Business at the Bar

Supreme Court decisions impact business decision-making.

2001 Volume 4 Issue 3

Recent decisions lessen likelihood of unreasonable punitive damage awards and support a business’s right to enforce arbitration instead of litigation.

After the 2000 presidential election and the court battles that followed, no one can deny that the U.S. Supreme Court can, and does, have a major impact on American life. But while the court’s most famous decision of the recently completed term was a rare direct incursion by the justices into an election, the Supreme Court’s less-publicized decisions regularly have an equally significant effect on the business world.

Three cases from the 2000-01 term may prove to be especially valuable to business interests. One court ruling will make it easier to overturn large punitive damages awarded by juries, and two other decisions will help businesses insist on arbitration, as opposed to litigation, with employees and customers.

Punitive Damages

The potential for large verdicts awarded by generous juries is a fear of most businesses. For example, last year Exxon Mobil Corp. was ordered by a jury to pay $3.4 billion in punitive damages for conduct that yielded a compensatory damage award of only $88 million. Although this verdict is currently on appeal, the case illustrates the danger for businesses that decide to take their chances in court.

A company is often at a disadvantage when it is a defendant in a jury trial, regardless of the facts or equities of a case. Perhaps it is just human nature, but jurors seem more inclined to be sympathetic to an individual plaintiff than to a corporate defendant. In a close case, that sympathy factor might make jurors more likely to rule for the plaintiff than for the defendant company. Further, the jury may be more willing to impose sizable monetary damages to compensate the plaintiff for the loss, on the theory that the business is either better insured or at least more capable of bearing the significant costs of injuries.

However, compensatory damages are only part of the story. Punitive damages — those designed to punish the wrongdoing defendant and deter future misconduct — are often many times larger than the compensatory damages, as in the Exxon Mobil case. The potential for multimillion or even billion dollar verdicts, which could bankrupt many companies, is one reason that corporate defendants often feel forced to settle cases. Especially after factoring in the costs of a trial, the option of settling out of court for a more predictable sum may appear to be a wise business decision — even when the business is confident that it did nothing wrong.

A May 2001 Supreme Court opinion, entitled Cooper Industries Inc. v. Leatherman Tool Group Inc., may provide some hope of relief from large punitive damages awards. In essence, the Supreme Court ruled that an appellate court asked to review a jury’s decision on punitive damages must reconsider all the evidence and reevaluate the award on its own. The high degree of deference normally given to jury decisions will not apply to punitive damages. In legalese, the appellate court should conduct a “de novo” review, rather than merely ask whether or not the jury’s decision was an “abuse of discretion.” As a result, large punitive damages awards will have to survive closer scrutiny from ostensibly neutral judges applying the law. Individual jurors possibly affected by sympathy for an injured plaintiff will not have the final word.

The case yielding this ruling was a trademark dispute between two competitors. Leatherman Tool Group sued Cooper Industries for false advertising and unfair competition, alleging that Cooper was using modified photographs of Leatherman’s product in advertising Cooper’s competing tool. The trial jury agreed, awarding Leatherman $50,000 in compensatory damages. The jury then added another $4.5 million to the verdict in punitive damages — an amount 90 times the size of the compensatory damages award.

Both the trial court judge and the 9th Circuit Court of Appeals denied Cooper’s requests to reduce the amount of punitive damages, noting that it is the jury’s primary responsibility to determine factual issues such as damages. But the U.S. Supreme Court reversed on an 8-1 vote, ruling that this deference to a jury’s fact-finding role applies only to compensatory damages. By contrast, punitive damages are more like “private fines,” according to the court. Since there are constitutional limits against grossly excessive punishments, an appellate court must give much closer scrutiny to a punitive damages award, conducting its own evaluation of the size.

This new ruling both strengthens and extends a 1996 Supreme Court decision limiting punitive damages. In BMW vs. Gore, the Supreme Court overturned a $2 million punitive damages award when the jury found that Gore, the purchaser of a new car, had suffered only $4,000 in compensatory damages. (Gore alleged that BMW failed to disclose that it had repainted the new car before it was sold to Gore, and that the covered-up damage reduced the value of his car.) Ultimately, as a result of the Supreme Court ruling, the $2 million punitive damages award was reduced to only $50,000.

In both the Cooper and BMW decisions, the Supreme Court lists three factors to be considered in deciding if a punitive damages award is too high: the reprehensibility of the defendant’s misconduct, the ratio of punitive damages to compensatory damages, and the size of other penalties that could be imposed for the defendant’s action. Although no precise mathematical formula is provided, these are the issues that an appellate court should study when it reevaluates a jury’s punitive damages award.

Clearly, it will require a pattern of cases and some time to see with certainty how the appellate courts interpret and apply the new Supreme Court decision. However, there should be no doubt that this decision is indeed a victory for business defendants. It means there will be less pressure on businesses to settle a case merely to avoid a potentially devastating punitive damages award. Further, as an 8-1 ruling from a court that often splits 5-4 on the most difficult cases, this opinion of the Supreme Court should stand for some time.

Arbitration

Although the danger of massive punitive damages awards may have been lessened somewhat, most corporate defendants would still prefer to stay out of court altogether. Generally, businesses consider arbitration or other means of alternative dispute resolution to be faster and less expensive than traditional litigation. That is why two other recent Supreme Court decisions supporting the use of arbitration are also of great importance to the business community.

The first decision, Circuit City Stores v. Adams, makes it easier for employers to enforce binding arbitration agreements in employment contracts. The Supreme Court ruled in March 2001 that the Federal Arbitration Act, which makes arbitration agreements enforceable in federal court, applies to most employment contracts. Only transportation workers are exempted under the federal statute.

