Courts have been reviewing class action settlements with increasingly close scrutiny, especially when the settlement involves cy pres awards donated to charity. The U.S. Court of Appeals for the Ninth Circuit recently struck down such a settlement, holding that the proposed cy pres award failed to benefit class members and that the proposed attorneys’ fees for class counsel were excessive. Dennis v. Kellogg Co., --- F.3d ---, 2012 WL 2870128 (9th Cir. July 13, 2012). Dennis is an important reminder to defendants to approach settlements involving a heavy cy pres component with caution.

In Dennis, plaintiffs asserted that Kellogg had made “marketing claims regarding the effect of Frosted Mini-Wheats on children’s attentiveness [that] were false” and that lacked adequate scientific support. Plaintiffs sued under various state consumer-protection statutes. Following settlement discussions—and shortly after the filing of an amended complaint—plaintiffs and Kellogg agreed to settle the lawsuit. 

The settlement agreement provided that Kellogg would establish a $2.75 million fund for class members, from which each class member who submitted a claim would receive $5 per box of cereal purchased, up to a maximum of $15 (at the time of oral argument, class members had submitted about $800,000 worth of claims, according to class counsel). The agreement contained a significant cy pres component: all unclaimed settlement funds would be distributed to unspecified charities, and an additional “$5.5 million ‘worth’ of specific Kellogg food items” would be distributed to charities for the indigent. The settlement also called for $2 million in attorneys’ fees and costs to be paid to class counsel. The district court approved the settlement over the objection of two class members.

The Ninth Circuit reversed and remanded the case for two reasons. First, the court held that the cy pres awards were improper. The court explained that “[t]o ensure that the settlement retains some connection to the plaintiff class and the underlying claims, …a cy pres award must qualify as ‘the next best distribution’ to giving the funds directly to class members.” According to the court, because the plaintiffs’ claims were that Kellogg made “alleged misrepresentations,” the “appropriate cy pres recipients” for a settlement involving such claims “are not charities that fund the needy, but organizations dedicated to protecting consumers from, or redressing injuries caused by, false advertising.” Feeding the indigent, the Ninth Circuit said, had “little or nothing to do with the purposes of the underlying lawsuit or the class of plaintiffs involved”—even though it was a “noble goal.”

Moreover, the court noted that it was obliged to pay “special attention” to the risk that the agreement “favor[ed]” class counsel’s “pursuit of [their own] self interests rather than the class’s interests.” According to the Ninth Circuit, “[c]y pres distributions present a particular danger in this regard” because “the selection process may answer to the whims and self interests of the parties, their counsel, or the court.” And the court held that the requirement that “Kellogg will donate ‘$5.5 million worth’ of food” is “unacceptably vague” because it did not state whether (i) the value of the food would be measured “at Kellogg’s cost,” at “wholesale value,” or at “retail” cost; (ii) Kellogg could take a tax deduction for the donated food; or (iii) whether “Kellogg has already obligated itself to donate” that food in previously planned charitable giving.

Second, the Ninth Circuit held that the award of attorneys’ fees improperly “grants [class] counsel a disproportionate distribution of the settlement compared with the benefit to the class”—leading the court to conclude that “it is possible the settlement was driven by fees.” The Ninth Circuit calculated that the requested $2 million fee award was “about 4.3 times” the “lodestar amount” (i.e., reasonable hourly rates times reasonable number of hours worked). That award “breaks out to just over $2,100 per hour”—an “extremely generous” amount that not even “the most highly sought after attorneys” charge their clients. The Ninth Circuit rejected such “windfall profits for class counsel” as unreasonable under the circumstances, which included “(1) the parties moved for settlement approval only three months after class counsel filed the amended complaint; (2) the settlement results in vaporous benefit to the class members and is flawed at its core; and (3) class counsel’s financing of the litigation and investment of time were rather limited.”

The Ninth Circuit’s decision in Dennis is a reminder to parties who enter into class settlements that federal courts will not simply rubber stamp those settlements. When defendants negotiate class settlements, they should carefully assess whether those settlements will be subject to attack—and the resulting, protracted approval process—especially if the settlement calls for attorneys’ fees that outstrip concrete benefits to class members or for use of a cy pres award as a substantial component of the total relief available.