If multiple class actions covering the same or similar claims are filed in federal courts, the Judicial Panel on Multidistrict Litigation would consolidate the actions in one forum. This consolidation prevents the defendants from pursuing a divide-and-conquer strategy with competing class counsel in different fora.

The panel's authority to consolidate cases should extend to multiforum state class actions as well as those combining state and federal forums.[66] Otherwise plaintiffs' attorneys will be reluctant to prosecute any class action claim in federal court, or at least pursue it to trial, "if it is possible for the defendants, at the 11th hour, to reach a low-cost settlement in a state court."[67]

IV. Changes in the Rules of Professional Responsibility to Address the Ethical Environment of Multiforum Litigation

Section III described changes in the substantive law required to prevent some opportunistic behavior attributed to multiforum class action practice. However, changing the substantive law will not address problems associated with the class counsel selling out the interests of class members during settlement negotiations in order to garner a larger fee award. To address this latter problem, the state and federal judiciaries should adopt a new Rule of Professional Responsibility specifically tailored to the ethical environment of multiforum class action practice. An example of the proposed new rule [hereinafter Athe Rule@] can be found in the Appendix. This section will highlight the important features of the new rule.

Like Model Rule 1.1, the Rule commences at the time a lawyer undertakes to represent an individual or group of individuals with a matter that the lawyer reasonably believes could lead to class action representation. Section (B) of the Rule imposes a number of limitations on a lawyer=s ability to represent a class. These limitations generally relate to the lawyer=s competency, conflicts of interests, and merits of the class action.

A. Competency

To satisfy the requirements of B(3), the lawyer must have the legal knowledge, skill, thoroughness, and preparation reasonably necessary to prosecute or defend against the underlying claims in the class action. Section B(3) is intended to capture the competency standard of Model Rule 1.1. The lawyer is not required to have prosecuted a class action lawsuit previously. A knowledgeable lawyer in the law and issues surrounding the underlying claims is clearly more desirable than a "class action specialist" attorney, who lacks any substantive specialty that might assist class members in their cause of action.

Unlike any provision of the Model Rules, which apply more appropriately to nonclass litigation, the Rule also contains a provision [Section (B)(2)] requiring the lawyer to assess the class representative=s competency to manage the lawyer and other aspects of the litigation. Ordinarily, an attorney is not required to assess the qualifications and independence of a potential client. But class actions, which have the ability to affect the rights of others beyond the lawyer=s immediate client, require an active participatory role for the class representative. In essence, a lawyer undertaking class representation must not only be competent but also have a competent client who can serve as class representative.

B. Potential or Actual Conflicts of Interest Limiting Representation

Under Subpart (B)(8), class members must be informed of a lawyer's significant stake in the class action litigation, but class members need not approve of the selection of the lawyer to serve as class counsel. In general, class members are never polled, and class members do not vote on procedural matters affecting the class. A lawyer's significant stake in a class action would include the interests of the lawyer's spouse and family. The standards that would trigger application of this rule include shareholder class actions in which the lawyer or his family own at least five percent of the outstanding shares of a corporation that is a party to the class action lawsuit.

Section B(8) includes, but is not limited to, situations where the lawyer serves on the board of a corporate class representative, the lawyer owns a significant amount of stock in a corporate class representative, or the lawyer or his firm has served as long-standing counsel to a corporate class representative. Section B(8) also includes situations in which the lawyer, along with other members of the class, are shareholders of a defendant corporation. notice required by Fed. R. Civ. P. 23(c)(2), or a similar state rule.

A class counsel cannot simultaneously serve as the class representative [Section (B)(1)]. The class representative must supervise and guide the activities of the class counsel. If a class counsel also served as class representative, he would be in the position of supervising himself. However, the class counsel may be a member of the class, because a separate class representative could then supervise the class counsel and make substantive decisions concerning the lawsuit. If the lawyer has other duties and responsibilities to one or more class members -- aside from his common representation to all class members -- and these duties and responsibilities would not adversely affect his representation of the class, then the lawyer's dual role or dual representation is generally consentable. In this case, the

class representative is capable of giving consent to the lawyer=s dual representation. This portion of the Rule [(B)(10)] is patterned after the consent provisions of Model Rule 1.7.

