A recent decision denying certification of a securities-fraud class action underscores that plaintiffs must prove with evidence that they satisfy the requirements of Federal Rule of Civil Procedure 23, not merely allege that they do so or promise that they can.

The decision in In re Kosmos Energy Limited Securities Litigation arose from a class action filed in the Northern District of Texas by plaintiffs challenging certain statements made in connection with the defendant’s initial public offering (“IPO”). The court denied the plaintiff’s motion to certify a putative class of stock purchasers.

In its opinion, the court provided a useful overview of class-certification law, explaining that courts have moved “away from the presumptively pro-plaintiff view” of class actions that had prevailed decades ago. The court explained that “[g]oing forward, the clear directive to plaintiffs seeking class certification—in any type of case—is that they will face a rigorous analysis by the federal courts, will not be afforded favorable presumptions from the pleadings or otherwise and must be prepared to prove with facts—and by a preponderance of the evidence—their compliance with the requirements of Rule 23” (emphases added)

The court concluded that the plaintiff had failed to provide evidence establishing that it would be an adequate class representative or that common issues of law or fact would predominate over individualized ones. The plaintiff had attempted to rest in large part on allegations in the complaint and broad statements in dicta in past decisions. The court didn’t buy it.

The court first explained that “adequacy is the plaintiff’s burden to prove—not the defendant’s burden to disprove.” The court also criticized the plaintiff’s declaration attesting in impossibly vague terms that she had “reviewed” the pleadings and “supervised” her lawyers. As the court put it, “this type of generic detail is really no detail at all, for it provides naught by which to assess [the plaintiff’s] credibility, her knowledge about the underlying facts of the case, or how much of what she has stated may have been prompted by counsel. Indeed, any potential class representative in any securities case could make almost identical assertions.”

With respect to predominance, the court concluded that the plaintiffs were effectively asking for an assumption that securities class actions are certifiable. That “assumption,” the court explained, was “ill-founded.” The court also emphasized that “[w]hile Defendants offered a 107-page Expert Report demonstrating the need for individual inquiries into investor knowledge, Lead Plaintiff offered no proof from which to draw an inference that individual inquiries may not be required if the Court were to certify this putative class . . . .”

This decision is good news for businesses—and not just in the context of securities-fraud class actions. True, those suits are subject to heightened pleading requirements set forth in the Private Securities Litigation Reform Act (“PSLRA”). But the court’s denial of class certification rested on fundamental principles arising from Rule 23 itself, which applies to all class actions in federal court.

Here’s the situation: You’re facing a class action in federal court in which the plaintiffs define the putative class so broadly as to encompass many people who weren’t injured by the alleged wrongdoing. For example, consider a false-advertising class action on behalf of “all purchasers” of a product that the vast majority of purchasers would have used without any problem whatsoever, meaning that the alleged rarely occurring (or entirely hypothetical) defect that the defendant failed to disclose makes no difference to them. What’s the best way to attack this weakness in the complaint?

One option would be to characterize the problem as a lack of Article III standing. Article III allows courts to hear a case only if the plaintiff has suffered an injury in fact that is fairly traceable to the defendant’s conduct and that could be redressed by a favorable decision from the court. In our hypo, the defendant could move to strike the class allegations on the ground that virtually all of the alleged class members lack standing.

This approach, however, has potential pitfalls. For example, some courts have held that Article III requires merely that the named plaintiffs have standing, a rule that (as plaintiffs argue with some success) allows a class action to go forward even though the putative class includes people who themselves lack standing and thus could not bring their own individual actions. See, e.g., Stearns v. Ticketmaster Corp., 655 F.3d 1013, 1021 (9th Cir. 2011). But see, e.g., Avritt v. Reliastar Life Ins. Co., 615 F.3d 1023, 1034 (8th Cir. 2010); Denney v. Deutsche Bank AG, 443 F.3d 253, 263-64 (2d Cir. 2006). In the wrong jurisdiction, the court will simply deny the motion to strike as foreclosed by circuit precedent.

To avoid this difficulty, the defendant can move to strike the class allegations, using the fact that most class members are uninjured to challenge commonality, typicality, adequacy, and predominance. Of course, because courts are divided over the standing issue, that issue is ripe for eventual Supreme Court review. Defendants therefore should consider raising the standing defect in the alternative in order to preserve the issue (though insofar as standing is jurisdictional, it should be possible to raise it at any time even if it has not been raised before).

