Blurring the Distinction Between Contract and Tort: the Resurrection ...

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Blurring the Distinction Between Contract and Tort: the Resurrection ...

SUPREME COURT WATCH

Blurring the Distinction Between Contract and Tort: the Resurrection of Seaman's

Christina J. Imre

Sedgwick, Detert, Moran & Arnold

Introduction

As this column goes to press, the California Supreme Court has just decided to hear a matter with

watershed implications for contract disputes and the imposition of punitive damages. See City of

Hope Nat'l Med. Ctr. v Genentech, Inc. (review granted Feb. 2, 2005, S129463; superseded

opinion at 123 CA4th 306, 20 CR3d 324).

In City of Hope (COH), the court of appeal's published opinion not only affirmed $300 million in

compensatory damages and $200 million in punitive damages, it arguably "tortified" a contract

dispute in order to do so. If the high court affirms the result, COH will be the largest punitive

verdict—by far—ever upheld in a California published opinion.

The litigation arose out of a dispute over the interpretation of the parties' contract. Genentech

funded COH doctors to research and perfect a DNA polypeptide. Under the agreement,

Genentech would license the product, collect royalties, and share them with COH. Things went

swimmingly for several years, with Genentech paying COH about $302 million. Then Genentech

took the position that COH's right to royalties had expired under the terms of the agreement.

The "Tortification" of a Contract Dispute

The court of appeal acknowledged that the critical provisions were ambiguous, to put it mildly,

terming the royalty paragraphs "confusing," "murky," "imprecise," "the antithesis of clarity," and

"like trying to walk across shifting sands." 123 CA4th at 326. The opinion noted three plausible

interpretations of the "interplay" between the clauses, conceding that the critical paragraph was

"reasonably susceptible to the parties' conflicting interpretations." 123 CA4th at 327.

Given these concessions, the notion that Genentech could be liable, not just for breach of

contract, but in tort and for punitive damages, is more than a little troubling. Even in the context

of insurance law in which the insurer is considered a "quasi-fiduciary," California courts

uniformly hold that, as a matter of law, the carrier's reasonable, though mistaken, interpretation

of its contract is an absolute defense to "bad faith" tort liability. See, e.g., Frommoethelydo v Fire

Ins. Exch. (1986) 42 C3d 208, 218, 228 CR 160; Dalrymple v United Servs. Auto. Ass'n (1995)

40 CA4th 497, 523, 46 CR2d 845; Tomaselli v Transamerica Ins. Corp. (1994) 25 CA4th 1269,

1280, 31 CR2d 433.

The court of appeal essentially concluded that, despite the objective reasonableness of

Genentech's interpretation, it could be liable in tort for its improper motive, i.e., for advancing a

contract interpretation that it knew to be wrong because it was a fiduciary (in this case, a third

party to whom an inventor had entrusted a secret). City of Hope Nat'l Med. Ctr. v Genentech, Inc.

(review granted Feb. 2, 2005, S129463; superseded opinion at 123 CA4th 306, 355, 20 CR3d

324). The potential blurring between contract and tort, and the thorny problems associated with


evaluating defendants' motive for the breach, are some of the reasons the supreme court

abolished the "Seaman's" tort, which had permitted tort liability for "bad faith" denial of the

existence of a contract. Freeman & Mills v Belcher Oil Co. (1995) 11 C4th 85, 102, 44 CR2d

420, overruling Seaman's Direct Buying Serv., Inc. v Standard Oil Co. (1984) 36 C3d 752, 206

CR 354. "To include bad faith denials of liability within Seaman's scope could potentially

convert every contract breach into a tort." Freeman & Mills, 11 C4th at 103. As the court

explained in an earlier decision, presaging the demise of Seaman's, there are "important

differences between contract and tort theories of recovery," and "the law generally does not

distinguish between good and bad motives for breaching a contract." Applied Equip. Corp. v

Litton Saudi Arabia Ltd. (1994) 7 C4th 503, 515, 28 CR2d 475.

