Limiting the punishment: after years of being the focus of proposed reforms, the court-imposed limit on punitive damages is significant for insurers. (Loss/Risk Management Insight).

In April, the United States Supreme Court issued an important decision restricting punitive damages--State Farm Mutual Automobile Insurance Co. vs. Campbell.

Punitive damages have long been on the "short list" of issues that concern businesses, particularly insurers, and have been the focus of proposed reforms at state and local levels. For years, businesses have wanted to limit punitive damages. Headlines have reported multi-million dollar awards for seemingly minor injuries, based upon punitive damages. These damages throw uncertainty into underwriting, risk management and other business planning.

Also, the threat of punitive damages inflates settlement payments. Every defense attorney in America has heard a plaintiff's lawyer privately admit that the actual injury is minimal, but the punitive possibility is valuable.

In the early days of this column, punitive damage restrictions were being pursued by America's businesses and insurers, but the restrictions seemed unattainable. As late as 1989, the Supreme Court declined to restrict these damages.

In 1996, the Supreme Court began to act, issuing its important decision in BMW of North America Inc. vs. Gore, a pivotal decision hailed by businesses and addressed in this column. Gore instructed courts "to consider 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 penalties authorized or imposed in comparable cases." Simply put, courts were to consider reprehensibility, proportionality and comparability.

Disparity, the second factor, was a major question. Courts were to consider whether the punitive damages were disparate to the compensatory damages, but the Supreme Court did not advise what it considered to be disparate. With Campbell, however, the Supreme Court provided guidelines, and those guidelines favor insurers and other businesses.

In Campbell, the plaintiff alleged that its insurer mishandled the defense of an auto accident. In a decision upheld by the Supreme Court of Utah, Campbell was awarded $145 million in punitive damages based upon a $1 million award of compensatory damages.

Considering the disparity test, the Campbell decision weighed in at a 145 to 1 ratio of punitive damages to compensatory damages.

The Supreme Court, focusing on the disparity test from Gore, examined the ratio in Campbell and adopted a limit on the ratio of punitive damages to compensatory damages. But the court indicated that its guideline might not apply in some circumstances. For example, this ratio might be too low "where a particularly egregious act has resulted in only a small amount of economic damages," the court said. On the other hand, it noted, this ratio might be too high where the compensatory damages are "substantial."

The court based its analysis on the constitutional principle of "due process." This principle requires that the measure of punishment be reasonable and proportionate to both the plaintiffs harm and the compensatory damages awarded.

At its core, Campbell adopted a general rule of nine: punitive damages generally should not be more than nine times greater than compensatory damages, subject to certain exceptions that might push the limiting multiplier higher or lower.

Lawyers being what we are, future litigation will undoubtedly focus upon the exceptions. Plaintiffs will seek punitive damages beyond the rule of nine by arguing that the defendant committed a "particularly egregious act." Courts will be forced to interpret the meaning of "particularly egregious."

Defendants will focus on the other side of the exception and argue that punitive damages must be limited below the rule of nine by arguing that the plaintiff had been awarded damages that are "substantial." Courts will be forced to interpret the meaning of "substantial."

Ultimately, despite the inevitability of future questions, Campbell represents an important limiting factor on punitive damages and is clearly a victory for businesses, particularly insurers.

Alan S. Rutkin, a Best's Review columnist, is a partner in Rivkin Radler LLP, Uniondale, N.Y. He can be reached at [e-mail].