But what if the named plaintiffs themselves appear to be uninjured because they didn’t experience the alleged product defect either? The defendant could challenge their standing in a motion to dismiss for lack of subject matter jurisdiction. But there is a risk to doing so. Some federal courts believe that the proper course when the named plaintiffs lack standing is to remand the case to state court, where laxer concepts of standing, more lenient class-certification standards, and antipathy toward out-of-state businesses may hamstring the defendant’s ability to defend itself. To make matters worse, the Tenth Circuit recently held that a district court decision remanding a class action to state court for lack of “standing” is non-reviewable under 28 U.S.C. § 1447(d). See Hill v. Vanderbilt Capital Advisors LLC (pdf), No. 11-2213 (10th Cir. Dec. 27, 2012). Accordingly, unless there is clear Circuit precedent indicating that the district court should not remand in this situation or the state court to which the case would be remanded is not hostile to business defendants, companies confronted with such a dilemma may be better served challenging the merits of the plaintiffs’ claims rather than their standing to assert them.

We’ve been blogging about the Second Circuit’s decision in NECA-IBEW Health & Welfare Fund v. Goldman Sachs (pdf), which held that a named plaintiff in a securities fraud suit might have standing in some situations to assert class action claims regarding securities that he or she never purchased. Yesterday, the Supreme Court denied (pdf) Goldman’s petition for certiorari (pdf) in that case. We’ll continue reporting on the aftermath of the Second Circuit’s decision.

In the meantime, defendants facing these sorts of claims should remember that the Second Circuit’s novel standing test requires that the claims regarding the unpurchased securities raise the same set of concerns as the claims regarding the securities that the named plaintiff actually bought. That limitation should help trim the sails of expansive securities fraud class actions.

In addition, defendants should emphasize that the fact that a named plaintiff may have standing to sue does not mean that he or she can represent a class of purchasers of securities that the named plaintiff never bought. At class certification, the defendant may be able to mount challenges to commonality, typicality, adequacy, and predominance based on the fact that the named plaintiff never bought some of the securities at issue.

The requirement that the named plaintiff must be an adequate class representative is not often the basis for denying class certification. But a recent decision from the Northern District of Illinois in a false-advertising class action illustrates the importance of taking discovery on facts that are relevant to the adequacy standard.

In Lipton v. Chattem, Inc., the district court denied class certification in a case alleging that purchasers of a weight-loss product, Dexatrim, had been deceived because the label did not disclose that its ingredients included hexavalent chromium, which allegedly can cause serious health problems. The court held that the named plaintiff, Tracy Lipton, was not an adequate class representative because her deposition testimony made her subject to a potential defense not applicable to the class as a whole: she admitted that she had not heard of hexavalent chromium at the time of her purchase and that, even if the label had listed hexavalent chromium as an ingredient, she would have bought Dexatrim anyway. These admissions, the court explained, posed a “serious problem” for Lipton’s claims because a jury could easily find that she had not proved materiality and causation (elements of the fraud and statutory consumer-protection claims), reliance (an element of the fraud claim), or a connection between the alleged detriment to her and the alleged benefit to the defendant (a requirement for the unjust-enrichment claim). Those obstacles to proving a claim presumably would not exist for putative class members who knew what hexavalent chromium was or who would not have bought Dexatrim if it had been listed as an ingredient. The court stressed that it did not need to find that a jury would find against Lipton; it held that Rule 23(a)(4)’s adequacy requirement is not satisfied if a jury might find against the plaintiff on grounds not applicable to the class as a whole—the defense need only be “arguable” to defeat class certification on adequacy grounds. The court went on to note that the same potential defenses meant that common issues did not predominate over individual issues and that a class action was not superior to other methods of adjudicating the controversy. In particular, Lipton had not offered “any practicable way” for the court to efficiently resolve key liability issues “without conducting hundreds or thousands of mini-trials”—the same point the Seventh Circuit made with respect to individual damages issues in the Espenscheid case we recently discussed.

