Учебный год 22-23 / Binding Promises - The Late 20th-Century Reformation of Contract Law

which the defendant must have been reasonably able to foresee the distress is moved forward. For contracts, it is when the parties made the contract, whereas for torts it is when the defendant took the wrongful action.75 Perhaps most important, the right to recover in tort cannot be contractually abrogated unless the parties have equal bargaining power. It is not inconceivable that employers and insurers, for example, could begin to include provisions in their contracts expressly precluding emotional distress damages. Courts would then have to decide whether such provisions were contrary to public policy or to reasonable expectations, unconscionable, or unenforceable for some other reason.

Punitive Damages

People ought not to be liable for punitive damages merely for breaching a contract. They have done nothing wrong if they pay full compensation. Indeed, society loses if people do not breach contracts that would cost them more to perform than to pay compensation for breaching.76 Nothing in the law of bad faith breach conflicts with these conclusions. Bad faith breach is a tort, not a mere breach of contract, and one of its elements is that the perpetrator tried to avoid paying compensation. The following analysis assumes the defendant has committed a tort and asks under what circumstances he should be liable for punitive damages and how the law should measure them.

Purposes

Another name for punitive damages is “exemplary damages.” The two names connote the two purposes of retribution and deterrence. They give the defendant his just deserts and set an example to discourage others from engaging in similar conduct.77 The retribution is both public and private. Punitive damages vindicate the public values against which the wrongdoer offended. They can also assuage the suffering of the injured party by demonstrating that those who injured him have been punished. They may be especially effective for this purpose because the injured party knows that he was instrumental in compelling the wrongdoer to pay them. However, the deterrence purpose is exclusively public. If the damages succeed in deterring people from engaging in similar conduct, the victim will benefit no more than will any other member of the class protected by that deterrence.

The fact that punitive damages punish the defendant does not distinguish them from compensatory damages. A defendant pays any damages under

court order, and doing anything one would not do voluntarily is a punishment. The distinction between punitive and compensatory damages is that the former are more than is necessary to compensate the plaintiff and thus serve only to punish the defendant. I will therefore sometimes refer to their purpose as providing “additional” punishment.

Although I have not seen it identified before, punitive damages also serve the purpose of rewarding plaintiffs and their lawyers for “convicting” the defendant. Public authorities often offer rewards for information leading to the conviction of criminals. The laws entitling plaintiffs to punitive damages serve a similar purpose of encouraging people to identify and punish those who are guilty of civil wrongdoing. This purpose is even more important for the enforcement of laws against civil wrongdoing than it is for criminal wrongdoing, because without the reward that punitive damages provide for plaintiffs, those who engage in civil wrongdoing would not be punished frequently enough to serve the deterrence and retribution purposes. Public enforcement authorities are generally too busy with serious criminal matters to bother with civil wrongdoing.

Our laws also provide other rewards for those who identify and punish civil wrongdoers. For example, courts generally reward the lawyers who succeed in winning a class action by allowing them to recover generously large attorneys’ fees.78 Federal antitrust laws entitle winning plaintiffs to three times their actual damages plus attorneys’ fees.79 State usury laws often entitle the debtors who expose their lenders as usurers to treble damages or other substantial benefits.80

The private law enforcement that such rewards encourage can be more efficient and more effective than public enforcement would be. The public authorities do not need to search for the victims, because the victims identify themselves. Victims cooperate in the prosecutions because they bring them. Victims have an incentive to keep the costs of prosecution reasonable because they will have to bear them if they lose. Even if a victim wins, the court can refuse to reimburse him for more than it considers to have been reasonable. Finally, punitive damages save time and money by combining the compensatory and punitive purposes in a single case. Even the defendants benefit from this efficiency, because they need to defend themselves only once.

Insurance regulation is an instance where private enforcement has been demonstrably superior to the public kind. Public authorities with the power to prosecute insurance fraud and other civil wrongdoing by insurers have existed in the United States for more than a century, but it was not until courts began to award punitive damages in insurance cases that insurers who engaged in serious civil wrongdoing began to run a material risk of being punished. Punishments of insurers in private actions vastly outweigh punishments imposed by public authorities.