The Punitive Damages Excessiveness Claim

Standard of Review on Appeal

In 2001, the U.S. Supreme Court held that, in deciding if the defendant's due process right to be

free from grossly excessive punitive awards has been violated, appellate courts must review the

issue de novo. Cooper Indus., Inc. v Leatherman's Tool Group, Inc. (2001) 532 US 424, 435, 149

L Ed 2d 674, 686, 121 S Ct 1678. In other words, the constitutional excessiveness analysis is

subject to an independent, not a deferential, standard of review. Cooper Indus., Inc. v

Leatherman's Tool Group, Inc., supra (emphasis added, quotation omitted). Yet the [PAGE

19]COH opinion admittedly viewed the entire record "most favorably to the judgment." City of

Hope Nat'l Med. Ctr. v Genentech, Inc., (review granted Feb. 2, 2005, S129463; superseded

opinion at 123 CA4th 306, 354, 20 CR3d 324) (emphasis added). Such deference to the

judgment arguably does not satisfy Cooper's mandate for independent, de novo review of the

federal excessiveness claim.

The Appellate Court's Application of Campbell

The BMW/Campbell Degree of Reprehensibility Factors

The three guideposts for evaluating a federal excessiveness claim are (1) the degree of

reprehensibility of the defendant's act; (2) the ratio of punitive to compensatory damages; and (3)

comparable fines or penalties for similar conduct. BMW v Gore (1996) 517 US 559, 575, 134 L

Ed 2d 809, 826, 116 S Ct 1589.

Terming "degree of reprehensibility" the most important guidepost, BMW created what could be

called a "scale of relative reprehensibility" as a benchmark for comparison, to decide how bad

this defendant's act was in relation to acts of other defendants. BMW v Gore, supra. Conduct

causing physical injury is generally considered more reprehensible than purely economic harm;

economic harm is worse, relatively speaking, when inflicted on the financially vulnerable than

on the wealthy; reckless disregard is more serious than indifference; repeated conduct is more

blameworthy than a single isolated act; and harm resulting from mere accident is less onerous

than intentional malice or deceit. BMW v Gore, supra.

In its most recent pronouncement on punitive damages, State Farm Mut. Auto. Ins. Co. v

Campbell (2003) 538 US 408, 419, 155 L Ed 2d 585, 602, 123 S Ct 151, the court evaluated the

degree of reprehensibility factors using a weighing or balancing test; observing "the existence of

any one of these factors weighing in favor of plaintiff may not be sufficient to sustain a punitive


damages award and the absence of all of them renders any award suspect." State Farm Mut.Auto.

Ins. Co. v Campbell, supra.

One is compelled to wonder if any of the five relative reprehensibility factors was truly satisfied

in COH. This was a failure to pay additional royalties, a purely economic dispute. The opinion

candidly acknowledged that "Genentech did not directly jeopardize anyone's life, safety or

health," but nonetheless concluded that defendant "damaged an entity that is in the business of

providing medical help to the poor," often at its own expense. City of Hope Nat'l Med. Ctr. v

Genentech, Inc. (review granted Feb. 2, 2005, S129463; superseded opinion at 123 CA4th 306,

357, 20 CR3d 324). Moreover, because City of Hope is a large, sophisticated institution that

collected $302 million in royalties on this contract, Genentech was hardly acting out the

traditional villain's role, exploiting the weak or unwary. Two large institutions butting heads

would not appear to be what Campbell had in mind.

In addition, it is difficult to see how advancing a plausible interpretation of an admittedly

ambiguous contract provision qualifies as "reckless" disregard of the other contracting party's

rights. And the opinion's notion that defendant was a recidivist within the meaning of Campbell

is likewise questionable. Genentech consistently took the same position regarding contract

interpretation throughout the duration of the parties' dispute, a position it communicated to City

of Hope early on. The opinion characterizes defendant's conduct as a series of multiple acts, not

"widespread as to the number of victims, but … pervasive and continuous as to City of Hope."

123 CA4th at 357. Under that interpretation, any act could be divided into multiple parts for

purposes of qualifying the defendant as a repeat offender. Finally, intentional malice, deceit, or

trickery is more reprehensible on the scale than is mere accident. State Farm Mut. Auto. Ins. Co.

v Campbell (2003) 538 US 408, 419, 155 L Ed 2d 585, 602, 123 S Ct 151. The conclusion of the

opinion in COH, that defendant concealed from City of Hope its "entitlement" to additional

royalties, begs the question: City of Hope was only entitled to more royalties if its interpretation

of the "murky" contract was correct. To support intentionality, COH resurrected a Seaman's-like

"motivational" analysis.

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