The Spoiler

SUPPLEMENT
TO THE LOS ANGELES DAILY JOURNAL AND SAN FRANCISCO DAILY JOURNAL

The Spoiler

Defense counsel can make
vast use of a certified public accountant’s expert testimony when attempting to
avoid or limit assessment of punitive damages.

BY
THOMAS M. NECHES

laintiff’s
counsel routinely rely on a certified public accountant’s expert testimony
regarding punitive damages. However, at times, defense counsel neglect the
opportunity to offer expert testimony to rebut plaintiff’s evaluation of
defendant’s wealth or to persuade the trier of fact that punitive damages
should not be awarded in the first place. Sometimes, defense counsel believes
that if the defendants needs an expert to deal with punitive damages, the
defendant should not be in trial, and the case settles.

            In fact, CPA assistance to defense
counsel can be invaluable in reducing the amount of punitive damages or, better
still, avoiding them entirely.

            “Punitive damages are awarded only
for outrageous conduct, that is, for acts done with a bad motive or with a
reckless indifference to the interests of others. “Martin v. Johns-Manville Copr., 508 Pa.
154, 494 A2d 1088, 1097 (1985). CPA expert testimony can be used to help
persuade the trier of fact not to award punitive damages. Often, the alleged
wrongful acts were purportedly committed by an individual, or a very small
number of employees or agents of a company. In such cases, the CPA may be able
to testify that the company’s system of financial internal controls could not
have been expected to detect the agent’s wrongful acts, as the agent’s acts
were not in furtherance of the company’s business and outside the scope of the
agent’s employment; the agent was not in a management capacity, as the agent’s
acts were not authorized, ratified or approved by the company; or the agent’s
employment history and work performance were consistent with the company’s and
industry employment standards.

            In some instances, the CPA may be
able to testify that defendant’s allegedly wrongful acts are a normal business
practice in defendant’s industry. The CPA may also be able to comment on and
quantify the effects of defendant’s efforts to repair the problem after the
fact. In tort cases, punitive damages may not be recovered without proof of
actual damages; therefore, CPA expert testimony that there are no economic
damages is desirable from a defense perspective.

            An effective CPA expert can help
defense counsel convince the trier of fact that plaintiff suffered no financial
loss even if defendant acted wrongfully. However, avoiding punitive damages by
claiming zero economic damages is an all-or-nothing proposition, as an award of
nominal damages is enough to support a further award of punitive damages. For
example, courts have affirmed an award of $550,000 in punitive damages based
upon an award of $1 compensatory damages. Werschkull
v. United California Bank, 85 Cal. App. 3d 981, 149 Cal. Rptr.
829 (1978).

            There is no clear-cut limit to the
size of punitive damages. The U.S. Supreme Court has stated: “We need not, and
indeed we cannot, draw a mathematical bright line between the constitutionally
acceptable and constitutionally unacceptable that would fit every case. We can
say, however, that general concerns of reasonableness and adequate guidance
from the court when the case is tried to a jury properly enter into the
constitutional calculus.” Pacific Mutual Life Insurance Co v. Haslip, 499 U.S. 1, 19 (1991). The high court then endorsed
a list of factors that could be taken into consideration in determining whether
a punitive damage award was excessive or inadequate (499 U.S. at 21): whether
there is a reasonable relationship between the punitive damage award and the
harm likely to result from the defendant’s conduct as well as the harm that
actually has occurred; the degree of reprehensibility of the defendant’s
conduct, the duration of that conduct, the defendant’s awareness, any
concealment, and the existence and frequency of similar past conduct; the
profitability to the defendant of the wrongful conduct and the desirability of
removing that profit and of having the defendant also sustain a loss: the “financial
position” of the defendant: the costs of litigation: the imposition of criminal
sanctions on the defendant for its conduct, these to be taken in mitigation:
the existence of other civil awards against the defendant for the same conduct,
these also to be taken in mitigation.

