Cy Pres and Class Action Settlements: Giving Away Other People’s Money

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This article was originally written for the Columbus Bar Lawyers Quarterly, supplement of The Daily Reporter, summer issue 2012.

It was recently reported that a charitable foundation received a generous gift out of the blue — from lawyers. A performing arts center in Ohio received $50,000 from a local law firm, which came from “cy pres money.”

Each publication running the story reported that “Cy pres is an ancient legal doctrine that allows law firms to distribute the unclaimed money from class action legal settlements to charities or nonprofit organizations.”

Really? There is nothing “ancient” about law firms or class action lawsuits. Nor are law firms permitted to “distribute unclaimed money” to charities or to anyone else. Nor, indeed, did the doctrine of cy pres evolve as a way to distribute unclaimed funds from class settlements. So where would a reporter get the idea that an “ancient doctrine” was responsible for a charity’s receipt of money that was actually intended to benefit plaintiffs in a class action suit?

From the courts, that's where.

Since the promulgation of Federal Rule 23 in 1966, courts have struggled with the persistent problem of unclaimed funds in class action settlements. Individual awards are often small, class members can be hard to find, and the claims processes are often cumbersome. The nagging truth is that as far as most class members are concerned, class awards are simply too small to matter. And if class members themselves don’t care enough to collect their money, then what purpose do class actions really serve? Unclaimed funds thus raise deeper questions about the proliferation — and the efficacy — of class action lawsuits.

With increasing frequency, courts solve the unclaimed funds problem by applying a judicial variation of the doctrine of cy pres, which permits them to give the unclaimed portions of class settlements to charities and other causes they deem to be worthy. Yet the application of cy pres — which is borrowed from the law of trusts — is hardly the answer to managing unclaimed funds. Indeed, giving class members’ money away to third parties is contrary to the most basic concepts of Article III standing and the separation of powers. While giving someone else’s money away may feel good, it undermines crucial constitutional principles. Courts need to take a more thoughtful approach this recent and rapidly growing trend.

What Is Cy Pres?

The term “cy pres” is familiar to every trust lawyer. It is from the French phrase “cy pres comme possible,” which means “as near as possible.”

Rooted in Roman and English history,1 the concept evolved as a solution to the thorny problem of what to do with a trust when its original purpose could not be achieved. Cy pres is thus a saving device applicable to charitable trusts that permits a court to direct application of the trust property to a different charitable purpose that most closely resembles the original.2

What Does Cy Pres Have to Do With Class Actions?

If cy pres is a doctrine that saves charitable trusts, then what does it have to do with unclaimed funds in class action lawsuits?

The concept appears to have it origins in student law review articles. In the first, the author proposed that where distribution problems arise in class funds, “courts may seek to apply their own version of cy pres by effectuating as closely as possible the intent of the legislature in providing the legal remedies on which the main cause of action was based.” 3

The author suggested that “when close approximation of the actual class is unavailable, ‘there is sufficient flexibility in the cy pres doctrine to permit the state to allocate the funds to other programs designed to maximize the public benefit.’”4

Later articles expanded on the concept, and advocated that unclaimed class funds should be donated to charitable purposes, even if only loosely or remotely connected to the claim in the original lawsuit or the injuries incurred by the class members.5

Courts caught on and began to apply the doctrine in connection with class funds as early as 1974. According to one analysis, cy pres awards were approved by federal courts alone approximately eight times per year since 2001, up from only once per year from 1974 through 2000.6 One website claims that it has distributed approximately $25 million in “cy pres” funds to charities and others.

Proponents argue that many class members will not be located due to passage of time, changed circumstances and the like, and that up to 80% of a fund may go unclaimed. Permitting corporate and other wrongdoers to keep these funds would undermine the deterrent value of Rule 23 and would provide an unjust “windfall” to defendants. To avoid these problems, they argue that justice is best served by giving the money to worthy causes — none of whom are parties to the case.

Courts justify cy pres awards, arguing that class members have an ownership interest in the unclaimed funds. Thus, a redistribution of the unclaimed funds is permissible as long as it accomplishes the “’next best compensation use, e.g., for the aggregate, indirect prospective benefit of the class.’”.7

What’s the Harm?

