High court weighs future of a class-action "hellhole"

January 7, 2013: 7:02 AM ET

Using procedural sleights-of-hand to keep big corporate defendants trapped in congenial Arkansas courts, local law firms have extracted almost $400 million in fees over seven years in one small, rural county. Can the defendants stage a breakout?

By Roger Parloff

supreme-courtFORTUNE -- On Monday, in the case known as Standard Fire Insurance v. Knowles, the U.S. Supreme Court will hear argument on what might, at first glance, look like a dry procedural question over whether certain interstate class-actions should be heard by state or federal courts.

But behind that technical question lurks a lurid, tragicomic, outlandish back story. That story concerns the goings-on inside the circuit court of Miller County, Ark., where a handful of local law firms have made almost $400 million in fees over the past seven years, all from class-action settlements that have been procured without a judge's ever having ruled that these cases are even worthy of class treatment, let alone meritorious.

Precisely how much cash the lawyers' clients -- the class members themselves -- have received from the lawyers' so amply-compensated efforts on their behalf is, on the other hand, a mystery to this day. Those numbers are regarded as "confidential" and "proprietary" by the plaintiffs attorneys, and have been found to be "irrelevant" by the Miller County court, which has repeatedly refused to order that information disclosed to defendants who have sought it.

Because this back story seems more newsworthy to me than the technical and, in my humble opinion, startlingly easy legal issue being argued today before the Court, I will tell this story chronologically, beginning near the beginning. But for those who just want to skip to the bottom line, here it is. (Spoiler alert!) Standard Fire and, by extension, countless insurers and corporate defendants nationwide, will win this case, possibly by a 9-0 vote.

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In 2005, Congress enacted the Class Action Fairness Act (CAFA). It was bipartisan legislation -- Senators Barack Obama, Chuck Schumer, and Dianne Feinstein all supported it, for instance -- intended to end certain abusive practices in a handful of quirky state court jurisdictions that, in Congress's view, were extracting suspiciously exorbitant settlements from out-of-state defendant corporations. These state courts, though few in number, could work an unusual amount of mischief, Congress determined, because their lax procedural rules permitted local lawyers to recruit plaintiffs from all over the country to file their cases there. Dispassionate academics referred to such courts as "magnet jurisdictions," wry plaintiffs lawyers called them "magic counties," and irate tort reformers called them "judicial hellholes."

Two of the most famous magnet jurisdictions were, and are, Madison County, Illinois, and Miller County, Arkansas. Miller County, whose county seat is Texarkana, on the Texas-Arkansas border, has a mostly rural population of about 45,000.

CAFA gave defendants the right to "remove" any class action to federal court if there was some minimal degree of "diversity" -- i.e., if class members came from a different state from the one where at least one defendant was based -- and so long as the "amount in controversy" (the total at stake, adding up damages, penalties, and attorneys fees) totalled more than $5 million. Both of these conditions were nearly always met in the cases that pro-CAFA legislators were most troubled by.

During the final weeks before CAFA took effect on February 18, 2005, several Texas-, Arkansas-, and Oklahoma-based plaintiffs firms filed several mammoth, nationwide class actions in Miller County circuit court, thereby getting their noses in under the wire under the pre-CAFA rules. The key firms were Keil & Goodson of Texarkana, Ark., and the Austin-based Nix Patterson & Roach, which has an office in Texarkana, Tex. These firms are also involved in the Standard Fire case, being heard today by the Supreme Court, though Standard Fire was not filed until much later, in 2011. Bear with me and we'll eventually get to Standard Fire. (Attorneys from Keil & Goodson and Nix Patterson each declined to return phone messages seeking to discuss court practices in Miller County.)

One of these last-minute, pre-CAFA, Keil & Goodson/Nix Patterson cases was Hensley v. Computer Sciences Corporation. It was brought by 15 plaintiffs who had suffered bodily injuries in auto accidents caused by uninsured or underinsured motorists. Each plaintiff's insurer made offers, engaged in negotiations, and in some in some instances reached settlements. But the class action attorneys now argued that all the insurers' settlement offers had been artificially depressed because of certain software programs -- the best known was called Colossus -- that were used by the insurers. Claims adjusters would enter the claimants' reported injuries and medical histories into spreadsheets and the software would compute a recommended range of settlement offers. The plaintiffs lawyers alleged that the insurers and software manufacturers were conspiring to use the software as a "'cost-containment' tool to enhance their profits at the expense of first party insured person."

