Punitive Damages from Economic Perspective and Recent Changes to PL Act

 

Abstract

Oxy Humidifier Sterilizer Scandal made people raise their voice on the necessity of charging corporates manufacturing harmful products with stricter responsibility. This led to the revision of Product Liability Law, enforced starting from April, 2018, and brought about significant changes and among them is implementation of punitive damages. To approach punitive damages from economic perspective and to analyze its features and how it would affect our overall economy, firstly there needs to be an examination of general theory of strict liability and derive the necessity for punitive damages, where perfect compensation does not work effectively to deter future torts. The general economic model suggests that punitive damages can be socially inefficient unless there are some constraints (pre-requisites). Thereby it suggests how courts can improve the consistency of punitive damages. Specifically, punitive damages should be restricted to exceptional cases where intentional faults go against the legal standard of care by a large amount. Also, the awards for punitive damages should be large enough to deter the future malicious behaviors by corporates. Fortunately, these characteristics are well-reflected in the newly revised Korean Product Liability Act via existence of manufacturer’s intentional faults, requirement of severe damage to life or a body of person, and compensation amount up to thrice the actual harm. Even though limitations of the revision exist, nevertheless, major changes have been made and the fact that these changes happened after 15 years of enforcement itself is already significant. In practice, if strict requirement clause is interpreted more flexibly by the court and applied rather broadly, it would make difference. Also, there needs to be more cases accumulated in order to find out further possible problems that need to be discussed.

 

Introduction

Oxy Humidifier Sterilizer Scandal aroused a sheer anger among South Koreans that this product caused 925 deaths and a total of 3995 victims still suffering from after-effects such as acute respiratory distress syndrome and septicemia (also known as blood poisoning)[i]. This incident made people raise their voice on the necessity of charging corporates manufacturing harmful products with stricter responsibility. This led to the revision of Product Liability Law, enforced starting from April, 2018, and brought about three major changes: the introduction of punitive damages, alleviation of consumer’s responsibility to prove the causal link between such product’s defect and actual damage that turned out and thereby putting a stricter responsibility on manufacturers.[ii] I would like to focus on the first change, which is punitive damages, since it is a significant change in Korean legal system such that seldom had it been acknowledged and in almost all cases compensatory had been accepted as the main doctrine under the ruling of the current legal system.

South Korean law has been greatly influenced by German and Japanese legal system and these continental legal systems have been abiding by the principle of compensatory damage when it comes to compensation on civil law system. Thereby, South Korean law also has adopted compensatory damages when its Product Liability Law was first established in January, 2000, and enforced in July, 2002. Although there were precedents implementing punitive damages in other laws such as Fair Transaction in Subcontracting Act (2011) and Personal Information Protect Act (2015)[iii], but through this tragic incident the first step ahead for acknowledging punitive damages in product liability has forwarded.

I would like to approach punitive damages from an economic perspective and analyze its features and to determine how it would affect our overall economy; that is to say, to prove whether this very compensatory principle would achieve or result in socially optimal level. Furthermore, I would like to introduce specific changes to Korean PL Act and its inherent limitation.

 

Ⅰ. General Theory: Liability

To provide general background knowledge of economic concepts, economists assume that a consumer can rank various consumption possibilities. The way the consumer ranks the consumption bundles can describe the consumer’s preferences and indifferent curves can be used to depict different kinds of preferences.[iv] Different points on the same indifference curve mean each point yields exactly the same amount of utility to the person and thus he is indifferent from choosing any point on the same indifference curve. To find out how rational parties will respond to the threat of punitive damages, one needs to first see whether their response will promote or fail to promote social welfare. The notion of social welfare is determined by the well-being of individuals: thus, social welfare generally rises as individuals’ well-being rises, and falls as individuals’ well-being falls[v]. In particular, social welfare reflects the deterrence objective of punitive damages, for the avoidance of harm preserves the well-being of persons and social welfare reflects the punishment objective of punitive damages, for the punishment of wrongdoers may be desired by individuals.[vi]

To make a simple model,

Let p: price;

q: quantity purchased;

h: harm

u: utility enjoyed from purchased goods;

c: per unit cost of manufacturing;

social welfare when no harm occurs: (u – pq) + (p – c)q;

social welfare when harm occurs: (u – pq – h) + (p – c)q

To make consumer indifferent between no harm and with harm, there needs to be compensatory damages in which manufacturer pays the consumer h amount of compensation. In economic models of strict liability, perfect compensation leaves the victim indifferent between no harm and harm with h amount of compensation, given that other things being equal (ceteris paribus)[vii]. In other words, perfect compensation restores the victim to the same indifference curve as if no injury had occurred. Given that this logical flow is consistent, one might pose a theoretical question on why not the government give the manufacturers the permission to do everything instead impose full compensation liability for all damages they have caused. As long as consumers who have experienced harm due to specific products are fully compensated and become indifferent between no harm and harm with compensation, it might seem economically efficient or even optimal to permit anything to corporates that manufacture products. At first glance, implementing perfect compensation seems rational when a defective product has a perfect substitute in the market, such as automobiles, but when it comes to a unique object with an imperfect substitute, such as an oil painting, claiming for perfect compensatory damages might not be possible. Also, if the injury caused by the product severely harms a person or a living thing, the loss cannot be counted accordingly. For instance, a certain product may cause a child’s death, and his parents may feel that no amount of money could make them indifferent to the death of their child[viii]. As such, the existence of losses that are not compensable signals inappropriate aspects of compensatory damages and suggests a need for an alternative principle.

