The Theory and Practice of Punitive Damages Awards
Businesses facing lawsuits often fear the prospect of a “runaway” jury ordering them to pay millions or even billions of dollars in punitive damages. A recent Supreme Court decision should provide corporate defendants some hope for relief.
Punitive damages are intended to punish a defendant and deter future misconduct, while compensatory damages are used to compensate the plaintiff. The danger for the business world is that some juries may decide to pile on the punitive damages to send a strong message to defendants. This threat can prompt corporate defendants to settle cases–even ones they believe are meritless–to avoid exposure to potential mega-verdicts.
One does not have to look far to find recent examples of massive punitive awards. Exxon Mobil Corp. was ordered by an Alabama jury in November 2003 to pay $11.8 billion in punitive damages to the State of Alabama, even though the compensatory damages in a natural gas royalties dispute were only $63.6 million. In a contract dispute between two businesses, a California jury in September 2003 ordered Flextronics International Ltd. to pay Beckman Coulter Inc. $931 million in punitive damages on top of only a $3 million compensatory award.
Many of these massive verdicts are of course significantly reduced or even eliminated on appeal. In fact, an appellate court cut the $11.8 billion punitive verdict against Exxon Mobil to $3.5 billion. Flextronics has already settled its case for only $23 million, with the recent Supreme Court decision apparently contributing to Beckman Coulter’s willingness to accept a much smaller sum in settlement. Even if the verdict is ultimately reduced, there can still be severe costs to the corporate defendant during the lengthy appeals process.
These recent jury awards against Exxon Mobil and Flextronics are notable for at least two reasons. First, the plaintiffs in these cases were a state government and a corporation. Neither case involved perhaps the greatest fear of a corporate defendant–a case brought by a sympathetic individual plaintiff, in which jurors might be even more likely to side with the individual against a corporation with “deep pockets.”
Second, both verdicts came only a few months after the Supreme Court provided some frank guidance against large punitive awards. This was not the first such ruling from the high court, which twice before in the past eight years made less definitive statements to rein in punitive damages. (For a fuller discussion of those two cases, see “Business at the Bar” in the Summer 2001 issue of the GBR.) Since those two decisions apparently did not accomplish that purpose, the Supreme Court strengthened the message in its April 2003 ruling in State Farm Mutual Automobile Insurance Co. v. Campbell.
The State Farm Case
This complicated case began when Curtis Campbell, who was insured by State Farm, was the driver in a 1981 accident in Utah that left one victim dead and a second victim permanently disabled. (Campbell himself escaped injury.) After rejecting offers to settle the victims’ claims for Campbell’s policy limit of only $50,000, State Farm assured Campbell and his wife that their personal assets were safe and that they did not need a separate attorney to represent them at the trial.
However, when a jury found Campbell responsible for the accident and ordered damages of $185,849, State Farm refused to pay any amount over $50,000. In addition, a State Farm attorney then suggested that the Campbells put a “for sale” sign on their house to facilitate paying the judgment. Instead, the plaintiffs in the automobile accident case agreed not to collect any money from the Campbells personally if the Campbells would in turn bring a bad faith denial of insurance claim against State Farm (with the plaintiffs entitled to 90 percent of whatever the Campbells won in the bad faith case).
After an appellate court upheld the accident verdict several years later, State Farm then paid the full damages award of $185,849. Nevertheless, the Campbells sued State Farm for bad faith, fraud, and emotional distress.
The jury in the bad faith trial ruled that State Farm’s refusal to settle the accident claim for any amount over $50,000 was unreasonable. When considering the damages, jurors were presented with testimony indicating that State Farm’s decision was due to a company policy to limit claims payouts nationwide, even though much of this evidence was unrelated to the Campbells’ particular case. After further appeals in Utah courts, State Farm was ordered to pay the Campbells $1 million in compensatory damages and $145 million in punitive damages.
The Supreme Court’s Guidance
The U.S. Supreme Court had little trouble deciding that the $145 million punitive award was excessive. “This case is neither close nor difficult,” Justice Anthony Kennedy wrote for the majority in the 6-3 decision. The more significant aspect of the ruling came from the fairly clear instruction on punitive damages. Typically, the Supreme Court chooses to shape the law through more general and even arguably ambiguous statements.
