Class Action Litigation in Outsourcing: Managing Consumer Litigation Risk after Class Action Fairness Act of 2005
Posted October 9, 2009 by Bierce & Kenerson, P.C. · 
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The enactment of U.S. federal legislation forcing litigants to argue large class-action claims in federal court will help business generally. If class actions are basically about violations of consumer rights, what impact will it have on outsourcing, and why? This article applies to all those who manage call centers, credit cards, employment and payroll, HR administration, finance and accounting and other consumer-facing business functions.
I. The Public Policy and Public Impact of Class Actions
Rule 23 of the Federal Rules of Civil Procedure allows federal courts to aggregate the claims of multiple injured parties – “plaintiffs” – against one or more common defendants. The claims may be joined into one massive complaint so long as (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of the class.
Rule 23 serves many societal purposes.
A. What is a Class: Size of Claims and Impact on Access to Judicial Redress.
1. Small Claims.
For small claims, it allows the aggregation of multiple claims that would not otherwise have been litigated. It thereby serves to protect the small consumer against the corporate tortfeasor where the damages per plaintiff are very small and the aggregate damages are substantial.2. Large Claims.
For large claims, Rule 23 economizes judicial resources by avoiding litigation on the fundamental facts affecting perhaps a small or “finite” number of injured parties each of whom has suffered substantial damages. If the facts are the same or substantially the same, class actions provide judicial efficiency.B. What is a Class: Technical Requirements.
Following extensive analysis by lawyers and judges that resulted in a multi-thousand page report dated May 1, 1997, on March 27, 2003, the U.S. Supreme Court amended Rule 23 of the Federal Rules of Civil Procedure. See http://www.uscourts.gov/rules/congress0303/CV-Letters.pdf and http://www.uscourts.gov/rules/WorkingPapers-Vol1.pdf As noted above, a class has to have sufficient “numerosity” to bundle a lot of claims, and sufficient “commonality” to justify treating the same facts or legal circumstances to the members of the class.C. Socially Engineered Remedies.
Remedies in class actions cover several types of damages.1. Compensatory Damages.
Each injured party could receive an appropriate amount of compensation for the loss suffered.2. Disgorgement.
Beyond compensating the victims, class actions can serve as a socially engineered tool for promoting equitable remedies where it is not possible to locate or compensate every member of the class. In such cases, class actions can force a wrongdoer (or group of wrongdoers with liability allocated by market share, for example) to disgorge ill-gotten gains from consumer fraud and deceit.3. Equitable Remedies.
Equitable remedies are applied in order to prevent an injustice. They can include contempt of court, but most often are structured as injunctions. An injunction can be issued to prohibit future violations of individual plaintiffs’ rights.D. Emerging Growth of Class Actions in an Automated Process-Driven Society.
Based on a federal court procedural rule initially adopted in 1966, class actions have burgeoned since the 1990’s.1. Automation of Injury-Causing Commercial Activity.
There has been a shift from individual litigation to representational litigation, as a more “efficient” and effective method of recovering damages from wrongdoing defendants. Such litigation seeks to recover damages from torts and other repetitious effects inherent in a mechanized, if not automated, Cyber Age. What started as a basis for supporting consumer product safety and civil rights cases became a weapon for extorting settlements, often of trivial financial value to the injured class, for mass torts and, increasingly, “mass actions” of all types.2. Impact on Business Process Outsourcing (“BPO”) and Internal Business Process Management (“BPM”).
Class actions have become the tool of choice for effectuating social change, by shifting money to victims, and for redress of torts involving such diverse problems as securities laws violations, consumer product safety, banking and insurance billing methods and debt collection procedures.The glorious scalability of business process automation (whether outsourced or not) can become an infamous scalability of mass torts. Mass torts occur when many people suffer the same consequences of the same (or similar acts) of the defendant(s). Since BPO and BPM can automate injury-causing interactions with consumers, class actions become everyone’s business. Accordingly, every business that performs, or hires someone to perform, such functions should be aware of the impact of the new Class Action Fairness Act of 2005 upon their business.
II. Consumer Litigation Risks in Outsourcing.
A. Customer Relationship Management.
Call centers contact customers and prospective customers in outbound calls. Such contacts may violate applicable consumer protection laws and rules of the Federal Communications Commission, the Federal Trade Commission or the various states. Fines and penalties may be imposed by the regulators. In addition, individuals may be able to recover damages for violations of their rights under state or federal law, depending on the type of violation. In short, by allowing the aggregation of clams common to a class of persons that are “similarly situated,” class actions for violations of laws could become a call center’s worst nightmare.B. Privacy Violations.
