In Volkswagen Group of Amer., Inc. v. Peter J. McNulty Law Firm, --- F.3d ----, Nos. 11-1438 & 11-1857, 2012 WL 3064844 (1st Cir. July 27, 2012), the First Circuit vacated a $30 million attorneys’ fee award to MDL Class Counsel in connection with the settlement of a diversity case against Volkswagen and Audi regarding alleged engine defects in certain vehicles prone to the formation of damaging engine sludge unless particular types of motor oil were used. The Court held it was error to apply federal law to determine the amount of attorneys’ fees to award to class counsel in connection with the settlement where, although the defendants agreed to pay reasonable attorneys’ fees as part of the settlement, the parties expressly disclaimed any agreement as to what choice of law governs the award. Rather, the parties agreed:

It is expressly understood and confirmed that the parties have not agreed to any choice, selection or waiver of state or federal law to be applied to any aspect of the construction, preliminary or final approval, or application of any provision of this Agreement of Settlement, including but not limited to attorney fees and costs.

The Court explained that there is a two-part inquiry for determining the source of law that governs a settlement agreement in a diversity case. First, the Court evaluates whether under the Erie doctrine federal or state law governs the matter. Second, if state law governs, and a choice of law must be made, the Court applies the choice of law rules of the forum state (subject to the complexities of MDL litigation where oftentimes cases are transferred from various states).

The Court began its analysis with the basic premise that the issue of attorneys’ fees has long been considered for Erie purposes to be substantive and not procedural such that state-law principles normally govern the award of fees. The Court then considered and rejected class counsel’s arguments that Federal Rule 23(h) provides a basis for federal law governing the award of attorneys’ fees and, separately, that federal courts have inherent equitable powers to provide a basis for applying federal-law principles to the award. The Court cited the Advisory Committee’s note that Rule 23(h) “[d]oes not undertake to create new grounds for an award . . . Instead, it applies when such awards are authorized by law or by agreement of the parties.” The parties in the case had not agreed that federal law applies. The Court further rejected the “inherent powers” argument, in part, because the basis for the award was the agreement itself, a contract under state law, and not federal law.

The First Circuit vacated the District Court’s award, which was made pursuant to the percentage of the fund method, and, after a detailed choice of law analysis, held that Massachusetts state law governs and that the issue of attorneys’ fees should be resolved under one of two approaches to determining attorneys’ fees pursuant to a contractual agreement under Massachusetts law - the lodestar approach or the multi-factor analysis.