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Halt the misuse of punitive damages.

Bloated awards will continue to provide incentive to sue until the courts reassume their duty to make the punishment fit the offense.

DESPITE several appeals to the Supreme Court, the law of punitive damages seems to be as confused as ever. While courts and commentators agree that punitive damages are intended to deter wrongdoing or to punish the wrongdoer, few go on to consider what deterrence really means.

Consider the decision in connection with the Exxon Valdez oil spill. In September, 1994, an Alaska jury found Exxon liable for $5,000,000,000 in punitive damages. The result was hailed as just what was needed to make the company change its ways. Mere compensatory damages would be inadequate, it was argued, to deter Exxon from recklessness. The payment simply would be viewed as part of the cost of doing business.

However, what would be so wrong with that? If anything, society should be elated when corporations treat environmental damages (and indeed all sorts of damages) as part of the cost of doing business. Aside from compensating the victim, it is the very purpose of damages to make the wrongdoer internalize the full "social cost" of its product. After all, what rational firm would rather pay damages than spend the same amount on prevention?

Why have punitive damages? The answer is that simple compensatory damages do not always work to encourage businesses to do the right thing. If the perpetrator often gets away with the wrongful act and escapes the need to pay for some or many misdeeds, punitive damages may make sense. If it is difficult to detect the misdeed in question, or if victims do not always seek compensation for some reason, then the wrongdoer will not be forced to consider the full cost of such activities and only will invest in safety up to the point that it is cheaper than paying the fraction of claims that are pursued. Simple Dr. Booth is professor of law, University of Maryland School of Law, Baltimore. compensatory damages have a deterrent effect. Other things being equal, a rational firm would rather invest in safety than pay damages. Punitive damages are different. They are--or should be--intended only to deter.

Perhaps the most important rationale for punitive damages arises in cases in which the perpetrator is likely to repeat the offense despite the payment of compensation. For example, if the act is one that holds out the prospect of profit for the wrongdoer, then a ruling of simple compensatory damages means that the worst that can happen is that the perpetrator will be forced to give up the ill-gotten gain. That is no reason not to try the scheme again.

Punitive damages are meant to deter by taking the profit (if any) out of bad behavior. They are not designed to compensate the victim. It just happens that the plaintiff gets to keep the money because the culprit can not be allowed to do so.

On the other hand, punitive damages are themselves a powerful incentive to sue. One well-placed award of punitive damages is likely to bring many more plaintiffs, out of the woodwork.

The usual complaint about punitive damages is that there is no clear standard by which they are measured. That seems to be true in practice, but this need not be so. What the court or jury should consider is the frequency of the offense, the likelihood of detection, the tendency of victims to sue, and the chances that the wrongdoer will do it all over again. For instance, if the culprit is likely to be caught in one out of four offenses, then damages, including compensatory damages, should equal four times the gain to the wrongdoer from one wrongful act. Many courts have stated that punitive damages should be limited to the amount necessary to deter the wrong in the future. The problem is that few have taken the extra step of actually receiving evidence on these questions.

None of these quite legitimate reasons for punitive damages apply to the Exxon Valdez. There is virtually no chance that an oil spill will escape detection. When Exxon is the owner of the tanker, there is even less chance that someone will fail to sue. Finally, there is no sense in which Exxon gains from an oil spill. Aside from the fact that the tanker is damaged, the oil is gone, and Exxon paid $3,400,000,000 to try to clean up the spill, the injury to third parties, for which the company must pay compensatory damages of $286,800,000, is a massive incentive to take care. Also to be considered is the damage to the firm's reputation. Of course, the deterrent effect of the award extends to many companies beyond Exxon, but why should that corporation's fine be based on what others may or may not do?

Some have maintained that a defendant's wealth ought to be considered in assessing punitive damages. The idea is that it takes a bigger fine to hurt a richer wrongdoer. The argument does not withstand scrutiny. Although a dollar may mean less to Exxon than it does to you, it still will pay up to a dollar to save a dollar, or a billion to save a billion. In short, the fact that Exxon has a lot of money does not change the logic of punitive damages.

