Opinion
No. 99 C 3827
June 14, 2000
MEMORANDUM OPINION AND ORDER
This class action is based on a form letter Discover Financial Services, Inc. sent to plaintiff Janice Follansbee and at least 50,000 other Discover card debtors in November 1998. The subject of the letter was "New IRS Tax Regulations." The letter stated that Follansbee owed Discover a Large sum for credit card charges she made, and that "[t]he IRS may treat the unpaid account balance as income to the cardholder, and require that the cardholder pay taxes on the unpaid account balance." Discover continued: "Our records indicate that we will soon be required to report to the IRS the due and unpaid balance on your account for the 1998 tax year. As a result, you may become liable for taxes on that balance." A footnote corresponding to this sentence advises the cardholder to "consult your tax advisor." The letter goes on to say: "in order that you may avoid the possibility of paying taxes on your due and unpaid balance, we would like to extend to you the opportunity to make appropriate payment arrangements with us."
Follansbee filed suit against Discover on June 9, 1999, alleging in her complaint — on behalf of herself as well as "all present, former and future Discover customers who have received or will receive letters threatening to report their unpaid debts to the IRS if the customer does not make payment arrangements with Discover" — that the Discover warning letter was deceptive and misleading in violation of the Truth in Lending Act (TILA) and that it constituted a breach of contract. Specifically, Follansbee alleged that the letter "created the false impression that if the debtor did not make payment arrangements with Discover . . . Discover would be required to report the unpaid debt to the IRS as taxable income of the debtor," and that "Discover would in fact report the unpaid debt to the IRS as taxable income of the debtor," but that upon information and belief. "Discover did not in fact report customer's unpaid debts to the IRS as taxable income of the debtors (as evidenced by the fact that Discover never sent Ms. Follansbee a 1099 form)." The complaint went on to allege that the letter "created the impression that the alleged unpaid balance would be treated as taxable income of the debtor, when in fact the alleged unpaid balance would not be so treated," and that the letter overstated Follansbee's account balance, because her credit card debt had been discharged in bankruptcy so she did not owe Discover any money at all. In Follansbee's May 21, 1999 demand letter to Discover, she asserted that Discover's conduct also violated the Massachusetts Consumer Fraud Act (Chapter 93A). But because she filed suit before the statutorily required thirty-day response period for consumer fraud act claims had expired, she could not include this claim in her original complaint.
One week after Follansbee filed this action, Matthew Morkavage — who received the same warning letter, but had not filed for bankruptcy — filed suit in the District of Massachusetts. Morkavage's suit was filed on behalf of himself and a putative class and against four defendants, including Discover Financial Services, Inc. (the others being Morgan Stanley Dean Witter Co., the parent corporation of Discover; Greenwood Trust Co., another Morgan Stanley company and issuer of the Discover card; and Novus Credit Services, Inc., a Morgan Stanley subsidiary that services the Discover card; all four defendants are represented by the same in-house Law Department). Morkavage alleged that Discover's warning letter violated TILA (both because it was misleading and because it failed to make the required disclosures of important billing information) as well as Massachusetts Chapter 93A (constituting an unfair and deceptive practice) and the unfair and deceptive acts or practices statutes the states of other cardholders who received the warning letter. More specifically, Morkavage alleged that under U.S. tax law, debts cannot be considered income, so none of the people who received the letter could possibly owe taxes to the IRS, regardless of individual circumstances.
After some initial discovery, the Follanshee parties agreed to a proposed class action settlement, which they presented to this Court on December 21, 1999. Under the proposed settlement, the class would consist of all persons who received the Discover warning letter. Those class members who had filed for bankruptcy protection prior to the delivery of the warning letter — estimated to be 1,137 people — would receive a check for $20, minus Court approved class counsel fees and expenses, not to exceed 30%, plus a refund of the amount (if any) that any such class member paid to Discover after receiving the warning letter. Those who had not filed for bankruptcy prior to receiving the warning letter and are still Discover cardholders — estimated to be 28,021 people — would receive a $10 credit against the balance they owe to Discover, minus attorneys' fees, under the terms stated above. And those who had not filed for bankruptcy prior to the warning letter but are no longer Discover customers because their accounts were sold by Discover — estimated to be 23,806 people — would get a check for $10, minus attorneys' fees, again under the same terms. Class counsel plans to ask this Court for an award of $127,000 in attorneys' fees and expenses, and Discover has agreed to pay up to $50,000 toward such an award, with the remainder to come out of the class members' cash recovery. Discover also agreed to pay for notice to the class and settlement administration, costs that would otherwise fall on the class or its counsel. Finally, Discover agreed to pay Follansbee an $1,000 incentive award. All of this, of course, was offered in exchange for the class members' agreement to release their claims against Discover as well as its parent and affiliate companies.
