This unpublished opinion presents a punitive damages issue I haven’t encountered before.

The issue is unique to shareholder derivative actions.  In such cases, a shareholder of a corporation brings a lawsuit on behalf of the corporation against a third party, typically a corporate insider.  The shareholder who brings the suit is referred to as a “nominal” plaintiff because, although he or she initiated the action, any recovery in the action belongs to the corporation, not the individual plaintiff.

The issue that arose here is how to analyze the issue of excessive punitive damages when a court in a derivative action awards punitive damages against a defendant who has a controlling interest in the corporation.  If the defendant pays $1 million in punitive damages to the corporation, but owns 60% of the corporation, then $600,000 of the punitive damages payment will flow right back to the defendant.  So the question is, can the maximum amount of punitive damages be adjusted upward to compensate for the fact that the defendant will benefit from his or her own payment of damages.  The California Court of Appeal (Fourth Appellate District, Division One) says “yes.”

The Court of Appeal accepted the trial court’s conclusion that, if this were not a shareholder derivative action, the facts of the case would not permit a punitive damages award in excess of the amount of compensatory damages (in this case, $2 million).  The Court of Appeal further held, however, that the trial court properly adjusted the award upward to $4.7 million to account for the defendant’s control over the corporation.  Taking into account the percentage of the punitive award that would flow back to the defendant, the court concluded that the effective award against the defendant would be $2 million, equal to the compensatory damages.

I can see the logic of the Court of Appeal’s reasoning.  But the opinion also suggests that the trial court increased the amount of the award partly to ensure that the shareholder who brought the derivative action would be entitled to a $2 million share of the punitive damages award, taking into account the plaintiff’s ownership interest in the corporation.  That doesn’t seem right at all.  The purpose of a derivative action is to provide a remedy for a wrong to the corporation, not to ensure that the shareholder who brought the action receives any particular amount.  And certainly the plaintiff is not entitled to any particular amount of punitive damages, which are always a windfall to the plaintiff.  Fortunately, however, the Court of Appeal stayed away from endorsing that part of the trial court’s analysis.