Defendant Class Actions: A Unicorn Survival Guide

The Fourth Circuit’s opinion in Bell v. Brockett, No. 18-1149 (4th Cir. Apr. 25, 2019), posits that “[d]efendant class actions are so rare they have been compared to unicorns.” But what may be even rarer is an opinion, like Bell, in which a court opines on the fundamental and concerning nature of the district court’s clear errors regarding the appointment of class counsel, but nonetheless decides not to reverse. 

Bell arises from the (“Zeek”) fraud scheme. Zeek offered participants the opportunity to share in revenues generated by Zeek’s supposed online auction business. In reality, Zeek participants made money only when other participants paid into the scheme, “necessarily robb[ing] Peter to pay Paul.” As with most Ponzi and pyramid schemes, the influx of participants—and, thus, of funds—dried up, leaving many participants with less money than they paid into Zeek (the “Net Losers”), and a small minority of participants with more (the “Net Winners”).

When the SEC discovered the scheme, it filed an enforcement action in the Western District of North Carolina. The district court appointed Kenneth Bell as Zeek’s Receiver. Bell filed a defendant class action against the Net Winners, seeking to use their winnings to compensate the Net Losers for injuries suffered as a result of Zeek’s fraud. The district court certified the class, but did not appoint class counsel until well into the case’s liability phase. In making the appointment, the court did not address the Rule 23(g) factors regarding whether class counsel is adequate to represent the class. No class member objected to the timeliness of the appointment or to the court’s failure to consider the Rule 23(g) factors. 

After the liability phase of the case concluded (with the district court granting Bell’s motion for summary judgment), after numerous defendant class members resolved the claims against them, and after the district court entered final judgment, a number of defendant class members moved to decertify based on class counsel’s alleged inadequacy. The decertification motions did not raise the district court’s failure to timely appoint class counsel or to analyze the Rule 23(g) factors. The district court denied both motions, and the class members appealed. For the first time, in its appeal, the defendant class members argued that the district court abused its discretion by failing to appoint class counsel at certification and to consider the Rule 23(g) factors. 

Evaluating the timing of class counsel’s appointment, the Fourth Circuit held that Rule 23(c)(1)(B) contains a clear requirement that “a court must appoint class counsel at the time of certification.” Similarly, in evaluating the district court’s failure to consider the Rule 23(g) factors, the Fourth Circuit stated that Rule 23(g)’s plain text sets forth four factors that courts must consider in appointing class counsel: “(1) the work counsel has done in identifying or investigating potential claims . . . ; (2) counsel’s experience in handling class actions [and similar cases]; (3) counsel’s knowledge of the applicable law; and (4) the resources that counsel will commit to representing the class.” The Court emphasized that these factors “provide critical safeguards against the due process concerns inherent in all class actions” and are “especially important for a defendant class action where due process risks are magnified” because “an unnamed class member can be . . . subjected to a judgment compelling the payment of money or other relief without ever being individually served with a lawsuit.” The Court then held that the district court failed to comply with both requirements—which apply equally to plaintiff and defendant class actions.

Notwithstanding its emphasis on the importance of these requirements and its finding that the district court violated both, the Fourth Circuit affirmed the district court’s denial of decertification. It did so in reliance on several factors unique to Bell:

  • No defendant class member objected to the district court’s failure to appoint class counsel at certification or to consider the Rule 23(g) factors before the case reached the Fourth Circuit;
  • The defendant class members had an opportunity to obtain separate counsel to challenge individually the proposed judgments against them;
  • The litigation had progressed so far that the district court had deemed the defendant class liable, more than 2,500 defendant class members had finally resolved the claims against them, and the Net Losers had received distributions; and
  • The defendant class members offered no evidence indicating that the district court’s errors caused them any harm.

Even after Bell, parties involved in both traditional plaintiff and “not so noble” defendant class actions should adhere closely to Rule 23’s requirements regarding the timing of and factors to consider when appointing class counsel. Absent the unicorn-like features that saved Bell, failure to comply with Rule 23 leaves parties exposed to significant risk of decertification.