Pearson v. NBTY, Inc.
772 F.3d 778, 2014 WL 6466128, 2014 U.S. App. LEXIS 21874 (2014)
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Rule of Law:
A class action settlement cannot be approved if it does not provide adequate actual benefit to the class members, awards excessive attorney fees (disproportionate to the actual class recovery), includes a 'kicker' clause that redirects unclaimed attorney fees to the defendant, or establishes a 'cy pres' award where direct distribution to class members is feasible.
Facts:
- NBTY and its subsidiary, Rexall Sundown, manufactured and marketed glucosamine pills.
- Rexall advertised these pills with claims such as 'help rebuild cartilage,' 'support renewal of cartilage,' and 'lubricate joints' to address joint disorders like osteoarthritis.
- Consumers purchased these glucosamine products, forming a large group numbering around 12 million people.
- Following the filing of several class action lawsuits, class counsel negotiated a nationwide settlement with Rexall.
- The proposed settlement included provisions for attorney fees (up to $4.5 million, with a 'clear-sailing' agreement), notice and administration costs ($1.5 million), and a 'kicker' clause stating that any reduction in attorney fees would revert to Rexall.
- The settlement also proposed a $1.13 million 'cy pres' award to the Orthopedic Research and Education Foundation and an injunction requiring Rexall to make minor label changes for 30 months.
- The claims process established by the settlement required specific documentation (like receipts) and included warnings about perjury and fraud for minimal payouts (e.g., $3 per bottle).
- Out of approximately 4.72 million class members who received postcard notice, only 30,245 filed claims, resulting in a total payout of $865,284 to the class.
Procedural Posture:
- Several class action lawsuits were filed in federal district courts across the country against NBTY, Rexall, and Target, alleging violations of state consumer protection laws for false claims regarding glucosamine pills.
- Eight months after the first suit was filed in a federal district court in Illinois, class counsel from all six cases negotiated a nationwide settlement with NBTY and Rexall and submitted it to that Illinois district court for approval.
- The district court granted preliminary approval and later approved the settlement, though with significant modifications, including reducing class counsel's requested attorney fees from $4.5 million to $1.93 million.
- Several class members, led by Theodore H. Frank of the Center for Class Action Fairness, objected to the approval of the settlement pursuant to Fed.R.Civ.P. 23(e)(5).
- Class counsel cross-appealed, arguing the district court should not have modified the settlement.
- Six appeals related to the settlement approval were consolidated for decision by the United States Court of Appeals for the Seventh Circuit.
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Issue:
Did the district court abuse its discretion by approving a class action settlement that provided negligible actual benefit to class members, awarded disproportionately high attorney fees, included a reversion clause for unawarded fees, contained an ineffective injunction, and utilized a 'cy pres' award when direct distribution was feasible?
Opinions:
Majority - Posner, Circuit Judge
Yes, the district court abused its discretion in approving the class action settlement, as it was primarily a self-serving deal between class counsel and the defendant that failed to adequately benefit the class. The court determined that the district judge erred in valuing the settlement based on potential rather than actual benefits to the class, which led to an inaccurate assessment of attorney fees. The actual aggregate value of the settlement (class recovery plus attorney fees) showed class counsel received an 'outlandish 69 percent' of the total, a clear sign of excessive compensation, reinforcing the principle from Redman v. RadioShack Corp. The claims process was deemed unnecessarily burdensome and designed to discourage class members from filing claims, thereby minimizing Rexall's payout to the class while increasing its willingness to pay class counsel. The court found the $1.13 million 'cy pres' award to a charitable foundation invalid because it was feasible to distribute the funds directly to class members, making a cy pres award inappropriate. Furthermore, the 30-month injunction was critiqued as 'superfluous' and 'cosmetic,' offering no substantive change to Rexall's claims and effectively providing judicial imprimatur to potentially misleading advertising. Finally, the court heavily criticized the 'kicker' or reversion clause, which stipulated that any reduction in attorney fees would revert to the defendant, not the class, calling it a 'gimmick for defeating objectors' and establishing a strong presumption of its invalidity. The opinion emphasized the heightened fiduciary duty of district judges in reviewing class action settlements due to the inherent conflict of interest between class counsel (seeking fees) and class members (seeking recovery), citing Eubank v. Pella Corp. and Creative Montessori Learning Centers v. Ashford Gear LLC.
Analysis:
This case significantly reinforces the Seventh Circuit's stringent scrutiny of class action settlements, particularly those that appear to prioritize attorney fees and defendant interests over actual class recovery. It establishes clear guidelines for evaluating the fairness of settlements, emphasizing the proper calculation of attorney fee ratios against actual benefits, strict conditions for approving 'cy pres' awards, and a strong presumption against 'kicker' clauses. Future courts will likely apply more rigorous scrutiny to settlements featuring high attorney fees coupled with low class participation rates, burdensome claims processes, or reversion clauses, ensuring that judicial review is not merely pro forma but robustly protective of absent class members.
