Hit 'Em Where it Hurts - Punitive Damages in the Business Tort Case

Scott B. Cooper

[ This article was first published in the September 2003 issue of Advocate, a monthly journal of Consumer Attorneys Associations for Southern California. ]

Punitive damages are associated primarily with personal injury or wrongful death suits. Those are the cases that attract the headlines. Most everyone has heard of the recent verdicts: $290 million against Ford ( Romo v. Ford Motor Co. ), $4.8 billion against General Motors ( Anderson v. General Motors ), and $28 billion against Philip Morris ( Bullock v. Philip Morris ).i These awards garner attention not just because of their size, but because they usually involve a newsworthy story of corporate indifference to the health and safety of consumers.

Sometimes overshadowed by these awards is the effectiveness of punitive damages in the ordinary business tort case. Just as in personal injury and wrongful death cases, the specter of punitive damages can be a powerful tool in exerting pressure on a business tort defendant, and an actual award can have the same deterrent effects.

This article will provide a general overview of just some of the issues involved when seeking punitive damages in business tort cases. It includes a discussion of the causes of action which can and cannot support such an award, the necessary showings to sustain a punitive award against a corporate defendant, and limitations on the size of the awards, including Constitutional constraints imposed by the U.S. Supreme Court.

A. Punitive Damages Must be Based on a Tort – Not Breach of Contract

Business tort cases often begin with a breach of a contract. The California punitive damages statute, however, provides that the plaintiff may only recover punitive damages “[i]n an action for the breach of an obligation not arising from contract. ” Civ. C. § 3294(a) (emphasis added). Thus, a breach of contract action will not support a punitive damage award no matter how egregious the defendant’s conduct. Cates Const., Inc. v. Talbot Partners , 21 Cal.4th 28, 61, 86 Cal.Rptr.2d 855, 878 (1999) (punitive damages may not be awarded for breach of contract even where the defendant’s conduct was “wilful, fraudulent, or malicious”).

Further, compensation for a breach of the implied covenant of good faith and fair dealing is limited to contract rather than tort remedies and may not include punitive damages. Id. , 21 Cal.4th at 43, 61, 86 Cal.Rptr.2d at 865, 878. The only exception to this general rule is that tort remedies, including punitive damages, are available in implied covenant cases involving insurance policies. Id. , 21 Cal.4th at 43-44, 86 Cal.Rptr.2d at 865.

Thus, a plaintiff wishing to pursue punitive damages in a business case must plead and prove a tort independent from a breach of contract. The possibilities are numerous, and the plaintiff’s counsel needs to carefully apply the facts to all potential causes of action that could support a punitive award.

The most obvious candidate is fraud. Not only is fraud an independent tort, it is one of the three “bad acts” that will justify an award of punitive damages under the statute. See Civ. C. § 3294(b), (c)(3). Similar to the common law, the punitive damage statute defines fraud as “an intentional misrepresentation, deceit, or concealment of a material fact known to the defendant with the intention on the part of the defendant of thereby depriving a person of property or legal rights or otherwise causing injury.” Civ. C. § 3294(c)(3). Although the predicates are similar for a compensatory fraud case and a punitive claim based on fraud, the level of proof required is different. The basic tort claim, of course, requires only a showing by a preponderance of the evidence, while the punitive claim requires a showing by “clear and convincing evidence.” Civ. C. § 3294(a). When presenting both claims to a jury, however, the practical effect of this distinction is likely to be negligible.

Additional business tort causes of action will also support a punitive claim. The possibilities are numerous and include interference with prospective economic advantage, interference with contractual relations, inducing breach of contract, and conversion. If the plaintiff cannot prove fraud, it will need to demonstrate by clear and convincing evidence that the defendant was guilty of one of the other two predicates for punitive damages – malice or oppression – as defined by the statute. Civ. C. § 3294(a).

