Judge OKs Settlement in Netflix Class-Action Suit

A judge has approved a class-action settlement requiring Netflix Inc. (NFLX) to offer a free month of DVDs to 5.5 million current and former subscribers, resolving a case that prompted the online rental service to acknowledge it gives preferential treatment to its most profitable customers.

The settlement, released Monday after being approved last Friday, had been delayed since late March when San Francisco Superior Court Judge Thomas Mellon Jr. balked at a proposal that would have guaranteed payments totaling $2.5 million to a handful of lawyers.

Under Mellon's final order, Netflix must pay $1.3 million to Adam Gutride and Seth Safier — the San Francisco attorneys who filed the suit in September 2004 — and another $60,000 to lawyers whose objections to an earlier agreement helped shape the final settlement.

Netflix expects to begin sending out notices of the final settlement later this month. The Los Gatos, Calif.-based company has estimated the total settlement costs at $8.95 million, but that figure assumes it will pay $2.5 million in attorney fees.

"We settled the case in the best interest of all parties," Netflix spokesman Steve Swasey said. The company isn't acknowledging any wrongdoing.

The case revolved around allegations that Netflix had been misleading subscribers about how quickly it delivered movies to subscribers until Jan 15, 2005 — the date that the company made a little-noticed change to its terms of use.

The revision disclosed for the first time that Netflix sometimes delays shipments to frequent renters so it can give higher priority to customers who keep their movies longer.

The practice, derided as "throttling" by its critics, helps boost Netflix's profits because the company charges a flat monthly fee and provides postage-paid envelopes for DVD returns.

The system means Netflix makes more money from infrequent renters and risks losing money on customers who return DVDs quickly so they can get the next movie on their online wish lists.

Most Netflix subscribers pay $17.99 per month to keep up to three DVDs at time. The system has been successful for Netflix so far, powering the company to a $42 million profit last year as it lures people away from conventional video store merchants like Blockbuster Inc. (BBI).

Current Netflix customers with the $17.99 monthly plan will have the option to check out four DVDS at no additional charge, a $6 savings. About 3.7 million former subscribers will be offered a free month of the $17.99 rental plan.

Under an earlier version of the settlement reached six months ago, Netflix would have been able to automatically charge customers after the free month of DVDs.

The Federal Trade Commission criticized that arrangement as a promotional gimmick, prompting changes that prevent Netflix from extending the service without prior customer approval.

Nearly 420,000 people accepted the original settlement. Mellon's order allows Safier and Gutride to apply for an additional $1.1 million in fees if the revised settlement entices substantially more people to sign up for the free DVDs.