On December 21, 1 999, this Court entered a preliminary order granting the parties' joint motion to conditionally certify the class pursuant to Federal Rule of Civil Procedure 23(a) and 23(b)(3), preliminarily approving the proposed settlement and defining the class to include: "All persons who currently have or previously had a credit card account with Discover . . . and to whom Discover caused to be delivered [the warning letter]." This Court also approved the plan for notice to the class and ordered that notice be sent, scheduled a fairness hearing and set a cutoff date for class members wishing to object to and/or opt out of the settlement, designated Follansbee as class representative, and named her attorneys as crass counsel.
On September 20, 1999, Discover moved to stay Morkavage's District of Massachusetts suit pending the outcome of this Court's Follansbee action, which involved the same alleged misconduct and seemed likely to settle soon. Morkavage opposed the motion, claiming that his claims were different than Follansbee's. The District of Massachusetts has not yet ruled on the motion to stay proceedings, but on January 22 Discover filed with that court a copy of our preliminary approval order and notified that court that notice was sent to the class.
The notice advised class members of Morkavage's pending case and informed them that remaining in the Follanshee class would preclude them from recovering anything in the Morkavage action. According to Discover, 16 people effectively requested to opt out of the class by the deadline, while four others requested exclusion but failed or refused to provide their social security numbers, so at most 20 people (less than .04% of the class) opted out. Two others have filed objections to the terms of the settlement. This Court held a fairness hearing on Tuesday, April 18, 2000 and is now prepared to rule on the following motions: 1) objector Morkavage's motion to intervene and his request that we deny final approval of the settlement, decertify the class, and grant him leave to propound requests for the production of documents by Discover and set an expedited discovery response period; and 2) plaintiff Follansbee's motion for final approval of the proposed class action settlement (supported by a memorandum from Discover) and application for attorneys' fees as well as an incentive award for the class representative.
This Court has reviewed the objections of class member Kay Shearin, and agrees with Discover that Shearin's objections are based on her misunderstanding of the terms of the proposed settlement. Shearin's concern is that even though she had declared bankruptcy and her debts were discharged before she got the letter, she would not be considered part of the subclass of cardholders who received the warning letter after having filed for bankruptcy (and thus are entitled to the $20 award) because as she read the proposed settlement, that group included only those for whom bankruptcy proceedings were still pending when that letter was received. But Shearin is mistaken. In fact, the Stipulation of Settlement explicitly says that a class member will be deemed to be a part of the bankruptcy subclass if Discover's business records indicate that the member had filed for bankruptcy protection and that his or her bankruptcy had not been dismissed prior to his or her receipt of the warning letter (emphasis added).
Morkavage maintains that his claims are so different from Follansbee's that she cannot adequately represent the entire class and its interests and thus that we should both decertify the class and deny approval of the proposed settlement and allow him to proceed with his District of Massachusetts case. Although Follansbee was bankrupt and many of the other class members, like Morkavage, were not, factual distinctions between class representatives and other class members generally do not render the class representative ineffective, even if these differences result in a disparity in damages claimed by the different parties. A class representative's claim is still typical so long as "`it arises from the same event or practice or course of conduct that gives rise to the claims of other class members and his or her claims are based on the same legal theory.'" Keele v. Waxler, 149 F.3d 589, 595 (7th Cir. 1998) (quoting De La Fuente v. Stokely Van Camp, Inc., 713 F.2d 225, 232 (7th Cir. 1983). Follansbee's claims arise out of the same course of conduct as do Morkavage's claims — Discover's use of the warning letter — and the legal theories that she asserted apply to all of the class members. This Court will not disqualify Follanshee as the class representative merely because she can assert additional claims based on her bankruptcy discharge that the other class members cannot claim. See Rosaric v. Livaditis, 963 F.2d 1013, 1018 (7th Cir. 1992) ("we have not previously interpreted Rule 23(a)(3) to require all class members suffer the same injury as the named class representative"); Young v. Meyer Njus, P.A., 183 F.R.D. 231, 234 (N.D. Ill. 1998) (finding class representative's claims typical because each class member received collection letter similar to that of class representative that allegedly violated same law, even though subclass had an additional claim arising from facts not applicable to the others). Morkavage argues that Follansbee's counsel must have focused his advocacy efforts on the invalidity of Discover's attempts to collect debts discharged in bankruptcy, a claim available only to the small subclass of which Follansbee is a part. But this argument is speculative — the only support Morkavage points to is the award differential that resulted. And as will be discussed later in this opinion when the fairness of the settlement is considered, there is nothing wrong with negotiating different damages awards for different subclasses, so long as the difference is based on legitimate considerations. See Be La Fuente, 713 F.2d at 233; In re Painewebber Ltd. Partnerships Litig., 171 F.R.D. 104, 131 (S.D.N.Y. 1997).
