Punitive Damages for Breach of Contract

ELT, Aug 2005

The California Supreme Court finds fraud based on contractual compliance certificates.

A recent California Supreme Court decision emphasizes the significance of ongoing compliance certification requirements in commercial contracts and thus highlights an increased need for those on the "front-end" of documenting deals to pay careful attention to provisions often overlooked as boilerplate. In Robinson Helicopter Company, Inc. v. Dana Corporation (22 CaI. Rptr. 3d 352), the California high court held that a plaintiff's claim for fraud and intentional misrepresentation based on false compliance certificates would support a tort award of punitive damages, even in the absence of personal injury or property damage.

At trial, a jury had awarded Robinson Helicopter Company, the plaintiff, just over $1.5 million in compensatory damages for breach of contract and breach of warranty plus $6 million in punitive damages for the tort of intentional misrepresentations and knowing concealment of fact with intent to defraud.

The Court of Appeal held that the plaintiff could not recover in tort because it had suffered only economic losses (the so-called "economic loss rule") and therefore overturned the punitive damage award. The California Supreme Court reversed the Court of Appeal decision on the economic loss rule, holding that the rule does not preclude tort recovery for affirmative acts of fraud relating to contract performance.

Just the Facts

The basic facts of the case are quite straightforward. Robinson manufactures helicopters, and Dana Corporation manufactures sprag clutches, a safety device that permits the blades of a helicopter to keep rotating (and thus allow a pilot to maintain control) after a loss of power. The Federal Aviation Administration (FAA) type certificate, i.e. the FAA approved design specification, for Robinson's helicopters required sprag clutches of a level of hardness described as "50/55 Rockwell." Robinson contracted with Dana to supply it with sprag clutches of the specified design and hardness. After twelve years of delivering sprag clutches with the 50/55 Rockwell hardness and without notifying either Robinson or the FAA, Dana changed its manufacturing process and produced sprag clutches of a higher level of hardness (61/63) during a period of fifteen months, and then changed back to its original process, also without notifying Robinson. During the 15-month period, Dana continued to deliver its sprag clutches to Robinson and provided a written certificate of compliance with contract specifications with each shipment.

The sprag clutches with a higher level of hardness cracked and failed at a much higher rate than the sprag clutches conforming to contract requirements delivered by Dana. As a result, the FAA required Robinson and its British counterpart to recall and replace all of the clutch assemblies in which the non-conforming sprag clutches had been installed. After completing the recall and replacement process, Robinson sued Dana for breach of contract, breach of warranty and negligent and intentional misrepresentation.

Analysis and Holding

In its analysis, the California Supreme Court focused solely on the fraud and misrepresentation claim based on defendant Dana's provision of certificates of compliance certifying that the sprag clutches it was delivering conformed to all contractual requirements and specifications, when it knew that this was not true due to the change it had made to its manufacturing process. The court analyzed the fraud claim as follbws:

The elements of fraud are: (1) a misrepresentation (false representation, concealment, or nondisclosure); (2) knowledge of falsity (or scienter); (3) intent to defraud, i.e., to induce reliance; (4) justifiable reliance; and (5) resulting damage.. .Dana's issuance of the false certificates of conformance were unquestionably affirmative misrepresentations that Robinson justifiably relied on to its detriment. But for Dana's affirmative misrepresentations by supplying the false certificates of conformance, Robinson would not have accepted delivery and used the nonconforming clutches over the course of several years, nor would it have incurred the cost of investigating the cause of the faulty clutches. Accordingly, Dana's tortious conduct was separate from the breach itself, which involved Dana's provision of the nonconforming clutches. In addition, Dana's provision of faulty clutches exposed Robinson to liability for personal damages if a helicopter crashed and to disciplinary action by the FAA. Thus, Dana's fraud is a tort independent of the breach.

(Robinson v. Dana, 22 Cal.Rptr.3d at 359-60, citations omitted, emphasis in original).

Although Robinson did not actually incur any losses or liabilities for third party claims for personal injury or property damage, the court found the mere exposure to such liability caused by Dana sufficient to sustain an award of tort damages, i.e., punitive damages. This prophylactic approach by the court may be beneficial to equipment lessors in several respects.