April 29, 2003
Background Paper
The Need for Class Action Reform

Class action lawsuits allow plaintiffs whose injuries might not be worth enough to justify
bringing individual suits to combine their damages into one lawsuit against a common
defendant. Class action lawsuits can facilitate the fair and efficient resolution of legitimate
claims of numerous parties. For those reasons, federal and state courts’ rules of civil procedure
enable litigants to proceed on a class basis in appropriate cases.

In recent years, however, a relatively small number of class action plaintiffs’ attorneys
have abused the class action procedures. The effects have been dramatic: a distortion of our
federalist system by the actions of a few rogue state courts; excessive compensation of attorneys
at the expense of injured plaintiffs; unprecedented costs to the national economy; and an overall
decline in public respect for our nation’s judicial system.

Congress has been attempting to reform the class action rules for several years despite
strong resistance from trial lawyers. On April 11, the Senate Judiciary Committee reported the
Class Action Fairness Act (S. 274) after a favorable, bipartisan vote. The RPC will release a
Legislative Notice when S. 274 is to be debated on the floor. Until then, this background paper
examines why class action reform is necessary.

The Role of Federal Courts in Multi-State Class Actions
The U.S. Constitution provides for federal jurisdiction over all lawsuits between citizens
of different states, i.e., those cases where the parties are of “diverse” citizenship.1 The first
Congresses enacted legislation narrowly construing “diversity jurisdiction” – long before the
class action procedure had been contemplated.2 Today, the most obviously “national” types of
litigation – multi-million-dollar class action cases involving national companies engaging in
interstate commerce with citizens of many states – are often stuck in state court. This is so
because Congress has narrowly construed constitutional diversity to require all plaintiffs to be
diverse from all defendants: “complete diversity.” Consequently, national class actions with
plaintiffs from all 50 states and defendants from multiple states are rarely eligible for federal court.

The result is that a few state courts are deciding cases with great national significance and
effectively regulating national industries and professions beyond their state borders.
Much has been written accusing these state courts of incompetence, anti-business biases,
and outright corruption. The Constitution provides for federal jurisdiction over cases between
citizens of different states precisely so that parties never have to deal with questions of local
bias. As Chief Justice Marshall once observed, “[H]owever true the fact may be, that the
tribunals of the states will administer justice as impartially as those of the nation, to parties of
every description, it is not less true that the Constitution itself either entertains apprehensions on
this subject, or views with such indulgence the possible fears and apprehensions of suitors, that it
has established national tribunals for the decision of controversies between aliens and a citizen,
or between citizens of different states.”3 The Senate need not pass judgment on the quality of
state court judges – most of whom are undoubtedly of high integrity and competence – to
recognize that parties to litigation should have a right to the protection of the constitutional
safeguard, and that nationwide class actions should not be barred from the federal courts.

The Growing Abuse of Coercive Interstate Class Actions
A literal class action industry devoted to finding opportunities to extract financial
payments from American business has developed in the past few decades. This class action
industry is dominated by a focused group of class action plaintiffs’ attorneys who “shop”
throughout the nation for the friendliest courts to hear possible cases. As a result, businesses
operating in the United States are increasingly at risk of being hauled into select state court
jurisdictions where judges are quick to certify a class and where juries are wont to render
extravagant awards.4 Moreover, because each state is sovereign, the same defendant often faces
copycat cases in different states, which frequently result in inconsistent judgments.
Forum-shopping has enabled clever attorneys to file in state court many lawsuits that
implicate citizens of many states and interstate commerce – precisely the kinds of lawsuits best
suited to the federal courts. However, due to the antiquated requirement of “complete diversity”
in citizenship among plaintiffs and defendants, these attorneys have been able to craft their
pleadings to evade federal court jurisdiction. For example, in Madison County, Illinois – one of
the most notorious of the plaintiff-friendly class action jurisdictions in the nation5 – a South
Carolina law firm filed a purported class action on behalf of three named plaintiffs, none of
whom lived in Madison County, against 31 defendants throughout the United States, none of
whom were located in Madison County.6 Instead, they base jurisdiction on the mere allegation
that some as-yet-unknown class members live in Madison County.
The effect of encouraging such forum-shopping has been dramatic. One study estimates
that “[v]irtually every sector of the United States economy is on trial in Madison County, Palm
Beach County [Florida], and Jefferson County [Texas] – long distance carriers, gasoline
purchasers, insurance companies, computer manufacturers and pharmaceutical developers.”7