Morkavage's objections — both to Follansbee's ability to represent the class and to the settlement terms — focus primarily on the differences between Follansbee's claims and those of the other class members and the way that these differences have affected the settlements proposed for each subclass. Thus, this Court's analysis at times may blur the line between evaluating the fairness of the settlement and evaluating Follansbee's representation of the class.
This analysis also applies to Morkavage's claim that his complaint is substantially different from Follansbee's because he received an IRS Form 1099-C indicating that Discover did in fact report his debt information to the IRS, while part of Follansbee's allegation was that the warning letter's statement that Discover would disclose the information to the IRS was misleading because Discover did not do so. This factual difference is minor, and Follansbee's claim is still at base the same as Morkavage's (that the letter was misleading with respect to the IRS's reporting requirements and the cardholder's potential tax liability).
Morkavage also finds fault with Follansbee's failure to include a Chapter 93A claim in her complaint alleging unfair and deceptive practices under state law. But even though she does not formally allege that particular cause of action, she did assert that claim in her demand letter to Discover. According to Follansbee's counsel, the claim could not be included in her original complaint because she filed it soon after she sent the demand letter, prior to the expiration of the 30-day waiting period required by the state statute. Follansbee's counsel assures this Court that the Chapter 93A allegation was asserted in the settlement talks and that Foliansbee was ready — and told Discover of this willingness — to amend her complaint at any time to include a Chapter 93A claim if the settlement did not appear to adequately compensate for that claim. And in fact, the stipulation of settlement explicitly says in paragraph D: "Follansbee alleges that . . . Discover has engaged in unlawful, fraudulent, deceptive and misleading acts that render Discover liable to Follanshee and the Settlement Class under Chapter 93A."
Morkavage's complaint — unlike Follansbee's — included a second TWA claim, alleging that the warning letter did not comply with TILA disclosure requirements. But this claim would face many obstacles, as does Follansbee's TILA claim that the letter was deceptive and misleading. For example, there is the threshold question whether the warning letter qualifies as a "periodic statement" governed by TILA regulations. In addition, Discover could raise the TILA defenses of bona fide errors and unintentional violations. See 15 U.S.C. § 1640 (c), (e). And although this Court is not to decide the merits of the case, it does look at the strength of the plaintiffs' claims in order to deem whether the settlement is fair. See Isby v. Bayh, 75 F.3d 11 91, 1199 (7th Cir. 1996). Were this Court to hold up class certification and doubt Follansbee's representative ability because of this difference, any class member could file a complaint with slightly different allegations and demand that the Court disqualify the settlement and decertify the class on these grounds. That is why any class member unhappy with the settlement had the opportunity to opt out. This Court does not know why Morkavage failed to do so if he was so unhappy with the claims Follansbee asserted, but it declines to allow him to direct the settlement process now that he has waived his opportunity to proceed on his own.
The same goes for Morkavage's argument that Follansbee's case is drastically different since her complaint names only Discover Financial Services, while Morkavage also brought suit against three other defendants, all of whom he claims collectively engaged in the alleged deceptive practices. Arguably the settlement terms were negotiated with possible claims against the three related companies in mind as well, as evidenced by paragraph 6 of the proposed final judgment and order which releases all claims "against Discover, its parent companies, holding companies, affiliates, or predecessors-in-interest." Whether Morkavage's lawyers think they could have negotiated a better settlement themselves is irrelevant to this Court's evaluation of the deal (which inevitably overlaps with the Court's consideration of Follansbee's ability to represent the class); rather, this Court looks at what Morkavage's class would be likely to recover were they to proceed with their claims to trial. See Linney v. Cellular Alaska Partnership, 151 F.3d 1234, 1242 (9th Cir. 19981 (court should not judge proposed settlement against "hypothetical and speculative measure of what might have been achieved by the negotiators") (internal citation omitted). And Morkavage's claim that Discover's parent and affiliated companies collectively engaged in the allegedly deceptive practices stands on no stronger footing than the plaintiffs' claims against Discover only. Additionally, the relative depth of the pockets of four defendants versus only one must be weighed against the risk and expense of pursuing litigation against all four. For all of these reasons, this Court rejects Morkavage's arguments and finds Follansbee to be an adequate class representative. And because the Court finds that the questions of law and fact common to the class members "predominate over any questions affecting only individual members," the Court hereby finalizes certification of the settlement class. See Fed.R.Civ.P. 23(b)(3).