Amounts

There are currently no rules for determining the amount of punitive damages. Rather, the law permits the court or jury to weigh certain factors. The chief factors are the culpability of the defendant’s conduct,81 the defendant’s net worth or total profitability,82 and the amount of compensatory damages awarded. Higher compensatory damages justify higher punitive damages.83 Of course the culpability of the conduct is relevant, but culpability is not an objective standard. Moreover, the second and third factors are inappropriate. The second punishes a defendant for being legitimately wealthy or profitable. Only a small portion of a defendant’s net worth or profitability is likely to have been attributable to the wrongdoing for which he is being held liable.84 The third arbitrarily compounds the punishment, because compensatory damages also punish a defendant.

However, the second factor (the defendant’s net worth or total profitability) is so widely employed85 that a few more words about it are appropriate. The underlying assumption is that it takes a larger liability to punish a wealthier defendant. This is presumably true if the defendant is a natural person, but the overwhelming majority of defendants in punitive damages cases are corporations or other legal entities. Whether it even makes sense to think of punishing a legal entity is problematic, but in any event the only persons who are directly punished when a court awards punitive damages against a legal entity are the entity’s owners (the corporation’s shareholders, for example), the value of whose shares in the entity are reduced. The owners may or may not respond by taking some action to punish the individuals within the legal entity who were responsible for the bad conduct, but even if they do, there is no assurance that the punishment they inflict will bear any reasonable relationship to the size of the punitive damages award. Moreover, the likelihood that the shareholders of a corporation will inflict any such punishment on the responsible corporate officers is generally inversely proportional to the wealth or total profitability of the corporation. This is because the wealthier or more profitable the corporation, the more likely it is to be “publicly held,” which is to say, to have so many shareholders, so widely scattered, that even as a group they are unable to exercise any effective control over the corporation’s executive officers. Thus we would do better to leave the punishment of shareholders or executive officers of wealthy corporations to criminal law enforcement agencies and concentrate instead on deterring the bad corporate conduct.

The wealth or total profitability of any defendant, whether a legal entity or a natural person, is irrelevant to the deterrent effect of a given amount of damages liability, at least if the defendant thinks and acts rationally. A

rational person weighs the probable gains against the probable losses and chooses to engage in conduct only if the former outweigh the latter. The only difference between an honest and a dishonest person in this respect is that the former includes moral considerations in his calculations whereas the latter looks only to the monetary measures. Therefore, in order to deter even dishonest persons from engaging in bad conduct, we must make the probable losses great enough to outweigh the probable gains, and if we succeed, the deterrence will work equally well against everyone, whatever his total profitability or wealth.

If the conduct we seek to deter was part of an ongoing policy, the profits the defendant must have expected to make are those he did make or would have made from pursuing the policy. If we require the defendant to disgorge just the profits he made or would have made from the single instance, he will still find the pursuit of the policy to be profitable. The minimum amount for which a defendant should be held liable in a punitive damages action, therefore, is the amount he made or would have made from pursuing the wrongful policy. One can also justify this conclusion on the ground that people who pursue a wrongful policy deserve more punishment than those who engage in only a single instance of wrongful conduct. This is the assumption underlying the laws punishing criminal conspiracies86 and organized crimes87 more severely than individual acts of criminality. It is also the assumption underlying the common practice of giving repeat criminal offenders more severe punishments. Moreover, the award should be no more than this amount, at least as a rule. An award should provide sufficient deterrence and retribution, and once these purposes are served, any additional punishment is gratuitous.

Because virtually all the defendants in bad faith cases are business organizations, I will assume that is the case here. I will refer to the organization as “the company.” The question then is whether the wrongful conduct was part of a “company policy.” The law should consider the acts of an employee to be company policy if the employee possessed the authority to act as he or she did, if the employee acted within the scope of a policy made by his or her superiors at a policymaking level, or if these superiors were aware of the employee’s actions and tolerated them. In substance, these conditions are restatements of the law for holding a principal criminally responsible for the acts of one of his agents.88

An outsider will generally find it very difficult to prove the existence of a company policy. Companies rarely keep public records of their wrongful policies, for obvious reasons, and the employees who could testify to their existence are typically under great pressure not to do so. The law ought therefore to place the burdens of proof and persuasion on a company to prove that the wrongful conduct of its employees was not pursuant to a company policy. Generally, only the company will have access to the evi-

dence needed to prove or disprove such an allegation. The law should presume that the defendant engaged in the same kind of wrong conduct in all its transactions of the kind unless it proved to the contrary. The pressure such a presumption would put on a company would be proportionate to the amount of business of the kind it was engaged in, which is appropriate. The more business of the kind a company is engaged in, the more harm its wrongful policies inflict, and the more damages liability it takes to deter its engaging in them.