If the lawyer has a special relationship with the class representative, then the class representative cannot consent on behalf of the rest of the class to the dual representation; the class representative could have a bias in favor of retaining his own attorney to serve as class counsel. Accordingly, in this instance, consent for the dual representation on behalf of the class must come from the court, not the class representative. The lawyer must also notify the class members of his dual representation. Due process requires that the class members participate in the class based on a knowing and informed decision, which includes accepting the class representative=s lawyer as the class counsel. By including the notice of dual representation with the notice required by Fed. R. Civ. P 23(c)(2), this Rule should impose a minimal cost or burden of compliance on the lawyer.

When the lawyer has a relationship with or represents individually one or more class members, other than the class representative, Section (B)(10) permits the class representative to consent to the dual representation on behalf of the class. Section (B)(10) assumes that the class representative has the knowledge of the subject matter, legal system, and relationship of counsel to the class member(s) to determine fairly if the lawyer can exercise impartially his duties as class counsel. The class representative must be strong and qualified to give consent for this dual representation. A class representative who exercises no independent judgement from the proposed class counsel cannot give the requisite neutral, disinterested consent for the dual representation. If the class representative does not approve the dual representation, then the lawyer may not serve as class counsel. In that sense, the class representative has veto power over the dual representation under Section B(9). Although the class representative can give his personal consent for the lawyer's dual representation under Section B(9)(b), the lawyer still has an ethical duty to notify class members of the dual representation.

Two other provisions of the Rule could prevent an attorney from undertaking to represent a class. Section (B)(6) prohibits the lawyer from undertaking the class representation if his service would conflict with Fed. R. Civ. P. 23, and Section (B)(5) imposes a limitation if the lawyer does not reasonably believe he can fairly and impartially protect the interest of class members.

C. Merits of the Proposed Class Action Litigation

A lawyer may not ethically participate in class action litigation if the claims are frivolous [Section (B)(7)] or even borderline frivolous [(B)(4)]. Indeed, Section (B)(4) imposes a requirement that the lawyer who seeks to undertake class action representation must first assess whether the relief sought - both pecuniary and equitable - is enough to justify the filing of the class action lawsuit. If this Rule had been adopted in Delaware and Alabama, then no attorney could have ethically filed the Bank of Boston case or the Delaware class action portion of Epstein. The former case would have failed to meet the expected value of relief calculation; from the outset, reasonable attorneys would have calculated that the prorata cost of prosecuting the case would exceed any relief individual class members might receive. The ethical standards would have prevented the Delaware class action lawsuit in Epstein, because the class counsel admitted that his own claims were weak, and he had no evidence to prove the allegations.

A lawyer cannot ethically proceed with a class action that the lawyer reasonably believes might result in any likelihood that the lawyer's fees in the action, as measured prorata by the number of class members, will exceed the recovery to each class member. In that instance, the lawyer must bear the costs of his own time invested in the class action, rather than shift that risk of payment and potential net negative benefit onto absent class members. Section (B)(4) anticipates that no rational and competent class representative would authorize a lawyer to file an action on behalf of class members in which those members might incur a financial liability greater than their financial gain from the class action. Such lawsuits should never arise in an environment in which a lawyer adheres to the ethical standards required by this rule. Section (B)(4) is specifically aimed at lawyers who previously filed patently unmeritorious class action lawsuits, in which prospective class members had little or no realistic recovery expectation, solely for purposes of obtaining a nuisance payment from the defendants to settle the litigation.

Class actions are intended to serve the interests of injured class members. Where the harm to class members is so slight that they would likely receive no recovery or equitable relief, then any minimal harm they may have sustained is part of the ordinary wear and tear of life and should foster no class action litigation. Under no circumstances should the lawyer's prospects for garnering a fee as class counsel be considered in evaluating the merits of filing the prospective class action lawsuit.

