Class Actions as Firms

Abstract

Contemporary class action literature is dominated by discussions of principal-agent problems. This singular focus has largely been tracked by the courts, which collectively treat the class action mechanism as a Pandora’s box of principal-agent problems via aggressive interpretation and application of Federal Rule of Civil Procedure 23 (“Rule 23”). The ascent of the “principal-agent framework” is unsurprising. The divide between class members and class counsel gives rise to a host of classical principal-agent problems: self-interested class counsel often have incentives to act contrary to the interests of class members, and class representatives are poor monitors of such behavior. However, the singular hegemony of this framework has misguided courts, which, searching only for principal-agent problems, rarely find anything but what they are looking for. Within this framework, all class action issues are construed as principal-agent problems. This has had a deleterious effect on doctrine — not only are principal-agent problems aggressively regulated, as they should be, but courts also constrain the size and scope of class actions without a clear sense of why doing so is necessary or in fact relates to constraining agency costs. That said, the principal-agent framework does rest on an important, but often unstated, foundation: principal-agent problems arise because class actions separate ownership (litigation interests belonging to class members) from management (class counsel). Turning on this observation, this Article refracts the frame of analysis by one degree — from the principal-agent framework to Coasean firm analysis. In so doing, it advances both a descriptive hypothesis and several doctrinal entailments that follow. Descriptively, the class action is — or, more accurately, should be analyzed as — a firm. Like firms, class actions are comprised of collective ownership interests that aggregate to avoid the higher costs of acting alone in the market, cede control to a manager, and organize around a profit-driven motive. And, importantly, like a firm, there is a natural — almost organic — limit to the growth of a class action: it will expand until litigating outside of the class action would be less costly than additional growth. This Article’s new “firm framework” is both consonant with the most-accurate components of the traditionalist principal-agent framework — those that implicitly rest on a divide between ownership and management — and breaks with the traditionalist account in important ways. Principally, its refraction permits an approach that is not singularly focused on the problems that class actions foster, enabling it to more usefully guide judicial practice. Dovetailing from this new framework, this Article articulates numerous doctrinal entailments that follow, touching on several areas of critical importance to class action practice and procedure. Critically, because class actions have heretofore been constructed exclusively as vehicles for principal-agent problems, Rule 23 has been construed exclusively as a means of mediating such problems. Instead, per the firm framework, courts should consider the various issues that class actions present along two tiers of analysis, discerning between principal-agent problems that demand judicial regulation and those efficiency-related issues that are self-regulating and beyond courts’ core competencies. This doctrinal overlay — which prescribes both a piercing judicial review of questions relating to internal governance of the class action, on the one hand, and a business-judgment-rule-like deference to questions relating to the external boundaries of class actions, on the other — both endorses and critiques status quo doctrine. Specifically, courts should apply a heavy hand when principal-agent problems are likely to be severe and costly, but proceed with a light touch when such problems are largely self-regulating. Several strains of extant class action doctrine “fit” within this two-tiered approach to Rule 23, but the firm framework also calls for considerable doctrinal change. This Article proceeds in four parts. First, it outlines the status quo dominance of the principal-agent framework. Second, it offers a new competitor — the firm framework — explaining both its contours and why it better resonates with the nature of the class action mechanism. Third, it canvasses several doctrinal entailments that follow, specifically calling for considerable change in how courts address questions concerning commonality and predominance. Fourth and finally, it presents a unique model to demonstrate how the firm framework assures that class counsel — even when regulated with a mere light touch — will self-regulate and make the “right” market-based decisions.