These arguments are appealing, to be sure. But are they right? More important, are they consistent with constitutional principles that are at the core of our constitutional democracy? Even the most laudable ends must satisfy constitutional means if we are to maintain public trust in the third branch of our government.

Many leading scholars offer persuasive arguments that cy pres has no place in class action practice, and at least one judge has called for a re-examination of the practice. Here are some of the issues they are raising:

Article III: The Case or Controversy Requirement

Perhaps the most fundamental restraint on the exercise of judicial power is the case-or-controversy requirement found in Article III of the United States Constitution.

Basic notions of justiciability and standing require that courts may only hear and decide actual disputes between live litigants, i.e., that a party has suffered a concrete injury traceable to a defendant’s unlawful behavior that can be remedied by a court.8

Yet when courts invoke cy pres in the class action setting, they introduce a new party that has no involvement in or injury arising from the underlying dispute, and thus “transform what begins as an adversary bilateral dispute (in accord with constitutional dictates) into a less-than-fully-adversary trilateral process, wholly unknown to the adjudicatory structure contemplated by Article III.”9

Awarding unclaimed funds to non-parties is wholly outside the scope of judicial authority. In such cases, the court assumes an executive — as opposed to judicial — role in the case when it “presides over the administrative redistribution of wealth for social good.”10

In other words, transferring money to someone who has suffered no injury and was never part of the underlying dispute is simply beyond the scope of a court’s constitutionally-defined role, which is limited to redress of injuries suffered by a party to the lawsuit. In one stroke, cy pres “violates both the constitutional separation of powers and the case-or-controversy requirement of Article III.”11

This concern is equally present in voluntary class action settlements because of the unique role courts must play in overseeing the fairness hearing and approving the terms of the proposed agreement.12 As a practical matter, the judiciary’s increasing appetite for cy pres distributions itself imposes a degree of coercion on settling defendants who must weigh the likelihood that approval of a settlement will depend on agreeing to some form of alternative distribution. As one judge opined:

It is inherently dubious to apply a doctrine associated with the voluntary distribution of a gift to the entirely unrelated context of a class action settlement, which a defendant no doubt agrees to as the lesser of various harms confronting it in litigation.13

Judicial power is thus a brooding presence over, and often the driving force behind, the imposition of cy pres even in the “voluntary” class settlement.14

Due Process

Cy pres also raises serious questions about the due process rights of absent class members.

It is axiomatic that Rule 23 imposes a number of procedural steps designed to safeguard the rights of the class. The requirements for adequacy of class representatives, common claims, adequacy of counsel, and notice to class members and the like are all designed to assure that the due process rights of class members — both present and absent — are protected.

Yet cy pres awards risk a sharp departure from courts’ usual concern for due process rights. Indeed, the decision to transfer class awards to third parties amounts to a judicial revocation of the substantive right of class members to compensatory relief.

Moreover, the presence of a cy pres mechanism may disincentivize class counsel “from vigorously pursuing individualized compensation for absent class members."15 This risk is especially acute where class counsel’s compensation is tied to the size of the award, and not to the amount distributed to actual class members.

Worse, selection of cy pres recipients raises the specter of conflicts of interest for counsel and judges alike. Even those with the best of intentions will recognize the temptation to select cy pres recipients whose interests align with their own. Examples abound.16

In short, cy pres recipients take at the expense of class members whose interests have been compromised by the court and their own counsel. The judiciary risks serious harm to its reputation and integrity each time these awards are made.

The Rules Enabling Act

Cy pres also violates the Rules Enabling Act (the Act).17

The Act says that procedural rules — including Rule 23 — may not “abridge, enlarge, or modify any substantive right” of any party. Rule 23 is a procedural mechanism that permits courts to aggregate similar claims of multiple parties that would be too expensive or inefficient to try separately. It is not a source of substantive law, nor does it permit courts to fashion new remedies or mete out new penalties.

