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The Wall Street Journal.

More Punitives to the People!
June 2, 2004

By Walter Olson

Gov. Arnold Schwarzenegger's proposal for the state of California to raise revenue by capturing 75% of punitive damage awards is showing crossover appeal in some surprising quarters. Several liberal commentators and editorial pages have voiced cautious approval; the chair of the Democratic assembly's budget committee called the plan "interesting" and "something we should be open to"; and even a few maverick plaintiff's attorneys have broken ranks with their colleagues by expressing less than full dismay. They're right to be interested -- but we should also bear in mind the law of unintended consequences.

The logic of the scheme is clear. Plaintiffs in civil lawsuits already get damages to compensate them for their actual harms, including pain, suffering, emotional distress and the like, and nothing would change that. But punitive damages, akin to the penalties of criminal law, are imposed for the benefit of those not present in the courtroom (including society as a whole) and to deter future misconduct. At present, however, they land in the lap of a single complainant as a windfall. Asks Schwarzenegger legislative secretary Richard Costigan: "How does it benefit everybody when one plaintiff gets $100 million?" Under the plan, therefore, 75% of punitives would go into a special Public Benefit Trust Fund to be used to pay for state programs and purposes "consistent with the award."

So far so good. But while punitive damages may make headlines in a relatively few cases that proceed to final verdict, they actually exert most of their influence by casting a shadow on the much larger number of civil cases that settle before that point. The shadow of a punitive demand enhances the case's settlement value, yet the new scheme does not propose to capture any of that enhanced value. The result is to give lawyers a powerful new incentive to settle punitive claims short of verdict, and to characterize the money that changes hands in such settlements (should anyone ask) as consisting entirely of compensatory damages.

In fact (barring some attempt at loophole-closing) lawyers are quite likely to get away with maneuvers of this sort even after a court returns a large punitive verdict. Suppose a case wins $5 million compensatory and $5 million punitive damages at trial, and the parties estimate there's a 50% chance that an appeals court will uphold liability. The parties can then settle at (say) $4 million in lieu of appeal, assuring the judge that every penny of that sum is meant as compensatory damages. Resulting contribution to Sacramento's fiscal needs: $0.00.

Which is one of several reasons to think state budgeters are being a little, um, optimistic in expecting the measure to haul in $450 million a year. Given parties' propensity to cash out cases short of final judgment, it's not surprising that early reports from the eight states which already have "split-award" laws on punitive damages -- Alaska, Georgia, Illinois, Indiana, Iowa, Missouri, Oregon and Utah -- have failed to show the laws making a big difference in court outcomes. In fact, attorney-Web blogger Dwight Meredith reports that a Georgia official cannot recall any money at all being paid to the state under the provision.

Interestingly, the issue badly splits the tort-reform camp. John Sullivan, who heads the Civil Justice Association of California, is among enthusiasts, calling the governor's proposal "a win-win across the board except for the trial lawyers." By contrast, many lawyers who defend business in court harbor misgivings. For starters, they fear that juries will begin being more generous with defendants' money once word gets out that punitive awards are going to a "good cause." Perhaps more problematic over the long run, they fear that award-sharing will gradually work to make the state a player rather than a neutral arbiter in civil litigation, giving it reason to intervene in suits to protect its financial stake (the Arnold plan includes a rule barring this, but rules can change), or even providing lawmakers with a rationale to tilt liability law against defendants in hopes that the money will roll in.

Maybe. On the other hand, it's hard to take seriously the argument we hear from some lawyers that nothing short of a plenary windfall will give the plaintiff's bar and its clients adequate incentive to bring these actions. As it happens, most lawyers pressing an existing lawsuit for compensatory damages don't need much encouragement to throw in a claim for punitive damages on top of it. The reason is that the punitive claim, even when it fails in itself, gives them an opportunity to direct the jury's attention to their opponent's allegedly wicked course of conduct and, if the opponent is a company, its large balance sheet. Both of those lines of argument are commonly helpful in improving their luck on the issues (not necessarily legally related) of whether an ordinary compensatory award is owing and, if so, how big. One major federal statute, the False Claims Act, does currently (wisely or not) employ a bounty-hunting system to encourage complaints. Under that law, the relevant bounties top out at 25%-30%, very comparable to the Schwarzenegger numbers.

Lawyers who sue for a living talk a great deal about how the general public has a stake in the success of their endeavors. Here's their chance to show they mean it.

Mr. Olson is senior fellow at the Manhattan Institute. He is the author of "The Rule of Lawyers," (St. Martin's, 2003).

©2004 The Wall Street Journal

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