Monday, August 31, 2015

A $32.5 Million Discovery Mistake

Soto v. Borgwarner Morse Tec Inc., No. B252995 (D2d4, as modified August 20, 2015)

Although some law-and-economics attuned federal judges have doubted the rationale behind the rule,* in California, the defendant’s economic condition and ability to pay are matters a jury must assess in awarding punitive damages. Indeed, the California Supreme Court considers them so important that if the trial record doesn’t contain meaningful evidence of the defendant’s economic condition, punitive damages can’t be awarded. See Adams v. Murakami, 54 Cal. 3d 105, 112 (1991).

The problem with this, of course, is that defendants hate turning over evidence regarding their economic condition that is otherwise irrelevant to the merits of plaintiff’s claims. Why make it easy to argue the deep pocket? And indeed, Civil Code § 3295(c) bars a plaintiff from taking pretrial discovery on the defendant’s economic condition. The code affords two avenues around that limit.

First, at any time the court can order the discovery court upon a plaintiff’s showing that there is a substantial probability that plaintiff will satisfy the standard for an award of punitive damages.  Second, § 3295(c) permits a plaintiff to subpoena the appearance of witnesses and production documents on the issue for trial and permits the court to require a defendant to identify relevant documents and the employees most competent to testify on the issue. Generally, this procedure is governed by the “notice to appear and/or produce” procedure in Code of Civil Procedure § 1987. An additional non-statutory procedure has also developed where the parties stipulate that financial condition documents will be brought to the court under seal and turned over in the event the jury finds the punitive damages standard has been authorized. 

It can get very messy. Defendants have every reason to delay or avoid this discovery for as long as possible, knowing that if the plaintiff isn’t diligent, it might not meet the Adams standard. Although they can’t be too dilatory, because some courts have found Adams waived when the defendant failed to comply with it discovery obligations. Plaintiffs, on the other hand, want the information early, but not too early where they will have to make a strong showing in advance. Plaintiffs further face the problem that, although California law requires bifurcation of the punitive stage, the same jury generally decides the amount a punitive award. Because courts understandably don’t want to leave the jury sitting around and waiting,
there is often little time between the liability verdict and the opening of the punitive phase. Just like a defendants’ non-compliance, plaintiff’s lack of diligence can lead to a forfeiture on the issue. 

Plaintiffs in this asbestos case—the estate and survivors of an auto parts worker who died of mesothelioma—tried to end-around § 3295(c) altogether by not taking any discovery on financial condition. Instead, they tried to establish defendant’s economic condition through an expert’s testimony, which in turn relied on publicly available financial information. The difficulty they faced, however, was that while Defendant’s parent company was a publicly traded company with reported audited financial statements, defendant itself was a sub that didn’t currently report on a non-consolidated basis with its parent. After Defendant objected that the testimony addressed the wrong entity, the Court asked Plaintiffs if they had sought any discovery from respond. Plaintiffs responded by explaining that they didn’t need to because the parent was the appropriate entity for the purposes of punitive damages. 

That night, Plaintiffs saw the writing on the wall.** When testimony opened the following morning, their expert suddenly testified that he was prepared to give specific testimony about the economic condition of the sub/defendant based on some old reported financials from 2002. He then did some mumbo jumbo to combine those figures with current numbers for the parent, and reached the ultimate conclusion that Defendant had 2012 revenues over $1.3 billion. On cross, the expert admitted that his calculations were only to an estimation of revenue; they did not address Defendant’s profit and loss, its cashflow, or the state of its balance sheet.

Plaintiffs also served a notice to appear and produce on the sub/Defendant the day before the punitive phase began. When Plaintiff attempted to call the subpoenaed witness, Defendant objected on the ground that the notice was extremely untimely, particularly given that the entity and persons it was served on the night before trial were in Michigan. The court trial commented that “the approach to the punitive damage thing should have been a lot different,” and rejected the notices as untimely.

The trial court did, however, let the issue go to the jury on the basis of the expert’s testimony. The jury awarded $32.5 million to the decedent’s estate. Defendant appealed.

After reviewing the general principles discussed above, the court of appeal holds that Plaintiff’s expert’s testimony didn’t cut it. The applicable standard isn’t rigorous—no one particular type of financial information is required. But reliance on only one method can be problematic. For instance, net worth is the most commonly used metric. But because net worth is susceptible to manipulation, net worth alone can’t be the sole standard for measuring ability to pay. The examination must be meaningful. Income must be offset by expenses and assets by liabilities. 

At the end of the day, the expert’s opinion that Defendant had $1.3 billion in revenues just said too little about Defendant’s economic heath to satisfy the standard. Revenue is only half of the profit equation, because it says nothing about cost. And revenue says nothing at all about the statue of Defendant’s balance sheet.*** The court thus holds that the trial court erred in letting a punitive calculation go to the jury.****

As to the discovery denied on the day of trial, the trial court could not be faulted for refusing to let Plaintiff get away with subpoenaing the economic evidence the day before the start of trial. Under the circumstances, it is within the discretion of the trial court to deny the belated discovery, particularly given the Plaintiffs’ lack of diligence and the lack of any record evidence that Defendant hampered Plaintiffs from seeking the discovery in a timely fashion.

Reversed on this issue.

* See BMW of N. Am., Inc. v. Gore, 517 U.S. 559, 591 (1996) (Breyer, J., concurring) (noting the “distant relation between a defendant’s wealth and its responses to economic incentives”); Kemezy v. Peters, 79 F.3d 33, 34–37 (7th Cir. 1996) (noting that the justification for these models is grounded in the marginal utility of money, a principle that “does not apply to institutions as distinct from natural persons”); Zazu Designs v. L’Oreal, S.A., 979 F.2d 499, 508 (7th Cir. 1992).

**The opinion does not actually address the proper entity to look at for financial condition when the defendant is part of a greater corporate conglomerate. Presumably, the corporate form is generally respected unless equity demands a different result, akin to an alter ego situation. 

***Some accounting for plaintiff lawyers: There are three key accounting reports: (1) the balance sheet, which shows current assets and liabilities; (2) the income statement—also called a profit and loss statement—which shows performance over a certain period of time; and (3) a statement of cash flows, which shows the movement of money in and out of the company. If you can get these three documents for the defendant’s prior fiscal year and most recently closed quarter, along with a witness to authenticate them, you should be good as gold.

****The court doesn’t really address the standard of review. Since this isn’t a constitutional aspect of punitive damages, presumably the standard is substantial evidence, the most deferential standard to the trial court. Even left unstated, that makes this case particularly useful precedent for defendants because the holding effectively requires financial evidence of a certain quality before the case can even make it to a jury.

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