Yet cy pres distributions exceed the restraints imposed by the Act. For example, some argue that cy pres distributions “transform substantive law ‘from a compensatory remedial structure to the equivalent of a remedial fine.’”18 That’s because transferring a defendant’s money to a charity serves no compensatory purpose — the charity wasn’t injured by the defendant’s conduct. The transfer looks like a punishment, yet no law authorizes a fine to be paid to someone who was neither harmed nor was a member of a group of people whom the law meant to protect.

More important, cy pres distributions have nothing to do with victim compensation, which lies at the heart of the substantive claims that are asserted on behalf of class members. Rule 23 has thus been used to create a new type of “cy pres right” that rewards third parties who have no stake in the action, merely to solve the court’s administrative difficulty in distributing funds to class members who either can’t be found or choose not to participate in the class settlement.

What’s the Solution?

The dilemma of low class response is almost always foreseeable. Indeed, cy pres recipients are usually identified in proposed settlement documents in frank recognition that a class award will go largely unclaimed by the class members.

There are better ways to address the disposition of unclaimed funds. One court suggests that the “preferable alternative . . . is to return any excess funds to the defendant.”19 This “corrects the parties’ mutual mistake as to the amount required to satisfy class members’ claims. . . . Our adversarial system should not effectuate transfers of funds from defendants beyond what they owe to the parties in judgments or settlements.”20

There is yet another approach to this problem: Don’t certify the class in the first place.

When a court chooses to certify a class that contains cy pres designations, it “must be presumed to be aware that a significant portion of the awarded funds cannot feasibly be distributed in a compensatory manner. . .” In such cases, it is only “the potential availability of cy pres [that] makes the class concept viable” in the first place.21

Thus, when a court certifies this type of class, it does so knowing that it is altering the constitutional dimensions of the class claims in order to certify an administratively infeasible class. “This is simply too big a dog for the small tail of Rule 23 to wag.”22

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Footnotes

1. For a more detailed account of the history of cy pres, see Martin H. Redish, et al., Cy Pres Relief and the Pathologies of the Modern Class Action: A Normative and Empirical Analysis, 62 Fl. L. Rev. 617, 625-630. (2010).
2. See Daloia v. Franciscan Health Sys., 79 Ohio St.3d 98, 106 (1997); see also Klier v. Elf Atochem North America, Inc., 658 F.3d 468, 473-74 (5th Cir. 2011); Cy pres is also codified as part of the Ohio Trust Code at R.C. 5804.13(B).
3. Stuart R. Shepherd, Comment, Damage Distribution in Class Actions: The Cy Pres Remedy, 39 U. Chi. L. Rev. 448 (1972) (cited in Redish, supra note 1 at 631).
4. Redish, supra note 1, at 633 (quoting Shepherd, Comment at 457).
5. Kerry Barnett, Note, Equitable Trusts: An Effective Remedy in Consumer Class Actions, 96 Yale. L.J., 1591, 1594 (1987); Natalie DeJarlais, Note, The Consumer Trust Fund: A Cy Pres Solution to Unclaimed Funds in Consumer Class Actions, 38 Hastings L. J., 729, 732 (1987); see Redish, supra note 1 at 633-34.
6. Redish, supra note 1, at 653.
7. Klier, 658 F.3d at 474.
8. See, e.g., Lujan v. Defenders of Wildlife, 504 U.S. 555-560-61 (1992).
9. Redish, supra note 1, at 641.
10. Id. at 642.
11. Id..
12. Fed. R. Civ. P. 23(e).
13. Klier, 658 F.3d at 480 (Jones, J., concurring).
14. Redish, supra note 1, at 644: It is “impossible to view use of cy pres in the course of class settlements as untied to federal courts’ exercise of judicial power.”
15. Id. at 650.
16. See, e.g., Securities & Exchange Comm’n v. Bear, Stearns & Co., Inc., 626 F. Supp.2d 402 (S.D.N.Y.) (judges and outside entities “dealing in the distribution of large sums of money creates an appearance of impropriety.”).
17. 28 U.S.C. §2072(b).
18. Klier, 658 F.3d at 481 (Jones, J., concurring).
19. Klier, 658 F.3d at 482 (Jones, J., concurring).
20. Id. (emphasis in original).
21. Redish, supra note 1, at 648-49.
22. Id. at 649.