On August 16, 2004, California Governor Arnold Schwarzenegger signed into law SB 1102, an appropriations bill implementing changes to various California statutes. One of the statutes affected by the appropriations bill is California’s punitive damages statute, found in California Civil Code section 3294. SB 1102 mandates that 75% of any punitive damages award will be allocated to a Public Benefit Trust Fund controlled by the state. California joins eight other states that have already enacted split-recovery laws.[1]
New Civil Code section 3294.5 provides that any defendant against whom a punitive damages judgment is entered is required to pay 75% of those damages to the state’s Public Benefit Trust Fund (the "Fund"), from which the state can withdraw for purposes "consist[ent] with the nature of the award." The remaining 25% of the punitive damages award is payable to the plaintiff through his or her attorney. The plaintiff’s 25% share is subject to the fee agreement between the lawyer and the plaintiff-client (e.g., a one-third contingency fee based on the client’s recovery). The plaintiff’s lawyer is also entitled to 25% of the proceeds paid into the Fund.
The legislature incorporated several protections to ensure that the law is applied fairly. First, to avoid biased judges, the Fund may not be used for court funding. Second, the jury is not informed that 75% of the punitive damages award will go to the state and the plaintiff’s lawyer. Third, the state is prohibited from participating in litigation when its sole interest is the potential recovery of a share of the plaintiff’s punitive damages award. The law was enacted to address "extraordinary and dire budgetary needs." The statute applies to any case filed after August 16, 2004 and will extend to any final judgment, including post-trial motions and appeals, entered before July 1, 2006. The legislature can decide to extend the law beyond the sunset date.
The law is viewed as a way to reduce the economic incentive for plaintiffs’ lawyers to obtain a punitive damages award while providing the state with additional revenue during California’s budget crisis. However, unless the law is extended beyond the sunset date, it is unlikely to have an appreciable impact on California’s budget deficit, or to discourage plaintiffs’ lawyers from bringing cases alleging punitive damages.
The following issues are likely to arise as the first punitive damage judgments are obtained under the new law:
- Does section 3294.5 apply to federal court cases in California? In federal cases where the courts subject-matter jurisdiction is based upon diversity of citizenship and state law claims are at issue, the court must determine whether section 3294.5 is substantive or procedural under the test developed by Erie and its progeny. The federal courts are only bound to apply substantive state law. If federal courts decline to apply section 3294.5 (by finding that it is merely a procedural law), plaintiffs’ lawyers may be inclined to file punitive damages cases in the federal courts to avoid the loss of a portion of their clients’ verdict to the state.
- Will the law potentially increase punitive damages exposure? As potential jurors become more aware that a large portion of punitive damages goes to the state instead of the individual plaintiff, jurors may be inclined to award higher damages that may provide a social benefit – essentially writing themselves as taxpayers a check on the defendant’s account.
- Will lawyers seek to avoid section 3294.5 with post-verdict settlements? Recognizing that a large portion of the recovery will go to the state, plaintiffs’ lawyers may attempt to maximize the benefit to their clients by affecting a post-verdict settlement prior to the entry of a final judgment. Post-verdict settlements might be able to re-characterize the damages paid in settlement as compensatory rather than punitive damages. However, after a verdict is entered for punitive damages, the State of California becomes a real party in interest and, therefore, may have an interest in participating in further settlement discussions. • Will the statute create a conflict of interest between the plaintiff’s counsel and the plaintiff because of the split of the punitive damages award between the client, the state, and the attorney? Plaintiff’s counsel probably will be required to obtain informed written consent from the client regarding divergent interests of the attorney and client in the proceeds of the punitive damages award. In sum, the new law is unlikely to have a significant short-term effect on the litigation of punitive damages claims in the California courts because of its relatively short window of applicability. However, if the changes to the California punitive damages statute presage a greater openness to future tort reform or are extended beyond the July 1, 2006 sunset date, new section 3294.5 may have broader implications. The new punitive damages statute may be a small first step in a broader tort reform effort under California’s Republican governor. While the change in the statute is unlikely to deter the filing of punitive damages cases—because of the enhanced leverage punitive damages claims provide plaintiffs in obtaining higher settlement values in cases, and the somewhat broader scope to relevant evidence of a defendant’s conduct at trial—the financial incentive to plaintiffs to pursue those claims through trial will be decreased.
Footnotes:
1: Alaska, Georgia, Illinois, Indiana, Iowa, Missouri, Oregon, and Utah have similar split-recovery laws.