A company could rebut the presumption in a number of ways. It could show that it fired or otherwise severely punished the employees promptly after learning of their behavior. It could prove that the conduct was merely accidental—the result of a misplaced file, for example. It could show that it had in place an effective program for preventing such conduct, which for plausible reasons failed to work in this instance. A less direct but still sufficient way would be to show that the company did not profit from the kind of conduct that such a policy would have produced. No rational business has legally wrongful policies unless it expects to profit from them. For example, if the insurer in Fletcher could have shown that its ratio of claims paid to coverage outstanding was no less than that of the reputable insurers in the disability insurance industry, that ought to have been enough to prove that its claims adjuster’s denial of the plaintiff’s claim on specious grounds was not pursuant to a company policy.

If a plaintiff were to recover all the defendant’s profits from its pursuit of a policy, a subsequent plaintiff who obtained a judgment against the defendant for injuries resulting from pursuit of the same policy would logically not get any punitive damages, although he would still recover compensatory damages. Although I am not aware of this ever happening, it could, and it might be unfair. The judges in the two or more actions ought to be able to work out a fair division of the punitive damages among the several plaintiffs if such a coincidence were to occur.

Almost all the reported bad faith breach cases seem to have involved company policies. One of the exceptions is Seaman’s, in which the defendant oil company’s bad faith denial of a binding contract was apparently opportunistic. The worldwide oil shortage unexpectedly required it to reduce its deliveries substantially, and it decided to favor its old customers by refusing to deliver any oil to the plaintiff. The defendant presumably could have carried the burdens of proof and persuasion that its bad faith breach against the plaintiff was not pursuant to a company policy. On the assumption that it carried these burdens, should the court still have awarded some punitive damages? No rule should control the answer. We should regard the approach I have suggested of gauging punitive damages by the profits the defendant made from pursuing a wrongful policy as a guideline, not a rule a court should follow under all circumstances.

The Roles of Judge and Jury

Setting the right amount of punitive damages is a matter of making the punishment fit the offense. The judge performs this function in criminal cases; all the jury does is decide whether the defendant was guilty. We should do the same for punitive damages. The judge should determine the amount of punitive damages if the jury decides that the defendant should pay them. Unlike the fines or sentences judges give in criminal cases, however, the amounts of punitive damages judges award should be appealable, and appellate courts should review them as matters of law. As of 1991, three states had statutes providing that judges set the amounts of punitive damages awards.89 There is no need for a state supreme court to await legislation, however. Courts traditionally determine the allocations of functions between judge and jury themselves (subject to constitutional constraints, of course).

These changes would only conform the theory with what the practice has already been for years in some places. Judges subsequently reduced nine out of the ten punitive damages awards juries made in excess of $500,000 from 1979 to 1984 in San Francisco County, California, and Cook County, Illinois.90 Thus, all the juries in the nine cases really decided was that the defendant had committed an offense warranting a punitive damages award; the judge in the trial court or some judges on an appellate court decided the amount. The same thing must have happened in effect even in the tenth case, because the trial judge had to approve the amount the jury awarded before he could rest his judgment on it. However, judges only decide the amount of punitive damages that will be awarded if the jury tries to award too much, and in many places juries are not generally trying to award too much, at least not yet.

