Court: Court of Appeals for the Second Circuit; March 31, 2006; Federal Appellate Court
Allegations involve professional advisors, specifically the Jenkens, Gilchrist law firm and Deutsche Bank, for improper and fraudulent tax counseling. Scott and James E. Mattei, class action plaintiffs, challenge a February 2005 judgment from the Southern District of New York that certified a class action and approved a settlement with the Jenkens, Gilchrist Defendants. The settlement resolves claims related to tax strategies deemed illegal by the IRS, which has assessed penalties against certain class members. The Matteis argue that the class includes members who have not faced tax penalties, questioning their standing and the adequacy of the named representatives who have been penalized. They also assert that the district court improperly conditioned class certification on the settlement and violated due process by not providing a second opt-out period.
Deutsche Bank contests provisions in the settlement concerning nonsettling defendants' rights to seek contribution and indemnity from settling defendants. They argue that the district court incorrectly approved a provision that extinguishes claims against settling defendants related to the tax strategies and that the "judgment credit" provision lacks clarity in its calculation method. The court affirms the class certification but vacates and remands the contribution and indemnity provisions, finding them inadequate in protecting nonsettling defendants' rights. Background details include allegations that the Jenkens, Gilchrist Defendants and Deutsche Bank created and marketed tax strategies through accounting firms, which misrepresented the origins of these strategies.
Defendants charged fees for tax counseling services linked to tax savings, despite allegedly knowing that the strategies would be rejected by the IRS. They marketed these strategies to plaintiffs to collect high fees. On July 23, 2003, a class action was initiated against law firm Jenkens, Gilchrist, accounting firm BDO, investment bank Deutsche Bank, and other advisors for violations of RICO and state law. Following the complaint, BDO and Deutsche Bank sought to compel arbitration based on agreements with individual plaintiffs, but the district court deemed these provisions void due to public policy, leading to an appeal.
Settlement negotiations commenced in November 2003, with Jenkens, Gilchrist under financial strain from tax shelter litigation. The class counsel believed a global settlement was in the best interest of class members. A settlement agreement on April 28, 2004, established a $75 million fund primarily from insurers, who were released from defense costs against opt-outs, although Jenkens, Gilchrist could terminate the agreement if opt-outs occurred. The district court preliminarily approved the settlement on May 14, 2004, and further revised the order on June 3, 2004, noting the class certification was solely for settlement purposes. Class members had until September 27, 2004, to opt out, with 122 initially opting out, of which 33 later returned.
Due to the high number of opt-outs, a fourth mediation resulted in a new settlement in December 2004, which included a supplemental class notice and set a deadline for objections but did not provide a new opt-out period. Following a fairness hearing on January 24, 2005, objections were raised by several plaintiffs, non-settling defendants, and the U.S. government regarding confidentiality provisions, leading to agreed changes in the settlement.
On January 27, 2005, the district court ordered the distribution of a class notice regarding a final settlement agreement, allowing an additional week for objections. While many individuals renewed objections, no new objectors emerged. On February 18, 2005, the court issued a Final Judgment certifying the class, approving the settlement, and dismissing claims against the Jenkens, Gilchrist Defendants under Fed. R. Civ. P. 54(b). The settlement includes an $81 million fund, $24.9 million for Jenkens, Gilchrist to handle claims from opt-outs, and potentially $25 million in insurance coverage. Timely appeals were filed by the Matteis, BDO, and Deutsche Bank against the class certification and settlement approval. BDO's appeal was dismissed on November 9, 2005.
Class counsel for over 1,000 claimants supported the settlement, citing the risk of no recovery if rejected, while Jenkens, Gilchrist's counsel emphasized its necessity for financial stability. Opposing class members argued the settlement unfairly binds them, and a nonsettling defendant claimed it compromises its recovery rights. Most challenges were deemed without merit. However, the settlement was remanded due to its failure to detail the judgment-reduction method for compensating nonsettling defendants and third parties.
The Matteis contested class certification, claiming inclusion of members without "injury-in-fact" at the time, affecting both Article III and RICO standing. They also argued class representatives, all facing tax penalties, could not adequately represent the class. While these challenges highlighted risks in class actions for future claims, the court affirmed the class certification under Fed. R. Civ. P. 23(b)(3) and found no abuse of discretion in the district court's decisions regarding class representatives and opt-out periods. The standing of class members faced no valid challenges. The court applies a de novo standard for standing and reviews class certification decisions for abuse of discretion, emphasizing greater deference when classes are certified versus denied. Adequacy of class notice is also reviewed for abuse of discretion.
