Could exemplary damages discourage corporate wrongdoings?

In a fast-evolving world of technological, commercial and societal evolution, the law is constantly playing catch-up. Consequently, this lag creates a commercial opportunity for sophisticated and well-resourced businesses to arbitrage in the pursuit of profit. Think Lloyd v Google, where wrong-doing was established (by the Fair Trade Commission), yet Google was able to retain the revenues thus generated. Or, put another way, today’s wrongfully earned profits far outweigh the cost of being successfully litigated against in the future (weighted not only by the probability of such litigation being successful but also the time value of money).

The real consequence is how this impacts recourse for victims through legal remedy. There’s not much to do about this arbitrage but what exacerbates the problem is the cost of recourse and the underfunded judiciary and the public bodies who exist to enforce justice.

Katherine Freeland’s Chasing Money highlights this in respect of fraud and why private prosecutions are necessarily validated. Beyond the criminal justice system, the recently published 2022 UK Judicial Attitude Survey, a continuous survey of working judges with a response rate of above 90% across salaried judges and 67% of fee-paid court judges, highlighted the on-going 'poor' or 'unacceptable' morale of court staff. This cannot be good for delivering justice.

Beyond the unrealistic canvasing of the justice secretary, there is one rarely discussed option – a punishment tax based on principles of exemplary damages.

For most UK lawyers, the notion of UK jurisprudence moving beyond a compensatory approach is simply offensive. Winning claimants shouldn’t be overcompensated by way of an undeserved financial windfall which would encourage more vexatious or 'punt-like' litigation, stressing an already stretched judiciary. However, there is more to exemplary damages.

In 1997, the Law Commission, chaired at the time by the future Supreme Court Justice Lady Arden of Heswall, published its final report in respect of Item 2 of the Sixth Programme of Law Reform – Aggravated, Exemplary and Restitutionary Damages. Interestingly, support for introducing exemplary damages was broad because rather than focusing on the negatives it might lead to, it turned to the positive deterrent such damages could play.

If the offensiveness is caused by the concept of 'damages' because it benefits a somewhat undeserving claimant, then the focus should shift to the concept of 'tax': punishing wrong-doers where it hurts (i.e. money) for the benefit of the judiciary. In other words, rather than framed as exemplary damages, it would be a punishment tax, where the proceeds of any such 'tax' go to the judiciary rather than the claimants. Again, one can hear grunts of sheer abhorrence but there are some obvious significant benefits.

For a start, it would have a significant behavioural impact, changing attitudes of current and prospective wrong-doers towards litigation risk. Let us assume, as above, that wrong-doers assess litigation risk of any given commercial decision not against a legal construct but against a commercial construct where today’s wrongfully earned profits far outweigh the cost of being successfully litigated against. Currently, this risk assessment only assumes damages to put the victim back into the position it would otherwise have been in had it not been for the wrong-doing the wrong-doer is about to commit. If successfully litigated against, with the risk of an additional 'tax', the commercial assessment of the litigation risk would become mathematically less favourable.

Even if the litigation risk was still worth taking, once they are found out for a wrong-doing leading to litigation, the stakes of losing are much higher with a punishment tax. If a defendant wrong-doer knows they have committed wrong, a settlement becomes far more attractive. Moreover, only the most convinced (of their innocence or strength of their defence) would pursue matters to trial.

Moreover, settlements save court time and mitigate the financial burdens faced by the commercial courts. For those defendants that braved a trial and lost, the wrong-doer would not only have to pay ordinary damages to the claimant but also an additional tax.

How that punishment tax is calculated would of course need to be determined. At this point, one can hear the sighs of traditionalists saying it’s too difficult to calculate anyway. But this applies to any tax. Income and corporation tax rates only make sense because they are historically benchmarked. The advantage of having no benchmark is the opportunity to create a fit-for-purpose benchmark. It could for example be guideline-based, such as a percentage or multiple of the headline claim value. A restitutionary approach would also be logical, where the tax is equal to the wrongfully earned profits (with 8% judgment interest in line with s17 of the Judgments Act 1838 of course).

Alternatively, it could be at the court’s discretion based on what it believes is an appropriate amount to act as both sufficient punishment and deterrent, which will vary from case to case anyway.

The central point though is that any such amount would go back into the judiciary. Put another way, the more underfunded the judiciary, the more leverage for potential wrong-doers, leading to an increase in litigation which means more wrong-doing and a more stressed judiciary. Not exactly a vicious circle society wants to get trapped in.

And the bigger picture: if wrong-doing in commercial litigation helped fund the criminal justice system to create a safer, most just society, it’ll be a win-win because it would create a better society, even for the profit-motivated wrong-doers, in which they can enjoy their undeserved profits.

Tets Ishikawa is managing director of LionFish, a litigation funder