Compensation's Role in Deterrence

ABSTRACT There are plenty of noneconomic reasons to care whether victims are compensated in class actions. The traditional law-and-economics view, however, is that when individual claim values are small, there is no reason to care whether victims are compensated. Rather than compensation deterring wrongdoing is tort law's primary economic objective. And on this score, law-and-economics scholars contend that only the aggregate amount of money that a defendant expects to pay affects deterrence. They say that it does not matter for deterrence purposes how that money is split between victims, lawyers, and charities. This Article challenges that claim about achieving tort law's primary objective and argues that there is an economic reason to care whether victims are compensated in class actions. It offers reason to think that compensating victims deters more wrongdoing than the same amount of relief in other forms, at least in damages class actions. Put a different way, this Article contends that the primary objectives of class actions--compensation and deterrence--are intertwined in ways that scholars have not previously recognized. Compensation affects the amount of reputational harm that class actions inflict on defendants, and anticipating that reputational harm provides a source of deterrence. Because the public cares whether victims are compensated in civil litigation, if class actions were frequently to slight compensation that would undermine public perception of the class device; class actions would come to seem more like plaintiffs' lawyers' extortion mechanisms than legitimate means of redressing harm. Diminished procedural legitimacy makes the class action a less powerful signal about the validity of the underlying claims, which undermines reputational deterrence. INTRODUCTION In 2014 Pepsi settled a labeling class action regarding Naked Juice for $9 million. (1) Of that $9 million settlement fund, $5.5 million was allocated to compensate customers. (2) A few years ago Facebook settled a privacy class action for $9.5 million; (3) in contrast to the Naked Juice settlement, none of the money went to victims. (4) It went instead to charity and class counsel as attorneys' fees. (5) There are, of course, noneconomic reasons to care whether victims are compensated in class actions: class counsel's professional responsibility or agency obligations to the class, (6) philosophical commitments to compensating victims, (7) or the Rules Enabling Act. (8) From an economic perspective, however, scholars have argued that for purposes of tort law's primary objective--deterring wrongdoing (9)--it does not matter whether victims are compensated in class actions. (10) Rather, they argue, only the aggregate amount and likelihood of payment matter when considering the settlement's deterrent effect. (11) Whether class actions typically follow the Naked Juice approach of giving much of the judgment to victims or the Facebook approach of giving nothing to victims--the thinking goes--does not affect deterrence. (12) This Article challenges that notion. Instead, it offers reason to think that compensation affects deterrence in ways that scholars have not recognized. A class action judgment will likely do more harm to a defendant's reputation if class action damages (13) are typically paid primarily to victims than if they are typically paid primarily to attorneys or charities. (14) Although class action judgments in practice typically compensate victims, some cases have recently pushed the boundaries of using cy pres awards for charity or attorneys' fees instead of compensating victims, (15) and the Supreme Court seems poised to consider the proper role for such compensation-less class settlements. (16) Although the primary goal of this Article is to refine the scholarly understanding of deterrence in damages class actions and recognize that compensation plays a role in deterrence, developing the theoretical underpinnings for how compensation-less settlements affect tort law's primary economic objective is particularly important in light of likely Supreme Court review. …