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US litigation

US Supreme Court limits punitive damages

Punitive damages, the bane of product manufacturers, have been consistently applied in US courts — despite frequent criticism — to punish manufacturers of defective or unsafe products. Recently, for the first time, the US Supreme Court took aim at punitive damages and struck down an award on the ground that it was 'grossly excessive' in light of the low level of reprehensible conduct and the minimal actual harm suffered by the plaintiff.

In BMW of North America v Gore, an individual named Gore purchased a new BMW automobile and subsequently discovered the car had been repainted. Gore brought suit against the US distributor of BMW's, alleging that its failure to disclose the repainting constituted fraud under the law of Alabama, where the car had been purchased. BMW acknowledged that it had a nationwide policy of not advising its dealers or their customers of pre-delivery damage when the cost of repair did not exceed 3% of the car's suggested retail price.

The jury returned a verdict for Gore, awarding compensatory damages of US$4,000 and punitive damages of US$4 million. BMW failed to persuade the trial court to set aside the punitive damage award as grossly excessive and in violation of the Due Process Clause of the Fourteenth Amendment. The Alabama Supreme Court also refused to set aside the award, but reduced it to US$2 million holding that the jury had calculated the award improperly by multiplying Gore's compensatory damages by the number of similar sales in all states, not just Alabama.

The Supreme Court ruled that the "grossly excessive award imposed in this case transcends the constitutional limit", but declined to draw a "bright line marking the limits of constitutionally acceptable punitive damages". Instead, the Court formulated three "guideposts" to aid in assessing the fairness of a punitive award:

  • the reprehensibility of the conduct being punished;
  • the ratio between compensatory and punitive awards; and
  • the difference between the punitive award and relevant civil or criminal sanctions.

The Court's ruling is a step forward in establishing an upper limit for punitive damages based on a rule of reason. While the decision does not limit the use of punitive damages in product liability claims, it will tend to curb some of the abuses.

Federal Arbitration Act preempts state laws

The Federal Arbitration Act (FAA) was reaffirmed as the preeminent arbitration law in the US by the Supreme Court in a recent decision. In Doctor's Associates Inc & Lombardi v Casarotto, the Court held that the FAA preempted a Montana statute which conditioned the enforceability of an arbitration agreement on compliance with special notice requirements.

Casarotto involved a dispute between two parties to a standard form franchise agreement which contained an arbitration clause set out in ordinary type at page 9 of the agreement. The franchisee sued the franchisor in Montana state court, but a Montana court stayed the lawsuit in favour of arbitration. On appeal, the Montana Supreme Court reversed, finding the arbitration clause was unenforceable because it did not satisfy a notice provision in a Montana arbitration statute. The provision requires that there be notice typed in "underlined capital letters on the first page of the contract" that a dispute is subject to arbitration.

The US Supreme Court reversed on the basis of Section 2 of the FAA, which provides that written arbitration agreements shall be "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract". The Court noted that Section 2 of the FAA contemplates that "generally applicable contract defenses, such as fraud, duress or unconscionability, may be applied to invalidate arbitration agreements without contravening" the FAA, but the Court indicated that courts may not "invalidate arbitration agreements under state laws applicable only to arbitration provisions". States may not single out arbitration provisions for special suspect status, as arbitration agreements must be placed on "the same footing as other contracts".

Applying these principles, the Court held the Montana statute was unenforceable because it "conditions the enforceability of arbitration agreements on compliance with a special notice requirement not applicable to contracts generally". The Court found that the "goals and policies" of the FAA as well as the Court's prior decisions are "antithetical to threshold limitations placed specifically and solely on arbitration provisions".

By reinforcing the preemptive nature of the FAA over state laws, the Court has furthered the goal of having a uniform national arbitration law.

Directors and officers — reliance on auditors

Directors and officers of public companies sued for fraud arising from the erroneous application of accounting principles in the company's financial statements by independent accountants can take comfort from a recent decision of a New York federal court. This decision reaffirms that reasonable reliance on the advice of an outside professional is inconsistent with an intent to defraud.

In Cohen v Koenig, Koenig Corporation acquired the assets of the plaintiffs' company. The plaintiffs agreed to extend credit to Koenig to finance the acquisition and agreed to forgo requiring personal guarantees from the officers and directors of Koenig based on the company's financial statements. Two years later, Koenig was unable to pay the debt, and the plaintiffs sued the officers and directors of Koenig for fraud under New York law based on the company's materially false financial statements.

The court concluded the company's financial statements contained material misrepresentations on which the plaintiffs had relied to their detriment. Nevertheless, the court dismissed the fraud claim because the officers and directors had relied reasonably on their accountants for guidance as to the application of accounting principles, and therefore did not have the requisite intent to defraud.

While the court observed that the officers and directors were "familiar with the company's finances", it stated that it was "quite different to keep abreast of a firm's sales and finances than to understand the esoteric accounting principles" applied to the financial statements. The court held that: "The principals of a corporation do not have the duty to personally review the work and conclusions of the professionals employed specifically for this purpose, especially where their knowledge and expertise is minimal in comparison to that of their accountants."

John J Kerr Jr and Elizabeth A Fuerstman
Simpson Thacher & Bartlett
New York

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