See the earlier reference to Discover's potential defenses to the TILA claims. The Court discusses the likelihood of success of the plaintiffs' other claims later in this opinion.
This Court turns now to Follansbee's motion for final approval of the settlement, and Morkavage's objections. It is well recognized that "[f]ederal courts naturally favor the settlement of class action litigation." Isby v. Bayl, 75 F.3d 1191, 1196 (7th Cir. 1996). In this case, contrary to Morkavage's objections, this Court finds the proposed class settlement to be fair, adequate, and reasonable. Morkavage first argues that the settlement unfairly gives the subclass of which Follansbee is a part — consisting of people who had filed for bankruptcy prior to receiving the warning letter and constituting about 2% of the settlement class — a much better deal than it gives the other two subclasses, which together make up 98% of the class. This is because the first subclass receives $20 (minus attorneys' fees and costs, not to exceed 30%), an award twice as large as that which the other two subclasses get, plus the first subclass gets a refund of any money its members paid to Discover pursuant to the warning letter, which the other two subclasses were not guaranteed. But distinctions in the damages awarded to different subclasses are not uncommon and will not defeat a class settlement so long as the distinctions are supported by a rational basis. See Ce La Fuente, 713 F.2d at 233; In re Paine webber Ltd. Partnerships Litig., 171 F.R.D. 104, 131 {S.D.N Y 1997). In this case, the differences in the subclass rewards reflect the relative strength of the different groups' claims and each group's likelihood of success and risk of non-recovery were the case to go to trial. That is, in addition to the claims common to the other class members, the bankrupt members could also claim that the letters they received misrepresented the amount of money they owed and violated their bankruptcy discharges or automatic stays. See 11 U.S.C. § 362, 524. So it is appropriate that these members receive more of the pro-rated settlement amount, especially because the $10 difference between the award amounts is not egregious.
Although this Court understands Morkavage's objection, it is told that in fact no money was paid to Discover by the bankrupt class members in response to the warning letter, so this turns out to be a distinction without a difference. Furthermore, while Morkavage contends that the settlement is unfair because it provides no such restitution to the nonbankrupt class members who may have sent money to Discover in response to the warning letters, he does not provide any evidence or even any suggestion as to who these individuals are and/or how much they paid. Plus, these individuals' debts were not discharged, so they continued to owe money to Discover. In fact, were this case to go to trial, Discover might have brought counterclaims or alleged a set-off defense against these class members based on their unpaid account balances. This Court thus finds a $10 credit against their debts to be a reasonable compromise.
Morkavage relies on a recent Seventh Circuit case to argue that the disparity in treatment of class members is enough to demonstrate that the terms of the settlement are unfair. See Crawford v. Equifax Payment Servs., Inc., 201 F.3d 877 (7th Cir. 2000). But in Crawford the settlement did not provide class members with notice and an opportunity to opt-out, the named plaintiff got $2000 and his attorney got $78,000 while the other class members received no damages award at all but lost the right to pursue a class action against the defendant in the future, and the class representative consented to a class so large (about 214,000 members) that no member could expect to recover very much given the statutory damages cap anyway. See Id. at 882. Furthermore, in that case the objectors' timely motions to intervene were denied, leaving them with no standing to appeal should the district court approve the settlement over their objections, See Id. at 880. This case does not present the same compelling circumstances.
Morkavage also contends that the third subclass — consisting of people (including Morkavage) who, although not bankrupt, are still Discover cardholders and stand to receive a $10 credit to the balances they owe — have carried their debts for so long that they actually are in danger of owing taxes on their unpaid Discover Card balances as debt forgiveness income, rendering the $10 credit effectively worthless to them. But he provides no support for this proposition, and the Court will not assume that a credit is totally worthless to people who continue to owe money to Discover, nor is the Court persuaded by Morkavage's argument that the right to restitution is a "vital component" of the damages pursued in his case and that this settlement works a grave injustice by stripping him and other class members of their right to pursue restitution elsewhere, because the entire class was given notice of the terms of the settlement and of their right to opt-out of the class but most of them declined to exercise that right, including Morkavage.
