The risk manager's role in minimising liability in a class action settlement.

The past several years have witnessed a pronounced growth in the filing of nationwide class and other mass tort actions. Most legal analysts predict that this upward trend will continue for the foreseeable future due to the fact that procedural devices like the class action, which permit the aggregation of large numbers of claims, greatly favour the class members at the expense of the defendant. Indeed, research has demonstrated that liability is much more likely to be imposed on corporate defendants in cases involving large numbers of plaintiffs than in those involving only one or a few. Furthermore, damage awards, including punitive damages, tend to increase significantly when more plaintiffs are involved.

In addition to waging a vigorous legal defence against such litigation through a company's legal department, risk managers should be aware that their unique expertise can, and should, be employed to help ensure that any liability imposed as a result of a ‘claims made' class action settlement is minimised to the greatest extent possible. The following are some ways in which a risk manager can use his or her expertise to help minimise the overall liability in a claims-made class action settlement.

Settlement structuring
A risk manager is particularly suited to evaluating the impact that certain terms and conditions will have on the future cost of claims.
Claims-made class action settlement agreements often contain a myriad set of somewhat arbitrary definitions and conditions that can profoundly affect the cost of settlement. Seemingly minor differences in the technical definitions of product failure, the conditions under which claimant compensation can be limited, depreciation schedules, compensation formulae and class notification provisions can result in significant differences in the company's payout on each individual claim.

Such details are typically found within the sphere of the risk manager's expertise. In negotiating the terms of settlement, an understanding of the effects that these definitions and conditions can have on a settlement's total cost is vital. Indeed, the impact of different compensation formulae can only be determined if one knows the actual statistical distribution of product failure in the market – the type of analysis a risk manager typically would understand or know how to execute. In the negotiation, the class members' counsel will advocate a compensation formula that maximises the class members' recovery so that the class counsel's contingency fee will, in turn, be maximised.

For example, in dealing with an allegedly defective building product such as an exterior insulation finish system (EIF system), the class counsel may try to force the defendant to provide a homeowner with an entirely new system if, for example, more than 50% of the homeowner's EIF system failed. Before a defendant can effectively deal with this point of negotiation, it needs to determine exactly what class counsel's demands will mean in real dollar terms. Specifically, in this example, the defendant would have to learn the approximate number of homeowners that have had more than 50% of their EIF system fail. This knowledge can only be obtained through a forensic investigation of a statistically valid sample of claimants. Investing in this type of strategy is highly advisable, particularly in class actions posing potentially staggering liability. It may turn out that, despite the heightened level of significance that class counsel attaches to this point of negotiation, this may actually be a non-issue that can be given away. Indeed, the defendant may learn that the 50% failure percentage that class counsel is advocating is rarely found. Having ‘given in' on this point, the defendant will be able to be more aggressive with much more important points of negotiation.

The defendants' effective use of a statistically valid forensic investigation may provide a substantial tactical advantage over the class counsel with respect to other seemingly innocuous details. For example, a company that incurs liability rarely is solely at fault from a legal standpoint (if it is at fault at all). This is particularly true in the product liability context, where often there are countless other entities involved in the product's manufacture, distribution, sale, installation, etc., which must share in the responsibility for the product's performance. Every other entity that participated in getting the product to its intended use, or that in any way came into contact with the product along the way, could have been a contributing cause of a claimant's injury.

Taking the EIF system example again, a forensic investigation may reveal that the failures of such systems in certain parts of a home were not the product's fault but, rather, caused by the building contractor's workmanship. Armed with that knowledge, the defendant can seek to carve out of the settlement agreement all liability for failures occurring in parts of a home that research reveals was subject to shoddy workmanship (for example, in or around a roof). Not realising the significance of this point, the class counsel may agree to this exception, thereby eliminating a significant percentage of the defendant's exposure. Again, risk managers typically possess the knowledge, or know-how, to conduct the research necessary to conduct an effective evaluation of settlement terms.