The Seventh Amendment to the Constitution of the United States would not prohibit this change. Whether a state constitution prohibits it would, of course, have to be determined for each state. The Seventh Amendment requires that the right to trial by jury be preserved as “at common law.” The U.S. Supreme Court has been lenient in allowing changes in jury functions under this standard. The rule is that a change does not violate this Amendment unless the change contradicts a practice that existed when the states ratified the Bill of Rights in 1789.91 There was no practice on the points at issue here in 1789, because jury verdicts did not distinguish between compensatory and punitive damages at the time.92

The 1988 California case of Tan Jay International, Ltd. v. Canadian Indemnity Co. is not typical, but it illustrates how far the punishment can exceed what appears to have been the seriousness of the offense under the current system. The sole shareholder of a California manufacturing com-

pany was a citizen and resident of Canada. He docked his yacht in a California port after returning from a race in the Indian Ocean and asked his company manager to move it into storage for him. The manager got the help of some of the company’s employees on a Saturday after they finished a softball game in a nearby public park. The employees had no experience with yachts or with moving a large object on a truck on a road. The mast of the yacht hit a power line while the employees were moving it, seriously injuring one of them. The company’s liability insurer denied coverage on the ground that the employees were not engaged in company business in moving the yacht. The jury found the denial to have been in bad faith and awarded $35 million in punitive damages in addition to $1 million in compensatory damages. The trial judge reduced the punitive damages to $4,273,257 and the compensatory damages to $500,000. The net worth of the insurer was less than $10 million.93

There was not even any evidence of bad faith in the case. The judge should have held the insurer’s denial of coverage to have been reasonable as a matter of law. Even if the denial was in bad faith, the jury award was grotesque, and the judge’s reduction of it was inadequate by far. The judge could not have justified the punitive damages he allowed on principled grounds, and if the defendant had appealed, the appellate court surely would have reduced the punitive damages again, if it did not eliminate them entirely.

The current law is unfair to both defendants and jurors. The days or weeks jurors spend listening and deliberating are wasted when the trial judge disregards their decision and substitutes his or her own. Such jurors must also be humiliated. The judge has treated them as though their opinions were worth nothing. The defendant is deprived of the benefits it might have obtained from an informed verdict or from a compromise verdict. Jurors who are not informed of the upper limits the judge will allow lack information they need in order to deliberate in a reasonable manner. For example, jurors who did not believe the defendant should be additionally punished at all might have compromised by voting for what they thought was a low amount, only to learn later that even that was more than the judge would allow. Had they known what the judge would allow, they could have demanded and presumably obtained an amount even lower as a compromise measure.

The Plaintiff’s Reward

Under the present system, the defendant’s added punishment and the plaintiff’s reward are necessarily the same, because the plaintiff is entitled to the punitive damages. We should break this connection. The amount by which

the defendant ought to be punished and the amount of reward the plaintiff ought to receive are not necessarily the same, and in fact bear no necessary relationship to one another. The reward could never be more than the added punishment, because the punitive damages are the only source from which the reward can be paid, but the reward could be less. The court should have the authority to make it less, by requiring that the defendant pay the difference to the state, just as a criminal defendant pays the state a fine.

The current system makes the rewards much too high. The excess is not just a waste of what could otherwise be public funds. It also encourages plaintiffs and their lawyers to engage in gross exaggeration or fraud, so that defendants are sometimes punished undeservedly. There are no objective measures of how often this happens but no one who has observed many of these proceedings or read the relevant depositions or reports can fail to believe that fraud and exaggeration are serious problems. These abuses of punitive damages are a tax on the honest consumer from whom the dishonest profit is ultimately taken, and they bring the system of civil justice into disrepute. Eight states by 1991 had statutes requiring that some portion of a punitive damages award in a product liability case be paid to the state,94 but I am not aware of any such statute for bad faith breach cases.

The judge would have to decide the size of the reward even if she or he did not decide the amount of the punitive damages. The decision on the size of the reward would have to take into account the difficulty, expense, and public importance of the case and the risk the plaintiff and plaintiff’s lawyer took of losing. These considerations require knowledge and experience in the law and in litigation in particular. A judge has this knowledge and experience, but jury members do not.

Necessary Procedural Controls If Juries Are to Continue to Set the Amounts

If we are going to continue to allow juries to set the amounts of punitive damages, we should at least give them the information they need to set them reasonably and to prevent the trial judge’s rendering their efforts nugatory. The law should require the trial judge to tell the jurors the maximum amount she or he will approve before they retire. At the same time the judge should make clear that this amount is only a maximum and that the jurors are free to award less or nothing at all. A three-judge panel of the U.S. Court of Appeals for the First Circuit ordered the circuit’s district judges to proceed in this manner in 1987,95 although it withdrew this part of its decision before the decision appeared in the Federal Reporter.96 The judges composing the panel must have belatedly realized that they lacked the authority to issue an order to all the district judges in the circuit.

