Thursday, March 4, 2010

2d Circuit rejects "common fund" method in awarding class action attorneys' fees

The Court of Appeals holds in a class-action settlement case that the district court can award attorneys' fees based on the traditional lodestar method rather than the common-fund model.

The case is McDaniel v. County of Schenectady, decided on February 16. The County settled a class action alleging that the County jail was strip searching inmates in violation of the Constitution, a practice that the Second Circuit deemed illegal in 2001. The settlement fund for aggrieved class members was $2.5 million. The parties agreed that plaintiffs' counsel would recover up to 26 percent of that fund in attorneys' fees, or $650,000. This is how many class actions are often resolved, but the trial court here applied a variant of the Second Circuit's recent Arbor Hill v. County of Albany, 522 F.3d 182 (2d Cir. 2008), which articulates a variety of factors, including the attorney hours expended and their hourly rates, in assessing a reasonable fee award. Under Arbor Hill, courts also bear in mind that "a reasonable paying client wishes to spend the minimum necessary to litigate the case effectively” and that a paying client's negotiating position may be strengthened by the attorneys’ “desire to obtain the reputational benefits that might accrue from being associated with the case.” This model will drive down attorneys' fees awards (since the hypothetical client will want to pay as little as possible), but that's a topic for another day.

The trial court awarded plaintiffs' counsel $344,795, holding that the case was not particularly complex, counsel had worked on similar cases in the past (which means "some of the ground work for this litigation was already established") and the trial court "took note of the compelling public policy issues for keeping an eye on attorneys' fees in class action cases." In the end, this reasoning is a departure from the way that attorneys' fees in class actions are typically awarded.

The Court of Appeals (Livingston, Walker and Kaplan, D.J.) affirms, however, noting that the trial court has discretion to resolve attorneys' fees disputes and that the Second Circuit has authorized this method in the past. The Court further rejects plaintiffs' argument that the more lucrative common-find approach should be the presumptive method in class actions. Other Circuit courts have agreed with this argument, but the Second Circuit will not.

Of interest to litigators, the Court then sets out the limitations and advantages of both the lodestar and common-fund methods:

The lodestar method is not perfect. It creates an incentive for attorneys to bill as many hours as possible, to do unnecessary work, and for these reasons also can create a disincentive to early settlement. Under certain conditions, moreover, lodestar awards can create the near opposite incentive, encouraging attorneys to settle before trial even when it is not in their clients’ best interest. While under the lodestar method lawyers share the “downside” risk of trial (i.e., the possibility of an adverse judgment, and hence no fee), they do not share in the potential economic “upside” (i.e., fees as a percentage of a large common fund), especially since trial requires comparatively fewer hours than the process of trial preparation. Although the district court is charged with ensuring the fairness of a proposed settlement, including any lodestar-based attorneys’ fee award, this task is often challenging in common fund cases, especially because – since the attorneys’ fees are drawn from a common fund rather than being paid separately by the defendants – there is little incentive for the defendants to contest the size of the fee. To the contrary, plaintiffs’ and defendants’ lawyers share an interest in the approval of an agreed upon settlement. As a result, the district judge “los[es] the benefit of an adversarial process, which may . . . inform[] and sharpen[] the judicial inquiry.”

But the percentage method has its limitations as well. [T]his Circuit’s adoption of the lodestar method was precipitated by the perception that percentage fees “tended to yield too little for the client-class, and an unjustified ‘golden harvest of fees’ for the lawyer.” Particularly in cases that result in a very large monetary award, the percentage method holds the potential to result in attorneys’ fees many times greater than those that would have been earned under the lodestar of hourly rate multiplied by hours worked. “The principal analytical flaw” in Appellants’ argument for a presumptive percentage award as a “benchmark” in common fund cases lies in the “assumption that there is substantial contingency risk in every common fund case” that would justify such a multiplier. Moreover, although the percentage method has the advantage of aligning the interests of plaintiffs and their attorneys more fully by allowing the latter to share in both the upside and downside risk of litigation, it can create perverse incentives of its own, potentially encouraging counsel to settle a case prematurely once their opportunity costs begin to rise. And as in the case of the lodestar method, neither defense counsel nor the actual plaintiffs have much of an incentive under the percentage-of-fund approach to oppose an award of attorneys’ fees, the latter since “[t]hey have no real incentive to mount a challenge that would result in only a ‘minuscule’ pro rata gain from a fee reduction.”

These competing arguments for and against the lodestar and common-fund methods of awarding attorneys' fees convince the Court of Appeals that the district court (which is most familiar with the case) is in the best position to fashion a fee award, and that it did not abuse its discretion in awarding plaintiffs' counsel $344,000. The Second Circuit seems to believe that this case was not that complex in light of the state of the law at the time the strip searches were challenged and counsel's groundwork in litigating similar cases in other counties. For these and other reasons, the trial court did not commit reversible error in applying the 12 Arbor Hill factors in awarding fees. While Arbor Hill involved statutory fees and the case against Schenectady County's strip searches is a common fund case arising from a constitutional dispute, the Court of Appeals rejects the "assumption that the lodestar method employed in the common fund context is distinct from that employed in the statutory context."

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