United States: Bankruptcy Court Imposes Massively Disproportionate $45 Million Punitive Exaction, Then Plays Santa Claus With $40 Million Of It

Last Updated: April 20 2017
Article by Evan M. Tager

Concluding in In re Sundquist that the defendant bank had violated the automatic stay by foreclosing on the home of a bankrupt mortgagor and enraged by what it perceived to be heavy-handed behavior both before and after the stay violation, the court awarded the plaintiffs $1,074,581.50 in compensatory damages and ordered the defendant to pay a whopping $45 million in punitive damages—i.e., nearly 42 times the quite substantial compensatory award.

But concerned that such a massive amount of punitive damages would be a windfall to the plaintiffs, the judge ordered the plaintiffs to pay $40 million, minus applicable taxes, to two non-profit organizations whose stated mission is to advance the interests of consumers in litigation and bankruptcy proceedings—the National Consumer Law Center and the National Consumer Bankruptcy Rights Center—and the five California state law schools. Specifically, the judge decided to bestow $10 million each (before taxes) on the two consumer law centers and $4 million each (before taxes) on the five law schools.

I'm sure that the defendant will have lots of grounds on which to appeal, but I focus here on the amount of punitive damages and the judge's unprecedented decision to allocate the lion's share of the exaction to groups of his own choosing.

The Amount Of Punitive Damages

Even accepting the judge's characterization of the conduct as entailing "a high degree of reprehensibility," a punitive award of $45 million that is nearly 42 times the compensatory damages is unsustainable under the Supreme Court's precedents.

To begin with, the judge failed to appreciate that the most directly relevant precedent is Exxon Shipping Co. v. Baker. Readers will recall that Exxon Shipping was a federal maritime case arising out of the grounding of the Exxon Valdez and ensuing oil spill. A jury imposed a $5 billion punitive award—on top of compensatory damages of approximately $500 million—and the Ninth Circuit cut the punitive award in half.

The Supreme Court held that, as a matter of federal common law, punitive damages in maritime cases generally should not exceed the amount of compensatory damages. In the course of so holding, the Court explained:

Today's enquiry differs from due process review because the case arises under federal maritime jurisdiction, and we are reviewing a jury award for conformity with maritime law, rather than the outer limit allowed by due process; we are examining the verdict in the exercise of federal maritime common law authority, which precedes and should obviate any application of the constitutional standard.

Anticipating arguments that it had no business capping the ratio of punitive to compensatory damages in maritime cases, the Court rejoined:

[W]e are acting here in the position of a common law court of last review, faced with a perceived defect in a common law remedy. Traditionally, courts have accepted primary responsibility for reviewing punitive damages and thus for their evolution, and if, in the absence of legislation, judicially derived standards leave the door open to outlier punitive-damages awards, it is hard to see how the judiciary can wash its hands of a problem it created, simply by calling quantified standards legislative.

The Court continued that "we may not slough off our responsibilities for common law remedies because Congress has not made a first move, and the absence of federal legislation constraining punitive damages does not imply a congressional decision that there should be no quantified rule."

Turning to the ratio itself, the Court explained that studies of punitive damages indicate that the median ratio of punitive to compensatory damages is 0.65:1, and it reasoned that "given the need to protect against the possibility (and the disruptive cost to the legal system) of awards that are unpredictable and unnecessary, either for deterrence or for measured retribution, we consider that a 1:1 ratio, which is above the median award, is a fair upper limit in . . . maritime cases."

It concluded that "our explanation of the constitutional upper limit confirms that the 1:1 ratio is not too low. In State Farm, we said that a single-digit maximum is appropriate in all but the most exceptional of cases, and '[w]hen compensatory damages are substantial, then a lesser ratio, perhaps only equal to compensatory damages, can reach the outermost limit of the due process guarantee.'"

Just as the Supreme Court noted the lack of congressional guidance in the maritime context, the bankruptcy court in Sundquist observed that "Congress has given no specific guidance about punitive damage boundaries under the [bankruptcy] statute other than that they be awarded 'in appropriate circumstances.'" And like the federal courts in Exxon Shipping, the bankruptcy court was, in imposing punitive damages without legislative constraints or guidelines, exercising common law power—a power on which the Supreme Court had imposed specific limits arguably applicable to all federal common-law cases.

