Coupon Settlements Under Siege

Reprinted with permission by Los Angeles County Bar Association. 

As "guardians of the rights of absentee class members,"[1] trial courts must determine whether proposed class action settlements are "fair, adequate and reasonable" to the class at large.[2]  In the wake of the federal Class Action Fairness Act of 2005 (CAFA) and recent federal and state court decisions, no other type of settlement has drawn greater scrutiny by trial courts conducting fairness hearings than so-called coupon settlements.  This is the result of what CAFA's proponents claimed were abusive settlement practices that resulted in little value to class members but significant fee awards to class counsel.[3]

Yet what exactly constitutes a coupon settlement remains unsettled, particularly in the absence of a statutory definition in CAFA.  These settlements can take various forms, including coupons, discounts, other in-kind compensation, or a combination of these elements.  Indeed, some courts have distinguished between "pure coupon settlements" and "variant[s] of the coupon settlement[s]" based on whether class members receive discounts that require them to make new purchases.[4] Ultimately, any settlement with some provision for nonmonetary compensation may be regarded as a coupon settlement.[5]

Coupon settlements create tough issues for courts to resolve when their actual value is difficult for the parties and the court to ascertain.[6] Unlike cash settlements, coupon settlements typically involve offers for discounted goods or services whose actual value may differ significantly from their face value.  As a result, ascertaining fairness often requires a more complex economic analysis than other types of settlements, and in some cases expert testimony is crucial.

Additionally, state and federal courts treat coupon settlements differently.  While federal courts strictly scrutinize these settlements under CAFA,[7] California has no analogous legislation, and California state courts have rejected the notion that coupon settlements are inherently suspect or improper.[8]

Court approval of coupon settlements hinges on how the settlement is structured, how its value to the class is determined, and the venue in which the dispute is being resolved.  Approval also depends upon the breadth of information litigants provide the court to enable it to properly assess the settlement's fairness.  Only after these matters are considered, addressed, and supported by appropriate evidence can parties ensure that the settlement will be approved at the fairness hearing.

Coupon Settlements under CAFA

In addition to significantly expanding federal jurisdiction over class actions,[9] several CAFA provisions require special scrutiny of coupon settlements in class actions pending in federal courts.  These provisions are applicable for cases originally filed in federal court and for those removed from state court.[10]

For example, prior to approving a coupon settlement, federal courts must hold a hearing and make specific findings that the settlement is fair, reasonable, and adequate, and that the class's interests are adequately represented.[11] This determination involves a consideration of numerous factors:

1)  The strength of the plaintiff's case.

2)  The risk, expense, complexity, and duration of further litigation.

3)  The risk of maintaining class action status.

4)  The amount offered in settlement.

5)  The extent of the discovery that has been completed.

6)  The experience of counsel.

7)  The presence of a governmental participant.

8)  The reaction of class members to the proposed settlement.[12]

Courts have noted that the "fair, reasonable and adequate" standard under CAFA is identical to the standard that has been in place under Rule 23(e) of the Federal Rules of Civil Procedure.[13] Under this standard the court usually presents its fairness determination in a writing after conducting the fairness hearing.[14] Nevertheless, CAFA has been invariably construed to require "the application of a higher level of scrutiny to the...criteria that existed pre-CAFA."[15] Courts applying this higher standard rely on CAFA's legislative intent.  Further, they note that coupon settlements "have been severely criticized by commentators in the field" and "are strongly disfavored by the Attorneys General of most of the states."[16]

Prior to the enactment of CAFA's coupon settlement provisions, the Ninth Circuit Court of Appeals held that fees may be based on the value "of the entire common fund created for the class, even if some [class] members make no claims against the fund so that money remains in it that otherwise would be returned to the defendants."[17] This standard remains applicable for settlements that do not include coupon components.[18]

However, CAFA regulates attorney's fees in coupon settlements by providing that any portion of fees attributable to the award of the coupons "shall be based on the value to class members of the coupons that are redeemed" rather than the theoretical value of the coupons available for redemption.[19] Redemption rates can be affected by various factors, including the eligibility and use restrictions associated with the coupons and the transaction costs involved in redeeming them.  Further, because valuation can be complex, CAFA provides that the court "may receive expert testimony...on the actual value to the class members of the coupons that are redeemed."[20]

Substantial creative energy has been spent crafting settlements that resolve class actions and provide class members with a benefit that the parties believe a court will approve as fair, adequate, and reasonable.  Several post-CAFA cases include parameters for how courts should define and value coupon settlements and illustrate the types of settlements that are likely to receive court approval.  Some of these cases reflect an inherent bias against coupon settlements and their derivatives.

