December 3, 2010

Are contracts limiting punitive damages enforceable?

One of our readers sent us an email with an interesting question about whether the law permits enforcement of contractual provisions that purport to limit or eliminate punitive damages claims.  I must confess I'm not aware of any authority directly addressing this question, but here are my initial thoughts:

The issue probably doesn't come up very often, because in most if not all U.S. jurisdictions, punitive damages are unavailable in a lawsuit for breach of contract. For that reason, parties to the contract would not ordinarily include any provisions in the contract regarding punitive damages.

Despite the unavailability of punitive damages for breach of contract, parties to a contract might want to include a provision about punitive damages, in anticipation of the possibility that one of the parties might sue the other for a tort claim independent of the contract.  In California, we have a statute that prohibits releases that are intended to “exempt” a party from responsibility for his own fraud or willful misconduct. (California Civil Code section 1668.)  Some might argue that, under section 1668, contracts purporting to eliminate liability for punitive damages would be unenforceable because punitive damages necessarily involve willful conduct.  But that argument would work only if a court construes a contractual limitation on one element of damages to be an “exemption” from responsibility. Arguably, a limitation is not the same as an exemption. I am not aware of any case addressing that question.

Arbitration contracts are one type of contract for which limits on punitive damages might be enforceable,  because arbitration contracts are subject to special deference. The California Supreme Court has held that arbitration clauses cannot eliminate "statutorily imposed remedies such as punitive damages and attorney fees."  (Armendariz v. Foundation Health (2000) 24 Cal.4th 83, 103.)  But in Armendariz the plaintiff's liability claim was based on a statute (the California Fair Employment and Housing Act).  What happens when a plaintiff is asserting a common law tort claim?  The plaintiff in such a case might say that the language in Armendariz, taken literally, prohibits any sort of arbitration clause eliminating punitive damages, since all punitive damages claims in California are statute-based (Civil Code 3294).  But if that's what the California Supreme Court meant, why didn't they just say that?  The Court's focus on statutory-based claims suggests their analysis might be limited to that context.  Even if Armendariz applies to all types of punitive damages claims, there would still be an argument that an arbitration clause limiting (as opposed to eliminating) punitive damages would still be permissible. 

These are just my preliminary thoughts.  If any readers have thoughts or are aware of relevant authorities, I'd love to hear about them.  Thanks to professor Fran├žois Xavier Licari, of the University of Metz law faculty, for raising the issue.