Extraterritoriality and punitive damages: is there a workable system? The U.S. Supreme should speak more definitively on the extent to which conduct in other instances and net worth may be used against defendants.

• Author: Hull, Cordell A.

OVER THE last decade, there has been a marked shift in the manner in which American courts award punitive damages. While it remains a goal of the judicial system to maintain the two-fold purpose of punitive damages--punishment of the offending party and deterrence of others--the U.S. Supreme Court recently laid down rules in State Farm Mutual Automobile Insurance Co. v. Campbell (1) that such damages may be awarded only if the defendant's constitutional rights are protected. Defendants facing punitive damages must have procedural and substantive due process protections to ensure against the arbitrary deprivation of property.

What factors are juries to consider in assessing and later appellate courts in reviewing punitive damages awards? To what extent may conduct outside the relevant jurisdiction be considered? This conduct is commonly referred to as constituting the "extraterritoriality" considerations. The State Farm decision answered some of the questions regarding extraterritoriality, but allowed others to remain--specifically, whether and to what extent juries may consider a defendant's wealth in computing punitive damages, and the decision's applicability to products liability cases.

PUNITIVE DAMAGES JURISPRUDENCE IN THE UNITED STATES

1. In the Beginning

   In American law, the concept of punitive damages has been recognized as "a well-established principle of common law." (2) In its earlier jurisprudence, the Supreme Court left the regulation of punitive damages awards to state legislatures and the discretion of judges and jurors in state courts. But in 1986 in Aetna Life Insurance Co. v. Lavoie, (3) it intimated that it would begin to review punitive damages awards based on due process. While the Court disposed of the case on alternative grounds, it noted that Aetna's due process arguments relating to the punitive damages award "raise important issues which, in an appropriate setting, must be resolved." (4)

   One of the Court's first opportunities post-Lavoie came in 1989 in Browning-Ferris Industries of Vermont Inc. v. Kelco Disposal Inc., (5) in which the Court held that a punitive damages award is not subject to invalidation under the excessive fines clause of the Eighth Amendment, which, the Court ruled, is applicable only to criminal sanctions. Then the Court began holding that the imposition of punitive damages must conform to both procedural (Honda Motor Co. v. Oberg) (6) and substantive (BMW of North America Inc. v. Gore) (7) due process requirements. In Pacific Mutual Life Insurance Co. v. Haslip (8) and TXO Production Corp. v. Alliance Resources Corp., (9) the Court began to examine the size of punitive awards compared to the compensatory award. While it upheld the punitives in both cases, it noted some uneasiness and concerns about due process and the uneven ratios of punitive to compensatory damages.

2. BMW and Cooper Industries

   In 1996 in BMW, the Court finally articulated a due process framework within which judges could work in considering punitive damage awards and invalidated an award that was "grossly excessive" in relation to compensatory damages.

   The plaintiff in BMW sued the carmaker after learning that his new car had been repainted, a common practice by BMW. He sued in Alabama state court based on fraud, alleging that the repainting diminished the car's value by some $4,000. The jury found for the plaintiff, awarding him that amount but tacking on $2 million in punitive damages. Recognizing "elementary notions of fairness," the Court held that a person must receive fair notice not only of the conduct that will subject him to punishment but also of the severity of the penalty that a state may impose, the Court invalidated the punitive award.

   BMW was not "on notice" of the severity of the punishment, the Court stated, and it set out three "guideposts" for lower courts to consider in awarding punitive damages: (1) "the degree of the reprehensibility" of the harm; (2) "the disparity between the harm or potential harm suffered by" the plaintiff and the amount of punitive damages; and (3) "the difference between [the punitive damages] remedy and the civil penalties authorized or imposed in comparable cases."

   Further expanding the applicability of the BMW framework, the Court in 2001 articulated a de novo standard of review of certain punitive damages awards. Cooper Industries Inc. v. Leatherman Tool Group Inc. (10) mandated that an appellate court reviewing a constitutional challenge to a punitive damages award must use the de novo standard rather than the abuse of discretion standard. But not all punitive damages awards must be subjected to de novo review. If no constitutional issue is raised, the Court noted, the role of the appellate court "is merely to review the trial court's determination under an abuse of discretion standard."

   It soon became apparent that BMW and Cooper Industries provided insufficient guidance to the lower courts. With the Supreme Court's decision in State Farm, however, the law on punitive damages--particularly in the area of extraterritorial considerations--finally received some much needed clarity.

3. Problems of Extraterritoriality

   The BMW decision was the first in which the Court recognized the problems of extraterritoriality relative to punitive damages awards, holding that a state may not impose an economic sanction to change lawful conduct in another state. Generally, the relevant components of extraterritoriality are broken down in two ways: (1) attempts to alter the defendant's conduct in another state, and (2) utilizing the income generated from the tortious (for purposes of the case being tried) activity in other states.

   With regard to the first of these components, it is a well-settled proposition that a state and its courts may not regulate conduct beyond its borders, either legislatively or judicially. (11) The commerce clause of the U.S. Constitution acts as one such limitation because it "'precludes the application of a state statute to commerce that takes place wholly outside of the state's borders, whether or not the commerce has effects within the state,'" a rule articulated in Healy v. Beer Institute, (12) and other cases.

   The Court in BMW relied on the Healy analysis to pronounce that no state can "impose its own policy choice on neighboring states," adding that an automobile manufacturer's "status as an active participant in the national economy implicates the federal interest in preventing individual states from imposing undue burdens on interstate commerce." There is certainly a federalism concern when a jury in one state is allowed to prescribe unlimited punitive damages, thereby affecting a defendant's conduct in other states. This is something the federal Constitution does not permit.

   These concerns are not merely abstract, academic ponderings. In fact, a state court jury in Illinois recently leveled a $1.18 billion award, upheld by an Illinois intermediate appellate court, against State Farm in Avery v. State Farm Mutual Automobile Insurance Co. (13) The interesting aspect of this award is that it was based on State Farm's use of non-original equipment manufacturer (OEM) parts, a practice prohibited in Illinois as a deceptive trade practice but permissible in...