I am an unabashed believer in the free market system. As such, I expected to have profound disagreement with the conclusions reached in the draft report of the Third Circuit's Task Force on the Selection of Class Counsel. The Task Force, appointed by Chief Judge Edward R. Becker to evaluate the recent spate of federal district court decisions that have awarded lead class action counsel status to the law firm bidder whose fees will be lowest, concluded that federal district courts should rarely if ever conduct such auctions.

I was hoping to be able to criticize the report for improperly rejecting the free market approach. And I was looking forward to suggesting that the Task Force's conclusions were unsurprising, given that the Task Force's membership was dominated by lawyers representing entrenched interests -- experienced class action plaintiff and defense counsel who had become adroit at benefiting from the existing system of class counsel selection that the auction process threatened to displace.

If you were hoping for such a scathing review, you will not find it here. Instead, I have concluded that the Third Circuit Task Force on the Selection of Class Counsel correctly warns against the widespread use of auctions to select lead class action counsel.

In typical, non-class action litigation, courts play no role in the selection of counsel for the parties. Parties in such cases are free to hire any attorney willing to serve as counsel and to negotiate, without court involvement, the terms of the attorney's compensation. In class actions, by contrast, the court is required to ensure that the class representative has selected qualified counsel. And, at the close of the case, the court has a responsibility to determine that the fees to be paid to the class's attorney are fair both to the class and to the attorney.

Courts have long struggled to determine how best to award counsel fees in class actions. In the 1970's, many courts began employing the "lodestar" approach, which required judges to review class counsel's time entries, determine the number of hours properly expended on the matter, and multiply those hours by a reasonable hourly rate. Depending on the litigation's overall success, or lack thereof, the lodestar rate could then be adjusted upward or downward by a results-reflecting multiplier. Critics of the lodestar method complained that it improperly caused class counsel to spend excess time on tasks and discouraged early settlement even when that would be in the class's best interest.

In 1985, the Third Circuit appointed a Task Force to examine whether the lodestar approach should remain the preferred way to determine fees for class counsel in "common fund" cases. Under the common fund doctrine, attorneys whose work produces a fund of money for the plaintiffs are entitled to be paid reasonable compensation from the fund. The common fund doctrine applies in cases where there is no fee shifting statute that requires the defendant to pay the attorneys' fees of a prevailing plaintiff.

The 1985 Third Circuit Task Force observed that the lodestar approach often required trial courts to engage in an extraordinarily time-consuming, "gimlet-eyed" review of attorneys' time records, in a task that led judges to play the role of Ebenezer Scrooge. Cf. Goldberger v. Integrated Res., Inc., 209 F.3d 43 (2d Cir. 2000) (employing this colorful language to describe the pitfalls of the lodestar method). Thus, the 1985 Task Force recommended that, in common fund cases, trial courts abandon the lodestar approach for the generally easier process of awarding to class counsel a "percentage of recovery" from the fund.

The percentage of recovery approach allowed trial courts to divert their attention from a detailed review of time records toward a consideration of the result achieved, the stage of the litigation at which the result occurred, and the overall amount of skill, time and effort that class counsel employed in achieving the result. Courts could invoke established percentage of recovery benchmarks, say one-quarter or one-third of the recovery would go to pay counsel, making the percentage of recovery procedure generally easier to apply than the lodestar method.

Over time, however, the percentage of recovery method has itself drawn much legitimate criticism. Some class action settlements involve such large sums of money that the traditional percentage benchmarks would produce an absurdly high attorneys' fee award for class counsel. In re Cendant Corp. PRIDES Litig., 243 F.3d 722 (3d Cir.) (vacating attorneys' fee award of 5.7 percent of settlement fund, which produced $19 million fee, as too large), cert. denied, 122 S. Ct. 202 (2001). Even in cases involving enormous settlements, few if any class members have the financial incentive to object to an overly large class counsel fee requested under the percentage of recovery method. The counsel fee petition process thus can resemble an ex parte proceeding between the class's counsel and the trial court. And fees awarded under the percentage of recovery approach often were based on little more than the inexplicable, gestalt judgment of a trial judge that was all but unreviewable on appeal under the abuse of discretion standard.

