Did the Supreme Court Finally Rein in Punitive Damages?

We anticipate that litigants in state courts will use the Baker decision as relevant, persuasive authority to argue for greater controls on punitive damages, although only time will tell if punitive damages have truly been reined in.

Joshua R. Schwartz is Associate General Counsel for ACE Bermuda Insurance Ltd. and also serves as Special Counsel to the ACE Group's Enterprise Risk Management team. His work focuses primarily on high severity/low frequency claims work and litigation involving all of ACE Bermuda's lines of business, as well as corporate litigation. Prior to joining ACE, Schwartz worked as Counsel for O'Melveny & Myers and also clerked for the Honorable Federico A. Moreno, Chief Judge for the Southern District of Florida.

The threat of a punitive damages award sends shivers down the spines of many corporate officers and directors. The concern that a runaway jury will disproportionately “punish” a corporation or individual for allegedly reckless or intentional conduct leads many to settle lawsuits for grossly inflated sums, even when strong defenses to liability are present. Almost everyone is familiar with the excessive punitive damages jury verdict levied against McDonald's for serving too-hot coffee that burned a customer, as well as many other tales of rogue juries awarding apparently outrageous punitive damages. High-profile jury verdicts, and the resulting fear instilled in many national and multinational corporations, have had a tremendous impact on the insurance industry, which is often required to indemnify settlements inflated by claims of punitive damages. Without a reasonable limit on punitive damages, corporations and individuals feel compelled to settle cases that would otherwise go to trial, typically at a premium that does not bear a rational relationship to the damage caused by the alleged wrongful conduct. Despite heavy lobbying by the insurance and business sectors and others, there is only piecemeal state legislation and no federal legislation to protect corporate America from punitive damages awards that shock the conscience.

The Supreme Court, in its 1996 landmark BMW of North America Inc. v. Gore , 517 U.S. 559 (1996), decision, joined the national debate, holding that a “grossly excessive” punitive damages award violates the Due Process Clause and is therefore unconstitutional. As explained in more detail below, while commentators viewed this decision as a positive step, the ruling did not set any definitive limits on what constitutes a “grossly excessive” punitive damages award. In 2003, the Court continued its analysis of the issue by holding in State Farm Mut. Automobile Ins. Co. v. Campbell , 538 U.S. 408 (2003), that an award with a ratio of punitive to compensatory damages significantly greater than 9:1 would, in almost all instances, be deemed unconstitutional. In the same ruling, the Court set a presumptive cap of 4:1 for state law claims. While these cases established the presumptive outer constitutional parameters of punitive damages awards, they did not provide the necessary clarity and certainty that the business community craved.

In June 2008, the Court took a significant step toward providing that clarity in Exxon Shipping Co. et al. v. Baker, 128 S.Ct. 2605 (2008). In this maritime case decided under federal common law, the Court held that a 1:1 ratio between compensatory and punitive damages is the appropriate limit for a punitive damages award when only reckless conduct is established, and overturned a $2.5 billion punitive damages award rendered in connection with the 1989 Exxon Valdez oil spill. In issuing its decision, the Court focused on the need for certainty in punitive damages awards and decried “eccentrically high” jury verdicts. While the Baker decision only references intentional conduct in dicta and is not binding on state courts (where the majority of punitive damages cases are decided), the decision nonetheless is persuasive authority that defendants should utilize to limit the size of settlements and punitive damages awards. The discussion below analyzes these three important Supreme Court decisions and provides guidance for managing litigation involving punitive damages.

BMW v. Gore

In Gore, the Supreme Court struck down a $2 million punitive damages award where the compensatory damages were minimal and the defendant's behavior was neither malicious nor egregiously improper. This 1996 case represented the first time that the Court held a punitive damages award in violation of the Due Process Clause and unconstitutional because the award was “grossly excessive.”

This case involved the plaintiff's purchase of a new BMW from an Alabama automobile dealership that did not disclose that the car had been repainted prior to the sale. Gore sued BMW in Alabama state court, alleging that BMW had committed fraud. The jury found BMW liable for $4,000 in compensatory damages and $4 million in punitive damages, which the Alabama Supreme Court reduced to $2 million. The U.S. Supreme Court granted certiorari to review the decision.

In its analysis, the Court noted that a state may impose punitive damages to further its “legitimate interest in punishing unlawful conduct and deterring its repetition.” However, it held that a state may not impose sanctions for conduct outside of its borders that was lawful where it occurred, as these sanctions would infringe upon state sovereignty. Attempting to create uniformity for punitive damages awards, the Court established three guideposts to determine if an award is “grossly excessive” and thus violates the Due Process Clause:

1. The degree of reprehensibility of the defendant's conduct;
2. The ratio between the amount of compensatory damages and punitive damages; and
3. The difference between the punitive damages award and the civil or criminal sanctions that state or federal governments could impose for comparable misconduct.