One of the key considerations in evaluating a proposed settlement is the strength of the plaintiffs' case as compared to the amount of the defendants' offer. See Isby, 75 F.3d at 1199. However, "district courts have been admonished `to refrain from resolving the merits of the controversy or making a precise determination of the parties' respective legal rights,'" so in deciding whether to approve the settlement this Court must focus on the general principles of fairness and reasonableness, not on the substantive law governing the plaintiffs' claims. Id. at 1196-97 (quoting EEOC v. Hiram Walker Sons, Inc., 768 F.2d 884, 889 (7th Cir. 1985)). Discover's memorandum in support of final approval outlines the many arguments that the company could raise before or during trial, all of which cast doubt on the strength of the plaintiffs' case. In addition to the TILA obstacles that were mentioned earlier in this opinion, Morkavage faces a number of hurdles in proving that the letter constituted an unfair or deceptive trade practice under the state laws of all of the states in which class members reside (Follansbee specifically alleges only a violation of Chapter 93A of Massachusetts law), as Discover maintains that stating that Treasury Department regulations required Discover to report certain unpaid account balances to the IRS, that payment arrangements by cardholders relieved Discover of such obligations, and that class members might want to consult a tax advisor was truthful and not intended to deceive in any way. And even if the plaintiffs were to prevail at trial, it is probable that Discover would assert set-offs against those class members who still owe money on their accounts, also, the plaintiffs' breach of contract claim is extremely speculative, as Follansbee cannot point to any express or implied obligation to Discover to refrain from sending out such warning letters.
Overall, the balance of factors in this case weighs in favor of settlement approval. The other factors this Court considers include the likely complexity, length and expense of taking the case to trial, the amount of opposition to the settlement expressed by affected parties, the opinion of competent counsel, and at what stage the proceedings are (and how much discovery has been conducted) at the time that a settlement is reached. See Isby, 75 F.3d at 1198-99. In this case, a trial would likely be long and expensive for both parties, and would subject both parties to substantial risk since the outcome is by no means certain. While all of the proposed class plaintiffs were given notice of the settlement terms and an opportunity to opt out or object, at most 20 members opted out (0.4%), and only two have filed formal objections, so the opposition from affected parties is minimal. Class counsel, who has considerable experience litigating class action suits, supports the settlement and finds it to be a fair and reasonable deal. And by the time the settlement was reached the parties had engaged in extensive discussions lasting over several months, exchanged written discovery regarding both the warning letter and the identification of class members, and conducted the depositions of three witnesses who testified regarding Discover's understanding and interpretation of IRS regulations, Discover's reporting to the IRS of unpaid account balances on Form 1099C, Discover's use of the warning letter, and the identification of class members. So the development of the case was not insubstantial at the time that a settlement was reached. Looking at the proposed deal in light of what the plaintiff class might have received after a trial, accounting for the costs and risks of litigation, see Linney, 151 F.3d at 1242, and recognizing that "`the essence of settlement is compromise,'" Isby, 75 F.3d at 1200 (quoting Armstrong v. Bd. of School Dirs., Etc., 616 F.2d 305, 315 (7th Cir. 1980)), this Court finds the class agreement to be fair and reasonable.
Follansbee has also moved for an attorneys' fees award of $127,000, of which $50,000 is to be paid by Discover. District courts have discretion to determine how attorneys' fees should be calculated depending on the circumstances of the case, see Cook v. Niedert, 142 F.3d 1004, 1010 (7th Cir. 1998), and this Court finds the percentage-of-recovery method to be appropriate in this case and advantageous in its simplicity. The award sought in this case would represent 21 percent of the total class recovery, which falls well within what courts consider to be reasonable. See Gaskill v. Gordon, 160 F.3d 361, 362-63 (7th Cir. 1998) (recognizing that the typical contingent fee for lawyers representing a class is between 33 and 40 percent; and that "[s]ome courts have suggested 25 percent as a benchmark figure for a contingent-fee award in a class action," and then approving a 38 percent award). This Court therefore approves the requested fee award. The requested incentive award of $1000 for named plaintiff Follansbee is also reasonable and this Court recognizes the importance of incentive awards for class representatives, see, e.g., In the Matter of Continental Illinois Secs. Litig., 962 F.2d 566, 571 (7th Cir. 1992), so the Court approves that request as well.
Morkavage waited three months after learning of the terms of the proposed settlement to file his motion to intervene. Though this Court questions this delay, it will grant Morkavage