The primary problem with the punitive verdict was that it was 145 times the size of the compensatory damages. The court’s prior opinions on punitive awards had discussed the ratio between punitive and compensatory damages, but refused to set a “bright-line,” quantitative test for how large that ratio could be before it would deny due process to a defendant and thus be unconstitutional.
In the State Farm case, the Supreme Court not only rejected this 145-to-1 ratio, but also came much closer to determining an acceptable ratio. By stating that “few awards exceeding a single-digit ratio” would be constitutional, the court indicated that any punitive award more than ten times the size of compensatory damages would very likely be unconstitutional. Moreover, the majority opinion favorably mentioned prior cases suggesting that punitive awards should be no more than four times compensatory damages. (Slipping back into more ambiguous wording, the ruling said of ratios of 4-to-1 or lower: “While these ratios are not binding, they are instructive.”)
Of course, as in almost any legal matter, there are exceptions. The court said these ratio guidelines might not apply when “a particularly egregious act” had produced a small compensatory damages award. On the other hand, for substantial compensatory damages, even a 4-to-1 ratio might be too high. The court indicated in that circumstance that punitive damages should perhaps be no greater than the compensatory award. Although the opinion did not define “substantial,” it found that the $1 million award to the Campbells qualified, especially since they suffered no monetary or physical loss due to State Farm’s actions.
Beyond the ratio, other factors must also be considered in judging the constitutionality of a large punitive award. For example, the more “reprehensible” the defendant’s conduct, the more likely large punitive damages will be justified. In this case, the court acknowledged that State Farm’s behavior “merits no praise,” but said that a smaller award could have still accomplished the purpose of deterrence or punishment.
The court also ruled that State Farm should be punished only for conduct specifically affecting the Campbells–not for unrelated actions or policies nationwide. More generally, punitive damages should not be used to punish a defendant for “being an unsavory individual or business.” Otherwise, defendants might face multiple punitive awards for the same behavior.
In yet another significant statement for the business world, the court seemed to restrict the long presumed practice of asking juries to make the punitive award large enough to hurt a particular defendant based on that defendant’s wealth. In wording that will surely require more interpretation in subsequent cases, the majority opinion does not completely preclude considering the defendant’s wealth. However, it does state: “The wealth of a defendant cannot justify an otherwise unconstitutional punitive damages award.”
Finally, although the Supreme Court officially sent the case back to Utah state courts to decide the appropriate punitive damages, the court strongly suggested setting the punitive award at roughly $1 million–in effect, a 1-to-1 ratio. The opinion concluded that all the appropriate considerations “likely would justify a punitive damages award at or near the amount of compensatory damages.”
The Ruling’s Impact in Pending Cases
The most immediate effect of State Farm can be seen in a recent product liability case involving a fatal accident in a Ford Bronco. Originally, a jury had ordered Ford Motor Co. to pay the plaintiffs $290 million in punitive damages compared to compensatory damages of $4.9 million (a ratio of 59 to 1). A California appeals court upheld the entire award in 2002. However, after the Supreme Court ordered reconsideration of that decision in light of State Farm, the very same California court cut the punitive award to only $23.7 million in 2003 (a ratio of 5 to 1).
Philip Morris saw a similar result in a case brought by a longtime smoker who developed lung cancer. The California Court of Appeal used State Farm to reject a $25 million punitive verdict when the compensatory damages were $1.5 million (a 17-to-1 ratio). In reducing the punitive damages to $9 million, for a 6-to-1 ratio, the California court noted that it was willing to exceed the 4-to-1 ratio that the Supreme Court seemed to prefer because of what it called “extraordinary reprehensible conduct” that harmed the plaintiff. Because this case continues on appeal, it could provide further instruction about both the importance of the 4-to-1 ratio guidance and what the Supreme Court meant when it indicated that even lower ratios should apply when compensatory damages are “substantial.”
