Roes v. SFBSC Management, LLC

          Argued and Submitted November 16, 2018 San Francisco, California

          Appeal from the United States District Court No. CV 14-3616 LB for the Northern District of California Laurel D. Beeler, Magistrate Judge, Presiding

          Shannon Liss-Riordan (argued), Lichten & Liss-Riordan P.C., Boston, Massachusetts, for Objectors-Appellants.

          F. Paul Bland Jr. (argued) and Karla Gilbride, Public Justice P.C., Washington, D.C.; Steven G. Tidrick and Joel B. Young, The Tidrick Law Firm, Oakland, California; for Plaintiffs-Appellees.

          Douglas J. Melton (argued) and Shane M. Cahill, Long & Levit LLP, San Francisco, California, for Defendants-Appellees.

          Eli Naduris-Weissman, Rothner Segall & Greenstone, Pasadena, California; Charles P. Yezbak III, Yezbak Law Offices PLLC, Nashville, Tennessee; for Amicus Curiae International Entertainment Adult Union.

          Before: A. Wallace Tashima and Milan D. Smith, Jr., Circuit Judges, and Lawrence L. Piersol, ^[*] District Judge.

         SUMMARY^[**]

         Labor Law / Class Action Settlement

         The panel reversed the district court's approval of a settlement notice process and a class action settlement, negotiated without a certified class, in a case in which exotic dancers working at various nightclubs in San Francisco alleged they were misclassified as independent contractors rather than being treated as employees.

         The panel held that the settlement notice did not meet the "best notice that is practicable under the circumstances" due process standard of Fed.R.Civ.P. 23(c)(2)(B). The content of the notice was adequate, even though it did not include information about related litigation, but the process used was inadequate because notice was sent only once by mail.

         The panel held that, in granting approval of the settlement as "fair, reasonable, and adequate" under Rule 23(e), the district court failed to apply the correct legal standard and conduct the heightened inquiry required for review of class action settlements negotiated without a certified class. Accordingly, the district court abused its discretion in approving the settlement. The panel held that, when the parties negotiate a settlement before a class has been certified, the district court must apply a higher level of scrutiny for evidence of collusion or other conflicts of interest before approving the settlement as fair. This more exacting review is warranted to ensure that class representatives and their counsel do not secure a disproportionate benefit at the expense of unnamed plaintiffs. The panel concluded that the district court failed to investigate or adequately address numerous problematic aspects of the settlement and subtle signs of implicit collusion, including a clear sailing agreement, a disproportionate cash distribution to attorneys' fees justified in part by potentially inflated non-monetary relief, large incentive awards to two plaintiffs, and reversionary clauses. The panel reversed and remanded for further proceedings.

          OPINION

          TASHIMA, Circuit Judge.

         This case arises out of a dispute under federal and California labor law whether exotic dancers working at various nightclubs in San Francisco were misclassified as independent contractors rather than being treated as employees. The district court approved a class action settlement that was negotiated in the absence of a certified class. Objectors-Appellants challenge that settlement approval under Federal Rule of Civil Procedure 23 ("Rule 23"). They contend that the settlement was inadequate because it recovered only a fraction of the class claims' value, accorded too much weight to worthless "coupons" and injunctive relief, and that the district court disregarded indicia of collusion that warranted additional scrutiny. Objectors-Appellants also challenge the adequacy of the notice process because it involved only a single notice sent by U.S. mail and hanging posters in the defendant nightclubs, and lacked any electronic outreach.

         Because the notice did not meet Rule 23's "best notice that is practicable under the circumstances" standard, and because, in granting approval of the settlement, the district court failed to apply the correct legal standard and conduct the heightened inquiry we require for review of class action settlements negotiated without a certified class, we reverse approval of the notice and of the settlement, and remand for further proceedings.

         BACKGROUND

         In 2014, Plaintiffs Jane Roes Nos. 1-2 filed this putative class and collective action alleging violations of the Fair Labor Standards Act ("FLSA"), 29 U.S.C. §§ 201-219, and various provisions of the California Labor Code and San Francisco municipal ordinance. The named Plaintiffs, as well as the nearly 4, 700 members of the putative Rule 23 class, worked as exotic dancers at eleven adult entertainment clubs in San Francisco. Plaintiffs brought suit against Defendant SFBSC Management, LLC ("SFBSC"), which, "broadly speaking," managed the eleven nightclubs where class members worked.

