Class action cy pres awards give judges a slush fund, critic argues

The SE Texas Record Jun. 14, 2011, 4:23am

Judge Richard Posner calls cy pres awards "purely punitive."

By Michael P. Tremoglie

The use of unclaimed funds from class action settlements to fund non-profit organizations is a common legal practice.

At its best, the practice benefits groups that need the funds to help others. At its worst, the practice can be used by lawyers to support an organization of their choice - often with little oversight from the court.

When a class action suit is settled, often a portion of the funds goes unclaimed when it is either impossible or impractical to distribute the settlement directly to the individuals who were injured.

Under the legal doctrine of cy pres, a French term meaning "as close as possible," a court may order that the funds be used for grants to benefit the class members indirectly or as near as possible in order to remedy or compensate for the harm to the class members.

A frequent use of the cy pres awards is to award the funds to a non-profit organization, like the Philadelphia Bar Foundation.

As the charitable arm of the Philadelphia Bar Association, the Philadelphia Bar Foundation is always seeking new sources of funds to cover the mounting expenses it is incurring from its ever-expanding client list.

Among possible income sources, the Foundation has stated its interest in receiving cy pres awards as a source of needed funds. On its website, the Bar Foundation states it "is vitally interested in becoming the beneficiary of unclaimed class action settlements."

Another non-profit organization, the Philadelphia Public Interest Law Center (PPILC), has been the recipient of cy pres funds in the past. One of its former board members, Jeffrey Golan, from the law firm of Barrack Rodos and Bacine, was praised by the organization in 2007 for designating the PPIC as the recipient of a cy pres award from a lawsuit in which Golan was co-lead counsel.

PPILC also recognized the contributions of board member Nicholas Chimicles on Jan. 30, 2008. Chimicles, of the law firm of Chimicles and Tikellis LLP, steered the proceeds of a cy pres award to PPILC. He recommended the proceeds, "the funds for which came from various cases in which the firm had been involved," go to PPILC.

The PPILC, the Philadelphia Bar Foundation, lawyers such as Chimicles and Golan are not alone in using the legal doctrine of cy pres to channel unclaimed funds in class actions lawsuits to nonprofit organizations.

While the nonprofit may or may not be related to the settlement itself, the use of cy pres awards has become common.

But not everyone in the legal community thinks that this is ethical or constitutional.

Judd Serrota is a commercial litigation partner with the Philadelphia law firm of Blank Rome LLP. He co-authored an article for the Aug. 6, 2008, edition of the Wall Street Journal in which he called this practice unconstitutional.

He wrote that courts are distributing money in an ad hoc manner to charities that have "little or no relationship to what was at issue in the original dispute."

On of the problems, Serrota wrote, is that attorneys often propose their own recipients of the funds.

His claim that this is unconstitutional is grounded in his belief that courts are established to resolve disputes, not to satisfy notions of deterrence by awarding a defendant's assets to a charity like a legal aid society that has not even appeared before the court.

Serrota's opinion is shared implicitly and explicitly. Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit noted that the use of cy pres in the litigation context is "purely punitive."

The Institute for Legal Reform, an affiliate of the U.S. Chamber of Commerce, has stated that cy pres poses numerous ethical problems.

An October 2010 report noted that "critics of cy pres awards have expressed concern that they do not provide compensation to injured class members-and thus depart from the objectives of the judicial system."

After all,"[t]here is no indirect benefit to the class from the defendant's giving the money to someone else," the report states. Thus, it is questionable whether most cy pres distributions "effectuate...the interests of [the] silent class members."

The ILR report cited an AOL case as an example. AOL was sued for inserting advertising in emails. They lost a class action suit and claimants received no settlement while the lawyers were paid $320,000.

The report continued, "The AOL case illustrates how far removed a cy pres settlement can be from the injured class members."

As law professor Martin Redish of Northwestern University School of Law aptly put it: cy pres awards merely "creat[e] the illusion of compensation."

"That illusion is contrary to the goals of civil justice. The bedrock of our system of civil justice is that a plaintiff who is injured can seek compensation for his or her injuries; using civil litigation to redistribute wealth to charities turns that fundamental goal on its head."

Lawyer Ted Frank certainly agrees with the ethical issues argument. As founder of the Center for Class Action Fairness in Washington, D.C., Frank has been conducting a crusade against cy pres settlements for years.

Frank said the main problem is that "nobody is watching the courts."

He contends that if the judges are not looking out for the conflicts, then they have been given a slush fund.

He noted a case in which cy pres funds were directed to a charity involving the judge's husband. The case was appealed to the Ninth Circuit Court.

Another example was that of a Kentucky mass tort inventory settlement of fen-phen cases. Millions of dollars intended for plaintiffs were diverted to a newly created charity. The charity's board members included the judge who approved the settlement and three of the plaintiffs' attorneys.

But the use of cy pres to distribute unclaimed funds has been in practice for a very long time and has gotten the seal of approval from the courts. Indeed, the Washington State Supreme Court codified the practice in 2006. The Civil Rule 23 provides that at least 25 percent of class-action residual funds in state cases be disbursed to provide legal aid for the needy.

"There are those who believe that this is a way to balance the scales of an unequal justice system," says Adam Pritchard of the University of Michigan Law School. "The plaintiffs' lawyers characterize the settlements as fighting for the little guy - even though some go to pet charities such as the alma mater of the plaintiff's attorneys.

The cloaking of the distribution by the courts of unclaimed class-action residual funds as charitable donations gives those in favor of the practice the moral high ground, Pritchard said.

He said it is difficult to argue against the practice when it is couched as helping the oppressed. Meanwhile nobody is watching the store. Judges have little inducement to supervise what happens to these funds.

"The judges are busy people," says Pritchard. "They want to approve the settlement because they are anxious to get the cases off their dockets. Since the plaintiff's and the defendant's agree it is in the judge's interest to get it off the docket. They want the case to go away. They could deny approval but they do not have an incentive."

Until there is a movement by the legal profession to ensure that those who are supposed to receive the money actually do receive the money from class actions suits, more groups will be soliciting cy pres class action funds like the Philadelphia Bar Foundation.

Editor's note: Legal Newsline and the Southeast Texas Record are owned by the Institute for Legal Reform.

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