The Court highlighted several factors that increase the degree of reprehensibility of a defendant's conduct, including violence or threats of violence, trickery or deceit, and endangering the health and safety of others. The Court declined to set a specific mathematical formula for the ratio of punitive damages to compensatory damages, but cautioned that the relationship should be “reasonable.” The Court also stated that a reviewing court should give “substantial deference” to legislative judgments of appropriate sanctions, as evidenced by civil and criminal penalties. The Court then held that the $2 million punitive damage award exceeded the Due Process constitutional limit and reversed the lower court's judgment.

Although this decision signaled the Court's desire to rein in punitive damages, it did not provide concrete guidance on what constitutes a reasonable award. Subsequent to the decision individual judges' interpretations of “reasonableness” and the three Gore guideposts varied significantly, so it had little impact on the incidence of excessive punitive damages awards. Because the Gore guideposts were subjective and the Court declined to provide additional quantitative guidance concerning the limits on punitive damages, this decision did not provide the certainty the Court intended and businesses needed.

State Farm v. Campbell

In 2003, the Supreme Court provided further guidance on the constitutional limits of punitive damages awards in Campbell. In this case, the Court struck down a “grossly excessive” punitive damages award of $145 million where compensatory damages were $1 million and the defendant's behavior was intentionally malicious. Significantly, the Court indicated that a ratio of punitive damages to compensatory damages that significantly exceeded single digits (9:1) would rarely comply with constitutional Due Process standards, even in instances of intentional conduct, although it declined to adopt a strict numerical cap.

In this case, the State Farm policyholder (Campbell) was involved in an automobile accident in which one person died and another incurred serious injuries. Although investigators and witnesses agreed that Campbell was at fault, State Farm contested liability, refused to settle for the policy limit of $50,000, ignored its own investigators' advice, and took the case to trial. After the jury returned a verdict for more than three times the policy limit, State Farm refused to pay the excess liability ' even advising Campbell to “put for sale signs on your property to get things moving” ' until after the Utah Supreme Court affirmed the ruling. Campbell then sued State Farm for bad faith, fraud, and intentional infliction of emotional distress. A Utah jury awarded Campbell $2.6 million in compensatory damages and $145 million in punitive damages, which the trial court reduced to $1 million and $25 million, respectively. The Utah Supreme Court, after reviewing the award using the three Gore guideposts, reinstated the $145 million punitive damages award. The U.S. Supreme Court granted certiorari.

Applying the Gore guideposts, the Court reversed the Utah Supreme Court, stating that this case was “neither close nor difficult.” The Court agreed that State Farm's conduct was intentional and malicious. However, it held that a state could not impose punitive damages for unlawful acts committed outside of its jurisdiction (thus expanding the Gore decision to include both lawful and unlawful acts outside the deciding court's jurisdiction). The Court indicated that few awards significantly greater than a 9:1 ratio will be constitutional and that when compensatory awards are substantial, a smaller ratio of 4:1 or even 1:1 may be appropriate. It noted, though, that ratios greater than single digits may be constitutional in exceptional cases when an extremely egregious act results in small economic damages. The Court also clarified that the wealth of a defendant cannot justify an otherwise unconstitutional award and emphasized the importance of reasonable jury instructions to prevent runaway verdicts.

In the wake of the Campbell ruling, a degree of optimism existed that the decision had the potential to decrease significantly the magnitude and quantity of punitive damages awards. However, courts have since developed a range of interpretations of the Campbell ruling, and the decision has had a much smaller impact on punitive damages awards than many predicted. Thus, more guidance from the Court appeared necessary to rein in punitive damages.

Exxon v. Baker

In 2008, the Court again addressed punitive damages, demonstrating a firm commitment to providing clear guidelines to lower courts on punitive damages awards and attempting to add a degree of certainty for businesses. In Baker, the Court held that punitive damages cannot exceed compensatory damages (i.e., a 1:1 ratio) in cases of reckless behavior under federal maritime law and reversed a $2.5 billion punitive damages award.

This case stemmed from the 1989 Exxon Valdez oil spill, when the drunken captain of the Exxon Valdez crashed the tanker and spilled millions of gallons of crude oil into Alaska's Prince William Sound. A class of commercial fishermen, landowners, and Native Alaskans who were injured by the spill sued Exxon. After years of litigation, the jury awarded approximately $507.5 million in compensatory damages and $5 billion in punitive damages to the class, which the Ninth Circuit reduced to $2.5 billion. Exxon appealed the decision to the Supreme Court, which granted certiorari.

