What Is a Class Action?

A class action is a legal proceeding in which one or several plaintiffs bring a lawsuit on behalf of a larger group, known as the class. The judgment or settlement agreed to arise from the suit covers all members of the group or class, where penalties paid by the defendant are divvied up among class members.

Key Takeaways

  • A class action refers to a legal course where the plaintiff brings forward a lawsuit for the benefit of a larger group of affected people.
  • This group, or class, must attest that they were affected by the defendant's actions, but only the lead plaintiff will try the case in court.
  • If the plaintiff wins, awards are paid out pro-rata among members of the class.
  • In finance, class action lawsuits are often brought against companies where the class is the company's shareholders.

Understanding Class Action

The class represented in a class-action lawsuit might consist of groups such as employees, consumers, investors, or patients. Lawsuits are designated, or certified, by the court with jurisdiction as class actions if they meet certain criteria spelled out in a legal rule known as Rule 23. The criteria include the existence of a sizable group of people with similar claims or common interest. Lead plaintiff(s) who are representative of the broader class members and “questions of law or fact common to the class.”

Benefits of Class Actions

Being certified as a class can enable litigation to proceed more expeditiously and cost-effectively, particularly in cases pursued against large corporations. Because they reduce the costs of legal pursuit, class actions may provide the only means for some individual claimants to pursue their case.

Individuals may also have a greater chance of successfully pursuing their claims against a defendant or defendants. Even when represented in a class, members may choose to opt-out of any eventual settlement and pursue their claims individually.

Types of Class Actions

Types of class actions include securities litigation, civil rights proceedings such as school funding, and consumer product liability cases. Congress laid out additional rules for securities class action lawsuits in the Private Securities Litigation Reform Act (PSLRA) of 1995.

Successful class action cases often result in hefty pre-trial settlements. The lawsuit Enron shareholders filed after the company’s collapse resulted in a $7.2 billion settlement. Another famous class action was the product liability case filed against Toyota for faulty brakes. It resulted in a costly recall and a $1 billion settlement.

Civil rights class action cases typically involve requests for injunctive relief, meaning legal remedies, instead of claims for payment. One of the most famous civil rights class actions is the Brown vs. Board of Education case the Supreme Court decided in 1954, which struck down school segregation as unconstitutional. These types of class actions now face greater legal restrictions than previously.

Lawyers typically take class action cases on contingency, collecting a percentage of any judgment or settlement fees make to plaintiffs. This practice has been scrutinized over the years because in some cases, legal teams’ payout can far exceed the amounts plaintiffs receive.

Example: Elon Musk, CEO of Tesla vs. TSLA Shareholders

Tesla Inc. (TSLA) and its outspoken Chief Executive Officer Elon Musk were slapped with two class-action lawsuits over Musk’s series of tweets in the summer of 2018, where Musk tweeted out a plan to take the company private. His tweets said he was considering taking the electric car maker private for a share price of $420, which shocked Wall Street and sent Tesla stock surging.

Since the series of Tweets and a letter to employees in which Musk laid out his thought process, there has been silence on the topic from both Musk and the company. That has led to inquiries by the Securities and Exchange Commission (SEC) into the situation and two class-action lawsuits by investors who USA Today reported contend the company violated federal securities laws via the tweets.

In one of the two lawsuits, which was filed in federal court in San Francisco by Kalman Issacs, the plaintiff contends Tesla and Musk "embarked on a scheme and course of conduct to artificially manipulate the price of Tesla stock to completely decimate the company’s short-sellers.”

The lawsuit alleges the tweets sent the stock up $45.47 above the stock’s closing price the day earlier, which cost short-sellers, or those that bet a stock will go lower with borrowed shares, billions of dollars in mark-to-market losses. The lawsuits also claim Musk hasn’t lined up the financing necessary to take Tesla private and therefore made false statements. In a separate class-action lawsuit also filed in federal court in San Francisco, William Chamberlain contends Musk “materially” misled investors between August 7 and August 10 claiming investor support for the deal was secured and that the funding was in place.