B. Corporate Defendants – Required Proof

1. No Vicarious Liability

In the business tort context, the plaintiff will often be seeking punitive damages against an employer for the acts of its employees. Although proving the employee was within the scope of employment may be sufficient to make an employer liable for compensatory damages, it is not enough to hold it responsible for punitive damages. College Hospital, Inc. v. Superior Court (Crowell) , 8 Cal.4th 704, 723-24, 34 Cal.Rptr.2d 898, 910, n.11 (1994).

In order to receive a punitive damage award from an employer, the plaintiff must prove one of the following:

– The employer had “advance knowledge of the unfitness of the employee” and employed him or her “with a conscious disregard of the rights or safety of others”;

– The employer “authorized or ratified” the employee’s wrongful conduct; or

– The employer was “personally guilty of oppression, fraud, or malice.”

Civ. C. § 3294(b); see also Weeks v. Baker & McKenzie , 63 Cal.App.4th 1128, 1153-54, 74 Cal.Rptr.2d 510, 525-26 (1998). As the statute makes clear, the employer’s liability for punitive damages is not vicarious. It is not based on the employee’s conduct, but rather on the employer’s own conduct. Weeks , 63 Cal.App.4th at 1154-56, 74 Cal.Rptr.2d at 526-27.

2. Determining Who is a Managing Agent

With respect to corporate employers, the conduct described above must have been perpetrated by “an officer, director, or managing agent of the corporation.” Civ. C. § 3294(b). Determining if a corporate employee is an officer or director is fairly straightforward. Determining who is a managing agent, on the other hand, requires some more analysis.

According to the case law, whether a corporate employee is a managing agent does not turn on the employee’s title or position in the corporation. Instead, the issue is how much authority the employee has over significant corporate decisions. The California Supreme Court has defined a managing agent as one “who exercise substantial independent authority and judgment over decisions that ultimately determine corporate policy.” White v. Ultramar , Inc., 21 Cal.4th 563, 576-77, 88 Cal.Rptr.2d 19, 26 (1999). He or she must be “more than a mere supervisory employee,” and the ability to hire and fire employees does not by itself make someone a managing agent. Id. , 21 Cal.4th at 566, 576-77, 88 Cal.Rptr.2d at 22, 26.

This determination is “a question of fact for decision on a case-by-case basis.” Id. , 21 Cal.4th at 567, 88 Cal.Rptr.2d at 22. Thus, determining who is a managing agent for purposes of the punitive damages statute is a fact-intensive inquiry that will require analogies to existing case law. Counsel for the plaintiff must be sure to conduct thorough discovery and perfect the record on this issue at trial in order to support a claim for punitive damages against a corporation for acts of an employee who is not an officer or director.

3. Proving Ratification

One of the most common ways to hold an employer liable for punitive damages is to show that the employer ratified the employee’s bad conduct. In the punitive damages context, “ratification generally occurs where, under the particular circumstances, the employer demonstrates an intent to adopt or approve oppressive, fraudulent, or malicious behavior by an employee in the performance of his job duties.” College Hospital, Inc. , 8 Cal.4th at 726, 34 Cal.Rptr.2d at 912.

Ratification often arises when an employer or its managing agent fails to intercede in a known pattern of workplace misconduct or fails to investigate or discipline the employee once the misconduct becomes known. Id. Corporate ratification in the punitive damages context requires actual knowledge of the conduct and its outrageous nature. Id.

Uncovering ratification can be difficult because it usually entails proof by circumstantial evidence. Rarely, if ever, will there be any formal ratification of what the employee has done. Instead, the plaintiff’s counsel must work to discover circumstantial evidence that the employer or its managing agent knew of the conduct and either failed to do anything (i.e., admonish, discipline, or terminate the employee) or actually condoned the conduct (i.e., promoting the employee). Proving ratification therefore requires sifting discovery, both formal and informal, to determine the corporate reaction to the employee’s misconduct.

