Don’t balance the budget on the backs of victims

By Jamie Court

Jamie Court

Gov. Arnold Schwarzenegger recently grabbed headlines with a proposal to give 75 percent of punitive damage awards to the state in order to help balance the budget. In principle, there’s nothing wrong with a small portion of punitive damages awards reverting back to the state. In fact, that’s something consumer advocates like myself have called for in the past.

The big problems with this proposal are timing and a sense of proportion.

First, there simply are not super-sized punitive damages any more after a recent ruling by the U.S. Supreme Court in State Farm v. Campbell. In April of 2003, the Supreme Court strictly capped every punitive damage verdict in the nation so that juries are no longer free to punish corporations for malice and oppression, the standard for punitive damages. Punitive damages can now, as a rule of thumb, be no more than nine times the amount of other compensatory losses. That means if a consumer recovers $1 million in damages for actual losses, punitive damages should not be more than $9 million.

Taking 75 percent of that now-limited amount away from injured consumers would be punitive. Even more punitive is, as the governor also proposes, stopping makers of exploding gas tanks and other dangerous products from having to pay punitive damages in every case. Schwarzenegger wants to have wrongdoers pay for their malice only in the first product liability case.

The real game seems to be to make it even less likely that big business ever faces punitive damages, which is why the proposal also takes away contingency fees paid on the 75 percent of punitive damages that go to the state. That would make attorneys a lot less likely to bring cases involving punitive damages on a contingency fee basis.

An alternative version of the Schwarzenegger proposal circulating in the Assembly is even harsher than the one submitted with the May budget revise. It limits punitive damages to one instance in all types of causes of action, not just product liability cases.

The alternate proposal also makes the State Farm v. Campbell decision more onerous by directing courts to consider similar cases in other states against companies when considering punitive damages.

Businesses held accountable in California courts for punitive damages in the last three years include biotech giant Genentech, which was slammed by a jury with $200 million in punitive damages in June 2002 for failing to pay for royalties for technology invented by two scientists that the company used. The jury found Genentech breached its contract with City of Hope hospital by concealing licensed sales of protein products (i.e., hepatitis vaccines) over a 15-year period.

Bank of America was slapped with a $3 million punitive damages award after a 28-year employee was fired when she criticized certain appraisal practices as a violation of banking regulations. A court ordered America Online to pay $3.5 million in punitive damages for defaming and firing the vice president of Netscape by alleging he knowingly allowed an assistant to falsify time cards.

In practice, however, punitive damage awards like these typically are not paid. The reason is that defendants’ insurance policies in California do not cover punitive damage payouts. As a result, a settlement is usually reached after the verdict and the payout is not categorized as punitive damages so the defendants’ insurance kicks in.

Plaintiffs have a dual incentive to settle. First, they will not have to face costly appeals. Second, punitive damages are taxable to the recipient, whereas a lump-sum settlement does not clearly carry tax liability.

The irony of current tax policy is that while the innocent victims who receive punitive damages must pay taxes on them, the payors — those who commit malice and oppression — can write off the payments as a tax deduction.

If the governor wants to truly generate money for the state by fixing a legal inequity, he should reform tax policies that relate both to punitive damages and other now-deductible damages resulting from cases beyond ordinary negligence.

Attempts have been made on Capitol Hill in recent years to end the deductibility of punitive damage payouts, but have failed under lobbying pressure from big industries. What better challenge for a governor who says he wants to fix problems that government has been unable to address.

The need is real. The Congressional debate over tax treatment of punitive damages produced a dramatic snapshot of the problem. Exxon’s $1.1 billion settlement with the U.S. government over the Exxon Valdez oil spill litigation cost Exxon a maximum of $524 million after the oil company’s tax deductions. The Congressional Research Office found that more than half of the civil damages totaling $900 million could be written off on Exxon’s federal tax return.

In California, where punitive damages are far less frequently paid, the trick for the governor will be to throw a bigger tax net around payments by big companies for wrongful conduct that should not win them a tax deduction. Let’s start with the notion that any corporation or individual that is held accountable by a court for fraud, intentional wrongdoing, bad faith, extreme and outrageous conduct, and civil rights violations should pay taxes on any settlement or payout resulting from the case.

If Schwarzenegger is the man of the people he says he is, he will balance his budget on the backs of wrongdoers, not innocent victims of malice.

• Consumer activist Jamie Court, author of Corporateering: How Corporate Power Steals Your Personal Freedom And What You Can Do About It (Tarcher/Putnam), is president of the Santa Monica-based Foundation For Taxpayer and Consumer Rights, www.consumerwatchdog.org.