Virtually any outsourced business process may involve privacy violations arising from mistakes or negligence in the receipt, custody, processing, storage, access, encryption and transmission of confidential records of individuals in a class could form the basis of a mass tort. records maintenance. Such violations may apply to health information, personally identifiable information (such as Social Security Numbers), and financial and other personal information submitted to financial institutions or others for valid commercial purposes. Violations of privacy may result in fines and liability under the Health Insurance Portability and Accountability Act (HIPAA), the Graham-Leach-Bliley Act and the Fair Credit Reporting Act, as amended.C. Racketeering and Corrupt Organizations Act (Treble Damages and Attorneys’ Fees).
Outsourcing that is performed remotely usually involves the use of interstate means of communication. Under RICO, two violations of predicate crimes within a ten year period using such means of communication are subject to triple damages and attorneys’ fees. Virtually any type of outsourcing could be theoretically subject to a RICO claim.D. Antitrust Violations (Treble Damages ).
Antitrust laws provide for triple damages and attorneys’ fees as well. Where two competitors, each with significant market share in a relevant market, collude to fix prices or allocate territories, the participants will be violating the Sherman Antitrust Act. Such laws are not likely to apply to outsourcing due to the vertical nature of the relationship arising from business process outsourcing. Indeed, consumers rarely assert antitrust violations. Consequently class actions for antitrust violations appear to be a remote possibility.E. Civil Rights Violations.
In human resources outsourcing, the service provider may be called upon to engaged in a series of important steps that, if mismanaged, could result in a claim of civil rights violations. Civil rights generally include discrimination on the basis of sex, race, religion, national origin and even sexual preference. Specific statutes protecting against age discrimination in employment also come into play in HR outsourcing.
III. Changes Introduced by the Class Action Fairness Act of 2005
Class actions have affected banks, insurance companies, asbestos manufacturers, tobacco sellers and pharmaceutical manufacturers. A consortium of business leaders lobbied Congress to change the rules so that interstate commerce can not suffer the burdens of favoritism or arbitrariness that are perceived by many to be part of the state court system. They also wanted to make the rules uniform across the country, which cannot happen but remains a reasonable ideal in a federal system.
Consequently, the new Act will reduce personal benefits to plaintiffs’ class action lawyers unless the benefits are more aligned with a large segment of the class members. This involves resetting the rules governing contingency legal fees and transferring cases to the federal district court if any defendant requests it.
A. Restructuring of Attorney Fee Incentives for Plaintiffs’ Class Action Lawyers.
Rebalancing the Uses (and Abuses) of Coupons in Class Action Settlements.
Any enterprise sued in a class action for violation of consumer protection laws might concede defeat, issue “coupons” for injured parties that force them to use “free” additional services in lieu of cash payments, and pay the attorneys’ fees of the plaintiffs’ lawyers. The Act will cut back on the ability of plaintiffs’ lawyers to collect cash based on the gross value of the coupons offered by limiting their fees to a percentage of the coupons actually used. 28 U.S.C. 1712(a), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a). If any portion of such attorneys’ fees is not based on the gross value of the coupons, then hourly rates will apply. Traditionally, hourly rates are not enough to create a wealthy plaintiff’s lawyer.In the past, coupons issued in class actions have notoriously have had low redemption rates due to the restrictions on duration of use, blackout dates limiting the scheduled use and other unpalatable coupon redemption rules. This “coupon” strategy will force plaintiffs’ lawyers to seek to maximize the market value of the coupons, thereby aligning the interest of the injured class with those of their lawyers.
Where the class action results in any injunctive or other equitable remedies against the defendant’s), the court may apply a “lodestar” computation with a multiplier method to award attorneys’ fees.
To punish defendants but not allow attorneys to benefit, the financial value of unused coupons could be donated to charity or to government as agreed to by the parties. 28 U.S.C. 1712(e), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a). This would benefit society generally but not benefit the plaintiffs’ attorneys, whose fees could not be based on any such donation.
Net Losses to Lead Plaintiffs.