C. Size of the Verdict – California Factors and Constitutional Limitations

With respect to punitive damages, getting the verdict is only half the battle. In the present appellate environment, holding on to the verdict can be just as challenging. In order to obtain and sustain a substantial punitive damages verdict, it is crucial to understand the factors used by the courts to review the awards on appeal. Knowing these factors will allow the plaintiffs’ counsel to gather the necessary evidence and make the necessary record in the trial court to support the verdict on appeal.

In considering these issues, there are two sources the attorney needs to consider. First is the California common law jurisprudence, which has developed a three-pronged test for assessing and evaluating the size of punitive damage awards. The second is the Constitutional “due process” analysis recently addressed by the U.S. Supreme Court.

1. California Factors

The California courts have identified three factors for a jury (and reviewing court) to consider when assessing punitive damages:

– The reprehensibility of the conduct of the defendant;

– The amount of punitive damages that will have a deterrent effect on the defendant in light of the defendant’s financial condition; and

– That the punitive damages bear a reasonable relation to the injury, harm, or damage actually suffered by the plaintiff.

BAJI 14.71 and 14.72.2; see also Neal v. Farmers Ins. Exchange , 21 Cal.3d 910, 928, 148 Cal.Rptr. 389, 399 (1978).

All three of these factors must be considered. See Adams v. Murakami , 54 Cal.3d 105, 111, 284 Cal.Rptr. 318, 321, n.2 (1991). They are not, however, meant to require strict adherence to a rigid formula. Rather, assessing punitive damages “involves a fluid process of adding or subtracting depending on the nature of the acts and the effect on the parties and the worth of the defendants.” Gagnon v. Continental Cas. Co. , 211 Cal.App.3d 1598, 1604, 260 Cal.Rptr. 305, 308 (1989).

A detailed discussion of these factors as applied over the years by the California courts is beyond the scope of this article. In crafting a discovery and trial strategy, however, plaintiff’s counsel needs to consider gathering and presenting evidence that will provide the jury and the appellate court ammunition to impose a punitive award when applying these factors.

2. Constitutional Analysis

Punitive damage awards are also subject to scrutiny under the due process clause of the Fourteenth Amendment to the Constitution. In 1996, the Supreme Court established three “guideposts” to determine the Constitutionality of punitive damage awards:

– The degree of reprehensibility of the defendant’s misconduct;

– The disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and

– The difference between the punitive damages awarded by the jury and the civil or criminal penalties that could be imposed for comparable misconduct.

BMW of North America, Inc. v. Gore , 517 U.S. 559, 575, 116 S.Ct. 1589 (1996). As of 2001, the reviewing court must conduct a de novo review of the trial court’s application of these guideposts. Cooper Industries, Inc. v. Leatherman Tool Group, Inc. , 532 U.S. 424, 121 S.Ct. 1678 (2001).

Recently, the Supreme Court revisited these guidelines in conjunction with a $145 million punitive damage award against State Farm. State Farm Mutual Automobile Ins. Co. v. Campbell , ___ U.S. ___, 123 S.Ct. 1513, 1521-26 (2003). In striking down that award, the Court returned to the three Gore factors and provided additional analysis that should be considered in the application of punitive damages.

As to the reprehensibility factor, the Court instructed lower courts to consider whether: “the harm caused was physical as opposed to economic; the tortious conduct evinced an indifference to or a reckless disregard of the health or safety of others; the target of the conduct had financial vulnerability; the conduct involved repeated actions or was an isolated incident; and the harm was the result of intentional malice, trickery, or deceit, or mere accident.” Id. at 1521. With respect to the business tort case, the first two factors will likely cut against a large punitive award, so the plaintiff’s counsel should focus on compiling and presenting evidence favoring the plaintiff on the remaining three factors.