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Though the named plaintiffs' policies had been written by just seven insurance companies, the suit was filed as a class action, naming 584 insurer defendants from across the country, as well as three software manufacturers. At least 24 "families" of insurance companies were sued, including, for instance, Allstate, State Farm, ANPAC (American National Property and Casualty), and Farmers. The plaintiffs asserted that they represented a class that included everyone who had filed uninsured motorist claims with any of these 584 companies going as far back as July 1996 -- almost nine years before the case was filed.

As in any class action, many defendants had certain threshold questions they wanted the court to address before allowing the case to go forward to the discovery stage -- the point when they would have to start disrupting operations and shelling out money to collect, review, redact, copy, and produce documents. Most, for instance, moved to dismiss on the grounds that the allegations, even if true, did not state a claim: How, for instance, were individual negotiations -- many of which culminated in amicable settlements -- tainted by the back-office software the insurer used to calculate an initial offer? Most defendants also claimed that the case wasn't suitable for class treatment, arguing that each offer was the product of its own unique circumstances. A number of companies claimed they'd never written insurance in Arkansas, so the Miller County court didn't even have jurisdiction over them. Others claimed they'd never used any of the software programs in question.

Most courts -- state and federal -- typically decide such threshold questions first, either delaying discovery until after they've been resolved, or ordering whatever limited discovery is needed to decide those threshold questions.

Not in Miller County, though, according to two amicus briefs submitted in the Standard Fire case: one, by a group of Farmers units (from the 21st Century Insurance Group) that were sued in the Hensley case and a second, filed jointly by ANPAC and the Manufactured Housing Institute, a trade institute whose members have also been defendants in Miller County. In Miller County class actions, these amici say, the court repeatedly ruled that decisions on most of their threshold motions would be deferred -- for as long as seven to nine years, in their experience -- while discovery went forward on all questions presented by the complaint. Thus, Farmers, for instance, maintains that it was ordered to produce all its case files nationwide -- about 55 million pages at a cost of more than $9 million -- even though the court had not yet ruled on its motion to dismiss or decided whether class treatment was suitable. (The plaintiffs attorneys who brought the Standard Fire case -- though they include some of the same lawyers who brought the cases against ANPAC and Farmers -- have declined to offer point-by-point rebuttals of Farmers's or ANPAC's accusations, arguing that the Supreme Court should not try to assess what happened in those other cases without having those entire records before them. Similarly, they have declined to address seemingly eye-popping Miller County practices recounted in various press articles --- like this or this or this or this or this or this -- arguing that they are inadmissible hearsay.

The oppressive discovery orders that Farmers and ANPAC allege they were hit with were, for the most part, nonappealable. Likewise, since no adverse rulings were ever made concerning the defendants' threshold motions -- decisions were just repeatedly put off until a later day that never seemed to arrive -- there was, again, nothing to appeal. As if in an episode of the Twilight Zone, they were caught in a perpetual litigation limbo from which settling seemed to be the only way out. (Appellate prospects were not, in any case, encouraging. The Arkansas Supreme Court tends to be extraordinarily pro-plaintiff in its interpretation of class-action law. In addition, Keil & Goodson partner John C. Goodson, who is involved in most of the Miller County class actions described in this article, is married to one of the seven justices of the Arkansas Supreme Court. She wrote a unanimous ruling in December 2011 striking down a state tort reform law which had sought to place caps on punitive damages.)

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Over time most defendants in the Miller County class actions capitulated. In 2006, for instance, Google settled a Miller County class action alleging "click fraud" in a deal that brought plaintiffs attorneys $30 million in fees while affording class members nothing but injunctive relief and non-cash coupons and "credits.")

In Hensley, 23 of the 24 insurance families settled. Each time one did, its portion of the case was severed into a separate case, a class "for settlement purposes only" was quickly certified without defense opposition (that being part of the settlement agreement) and attorneys fees were paid to the tune of $26 million (by The Hartford), or $27 million (American Family), or $36.5 million (Allstate). The total fees paid to plaintiffs attorneys in Hensley as of early this year came to more than $177 million. In each settlement the Miller County court ruled that the fees awarded were reasonable because the plaintiffs attorneys' had retained economic consultants who estimated (again, without dispute, since the case was settling) that the class was receiving from a theoretical projected benefit that was typically valued in the nine-figure range. These estimates consisted in part of enormous valuations assigned to the non-cash injunctive relief the class was getting—typically an informational web site set up by the defendant plus a five-year commitment to change certain internal policies or "recommended practices." The rest of the projected benefit consisted of an estimate of the maximum conceivable cash payment the defendant might have to make if every single eligible class member filed a valid, notarized claim form within the time period allotted for doing so, and was fully paid as a consequence. (In practice, it's not unusual, however, for fewer than 5% of class members to actually submit claims.)