The Supreme Court's decision addressed three issues: 1) whether an employer can be liable for punitive damages for the reckless acts of its managerial employees; 2) whether the Clean Water Act (“CWA”) pre-empts punitive damages; and 3) whether the punitive damages awarded were excessive under maritime law. The Court split evenly on whether an employer could be liable for punitive damages due to the reckless acts of its managerial employee (as Justice Samuel Alito did not participate in the decision). The Court also held that the CWA did not pre-empt punitive damages, because there was no evidence that Congress intended it to be the sole source of remedies for pollution.

With respect to the excessiveness of the award, the Court held that the $2.5 billion punitive damages award was excessive and ruled that a punitive damages award for reckless behavior could not exceed compensatory damages under maritime common law. The Court began by surveying the history of punitive damages in Anglo-American jurisprudence. It noted that even ancient legal codes allowed for multiple damages for certain harmful acts, such as the Code of Hammurabi Section 8, which mandates a tenfold penalty for stealing the goat of a free man. Although early common law rationales for punitive damages awards varied, the Court's opinion confirmed that the primary functions of punitive damages today are retribution and to deter further harmful conduct. While the Court noted that, overall, punitive damages awards have been mostly consistent over time, the “stark unpredictability” of punitive damages is a major problem. The Court honed in on the need for certainty and condemned the potential for “unpredictable outlier” verdicts, which it felt essentially created a lottery system.

The Court discussed three ways to increase the certainty of punitive damage awards: verbal standards, an absolute numerical cap, and a ratio of punitive damages to compensatory damages. The Court rejected verbal standards, such as more specific jury instructions, because they would not provide enough guidance for juries and certainty for litigants. It dismissed an absolute numerical cap because the diversity of torts that might warrant punitive damages made it difficult to determine an appropriate dollar figure that would address the uniqueness of each particular tort. The Court therefore decided that a quantitative approach ' a ratio of punitive damages to compensatory damages ' would be the best method of increasing consistency since it would peg punitive damages to the amount of harm assessed by juries through compensatory damages. The Court determined that a 1:1 ratio, based on the median of punitive damages award, is a fair limit in cases like Baker involving “a case of reckless action, profitless to the tortfeasor, resulting in substantial recovery for substantial injury.”

Considerations for Litigants and Insurers

The Supreme Court is not the only court concerned with excessive punitive damages awards, as many state court judges continue to decry the unpredictability of punitive damages as well. While the Baker decision is factually binding only in federal maritime cases and perhaps under federal common law, state courts should find the Baker decision persuasive and, in the absence of statutory guidance, will likely apply a similar rationale to state court cases. There have been some inconsistencies in the application of the Baker ruling in the months since issuance of the decision. A Pennsylvania District Court has noted that “it is clear that the Supreme Court intends that its holding have a much broader application,” while in contrast an Illinois federal district court has taken the opposite view, stating that the decision “is of limited applicability by its own terms.” It is thus fair to state that it is too early to predict, given the limited case law since the Baker decision, whether the decision will have the desired impact on outlier punitive damages jury verdicts and excessive settlements driven by fear of punitive damages.

In order to minimize punitive damages, litigants should consider the following steps when managing litigation involving punitive damages:

• Focus trial judges on the constitutional restrictions on punitive damages, especially when admitting evidence and submitting proposed jury instructions.
• Dispel any nexus between out-of-state conduct and the harm alleged by the plaintiff.
• Dispel any connection between dissimilar acts and the harm alleged by the plaintiff.
• Move to bifurcate the punitive damages portion of the trial, if such bifurcation is not automatic under statute or rule.
• Determine whether any state civil penalties and/or maximum punitive penalties apply under state statute.
• Be cautious with cases that involve physical injuries, as this could still lead to a double-digit punitive/compensatory ratio.

Despite the uncertainty, the growing number of cases limiting punitive damages should encourage corporations to no longer be as wary of punitive damages verdicts and to consider making settlement offers including a punitive damage component that are more reasonable in comparison to potential compensatory damages. The Baker decision should also have a direct impact on how insurers work with policyholders to settle suits alleging punitive damages and how insurers associate with counsel in the defense of policyholder punitive damages cases. Insurers should encourage policyholders to hold firm against the plaintiff's bar's threats of excessive punitive damages jury verdicts by pointing to the Baker decision and the recent trend of decreased outlier jury verdicts.

We anticipate that litigants in state courts will use the Baker decision as relevant, persuasive authority to argue for greater controls on punitive damages, although only time will tell if punitive damages have truly been reined in.

Joshua R. Schwartz is Associate General Counsel for ACE Bermuda Insurance Ltd. and also serves as Special Counsel to the ACE Group's Enterprise Risk Management team. His work focuses primarily on high severity/low frequency claims work and litigation involving all of ACE Bermuda's lines of business, as well as corporate litigation. Prior to joining ACE, Schwartz worked as Counsel for O'Melveny & Myers and also clerked for the Honorable Federico A. Moreno, Chief Judge for the Southern District of Florida.