A risk manager is particularly suited to estimating the future costs of claims and administration.
It is not possible to competently settle a mass tort or class action lawsuit without having a realistic understanding of the potential liability that is being assumed. Further, when dealing with complex litigation, the full breadth of the potential liability often is a composition of many variables and components. Again, in the product liability context, the total liability may include:

  • amounts paid to claimants as compensation for property damage/bodily injury;

  • in the case of a class action, the costs of notifying all potential claimants;

  • the cost of a third-party inspector and claims administrator; and

  • the cost of the contingency fee often paid up front to the class counsel.

    Obtaining a realistic projection of these and other costs is crucial to the effective structuring of the settlement. In as much as actuarial projections and cost projections are part of a risk manager's daily responsibilities, this presents yet another situation in which risk managers can, and should, offer input and exert influence. Indeed, if a risk manager aggressively offers his or her knowledge to the attorneys, the result undoubtedly will be a more effective defence and a reduction in ultimate liability.

    A risk manager can control the cost of settlement claims administration.
    Even after the basic structure of a settlement has been reached, there are certain mechanisms and protocols that a risk manager can implement to control the overall cost to a class action defendant. Specifically, the risk manager should seek to ensure that the company secures a meaningful ‘audit right' with respect to the claims administration process and then oversee that audit right.

    Most class action settlements require a company to set up a facility for the processing of class members' claims. Usually an independent claims administrator is hired to implement the terms of a settlement agreement by processing class members' claims. Typically, class actions settlement proceed through the following steps:

    (i) class members are notified of the settlement through direct mail or advertisements;

    (ii) class members that want to submit a claim call a toll-free number or return a postcard, requesting an official claims kit;

    (iii) class members complete the claims kits, which may vary greatly in complexity depending on the nature of the alleged property damage or bodily injury;

    (iv) the claims administrator analyses the claims and determines whether the class members are entitled to compensation and, if so, how much; and

    (v) payment is issued to the claimant, thereby settling the class members' claim.

    Although the claims administrator is meant to function independently, it is vitally important that the settling company retains as much control as possible over the settlement process. This generally can be accomplished by incorporating into the settlement agreement the right to audit the claims administrator to ensure compliance with the terms of the settlement.

    This audit should not be carried out in a casual manner. It should be conducted continuously by personnel highly familiar with the terms of the settlement and focused on ensuring that claimants are not excessively compensated. If it is carried out by a consultant, he must be fully familiar with the settlement agreement's precise terms and the substance of the alleged property damage or bodily injury. The audit process must involve routine analysis of supporting documents and measurements; reviews of photographs, product samples and tests; and visual inspections, among other things. For example, in the EIF system context, an effective audit would involve such things as:

    (i) examining product samples to ensure proper product identifications;

    (ii) reviewing photographs and/or making visual inspections to ensure that claims involve the type of damage being covered by the settlement;

    (iii) ensuring that damage excepted from the settlement agreement is not included in the compensation calculation;

    (iv) ensuring that the damaged areas are properly measured;

    (v) ensuring that the proper compensation formula is employed; and

    (vi) ensuring that the compensation formula is applied accurately.

    Obviously, if the claims adjustment process is simple, the audit process can be simplified.

    Whether the company chooses to audit the claims administrator itself or hire a consultant, an effective audit program requires competently trained auditors and careful management of the process to ensure that problems are identified and corrected without interfering with the claims administration process. This should entail close oversight of the claims administrator, including tracking the frequency of the claims, being fully aware of the average and aggregate payment amounts at all times and understanding geographic trends (such as the location in the country the claims are coming from and why). Understanding such facts can help the company manage its liability and will also help the company learn valuable information that can help avoid such liability in the future. Again, considering the risk manager's unique expertise with respect to claims handling, this is an area where the risk manager should undertake significant responsibility.

    In short, a class action defendant's court room defence is only one component of minimising or avoiding liability. These techniques and others that are squarely within the risk manager's area of expertise often can result in significant liability reductions.