Law Offices of Clinton D. Hubbard

 

California Supreme Court Expands Access To Punitive Damages In A Breach Of Contract Case Between Businesses

 

Lesson: Do not submit false certificates of specification compliance to your buyer (even if you think your product is just as good) or you may get hit with punitive damages. In fact, do not even suggest that you are giving the buyer the exactly specified product if you are not in fact doing so.

 

In a stunning ruling on December 23, 2004, the California Supreme Court gave businesses a new incentive to be honest by holding that they could incur punitive damages for fraudulently breaching contracts. Normally there are only economic damages recoverable for breach. The 6-1 decision affirms in principle a Los Angeles jury award of $6,000,000 in punitive damages on top of $1,500,000 in economic damages. This was not a “consumer” case but an action between two sophisticated businesses.

 

Plaintiff Robinson Helicopter Co. manufactured helicopters that used sprag clutches manufactured by defendant Dana Corp. Part way through the contract the clutch supplier changed certain aspects of the assembly but did not disclose this change to Robinson Helicopter, and in fact continued to provide a routine certificate saying that each delivery exactly conformed to the original contract (and federal) specification. This change later produced a much higher defect rate and after a delay Dana finally came clean, told Robinson what it had done, and identified the non-conforming units. However, there was no evidence that Dana tried to or did save money by this change or that it knew the change would adversely affect quality. It cost Robinson $1.5 million to replace the already-installed non-conforming parts.

 

Plaintiff's misrepresentation and fraud claims were based on defendant's provision of false certificates of conformance. The jury found that defendant had made false misrepresentations of fact and had knowingly misrepresented or concealed material facts with the intent to defraud. The Supreme Court held that the traditional “economic loss rule” did not bar plaintiff's fraud and intentional misrepresentation claims because they were independent of defendant's breach of contract. The court stated that but for defendant's affirmative misrepresentations by supplying the false certificates of conformance, plaintiff would not have accepted delivery and used the nonconforming clutches over the course of several years, nor would it have incurred the cost of investigating the cause of the faulty clutches. Accordingly, defendant's tortious conduct was separate from the breach itself, which involved defendant's provision of the nonconforming clutches.

 

The single dissenting Justice complained that this decision greatly enhances the ease with which every breach of contract claim can include a tort/punitive damages claim as well. There is a general rule that that punitive damages in a primarily contract case between businesses weren't permissible under the state's “economic loss rule”, which prohibits tort damages in contractual disputes unless some person or property is physically injured/damaged. Here, none of the helicopters with faulty parts crashed.

 

However, the 6-1 majority held that the economic loss rule doesn't bar fraud claims if they are independent of the underlying breach. "Allowing Robinson's claim for Dana's affirmative misrepresentation discourages such practices in the future while encouraging a business climate free of fraud and deceptive practices," Justice Brown wrote.

The Court attempts to limit the scope of this ruling: “Nor do we believe that our decision will open the floodgates to future litigation. Our holding today is narrow in scope and limited to a defendant's affirmative misrepresentations on which a plaintiff relies and which expose a plaintiff to liability for personal damages independent of the plaintiff's economic loss.”

 

As a practical matter most litigators will probably choose to add a fraud/tort cause of action (with punitive damages) to the basic ‘breach of contract’ case, where the supplier may have misrepresented the quality of the product or service actually delivered, or made some other false representation at the outset of the contract, which could potentially have caused property damage or personal injury to a re-sale customer or the end user.

 

When punitive damages are available in a contract case –

To review the main instances under California law where tort damages are permitted in contract cases: 1- where a breach of duty directly causes physical injury; 2- for breach of the covenant of good faith and fair dealing in insurance contracts ; 3- for wrongful employment discharge in violation of fundamental public policy; 4- or where the contract was fraudulently induced. In each of these cases, the duty that gives rise to tort liability is either completely independent of the contract or arises from conduct which is both intentional and intended to harm.

Robinson Helicopter Co. expands these opportunities for punitive damages: Generally, when one party commits a fraud during the contract formation or performance, the injured party may recover in contract and tort. Specifically, a tortious breach of contract may be found when either (a) the breach is accompanied by a traditional common law tort, such as fraud or conversion; or (b) the means used to breach the contract are tortious, involving deceit or undue coercion; or (c) one party intentionally breaches the contract intending or knowing that such a breach will cause severe, unmitigable harm in the form of mental anguish, personal hardship, or substantial consequential damages.

 

In summary, if you deceive the buyer into thinking you are giving it exactly what the specification requires you may be liable for fraud damages. It is not yet clear whether you avoid exposure to fraud liability if the breach has no potential to make the buyer liable for personal/property damages to its customer or other users.   In either case you would still be liable for ordinary breach of contract economic damages.