(Reuters) - A federal appeals court on Tuesday voided a controversial $5.2 million settlement intended to resolve allegations that Encore Capital Group Inc (ECPG.O) used false affidavits and other illegal tactics to collect debts from 1.44 million consumers.
The 6th U.S. Circuit Court of Appeals in Cincinnati said U.S. District Judge David Katz abused his discretion in August 2011 when he approved the settlement with Encore and its Midland Funding and Midland Credit Management units as "fair, reasonable and adequate," and certified a nationwide settlement class.
The settlement was intended to resolve claims that Midland employees relied on false or "robo-signed" affidavits to collect consumer debt that was not owed or was already paid off.
Midland employees had been accused of signing 200 to 400 computer-generated affidavits a day without knowing their contents. Robo-signing is more commonly associated with the mortgage industry.
The settlement drew opposition from 38 state attorneys general, consumer groups and the AARP, an influential nonprofit organization representing people 50 and older, in part because Midland kept the right to pursue many debt collection cases.
"We're delighted with the opinion," Ian Lyngklip, who argued the appeal on behalf of eight class members, said in a phone interview. "It signals that federal courts are not going to allow class action settlements that sacrifice significant rights of class members. The 6th Circuit has opened the door to all the victims of Midland's practice of filing false affidavits to seek to throw out debt collection judgments against them."
Encore spokesmen were not immediately available for comment. The San Diego-based company has said it changed its affidavit process in 2009 to ensure that signers review underlying documentation.
More than 133,000 class members had filed claims under the settlement, while 4,262 opted out and 61 objected.
In midday trading, Encore shares were down $2.76, or 8.8 percent, at $28.58 on the Nasdaq.
Writing for a three-judge 6th Circuit panel, Circuit Judge R. Guy Cole said the settlement relief was "perfunctory at best," including typical payments of just $17.38 to class members believed to owe hundreds or thousands of dollars each.
Cole also said a related injunction intended to improve Midland's policies and oversight offered "little value."
He said this was because the injunction did not prohibit the use of false affidavits; lasted only one year, after which Midland was "free to resume its predatory practices should it choose to do so"; and offered only future relief "that likely does not benefit class members at all."
The court decertified the class for several reasons, including that the named class representatives would have their debts to Midland forgiven, while others would not.
In opposing the settlement, the 38 state attorneys general, led by New York's Eric Schneiderman, called the payout "paltry" and said the accord deprived consumers of their right to defend against existing Midland lawsuits.
James Freedland, a spokesman for Schneiderman, did not immediately respond to a request for comment.
The AARP in court papers said the settlement "rewards debt collectors for business practices that rely upon rampant fraud and abusive collection practices."
Encore typically buys debt from credit card companies. Last year, it invested $562.3 million to buy accounts with a face value of $18.5 billion, equal to about 3 cents on the dollar.
The 6th Circuit returned the case to the district court for further proceedings. Judge Katz works in Toledo, Ohio.
The case is Vassalle et al v. Midland Funding LLC et al, 6th U.S. Circuit Court of Appeals, Nos. 11-3814, 11-3961, 11-4016, 11-4019 and 11-4021.
Reporting by Jonathan Stempel in New York; additional reporting by Karen Freifeld in New York; Editing by Gerald E. McCormick, Grant McCool and John Wallace