By Wayne D. Garris Jr., J.D.
Three dancers who filed individual FLSA claims against San Francisco area clubs objected to the proposed settlement of putative class claims brought by two plaintiffs in a separate FLSA action.
The Ninth Circuit reversed a district court’s approval of a settlement agreement, executed prior to class certification, to resolve a misclassification lawsuit brought by exotic dancers at various nightclubs in the San Francisco area. The appeals court concluded that the notice process was inadequate under Rule 23(c)(2)(B)—the claims administrator sent notice of the settlement via mail only, and the employer set a up a website and hung a poster inside the clubs. Further, the district court erred by reviewing the agreement under Rule 23(e)’s “fair, reasonable, and adequate” standard, rather than the heightened standard of scrutiny that is required for pre-certification agreements. As a result, the district failed to investigate many terms in the settlement that were indicative of collusion or other conflicts of interest (Murphy v. SFBSC Management, December 11, 2019, Tashima, A.).
Background. In 2014, two exotic dancers filed a putative class and collective action against a company that managed eleven nightclubs in the San Francisco area. The suit alleged that the employer violated the FLSA and the California Labor Code by misclassifying the named plaintiffs and 4,700 members of the putative class as independent contractors instead of as employees. The employer unsuccessfully moved to compel arbitration, and during the appeal of the arbitration issue, the parties executed a settlement agreement.
Settlement terms. Under the terms of the proposed settlement, the plaintiffs released their wage claims against the employer and the individuals and entities that owned the eleven clubs. In exchange, the employer agreed to a two-tiered cash payout structure. The first tier of $2 million would be used for compensation to the settlement class, attorneys’ fees, enhanced payments, a $100,000 payment required by state law, and administrative costs. The employers would only be required to fund the second tier, up to $1 million, if the first tier didn’t cover all of the required payments. The agreement also provided for up to $1 million in dance fee payments in which a dancer could elect to keep 100 percent of dance fees, up to $8,000, in lieu of a share of the cash settlement. Finally, the employer agreed to change several of its business practices.
Objectors. During the appeal and settlement process, the plaintiffs in separate FLSA actions against three of the individual nightclubs involved in the putative class action learned of the proposed settlement and objected to preliminary approval of the settlement. Despite these objections, the district court approved the agreement finding that it met Rule 23’s “fair, reasonable, and adequate” standard.
Notice and claims forms. The district court approved the settlement and class notice plan. The claims administrator sent, by U.S. mail, the court-approved notice to class members at their last known address from their most recent contract with the employer; 1,546 notices of the 4,681 notices were returned as undeliverable. The administrator resent notices, and a total of 560 notices remained undeliverable. The administrator did not send any reminders, follow-ups, or electronic notice. The plaintiffs set up a settlement website and the employer displayed posters in nightclub’s dressing rooms. At the end of the opt-out period, only 856 of 4,681 class members submitted claims forms to receive payment; 790 of them chose the cash payment and 75 chose the dance fee option.
Final approval. Despite more objections, the district court granted final approval, deemed the notice adequate, and awarded the requested attorneys’ fees and service awards. Overall, the settlement provided $2 million in cash, of which $950,000 was allocated to attorneys’ fees. The objectors appealed challenging the adequacy of the notice and the district court’s approval of the settlement.
Adequacy of notice. Rejecting the objectors’ argument that the notice was insufficient because it did not notify class members about related litigation, the Ninth Circuit nonetheless agreed that the process was inadequate because it did not provide the “best notice practicable.”
The court noted that the lack of electronic mail and the exclusive use of mail rendered the notice inadequate. The court was especially troubled that the employer asserted that class members were difficult to reach because of their “transient” nature, yet it relied solely on mail to try to contact them. Furthermore, the administrator failed to send any follow-up notice. The inadequate notice may have caused the low claims rate for the settlement, the court agreed. It was not persuaded that the employer’s use of the poster made the notice adequate since the posters would only be visible to those members of the class who still worked in the defendant’s nightclubs.
Adequacy of settlement. Turning to the substance of the settlement agreement, the court found that the district court erred in failing to apply a heightened level of scrutiny, beyond Rule 23’s “fair, reasonable, and adequate” standard, as is required when the parties negotiate a settlement prior to class certification. The heightened scrutiny is necessary to investigate evidence of “collusion or other conflicts of interest.” Instead, the district court concluded that the settlement was reasonable and overlooked “numerous problematic aspects of the settlement and subtle signs of implicit collusion.”
The court remanded the case to the district court to apply the proper analysis to the agreement and identified several specific problematic terms of the settlement: the clear sailing agreement, the disproportionate amount of attorneys’ fees, the large incentive payments to the named plaintiffs, and reversionary clauses.
Clear sailing agreement and attorneys’ fees. While clear sailing provisions are not prohibited (here, the defendants agreed they would not object to an attorneys’ fees and expense award of up to $1 million), the court had previously held that clear sailing agreements are “important warning signs of collusion” because they “increase the likelihood that class counsel will have bargained away something of value to the class.” Of the $2 million in settlement cash, $950,000 went to class counsel while $864,115 went to the class members. The court noted that this distribution is not per se an issue, but it is something that should have been examined more closely by the district court.
Furthermore, the court raised questions about the district court’s calculation of the total settlement value when it determined that the proportion of attorneys’ fees was reasonable. Specifically, the court valued the dance fee payment at $1 million—even though it was a coupon that only lasted for two years, could not be used by former employees, and failed to “disgorge ill-gotten gains” from the employer. While not binding on the district court, the Ninth Circuit cited the Class Action Fairness Act’s requirement that the portion of an attorneys’ fee award that is attributable to coupons be based on the value of the coupons that are actually redeemed.
Valuation of injunctive relief. The district court also valued the employer’s agreement to change its business practices at $1 million. The objectors argued that the injunctive relief is worthless because the employer had adopted these business practices prior to the settlement. In the appeals court’s view, the district court should have explained why the value of the injunctive relief’s benefits to individual class members “was readily quantifiable and worth $1 million, or excluded the injunctive relief from the valuation of the settlement and explained why attorneys’ fees of 31.6% or more were justified.”
Incentive payments. The settlement provided the named plaintiffs with $20,000 “General Release Enhancement Payments” as consideration for their execution of the general release. The district court failed to cite any case law supporting such large incentives for what the court called a “side settlement” between themselves and the employer covering additional claims not covered in the class settlement. Reasonable incentive awards are permitted for services to the class, but it was not clear how signing the release served the class, or why the amount of the incentive payment was substantially greater than a typical incentive payment.
Reversionary clause. Lastly, the court took issue with settlement’s use of reversionary funds in the second tier and dance fee payment pools. Reversionary clauses are not prohibited, but they raise the suspicion of collusion as they reduces the amount of money that the employer may have to pay but also increase the value of the settlement amount from which the attorneys’ fee is derived. Here, given the inadequate notice, low claims rate, and disproportionate share of the cash that was allocated to attorneys’ fees, the district court should have examined the clauses more closely, which it failed to do.
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