Class actions typically involve a proposed class of plaintiffs seeking recovery from the same defendant on similar grounds. But that is not the only animal in the class action corral. Rule 23 makes this clear in its very first sentence: One or more members of a class may sue or be sued as representative parties on behalf of all members….” But this particular class action animal is more often imagined than seen. Indeed, as the Fourth Circuit recently observed, “Defendant class actions are so rare they have been compared to ‘unicorns.’”
The reason defendant class actions are so rare is that they present a host of practical challenges, due process challenges, and adequacy challenges. How can you force an involuntary defendant to look out for the interests of a defendant class? Can’t the defendant class representative defeat certification simply by filing a statement with the court that it has absolutely no intention of looking out for the interests of anyone but itself, and is fully willing to sacrifice the interests of the class in order to obtain a better deal for itself? Doesn’t a corporation’s duty to its own shareholders require just that? Wouldn’t any absent member of the defendant class that was in its right mind opt out anyway? Besides, who pays the counsel for a defendant class, given that the class is being asked to involuntarily pay money and not seeking to recover money? And how does Rule 23 allow the assertion of personal jurisdiction over out-of-state members of a defendant class? Because of these challenges and others like them, a recent law review article by Francis Shen found that only 177 defendant class actions had ever even been proposed as of early 2011, and most of those had to do with declaratory relief as to the meaning of a state or federal statute.
But recently, believe it or not, there has been an actual confirmed sighting of this mythical class action unicorn in the form of a certified (and affirmed) defendant class action. The discovery was made by the Fourth Circuit and happened in a case called Bell v. Brocket. It turns out that the unicorn was actually created by mistake. Or rather, by an accumulation of mistakes.
The case devolved from the SEC’s enforcement action against on an online auction site allegedly being run as an effective Ponzi scheme. The SEC froze the assets of the allegedly offending LLC, whereupon Bell was appointed receiver for the LLC. He proceeded to file a defendant class action against all those who had received at least $1,000 more from the scheme than they put in, for the purposes of returning the difference to those who had a net loss from investing in the scheme. Some of the “net winners” were named as defendants and proposed representatives of the defendant class. Some defendants objected to serving as class reps on cost grounds, arguing that they could not afford to fairly represent the class. But they did not argue that the proposed no-opt-out class violated their due process rights, and they did not argue that some members of the class were not subject to personal jurisdiction in the forum.
The trial court certified the class as a no-opt-out class under 23(b)(1), typically applicable in damage actions only when the target of multiple damage claims has funds too limited to pay all claims. But here there were many defendants who were the target of one receiver’s damage claims. (The phrase square peg in a round hole seems to fit here.) Compounding the problem, the court directed notice to the class, but did not appoint anyone counsel for the defendant class. Remarkably, no absent class member objected to this failure at the time.
As the case proceeded, counsel for the individual named defendants made it clear that they and their counsel were not interested in representing the defendant class unless somebody agreed to pay them to do so. With no such volunteer appearing, counsel for most defendants formally withdrew. One, Mr. Edmundson, stayed on as counsel for his individual clients. Meanwhile, while the defendant class went unrepresented, not only had notice been sent without the input of anyone acting as counsel for the defendant class, but the court had appointed one of the named defendant’s experts as expert for the defendant class.
Well after the expert’s work was underway, the court finally appointed Mr. Edmundson as class counsel, despite his long and understandable reluctance to assume the risk of leaping upon an already running unicorn, but with a catch—Mr. Edmundson would only be class counsel for the liability phase of the case. The expert previously appointed by the court then promptly filed a report conceding that the operation was a Ponzi scheme, and thereby effectively all but conceding the liability of the defendant class. Class counsel then declined to even depose the plaintiff’s expert. The trial court then granted summary judgment against the defendant class and proceeded to notify class members of an unusual and distinctly homemade plan for determining damages, without objection by Mr. Edmundson, whose appointment as class counsel did not extend to the damages phase in any event. The plan called for the receiver to send his damage calculations to each class member for them to either accept or object to.
On the eve of entry of final judgment against class member defendants whose liability was thus determined, sanity attempted to intervene in the form of objector Edward Rourke. He moved to decertify, finally pointing out some of the problems that should have been obvious all along: “(1) Edmundson had conflicting interests as class counsel; (2) Edmundson failed to obtain an independent expert evaluation of the business and conceded the existence of a Ponzi scheme; and (3) since Edmundson only represented the class through the liability phase of the action, there was no adequate representation of class members during the damages phase and decertification was warranted.” Unphased, the trial court entered final judgment.
Sanity persisted in beating its head against the wall. Several more absent class members sought to intervene and object post judgment, arguing that: “(1) Edmundson failed to vigorously represent the interests of the class and unnecessarily conceded the existence of a Ponzi scheme; (2) following the district court’s entry of summary judgment, Edmundson failed to represent the interests of the class; and (3) Edmundson had potential conflicts of interest throughout his time as class counsel.” Bell opposed, arguing that these objections came too late. In reply, the objectors finally pointed out that the damages procedure violated the right to due process and a jury trial. But even these objectors said nothing about the failure of the district court to name class counsel at the time it certified the class; the failure of the district court to apply the Rule 23(g) factors in deciding whom to appoint as class counsel; or any challenge to commonality, typicality, jurisdiction, or the absence of opt-out rights.
The trial court rejected all of these objections as untimely second guessing of strategic choices made by class counsel. The late-arriving objectors then appealed.
A clearly pained Fourth Circuit held its nose and affirmed. (Apparently unicorns smell bad, or at least this one did.) The Fourth Circuit flatly declared that “Defendant class actions, like plaintiff class actions, must comply with Rule 23.” It then essentially conceded that this one didn’t. It noted that prompt appointment of class counsel was mandatory upon certification and did not happen here. It noted that consideration of the Rule 23g factors in choosing class counsel was likewise mandatory, not optional. And it agreed there was prejudice to the class from these errors by the trial court, since the key events upon which the liability and damage findings were based occurred in large part while the class went unrepresented.
But then the Fourth Circuit confronted the “horn” of the dilemma: Do we enforce Rule 23 or our own rule that issues not timely raised below cannot be considered on appeal? With a clearly sour stomach, the Fourth Circuit surveyed the situation, noted that many net winners had already individually accepted and paid their calculated liability to net losers, and concluded that “the toothpaste cannot be put back in the tube.” Therefore, while painstakingly pointing out the errors of the court and counsel that forced it to do so and reminding future courts and litigants not to ignore the requirements of Rule 23 in considering defendant classes, the Fourth Circuit reluctantly affirmed, thereby confirming the existence of at least one defendant class unicorn.
The moral of the story? However difficult it may be to conjure up a unicorn intentionally, it’s really not that hard to create one through lack of attention — which is why the Fourth Circuit’s decision is itself suspect. Especially as to adequacy and due process issues, the Supreme Court has long said that absent class members are not supposed to be bound by the failure of their representatives or the certifying court to ensure adequacy of representation and fundamental due process (see Phillips Petroleum Co. v. Shutts, 472 U.S. 797 (1985)). So while there may indeed have been a sighting, this unicorn remains on the endangered species list.