One of the larger points of contention in class-action settlements is the size of the attorneys’ fees. Indeed, with a few exceptions, no one defends the size of attorneys fees, and the most heated criticisms decry the size of the fees compared to the recovery the class actually receives. Which is what makes a recent case from the Ninth Circuit, In re Mercury Interactive Corp. Securities Litigation, so surprising: it turns out that Rule 23 already has one simple, often-ignored measure for limiting the amount of fees class counsel can charge.

The Mercury case arose after public disclosures that Mercury’s then-CEO, CFO, and General Counsel had participated in a scheme to backdate stock options. (Backdating, for those who remember the bull market, is a practice of revising the date that individuals were granted stock options to allow for the largest possible profit on the stock. In other words, someone who was backdating options would revise the grant date to reflect the lowest possible stock price. When the grantee exercised the option, he’d pay a lower price for valuable stock.)

Like with many (but not all) securities class actions, this one settled quickly. As part of the settlement approval process, the district court held a fairness hearing, and provided a deadline for objections. However, the court set the deadline for objections before the plaintiffs’ counsel’s fee application deadline. That, as one might guess, presented a problem for the objectors: without seeing the details of plaintiffs’ fee proposal, it was extremely difficult for them to evaluate whether it was properly justified.

One of the objectors, the New York State Teachers’ Retirement System, nonetheless tried to challenge plaintiffs’ fees, submitting a generalized objection to the anticipated 25% contingency fee. The district court approved the fee anyway, stating in part that:

[The objectors] do not object to any line item of work that was done, but rather they simply believe that the amount of the contingency fee should be 18 percent rather than 25 percent.

Teachers appealed, arguing that, in approving plaintiffs’ fees, the district court had violated Rule 23(h). Rule 23(h), which governs awards of fees and taxable costs, provides that:

In a certified class action, the court may award reasonable attorney’s fees and nontaxable costs that are authorized by law or by the parties’ agreement. The following procedures apply:

(1) A claim for an award must be made by motion under Rule 54(d)(2), subject to the provisions of this subdivision (h), at a time the court sets. Notice of the motion must be served on all parties and, for motions by class counsel, directed to class members in a reasonable manner.
(2) A class member, or a party from whom payment is sought, may object to the motion.
(3) The court may hold a hearing and must find the facts and state its legal conclusions under Rule 52(a).
(4) The court may refer issues related to the amount of the award to a special master or a magistrate judge, as provided in Rule 54(d)(2)(D).

The Ninth Circuit reversed, holding that the district court had abused its discretion by violating Rule 23(h). In fact, it went even further, stating that

the practice borders on a denial of due process because it deprives objecting class members of a full and fair opportunity to contest class counsel’s fee motion.

Why would this rise to the level of a due process violation?  As the Ninth Circuit pointed out

During the fee-setting stage of common fund class action suits such as this one, plaintiffs’ counsel, otherwise a fiduciary for the class, becomes a claimant against the fund created for the benefit of the class. This shift puts plaintiffs’ counsel’s understandable interest in getting paid the most for its work representing the class at odds with the class’ interest in securing the largest possible recovery for its members.

(Internal quotations omitted.) As a result, by requiring plaintiffs to submit a fee request before objections are due, Rule 23(h) provides an important check on plaintiffs’ counsel at exactly the moment their interests diverge from those of the class.

Allowing class members an opportunity thoroughly to examine counsel’s fee motion, inquire into the bases for various charges and ensure that they are adequately documented and supported is essential for the protection of the rights of class members. It also ensures that the district court, acting as a fiduciary for the class, is presented with adequate, and adequately-tested, information to evaluate the reasonableness of a proposed fee.

This may seem like an obvious point, one that hardly requires an entire blog post. But a number of trained lawyers have missed it over the years, and not just the lawyers and courts that have made submitting objections before fee requests "a common practice." When Professor Brian Fitzpatrick defended "quick-pay" provisions–and when I critiqued that defense–neither of us took into account the obvious problem; quick-pay provisions (which pay plaintiffs’ counsel before the settlement has been approved) clearly violate the procedure dictated by Rule 23(h).

So what’s the takeaway for this case? Always read the rules. Rule 23 exists to enable class actions, but also to ensure that, at all times, absent class members are adequately protected. And those protections often exist to rein in the excesses of plaintiffs’ counsel.

EDITED AT 11:30 AM TO ADD:

Ted Frank, of the Center for Class Action Fairness, has commented to point out that the majority of quick-pay provisions allow payment after approval, but before appeals have been exhausted, which means that they would not facially violate Rule 23(h).  And I should note that Professor Fitzpatrick accurately described the timing of payment in his article.  The takeaway from this?  Bloggers should reread old posts if they’re going to revisit them later; especially if it turns out they were right the first time.