The possibility of punitive damage awards has long caused anxiety among defendants. In June, the United States Supreme Court issued an opinion that could provide more certainty to franchisors and other companies faced with claims for which punitive damages are sought. Exxon Shipping Co. v. Baker, No. 07-219, 2008 U.S. LEXIS 5263 (U.S. June 25, 2008), highlights the legal complexities that arose in the more than 19 years of litigation that surrounded the Exxon Valdez oil spill in Alaska's Prince William Sound. While technically limited to maritime law cases, the Justices' discussion and holding regarding punitive damage awards may have broader implications for all varieties of business disputes.
In Exxon, the five-Justice majority held that a $2.5 billion punitive award imposed on Exxon, which was reduced by the U.S. Court of Appeals for the Ninth Circuit from $5 billion, was impermissible under maritime law. This holding closely follows a recent line of cases in which the Supreme Court has invalidated punitive damage awards and criticized their increasingly unpredictable and excessive size. For example, in BMW v. Gore, 517 U.S. 559 (1996) and State Farm Insurance v. Campbell, 538 U.S. 408 (2002), the Court struck down large awards on constitutional grounds, finding that the amount of a punitive damage award could be so grossly excessive that it would violate the Due Process Clause of the Fourteenth Amendment. Because Exxon did not involve constitutional issues, the Court was able to address broader questions about the reasonableness of punitive damages. As a result, many commentators have indicated that Exxon will stand as a guidepost for other courts that review large punitive damage awards.
Historically, early common law cases allowed punitive awards "for example's sake," "to deter from any such proceeding in the future" or to "compensate for intangible injuries" that were not within the conception of compensatory damages. More recently, courts have viewed punitive damage awards as a method of retribution or to deter harmful conduct, and as a result, they have allowed higher awards where the "wrongdoing is hard to detect." In Exxon, Justice Souter, writing for the majority, did not take issue with any of these purposes, but noted that notwithstanding the motive behind such damages, the "real problem . . . is the stark unpredictability of punitive awards."
While the ratio of the amount of punitive damage awards to the amount of compensatory awards has been relatively constant, the range of awards has varied dramatically. In addition, punitive damage awards have not been consistent, even in cases with similar fact patterns. This, Justice Souter stated, suggests an offending unfairness within the judicial system.
With these circumstances in mind, the Court attempted to decrease such unfairness by tying punitive damages to compensatory damages using a concrete ratio in cases like Exxon, where the defendant was more reckless than malicious and where the compensatory damages were quite high. After examining various state provisions and common law rules, the majority settled on a 1:1 ratio as the optimal balance and a "fair upper limit in maritime cases," while leaving open the option of a higher ratio in cases where the defendant might be acting "primarily by a desire for gain." The Court also was quick to note that the constitutional or substantive due process limit on punitive damages "may well be 1:1" in this case, but fell just short of establishing a firm upper limit. Indeed, the Court's ruling likely does not go so far as to set a firm cap on punitive damages at a concrete ratio.
It remains to be seen whether the Exxon holding will extend to non-maritime situations in which the punitive damages imposed far exceed the amount paid to compensate victims of wrongdoing. Although, on its face, the rule set forth in Exxon is technically very limited, the length and comprehensiveness of the opinion will easily lend itself to applicability in other federal cases dealing with punitive damages law. Additionally, since Congress has rarely given specific ratios for punitive damages, the Exxon opinion could become a foundation for policy in this area. Some have even suggested that states may use Justice Souter's rubric to evaluate their own punitive damages systems, especially in cases where the state legislature has not spoken to the issue. While the reach of Exxon is not yet clear, its potential impact might lead to fewer sensational punitive damage awards.
Although the holding of Exxon is not directly applicable to state law claims such as the contract and tort claims typically seen in franchise litigation, the Court's decision makes clear that it takes seriously "the implication of unfairness that an eccentrically high punitive verdict causes." The case therefore could provide greater clarity in franchise cases in which punitive damages are sought. This is especially true because the vast majority of franchise litigation involves situations in which a party has suffered economic damage, rather than emotional or other intangible damage. The earlier holdings in Gore and State Farm already have mitigated the punitive damages a franchisor might face simply because of reckless or negligent conduct. As Justice Kennedy observed in Gore, only in situations where "a particularly egregious act has resulted in only a small amount of economic damages" would a double-digit ratio between punitive and compensatory damages satisfy due process. Exxon provides another foundation for this reasoning, by giving fairness and predictability a voice in the assessment of punitive damages. By utilizing a 1:1 ratio in an extraordinary case, the Court has signaled that there are very few situations that would justify punitive damages above that ratio. Because such situations are ones in which franchisors are unlikely to find themselves, Exxon may provide a little more predictability to what before was uncharted territory.
The authors acknowledge the assistance of Wiley Rein summer associate Christopher Trendler, a rising third-year student at the University of Chicago Law School.