Lipton demonstrates why it is essential to question proposed class representatives carefully in depositions; the facts elicited may well reveal that they are subject to individualized defenses that may not apply to some members of the putative class. And sometimes the allegations of the complaint alone will indicate the same thing. In that instance, a defendant can use one of our favorite devices for defeating class certification without discovery—a motion to strike the class allegations. Finally, Lipton and Espenscheid both highlight that defendants faced with potential individualized issues in the case should emphasize the practical difficulties of resolving those issues in a single proceeding; if even one issue cannot be decided without hundreds of mini-trials for each class member, the case should not be certified in the first place.

A recent decision from the Delaware Supreme Court is a reminder that the members of a mandatory class—one in which the class isn’t guaranteed opt-out rights—sometimes may be given the right to opt out in order to pursue their own individual actions.

The decision, In re Celera Corp. Shareholder Litigation (pdf), addressed a class settlement of claims that the directors of Celera Corp. had breached their fiduciary duties in agreeing to a merger with Quest Diagnostics. The settlement promised “therapeutic benefits” to the class of Celera shareholders, such as additional disclosures and changes to the merger agreement that made it easier for Celera to entertain other offers. But the settlement gave class members no damages, it released all shareholder claims related to the merger, and it barred class members from opting out to pursue individual actions. The chancery court certified the class under its Rule 23(b)(1) (because of the potential for inconsistent adjudications) and Rule 23(b)(2) (because the class sought injunctive relief). The chancery court also overruled the objection to the settlement lodged by Celera’s largest shareholder, BVF Partners, which believed that the transaction undervalued Celera and wanted to pursue an individual claim for damages.

On appeal, the Delaware Supreme Court rejected BVF’s challenge to the standing of the named plaintiff. The court ruled that even though the named plaintiff sold its shares before the consummation of the merger, the plaintiff still was an adequate class representative, albeit “barely,” because it owned the shares when the merger was announced and did not “acquiesce” to the merger. The Delaware Supreme Court also saw no merit in BVF’s argument that the class’s potential damages claims should have precluded any class certification except under Delaware’s Rule 23(b)(3), which guarantees opt-out rights to class members. The court explained that Delaware precedent allows shareholders to bring mandatory class actions under Rules 23(b)(1) and (b)(2) in order to challenge director conduct in carrying out corporate transactions.

BVF had better success with its request to opt out of the certified class. The Delaware Supreme Court concluded that the chancery court should have allowed BVF to opt out. Worried that absent class members “could have their claims released without an opportunity to be heard,” the court explained that the chancery court has discretion to permit class members to opt out of (b)(2) classes. The court noted that such discretionary opt-out rights have been allowed when an objector has a distinct claim or when allowing opt outs would facilitate fair and efficient litigation. The court then explained that the “objective of global peace” shared by the parties to the settlement was “outweighed by due process concerns” arising from BVF’s circumstances. In particular, the named plaintiff was “barely” adequate, the “therapeutic relief” afforded by the class settlement was quickly mooted by consummation of the merger, and BVF was a substantial shareholder with a supportable damages claim. The court therefore concluded that barring BVF from opting out was an abuse of discretion.

The Celera decision promises to become an important consideration in negotiating class settlements of challenges to corporate transactions in Delaware and elsewhere. Defendants can no longer count on obtaining global peace from a non-monetary class settlement. And both sides must now be ready to account for the possibility that objecting shareholders may try to obtain opt-out rights.

Plaintiff Christopher Rapczynski testified that he purchased Skinnygirl Margarita mix “because I love my wife,” she “said she liked it,” and she “has my three children and works very hard.” Those all may be good reasons for a nice Valentine’s Day present, but not for bringing a class action. As the Southern District of New York recently held, Rapczynski was an inadequate class representative—not for lack of love—but because he hadn’t relied on the allegedly false claim on the product’s label about which he was suing. For that and other reasons, the court denied certification of a putative class of Skinnygirl purchasers. See Rapczinsky v. Skinnygirl Cocktails LLC (pdf), 2013 WL 93636 (S.D.N.Y. Jan. 9, 2013).

Rapczynski had filed a putative false advertising class action against the makers and distributors of Skinnygirl Margaritas, alleging that the “All Natural” statement on the product label was misleading because the product contains sodium benzoate (a preservative) and mixto (a tequila byproduct). (The Skinnygirl brand was created by reality TV star Bethenny Frankel, but as fans of her show know (and non-fans can learn from Wikipedia), she sold the brand for an obscene amount.)