Article III standing is a constitutional prerequisite for justiciability, determining whether a "case or controversy" exists between the plaintiff and defendant, which is essential for federal court jurisdiction. The requirement for standing remains unchanged regardless of whether the suit is filed as a class action. To establish standing, a plaintiff must demonstrate an "injury in fact" that is distinct and concrete, traceable to the defendant's actions, and likely to be remedied by a favorable court ruling. In assessing standing, courts must accept all material allegations in the complaint as true and interpret them favorably for the plaintiff. Class members do not need to individually prove standing; rather, the focus is on the named plaintiff's standing. However, a class cannot be certified if it includes members without Article III standing. Class definitions must be clear and ensure that all members have experienced a constitutional or statutory violation warranting relief. The court must ascertain that both the class and its representatives have suffered an injury that necessitates judicial intervention.
The Matteis contend that the Denney class comprises two categories of individuals who have not experienced, and are unlikely to experience, an injury-in-fact: (1) those who utilized certain tax strategies in 1998 or 1999 but were not audited within three years of filing their returns, and (2) individuals who initiated but did not finalize a tax strategy transaction without obtaining a tax opinion from Jenkens, Gilchrist. Jenkens, Gilchrist acknowledged that the first category could include several hundred individuals protected by the statute of limitations, while the second category encompasses several dozen individuals.
An injury-in-fact must be concrete and immediate, not abstract or hypothetical. It can arise from the fear or anxiety of potential harm, as illustrated by case law where exposure to harmful substances sufficed to meet the Article III injury-in-fact standard, even without physical injury. The determination of standing does not rely on the merits of the plaintiffs' claims. The requirement for an injury-in-fact is not overly stringent; the possibility of future harm may establish standing, including economic costs related to preventive measures or emotional distress. Importantly, the potential for injury does not negate standing, even if other benefits exist.
The future-risk members of the Denney class have indeed experienced injuries-in-fact, regardless of whether these injuries can support a cause of action. Each class member received allegedly negligent or fraudulent tax advice and acted on it. According to the plaintiffs' complaint—accepted as true—they have "paid excessive fees for negligent or fraudulent tax advice," incurred costs to remedy actions taken based on this advice, and missed legitimate opportunities for tax savings.
Members who completed tax transactions but have not been audited may still face penalties due to a statute of limitations exception. The United States has contested confidentiality proceedings related to these transactions and incurred expenses to correct past tax filings, which cannot be offset against taxes saved through the challenged strategies. Members who did not complete transactions still incurred costs in reliance on the advice provided. Consequently, each member of the Denney class has experienced an injury-in-fact, satisfying the elements of Article III standing, including traceability and redressability, as their economic and psychological injuries are directly linked to the defendants' conduct.
Regarding RICO standing, the Matteis argue that it is more stringent than Article III standing. A RICO plaintiff can only secure standing if injured in business or property due to RICO violations, and damages must be clear and definite. The Denney complaint identifies direct harms but acknowledges that damages for some members remain uncertain, particularly if they face potential IRS penalties. Therefore, those members do not meet the "clear and definite" requirement for RICO standing. Nonetheless, the district court retains discretion to maintain jurisdiction over state law claims for members with unripe RICO claims, as RICO standing is not jurisdictional. The court can exercise supplemental jurisdiction over state law claims even if RICO claims are dismissed, as highlighted in the Lerner case, where the court was remanded to reconsider state claims amidst similar ongoing actions.
Lerner's application in class action contexts does not warrant a distinction from its application in other lawsuits, as both may involve numerous parties affected by similar fraudulent schemes. Even if federal law claims are dismissed, courts typically dismiss state law claims unless judicial economy favors retaining jurisdiction. In most scenarios where all federal claims are eliminated, factors will usually lead to declining jurisdiction over remaining state claims. The likelihood of a scenario where some plaintiffs have RICO standing while others do not is diminished within a class action framework.
Fed. R. Civ. P. 23(a) outlines four essential requirements for class actions: numerosity, commonality, typicality, and adequacy of representation. Additional criteria in Fed. R. Civ. P. 23(b)(3) stipulate that common issues must dominate individual concerns and that class resolution must be superior to other methods for fair adjudication. Typically, if some plaintiffs lack RICO standing, class certification may fail on grounds of commonality, adequacy, or superiority, thus avoiding the Lerner issue.
In this case, the district court implicitly affirmed class action status without abuse of discretion, as the same factual and legal issues apply to both RICO and non-RICO class members, promoting judicial economy and consistency. Therefore, despite some class members lacking RICO standing, the court could legitimately retain jurisdiction over their state law claims, upholding class certification on standing grounds. The remaining challenges regarding class certification and settlement approval were thoroughly analyzed by the district court, warranting limited discussion on appeal.
