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The oil fields of Alabama have produced what promises to be the first major contest under the U.S. Supreme Court’s new guidelines on punitive damages limits. And it’s a gusher — the largest verdict of 2003 and the second-largest ever to a single plaintiff. On Nov. 14, a Montgomery, Ala., jury handed down an $11.9 billion verdict against ExxonMobil Corp., $11.8 billion of it in punitives. The case is focused on a dispute over royalties owed on oil field leases. State of Alabama v. Exxon Corp., CV-99-2369 (Montgomery Co., Ala., Cir. Ct.). Now comes the next round: an appeals process that will pit the whopping punitives in Exxon against the high court’s April 7 ruling aimed at strictly controlling punitive damages awards. State Farm Mut. Auto Ins. Co. v. Campbell, 123 S. Ct. 1513. The company’s lead trial lawyer, Sam Franklin of Franklin, Lightfoot & White in Birmingham, Ala., said they will ask Montgomery County Circuit Judge Tracy McCooey to set aside or reduce the award or grant a new trial. Failing there, they say they will turn to the Alabama Supreme Court. Exxon asserts that the approximately 180-to-1 ratio of the verdict — $11.8 billion in punitives and $63.6 million in compensatory damages — flies in the face of the guidelines established in State Farm. Lawyers for the state are relying on a 10-year-old U.S. Supreme Court decision to justify the high punitives, as well as an exception highlighted in the State Farm ruling. TXO v. Alliance, 509 U.S. 443, 113 S. Ct. 2711 (1993). In TXO, the high court upheld a $10 million punitive judgment in an oil royalties dispute despite the fact that it involved only $19,000 in actual damages. More importantly, the state’s lawyers say, TXO paved the way for a plaintiff to recover punitives based not only on the actual loss, but also on what could have been lost if the defendant’s conduct hadn’t been discovered. DIFFERENT BENCHMARKS “The single digit is not necessarily the benchmark,” said Robert Cunningham of Cunningham, Bounds, Yance, Crowder & Brown in Mobile, Ala., one of the three lead attorneys for Alabama. “It should hold because it’s a 12-to-1 ratio using potential harm as evidence.” Some lawyers suggest that TXO is an anomaly in the canon of U.S. Supreme Court law on punitives and alone cannot justify the Exxon verdict. “I think the window on TXO is going to close,” said Victor Schwartz of Kansas City, Mo.’s Shook, Hardy & Bacon and general counsel of the American Tort Reform Association. “The argument about future economic harm can arise in too many places.” Professor Michael Rustad of Suffolk University Law School has studied the progression of punitive damages for 25 years. He said that the ratio of the Exxon award would seem more rational under the TXO formulation, but still has to meet the court’s guidelines in State Farm v. Campbell. “It would be a nice correlation, but you still have to look at the Campbell factors,” said Rustad. In State Farm, the high court didn’t establish a fixed ratio but suggested that few punitive awards should exceed a 9-to-1 ratio. The decision threw out a $145 billion punitive damages award won by the plaintiff in a bad-faith action against the auto insurer. Compensatory damages totaled $1 million. The court said ratios higher than single digits can be justified by the reprehensibility of a defendant’s conduct, what a defendant might have to pay in regulatory penalties or by compensatory damages that are quite low. The question then is whether the damages in the Exxon case fill the bill. Exxon claims that the case is a contract dispute in which each side had different interpretations of the allowable deductions, and that its conduct was not reprehensible. INTENT TO CHEAT? “This is a royalty disputes issue,” said Ken Cohen, vice president-public affairs, for Exxon and a former general counsel of one of its holdings. “It’s a routine matter of do you deduct for this or for that.” Cohen said that every oil producer has a right to raise questions about whether certain deductions are allowable as part of the production cost. Lawyers for Alabama charge that the oil company made a cost-benefit analysis of the risk of cheating the state out of its due royalties, then decided to underpay the state because the probability of its being caught was low. “Exxon’s internal documents revealed a knowing intent to cheat the state, including financial projections of how much they would make if they did,” said Cunningham. “And that justifiably incensed the jury.” The contract between the parties was written by an attorney for the state. Unlike most such agreements, this one did not allow any deductions for the cost of extracting or treating the gas, according to the state’s lawyers. They maintain that Exxon secretly wrote off expenses like landscaping, travel and employee meals in order to reduce the royalties. Two Alabama juries were