         Plaintiffs alleged that they were misclassified as independent contractors and should have been classified as employees of SFBSC. Plaintiffs sought to recover the following categories of damages on a classwide basis: unpaid minimum wages under federal, state, and San Francisco law for all hours worked on the clubs' premises; reimbursement of stage fees paid to the clubs for each night that a dancer worked; unpaid overtime wages; liquidated damages; PAGA penalties^[1]; and attorneys' fees and costs.

         A. Litigation History

         Shortly after the case was filed, SFBSC brought a motion to compel arbitration. The district court denied that motion on March 2, 2015, holding that the relevant arbitration provision was unconscionable and therefore unenforceable. SFBSC appealed the district court's decision, but we affirmed, albeit on the alternative ground that SFBSC lacked standing to enforce the arbitration provisions at issue because SFBSC was not a party to the relevant contracts between the nightclubs and class members, which contained the arbitration provision. See Roes v. SFBSC Mgmt., LLC, 656 Fed.Appx. 828, 829 (9th Cir. 2016).

         During the appeal concerning the arbitration issue, "the parties conducted three in-person mediations and multiple telephone conferences with the Ninth Circuit Mediator, exchanging information about working conditions, hours worked, compensation, and the parties' relative control over their work, among other matters." Ultimately, the parties executed a settlement agreement and, per the parties' stipulation, we then dismissed the appeal without prejudice to its reinstatement if the district court did not approve the parties' settlement. As part of the settlement, and for settlement purposes only, the parties agreed to add the eleven individual nightclubs as defendants; they submitted a proposed second amended complaint to that effect.

         Meanwhile, during the appeal and negotiation process, counsel who now represents Objectors Sarah Murphy, Poohrawn Mehraban, and Devon Locke (collectively, "Objectors") brought two separate misclassification suits directly against three of those nightclubs-Larry Flynt's Hustler Club, the Gold Club, and Condor Gentlemen's Club. The suits, Hughes v. S.A.W. Entm't, Ltd., 16-cv-03371-LB (N.D. Cal.), and Pera v. S.A.W. Entm't, Ltd., 17-cv-00138-LB (N.D. Cal.), involve the same kind of substantive claims for wage-and-hour violations as are involved here. When the plaintiffs in those cases discovered that they were part of the putative class in this case, and learned the proposed terms of the settlement in this case, they objected to preliminary approval of the settlement.

         B. The Settlement and its Approval

         Following dismissal of the appeal, the Roe parties moved for preliminary approval of their proposed class action settlement pursuant to Rule 23(e). The Settlement Agreement proposed to release wage claims against SFBSC, as well as against the individuals and entities-which had not been named in the original complaint-that directly owned and operated the eleven nightclubs in San Francisco. In return, the settlement included several different types of consideration.

         First, the proposed settlement provided for two tiers of cash: a first tier of $2 million ("First Tier Cash Pool") and a possible second tier of up to $1 million ("Second Tier Cash Pool"). The First Tier Cash Pool would be used for: (1) cash compensation to Settlement Class Members who timely elected to receive a Cash Payment, (2) attorneys' fees and expenses, (3) enhancement payments of up to $71, 000 total, (4) a $100, 000 PAGA payment, ^[2] and (5) administrative costs of up to $50, 000. Only if the sum of those five items exceeded $2 million, would the defendants be required to fund the Second Tier Cash Pool in the amount, up to $1 million, sufficient to fully cover the sum of the valid claims for cash payment, the attorneys' fees and expenses, the enhancement payments, the PAGA payment, and administrative costs. Under the proposed settlement, the Cash Payments were calculated based on the number of months in which a class member had worked for the nightclubs during the class period, and ranged from $350 to $800, although the amount could be increased or reduced on a pro rata basis based on the number of claims submitted. To receive a Cash Payment, class members had to submit an FLSA claim form by the deadline.

