May 01, 2005

Nuts and Bolts of the New Class Action Legislation

The Class Action Fairness Act of 2005 (CAFA) was one of the first bills passed by the newly-convened 109th Congress, but it is the product of nearly a decade of legislative efforts. CAFA makes substantial changes in two areas related to class action law where Congress perceived abuses to be occurring.

First, CAFA dramatically extends the reach of federal jurisdiction over state law class actions, in order to reduce the prominence of certain "magnet" state courts where numerous nationwide class actions were filed and litigated. Second, CAFA imposes new requirements on the settlement of class actions in order to prevent perceived abuses.

CAFA is not retroactive. Its provisions apply to all claims filed on or after its enactment on February 18, 2005.

I. Original Federal Diversity Jurisdiction for Interstate Class Actions

CAFA provides original federal jurisdiction over class action complaints alleging state law claims where class members' aggregate alleged damages exceed $5 million, and where "any member" of a plaintiff class is a citizen of a different state "from any defendant." This language eliminates two features of federal diversity jurisdiction law that previously kept many class actions in state court. First, it no longer requires "complete" diversity between plaintiffs and defendants – i.e., that every plaintiff must be from a different state from every defendant. This longstanding limit on federal diversity jurisdiction meant that a class action could be kept out of federal court simply by naming a peripheral defendant from the same state as one of the plaintiffs. For example, a plaintiff suing an out-of-state insurance company could also name a local agent of that company as a defendant.

Second, the $5 million threshold removes a limit that had kept many significant class actions in state court. Following a 1969 Supreme Court opinion, courts have not allowed the claims of individual class members to be aggregated to satisfy the amount in controversy requirement (currently $75,000). This approach meant that in most cases class actions could not be heard in federal court unless each class member stood to recover more than $75,000 individually.1 CAFA allows the individual class members' damages claims to be aggregated, but imposes a higher $5 million amount in controversy requirement.

CAFA is not limited to nationwide class actions. It authorizes federal jurisdiction over many class actions where the classes are limited to a single state. For example, federal diversity jurisdiction now exists over cases filed on behalf of a putative class solely of Colorado residents, if the defendant is not a Colorado citizen.

A. Exceptions

CAFA provides certain exceptions to its expansion of federal jurisdiction:

1. Where a defendant is sued in its home state

Where the "primary defendants" are citizens of the state in which a case is filed, CAFA considers the citizenship of the putative class members in determining federal jurisdiction:

a) No federal jurisdiction exists if two-thirds or more of the putative class members are citizens of that state. The case must remain in state court.

b) The case is subject to federal jurisdiction if one-third or less of the putative class members are citizens of that state.

c) If more than one-third but less than two-thirds of the putative class members are from the defendants' home state, the federal court "may, in the interests of justice and looking at the totality of the circumstances, decline to exercise jurisdiction."

2. Where the action involves a local controversy

CAFA also carves out an exception for certain class actions deemed to involve a "local controversy." No federal diversity jurisdiction exists over a class action in which more than two-thirds of the putative class members are citizens of the state in which the action is filed, if:

a) At least one defendant

(i) is a citizen of that state,

(ii) "significant relief" is sought from that defendant, and

(iii) that defendant's alleged conduct "forms a significant basis for the claims asserted by the proposed plaintiff class"; and

b) The "principal injuries" of the class members occurred in the state where the suit is brought; and

c) No other class action has been filed in the past three years "asserting the same or similar factual allegations against any of the defendants."

The paradigmatic example of such a local controversy would involve a toxic chemical spill from an industrial facility that injured nearby residents. Even in that case, though, the plaintiffs would have to seek "significant relief" from in-state operators or employees of the facility if it were owned by an out-of-state company.

The legislative history indicates that Congress intended the local controversy exception to apply only in limited circumstances. The in-state defendant "must be a primary focus of the plaintiffs' claims, not just a retailer or other peripheral defendant." The local controversy exception cannot be used, for example, in a consumer fraud case against an out-of-state insurance company by naming a local agent of that company.2

Moreover, the "principal injury" requirement means that "all or almost all of the damage caused by defendant's conduct must have occurred in the State" where the case was brought. Thus, if the class action challenges conduct that allegedly injured consumers all over the country (such as in an insurance or products liability case), the local controversy exception is unavailable, even if the case is brought only on behalf of consumers in a single state.3

3. Where the putative class consists of fewer than 100 members

CAFA's expansion of diversity jurisdiction does not include small putative classes involving fewer than 100 members. For such cases, the normal ban on aggregating the amounts in controversy, and the requirement of complete diversity, still apply.

4. Securities and corporate governance cases

CAFA's expansion of diversity jurisdiction also exempts class actions that solely involve claims concerning "covered securities" as defined by federal securities laws, or the rights and obligations relating to any security. These securities class actions have largely been addressed by the Private Securities Litigation Reform Act of 1995 (PSLRA) and the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

Finally, class actions involving corporate governance issues brought under the law of the state where the defendant is incorporated also are not subject to CAFA's expansion of federal diversity jurisdiction.