In Synfuel Technologies, Inc. v. DHL Express,[21] for example, the trial court approved a settlement that offered up to four prepaid DHL shipping envelopes or $30 cash in addition to injunctive relief.  Noting that the trial court's role in reviewing a settlement agreement is "akin to the high duty of care that the law requires of fiduciaries,"[22] the Seventh Circuit reversed because "the [trial] court did not attempt to quantify the value of [the] plaintiffs' case or even the overall value of the settlement offer to class members."[23] The court also criticized the "in-kind compensation" component of the settlement, noting that it was akin to coupons.  While the DHL shipping envelopes were not "identical to coupons" because they represented an "entire product, not just a discount on a proposed purchase," they nevertheless shared some characteristics of coupons because some percentage of the prepaid envelopes would not be used and thus would not constitute a cost to the defendant.  Like coupons, the envelopes also forced class members to continue doing business with the defendants.  Given these similarities, the court stated that, even if CAFA was not theoretically applicable, the "in-kind compensation" component of the settlement was subject to higher scrutiny by the trial court.[24]

In some circumstances, giving class members a complete, and free, product might prove valuable and acceptable because it does not create a continuing business relationship between the class members and the defendant.  Yeagley v. Wells Fargo & Company illustrates the point.[25] In Yeagley, the parties reached a settlement agreement in which each class member was eligible to receive two free credit reports and a $50 discount on a new mortgage.  Noting the absence of a statutory definition of "coupons" under CAFA, the Northern District of California reasoned that the settlement "arguably provided the class with a ‘coupon' for a free...credit report."[26] The court suggested that "a free credit report is unlike a coupon in that it does not require a class member to do business with Wells Fargo, and it entitles the member to a whole product...rather than merely a discount." Even if the credit report did not fall under CAFA's coupon provisions, the court concluded, CAFA was nevertheless "instructive."[27]

Then the court analyzed the value of the settlement-to determine whether it was fair and adequate, and to calculate the fee award.  It valued the settlement by multiplying the number of redemptions (less than 1 percent) by the price that Wells Fargo paid for each report, rather than the actual cost of the report to the public at large.[28] The court reasoned that the second credit report presented no value to the class because the likelihood of redemption was negligible, and the $50 discount was merely a marketing opportunity for Wells Fargo that provided no benefit to the class.  Despite these findings, the court nevertheless concluded the settlement was fair and adequate because the plaintiffs' prospects for prevailing in the litigation were "so bleak as to render this a ‘good value' for a relatively weak case."[29]

Credit reports were also at issue in Acosta v. Trans Union, LLC, in which the Central District of California evaluated a settlement that provided free credit reports to the class and a cash component to certain class members.  Although the court did not characterize the credit reports as coupons, it closely scrutinized the settlement and concluded that the reports provided little or no value to the class because consumers were already entitled to one free credit report, which most consumers did not redeem.[30] The court also noted that few class members would qualify for the cash component and found that class counsel had conducted very limited discovery and did not even consult any experts until the settlement was finalized.  Therefore, the court rejected the settlement, noting in particular that "the economic value of the Settlement pales in comparison to [the] Plaintiffs' potential recovery through litigation."[31] The court was particularly critical in light of its finding that the proposed attorney's fees of roughly $5.5 million was "so grossly out of proportion to the class members' probable aggregate recovery as to suggest a strong possibility of impropriety."[32]

Coupons that create a continuing business relationship may be approved, but their terms must demonstrate value to the class.  In Figueroa v. Sharper Image, the settlement provided class members with $19 coupons for use at the defendant's stores plus a guard to protect against emissions of allegedly defective air purifiers.[33] After the parties received considerable objection to the original settlement agreement, they retained a "nation-wide expert on coupon settlements" to improve the settlement and cure the objections.[34] The third draft of the agreement enlarged the redemption period, provided for the transferability and aggregation of the coupons, allowed their use against any product, and included a provision for cy-pres distribution to certain charities.[35]

Applying a "greater level of scrutiny," the Southern District of Florida rejected the settlement, reasoning that it was not the product of an informed, arm's-length negotiation.  The parties failed to provide the court with sufficient information regarding the potential value of the litigation and the range of possible outcomes.  Thus "the issue of whether the $19 is sufficient [had] still not been answered."[36] The court also rejected the use restriction improvements suggested by the parties' expert, noting that "enhancements to what is nothing more than a coupon settlement" did not make it "fair, adequate or reasonable."[37]