Adams, while seeking a job at Circuit City, signed an employment application agreeing to submit any employment-related claims to binding arbitration. But two years after being hired as a sales counselor, Adams claimed employment discrimination through sexual harassment and took Circuit City to court, rather than going through arbitration. Circuit City responded by attempting to block the court action and instead enforce the arbitration agreement.

The trial court agreed with Circuit City that Adams’ claim must be decided by arbitration. However, the 9th Circuit Court of Appeals reversed, interpreting the 1925 Federal Arbitration Act to exclude all employment contracts. The 9th Circuit’s ruling conflicted with the decisions of other appellate courts on the same issue. But businesses already using binding arbitration agreements with their employees were concerned, as the ruling excluding employment contracts from arbitration applied to California and other Western states included in the 9th Circuit.

The Supreme Court again overruled the 9th Circuit, although in this case by a razor-thin 5-4 margin. The five justices in the majority were those generally considered to be the court’s conservative bloc — Justices Rehnquist, Scalia, Thomas, Kennedy, and O’Connor.

The decision turned on a complicated and, at times, tedious analysis of the 1925 act, focusing on minor word differences and ancient rules for interpreting statutes. Perhaps more important, though, was strong language from the five justices in the majority implicitly endorsing arbitration in the abstract. The majority opinion spoke of the “real benefits to the enforcement of arbitration provisions,” as arbitration allows both sides to avoid litigation costs.

As in most cases, the Supreme Court opinion in Circuit City decided only the specific issue presented to the court. That means many unresolved questions remain. In future cases, courts may be asked to decide exactly who qualifies as a “transportation worker” to gain this exemption from binding arbitration.

Further, it is still possible that other employees may be able to avoid binding arbitration by proving that the arbitration agreement was not entered voluntarily or that the arbitration process would not fully protect all of the employee’s rights. (For example, a decision of the California Supreme Court last year in principle upheld the legality of mandatory arbitration in employment contracts in California. But the ruling also placed limits on businesses imposing mandatory arbitration by saying that the employer had to bear the costs of arbitration and that the arbitration process had to provide the employee with the same remedies or damages as a court would.)

Yet another issue, involving the role of the federal Equal Employment Opportunity Commission when an employer has a binding arbitration agreement, will be before the Supreme Court for decision in the coming 2001-02 term. In summary, while Circuit City provides reassurance for businesses with binding arbitration clauses already in employment contracts, these and other pending questions might suggest patience for employers deciding now whether to impose new binding arbitration programs based on this latest Supreme Court ruling.

In a similar case involving a consumer contract, the same 5-4 majority of the Supreme Court enforced an arbitration agreement in a mortgage contract, despite the consumer’s argument that the arbitration process might have been too costly. In Green Tree Financial Corp. v. Randolph, the court ruled last December that the arbitration agreement’s failure to address the question of costs to the consumer did not allow the borrower to avoid arbitration and instead take the issue to court.

Green Tree had financed Randolph’s mobile home purchase, using a contract providing that all disputes would be resolved by binding arbitration. The financing contract also required that Randolph, the borrower, buy insurance to protect Green Tree from the costs of repossession if Randolph defaulted on the loan. Randolph subsequently sued, claiming that Green Tree’s failure to disclose the $15 per year cost of this insurance violated the Truth in Lending Act. (Randolph unsuccessfully sought to make this a class action on behalf of similar Green Tree borrowers.)

The trial court denied her lawsuit and ordered arbitration, but the 11th Circuit Court of Appeals reversed, because of a risk that her rights would be harmed by high arbitration costs. The Supreme Court disagreed and reinstated the arbitration order. The fact that the arbitration agreement was silent on which side would pay the costs was not a sufficient reason to void the arbitration requirement, according to the majority opinion. Nor was the mere risk or fear that the consumer’s rights would be harmed by arbitration when she had presented no evidence on what the actual costs of arbitration would be.

The four dissenters in Green Tree (those considered to be the court’s more liberal group — Justices Stevens, Souter, Ginsburg, and Breyer) thought the decision was premature. They did not argue that the arbitration agreement was clearly unenforceable. Rather, they urged sending the case back to the lower courts to get more facts about the costs to the consumer before reaching a decision.

Implications for Business

Based in part on these three decisions, the 2000-01 Supreme Court term should be seen as a good year for businesses attempting to be fair and honest. A company that believes it has a strong case can be more comfortable about defending itself at trial, rather than feeling forced to settle a claim to avoid the risk of an excessive punitive damages award. The 8-1 ruling in the Cooper case appears quite solid.

In both arbitration cases, the decisions support the right of businesses to use arbitration to avoid litigation, as the court’s opinions noted that federal policy favors arbitration agreements. That may be the clearest message from these two cases. But considering that these 5-4 decisions potentially could be changed by the retirement of only one justice, a more subtle message might be that businesses would still be wise to be very careful in writing and imposing binding arbitration agreements, whether in employment or consumer contracts. These arbitration agreements should be as fair, evenhanded, and non-coercive as possible. Otherwise, businesses may still end up defending them — ironically, spending time and money in court to argue that the underlying claim should not even be in court.

About the Author(s)

Larry Bumgardner, JD, is an associate professor of business law at Pepperdine University's Graziadio School of Business and Management. Previously, he served as executive director of the Ronald Reagan Presidential Foundation and the Reagan Center for Public Affairs in Simi Valley, California. A graduate of Vanderbilt University School of Law, he has also taught political science, public policy, and communications courses at Pepperdine.

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