But rather than turning to Exxon Shipping for guidance and honoring the 1:1 presumptive maximum ratio announced in that case, the bankruptcy court instead jumped directly to the Supreme Court's due process cases. Though purporting to apply the three guideposts articulated in BMW and refined in State Farm, the court held that a $45 million exaction was warranted for a reason expressly criticized in State Farm as having nothing to do with any of those guideposts: the bank's substantial wealth.

The court reasoned that the punitive damages have to be "sufficient to have a deterrent effect on [the bank] and not be laughed off in the boardroom as petty cash or 'chump change.'" Noting that the bank had settled litigation brought by the federal and state governments arising out of the financial crisis for billions of dollars, the court insisted that "a few million dollars awarded as . . . punitive damages . . . in a real estate case involving real people, in which the human element of the consequences of [the bank's] behavior comes to the fore for the first time is appropriate and proportional."

The court's failure to even acknowledge a controlling Supreme Court case is bad enough. But its application of the Supreme Court's remaining cases is downright indefensible.

Since the Supreme Court decided State Farm 14 years ago, no court has allowed a punitive/compensatory ratio of anything close to 42:1 when the compensatory damages have exceeded $1 million. And many courts confronted with compensatory awards of that magnitude have heeded the Supreme Court's guidance that a 1:1 ratio can reach the constitutional maximum.

In short, the $45 million punitive award is highly unlikely to stand. The only real question is how much of a haircut it receives.

Redirection Of The Lion's Share Of The Punitive Award

Concerned that a $45 million punishment would give plaintiffs too large a windfall, the bankruptcy judge took it upon himself to order the plaintiffs to distribute $40 million of the $45 million punitive damages (less the amount of taxes owed on the $40 million) to two consumer-rights organizations and the five California state law schools.

Casual observers might think that this is a Solomonic solution to the conundrum that punitive damages supposedly serve public interests yet are awarded to private individuals. But this solution is in fact worse than the problem it is designed to solve.

For one thing, it is lawless. When Congress authorized an award of punitive damages in appropriate circumstances, it did so against the backdrop of common law punitive damages, which have always gone to the plaintiff. The statute does not give bankruptcy judges authority to direct plaintiffs to give some or all of their punitive damages to third parties, and there is no basis for inferring that Congress meant them to have such power.

Indeed, there are good reasons why it would not have wanted bankruptcy judges to be able to redistribute creditors' wealth in this way. If bankruptcy judges have unfettered discretion to redistribute creditors' wealth to non-parties via an award of punitive damages, there is a significant risk that they will be inclined to impose higher punitive awards.

And that risk is all the more substantial if the judges get to pick the donees. When judges are allowed to fund their favored non-profits with someone else's money, it is human nature that they will be apt to be more "generous" than they might otherwise be.

It is no answer to say, as this court did, that the donees must be "rationally linked to redressing the underlying conduct that warrants punitive damages in the first place." As this case demonstrates, that isn't much of a limitation at all.

The court deemed it justifiable to redirect tens of millions of dollars to consumer groups that are closely aligned with the plaintiffs' bar and to all five California state law schools. Even though the court instructed that the law schools must devote their windfall to educating students in "consumer law," the amount of the gift is enormous—$4 million per school before taxes—and will free up the same amount for purposes unrelated to consumer law. That will surely make this judge one of the largest benefactors of each school.

Likewise, the judge's "gift" of $10 million to each consumer organization (before taxes) will surely make him their largest benefactor. Even if he had ordered a transfer of a tenth of that amount, it could give rise to an appearance of impropriety in future cases in which those organizations are involved, necessitating his recusal. Indeed, even in cases in which those organizations are not involved, the very act of conveying money to them could undermine the judge's appearance of neutrality in any case pitting a consumer against a creditor and will likely result in a tidal wave of recusal motions.

In short, though the court's unease about bestowing a large windfall on the plaintiffs is understandable, transferring it to donees of the judge's own choosing is not an acceptable solution. Indeed, the court's decision in this case raises many of the questions that Chief Justice Roberts has identified in connection with the use of cy pres in class actions. Those questions can and should be asked in any appeal from the judgment in this case.

Originally published April 18, 2017

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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