Governor Schwarzenegger Pumps Up Tort Reform:
Should California Get Seventy-Five Percent of Plaintiffs' Punitive Damages Awards?

Recently, California Governor Arnold Schwarzenegger released his May budgetary revision to the public. It included a proposal that 75% of all punitive damages awards entered in California be paid to a Public Benefit Trust Fund, with each deposit to "be used for public good purposes that are consistent with the nature of the award."

Schwarzenegger estimates that the result will be to reduce the state's deficit by $450 million. (Many have criticized this number as highly inflated, however. The latest estimate from California's independent legislative analysis places the figure at $60 million.).

Already - and unsurprisingly -- the proposal has faced scathing criticism from the plaintiffs' bar. James Sturdevant, president of the Consumer Attorneys of California, complained to the Wall Street Journal that "[i]t wouldn't incentivize the kind of cases that should be brought . . . [for example] against companies the size of R.J. Reynolds or Ford."

In addition - and much more unusually - the general concept has also faced vigorous resistance by corporate defense attorneys. For instance, Victor Schwartz, general counsel to the American Tort Reform Association, in an op-ed in USA Today, admonishes: "Some things--such as Venus' flytraps and beautifully colored snakes--may look good, but they are poisonous. The same is true of the idea of having punitive damage awards go to the state rather than to an individual plaintiff."

Any "tort reform" measure that riles plaintiffs' and defendants' counsel - and Democrats and Republicans -- alike merits a closer look.

In this column, I will argue that, despite these attacks, Governor Schwarzenegger should, at a minimum, be commended for creating the opportunity to consider an intriguing tort reform measure that has, to date, too often been ignored. Split-recovery schemes aren't perfect, but neither is our current punitive damages system.

The Purpose of Punitive Damages: Why "Split-Recovery" Schemes Make Sense

To understand the idea behind "split-recovery" schemes, it's necessary to look at the purposes of punitive damages.

In theory, compensatory and punitive damages serve different purposes in our judicial system. Compensatory damages, which include, for example, amounts of lost wages, pain and suffering, and the like, redress concrete losses suffered by the plaintiff. They are intended to "make the plaintiff whole" by restoring him or her to the position he or she enjoyed before the events that led to the lawsuit occurred.

Punitive damages, by contrast, are aimed at retribution and deterrence, and focus not on the plaintiffs' losses, but on the defendant's misconduct. In other words, they are intended to punish the defendant and to deter others from engaging in similar misconduct.

Punitive damages can also serve other purposes, including compensating individuals for intangible injuries not included within compensatory damages, or else to compensate for the big chunk an attorney will take out of the total compensatory damages award. Thus, punitive damages can serve as an inexact assurance that the plaintiff, indeed, will be fully compensated.

Punitive damages also create an incentive for private law enforcement (i.e., the private attorney's general function). Absent punitive damages, plaintiffs might have difficulty finding a lawyer willing to handle a case involving only modest stakes, for the usual 33-40% contingency fee.

Nevertheless, in many cases, a punitive damages award may be an undeserved "windfall" to the plaintiff. Suppose a plaintiff suffers $10,000 worth of injury (and therefore gets $10,000 in compensatory damages), but also reaps a $10 million punitive damages award. If the main purpose of the punitive damages award is to punish the company, and deter it from repeating its heinous conduct, critics have asked, then why are they awarded, in lottery fashion, as a windfall to the plaintiff?

Put another way, if punitive damages serve societal objectives of punishment and deterrence, why shouldn't the public interest be served by the punitive damages award? Perhaps the plaintiff (and his or her attorney) should get part of the award as a reward for bringing the public-interested suit. But why should the plaintiff get the entire multimillion dollar award, when he or she has been compensated for his or her own injury, and the rest of the damage is more widespread?

Several States' High Courts Have Endorsed - and Even Created - Split Recovery Schemes

In 2002, this very reasoning convinced the Ohio State Supreme Court to apportion $20 million (minus attorneys' fees) of a $30 million punitive damages judgment -- awarded against an insurance company for bad faith denial of reimbursements for cancer treatments -- to a cancer research fund it established. In so doing, the court emphasized that "[a]t the punitive-damages level, it is the societal element that is most important. The plaintiff remains a party, but the de facto party is our society . . . ."

The decision was controversial because no statute authorized the court's apportionment of punitive damages. But the reasoning behind it is the same reasoning that has led other courts to uphold - and Governor Schwarzenegger to propose - "split-recovery schemes."

Indiana and Oregon's highest state courts have similarly emphasized that punitive damages vindicate societal, as opposed to individual, interests.

Other States' Statutory Split-Recovery Schemes, and How They Differ

In providing further specifics for his proposal, Governor Schwarzenegger would do well to look to the pronouncements of these courts, as well as to other states' experience with split-recovery statutes.

In the mid-1980s, eight other states -- Alaska, Georgia, Illinois, Indiana, Iowa, Missouri, Oregon, and Utah -- introduced the same kind of "split recovery" scheme. Most states require a fixed percentage (ranging from 50% to 75%) of the punitive damage awards to be allocated to the state. But in Illinois, the trial court has total discretion over the extent of apportionment.

States also differ as to which cases such schemes affect. Most split-recovery states apply the scheme to all cases in which punitive damages are available and awarded, but Georgia applies it only to products liability cases, and Iowa applies it only where the jury determines that the defendant's misconduct was not directed specifically at the individual plaintiff.

The schemes also take contrasting approaches to calculating the plaintiffs' attorneys' full contingency fee. Should it be based upon the entirety of the punitive award -- which is most states' approach? Or should it, as indicated in a more detailed version of the Governor's proposal, be based upon only the plaintiff's portion of the award (the approach of Indiana and Oregon)?

Finally, the schemes differ with respect to the recipient of the monies. In Alaska, Georgia, and Utah, the state's portion is deposited into a general revenue fund, while other states have established specialized funds. For example, Missouri deposits its portion into a fund designed to compensate tort plaintiffs unable to collect judgments from insolvent defendants. Oregon distributes its portion to a Criminal Injuries Compensation Account.

Is a Broad Fund, Or a Narrowly Tailored One Preferable?

This last issue is one to which Governor Schwarzenegger should pay careful attention. He has proposed a scheme that equates the "public good" with closing the state's multi-billion dollar budget gap via a large all-purpose fund. And that's certainly an attractive option. But it's worth thinking about more specifically-tailored funds as well.

So rather than Schwarzenegger's general fund, the legislature might opt to create narrowly tailored funds intended to compensate more diffuse harms to individuals or groups caused by the same, or similar, wrongdoing on the part of the defendant.

For instance, suppose a particular defendant's bad faith insurance fraud affected not only a particular plaintiff, but a wider group of individuals, who, perhaps because of the concealed nature of the wrongdoing, do not bring their own lawsuits. Instead of the entirety of the punitive damages award being handed over to the individual plaintiff, these damages could be directed to a specific fund, such as an insurance assistance program, designed to redress the type of harm at issue in the case.

In the end, split-recovery schemes are no panacea to the ills that plague our tort law system. Constitutional and practical objections abound and warrant serious thought. But they do reflect a mismatch between the goals of punitive damages, and the beneficiaries of punitive damages awards. Addressing that mismatch is a worthy goal.