Cy Pres Awards

October 11, 2012

Several courts have recently reviewed class action settlements involving cy pres awards, in which benefits are paid out to a third party rather than to class members. Courts generally cannot modify or strike individual settlement terms, thus a court may wholly deny a proposed class settlement based on objectionable components such as an unfair cy pres award. Most recently, the California district court rejected a settlement for lack of sufficient nexus between the cy pres award and the claims alleged. This and other recent decisions beg the question whether cy pres awards are still feasible in large class action settlements, and if so, under what circumstances.

To be approved, a class action settlement must be fair, adequate, and reasonable. Where settlement funds are unclaimed or non-distributable to individual class members—such as where proof of individual claims would be burdensome or distribution of damages costly—the doctrine of cy pres provides an alternative. This doctrine (also known as fluid recovery) enables class members to receive an indirect benefit, typically through a donation to a third party. Although appellate review of class settlements is fairly limited, courts may deny approval in cases where counsel negotiate settlement before class certification, particularly if there are signs of collusion or indications that the interests of counsel have pervaded negotiations.

In September 2012, the Ninth Circuit in Dennis v. Kellogg1 reviewed a class action settlement stemming from claims that Kellogg’s cereal marketing constituted false advertising under California law. Under the proposed settlement, Kellogg agreed to set up a $2.75 million settlement fund for distribution to class members on a claims-made basis. Remaining funds would be donated to charities under the cy pres doctrine. Kellogg also agreed to distribute $5.5 million “worth” of food to charities, but did not specify the recipients or indicate how to value that food. However, the Ninth Circuit rejected such a settlement. The Court found the cy pres distribution too divorced from concerns embodied in consumer protection laws underlying the case, with no sufficient “driving nexus” between the plaintiff class and cy pres beneficiaries.

The Ninth Circuit reached a different conclusion in McCall v. Facebook, which involved privacy claims relating to an online tool that gathered and disseminated users’ activities without permission.2 The parties agreed to a settlement in which Facebook would pay $9.5 million, some of which would cover attorneys’ fees, costs, and incentive payments, while the remainder would fund a new charitable organization dedicated to education on protecting personal information online. A Facebook employee was slated for the organization’s three-person board of directors.

On review, the Ninth Circuit upheld approval of the settlement. Citing Kellogg, the Court in McCall confirmed that a settlement should not be approved unless the cy pres remedy accounts for the nature of the lawsuit, the objectives of underlying statutes, and the interests of silent class members. The Court disagreed with objectors’ argument that the presence of a Facebook employee on the board did not provide the next best distribution, finding that the cy pres award did not require an ideal recipient—it only required a substantial nexus to class interests.3 Notably, the dissent opined that to the contrary, there were strong incentives for collusion where the settlement’s cy pres organization allowed a defendant to manage the charity and had no record of acts beneficial to people in the wronged class.

Most recently, the Southern District of California struck down a class settlement over concerns that proposed cy pres payments were inappropriately tailored to the lawsuit. In In re Groupon,4 plaintiffs claimed that defendant’s daily vouchers violated consumer protection laws. The parties reached a settlement in which claims were to be paid out of an $8.5 million fund until the balance fell to $75,000. The remainder would be split between two advocacy organizations dedicated to pursuing Internet consumer rights. In reviewing the settlement, the district court invoked Kellogg’s requirement of a “driving nexus,” not just between the class and cy pres beneficiary, but between claims alleged in the case and the cy pres beneficiary. The court failed to see such a nexus: the fact that vouchers were purchased on the Internet was only incidental to claims at issue, too remote from the class and insufficient to constitute a benefit to the class. The court also took issue with the provision for cy pres payment even if claims remained outstanding. Lacking authority to strike only those terms, the court wholly rejected the settlement.

To some extent, the Groupon decision appears to clash with other authority allowing settlements where a cy pres beneficiary such as a non-profit organization might benefit a class broadly, even if not directly tailored to the claims at issue. It also raises questions as to what could have provided an adequate nexus. The court’s discussion suggested that the solution was to create an entirely new beneficiary dedicated to the precise consumer protection issue at hand, akin to the McCall settlement. This has raised some concern that stringent nexus requirements may cause cy pres awards to become unworkable. The Northern District of California may soon address this question in Fraley v. Facebook, a class action over the use of user images in “Sponsored Stories” advertisements. Facebook has proposed a $20 million settlement that may include a cy pres award to organizations that advocate for Internet and social media privacy, some of whom were rejected in the Groupon case as lacking sufficient nexus.5

These opinions implicate several recommendations for parties considering cy pres awards in class action settlements:

  • Shape cy pres awards so as to benefit the entire class, rather than cater to the class representative or class counsel’s interests.
  • Clearly identify the cy pres beneficiary and the value of the benefit so that they can be reasonably assessed.
  • Where possible, shape an award to fund an entity with a record of past performance that indicates a likely benefit to people in the wronged class. Some courts have required a record of past performance or charitable acts, and have rejected cy pres awards where there is no reasonably certainty that any class member would benefit, or where the geographic scope of distribution is too limited in relation to the class.
  • Avoid provisions that allow for cy pres payment even if class claims remain outstanding

A court must take a proposed settlement as a whole when reviewing for fairness. As such, parties considering settlement of class actions should be mindful that a court may wholly reject a settlement where a cy pres award is not sufficiently connected to the objectives of the underlying statutes and the interests of the class members.

Dennis v. Kellogg Co., 2012 WL 38000230, 2012 DJDAR 12484 (9th Cir., Sep. 4, 2012)

2 McCall v. Facebook Inc., 2012 DJDAR 13213 (9th Cir. 2012)

3 Here, objectors had conceded that direct payments would be infeasible, and that the proposed distribution would benefit absent class members and further the purposes of the privacy statutes at issue. Moreover, the Court knew exactly how the funds would be used based on the organization’s mission statement, which established the requisite nexus between the remedy and underlying interests in the suit.

4 In re Groupon Inc. Marketing and Sales Practices Litigation, MD 11-2238 (S.D. Cal., filed June 2, 2011)

5 Angel Fraley v. Facebook Inc., 3:11-cv-01726 (N.D. Cal., filed Mar. 11, 2011)

This article was originally published by Bingham McCutchen LLP.