         Second, the proposed settlement also provided for up to $1 million in "dance fee payments." A "dance fee" is the published amount that a customer at the defendant nightclubs must pay to a dancer for each dance that she performs.^[3] The clubs normally retain a significant portion of those fees pursuant to their "Dancer Contracts." As part of the settlement, a class member who continues to work at one of the defendants' clubs could claim as much as $8, 000 in "dance fee payments" in lieu of a cash settlement share. Such "dance fee payments" would allow a class member to, on specified nights, keep the "dance fees" that she would normally remit to the clubs. Specifically, a dancer could receive up to $5, 000 in "dance fee payments" to be used at a "Primary Nightclub" she designates on her claim form, and up to $3, 000 to be used at her "Secondary Nightclub."^[4]. The settlement required a class member to schedule, at least three business days in advance, a Date of Performance at her Primary or Secondary Nightclub during the two-year Dance Fee Redemption Period. On that Date of Performance, she would then be permitted to retain 100% of the dance fees she earned, capped at her total dance fee payment allocation for that nightclub.

         If the total amount of Dance Fee Payments claimed was less than $100, 000 for any of the defendant nightclubs, that nightclub would create a "Residual Dance Fee Payment Pool" for the residual amounts. Class members who did not submit an FLSA claim form during the original claims period could claim dance fee payments from the Residual Pool by submitting a Residual Dance Fee Claim Form, which would be available from management at the clubs and would contain an acknowledgment that the claimant did not submit an FLSA claim. The dance fee payment vouchers were set to expire in two years, at which time the "value" of any unredeemed claims (i.e., of dance fee payments that class members had claimed, but had not yet cashed in by working on a scheduled Date of Performance) would revert to the defendant nightclubs.

         Third, the settlement also included an injunction memorializing the clubs' offer of employee status to prospective dancers, under which any dancer interested in working at the clubs would be given the "option" of working as an employee or independent contractor. The employee option would provide dancers with an hourly rate of $15, plus a 20% commission for total sales of private dances over $150 on any given night. Other changes made to the nightclubs' business practices under the settlement involved reviewing employment choices (independent contractor versus employee status) with dancers, the context in which those choices are permitted to be made (not while intoxicated or nude), provisions allowing dancers to change their status to an employee, control over clothing choices for independent contractors, a prohibition against tip-sharing for independent contractors, training videos, and guaranteed average earnings for independent contractors.

         The settlement would release all state law wage claims of approximately 4, 700 members of the class spanning nearly seven years, from August 8, 2010, to April 14, 2017 (the date of preliminary approval). If a class member did not exclude herself from the settlement, she released all wage claims except claims under the FLSA. If a class member submitted a claim form, she released all claims, including her FLSA claims.

         Despite objections, the district court preliminarily approved the settlement and the class notice plan on April 14, 2017. The claims administrator subsequently mailed, by U.S. mail, the court-approved notice to class members at their last known address from their most recent contract with defendants, or at any more current address reflected in the National Change of Address database. When 1, 546 notices of the 4, 681 notices mailed were returned as undeliverable, the administrator performed address traces and resent notices, but ultimately a total of 560 notices remained undeliverable. No reminder, follow up, or electronic notice was sent to any class member. However, Plaintiffs did set up a settlement website, and "the nightclubs displayed posters in the dancers' dressing rooms to ensure that they were seen, were confident that they were seen by all entertainers at the clubs, and responded to questions by encouraging entertainers to review the settlement notice, website, and poster."

         Following the distribution of notice and the close of the period during which class members could opt out, object, or file a claim, the parties moved for final settlement approval. They reported that only 865 out of 4, 681 class members (18.5% of the class) submitted claim forms to receive payments from the settlement; of those, 790 opted for a cash payment and 75 opted for a Dance Fee Payment. Fourteen class members requested exclusion from the settlement, and several class members filed objections, challenging both the fairness of the settlement and the adequacy of the notice.

         As a result of the low claims rate, defendants were not required to fund the Second Tier Cash Pool of $1 million (i.e., that money reverted to defendants). In addition, although the parties initially expected that the class members would receive approximately $350-$800 each if they submitted claims for cash payments, the individual shares ultimately ranged from $650-$1500 as a result of the low claims rate.^[5]At the time of final approval, 75 class members had claimed a face value of $370, 000 of the Dance Fee Payment Pool. Class members could continue to claim these dance fee payment vouchers for two years after final approval; however, the vouchers would be distributed on a first come, first served basis.

