Real Estate Reporter, March 2005

CLASS ACTION "FAIRNESS" – WILL IT REALLY MAKE A DIFFERENCE?

By Barry MacNaughton

President Bush has made "tort reform" a centerpiece of his new administration. The first foray into tort reform is the Class Action Fairness Act of 2005 (Act). The Act expands federal jurisdiction over class actions by increasing the number of class actions that can be heard by the federal courts. By doing so, supporters of the Act hope to reduce frivolous class actions and provide more efficient resolution of meritorious claims by providing the federal courts as an assumedly more conservative and consistent forum.

One of the Act's primary goals is to reduce forum shopping. "Forum shopping" is a practice where plaintiffs lawyers seek out favorable state courts in which to bring a class action, and then attempt to have that state court certify a nationwide class. The Act limits this practice by changing the "amount in controversy" rules for class actions and by making it easier to remove class actions filed in state courts to federal court on diversity grounds. The Act also establishes new standards for notice, attorneys' fees and coupon settlements. The Act applies to any civil action filed on or after February 18, 2005, the date of enactment. The Act may reduce the number of large class actions due to the easier removal requirements and restrictions on federal courts applying differing state laws in multi-state disputes. It is unclear whether this will lead to fewer class actions overall, or fragment class action claims into a series of state law-based cases.

Federal Jurisdiction Over Class Actions After the Act

The Act primarily achieves its goals by expanding federal diversity jurisdiction. Diversity jurisdiction exists where all plaintiffs are from different states than all defendants. In that situation, a plaintiff can file the action in federal court or, if an action is filed in state court, the defendant can remove that action to federal court. Diversity jurisdiction also must now meet an "amount in controversy" test. There must be at least $75,000 at issue for each plaintiff unless the case involves a question of federal law. The total amount in controversy requirements makes it easier for plaintiffs lawyers to defeat diversity by naming at least one defendant, no matter how nominal, who is a citizen of the same state as at least one plaintiff, and by including plaintiffs whose claims cannot meet the amount in controversy threshold.

The Act expands federal diversity jurisdiction to cover any class action where: (a) the class is at least 100 members; (b) the aggregate amount in controversy is at least $5,000,000; and (c) any class member is a citizen of a state different from any defendant.

The Act sets out two exceptions for strictly local controversies. First, federal courts can decline jurisdiction "in the interest of justice and looking at the totality of the circumstances," if more than one third, but less than two thirds of the plaintiffs in the class and the primary defendants are citizens of the state in which the case was originally filed. The court undertakes this analysis by looking at whether the case involves matters of a local or national interest and considerations of governing law.

Second, federal courts are required to decline jurisdiction where more than two thirds of the asserted class members, and all of the primary defendants, are citizens of the state in which the action is filed. The federal courts may also decline jurisdiction where (1) more than two thirds of the plaintiffs are citizens of the state in which the action is filed, (2) at least one main defendant is a citizen of that state, (3) the principle injuries occurred in that state and (4) no other class actions have been filed asserting the same or similar allegations against any of the same defendants within the last three years. While these exceptions give federal courts some "wiggle room" to decline jurisdiction, they are designed to apply primarily in cases where an exclusively local controversy is the focus of the class action claim.

The Act includes two other procedural changes designed to encourage federal jurisdiction. First, any defendant without the consent of the other defendants may remove a matter from state court to federal court; unanimity of the defendants is not required. Second, the Act provides for immediate appellate review should federal courts not accept a case being removed from the state courts.

Settlement and Attorneys' Fees Changes

Perhaps the biggest concern raised about class actions is that they are primarily run by and for the attorneys, not the class members. This concern is exacerbated when class actions are settled by large cash payments to plaintiffs attorneys with only coupons to class members.

The Act addresses these kinds of settlements by limiting contingent attorneys' fees awarded to class members to the actual value of the coupons redeemed by class members, or the actual hours reasonably spent working on the case, not the aggregate value of coupons issued. The statistical evidence shows that a substantial portion of the coupons generated by class action coupon settlements go unredeemed. The court must approve all class action settlements, and the reviewing court also may require that a portion of unclaimed coupons go to a charitable organization.

These changes will have a significant impact. Consumers may benefit, as attorneys are less likely to accept coupon settlements when a defendant essentially promotes business by giving coupons for future purchases in lieu of cash. Also, plaintiffs lawyers may be less likely to accept class action representation due to the fee limitations. This portion of the Act is designed to force plaintiffs lawyers to only accept and litigate cases where a reasonable financial return is in the cards, and force liable defendants to pay an actual penalty for their wrongs, rather than simply using a settlement as a promotional effort to increase patronage.

Application of the Act to Real Estate Disputes

While many class actions involve consumer protection statutes, California courts are often faced with class or representative actions involving claims against title insurers and developers, and based on construction defect claims. The Act may be applicable to these claims, particularly where an out-of-state developer or insurer is the primary defendant. Federal courts do have an "out" in such circumstances should they want to avoid jurisdiction. Many real estate matters are localized claims involving a specific geographic locale, especially construction defect claims. Conversely, class actions involving the fees and costs of sale, such as title insurance, escrow fees and other escrow charges, would be subject to the Act and are more likely to be litigated in the federal courts. It is far less likely that construction defect suits will go to the federal courts as those courts are likely to decline jurisdiction over such cases.

Will the Act Achieve its Goals?

Supporters of the Act believe it will reduce frivolous lawsuits because plaintiffs lawyers will not be able to bring multi-state class actions in state court jurisdictions sympathetic to those claims. The Act may also reduce class actions because a federal court cannot consider a class claim as a single action in which there are material differences in the laws of the affected states. Thus, there may be class actions that cannot be brought in either the federal or state courts. Thus, the Act may have the intended effect of reducing class actions overall.

Inevitably, any attempt to regulate a complex area leads to unintended consequences. The Act is no exception. The Act is likely to have the following unintended consequences that could actually increase the burden on business:

• Plaintiffs may file class actions over similar claims in a multitude of state courts using state law principles to avoid a federal court taking jurisdiction and dismissing the action because of substantive legal differences between states. This will increase the number of actions and costs of defense.
  
• The Act may put pressure on federal courts to change rules barring those courts from hearing multi-state actions, where the laws of the affected states differ and effectively increase available class action jurisdiction.
  
• Plaintiffs may be able to use the Act to circumvent recently enacted state law class action protections, such as the recent Texas rules limiting contingent fees in class actions. These state court protections are unlikely to apply in the federal courts even if only substantive state law questions are presented in that court.
  
• The Act may make it very difficult for defendants to reach a global settlement of similar claims pending in multiple jurisdictions and may limit the effect of a defense result in one of multiple state class actions. Defendants may find they have no alternative but to litigate on various fronts where plaintiffs lawyers file several actions in multiple states over the same core claims.

The Act tries to eliminate frivolous class actions while preserving fair and efficient resolution of meritorious claims. While it has made some strides in this direction, unintended consequences could cause certain disputes to become more costly and time-consuming for defendants, with no commensurate reward for class members. Only time will tell whether the courts and Congress can harmonize the procedural and substantive law to achieve these goals.