The court found that Rapczynski was not an adequate representative of the class and that his claims were not typical of those of the putative class members because his deposition testimony confirmed that he hadn’t relied on the allegedly false statement, a necessary element of claims for breach of express warranty and promissory estoppel under New York law. Rapczynski admitted that he had bought the product to thank his wife and because he knew that she enjoyed it, rather than because of anything on the label. His statements further established that “he would have bought that product regardless of price” and that “his belief with respect to its naturalness was irrelevant to his purchasing decision.”

The court also held that Rapczynski’s claims were not typical of those of a putative class of New York purchasers because he had bought the product outside of New York state and thus was attempting “to assert the class’s rights under at least two statutes that do not guard against the [out-of-state] transactions which allegedly caused him injury.”

The court’s denial of class certification serves as a reminder that the deposition of a class representative can be the key to defeating class certification. It is also a reminder that consumers buy products for all sorts of reasons—including ones that have absolutely nothing to do with the representations alleged in a false-advertising or breach-of-warranty complaint. Although not every class representative may be as candid as Rapczynski, the cases serves as a good illustration of the kinds of arguments that defendants in false advertising class actions can develop to show either that the proposed class representative is atypical and inadequate or that the reliance or causation elements of the plaintiffs’ claims turn on an endless series of individualized determinations, thus precluding class certification.

According to an interesting student note that will soon be published in the Stanford Law Review, the answer to both questions is “yes.” Specifically, the would-be class counsel must “protect[] the substantive legal rights of putative class members . . . from prejudice” “resulting from the actions of class counsel.”

The implications for defendants opposing class certification are significant: If the plaintiff’s lawyers have prejudiced the rights of absent class members, then they have demonstrated that they will not “fairly and adequate protect the interests of the class,” as required by Federal Rule of Civil Procedure 23(a)(4). And that means that a class can’t be certified—at least not with those lawyers at the helm. Here are three common ways in which plaintiff’s lawyers exalt their own interests over those of the absent class members:

  • Stipulations to limit the class recovery. Because the Class Action Fairness Act permits removal of class actions in which the amount in controversy exceeds $5,000,000, some plaintiffs’ lawyers have been trying to stipulate that the class recovery would be less than that amount in an attempt to evade removal. The Supreme Court will determine whether these stipulations actually do eliminate jurisdiction later this term in Standard Fire Insurance Co. v. Knowles. But regardless of the effect on federal jurisdiction, placing an artificial cap on the recovery of absent class members would appear to be a textbook violation of the lawyer’s fiduciary duties to the putative class.
  • Forgoing claims for punitive damages. Either as a means of reducing the amount in controversy to dodge removal under CAFA or in an effort to prevent individualized issues of law from swamping common issues, plaintiffs’ lawyers sometimes forswear punitive damages even when the cause of action they allege would otherwise support such damages. Because a legitimate punitive damages claim could (in theory) increase an individual’s recovery several fold, plaintiffs’ lawyers who eschew such a claim in an effort to satisfy the criteria for class certification (or remain in state court) have created an irreconcilable conflict with their own clients.
  • Jettisoning individualized claims. To try to tilt the playing field towards class certification with respect to some claims, plaintiffs’ lawyers often abandon other claims arising out of the same facts that are rife with individualized issues. For example, the complaint might seek restitution for the purchase price of an allegedly defective product under a false-advertising theory, but leave out claims for much greater damages from the resulting personal injuries or property damage that some absent class members would have experienced, because those latter claims involve individualized issues of causation. Yet if the low-value restitution claims are allowed to proceed on a class-wide basis, the doctrine of res judicata and prohibitions against claims splitting would bar absent class members from pursuing high-value claims personal-injury or property-damage claims in individual actions. Similarly, a plaintiffs’ lawyer might forgo pleading a common-law or statutory fraud claim because of the individualized issues that such a claim often entails and instead proceed only on a breach-of-contract claim even though the remedies for the former are broader than those for the latter.

Defendants in class actions should remain vigilant for these and other similar gambits. By attempting to increase the chances of class certification, putative class counsel may—ironically—supply the grounds for rejecting the very outcome they seek.

The Ninth Circuit’s recent decision in a TCPA case—Meyer v. Portfolio Recovery Associates (pdf)—involves several interesting issues for class-action practitioners even outside the TCPA setting.

