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Lionel Simon must have been pretty dejected in March 1998 when a California jury announced it was awarding him only $5,000 in actual damages at the conclusion of his case against Sao Paolo U.S. Holding Co. Inc. for fraudulently backing out of a real estate deal.

But when the jury tacked on $1.7 million in punitive damages, it was the defendant who was dismayed.

Like many corporate defendants before it, Sao Paolo, a subsidiary of the Italian bank Instituto Bancario San Paolo, was outraged that miniscule actual damages could attract grossly disproportionate punitive damages--in this case, in a ratio of 340:1.

Sao Paolo appealed to the California Court of Appeal, which upheld the

verdict in December 2003 despite the Supreme Court's decision earlier that year to limit disproportionate punitive awards.

In State Farm Mutual Auto Insurance Co. v. Campbell, the Court ruled that punitive damages must bear a reasonable relationship to the harm the plaintiff suffered. It decided that there existed a presumptive preference for punitive damages lower than 10 times the actual or potential harm to a plaintiff.

"The Court of Appeal paid lip service to State Farm, but misconstrued the case," says Larry Abelson, a partner at Epport, Richman & Robbins in Los Angeles and a member of the team that represented Sao Paolo.

The appeal that followed gave the Supreme Court of California its first opportunity to consider the parameters of State Farm. On June 15, the court decided to reduce Simon's damages to $50,000. Corporate defendants everywhere breathed a sigh of relief.

"Simon continues the nationwide trend of courts hacking away at punitives," Abelson says. "Court after court is taking the cue from State Farm that runaway punitive damage awards will no longer be tolerated."

Even in cases of intentional fraud, it seems.

Millions For Malice

When Sao Paolo refused to close a transaction to sell Simon an office building, Simon--who was leasing premises and intended to use the building to house his paper supply company--sued for breach of contract and promissory fraud. But while finding that Sao Paolo defrauded Simon, the jury awarded only $5,000 in compensatory damages for money Simon had paid the lawyer who represented him on the failed transaction.

The jury also found, however, that Sao Paolo never intended to consummate the deal and had therefore acted with sufficient "fraud, malice and oppression" to attract punitive damages of $1.7 million.

The Court of Appeal affirmed the award. In calculating the ratio of punitive to compensatory damages, the court reasoned, the jury was entitled to take into account not only the actual damages but also uncompensated "potential" harm.

"The U.S. Supreme Court had left open the question of the type of potential harm courts could take into account when considering the propriety of the ratio between punitives and compensatory damages," says Jedediah Wakefield, a litigation partner in the San Francisco office of Fenwick & West.

Here, Simon claimed uncompensated harm of $400,000 for profits he lost when the sale fell through. His lawyer, Andr?? 1/2 Jardini of Knapp Petersen & Clarke's Glendale, Calif. office, also argued that had his client given up his leased premises with the expectation of moving into the new building, he would have "found himself on the street" when Sao Paolo refused to close. This added to the potential harm Simon could have suffered due to Sao Paolo's fraud.

As the Court of Appeal saw it, the jury must have taken the $400,000 claim into account in awarding $1.7 million in punitives. The court reasoned that Civil Code Sec. 3343--which limits damages for attempted purchasers of real estate to the actual expenses they incur--prevented the jury from awarding the $400,000. It did not, however, prevent the jury from taking that sum into account in assessing punitives.

On this analysis, the ratio of punitives to compensated and potential harm was less than 5:1, and the award stood.

But the California Supreme Court didn't see it that way.

Supreme Speculation

The Supreme Court acknowledged that a jury could consider uncompensated or potential harm in assessing the appropriate ratio for punitive damages. But the plaintiff, the court ruled, had to demonstrate both that the defendant's wrongful conduct caused the harm and that the harm was reasonably foreseeable.

Simon's claim for loss of profits--to which he would have been entitled had the jury upheld a claim for breach of contract--did not flow from the fraud, the court reasoned.

"Fraudulent promises to negotiate exclusively and proceed to escrow may cause the attempted buyer to expend money in reliance, but they do not themselves cause the losses occasioned by the attempted buyer's failure to actually obtain the property," the court wrote.

Similarly, the court held potential losses resulting from Simon finding himself "on the street" could not be taken into account in determining the ratio because such damages were not foreseeable.

"As observed by an amicus curiae," the court stated, "'there is no basis for believing that Sao Paolo knew that Simon was at risk of having no place to operate his business, much less intended him to suffer that consequence.'"

The $5,000 award of compensatory damages was therefore the true measure of harm or potential harm. On that basis, the proper punitive award was $50,000.

Wakefield sees Simon as a significant victory for defendants.

"The decision greatly reduces the risk that a defendant threatened with punitives will be liable for unrealized or theoretical damages that the defendant could never have reasonably anticipated," he said.

Still, the plaintiffs' bar has found some comfort in the ruling.

"Many attorneys on the plaintiff's side see Simon as reasonably favorable to their clients because it upholds the discretion of trial courts to award substantial punitive damages where there is significant evidence that supports severely egregious conduct," says Peter Mason, a litigation partner who manages Fulbright & Jaworski's Los Angeles office.

Also significant was the court's ruling that juries could take potential harm into account.

"Defendants cannot sit back and say that regardless of their conduct, no substantial harm came to the plaintiff," Mason explains. "It remains open to plaintiffs to take foreseeable potential harm into account as a basis for calculating punitive damages."

Abelson does not disagree with Mason's interpretation. But he says the horse is out of the barn.

"Simon demonstrates that courts are taking very seriously the notion that single digit ratios for punitives are the rule in the normal case," he says. "The doors for higher multiples are open, but they're not open wide and they're a lot harder to dislodge than they used to be."

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Julius Melnitzer

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