Incentive Payments and Adequacy Challenges -- Promises of Incentive Payments Can Create Conflicts of Interest Issues and Defeat Class Certification

When promises of incentive payments are made by class counsel (outside of the settlement context where the parties reach an agreement to make such a payment after the material terms of the settlement have been reached), such promises can make the proposed named plaintiff and class counsel inadequate class representatives.     The Seventh and Ninth Circuits issued important decisions recently that highlight, among other things, that improper incentive agreement promises can create adequacy issues.  Such promises should be explored during discovery of named plaintiffs and should be examined as one of many arguments that may be available to defeat class certification.

In Espenscheid, et al. v. DirectSat, LLC et al., Case No. 12-1943 (7th Cir., August 6, 2012), the United States Court of Appeals for the Seventh Circuit held that a named plaintiff had standing to appeal the decertification of a class, even though plaintiff entered into an individual settlement resolving his claim, because there was an express preservation of the right to seek an incentive payment if the matter was later certified as a class.  Id. at 10.  In the decision, Judge Posner explained the use of incentive awards, stating:

"It is true that class actions are almost always the brainchild of lawyers who specialize in bringing such actions.  But they still have to find someone who is a member of the prospective class to agree to be named as plaintiff, because a suit cannot be brought without a plaintiff.  And a class action plaintiff assumes a risk; should the suit fail, he may find himself liable for the defendant's costs or even, if the suit is held to have been frivolous, for the defendant's attorneys' fees.  The incentive reward is designed to compensate him for bearing these risks, as well as for as any time he spent sitting for depositions and otherwise participating in the litigation as any plaintiff must do. The plaintiff's duties are not onerous and the risk of incurring liability is small; a defendant is unlikely to seek a judgment against an individual of modest means (and how often are wealthy people the named plaintiffs in class action suits?).  The incentive award therefore usually is modest--the median award is only $4,000 per class representative."

Id. at 7-8.   Importantly, the Court explained that "[i]t's true that having settled, [the named plaintiff] will no longer have a stake in any damages that may be awarded to the class.  And that will cast doubt on his adequacy to represent the class members, his interest in the case no longer being perfectly aligned with theirs."  Id. at 5 (citing Amchem Products, Inc. v. Windsor, 521 U.S. 591, 625-28 (1997); 1 William B. Rubenstein, Newberg on Class Actions § 3:44, pp. 294-95 (5th ed. 2012).  While the Court held that the named plaintiff had standing to pursue the appeal, it stated that incentive payments may create adequacy issues where the named plaintiff's interests are no longer aligned with the class directly.  Id. at 5-6.

Less than four days later and in the context of affirming the denial of attorneys' fees to class counsel, the United States Court of Appeals for the Ninth Circuit reminded class action practitioners of the circumstances where improper promises of incentive payment could create conflict of interest issues, making both the named plaintiff and proposed class counsel inadequate class representatives.  Rodriguez v. Disner et al. (Rodriguez II), Case Nos. 10-55309, 10-55342,10-56730, 10-55670, 10-56703, 10-56724, 10-56737, 10-56803, 10-57037 (9th Cir., August 10, 2012).  Rodriguez is another decision in the long-running antitrust litigation against West Publishing Corp. and Kaplan, Inc.  See Rodriquez v. W. Publ'g Corp. (Rodriguez I), 563 F.3d 948 (9th Cir. 2009).  In the present appeal, the Ninth Circuit considered, among other things, whether class counsel can be denied an award of attorneys' fees when the class counsel enters into improper incentive payment agreements.

Here, class counsel entered into incentive agreements with five plaintiffs.  Id. at 9073.  Counsel agreed to seek incentive compensation in an amount equal to between $10,000 and $75,000, depending on the value of the settlement or verdict.  Id.  Specifically, the incentive agreement provided that, if the settlement amount was greater than or equal to $500,000, counsel would seek a $10,000 incentive award for each client; if the settlement amount was $1.5 million or more, counsel would seek $50,000; and if it was $10 million or more, counsel would seek $75,000.  Id.  The parties settled shortly before trial, and defendants agreed to pay $49 million allocated pro rata to class members.  Id. at 9074.  Before the final fairness hearing, class counsel filed motions seeking $325,000 in incentive awards for the class representatives and seeking fees for their representation of the class.  Id.

Multiple objectors challenged, among other things, the application for $325,000 in incentive awards for the class representatives and class counsel's fee request.  The objectors argued that the incentive agreements created a conflict of interest between class counsel and the class representatives who entered into the agreements, on one hand, and the remaining members of the class, on the other hand.  Id. at 9074-75.  The district court agreed, declining to approve incentive awards totaling $325,000 to the class representatives.  Rodriguez I, 563 F.3d at 958.  Later, in Rodriquez II, the Ninth Circuit "confirm[ed] the district court's conclusion that [class counsel] committed an ethical violation" when class counsel entered into the incentive agreements that created actual conflicts of interest.  Rodriguez II, at 9084.  The incentive agreements "put class counsel and the contracting class representatives into a conflict position from day one" because "[b]y trying their compensation -- in advance -- to a sliding scale based on the amount recovered, the incentive agreement disjoined the contingency financial interests of the contracting representatives from the class."  Rodriguez I, 563 F.3d at 959.  "Once the threshold cash settlement was met, the agreements created a disincentive to go to trial; going to trial would put their $75,000 at risk in return for only a marginal individual gain even if the verdict were significantly greater than the settlement."  Id. at 959-60.  Under California law (as is the law in other jurisdictions), "[s]imultaneous representation of clients with conflicting interests (and without written informed consent) is an automatic ethics violation" and grounds for disqualification.   Id. at 960.  The Court affirmed the denial of attorneys' fees to conflicted class counsel as a result of the ethical violation.  Rodriguez II, at 9088

Both decisions show that improper promises of incentive payments can create conflict of interest issues with class representatives.  Such promises make the proposed named plaintiff and class counsel inadequate class representatives.  Class action defendants' counsel need to explore such agreements when seeking pre-certification discovery, as promises of incentive payments open another avenue of argument to defeat motions for class certification.

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Brian Wright | Faruki Co-Managing Partner