Putting an End to Punitive Damages for 'Fraudulent Fraud'
Many courts read Texas Civil Practice & Remedies Code § 41.003 as permitting an award of exemplary damages for "fraudulent fraud." In other words, when the jury finds that the defendant committed fraud, a second finding of the same fraud, this time by clear and convincing evidence, authorizes recovery of exemplary damages. But when the defendant's wrongful act that caused the plaintiff's damages is fraud, can that same fraud properly be considered as an aggravating circumstance justifying exemplary damages?
The answer, of course, is "no." Section 41.003's limitation on exemplary damages requires a finding that the defendant's wrongful conduct was accompanied by aggravating circumstances. Section 41.003(a) embodies this common law rule, stated in numerous cases decided before Chapter 41 was enacted: "Exemplary damages are recoverable if the injury complained of results from a wrong accompanied by aggravating circumstances of malice, fraud, or gross negligence." The presence of a wrong accompanied by "aggravating circumstances" has been the basis for punitive damages in Texas since at least 1888.
"Aggravating circumstances" generally means that, in addition to engaging in wrongful behavior, the defendant also had an illicit motive, desiring to harm or revenge himself upon the plaintiff. Thus, in 1990, the Fourteenth Court of Appeals explained that a defendant's "profit-motivated business interests," though "self-serving," will not amount to "ill-will, spite, evil malice" or other "aggravating circumstances."
To establish an aggravating circumstance, the plaintiff must prove something more—that the defendant committed the fraud with malice. The Texas Supreme Court said as much back in the 1966 case of Dennis v. Dial Finance & Thrift Co., explaining that exemplary damages are available for fraud "intentionally committed for the purpose of injuring [the plaintiff]." That is the precise definition of malice in Chapter 41. According to §41.007(7), "'Malice' means a specific intent by the defendant to cause substantial injury or harm to the claimant."
The Texas Supreme Court reinforced this requirement in 2012 in Safeshred. v. Martinez, reiterating that an aggravating circumstance must be something separate from, and in addition to, the underlying wrongful act: "when a tort requires willful harm as a necessary element of liability, that willfulness alone cannot justify a punitive damages award." In Safeshred, the court was addressing a Sabine Pilot claim. The court explained that in Sabine Pilot claims, punitive damages could not be based on the employer's intent to fire the employee because that intent was a necessary element of liability. To justify punitive damages, a Sabine Pilot plaintiff must prove something more such as "interference with the employee's future employment, harassment, or terminating his employment knowing the reason for doing so is unlawful."
So, obviously, when the wrongful conduct is fraud, the same fraud cannot be an aggravating circumstance. Fraud can be an aggravating factor for other wrongful conduct, such as conversion or breach of fiduciary duties. But if the underlying wrongful act is itself fraud, then fraud cannot be an aggravating circumstance. The plaintiff must prove the fraud was committed with malice. Requiring malice is consistent with the common law that §41.003 embodies, and absent a clear intent to change it, the statute must be construed in harmony with the common law.
Numerous other jurisdictions agree that "fraudulent fraud" will not support an award of exemplary damages. In Pennsylvania, for example, "when fraud is the basis of compensatory damages, the same fraudulent conduct is not sufficient to base an award of punitive damages without more." In Iowa, punitive damages may be awarded in a fraud case "when, in conjunction with the fraud, the defendant acts with legal malice or engages in other aggravating conduct amounting to actual malice." And in Ohio, if the underlying tort is fraud, to recover punitive damages the plaintiff must prove the fraud was committed maliciously. Courts in the District of Columbia, Illinois, Indiana, Kentucky, Michigan, Mississippi, New York, Oklahoma, Oregon, and Rhode Island have all reached the same conclusion.
Permitting recovery of exemplary damages for "fraudulent fraud" does not foster §41.003's purpose. When a jury has found fraud under the preponderance-of-the-evidence standard, another question asking whether the defendant committed the same fraud—this time by clear-and-convincing evidence—does not impose a meaningful threshold for imposing punitive damages. It is akin to asking, "Did you really mean to find fraud?" Of course the jury will say "yes." The jury always says yes. It is time for the courts to start setting a meaningful threshold for imposing punitive damages in fraud cases by requiring the jury to find malice.
Reprinted with permission from the May 25, 2015 edition of Texas Lawyer. © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.