Settlement Structures, Residual Funds, Attorneys’ Fees, and Reverters: Part I

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Class action settlements can be structured in a variety of ways. Many include a common fund, consisting of an agreed-to amount the defendant deposits into a Qualified Settlement Fund, or “QSF,” a tax vehicle that facilitates settlements. Some settlements require the funds to be deposited after the trial court orders preliminary approval of the settlement, while others require that the deposit be made after final approval. The common fund often is a comprehensive amount that includes the funds that will be distributed to class members, as well as amounts for service awards to named plaintiffs, court-approved attorneys’ fees, and expenses that have been and/or will be advanced by class counsel to support the litigation and settlement administration. In other settlements, the common fund includes only those amounts that will be distributed to class members, with the defendant agreeing to pay the other items separately once the court decides how much it will approve and directs the defendant to pay the approved amounts.

Other variations exist both within and outside the universe of common fund settlements. Some common fund settlements include a claims process, so that only class members who submit claims will receive payments from the fund. Others will involve automatic payments to class members without the need for the recipients to submit claims, such as when the defendant maintains a database that includes the names and last known addresses of all class members. For example, a public company will have records of its shareholders, a bank will have records of its depositors, and all companies will (or at least should) have records of their employees. In contrast, a company that sells products at brick and mortar stores may not have records of all purchasers, especially when those products can be purchased for cash. Some claims-made settlements may not involve a deposit into a common fund at all, but simply require the settling defendants to pay claims from the defendant’s ordinary business accounts as or after the claims come in. And some settlements may not provide for any money to be paid to class members, such as settlements that provide only injunctive relief or settlements providing some substitute for cash, such as coupons (a rare form of settlement consideration since passage of the Class Action Fairness Act in 2005).

Both a claims-made, common-fund settlement and a settlement involving automatic distributions from a common fund will almost always have money left over after funds are distributed. This outcome is most dramatic in the claims-made context, because only a fraction (usually a small fraction) of class members typically submit claims. Also, in both the claims-made and automatic-payments situations, there will be class members who don’t receive their checks, and others who receive them but fail to cash or deposit them. The settlement agreement should spell out what is supposed to happen to these “residual funds.” The alternatives may include “cy pres” payments to a court-approved beneficiary, additional distributions to some or all class members (for example, the subset of class members who submitted claims and cashed their checks), or return of some or all of the residual funds to the defendant.

The return of residual funds to the defendant is generally known as a “reverter” or “kicker.” It is highly disfavored and is rarely, if ever, approved. Courts reviewing proposed class action settlements are charged with ensuring that funds committed to paying class members’ claims actually reach the class members or, at a minimum, that any remaining funds after class distributions support a third party whose mission includes protection of similar categories of people from the types of harm the settlement is intended to remedy. And, because the amount a court awards to class counsel for attorneys’ fees will take into account the amount to be paid to the class, a return of any portion of the class relief to the defendant may result in a disproportionate share of the settlement consideration going to the attorneys.

It is common knowledge among class action lawyers that unclaimed funds that were earmarked for class members generally should not revert to the defendant that paid them. What may be less understood is whether the difference between the amount the defendant had agreed it would pay for attorneys’ fees and a lower fee amount approved by a court should also be treated like residual funds, even where the agreed fee amount was never deposited into a common fund and remains in the defendant’s possession. Settlement objectors in some 9th Circuit cases have urged courts to treat such amounts as “constructive common funds.” In a handful of recent decisions, Ninth Circuit panels have characterized such unawarded and unpaid attorneys’ fee amounts as reverters, and have reversed and remanded final approval orders with directions that the unpaid money be distributed to class members, even though the defendant never intended it to go to the class.

In our next post, we will explore some of these decisions and the implications for settling parties.