Current Class Action Abuses Continue to Harm Plaintiffs
Injured plaintiffs can also suffer due to insufficient judicial oversight of lawsuits that
have come to be dominated by class action attorneys. The costs of litigation and the windfall
profits to attorneys have produced a legal system that returns less than 50 cents on the dollar to
people it is designed to help, and only 22 cents to compensate for actual economic loss.8
As a by-product of attorney-dominated class action litigation, many class action
settlements consist of disproportionate payments of attorneys fees to plaintiffs’ attorneys and
nothing of real value to the injured plaintiffs. Indeed, in some settlements, the plaintiffs receive
no cash whatsoever, while the attorneys purporting to represent them receive millions of dollars.
For example, in a case against Blockbuster, Inc., customers who alleged they were charged
excessive late fees for video rentals were to receive $1 coupons while their attorneys received
over $9 million.9 In an Illinois case about cellular phone charges, settling class members
received coupons to buy future products (but not to pay current bills), while their attorneys
received more that $1 million in fees.10 In a similar “coupon” case settlement in California, class
members received a $13 rebate towards the purchase of new computer monitors, while their
attorneys received $6 million.11 Given the unlikelihood that many class members will ever be
able to convert these “coupons” into much of value, these settlements have the effect of granting
the attorneys the vast majority of the economic value of the settlements.
Injured parties also suffer when they receive complicated settlement notices that do not
adequately explain their right to challenge the settlement or to enjoy the full benefits of the
settlement. Even more troubling, some have accused defendants of conspiring with plaintiffs’
attorneys to produce confusing notices in order to ensure that the actual economic value of the
settlement to the class members is lower than reported to the court.12 Relatedly, some
settlements have been crafted to provide very large payments to the “named” plaintiff – the
original plaintiff who brought the suit prior to class certification – in order to persuade that
plaintiff to agree to a settlement that will give fellow class members far less compensation (if
any). Additional judicial scrutiny is necessary to ensure that the class members – those who
allegedly have been injured, as opposed to their attorneys – understand their rights.

The Costs of Runaway Litigation to the National Economy
Over the past decade, class action lawsuits have grown by over 1,000-percent.13 This
growth in class action litigation contributes to the increasing burdens that civil lawsuits place on
the American economy.14 While some of that increase in class actions may be due to legitimate
increases in injuries to innocent plaintiffs, it is also due to a myriad of lawsuits filed with the
intent of forcing early settlements. Plaintiffs’ attorneys have manipulated the class action legal
procedures in certain states to force early settlements on even the most frivolous of claims,
especially if a pliant judge can be persuaded at an early stage to certify the case as a class action.
Because class actions aggregate many potential claims into one lawsuit, and because many
unfair, or even unconstitutional, certification rulings cannot be appealed until after an expensive
trial on the merits, defendants often face the risk of a single judgment in the tens of millions or
even billions of dollars.

The risk of a single, bankrupting award often forces defendants to settle the case with
sizable payments even when the defendant has meritorious defenses. As one federal court
explained, “The risk of facing an all-or-nothing verdict presents too high a risk, even when the
probability of an adverse judgment is low. These settlements have been referred to as judicial
blackmail.”15 Thus, defendants facing non-meritorious class action lawsuits must decide
whether to assume even a slight risk of an unfavorable jury award that could bankrupt the
company. This “judicial blackmail” imposes increased costs on the economy, causing higher
prices and lower wages (along with the enrichment of those attorneys who brought the weak
claims in the first place).

Noting this drag on the American economy and the difficulty that insurers have in
accounting for litigation risk, the chairman of Lloyd’s of London recently remarked, “In such an
environment, what hope is there to keep the spirit of risk-taking alive, to fuel the appetite for
innovation and creation? Would those who trekked their way across the dusty plains, or built up
vast commercial empires, or realised the dream of putting man on the Moon – would they have
achieved any of this if they had to face the threat of being sued?”16 When litigation costs
become too unpredictable, the effect will be to dissuade investment, discourage
entrepreneurship, increase the costs of risk planning, and threaten the core economic activities
that have long characterized American capitalism.

S.274’s Reforms Will Address These Problems
As will be discussed more fully in the forthcoming Legislative Notice, S.274 remedies
the problems discussed in this background paper. First, it expands federal jurisdiction over class
actions by eliminating the need for “complete diversity.” The effect of this change will be to
drive those cases that are multi-state, or national, in scope to federal court, while keeping state
courts involved in adjudicating matters that primarily involve the forum state. This expanded
federal jurisdiction will also eliminate the allure of forum shopping for the most favorable forum
because defendants will be able to avail themselves of unbiased federal courts in high-dollar,
multi-state cases.

The bill also has several consumer-protection provisions. It requires that notices be clear
and not bogged-down with “legalese” so that plaintiffs can better understand their rights. It also
requires that state attorneys general, or other relevant state officials, be notified of pending class
action settlements so that these elected officials can protect their citizens. The bill also requires
federal judges to scrutinize non-cash settlements to ensure that plaintiffs are treated fairly when
their lawyers get cash settlements but they get coupons. And, it requires that the Judicial
Conference study ways to ensure that lawyers are not getting unfair, outrageous fees at the
expense of consumers.
Conclusion

Class actions are an important part of our litigation system that, when used properly,
should produce a net savings to the litigation system and just recoveries to injured parties. But
without reform, the class action process will remain a system ripe for exploitation, and the harm
to the fundamental fairness of the civil justice system will continue to grow.

http://www.senate.gov/~rpc/releases/2003/jd042903.pdf

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