In Re: Volkswagen and Audi Warranty, 2012 WL 3064844 (1st Cir. July 27, 2012).

Plaintiffs nationwide sought to bring claims on behalf of all persons or entities in the United States who were current or former owners of several particular vehicles, alleging that the engines were defectively designed and that the defendants concealed the defects. 

 Five putative statewide class actions were ultimately filed in five federal district courts alleging, among other things, consumer fraud and unfair and deceptive trade practices. The suits were subsequently consolidated by the Judicial Panel of Multidistrict Litigation and transferred to the District of Massachusetts for pretrial proceedings.    

After much negotiation, the parties submitted a proposed settlement agreement to the district court, along with a motion requesting conditional approval of the settlement and certification of a class for settlement purposes. Class counsel subsequently submitted a request for $37.5 million in attorneys’ fees under Federal Rule of Civil Procedure 23(h) and argued that federal law governed the award of the fees. 

While the defendants did not argue that the court should not award attorneys’ fees, they strongly opposed the argument that federal law could apply. The defendants also opposed class counsel’s fee calculation methodology. 

The special master issued a report finding that federal law governed the fee award and recommending an award of $30 million in attorneys’ fees and $1.2 million in costs. 

The district court adopted the special master’s recommendation virtually verbatim, and the defendants appealed.   

The First Circuit vacated the fee award, holding that the district court erred in applying federal law principles instead of the relevant state’s law when calculating the fee award. The court began its analysis by noting that, under the “American Rule,” it is axiomatic that each litigant pays his own attorneys’ fees, win or lose, unless a statute or contract provides otherwise. One of the exceptions applied here, as the defendants had agreed to pay reasonable attorneys’ fees as part of the settlement agreement. The real question in the case, the court noted, was what source of law governed the fee award, and the district court had erred when it held that federal law did. 

To determine the source of law that governed the settlement agreement, the court stated that it must engage in a two-part inquiry. First, it had to evaluate whether, under the Erie doctrine, federal or state law governed. 

Second, if state law governed and a choice of law must be made, it had to determine which state’s law applied, by applying the choice of law rules of the forum state (subject to the complexities of MDL litigation).

As for the first inquiry, the court stated that, as a general matter, interpreting settlement agreements and their scope is a matter of state contract law. The court noted that it also started with the basic premise that the issue of attorneys’ fees has long been considered, for Erie purposes, to be substantive and not procedural, and so state-law principles normally govern the award of fees. The court rejected class counsel’s argument that FRCP 23(h) provided a basis for applying federal law principles to the award of attorneys’ fees, noting that “Rule 23(h) does not provide a free-floating grant of authority to apply federal law to award attorneys’ fees in class actions; rather it allows the federal court to make fee awards where they ‘are authorized by law or by the parties’ agreement.’”  

The court also rejected class counsel’s argument that the court had “inherent federal equitable powers” to fashion an attorneys’ fee award, stating that “[t]he basis for the award here is the agreement itself, a contract under state law, and not federal law.” “The fact that attorneys’ fees are provided for by the settlement agreement is one of several reasons why there is no basis to resort to these federal equitable doctrines.”

After concluding that state law governed, the court moved on to the second inquiry – which state’s choice of law principles applied. The court noted that, in diversity cases, a court ordinarily must apply the choice-of-law rules of the state in which it sits. But special rules apply in MDL cases – where a suit is consolidated and transferred, courts typically apply the choice of law rules of each of the transferor courts. 

Here, a total of seven cases ultimately were transferred to the District of Massachusetts, from six states. The court noted that most of the states in which the suits originated followed the “most significant relationship” test to determine the source of law that applies to contracts that do not contain a choice of law provision. 

Under that approach, Massachusetts law would apply, as the settlement negotiations occurred there, the settlement agreement was drafted there, etc. Although the two other transferor states used different approaches to determine source of law, the court concluded that their respective tests would also apply Massachusetts law. 

Thus, the court held, the district court should have applied the substantive law of Massachusetts when considering the attorney fee award, and it remanded the case to the district court with instructions to do so. Score one for the Tenth Amendment.