Adequacy of class representatives under Fed. R. Civ. P. 23(a)(4) requires that they fairly and adequately protect class interests, independent of the overall fairness of a settlement. Adequacy is assessed through two criteria: the representative must actively pursue the class's claims and have no conflicting interests with other members. A mere potential conflict does not automatically disqualify class certification; it must be fundamental. The Matteis argue that the Denney class fails certification due to a conflict between class representatives, who have already incurred penalties, and future-risk members, who may face penalties later. This argument references the Supreme Court's ruling in Amchem, which stated that representatives with immediate claims cannot adequately represent those with potential future claims. The Court in Amchem emphasized the need for subclasses for individuals with different claim timelines. However, the district court found Amchem inapplicable to the Denney class, as all members were identified, notified, and given opportunities to participate or object, contrasting with Amchem’s scenario involving unknown future claimants. The ruling indicates that a single class can include both currently injured and future claimants without a per se prohibition.
The future-risk class members will have a clear understanding of their injuries and damages by the time they consult with the Special Master for settlement fund distribution. Unlike the situation in Amchem, no long-term fund is necessary, and class representatives are motivated to act in the best interest of all members, indicating no fundamental conflicts exist between them.
During 2004 settlement negotiations, the district court conditionally certified a class under Fed. R. Civ. P. 23(b)(3), stipulating that certification would automatically become void if the settlement was not finalized. The court noted that while the viability of conditional class certifications under amended Rule 23 has not been previously addressed, lower courts have continued to implement this practice.
The Matteis contend that conditional certification is not permissible under the amended Rule 23 and the Supreme Court’s ruling in Amchem. They argue that the deletion of the phrase allowing conditional certification in the 2003 amendments was intended to prohibit this practice. However, the text of the amended rule does not explicitly ban conditional certification, and the Advisory Committee Notes clarify that the change aimed to clarify court obligations without eliminating conditional certification. The court emphasizes that Rule 23(c)(1) should not allow tentative class certifications if the rule's requirements are not met, aligning with the Supreme Court's stance that the fairness inquiry under Rule 23(e) cannot replace the certification requirements under Rules 23(a) and (b). Consequently, the court concludes that conditional certification remains valid post-amendment.
Certification under Rule 23(a) and (b) must be satisfied before a court can approve any settlement, regardless of perceived fairness. The district court's conditional certification of the Denney class was deemed permissible, as it conducted a thorough analysis independent of its fairness review under Rule 23(e). The Matteis contended that a second opt-out period was necessary due to changes in the settlement terms. However, the court found no requirement for an additional opt-out period merely due to improved terms. Rule 23(e)(3) allows, but does not necessitate, a new opt-out opportunity in cases where settlement terms change post-certification. The court emphasized that requiring such a period could hinder settlement processes, as certification would not be finalized until after settlement terms are agreed upon. The original notice had sufficiently informed class members of potential changes, and improvements in the settlement terms did not obligate the court to provide a new opt-out opportunity. The court also noted that the uncertainty of insurance coverage for non-settling plaintiffs had not changed since the original notice. Thus, no abuse of discretion was found in denying the request for a second opt-out period.
The Matteis opted out of a settlement before the first period closed, accepting the risk that Jenkens, Gilchrist might not meet their claims, while they believed they lost this gamble. They did not present a valid argument to disrupt a fair settlement for a second opt-out opportunity despite improved terms for nonsettling parties. Deutsche Bank, a nonsettling defendant, objected to two provisions in the settlement: the bar order and the judgment credit. The bar order prevents nonsettling defendants or third parties from making claims against settling defendants related to the Tax Strategies, including claims for contribution and indemnity for amounts owed to class members. This bar is mutual, also prohibiting settling defendants from asserting claims against nonsettling parties. To offset this restriction, the settlement includes a judgment credit provision, ensuring that any judgment against a nonsettling defendant will be reduced by the amount necessary to relieve the settling defendants of liability for the barred claims. If applicable law does not specify the reduction method, the settlement credit will be determined based on the specifics of the case. The document notes that courts should not approve a settlement that grants a nonsettling defendant a judgment reduction less than what settling defendants paid for damages for which the nonsettling defendant is jointly liable. However, the settlement agreement lacks clarity on the calculation method for the judgment reduction, leaving it ambiguous.
The excerpt outlines three key methods relevant to the allocation of fault in legal settlements: pro rata, proportionate fault, and pro tanto. The district court emphasized the need for flexibility in interpreting "applicable law" due to the diversity of jurisdictions involved in the case. It asserts that the decision to approve a settlement lies within the discretion of the district judge, but de novo review is warranted when novel legal issues are presented.
The document addresses the bar order provision, noting that Deutsche Bank does not contest the approval of a bar order that prevents claims for contribution or indemnification against settling defendants. However, Deutsche Bank raises concerns that the Denney bar order improperly limits independent claims of nonsettling parties against settling defendants, contradicting the ruling in Gerber. The Gerber case established that while a district court can bar claims for contribution or indemnity, independent claims should not be extinguished without proper compensation for losses.