Other federal decisions show greater favor for agreements that include variants of a coupon settlement.  In Fleury v. Richemont North America, Inc., the Northern District of California reasoned that "it is the settlement, taken as a whole, rather than the individual component parts, that must be examined for overall fairness."[38] The Fleury court approved a settlement of an antitrust class action brought by two classes of watchmakers and consumers alleging that the defendant's illegal tying arrangement precluded independent watchmakers from repairing Cartier watches.[39] The settlement called for the defendant to, inter alia, expand its network of authorized repair workshops, pay certain watchmakers the costs for Cartier-specific tooling, and issue $100 transferable credit vouchers to the consumer subclass.  The court found that "the settlement value, although not great, [was] not without any worth" and was "appropriate in light of the significant litigation risks attendant to [the] Plaintiffs' case."[40]

In Young v. Polo Retail, LLC, the same court approved a proposed class settlement for $1 million in cash and $500,000 in gift cards to class members.[41] While noting that "the primary downside of the proposed settlement is the use of product vouchers," the court reasoned that the vouchers did not have product restrictions and were fully transferable.[42] Presumably because the gift cards did not constitute coupons, the court did not decide the case under CAFA, and thus did not limit attorney's fees based on the number of actual redemptions.[43]

Another Northern District decision offers a way to distinguish settlements providing for free goods from those providing only coupons.  The court in Browning v. Yahoo! Inc. approved two class action settlements providing class members with either a free credit score or two months of free credit monitoring.[44] The court determined that "the in-kind relief offered in this case is not a ‘coupon settlement' because it does not require class members to spend money in order to realize the settlement benefit."[45] It concluded that the settlement, "although modest, is appropriate and valuable" and recognized that "settlement, as a product of compromise, typically offers less than a full recovery."[46]

California's Presumption of Fairness

California state courts generally give coupon settlements greater deference than their federal counterparts.[47] State courts are not bound by CAFA and "have never adopted Rule 23 as a procedural strait jacket."[48] To the contrary, "trial courts [are] urged to exercise pragmatism and flexibility in dealing with class actions"[49] and must give "due regard...to what is otherwise a private consensual agreement between the parties."[50]

While state courts generally follow a similar analytical framework as federal courts in assessing fairness,[51] a state court settlement is presumed fair if:

(1) the settlement is reached through arm's-length bargaining;

(2) investigation and discovery are sufficient to allow counsel and the court to act intelligently;

(3) counsel is experienced in similar litigation; and

(4) the percentage of objectors is small.[52]

This presumption applies with equal force to coupon settlements, which are neither per se improper nor subject to heightened scrutiny.[53] Moreover, the California Court of Appeal recently distinguished between "pure coupon settlements" and "variant[s] of coupon settlements," suggesting that the latter should receive more deference.[54]

In Chavez v. Netflix, Inc., the court approved a class action settlement that provided one month of free DVD rental services or membership upgrades.  One objector appealed, claiming that CAFA regarded coupon settlements as "highly suspicious" and "inherently suspect" and therefore required greater scrutiny under state law.[55] The objector further argued that the settlement was an improper coupon settlement because it provided a free service of nominal value while giving the defendant a promotional opportunity.[56]

The Chavez court upheld the judgment, noting that the objector had failed to challenge any of the factors establishing a presumption of fairness.  Moreover, the court concluded that the settlement was not a "pure coupon settlement," explaining that:

In a pure coupon settlement, the class members would receive a coupon, voucher, or discount that would partly defray the cost of making a new purchase of goods or services from the defendant.  In many cases, the coupon might induce the member to make a purchase he or she would not otherwise have made, which may actually produce a net benefit for the defendant.[57]

In contrast, the DVD subscription at issue in Chavez was "a variant of the coupon settlement" because class members were not necessarily required to make a purchase, and the potential benefit to the defendant was reduced, limited, or altogether absent.[58]

The court of appeal's affirmance of the trial court's ruling was based squarely on the factors establishing a presumption of fairness.  It noted that the agreement resulted from arm's-length bargaining during mediation with a respected magistrate judge, the parties had engaged in extensive discovery, the attorneys possessed substantial experience in class action litigation, and the percentage of objectors to the settlement was small.[59]

