Can Common Sense Return to Our Legal System?

This week, the U.S. Supreme Court brought a measure of reason back to the nation’s costly legal system when it rejected a $145 million punitive damages award against State Farm (State Farm Mutual Automobile Insurance Co. v. Campbell, et al). In a 6-3 decision, the Court claimed that the Utah Supreme Court had incorrectly reinstated the award because it failed to follow earlier guidelines on punitive damages established by the Supreme Court. The decision reverberates well beyond the case in Utah, addressing the abuse of punitive damages in general, which the Court describes as “an irrational and arbitrary deprivation of the property of the defendant.”

Punitive damages have been a vexing problem in recent years, and many attribute much of the current legal crisis to the increasingly large and arbitrary awards granted by juries, which creates incentives to file more suits in pursuit of large damage awards. The establishment of a “litigation industry” has taken a toll on the U.S. economy. According to the Chairman of Lloyd’s of London, litigation cost Americans $205 billion in 2000 and is expected to cost $298 billion by 2005.

Traditionally, the courts use punitive damages to punish wrongdoers in civil cases and to deter dangerous or reprehensible behavior. Punitive damages are used to address outrageous conduct, reckless indifference, and evil intent by alerting potential wrongdoers that there is a price to be paid for such actions. Punitive damages are not used to compensate a victim for loss; they are awarded in addition to compensatory damages, which cover the costs of making an injured party whole. In this sense, punitive damages are a disciplinary measure invoked by the state to punish wrongdoers in civil cases, similar to penalties levied in criminal cases.

In practice, unfortunately, punitive damages may not achieve their desired result. Oftentimes punitive damages awards are applied in an arbitrary nature with widely varying awards for similar behavior. The uncertainty and unpredictability of such awards makes it difficult to deter or alter specific behavior, because no clear message is sent to the parties involved. Moreover, even though punitive damages are a form of state-sanctioned punishment, wrongdoers do not enjoy the protections afforded in criminal proceedings; for example, standards of evidence are lower in civil cases than in criminal cases.

That punitive damages awards have become problematic is indicated by recent Supreme Court efforts to address the issue. This week’s decision is just the latest in a series of decisions attempting to establish more rational ground rules for the use of punitive damages awards. Since 1990 a number of important cases before the Supreme Court have addressed this issue. Perhaps the most important was the 1996 case, BMW of North America, Inc. v. Gore, where the Supreme Court established guideposts for determining punitive damages. In that case, a dispute over a $4,000 paint job resulted in a $4 million punitive damages award, which was rejected by the Supreme Court. To clarify, the Supreme Court proposed three criteria to evaluate when determining punitive damages awards: the reprehensibility of the defendant’s conduct, the disparity between actual harm and the punitive damages award, and the difference between the punitive damages awards granted by the jury and civil penalties imposed in similar cases.

The Supreme Court found that these guideposts were not properly applied in the State Farm case, leading to a violation of the Due Process Clause of the 14th Amendment. What troubled the Court was a lack of proportionality between the compensatory damages and the punitive damages, as well as the information used to determine the value of the award. In the State Farm case the plaintiff received $1 million in compensatory damages coupled with $145 million in punitive damages, which fails the Gore test, because it was “neither reasonable nor proportionate to the wrong committed,” according to the Court.

Interestingly, the Court attempted to clarify the role of punitive damages as well as what should be considered when setting a value for such an award. In particular, the Court emphasizes that the punitive damages award must address the specific wrongdoing alleged by the plaintiff. In the State Farm case, the plaintiffs presented a wide array of general practices employed by State Farm throughout the country that had little to do with the specifics of the case in the Utah court.

Citizens for a Sound Economy Foundation addressed this issue in an amicus brief. In particular, CSE Foundation argued that the Utah Supreme Court miscalculated the punitive damages award because it included behavior that had no bearing on the case before the court.

The Supreme Court found additional problems with Utah’s assessment of punitive damages based on nationwide behavior of State Farm. First, the Utah court was attempting to punish State Farm for activities that were perfectly legal in other states. Second, even in instances where conduct may have been inappropriate, the Utah court cannot impose its laws on other states and should therefore limit its focus to the harms associated with the specific case before the court.

The Court also examined the proportionality of the compensatory and punitive damages awards. Noting that the compensatory damages award of $1 million was, in fact, a generous award, the Court found that a punitive damages award 145 times greater was unjustified. The Court made it quite clear that it was not attempting to establish a limit on the size of punitive damages awards, but it did note that in practice, any punitive damages award 10 or more times greater than a compensatory damages award was most likely not proportional.

The Supreme Court’s efforts to address problematic punitive damages awards is critical to restoring reason to a legal system in disrepair. The current system provides no predictability and, therefore, no guidance that can effectively reduce inappropriate behavior. A well-functioning legal system is critical for resolving disputes and addressing real grievances. But today’s courtrooms do this poorly, at best. The wheels turn slowly, with the average case taking more than five years to resolve, and this has been increasing. At the same time, the system’s approach to making injured parties whole is inefficient, with roughly two-thirds of the legal system’s costs being spent on things other than compensation. Legislation has been proposed in several states to address concerns in the legal system, and Congress is also examining federal reforms. This week’s action by the Supreme Court is an another important attempt to eliminate the costly excesses in our current legal system.