Wampum

In the spring of 2004, California Governor Arnold Schwarzenegger was trying to fill a hole in the state budget. He proposed to raise $450 million in state revenue by taxing punitive damages awards in civil law suits. In particular, he proposed that 75% of all such payments be placed in a special State Benefit Trust Fund.

I thought at the time that the governor might be overestimating the amount of revenue such a proposal might generate. Others agreed. For instance, the California Legislative Analyst's Office (a non-partisan group) estimated that the provision would take in about $60 million instead of $450 million.

Who was right? Via Stephanie Mencimer, we learn that California's total revenue from that provision over a two year period was exactly zero.

That is really not surprising. In 1997, Georgia enacted a revision of product liability code ( OCGA §51-12-5.1) that provided, in part, as follows:

Seventy-five percent of any amounts awarded under this subsection as punitive damages, less a proportionate part of the costs of litigation, including reasonable attorney's fees, all as determined by the trial judge, shall be paid into the treasury of the state through the Office of Treasury and Fiscal Services.

By 2004, the total revenue generated by the State of Georgia under that provision was, again, exactly zero.

Still, one might imagine that a pro-business Republican like Schwarzenegger might have been happy with the outcome even if taxing punitive damages did not provide revenue for the state. After all, if the state did not receive any money from its 75% share of punitive damages, that might mean that defendants paid no punitive damages. Many pro-business types might consider that a good thing. Why then, when California's Democratic legislature proposed extending the provision for five more years, did Schwarzenegger veto it?

Two reasons. First, the amount of revenue generated for the state does is not related to amount of punitive damages paid by the defendants for the simple reason that the state is not present during settlement negotiations. As I wrote two years ago:

When the state takes the bulk of any punitive damage award, settlement negotiations are held in the circumstance that a trial may result in the defendant paying an amount greater than the plaintiff will receive. It will not be hard to structure any settlement in such a way to minimize or eliminate the amounts paid to the state.

Under the Georgia statute, the state's right to recover is triggered by the entry of a judgment. That is not the same thing as the rendering of a verdict. After the verdict and before the entry of judgment, the parties may settle on any terms they see fit.

Take as an example a Georgia products liability case in which the jury returns a verdict for $500,000 in compensatory damages and $250,000 in punitive damages. Under a typical 1/3 contingency arrangement, if that verdict goes to judgment, the position of the interested parties will be as follows:

The defendant will pay $750,000.

The plaintiff’s lawyer will receive 1/3 of the total award or $250,000 (plus litigation expenses but I will ignore those expenses for the purpose of simplicity).

The plaintiff will receive 2/3 of the compensatory damages or about $333,000 plus 2/3 of 1/4 of the punitive damage award or about $42,000 for a total of about $375,000.

The state will receive 3/4 of 2/3 of the punitive damage award or about $126,000.

The plaintiff and the defendant may agree to a settlement on different terms. Assume they agree to split the State's $126,000. They could settle for $687,000 in compensatory damages with no punitive damages.

Under that settlement, the position of the parties would be as follows:

The defendant would pay $687,000 thereby saving itself $63,000.

The plaintiff would receive 2/3 of $687,000 or $458,000 increasing his or her take by $83,000.

The plaintiff's attorney would lose about $21,000 in fees but is obligated to do so as part of the fiduciary relationship between attorney and client.

The state, of course, would get nothing.

If California thinks that plaintiffs and defendants will pay $450 million in a punitive damage tax that they could just as easily split among themselves, it has not been in many settlement negotiations.

And, of course, that is exactly what happened in California.

The second reason that Schwarzenegger vetoed the proposed extension of the punitive damage tax is that it makes it much easier to obtain larger punitive damages verdicts (which would then be modified in post-verdict, pre-judgment negotiations in which the state would be shut out).

After all, if jurors believe that that 75% of any amount of punitive damages will be used to fund better schools, better health care, better retirement benefits, or will otherwise just reduce taxes, are they not more likely to award punitive damages and more likely to award a large number? That is one reason why at least one person made a semi-serious suggestion that instead of turning 75% of punitive damages over to the state treasury, that the money just be burned.

In other words, whether the purpose of the California law was to raise revenue and/or reduce the amounts paid in punitive damages, it failed. Hence, Schwarzenegger's veto of the proposed five year extension.

I do not believe that there are too many punitive damage awards or that such awards are too high. In my experience, juries punish only the most egregious behavior. Nonetheless, I was recently asked what reform would be most effective at reducing the number of punitive damage awards. I am pretty sure the answer is bifurcation.

In Georgia, evidence is first presented on the issues of liability and compensatory damages. Once that evidence is complete, closing arguments made, and the jury instructions provided, the jury retires to deliberate. The verdict form to be filled out by the jury asks whether liability exists and the amount of compensatory damages. If the jury finds for the plaintiff, the jury is also asked whether the case is appropriate for punitive damages.

If the jury decides the case is an appropriate one for punitives, they return to courtroom to hear testimony on the appropriate amount of such damages.

That is a system designed to prevent the award of punitive damages. Look at it from the point of view of an average juror, Unlucky Louie. Louie was unlucky enough to be chosen for the jury pool. He took off work to show up. Still, Louie was hoping that he would not have to actually serve on the jury.

Of course, the judge denied Louie's request to be dismissed on the basis of hardship. If it had been granted, he would not be Unlucky Louie. Even worse, the lawyers failed to recognize that he was hopelessly biased against both parties (or, perhaps, they recognized it all too well) and so refused to strike him from the jury. Louis was unlucky, he had to sit on the jury.

As a result, Louie sat through six days of deathly dull testimony about a dispute he really did not care about. Then, he had to sit through half a day of lawyers spinning the facts in closing argument. Even worse was the three hours during which a judge read (without any inflection) hopelessly complex, incomprehensible, apparently mutually contradictory statements of the law. Finally, Louie and 11 other unlucky souls retired to the jury room to deliberate and decide the case.

During all of that time, Louie had no choice in the matter. He was summoned to jury duty without his consent. The Judge ignored his plea of hardship. The lawyers were worried about their clients not Louie. No one asked Louie if he wanted to hear the testimony of one more expert.

After deciding that the evidence was overwhelmingly in favor or the plaintiff, the jury found liability and decided on compensatory damages. Louie, thinking that his ordeal was finally over was reaching for his coat when the foreperson noted that they had one more issue to decide.

Louie asked what issue remained and the foreperson (having listened more carefully to the jury instructions than Louie) explained Georgia's bifurcated punitive damages procedure.

"Let me see if I have this straight," said Louie. "We can check the 'yes' box and go back to the courtroom and listen to lawyers for another day or two, or we can check the 'no' box and go home. Is that right?"

For the first time since the computer selected his name for jury duty, Louie had some control over the situation. How do you think he voted?