Section (B)(4) uses the phrase "relief sought" and "benefit" to recognize that some class actions are brought for declaratory or injunctive relief, rather than for monetary recovery. In such instances, the value and benefit to class members could be significant, even though their monetary damages are minimal. However, a class action that offers members no equitable relief and little or no monetary relief should not be filed. Such a case might arise where class members have suffered a trivial injury, which should be considered part of the ordinary wear and tear of life, not a cause of action for a class action lawsuit. As a general rule, if class members only obtain monetary benefit, then a class action that offers members a maximum recovery of $5/person or less, should not be brought.

Section (B)(8) pertains to even further egregious cases where the class members have not sustained a cognizable legal injury, and any complaint allegeding such injury would be frivolous. In essence, Section (B)(8) states that the Rule 3.1 ethical prohibition against frivolous court documents applies in the class action setting as well.

Attorney = s Conduct While Serving as Class Counsel

During the course of the class action, the class counsel must comply with the notice requirements of Fed. R. Civ. P. 23(c)(2) or a similar state rule. [Section (C)(1)]. If the class representative asks the lawyer to take some action that either violates the law or harms the interests of the class, then the lawyer should ask the class representative to reconsider the matter. If the class representative persists with his instructions, then the lawyer may ask the court for permission to withdraw as class counsel. Furthermore, the lawyer may make a Anoisy withdrawal,@ as defined in Model Rule 1.16.

Section (C)(2) follows the process of Model Rule 1.13, in which an officer of an organization asks the attorney representing the organization to act unlawfully or in a manner inconsistent with the best interests of the organization. In the case of class representation, the class counsel will receive instructions exclusively from the class representative; the class counsel has no higher authority to whom he can appeal adverse instructions. The class counsel=s only recourse is to request permission to withdraw from the court.

Under Model Rule 1.13, a lawyer representing an organizational client must explain to any constituent of the organization, at any time when the constituent=s interests are adverse to those of the organization, that the lawyer represents the organizational client and not the constituent. Section (C)(3) establishes a corresponding duty for the class counsel with respect to any interest of the class representative that may be adverse to those of the class as a whole.

Section (C)(4) prohibits the lawyer from discussing his fee with anyone except the class representative and the court. This section is a key to the entire new proposed ethical rule, because the crux of the problem with multiforum class action representation has been lawyers bargaining away the claims of class members in exchange for an attorney fee award as part of any proposed settlement. In the context of ordinary, single-party litigation, the suggestion that plaintiff=s counsel would discuss with the defendants a Adeal@ that includes his payment for services seems unethical and collusive. Yet this practice has prevailed in class action litigation for years.

This section of the proposed new rule is intended to eliminate the potential for class counsel to enter into award fee negotiations with the defendants, or their counsel, that might influence his recommendation to settle the class action. Similar provisions in Section (C)(9) and (C)(10) prevent the class counsel from submitting to the court a proposed settlement, which offers class members little or no relief, but which includes a significant or disproportionately high payment of attorney fees.

Section (C)(5) imposes an ethical duty for the class counsel to act impartially in actions concerning the class members. Sections (C)(6) and (C)(7) discuss the lawyer=s duty to keep information confidential and is patterned after Model Rule 1.6. Section (C)(8) requires the lawyer to consult with the class representative on decisions that affect the litigation and advise him on the

Michael A. S. Guth, Ph.D., J.D., is a constitutional law attorney, legal brief writer, and health care researcher based in Oak Ridge, TN. A web page describing his law practice and other legal writings is available at http://riskmgmt.biz His current research comprises inefficiencies in health care insurance, pharmaceutical pricing, and best available treatments for Alzheimers disease, osteoporosis, and high cholesterol. He has developed and/or taught more than twenty on-line courses at more than a dozen educational institutions in the areas of economics, finance, business strategy, business law, health care administration, politics, and criminal justice. Interested students are encouraged to view his web page at http://riskmgmt.biz/economist.htm and click on some of the papers and articles he has written.

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