            CPAs have important information to
provide the trier of fact about each of these factors. Regarding actual and
potential harm caused by defendant’s conduct, if the punitive damages phase of
trial has been reached, actual economic harm has already been determined. A
finding of nominal economic damages does not let defense counsel rest easy on
punitive damages, however, Punitive damages awards that are up to 500 times
greater than compensatory damages have been found to be reasonable by appellate
courts. In addition, if actual damages are found to be nominal, plaintiff’s
counsel will likely argue that potential damages could have been much greater.
Defense counsel should be ready with CPA expert testimony to rebut this
contention. Regarding the duration of conduct and frequency of similar conduct,
CPA expert testimony can inform the trier of fact when the wrongful conduct
began and ended, based on the review of defendant’s financial records. The CPA
also may be able to testify to whether similar conduct had been previously
discovered. On the question of profits earned by the defendant because of the
wrongful conduct and the financial position of the defendant, the analysis of
defendant’s profitability and financial position is the domain of the CPA
expert. Evidence of defendant’s financial condition must be punitive damages
can be imposed. Adams v. Murahami, 54. Cal.3d 105
(1991). In providing information to the jury about defendant’s financial
condition, most courts focus on net worth, which should be determined as of the
trial date, rather than when the wrongful acts were committed. Zhadan v. Downtown Los Angeles Motors, 100 Cal. App.3d 821,
839, 136 Cal. Rptr. 132, 143 (1979). A rule of thumb
seems to be that punitive damage awards generally are not allowed to exceed 10
percent of the defendant’s net worth. Devlin v. Kearny Mesa AMC/Jeep/Renault,
Inc., 155 Cal. App.3d 381, 393-96, 202 Cal. Rptr. 204
(1984).

            Defense counsel may use CPA expert
testimony to undermine plaintiff’s calculations of defendant’s wealth and
profits. In some cases CPA expert testimony may be
used to explain to the jury why a company’s net worth as determined by
plaintiff is an inappropriate, incomplete or inaccurate measure of the
company’s wealth or ability to pay a punitive damages award.

            Suppose, for example, plaintiff’s
expert relies on the net worth of a company as reported in its audited
financial statements prepared in accordance with generally accepted accounting
principles. This would seem to be an ideal basis for determining a company’s
net worth. However, a company’s net worth as reported in its financial
statements often is quite different from the company’s actual current market
value. The primary reason for this is that assets are recorded in financial
prices, rather than their current market values. Perhaps defendant’s net worth
consists primarily of non-liquid, non-income-producing assets, for example,
undeveloped land, purchased and recorded in defendant’s financial statements at
a price higher than its current market value. In this case, defendant’s net
worth as reported in its financial statements would overstate both defendant’s
actual net worth and its ability to pay a punitive damages award.

            Plaintiff’s expert may have focused
primarily on plaintiff’s business and may have a limited understanding of that
business, limited access to defendant’s business records and limited time and
resources to conduct an analysis of defendant’s net worth or profit margins. In
such cases, defense counsel should memorialize at deposition plaintiff’s
expert’s scanty understanding of defendant and its industry. Defense counsel
should use the CPA expert to uncover any errors plaintiff’s expert has made in
interpreting defendant’s financial records and help develop cross-examination
questions highlighting this expert’s lack of knowledge about unusual aspects of
defendant’s accounting records, non-recurring items, or the “story” behind
specific entries in financial statements. Defense counsel may be able to use
this information to show the jury that plaintiff’s expert really is not
particularly expert in this setting.

            A
CPA retained by defense counsel may have the advantage of being better informed
than plaintiff’s expert about defendant’s business operations. If plaintiff has
not made a claim for disgorgement of defendant’s unjust enrichment, defendant
may not be required to disclose its financial records prior to the punitive
damages phase of trial. For non-publicly held defendants, plaintiff’s expert
may have only a matter of days or even hours to analyze defendant’s financial
records to determine defendant’s wealth or profits. For publicly held
corporations, detailed financial information disclosed in Securities and
Exchange Commission fillings are readily accessible
via the Internet. Similarly, insurance companies’ financial statements are
available through quarterly filings with the state departments of insurance.
However, even in these cases, the superior knowledge about the defendant’s
financial and business operations available to the defense CPA expert may be
able to tip the scale in defendant’s favor.

            Another
situation in which CPAs can assist defense counsel may arise if plaintiff
attempts to present financial information to the jury pertaining to defendant’s
owners or parent or controlling companies. CPAs can assist defense counsel in
protecting the “corporate veil” by providing expert testimony as to whether
defendant filed articles of incorporation, issued stock, adopted corporate
by-laws, appointed officers, held and documented meetings of shareholders and
the board of directors, obtained an employer identification number, invested
sufficient capital to conduct business, maintained separate accounting records,
filed corporate tax returns, segregated corporate and personal funds,
documented and maintained at arms length all
related-party transactions, or treated as compensation all personal use of
corporate assets.

            CPAs
can be used by defense counsel to collect, verify, analyze and testify about
both plaintiff’s and defendant’s costs and expenses, and can rebut overstated
claims made by plaintiff. For example, a significant portion of costs of
litigation claimed by plaintiff may in fact be regular legal costs incurred in
plaintiff’s ordinary course of business.

———————-

Thomas
M. Neches, a
certified public accountant, is senior partner of Simpson & Company, a firm
of certified public accountants specializing in litigation services.