In some cases, a named plaintiff or other individual plaintiff must pay “sums” to class action attorneys that would make a net loss to that plaintiff. The new law permits such arrangements only if judicially approved in a determination that the non-monetary benefits bestowed substantially outweigh the monetary loss. 28 U.S.C. 1713, as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a).B. When Must the Mass Action be Transferred to Federal Courts.
1. The General Rile Requiring Transfer of Mass Actions to Federal Courts.
The new law will transfer to federal courts all class actions that are “mass actions,” subject to certain exceptions, upon the demand by any defendant. Litigation in state courts must be transferred to federal courts where the amount in controversy, as an aggregate of all claims of all individual plaintiffs, does not exceed the “sum or value” of $5 million, exclusive of interest and costs. 28 U.S.C. 1332(d)(6), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a); 28 U.S.C. 1453(b), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec. 5.A “mass action” means “any civil action (except a class action filed in or removed to a federal district court under Rule 23 of the F.R.Civ.P. “in which monetary relief claims of 100 or more persons are proposed to be tried jointly on the ground that the plaintiffs’ claims involve common questions of law or fact, except that jurisdiction shall exist only over those plaintiffs whose claims in a mass action satisfy the jurisdictional amount requirements” of $75,000 per claim. 28 U.S.C. 1332(d)(11)(B)(i), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a).
2. The Exceptions to Mandatory Transfer.
(a) Judicial Evaluation based on Balancing of Factors.
The Act authorizes the district courts to decline to exercise jurisdiction over a class action where between one third and two-thirds of the members of all proposed plaintiff classes in the aggregate and the primary defendants are citizens of the state where the action was originally filed. In such cases, the court may take into consideration various enumerated public policy and procedural considerations listed in the Act. 28 U.S.C. 1332(d)(3), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a).(b) Prohibition on Mandatory Transfers in Cases of Local-Impact Class Actions.
Congress chose not to require the mandatory transfer to federal district court of class actions that have a distinctly local character. Local character applies where several conditions all apply. In each case, the plaintiffs and at least one major defendant must be local. In each formulation, more than “two-thirds of the members of all proposed plaintiff classes in the aggregate are citizens of the State in which the action was originally filed.” Also, in each “localization” situation, there must be at least 100 members of the proposed plaintiff class. 28 U.S.C. 1332(d)(5)(B), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a).(i) One Defendant’s Conduct.
Under one formulation of this principle,” at least one defendant is a defendant from whom significant relief is sought by members of the plaintiff class,” and “whose alleged conduct forms a significant basis for the claims asserted by the proposed plaintiff class is a citizen of the State in which the action was originally filed.” Such cases must be transferred to federal district court where the “principal injuries resulting from the alleged conduct or any related conduct of each defendant were incurred in the State in which the action was originally filed.” 28 U.S.C. 1332(d)(4)(A)(i), as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.4(a).As to such situations, Congress chose not to require the mandatory transfer to federal district court of class actions that are not bunched in time with other similar class actions. Thus, in such situations, there is no mandatory transfer where, ” during the 3-year period preceding the filing of that class action , no other class action has been filed asserting the same or similar factual allegations against any of the defendants on behalf of the same or other persons.” Id.
(ii) The Primary Defendants.
Under another formulation of this principle, the “primary defendants” are citizens of the local state. The statute does not define the term “primary,” so legislative history must be consulted on the legislative intent. This formulation of “local” damages does not consider whether the principal injuries resulting from the alleged conduct or any related conduct of each defendant were incurred in the State in which the action was originally filed.(c) Excluded Transactions.
Congress denied federal courts any jurisdiction for mass actions involving two types of claims for which local courts are well suited to class actions or that relate essentially to local law, and are already covered by Rule 23.1 (Derivative Actions by Shareholders) and Rule 23.2 (Actions Related to Unincorporated Associations):
- Securities Law Violations: a “covered security” (under the federal securities law, Section 16(f)(3) of the Securities Act of 1933 and Section 28(f)(5)(E) of the Securities Exchange Act of 1934) or rights, duties and obligations (inclining fiduciary duties) relating to any “security” (under federal securities laws, Section 2(a) of the Securities Act of 1933); and
- Shareholder Claims: shareholder class actions that relate to the “internal affairs or governance” of a corporate entity are not covered if the class action is filed in the state court of the state of incorporation.
IV. Impact of the Class Action Fairness Act of 2005.
This new law requires the transfer to federal courts of all class action litigations that involve interstate or international commerce (which Congress has the constitutional power to regulate) and the claims are at least $5 million in the aggregate, exclusive of interest and costs.
