Issues surrounding network rules made headlines recently, with the Second Circuit Court of Appeals rejecting a $7.25 billion deal between Visa and MasterCard and approximately 12 million merchants claiming the networks worked together to fix credit and debit interchange fees, as well as the U.S. Supreme Court agreeing to decide whether the companies and their partner banks violated federal antitrust law by conspiring to inflate the prices of ATM fees.

What happened

In 2013, a New York federal court judge signed off on the deal in consolidated actions filed by merchants against Visa, MasterCard, and various issuing and acquiring banks. The estimated 12 million plaintiffs alleged the network rules established by the defendants (such as the default interchange fee and honor-all-cards rule) allowed issuing banks to impose an artificially inflated interchange fee that merchants had little choice but to accept.

Originally filed in 2006, the action spanned years of litigation, including 400 depositions, 17 expert reports, 32 days of expert deposition testimony, and the production of over 80 million pages of documents. After repeated mediation sessions and settlement negotiations, the parties reached a deal in 2012, which was finally approved by the district court on December 13, 2013.

The settlement agreement divided the plaintiffs into two classes: one under Federal Rule of Civil Procedure 23(b)(3) covering merchants that accepted Visa and/or MasterCard from January 1, 2004 to November 28, 2012, and a second class under Rule 23(b)(2) for merchants that accepted or will accept Visa and/or MasterCard from November 28, 2012 and onward.

Members of the (b)(3) class would be eligible for a piece of the $7.25 billion in monetary relief provided by the defendants, while the (b)(2) class would receive injunctive relief in the form of changes to the network rules. Given the differences between the rules, members of the first class who received money damages could opt out, but those in the second class could not.

Despite objections to the deal, the district court approved the settlement as fair and reasonable. Numerous objectors and opt-out plaintiffs appealed and the Second Circuit vacated the district court's certification of the class action and reversed the approval of the settlement.

Class members of the Rule 23(b)(2) class were inadequately represented in violation of Rule 23(a)(4) and the Due Process Clause, the unanimous panel held, because the same attorneys provided representation to both classes of plaintiffs despite the conflict of interest between the two.

"The conflict is clear between merchants of the (b)(3) class, which are pursuing solely monetary relief, and merchants in the (b)(2) class, defined as those seeking only injunctive relief," the court explained. "The former would want to maximize cash compensation for past harm, and the latter would want to maximize restraints on network rules to prevent harm in the future." Such divergent interests, the court held, require separate counsel when it impacts the "essential allocation decisions" of plaintiffs' compensation and defendants' liability.

Class counsel and class representatives were in the position to trade diminution of (b)(2) relief for an increase of (b)(3) relief, the panel said. "Unitary representation of separate classes that claim distinct, competing, and conflicting relief creates unacceptable incentives for counsel to trade benefits to one class for benefits to the other in order somehow to reach a settlement," the court wrote. "Divided loyalties are rarely divided down the middle."

Class counsel "stood to gain enormously if the deal got done," the Second Circuit said, with $544.8 million in fees on the line, calculated based on the amount of monetary compensation to the (b)(3) class but without regard to the value of the injunctive relief to the (b)(2) class. While the court expressly did not impugn the motives or acts of class counsel, it said they were "charged with an inequitable task."

Because the class plaintiffs were inadequately represented, the settlement and release resulting from the representation were nullities, the panel declared, an outcome confirmed by the substance of the deal itself. "[T]he bargain that was struck between relief and release on behalf of absent class members is so unreasonable that it evidences inadequate representation."

For example, merchants in the (b)(2) class that accept American Express (whose network rules prohibit surcharging and include a most-favored-nation clause) or operate in states that prohibit surcharging—California, Florida, New York, and Texas—"gain no appreciable benefit" from the settlement, while merchants that begin business after the termination of the deal on July 20, 2021 gain no benefit at all. Yet, "class counsel forced these merchants to release virtually any claims they would ever have against the defendants."

"This is a matter of class counsel trading the claims of many merchants for relief they cannot use: they actually received nothing," the panel wrote, and remain bound by "an exceptionally broad release."

Merchants in the (b)(2) class that cannot surcharge "suffer an unreasonable tradeoff between relief and release that demonstrates their representation did not comply with due process," the Second Circuit said. The court recognized that broad class action settlements are common, particularly when a defendant's ability to limit future liability is an important factor in the willingness to settle. "But the benefits of litigation peace do not outweigh class members' due process right to adequate representation," the court concluded.

A concurring opinion went one step further with regard to the release, calling the deal "not a settlement [but] a confiscation," with one class of plaintiffs receiving money and in return giving up the future rights of others.

Network rules were also at the heart of a new case added to the U.S. Supreme Court's docket for the coming term. The eight Justices agreed to weigh in on whether Visa, MasterCard, and affiliated banks conspired to inflate the prices of ATM access fees in violation of federal antitrust law.

The trio of consolidated cases (two filed by consumers and a third filed by independent ATM operators) alleged that the defendants adopted rules blocking ATM operators from charging less when transactions were processed by competing networks. Visa and MasterCard profited from the fees, as did the banks, the plaintiffs argued, because they owned equity in the companies before they went public.

The defendants countered that the plaintiffs lacked standing, the rules were created prior to the companies going public, and that membership in a business association alone (in this case, being part of the Visa and MasterCard networks) is not sufficient to demonstrate a conspiracy under antitrust law.

A federal district court agreed, tossing the suit in 2013. The judge found the injury alleged by the plaintiffs too speculative and said they failed to demonstrate that membership in the association amounted to collusion under federal antitrust law.

But last August the D.C. Circuit Court of Appeals reversed, reinstating the cases. The plaintiffs "alleged that the member banks used the bankcard associations to adopt and enforce a supracompetitive pricing regime for ATM access fees," the panel said. "That is enough to satisfy the plausibility standard."

Noting a split between the D.C. Circuit and the Third, Fourth, and Ninth Circuits, the defendants filed a writ of certiorari. "If firms that participate in business associations must incur the burden of defending costly antitrust litigation and discovery on mere allegations like these, the antitrust laws will become a substantial deterrent to the use of this precompetitive form of business organization," the petitioners argued.

Granting the writ, the Justices agreed to answer the question of "[w]hether allegations that members of a business association agreed to adhere to the association's rules and possess governance rights in the association, without more, are sufficient to plead the element of conspiracy in violation of Section 1 of the Sherman Act."

Oral argument will be heard next term.

To read the opinion in In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, click here. Link: I sent PDF

To read the petition for writ of certiorari in Visa v. Stoumbos, click here.

Why it matters

The $7.25 billion deal in the merchant case was the largest-ever cash settlement in an antitrust class action, and the Second Circuit opinion sends the parties back to the drawing board for a new agreement. The panel did note that (b)(3) and (b)(2) classes can be combined in a single case (and may not always require separate representation), but made it clear that structural defects in the class action created a fundamental conflict between the classes and "sapped class counsel of the incentive to zealously represent the latter."

The legal issues for Visa and MasterCard will continue not just on remand but in the separate antitrust action set to be heard by the Justices of the U.S. Supreme Court next term.