Verdicts & Settlements

9th Circuit tosses Massage Envy settlement, says judge must consider warning signs of lawyer collusion

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A federal appeals court has tossed a $10 million voucher settlement and $2.6 million in attorney fees in class action litigation over increased membership fees charged by Massage Envy franchises.

The San Francisco-based 9th U.S. Circuit Court of Appeals said a federal judge wrongly found the vouchers are not coupons under the Class Action Fairness Act, which meant the fairness of the settlement was evaluated under a less-exacting standard.

The appeals court also said the judge failed to examine the “three warning signs of implicit collusion” by attorneys as required by a 2011 decision involving settlements reached before class certification. Reuters and Law360 have coverage of the Oct. 20 opinion, written by U.S. Circuit Judge Ronald Gould.

The class action lawsuit had claimed Massage Envy franchises wrongly increased membership fees without the authorization of its members.

Voucher amounts for class members under the settlement ranged from $36.28 to $180.68, depending on how much their membership fees had increased. The lowest voucher amount was enough for some products but not enough for most of Massage Envy’s services, including massages. The vouchers were valid for 18 months.

If the class plaintiffs didn’t claim enough vouchers to use the full $10 million settlement, voucher amounts would be increased upward pro rata until the $10 million floor was reached. If vouchers expired without being used, the unused value would go back to Massage Envy Franchising.

Massage Envy Franchising agreed it would not object to any fee request by lawyers for the plaintiffs as long as the amount didn’t exceed $3.3 million. If the court awarded less than $3.3 million, the excess funds would go to Massage Envy rather than the class.

Since the judge awarded less than the requested $3.3 million in attorney fees for class counsel, about $600,000 in awarded fees reverted to Massage Envy Franchising. Class members requested only $3 million in vouchers, but their voucher amounts increased until the $10 million floor was reached.

Only 19 of 1.7 million class members objected to the settlement.

The appeals court remanded the case to the district judge to award attorney fees based on the vouchers that were redeemed instead of their $10 million face value. In coupon settlements, attorney fees are based on redemption value. A coupon settlement must also be subjected to heightened scrutiny by the district judge.

The appeals court determined the vouchers were coupons using a three-part test that considers: whether class members have to pay money to use the benefits; whether the credit was valid for only certain products or services; and how much flexibility the credit provided, including whether it expires or can be transferred. The court said no single factor controlled, but the test indicated the vouchers were coupons.

The court also said the district judge should have investigated some of the potentially problematic aspects of the relationship between attorney fees and class benefits.

“When a federal court considers whether to approve a settlement, we require the court to closely scrutinize the agreement for any evidence that class counsel’s self-interest infected the negotiations at the expense of the class,” the appeals court said. “When that approval comes before the class is certified and therefore before class counsel have expended substantial resources, there is an even greater risk that class counsel will breach the fiduciary duty owed to absent class members.”

In assessing whether class counsel “allowed pursuit of their own self-interests to infect the negotiations,” courts look to three factors, the appeals court said. They are: whether the class counsel received a disproportionate distribution of the settlement, whether there is a “clear-sailing arrangement” in which the defendant agrees not to challenge an agreed-upon attorney fee, and whether unawarded attorney fees revert to the defendant rather than the class.

The clear-sailing and reverter provisions are both present in the Massage Envy case, and the district court “did not adequately investigate or address the implications of those provisions,” the appeals court said.

On remand, the district court may still find the settlement is fair. “But because we hold the court to a higher procedural standard, the court must ‘provide the necessary explanations’ in making that finding,” the appeals court said.

The class member who challenged the settlement, Kurt Oreshack, was represented by Hamilton Lincoln Law Institute’s Center for Class Action Fairness.

The proposed class was represented by Jeffrey Krinsk of Finkelstein & Krinsk. He told Reuters there was absolutely no risk of collusion in the case, and the 9th Circuit’s comments were a warning to the entire class action bar.

“This was not a particularly profitable undertaking by plaintiffs’ counsel,” Krinsk told Reuters.

The case is McKinney-Drobnis v. Massage Envy Franchising.

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