While it remains popular among settling lawyers and courts, the doctrine of cy pres in class actions (where defendants wind up paying charities with an ostensible link to the gravamen of a lawsuit) has been garnering criticism for some time. A few federal district courts (including the Southern District of New York and the District of New Hampshire) have questioned the application of cy pres in specific cases. Last year, Professor Martin Redish published an article questioning whether cy pres relief violates the Rules Enabling Act. After that, John Beisner and Jessica Miller of Skadden Arps published a working paper through the Chamber of Commerce expanding on the critique. And the press has begun to pay attention as well.

Now, a federal appellate court (the Court of Appeals for the Fifth Circuit) has weighed in as well, in Klier v. Elf Atochem, Inc.  Alison Frankel provided excellent immediate coverage of the opinion here, but Judge Higginbotham’s opinion (coupled with Judge Jones’s concurrence) does far more than just call the doctrine of cy pres into question.

Before we get into what else it did, a quick recap of the background. The defendant, Elf Atochem (now Arkema, Inc.), had previously settled a class action in Texas state court that had accused one of its agrochemical plants of contaminating the local environment with arsenic and other toxic chemicals. The class action ultimately settled for $41.4 million, which was supposed to be distributed among three subclasses:

• Subclass A included class members who had suffered actual physical injuries (primarily cancer, stillborn pregnancies, or other birth defects).
• Subclass B included class members who had been exposed to chemicals, and wanted medical monitoring.
• Subclass C included class members who had suffered damage to their property.

The settlement agreement did not include a provision for a cy pres distribution, or for reversion of unspent funds to the defendant. It was approved, and the settlement funds were paid out to the various subclasses according to the agreements’ terms. (As one might expect, this meant that Subclass A members did not receive what they considered full compensation for their injuries.) After the funds were paid out, the claims administrator reported that $830,000 remained unspent from Category B. As the Fifth Circuit described what happened next:

Taking an inexplicably narrow view of their duty to the class, class counsel did not respond.

Arkema, however, did, suggesting the remainder could be donated to a scholarship fund and two local museums. One of the Subclass A members (Ralph Klier) objected, arguing that the funds would be better spent on the injured who had only been partially compensated. The court disagreed, and designated the charities, as well as a local genealogy and history library.

Klier appealed, and the Fifth Circuit agreed with his arguments. As Judge Higginbotham’s opinion put it:

Because the settlement funds are the property of the class, a cy pres distribution to a third party of unclaimed settlement funds is permissible "only when it is not feasible to make further distributions to class members." Where it is still logistically feasible and economically viable to make additional pro rata distributions to class members, the district court should do so, except where an additional distribution would provide a windfall to class members with liquidated-damages claims that were 100 percent satisfied by the initial distribution.

(Internal footnotes omitted.)  The opinion would be notable for this discussion of cy pres alone. But, as it turns out, it went far further. What else did it do?

It provided a gimlet-eyed statement of the benefits defendants get out of class actions. Judge Higginbotham began his opinion with a description of the settlement from the defendant’s point of view.

The defendant paid substantial sums for res judicata protection from the claims of persons assertedly injured by the toxic emissions of an industrial plant near Bryan, Texas.

Defendants may settle cases for other reasons: it may be cheaper to settle than to continue to litigate, for example. Or the specter of classwide liability may provide the proverbial "hydraulic pressure" to settle. But the primary benefit the defendant receives is, in fact, preclusion of any further claims.

It renders a stark critique of medical monitoring. One question lurks behind the issue that prompted the appeal: why were there extra funds in the medical monitoring subclass? The opinion does not shy from the answer:

First, the initial participation rate was low. Some 329 members of Subclass B—less than three percent of the total subclass membership—opted to receive medical monitoring in lieu of a cash payment; just 221 attended their first monitoring examination.

In fact, the opinion’s description of medical monitoring is even more damning, noting that most of those 221 members eventually dropped out of the program as well. Plaintiffs often proffer medical monitoring as a means of helping class members, but few scholars or pundits have followed up on whether medical monitoring programs actually work. Assuming this was a typical medical monitoring program (and we have no reason to assume it wasn’t), it would appear that the benefits of medical monitoring programs are overhyped.

It makes a strong case for reverter settlements. Judge Jones wrote separately, primarily to suggest that if the settlement agreement had not waived the defendant’s right to a refund of unspent funds, then it could have simply collected them. According to Judge Jones, reverter settlements are superior to cy pres settlements because they are not subject to the same abuse as cy pres. (And she spends some time, relying in no small part on Professor Redish, detailing that abuse.) As Judge Jones points out, a reverter settlement does a better of job of actually determining the value of the benefits to the class. If funds revert to the defendant, that’s an indication that the class was not harmed as much as the parties thought at first. (Judge Jones describes this in contract terms, as a "mutual mistake.")

These critiques are not likely to be popular. Many defendants have a vested interest in cy pres awards, because they allow them to settle cases quickly with a minimum of fuss. But in the long term, making sure settlements reflect the actual benefits to class members serves defendants’ interests. If it turns out that the techniques lawyers use to inflate settlement value–such as cy pres and medical monitoring–do not pass muster with courts, then perhaps plaintiffs’ lawyers will file fewer cases that require these kinds of inflation.

(Hat tip to Alison Frankel of Reuters, who first reported on this case when it came out.)