Chavez follows a line of California cases approving coupon settlements based on evidence establishing a presumption of fairness.  In Dunk v. Ford Motor Company, a 1996 pre-CAFA case, the court approved a settlement in which class members received coupons for $400 off the price of a new vehicle.[60] The court established and applied the four-factor test and found the settlement presumptively fair, noting in particular that the parties conducted extensive discovery, the number of objectors was small, and the settlement coupons represented at least two-thirds of the highest noted damages to class members.[61]

More recently, in Wershba v. Apple Computer, Inc., the court of appeal approved a class settlement that provided class members with either a $35 reimbursement or $50 coupon toward any purchase over $99.[62] The court noted this settlement was "much more attractive" than the deal in Dunk because the coupons were transferable (although they could not be aggregated), and some class members were eligible for cash reimbursements.  Furthermore, "[i]n the context of a settlement agreement, the test is not the maximum amount plaintiffs might have obtained at trial on the complaint, but rather whether the settlement is reasonable under all of the circumstances."[63]

The approach of California courts has changed little since CAFA's enactment.  In In re Microsoft I-V, the trial court approved a settlement providing vouchers ranging from $5 to $29.[64] The settlement also included a cy-pres remedy in which a portion of unclaimed vouchers was redistributed to California schools to provide indirect compensation to the class and ensure disgorgement by the defendant.  The settlement thus provided a "fair and reasonable residual distribution" that was "as near as possible" to accomplishing the overarching purposes of the litigation.[65] In re Microsoft thus illustrates the types of "enhancements" that provide increased value to the class, including the aggregation and transferability of the coupons, long redemption periods, and a residual distribution plan.[66]

At least three unpublished, post-CAFA, state court decisions have also upheld coupon settlements based on evidence establishing a presumption of fairness.  For example, in Intervention, Inc. v. Avanir Pharmaceuticals,[67] the court approved a settlement that provided 50 million vouchers to class members and $1 million in cold sore research grants.  The court observed that while class members received a nominal $3 discount, the grant funds provided a significant benefit to the entire class, particularly given the difficulty in locating class members.[68] In Vroegh v. Eastman Kodak Company, the court approved a settlement providing a 5 percent refund or 10 percent discount on future purchases of flash memory drives.[69] In Campbell v. Airtouch Cellular, the court approved a settlement providing two vouchers for a service credit, six months of text messaging, a phone accessory, long distance minutes, and/or a hands-free device.[70]

While giving coupon settlements more deference, California state courts arguably place less emphasis on an analysis of the underlying action's merits or the valuation of the settlement.  Thus "the merits of the underlying class claims are not a basis for upsetting the settlement of a class action," and "the proposed settlement is not to be judged against a hypothetical or speculative measure of what might have been achieved had [the] plaintiffs prevailed at trial."[71] The trial court's fairness analysis is ultimately "nothing more than an amalgam of delicate balancing, gross approximations and rough justice."[72] Thus, coupon settlements under California state law may not require the more nuanced economic analyses often used, and sometimes required, under CAFA.

Structuring a Coupon Settlement

Whether a case is pending in state or federal court, properly structuring a coupon settlement is crucial to obtaining final approval from the trial court.  Courts are more likely to approve coupon settlements that impose no use restrictions, or only very limited ones, on the coupons.  For example, coupons that are freely transferable and do not have aggregation limits provide more value to the class members, as do coupons that have longer redemption periods and are not limited to particular products or services.  Coupon settlements that avoid restrictions on use and transferability or that include enhancements, in-kind compensation, and/or cash components are also less likely to draw opt-outs and objectors.  This will in turn facilitate the trial court's decision to approve the settlement.  A hybrid settlement that includes a cash component or a variant of the coupon settlement that provides in-kind compensation is also likely to receive greater deference.

To be successful, a motion for final approval of the settlement must also include sufficient information to enable the trial court to make an informed analysis of the fairness factors under state or federal law.  At a minimum, the motion must provide an appropriate level of detail regarding the discovery efforts and settlement negotiations of the parties.  If the settlement was reached through mediation, the parties should inform the court of the mediator's endorsement of the settlement.  Depending on the complexity of the coupon settlement, the parties should also consider retaining an expert to assess its value.

Litigants should remind the trial court of the policies in state and federal court favoring the settlement of disputes.  Those policies are furthered by approving the settlement of particularly weak-and particularly strong-cases early.  Thus, in order to put the settlement in proper perspective, the parties should provide the trial court with a cogent analysis of the strengths and weaknesses of the claims and defenses.  Only in view of the facts and law applicable to the case can the court properly assess whether the settlement is fair, adequate, and reasonable.