According to an annotated breakdown submitted in the Standard Fire case by ANPAC, the Keil & Goodson and Nix Patterson law firms were involved in at least 24 Arkansas state class action settlements since 2005 -- 23 of them in Miller County -- from which the plaintiffs attorneys were paid $421 million in fees ($392 million in Miller County). These numbers have not been contested in the Standard Fire case, which is also being brought by the Keil & Goodson and Nix Patterson firms.)

Like a bush whose stems can be snipped, rooted, and then replanted to create new bushes throughout a yard, the Hensley and other pre-CAFA cases were, over the past seven years, severed into multiple spinoff cases, with both new plaintiffs and defendants being added. Miller County courts continued to treat most of these as pre-CAFA cases.

Nevertheless, at a certain point the Keil & Goodson and Nix Patterson firms did start filing unambiguously new cases that were finally going to be covered by CAFA's rules. The question then became: How could these be kept in Miller County or some other propitious Arkansas venue?

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The answer was a "stipulation" that plaintiffs attorneys started writing into each complaint. In it the named plaintiff averred that he and every member of the class he hoped to eventually be certified to represent would not "seek," in aggregate, more than $5 million in damages and attorneys fees in the lawsuit. Accordingly, the plaintiffs argued, the "amount in controversy" was under the $5 million threshold that Congress required before a defendant could remove the case to federal court under CAFA.

Last year, the Keil & Goodson and Nix Patterson firms filed at least 25 new class actions in Arkansas state courts containing such a stipulation, including the Standard Fire case. Though Standard Fire tried to remove that case to federal court, arguing that the stip was unenforceable and made in bad faith, both the federal district and appeals courts rejected that argument and ordered the case sent back to Miller County. The Supreme Court then agreed to hear the matter in August.

The problems defendants have with these stipulations are legion. To begin with, the defendants don't believe for a second that any of these cases can be settled for $5 million or less. (Whatever settlement negotiations have occurred to date are confidential, so there is no hard evidence in the record on that question.) Defendants note that a commitment not to "seek" more than $5 million is not a commitment to "refuse" more than $5 million, if a sufficiently desperate defendant is spooked into offering it.

At a more basic, logical level, they also argue -- and this is the crux of the legal issue before the Court today -- that it is impossible for a named representative of an as-yet theoretical class (i.e., one that has not yet been certified into existence) to purport to waive the rights of other class members (whom he has not yet been adjudged suitable to represent) to recover money to which they are allegedly entitled. (CAFA dictates that whether the $5 million threshold is met "shall" be determined by aggregating "the claims of the individual class members.")

The plaintiffs lawyers respond that removal proceedings are traditionally decided based on the bare assertions contained in the complaint, so the stipulation alone should suffice to keep the case in state court. (Before the Supreme Court today, the plaintiffs are being represented by David C. Frederick of Washington, D.C.'s Kellogg, Huber, Hansen, Todd, Evans & Figel, while Standard Fire's argument will be presented by Theodore J. Boutrous, Jr., of Gibson Dunn & Crutcher.)

For what it's worth, I think the language of CAFA, the legislative history, the force of logic, and public policy considerations all point in a single direction here: reversal. Standard Fire and other out-of-state defendants should be granted the escape from Miller County that CAFA was enacted to provide.

There are, I recognize, some liberals who believe that magnet jurisdictions don't exist at all, and that they are, rather, constructs built of spurious anecdotes spun by insurance lawyers. Such liberals deny the existence of class-action abuses with the same puzzling and unflappable persistance with which some conservatives insist that President Obama was born in Kenya.

But there are no liberals of that description on the Supreme Court. Recognizing that abuses exist does not mean that anyone is accusing most class-action lawyers of being greedy or most state courts of being biased. Belief in the reality and harmfulness of magnet jurisdictions is not viewed by the Supreme Court as a liberal or conservative issue. It's seen as a matter of whether or not you were born yesterday. None of these justices were born yesterday. That's why I think the vote in today's case might be 9-0 for Standard Fire.

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