Charges and Concerns

Justices William P. Clark and Frank K. Richardson of the California Supreme Court reflected the concerns of many people when they charged some years ago that consumers ultimately bear the burden of punitive damages because the businesses that pay the damages pass them on in the form of higher prices.97 However, the charge is correct only if the system is not working properly. In a properly working system, the businesses that pay punitive damages can no more pass them on by increasing their prices than convicted thieves can pass on the fines they pay by increasing their stealing.

A business in a competitive industry can pass on its additional costs to consumers by raising its prices only under one of two conditions. One is that consumers will willingly pay the higher prices because they consider the higher quality of the products to be worth them. A business could not pass on the costs of paying punitive damages for this reason, because paying punitive damages does not improve the quality of its products. The other condition is that all the businesses in the industry incur about the same additional costs per product. Consumers then have no choice but to pay the higher prices, because every business charges them. This condition also does not exist for punitive damages unless the system for identifying the businesses that ought to pay punitive damages is so inaccurate that innocent businesses are about as likely to have to pay them as are guilty ones. All the businesses will then be able to pass on the added costs of the punitive damages because those costs will be about the same per product for every business in the industry.

A related charge is that consumers ultimately pay at least the costs the businesses incur in avoiding having to pay punitive damages, because at least these “avoidance costs” are passed on in the form of higher prices.98 This charge possesses the same logical faults as the previous charge to the extent the avoidance costs are themselves avoidable. If the system for identifying the businesses that ought to pay punitive damages is so inaccurate that innocent businesses are about as likely as guilty businesses to have to pay them, every business will have to incur about the same avoidance costs, and these costs will indeed be passed on to consumers in the form of higher prices.

Of course the reasonable response to both charges is to maintain the accuracy of the system or improve it if it has fallen to such a low level. The reforms I have suggested should do this. However, because no system can distinguish between the guilty and the innocent with perfect accuracy,

some minimum avoidance costs will inevitably have to be incurred by every business in an affected industry. Consumers and society as a whole will still be better off than if punitive damages were abolished if these minimum avoidance costs are less than the costs of allowing the bad behavior of the guilty businesses to go unpunished.99 We have to decide which way this balance goes for the kinds of bad conduct we choose to punish with punitive damages, but there is no doubt that the balance comes out positive at least for bad faith breach. The costs of avoiding committing a bad faith breach are practically nothing if the legal system is working properly, because they are only the “costs” of behaving honestly and with a decent regard for the feelings of others. No honest and decent business would have behaved as the defendants did in Fletcher and Seaman’s, for example.

The Roles of Bad Faith Breach and Remedies Reform in the Reform of Contract Law

Both these developments grew out of a desire to punish producers for engaging in socially harmful conduct. The concept of the bad faith breach defines the conduct. Punitive damages provide the principal punishment, and fee-shifting and damages for emotional distress add more. The damages entitlements also make the punishment more certain by providing a powerful incentive for the victims of the wrongdoing to prosecute the perpetrators. Fee-shifting and damages for emotional distress also serve to compensate the victim. Even punitive damages can serve a compensatory purpose by providing victims with the satisfaction of punishing those who wronged them. But though both developments grew out of a desire to punish producers, except for damages for emotional distress, which the courts presumably will not award to business organizations, both are available to punish wrongdoers of any kind. Indeed, an important potential application of fee-shifting and punitive damages is to punish plaintiffs and lawyers who press dishonest claims.

The law of bad faith breach imposes public responsibility: the responsibility to act in good faith in the performance of one’s contracts, which means honestly and with a decent regard for the rights and sensibilities of the other parties. Bad faith breach and the new damages entitlements also serve to enforce the public responsibilities that the courts have placed upon producers through the relational torts. The classical damages entitlements are insufficient to enforce these responsibilities under most circumstances. Both developments also increase consumers’ bargaining power, in particu-