Another important limitation stated in Gore and applied with renewed vigor by the Campbell Court is that the award must be based on conduct that harmed the plaintiff, not on other “unsavory” or out-of-state conduct. Id. at 1522-23. This presents a difficult choice for the plaintiff’s counsel. The natural instinct in these cases is to present all possible evidence of the defendant’s bad conduct, including evidence of company-wide practices or policies, to demonstrate the requisite culpability for punitive damages. In light of the Campbell admonitions, however, such evidence, if admitted, could be used by the defendant on appeal to argue that the award was based on conduct beyond that which harmed the plaintiff. Thus, plaintiff’s counsel must carefully consider what evidence to offer, balancing the desire to maximize the award at the trial level with the goal of avoiding a reversal on appeal. To the extent evidence of other wrongful conduct is identified, plaintiff’s counsel should make every effort to demonstrate its similarity to the conduct that harmed the plaintiff.

The Campbell Court also discussed in detail the ratio of the punitive to compensatory damages. While stating that “there are no rigid benchmarks that a punitive damages award may not pass,” the Court implied a strong preference for awards that do not exceed single-digit ratios, with the appropriate ratio changing depending on the egregiousness of the conduct and the amount of compensatory damages awarded. Id. at 1524. It reiterated that a ratio greater than four-to-one “might be close to the line of constitutional impropriety.” Id.

How this affects the business tort case will, of course, depend on the facts of each particular case. Because business torts generally do not involve physical harm or threats to the health and safety of the plaintiffs, they will often be viewed by courts as not extremely egregious. On the other hand, business tort cases can often involve large compensatory verdicts, allowing for a large punitive award while retaining a lower ratio. For example, after its decision in Campbell , the Supreme Court denied certiorari on a business tort case in which the lower court affirmed a $257 million punitive award. See Time Warner Entertainment Co. v. Six Flags Over Georgia , ___ U.S. ___, 123 S.Ct. 1783 (2003); Time Warner Entertainment Co., L.P. v. Six Flags Over Georgia, LLC , 254 Ga.App. 598, 563 S.E.2d 178 (2002).

It remains to be seen how rigidly the California courts will apply the Campbell analysis. Division Three of the Fourth District Court of Appeal recently used Campbell to slash a $5.5 million punitive award in a business tort case. See Diamond Woodworks, Inc. v. Argonaut Ins. Co. , ___ Cal.App.4th ___, ___ Cal.Rptr.2d ___, 2003 WL 21361143 (June 13, 2003). While there are numerous troubling aspects of this opinion, the most notable portion is the discussion of the punitive-to-compensatory ratio. The court began that analysis by making this surprisingly brazen statement: “[W]e have no doubt that anything exceeding four-to-one would not comport with due process under Campbell .” Id. at *19. That sounds very much like the “rigid benchmark” specifically cautioned against in Campbell and Gore .

Perhaps the court believed that was the appropriate limit because Diamond Woodworks was the “usual case, i.e., a case in which the compensatory damages are neither exceptionally high nor low, and in which the defendant’s conduct is neither exceptionally extreme nor trivial.” Id. at *20. If that is what the court meant, however, it did not state it clearly. As it stands now, the case could be read as advocating the rigid application of a four-to-one “cap” on the ratio of punitive to compensatory damages, which would contradict the Supreme Court opinions and interfere with the right to trial by jury. As of the date this article went to press, the time to seek review or depublication of the Diamond Woodworks opinion had not yet passed.

Another striking aspect of the opinion (and the Supreme Court due process analysis) is that it essentially ignores the wealth of the defendant. According to California law, the defendant’s financial status is not only relevant, it is necessary in determining the appropriateness of the size of the award. Adams , 54 Cal.3d at 110, 284 Cal.Rptr. at 320-21. Although this evidence might not be considered in a due process analysis, plaintiff’s counsel should still present the evidence in order to defend the award under the current California standards.

In sum, plaintiff’s counsel should consider the possibility of pursuing punitive damages in every business tort case. They can benefit not only the plaintiff, but also the rest of the business community. To pursue them effectively, however, plaintiff’s counsel needs to consider all of the potential issues and hurdles from the pleading stage all the way through final appeal.