On The Case

Law prof (and ex-Scalia clerk): Evidence shows class actions deter corporate misconduct

(Reuters) - Vanderbilt law professor Brian Fitzpatrick has impeccable conservative credentials. After graduating first in his class from Harvard Law School, he clerked for Judge Diarmuid O’Scannlain of the 9th U.S. Circuit Court of Appeals, a Reagan appointee, then for U.S. Supreme Court Justice Antonin Scalia. Fitzpatrick was a corporate lawyer at Sidley Austin before he entered academia.

Based on that history, you would expect Fitzpatrick to be a class action stickler, if not outright skeptic. But in a recently published draft paper, "Do Class Actions Deter Wrongdoing?", Fitzpatrick not only argues that the primary justification of class actions is to deter corporate misconduct - in contrast to recent conventional conservative wisdom that class actions are intended to be merely a procedural vehicle to promote litigation efficiency – but that the admittedly scant empirical evidence shows the cases do, in fact, serve that purpose. (The paper is a shortened version of a chapter in Fitzpatrick’s soon-to-be-published book, "The Conservative Case for Class Actions.")

“The theory of deterrence remains just as strong today as it was when it was introduced 50 years ago by the ‘classical’ law and economics movement,” Fitzpatrick wrote. “Moreover, although there is not a great deal of empirical evidence to support the theory for class actions, there is some, it is uncontroverted, and it is consistent with reams and reams of empirical evidence in favor of deterrence for individual lawsuits. In short, I think the conventional view that the class action can be justified by the deterrence rationale alone remains sound.”

Fitzpatrick’s paper is remarkably good at laying out the theory of deterrence, as well as criticism of the theory, without resorting to jargon. You really can’t do much better than his opening paragraph to summarize debate over the purpose and practicality of class actions:

“When the claims at issue in a class action are small, as they usually are in the United States, it is unlikely that any litigation efficiency is gained because there would be no individual litigation at all in the absence of the class action,” he wrote. “This leaves us with compensation and deterrence. But the class action is not known for its success at delivering compensation to class members; sometimes it does it well - and it may get better as technology improves - but, in the run-of-the-mill case, only a small percentage of victims are made whole. None of this has bothered me or many other scholars because we have always pointed to the deterrence virtue of the class action, arguing that alone is enough to justify the class device.”

Underlying that theory, he explains (with copious footnotes showing his mastery of class action scholarship) is the assumption that corporations act rationally. When they face the prospect of punishment, in the form of a class action, they are less likely to misbehave. That seems obvious but critics, as Fitzpatrick explains, have raised two arguments against the theory. First, corporate officers may not be deterred because they’re not held personally responsible in class actions and second, class action litigation is too inherently unpredictable for corporations to predicate behavior on the risk of being sued.

Fitzpatrick knocks back both theories. Corporations hire rafts of lawyers to advise them on litigation risk, he said, and if we were to assume that officers and directors are not influenced by class action risk, then we have to assume their conduct is unaffected by any prospective reaction. “If class action lawsuits can’t deter corporate misconduct … then nothing else that costs the corporation money can either,” he wrote. “Thus, if we contend that class action lawsuits are failures, then we have to admit that other lawsuits and the market feedback loops are, too. But no one wants to admit all that.”

Fitzpatrick is such a good writer that you don’t really get a sense of the roiling controversy over the very idea that deterrence is a legitimate justification for class actions. In a phone interview, Fitzpatrick told me that the Rules Committee that drafted modern class action rules in the 1960s didn’t really contemplate corporate deterrence through small-dollar consumer class actions. (In fact, he said, committee members were focused on their concern that the class action vehicle would unduly favor defendants, which just goes to show that even very smart lawyers aren’t good prognosticators.)

Fitzpatrick argues that if you accept the proposition that corporations shouldn’t be allowed to extract even small amounts of money from hoodwinked consumers, then class actions are actually a conservative way to make sure they don’t. The other options are to provide no vehicle to litigate small-dollar claims, thus allowing businesses to steal from customers, or to rely on the government to enforce corporate honesty. I suggested that perhaps we can rely on the market to punish deceptive businesses; Fitzpatrick said class actions act as a megaphone to amplify warnings to consumers.

That point brings me to Fitzpatrick’s empirical evidence that class actions influence corporate behavior for the better. His first conclusion is that consumers benefit from injunctive relief corporations grant in class action settlements. Roughly speaking, a quarter of class settlements include an injunction. As Fitzpatrick acknowledges, there’s considerable debate over whether those injunctions are worth the paper they’re printed on (let alone the hundreds of thousands or even millions of dollars in legal fees for plaintiffs’ lawyers.) He concludes, however, that in the dozens of cases in which he has served as an expert witness and examined the merits of injunctions, “none of the provisions … were toothless.”

Class action reformer Ted Frank, who will be debating Fitzpatrick at an American Bar Association conference in October, has a much dimmer view of the merits of injunctions. (As you may recall, the 7th Circuit sided with Frank on Friday when it tossed an injunction-only settlement in a “worthless” class action accusing of Subway of falsely advertising its foot-long sandwiches.)

“When there is a meaningless injunction, the corporation is either getting away with something or being penalized by the class action system,” said Frank, who accuses Fitzpatrick of confirmation bias. “If the system isn’t adequately distinguishing between good corporations and bad ones … it is exactly backward.” (Fitzpatrick, noting that two other federal circuit courts have recently affirmed injunctive settlements in which Frank represented objectors, said he has looked at all of the injunctions Frank specifically cited as meritless in a recent paper and found many of them were legitimate. “Just because Ted Frank thinks something is toothless doesn’t mean it is,” Fitzpatrick said. “When the federal judiciary hears and thoughtfully rejects his arguments, I don’t think we can count those injunctions as toothless.”)

A bigger question than the specific deterrence a particular injunction might provide is the generally cautionary impact of the prospect of the prospect of a class action. Fitzpatrick cites copious empirical evidence that the threat of individual suits makes prospective defendants more careful but said a half-dozen studies find the same correlation between corporate conduct and the risk of facing a class action. One study examined the market for white bread to distinguish the disparate deterrent effects of government and private antitrust enforcement. It concluded that white bread makers seemed to be more wary of class actions than government enforcement. The other studies generally found corporations made more robust disclosures to shareholders when they faced greater risk of securities class actions.

“Although these studies of class actions and deterrence are not numerous, they are unanimous: Class action lawsuits generate general deterrence,” Fitzpatrick wrote.

I asked Mayer Brown’s Andrew Pincus, who frequently represents class action detractors, what he thought of Fitzpatrick’s argument. Like Frank, Pincus said the professor didn’t pay enough attention to the impact of unwarranted class actions. “The article skillfully avoids the critical question relating to general deterrence,” Pincus said in an email. “Of course companies are aware that they may be subject to class actions – that’s inevitable for anyone doing business in today’s world. But the deterrence argument works only if companies believe that lawful conduct will not trigger class action suits that impose high costs. That just isn’t true: Because class actions are almost never decided on the merits, the system does not filter out legitimate from illegitimate claims … Class action costs and settlement liability are the unavoidable cost of doing business, present no matter what steps a company takes to comply with the law, and therefore have no beneficial deterrent effect.”

Fitzpatrick’s paper and upcoming book obviously aren’t going to be the last word on class action efficacy. But he’s putting out provocative ideas and backing them up with evidence. Let the debate rage on!