First, a bit of background. In Meyer, the plaintiff sued a debt collector under the TCPA, alleging that it used an autodialer to call his cell phone number impermissibly. The plaintiff sought statutory damages and injunctive relief on behalf of a putative class of all California residents whom the defendant had called at cell phone numbers that had not been provided as part of the transaction giving rise to the debt in question. The district court certified the class under Federal Rule of Civil Procedure 23(b)(2) for the limited purpose of entering a preliminary injunction against the challenged conduct. The Ninth Circuit affirmed.

Setting aside the TCPA issues—which will be addressed in a subsequent post—the Ninth Circuit’s decision contains several holdings that should be of interest (and concern) to class-action defendants more broadly:

Continue Reading Ninth Circuit Upholds “Provisional” Class Certification for Entry of a Preliminary Injunction in TCPA Class Action

Should a class action go forward when the company voluntarily has provided all the relief plaintiffs have sought?  At least in some circumstances, the answer is “no,” according to the Tenth Circuit.

Here’s some background.   Many product manufacturers—and especially auto makers—are targeted by the class action bar when they announce voluntary recalls.  The lawsuits typically allege (among other things) that the manufacturer had fraudulently concealed the defect, and seek an injunction ordering the manufacturer to repair the defect.  In other words, these suits seek precisely the same relief that the manufacturer is already providing.  Sometimes the plaintiffs tack on requests for damages, even though practically—or literally—none of the members of the putative class have experienced any injury or harm, because the manufacturer announced the recall even though the defect has manifested only a handful of times.  Thus, these lawsuits often represent little more than attempted shakedowns by plaintiffs’ lawyers, who hope to capitalize on a manufacturer’s perceived vulnerability and thereby get a quick settlement for attorneys’ fees.  The consumers in whose names the suits are brought, however, get nothing at all, because the recall already has given them all of the relief for which they might have a legitimate claim.

Manufacturers who face these lawsuits often seek dismissal on the ground that the recall renders the claims moot.  Winzler v. Toyota Motor Sales USA, Inc. (pdf), 681 F.3d 1208 (10th Cir. 2012), is a perfect illustration of a successful invocation of the mootness argument.  In that case, the district court dismissed a lawsuit alleging a defect in certain Toyota vehicles for failure to state a claim.  During the pendency of the plaintiff’s appeal, Toyota announced a voluntary recall of certain Toyota vehicles.  The Tenth Circuit therefore affirmed the dismissal on the alternative ground that the lawsuit was now moot—a doctrine that the court said “describes a situation where events in the world have so overtaken a lawsuit that deciding it involves more energy than effect, a waste of effort on questions now more pedantic than practical.”  Id. at 1209.

The court explained that “promises of reform or remedy aren’t often sufficient to render a case moot as a constitutional matter,” because of the “risk” that “as soon the court turns its back, the defendant might renounce his promise and ‘return to his old ways.’”  Id. at 1210 (citation omitted).  But the court added that that risk “isn’t necessarily enough to avoid the application of prudential mootness doctrine. That’s because any party invoking the equitable remedial powers of the federal courts must still ‘satisfy the court that [requested] relief is needed,’ and when it comes to assessing that question, a remedial promise always qualifies as ‘one of the factors to be considered.’”  Id. at 1210-11 (citations omitted).  The court then held that the plaintiff in that case couldn’t meet the burden of avoiding mootness because, by beginning the recall process, Toyota had undertaken the obligation to inform all affected owners and to conduct the recall under the supervision of NHTSA.  Id. at 1212.

Businesses should remain alert for possible challenges to class actions that seek superfluous relief on mootness grounds.  Alternatively, businesses could argue that such class actions flunk either Rule 23(b)(3)’s requirement that a class action be “superior” to other methods of resolving the dispute or Rule 23(a)(4)’s requirement that the class representative be adequate to protect the interests of the class.  Other courts—such as the Seventh Circuit—have recognized that a plaintiff bringing a class action that would simply duplicate—at much expense—relief already available to the class cannot satisfy Rule 23(a)(4)’s “adequacy of representation” requirement.  See, e.g., In re Aqua Dots Prod. Liab. Litig. (pdf), 654 F.3d 748 (7th Cir. 2011).