Settling Class Actions, from the Defending Company’s Perspective
While class counsel has its own objectives when it comes to settling class action lawsuits, the defending company has fundamentally different analyses.
First is whether it should settle the case at all, as there are often business reasons not to do so. For example, the company may not want the reputational hit, to invite regulatory scrutiny or to set a bad precedent by settling.
So, to decide on the settlement route, the economics need to be compelling. Companies require approval of owners, boards, senior management, counsel and other high-level stakeholders, all of whom have different constituencies to satisfy. The questions that typically arise are:
- Can the company afford the cost of settlement?
- Can the company afford the cost of continued litigation?
- What will the impact of settlement be on the company’s operations, reputation and finances?
- Will we buy peace from existing and related claims, thereby ending litigation?
- Will the company get approval of the deal internally and then from the Court?
- What are the tax implications of settlement?
- Will the Court approve the release?
The first major roadblock is the uncertain costs of settlement—internal decision-makers do not know how to assess the payout risk, making approvals and budget-setting highly challenging. Additionally, companies must deal with the negative financial impact of settlement on their P&L. According to an article by Peter Robbins, Partner at Corbett & Robbins, LLP:
“Since a class action settlement agreement creates a known and probable liability, GAAP requires that the Company book the entire settlement and assumes 100% “take rate” participation in order to provide legal and financial transparency to the public regarding the claim.”
-Class Action Settlements: Financial and Tax Reporting, Arizona Bar Journal (March 2013)
Taking a charge against its P&L can create the following unintended business implications:
- Missed quarterly earnings
- Weakened financial statements
- Acceleration of debt for breach of loan covenants
- Impact on financing or M&A transactions
Once companies realize that they have to account for the entire settlement on their P&L and have cost uncertainties, they then face tax implications arising out of settlement. Per CPA Robbins, “If the settlement and payment represents a fine or statutory penalty (like TCPA, FCRA), then the payments are likely not tax deductible.”
From cost uncertainties to business operation impacts, from P&L concerns to negative tax implications, both continued litigation and settlement will certainly cause financial, legal and business repercussions. Yet, resolution is achievable, and companies tend to move closer to settlement when the terms become more tolerable. In other words, the better the terms, the more certain the cost and the more efficient a deal is from accounting, tax and business rationale—making settlement more likely.