The effect of the Supreme Court ruling is still uncertain for Exxon Mobil, the subject of a multibillion dollar punitive award in the Alabama natural gas case. In an older, separate case involving the Exxon Valdez oil spill in 1989, Exxon was originally ordered to pay $5 billion in punitive damages in a class action suit brought by local businesses and fishermen, when the compensatory damages were only $287 million (a ratio of 17 to 1). Although the punitive damages had already been reduced to $4 billion, after State Farm a federal appeals court ordered the trial judge to reconsider even the lower sum. In response, though, the trial judge in early 2004 actually increased the punitive award to $4.5 billion based on his reading of the Supreme Court’s decision.
Although this latest Exxon Valdez ruling will once again be appealed, it shows continued inconsistency on punitive damages. Most lower courts seem to be following State Farm, but others still appear to be trying to elude the Supreme Court’s obvious intent. For example, a federal appeals court recently upheld punitive awards of $186,000, compared to $5,000 in compensatory damages (a 37-to-1 ratio), to each of two plaintiffs who were bitten by bedbugs at the defendant’s motel. The opinion, written by a respected federal judge, explained that State Farm did not set absolute rules on acceptable ratios and further noted the small compensatory damages awarded in the case.
A more surprising aberration came in a breach of contract and fraud case over a commercial real estate deal that was not completed. A California appeals court recently affirmed a $1.7 million punitive award, even though the jury had granted only $5,000 in compensatory damages (a 340-to-1 ratio). Although acknowledging the State Farm ruling, the California Court of Appeal decided that the “actual harm” to the plaintiff, including “lost opportunity” based on the appraised value of the building to be sold, was at least $400,000, not just the $5,000 in out-of-pocket expenses awarded by the jury. Considering that additional harm, the ratio would be an acceptable 4 to 1. Further appeals in this case are likely, as the Supreme Court has twice before remanded this large punitive award for further consideration.
Clearly, the best defense for any business against punitive damages is to avoid engaging in egregious conduct that might give a jury an excuse to award an excessive sum. Nevertheless, even in the absence of reprehensible conduct by a defendant, some juries will still choose to assist a sympathetic plaintiff or punish a deep-pocketed defendant through a large punitive verdict. That is why the State Farm decision is very useful to the business world.
There are still potential loopholes and ambiguities even after the Supreme Court’s much clearer statement on punitive damages. Lawyers will argue over the exact meaning of State Farm, and various appellate courts and trial judges will have differing interpretations. However, the overall message is plain: a solid majority of the Supreme Court is determined to limit excessive punitive awards. That knowledge alone should help businesses, both in fighting frivolous suits and in negotiating settlements on legitimate claims.
 Jennifer Bayot, Exxon Is Ordered to Pay $11.9 Billion to Alabama, N.Y. Times, Nov. 15, 2003, at C3.
 Lisa Girion & Debora Vrana, Massive Verdict for Biomedical Company, L.A. Times, Sept. 25, 2003, at C1.
 Lisa Girion, Beckman Coulter Agrees to a Huge Cut in Judgment, L.A. Times, Nov. 27, 2003, at C1.
 For example, after Philip Morris was ordered to pay a total of $10.1 billion in a class-action suit concerning advertisements for “light” cigarettes, the company initially faced having to post a $12 billion bond to be allowed to appeal the verdict. Philip Morris said an appeal bond of that size could force the company into bankruptcy. Ultimately, the required bond was reduced to the still sizable sum of $6.8 billion.
 State Farm Mut. Auto. Ins. Co. v. Campbell, 123 S. Ct. 1513 (2003).
 Id. at 1521.
 Id. at 1524.
 Id. at 1521.
 Id. at 1523.
 Id. at 1525.
 Id. at 1526.
 Ford Motor Co. v. Romo, 113 Cal. App. 4th 738 (5th App. Dist. 2003).
 Henley v. Philip Morris Inc., 112 Cal. App. 4th 198 (1st App. Dist. 2003).
 Russell Gold, U.S. Court Rejects Punitive Award for Exxon Spill, Wall St. J., Aug. 25, 2003, at B2.
 In re the Exxon Valdez, 2004 U.S. Dist. LEXIS 1514 (D. Alaska 2004).
 Mathias v. Accor Economy Lodging Inc., 347 F.3d 672 (7th Cir. 2003).
 Simon v. San Paolo U.S. Holding Co., 113 Cal. App. 4th 1137 (2d App. Dist. 2003).