Ruling Limits Damages in Fraud Suits

A California appellate court has effectively shut the door on efforts to obtain punitive damages in breach-of-contract disputes that are filed as fraud lawsuits.

In a unanimous decision, the Court of Appeal’s 2nd District ruled Friday in Los Angeles that concealing a contract breach does not qualify as a separate fraud that would give rise to punitive damages.

The precedent-setting ruling came in a breach-of-contract case that Robinson Helicopter Co. of Torrance brought against Dana Corp., a vehicle-parts manufacturer based in Toledo, Ohio.

A Los Angeles jury in 2001 awarded Robinson $7.5 million -- including $6 million in punitive damages -- after deciding that Dana had changed the specifications on the sprag clutches it supplied to the helicopter maker without informing the company.

Robinson had sent several letters to Dana reporting that customers had returned 11 cracked sprag clutches. But it was not until a conference call with Robinson executives more than two years after the part had been changed that Dana executives disclosed the change.

No accidents were attributed to the parts in question, but the Federal Aviation Administration eventually ordered that they be recalled.

Robinson sued to recover more than $1.5 million it said it spent on efforts to determine which of the R-22 and R-44 helicopters it manufactured had the inferior clutches and to replace them. In addition to breach of contract, the helicopter maker accused Dana of fraud for intentionally concealing the change.

The Court of Appeal struck down the punitive damage portion of the award, saying Robinson’s grievance was nothing more than a breach of contract.

California law allows punitive damages to be imposed only when jurors find evidence of oppression, fraud or malice in the “breach of an obligation not arising from contract,” the court said.

Edwin V. Woodsome Jr., the Los Angeles lawyer who represented Dana, said the ruling would make it easier for businesses to assess their risks under sales agreements.

“The advantage of this opinion is it gives a measure of predictability,” Woodsome said. “It allows businesses to understand the limits of liability exposure.”

Robinson plans to ask the appellate court to rehear the case and, if necessary, appeal to the state Supreme Court, said Edward J. Horowitz, a Pacific Palisades lawyer who represented the company.

Horowitz said the appellate decision is bad public policy.

“Under this ruling, you don’t get any more sanctions if you fraudulently cover up the breach, so you may as well fraudulently cover up the breach,” he said. “As long as nobody dies or gets injured, you’re not going to be liable for a tort.

“I don’t know that that’s the kind of business ethics we want to encourage,” Horowitz added. “It seems to me there has to be some deterrent to keep people from cheating or committing fraud after they know they’ve breached a contract.”

Although new for California, the ruling follows the analysis of recent similar decisions by the U.S. 3rd Circuit Court of Appeals in Philadelphia, and Michigan and Nevada state courts.