Of course, it may be that compensatory damages do not account for the full cost of the spill. Indeed, the plaintiffs in the Exxon case argued as much. Yet, two wrongs do not make a right. Using punitive damages to make up for what may be perceived to be an inadequate award of compensation is sloppy law.

Just when do punitive damages make sense? They might be logical in the context of surreptitious dumping of hazardous wastes into a landfill. Treble damages in anti-trust cases and a similar scheme of fines in connection with insider trading, both of which are closely akin to punitive damages, are sensible, although one may

One is tempted to cite interference with contract as in the case of Texaco's enticing Getty Oil to walk away from its merger agreement with Pennzoil. In that 1984 case, Pennzoil was awarded $7,530,000,000 in ordinary damages plus $3,000,000,000 in punitives. The chances that Texaco ever would get away with such tactics--in connection with a high-profile merger where the rule is sue first and figure out why later--are slim. Thus, the justification for the punitive award is unclear.

There are rays of hope and pockets of progress. Because punitive damages are more in the nature of a fine, the courts of New York have prohibited their award in arbitration, which is, after all, a scheme of private dispute resolution. To allow the award argue with the details. In addition, punitive damages may have a legitimate role in more run-of-the-mill offenses such as a stockbroker's churning of an investor's account or an insurance company's wrongful refusal to pay a claim. In all of these cases, the prospect of gain combined with the possibility that the offense will escape detection or that the victim will decline to sue suggests that additional deterrence may be required. of punitive damages in such a proceeding is rather like allowing an arbitration panel to impose criminal sanctions such as imprisonment. Nevertheless, the Supreme Court has ruled that the limitation may not apply in arbitrations before the National Association of Securities Dealers, even though punitive damages generally are unavailable as a matter of Federal securities law.

The California Supreme Court, in a landmark ruling on securities fraud under state law, stated that punitive damages are inappropriate in a class action, which amasses many small claims that otherwise might go unpursued. In other words, even though the nature of the claim being litigated in a class action is one for which punitive damages sometimes may be appropriate, the fact that it is litigated in the context of a class action well may obviate the need for additional deterrence. Similarly, the global settlement between Prudential and the Security and Exchange Commission (SEC) provides that investors who are compensated from the approximately $700,000,000 now set aside for them shall not be entitled to seek punitive damages.

In some states, the legislatures have required that some portion of punitive damages awards go to the state--just as any fine would and just as triple-the-gain fines for insider trading go to the SEC. If punitive damages are punishment rather than compensation, it is far from clear that private litigants should get to keep the award beyond the extent necessary to encourage them to sue. It is for the same reason that insurance companies generally refuse to cover claims for such awards (unless they are purely vicarious) and that punitive damages are taxable, whereas compensatory damages are not. Several states have enacted statutes that limit punitive damages to some specific dollar amount. Similar legislation has cleared Congress. Such statutes do more harm than good. They preclude the courts from making a large award when appropriate. Moreover, and even worse, the ceiling imposed by such statutes likely will become a floor. By limiting punitive damages to some arbitrary amount, courts and juries no longer need to worry about whether an award is reasonable.

To his credit, Judge H. Russel Holland, who presided over the Exxon case in Federal court, confined the consideration of punitive damages to a separate phase of the trial, a method championed by the Supreme Court of Tennessee and designed to allow the jury to consider the need for deterrence in isolation from liability and simple damages. A separate trial can not help but focus attention on the real reasons for punitive damages.

Still, the real problem with punitive damages is that the courts have lost sight of the purpose of such awards and therefore have abdicated their responsibility to tailor the remedy to the conduct to be deferred. If only the courts would focus on the gain to the wrongdoer, rather than the plight of the wronged, much of the needed reform would follow quite naturally. Whatever the mechanism of reform turns out to be, punitive damages will continue to operate as an incentive to sue until the courts reassume their duty to make the punishment fit the offense.
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Title Annotation:legal reform
Author:Booth, Richard A.
Publication:USA Today (Magazine)
Date:Sep 1, 1995
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