Based on a concern that the percentage of recovery method has produced attorneys' fee awards to class counsel that are far too large, and that the selection of an appropriate percentage can represent an arbitrary act of judicial discretion, the Third Circuit has recommended that trial courts should, in close cases, perform a lodestar cross-check. In re Cendant Corp. Litig., 264 F.3d 201 (3d Cir. 2001). Such a cross-check requires the trial court to compare the fees the percentage of recovery method produces with the fees that the lodestar method would produce. Of course, a trial court that engages in such a cross-check loses the benefit of whatever relative ease of use the percentage of recovery method was intended to offer.

Given legitimate concern that neither the lodestar nor the percentage of recovery method worked well in practice, several federal district judges have begun to experiment with the auctioning of lead class counsel to the lowest fee bidder. These trial courts have solicited attorneys' fee bids from law firms qualified to handle the case and have awarded the position of lead class counsel to the law firm that is willing to handle the case for the smallest fee. This approach sounds quite logical, because in common fund cases, where both the class and the attorneys are compensated from the same pool of money, a smaller attorneys' fee must mean more money for class members. Upon analysis, however, it becomes clear that auctioning the position of lead counsel to the lowest bidder makes sense in few if any cases.

In the actual market for counsel, an attorney's fee is just one, albeit important, factor that a client considers in choosing which lawyer to hire. Savvy clients understand that lawyers with experience and a well-earned reputation for success often charge more than inexperienced and untested lawyers, but the results achieved can be well-worth the added cost. Lawyers are not fungible the way that widgets are, and therefore work does not invariably flow to the attorneys who charge the least. If, as is often the case, a more expensive lawyer can achieve a better result, the question becomes whether the better result is worth the added expense from the client's perspective.

The goal in selecting class counsel should be to choose the lawyer or law firm that will achieve the greatest recovery for the class after payment of attorneys' fees and disbursements. In a case in which all qualified attorneys would achieve the same result, an attorney's cost should be a factor of overriding importance. Few litigated cases, however, fall into that category. In the remaining vast majority of cases, where attorney skill makes a difference in the result, the use of the auction mechanism simply does not make sense. The draft report of the Third Circuit Task Force on the Selection of Class Counsel arrives at precisely this result, and I find myself in complete agreement.

Where the Task Force and I part company is on the question of what method of fee award trial courts should pursue in the vast majority of cases where the auctioning of class counsel to the lowest bidder makes no sense. The current Task Force reaffirms the 1985 Task Force's conclusion that the percentage of recovery method is preferred, augmented where appropriate by a lodestar cross-check. I, however, strongly prefer the "market-mimicking" approach that the U.S. Court of Appeals for the Seventh Circuit follows.

As the Seventh Circuit explained in In re Synthroid Mktg. Litig., 264 F.3d 712 (7th Cir. 2001), "[t]he market rate for legal fees depends in part on the risk of nonpayment a firm agrees to bear, in part on the quality of its performance, in part on the amount of work necessary to resolve the litigation, and in part on the stakes of the case." The Seventh Circuit instructs federal district courts within its geographical boundaries to determine fees near the start of the litigation, based on the terms that private plaintiffs would negotiate with their lawyers at the outset of the case. "Before the litigation occurs, a judge can design a fee structure that emulates the incentives a private client would put in place. At the same time, both counsel and class members can decide whether it is worthwhile to proceed with that compensation system in place."

The Seventh Circuit's approach, ably explained by Circuit Judge Frank H. Easterbrook in the Synthroid decision, conflicts both with the Third Circuit's Task Force's recommendation that the percentage of recovery approach be applied post-recovery in common fund cases and with existing Third Circuit caselaw. The Third Circuit has construed Federal Rule of Civil Procedure 23(e)'s requirement that a class action "shall not be dismissed or compromised without the approval of the court" to require a searching, post-recovery review of the proposed attorneys' fee award based on all of the facts and circumstances known at the conclusion of the litigation. Under the Seventh Circuit's approach, by contrast, the setting of a market-driven fee at the outset of a case eliminates the "perilous process" of determining attorneys' fees after the case has concluded.

In conclusion, I applaud the Third Circuit Task Force for warning against the widespread use of class counsel auctions. The Task Force, in finalizing its draft report, should reconsider its preference for the percentage of recovery method and should instead recommend that trial courts follow the market-mimicking approach that is the law in the Seventh Circuit.

This article is reprinted with permission from the December 10, 2001 issue of The Legal Intelligencer © 2002 NLP IP Company.