The ambiguity in the Gerber bar order regarding independent claims led to a modification for clarity. In the current context, the Denney bar order specifically targets claims related to tax strategies and recovery of funds from the class or its members. It clarifies that a “Claim Over” encompasses more than just contribution and indemnity, but does not extend the bar to independent claims. Deutsche Bank contends that the bar should be explicitly limited to claims tied to payments made based on nonsettling defendants' liability. However, the court finds that payments made in settlement do not equate to independent claims, thus validating the scope of the bar order.
Payments made by nonsettling parties to settle claims of liability, including reputational risks, are deemed to be repackaged contribution claims and thus prohibited under the bar order. This prohibition prevents nonsettling parties from circumventing liability by settling with plaintiffs and then seeking contribution from original settling defendants. Allowing such settlements could enable collusion between nonsettling parties and class members, undermining the fairness of the process. The district court's approval of the bar order is upheld, as nonsettling parties retain the ability to negotiate settlements reflecting their relative liability, with the plaintiffs’ recovery at trial adjusted accordingly.
However, the judgment credit provision creates unfairness for nonsettling parties like Deutsche Bank. While it aims to ensure that nonsettling parties are adequately compensated, it lacks specificity in how this compensation is calculated, leading to potential prejudice against their contribution rights. The reasoning of the Fourth Circuit in In re Jiffy Lube is noted, emphasizing the need for a clear methodology for calculating judgment credits to protect nonsettling defendants and maintain fairness for plaintiffs assessing settlement merits.
The choice of setoff method significantly impacts trial strategy for nonsettling defendants and the plaintiffs' assessment of the settlement's value. Different methodologies (proportionate, pro rata, or pro tanto) affect the allocation of risk and certainty regarding the final settlement amount, necessitating clear communication to the class about these implications. Nonsettling defendants must understand the applicable legal framework before trial to adequately prepare their defense.
The court's omission of a designated setoff method for a non-settling defendant creates a risk of insufficient credit due to a contribution bar. While any chosen method carries inherent risks, having a designated approach would clarify those risks for the parties involved. The court indicated it would use its equitable powers to ensure appropriate credit for non-settling defendants but failed to outline how these powers would be applied. Although the Fourth Circuit's approach has not been explicitly adopted, it has been favorably referenced in previous cases. Arguments against specifying a judgment credit methodology cite potential complexities; however, these complexities would equally affect non-settling parties in multiple jurisdictions. The certainty achieved by the settling defendants does not justify denying predictability to non-settling parties. Consequently, the judgment is vacated and remanded for adjustments to the judgment credit and bar order provisions. Additionally, non-settling defendant BDO's appeal regarding these provisions was dismissed. The case involves multiple class representatives, and a standing challenge raised by the Matteis was not fully addressed by the lower court. The settlement agreement defines the Denney class based on specific criteria related to tax strategies from 1999 to 2003. Even if the statute of limitations may have expired for some class members concerning IRS penalties, this does not eliminate the possibility of future tax assessments due to potential exceptions under the law.
The IRS may contend that certain class members aimed to evade tax obligations or willfully attempted such evasion. The cases referenced by Matteis assert that erroneous tax advice does not constitute an injury, focusing on "legal interest" rather than injury-in-fact relevant for standing. Only one sister court, in Fielder v. Credit Acceptance Corp., has addressed supplemental jurisdiction concerning state law claims of class members lacking federal subject matter jurisdiction, concluding that federal courts can only hear state law claims tied to federal claims. This view contrasts with Ansoumana v. Gristede’s Operating Corp., which declined to follow Fielder.
Matteis also cites the 2003 amendment to Rule 23(c)(2)(B), arguing it implies that conditional certifications are no longer valid. They interpret the term "certified" to mean that opt-out notices cannot be sent before certification, effectively precluding preliminary certifications. However, the amendment lacks clear language to support this interpretation, and the Committee Notes do not address it, leading to the conclusion that this reading is unwarranted.
Furthermore, the phrase "not limited to" does not exclude independent claims but ensures that the bar includes all dependent claims related to tax strategies and amounts owed to the class or its members. This aligns with the Gerber decision, which discusses claims for contribution or indemnity arising from liabilities to plaintiffs. Several states have laws prohibiting nonsettling parties from seeking contribution from settling parties to promote settlements by providing certainty regarding future liabilities. The Gerber court noted that prior to trial, the district court communicated the method for calculating set-offs, allowing nonsettling defendants to strategize accordingly. The reliance on In re Ivan F. Boesky Sec. Litig. was deemed inappropriate since approval for the judgment credit provision was partly due to the absence of objections from settling and non-settling defendants. The judgment credit provision may need to accommodate different methodologies across jurisdictions due to varying state laws governing contribution and indemnity claims.