A. Benefits to Businesses that Might be Defendants.
For businesses (including both outsourcers and their enterprise customers), the benefits derive from:
- Less Pandering:
a federal judiciary that is appointed for life, and therefore under no personal compulsion to seek election or re-election by pandering to consumer groups;- Tighter Rules of Civil Procedure:
a body of federal rules of civil procedure that impose the risk of severe sanctions if pleadings and practices are contemptuous or otherwise non-compliant with the rules, including personal sanctions and civil fines on the litigant, the litigant’s executives (if it is an entity) and the attorneys litigating engaging in sanctionable procedural misdeeds.- Allocation of Discovery Costs to Plaintiffs:
an emerging body of cost-allocating and risk-allocating procedural rules that may impose on the plaintiffs significant costs of imposing demands that the defendant (usually a business) deliver myriads of documents and records during the pre-trial discovery process.- Elimination of Geographical Favoritism:
the new prohibition on class action settlements that provide for favoritism in disproportionate payments to some class members simply by reason of closer geographical proximity to the court. 28 U.S.C. 1714, as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec.3.- Comments by Regulators of FDIC-Insured Depository Institutions:
state and federal regulators of depository institutions whose deposits are insured or regulated by the Federal Deposit Insurance Corporation will be notified of any proposed settlement and will have 90 days to comment on it. 28 U.S.C. 1715, as amended by Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec. 3.- Judicial Conference Study Recommendations on Best Practices:
the requirement of a new judicial study to contain “best practice” recommendations for (i) the fees and expenses awarded to counsel in connection with a class action settlement appropriately reflect the extent to which counsel succeeded in obtaining full redress for the injuries alleged and the time, expense, and risk that counsel devoted to the litigation; and (ii) the class members on whose behalf the settlement is proposed are the primary beneficiaries of the settlement. Class Action Fairness Act of 2005, 109 Cong., 1st Sess., S. 5, Sec. 6. This will further focus on alignment of fee incentives for plaintiffs’ counsel with the rewards obtained for the class members.- Neutralization of the Coercive Effect of Class Actions:
a regime that removes financial incentives for plaintiffs’ class attorneys to inflate claims, delay settlement or otherwise impose punishing burdens on defendants solely because the aggregation of claims to huge financial levels creates its own substantive rule that settlement is cheaper at all costs than the risk of astronomical liability. The new Act overcomes part of the substantive effect of class actions that are independent of the underlying claims of the plaintiffs.B. Greater Segmentation of Smaller Classes in Narrower Geographic Scope.
This law might encourage the plaintiff’s attorneys to file separate class actions in multiple states, with narrowly defined classes limited to individuals or other victims within a limited geographical territory.C. Cost Reduction for Businesses with Possible Sharing with Consumers.
The new law specifically addresses the costs of doing business, with an expressed intention of reducing such costs. In practice, the reduction in the number of class actions may be expected to reduce insurance premiums for general liability, thereby enabling businesses (whether service providers or enterprise customers) to increase their coverages, retain a higher self-insured deductible or cut insurance premiums. Such savings could generate chain-reaction benefits of additional capital available for capital investment, research and development, dividends to shareholders and/or reduced prices to consumers.D. Promotion of Innovation.
The law seeks to “benefit society by encouraging innovation and lowering consumer prices.” Act, Sec. 2(b). This theme will likely be the mantra of the second administration of President George W. Bush (January 20, 2005-Jan. 19, 2009). The Act does not specifically encourage innovation, but if insurance premiums are reduced, the risk of unacceptably high damages is more manageable because federal judges will be deciding class action procedures, then entrepreneurs and businesses could justify taking slightly greater risks.
V. Impact on Outsourcing.
The Act reduces the burden of class action defense by correcting some historic abuses. The Act impacts outsourcing by making reducing litigation risks for both enterprise customers and their service providers. Such risks exist in every BPO relationship, since third parties — who could be consumers, patients, loan applicants, customers, technology users, family members — could conceivably be injured by the acts or omissions of the service provider, the enterprise customer or both.
For suggestions on how to minimize your risks of a class action, with particular reference to diverse services such as call centers and multifarious BPO performed in foreign back offices, engineering, design, manufacturing, distribution and logistics, please consult our White Paper, “Are You Ready for Class Action Litigation in Outsourcing?”.