B. Changes to Removal Provisions

In addition to expanding the scope of diversity jurisdiction, CAFA makes it procedurally easier to remove class actions to federal court. Under CAFA, a class action may be removed to federal court:

1. Even where one defendant is a citizen of the state where the case was filed; and

2. By any defendant without the consent of all other defendants.

CAFA also creates an exception to the general rule precluding an appeal of a federal court order that remands a case to state court after removal. Federal Courts of Appeal now have the discretion to review such remand orders in class actions.

C. Original Federal Jurisdiction for Mass Actions

CAFA defines "class action" to include certain "mass actions" where numerous plaintiffs are joined in a single case without relying on the class action mechanism. Original jurisdiction exists for any civil action seeking monetary relief where (a) the claims of 100 or more named plaintiffs (b) involving common questions of law or fact are proposed to be tried jointly, and (c) the claims of each plaintiff meets the amount in controversy requirement (currently $75,000).

II. Requirements for Class Action Settlements

CAFA also includes a "Consumer Class Action Bill of Rights" that imposes new requirements for the settlement of class actions. First, defendants are now required to notify the federal and state governments of the terms of a proposed class action settlement. Second, certain types of settlements (such as those where the class members receive coupons instead of cash) are subject to heightened scrutiny.

A. Mandatory Notice of Settlement Provisions

Settlements of cases that have been certified as class actions already require approval from the court. CAFA adds an additional requirement that federal and state governments also be given an opportunity to object to such settlements. Within 10 days of filing a proposed class action settlement, each defendant is obligated to give notice of it to the appropriate federal official, and to the appropriate state officials in every state where a putative class member resides. Depending on the particular defendant, the "appropriate" federal and state officials can be the governing regulatory agencies, and/or the Attorneys General of the United States and affected States. A court cannot issue a final order approving a class action settlement until 90 days after the required notice is provided.

B. Scrutiny Over Certain Settlements

CAFA requires that certain types of settlements, perceived by Congress to have particular potential for abuse, be subject to heightened scrutiny by the court. These settlements include (a) "coupon settlements," (b) "net loss settlements," and (c) geographically discriminatory settlements.

1. Coupon and Non-Cash Settlements

CAFA specifically addresses class action settlements in which class members receive "coupons." The term "coupon" is not defined in the statute, but CAFA's legislative history indicates that Congress was addressing "promotional coupons to purchase more products from the defendants." Congress expressed concern that class counsel were in some cases receiving large attorney fee awards for settlements in which class members received only coupons with very modest value. In some cases, only a fraction of the class members could be expected ultimately to redeem the coupons. In other settlements, defendants reportedly generated increased business and revenue through coupon redemptions, because the coupons covered only part of the cost of new purchases.4

Under CAFA, a court may approve a settlement in which class members would be awarded coupons only after a hearing and making a written finding that the settlement is "fair, reasonable and adequate for class members." The court may require that the value of unclaimed coupons be distributed to charitable or government organizations.

Further, contingent fee awards to class counsel in coupon settlements must be "based on the value of the coupons actually redeemed," rather than the total coupons issued. Alternatively, the attorney fee award may be calculated based on the hours spent prosecuting the action. An appropriate fee may also be awarded for injunctive relief obtained as part of the settlement.

2. Net Loss Settlements

Members of Congress also expressed concern over settlements in which class members actually lose money. Such a settlement might occur where the predominant relief awarded to the class is injunctive or non-monetary in nature, and a substantial attorney fee award is paid. A net loss settlement has been approved in at least one case that drew Congress' attention. CAFA requires that where "any class member is obligated to pay sums to class counsel that would result in a net loss to the class member," the settlement may be approved only through a written finding by the court that the non-monetary benefits to the class member outweigh the monetary loss.

3. Geographically discriminatory settlements

Finally, CAFA forbids a court from approving a proposed settlement that "provides for the payment of greater sums to some class members than to others solely on the basis that [they] are located in closer geographic proximity to the court."

It is difficult to predict how CAFA will affect class action litigation in the future, and what unintended consequences may result from the new law. Indeed, since the similar effort in the 1990s to federalize securities class actions through PSLRA and SLUSA, such litigation has actually increased.5 However, CAFA does make many state-law cases less likely to be certified as class actions, now that they can be removed to federal court. This is especially apparent for state-law class actions involving nationwide classes.

ENDNOTES

1

Some courts have ruled that, as long as one class member has $75,000 at issue, the supplemental jurisdiction statute, 28 U.S.C. § 1367, authorizes federal jurisdiction over the entire class. The federal circuit courts of appeal are split over this issue, and the Supreme Court this term will hear an appeal in Allapattah Services, Inc. v. Exxon Corp. presenting the issue for resolution. A similar division exists with regard to injunctive relief. See, e.g., Justice v. Atchison, Topeka & Santa Fe Rwy, 927 F.2d 503, 505 (10th Cir. 1991).

2

Comms. Of Rep. Sensenbrenner, Feb. 17, 2005 Cong. Rec. AT H731.

3

Feb. 17, 2005 Cong. Rec. at H728, H731.

4

Sen. Rep. 108-123 at 16-18.

5

Stanford Law School Securities Class Action Clearinghouse, Indices of Securities Class Action Filings, http://securities.stanford.edu/litigation_activity.html ; Loomis, Securities Reform: What Went Wrong?, New York Law Journal (Oct. 26, 2000).

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