         Despite vigorous objections, the district court granted final approval, deemed the notice adequate, and awarded the requested attorneys' fees and service awards. Overall, the settlement provided $2 million in cash, of which $950, 000-more than the class would receive in total cash distribution-was allocated to attorneys' fees. Specifically, beside the $950, 000 in attorneys' fees, $864, 115 went to payments to class members, $4, 884.21 to expenses, $71, 000 to incentive payments, ^[6] $35, 000 to the costs of settlement administration, and $75, 000 to the State of California (for the PAGA allocation). Objectors appealed, challenging both the adequacy of the notice to class members and the district court's approval of the settlement.

         STANDARD OF REVIEW

         We have jurisdiction under 28 U.S.C. § 1291, and "[w]e review a district court's rulings regarding notice de novo." Molski v. Gleich, 318 F.3d 937, 951 (9th Cir. 2003) (citing Silber v. Mabon, 18 F.3d 1449, 1453 (9th Cir. 1994)), overruled on other grounds by Dukes v. Wal-Mart Stores, Inc., 603 F.3d 571 (9th Cir. 2010), rev'd, 564 U.S. 338 (2011); see also Lane v. Facebook, Inc., 696 F.3d 811, 834 (9th Cir. 2012) (Kleinfeld, J., dissenting) (explaining that we review adequacy of notice de novo, rather than deferentially, "because notice is a matter of due process of law," and "[i]f a person owns a claim, it is property, and the owner of the claim is constitutionally entitled not to have it taken from him except with reasonable notice and an opportunity to be heard").

         We "review a district court's decision to approve a class action settlement 'for clear abuse of discretion.'" In re Online DVD-Rental Antitrust Litig., 779 F.3d 934, 942 (9th Cir. 2015) (quoting In re Bluetooth Headset Prods. Liab. Litig., 654 F.3d 935, 940 (9th Cir. 2011)). "A court abuses its discretion when it fails to apply the correct legal standard or bases its decision on unreasonable findings of fact." Nachshin v. AOL, LLC, 663 F.3d 1034, 1038 (9th Cir. 2011). Although our own substantive review of class settlement fairness is "extremely limited," we hold district courts to a "higher procedural standard when making that determination of substantive fairness." Allen v. Bedolla, 787 F.3d 1218, 1223 (9th Cir. 2015). "That procedural burden is more strict when a settlement is negotiated absent class certification." Id. at 1224. In such cases, the district court abuses its discretion if it fails to apply "an even higher level of scrutiny for evidence of collusion or other conflicts of interest than is ordinarily required under Rule 23(e)." In re Bluetooth, 654 F.3d at 946. We review a pre-certification settlement approval not only for whether the district court has "explored comprehensively all factors, . . . given a reasoned response to all non-frivolous objections," and "adequately . . . develop[ed] the record to support its final approval decision," but also for whether the district court has looked for and scrutinized any "subtle signs that class counsel have allowed pursuit of their own self-interests . . . to infect the negotiations." Allen, 787 F.3d at 1223-24 (third alteration in original) (first quoting Dennis v. Kellogg Co., 697 F.3d 858, 864 (9th Cir. 2012); then quoting In re Bluetooth, 654 F.3d at 947).

         DISCUSSION

         The main thrust of Objectors' argument on appeal is that the district court abused its discretion in approving a class action settlement that does not provide enough benefit to class members and contains indicia of collusion. As part of this challenge to settlement approval, Objectors also argue that the notice process that was used to inform class members about the proposed settlement was inadequate. Because the adequacy of notice can not only play a role in the overall fairness of the settlement, but is also a discrete issue subject to a de novo standard of review, we address Objectors' challenge to the adequacy of notice first and then turn to the district court's approval of the settlement as a whole.

         I. Adequacy of Class-Wide Settlement Notice

         On appeal, Objectors argue that the settlement notice provided in this case was inadequate for two reasons: (1) content-wise, the notice was inadequate because it did not notify class members about the related Hughes and Pera lawsuits; and (2) the process used to provide notice was inadequate because notice was sent only once by mail-no reminder notice or electronic notice was given. As explained below, we reject Objectors' first argument because the notice met the requirements to provide various information about the settlement in this case, but ...