persuaded by the state’s argument. The first returned a $3.5 billion verdict against Exxon three years ago. That verdict was set aside on appeal after the Alabama Supreme Court determined that the jury had been incorrectly allowed to see a privileged communication between Exxon and its lawyers. Jere Beasley of Montgomery’s Beasley, Allen, Crow, Methvin, Portis & Miles, another of the state’s lead lawyers, said the reversal was a “technicality.” During the second trial, that state produced several other “smoking gun” documents that equally implicated Exxon. In one of them, Exxon acknowledged that it was allowed “zero” deductions. In another, company analysts calculated that the risk of exposure was low and that the worst outcome was that the deductions would be detected and would have to be refunded with 12 percent interest. The state’s lawyers were able to cross-examine the president of Exxon and other witnesses who were not included in the first trial. Exxon hired a different legal team for the second trial, which employed a different strategy that included calling more witnesses who didn’t do well on cross-examination, according to Beasley. Those factors may explain why the second jury more than tripled the first jury’s award, he said. “This was massive fraud at the boardroom level,” Beasley charged. “The jury saw the conduct of this corporation in dealing with a state that was inexperienced in this business and maybe had one auditor compared to 100 for Exxon. “The nature of the fraud being so massive and exercised at the top level with documentation puts this case in a totally different context” from others in terms of reprehensibility. The behavior of a defendant who has weighed the risk of getting caught could be considered reprehensible to satisfy the exception in State Farm, according to Suffolk University’s Rustad. “There is a school of thought that says where the probability of detection is low, that’s where you need the hammer of punitive damages,” he said. The company’s wealth alone would not justify a large verdict, he said, but it would if wealth-based punishment was intended to deter Exxon from cheating in the future. Taking Exxon’s side of the argument, Andrew L. Frey, a partner in the Washington office of Chicago-based Mayer, Brown, Rowe & Maw, said the key to State Farm exceptions is whether the compensatory damages are substantial or not. “A case with $63 million in compensatory damages that is a fight between a state and big business, where it is at least arguable whether there should be punitives or not, does not seem to me to have the ingredients to justify a high punitive ratio,” Frey said. Frey argued an earlier Alabama case on punitive awards before the Supreme Court, BMW of North America v. Gore, 517 U.S. 559 (1996), which the court relied on in the State Farm decision. In Gore, the high court rejected a $2 million punitive award in a case that involved $4,000 in damages. GUIDELINES FROM 1996 The 1996 ruling was the first in which the high court struck down a punitive award as grossly excessive. It laid out three guideposts that it relied on in State Farm. Those guidelines are the reprehensibility of the defendant’s conduct; the ratio between punitive damages and actual harm; and state regulatory sanctions for comparable misconduct. Since Gore, Alabama has been in the eye of the storm surrounding “tort reform.” “Alabama is tort hell,” Rustad said. In 1999, the Alabama Legislature enacted a statute that caps punitive damages at three times the amount of the compensatory award in nonpersonal injury cases. The rule does not apply to the Exxon verdict because the case was under way when the law was written. But Franklin said it presents an obvious conflict when the plaintiff is the same lawmaking body that brought tort suit restrictions to the state. “Obviously, the Legislature passed that in 1999 from a perception that Alabama was out of step with mainstream and people perceive our system to be unfavorable and unfair,” Franklin said. “It’s a little bizarre that the state of Alabama would choose to ignore the public policy behind that and pursue the punitives that were sought in this case.” The Legislature’s intent with the statute might be a factor in the minds of the Alabama Supreme Court justices if they hear the case, some lawyers said. “Technically, that cap doesn’t apply, but the will of the Legislature in capping damages is a clear indication of the public policy, said Schwartz, the American Tort Reform Association counsel. “This is a different court than Gore.” He noted that Exxon’s stock did not dip after the verdict — a sign that market analysts are not taking it very seriously. Rustad thinks it will eventually make its way to the U.S. Supreme Court. “Even if the court reduces it, I think it’s inevitable that the U.S. Supreme Court will hear this issue,” he said.

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