 

Ⅱ. The Necessity of Punitive Damages and its Characteristics

Generally speaking, punitive damages punish injurers by charging the amount far exceeding the cost of actual harm occurred in the cases where intentional malice or anti-social behavior is detected.[ix] In this way, it can be said that the purpose of punitive damages is to punish the defendant, deter potential injurers, reward victims for undergoing litigation, and to correct a shortfall between actual harm and allowable damages.

However, economic model does not support the view that punitive damages should correct the shortfall between actual harm and allowed compensation or reward plaintiffs who otherwise would not sue.[x] In particular, continuing from the above equation;

social welfare when harm occurs: (u – pq – h) + (p – c)q

If injurer pays compensation three times the actual harm, 3h, that would make the social welfare less than the former. In the process of litigation, a victim needs to prove the causal link between the manufacturer’s negligence and the serious damage he has suffered, and let say this cost be L.

social welfare when compensatory damages: (u – pq – h) + h + (p – c)q – h > social welfare when punitive damages: (u – pq – h) – 3h – L + (p – c)q – 3h

The rules of strict liability are socially inefficient even if only some costs are externalized. The economic model, nevertheless, suggests how courts can improve the consistency of punitive damages. As such, punitive damages should be restricted to exceptional cases where intentional faults go against the legal standard of care by a significantly large amount[xi]. Also, the awards for punitive damages should be large enough to deter the future malicious behaviors by corporates.[xii] These characteristics – the existence of manufacturer’s intentional faults, requirement of severe damage to life or a body of person, and compensation amount up to thrice the actual harm inflicted – are well-reflected in the newly revised Korean Product Liability Act.

 

Ⅲ. Specific Changes to Korean PL Act

1. Legislative Purpose

There have been continuous claims for revising Product Liability Act in Korea, and after Oxy Humidifier Sterilizer scandal broke out, a number of National Assembly members have begun to take actual actions on the legislation on punitive damages. Thereafter, a new clause has been added to Article 3:

(2)  Notwithstanding paragraph (1), if a manufacturer causes serious damage to life or body of a person as a result of not taking necessary measures against a defect of a product despite the manufacturer’s knowledge of such defect, the manufacturer shall be liable up to three times the damage sustained by the person. In such cases, the court shall consider the following factors when determining damages: <Newly Inserted by Act No. 14764, Apr. 18, 2017> 1.  Degree of intentionality; 2.  Severity of damage caused due to the defect of the relevant product; 3.  Financial gains obtained by the manufacturer from supplying the relevant product; 4.  Where any criminal punishment or administrative disposition is imposed on the manufacturer due to the defect of the relevant product, severity of such criminal punishment or administrative disposition; 5.  Period during which the relevant product is supplied and supply volume; 6.  Financial status of the manufacturer; 7.  Efforts made by the manufacturer to repair the damage.

 

The clause preceding this one (Article 3 Clause 1) is about general principle on the range of compensation such that “A manufacturer shall compensate for damages to the life, body or property of a person caused by a defect of a product (excluding damages inflicted only to the relevant product)” and the next clause which is newly inserted is a special provision to the former. The reason behind implementing this principle, which is declared in the proposed amendment of National Assembly, is that victims are not sufficiently protected and that the financial compensation received does not reach the expected amount based on common knowledge.[xiii] The fact that profits yielded by manufacturers committing illegal acts are enormous whereas damages to each victim remain small, leads to repeated malicious tort and moral hazard of corporates. Considering this, punitive damages is implemented on the intention to effectively deter further intentional illegal behaviors of corporates in the future and to substantially reward victims. In other words, through punitive damages, the court can reclaim unjust profit collected by malicious corporates and provide policy implications that can contribute to prevent similar incidents from happening.

 

2. Requisite for Punitive Damages

The requirements for awarding punitive damages consist of three main conditions: (1) manufacturers were aware of the product defect yet did not take any further action needed to prevent the harm (2) as a result, serious damage to life or a body of person occurred (3) there is a causal relationship between the first and second conditions. That is to say, damage needs to be occurred as a consequence of the manufacturer’s nonfeasance.

The controversial topic arises from debate over who has the responsibility to prove this very relationship[xiv]. It is expressly stipulated in Article 3-2 that:

Where the injured person proves the following facts, it shall be presumed that the product had a defect at the time the product was supplied and damage was caused because of the defect: 1.  That damage was caused to the injured person while the product was being used normally; 2.  That the damage referred to in subparagraph 1 was attributable to a cause practically controllable by the manufacturer; 3.  That the damage referred to in subparagraph 1 would not ordinarily be caused if it were not for the relevant defect of the product. [This Article Newly Inserted by Act No. 14764, Apr. 18, 2017]

 

However, as previously mentioned in order to be acknowledged as punitive damages, there needs to be a proven causal relationship between the manufacturer’s intentional non-performance, such as not taking further measure to prevent the harm, and the actual harm. Here the question rises whether this causal relationship is separate from the one mentioned in Article 3-2[xv]. There has not been a unified consensus or precedents yet, and thus further discussion over this matter needs to be developed.

 

3. Effects of the Act

Once a case satisfies above-mentioned requirements, it is subject to be punitive damages claim and the specific manufacturer should compensate for the loss up to three times the injury. The reason constraining the range to thrice is not only to consider the financial burden on corporate’s side but also to consider the balance with other regulations which already contains punitive damages itself such as Fair Transaction in Subcontracting Act. Otherwise, it would result in levying excessive amount of compensation.

 

4. Limitation of the Act

Since punitive damages is a special provision to compensatory damages, it seems natural that the requisite to acknowledge punitive damages is strict and confines to exceptional cases (that in principle, victim needs to prove harm occurred unless there exists any specia). However, if the range of these exceptionally accepted cases is narrow, the new revision to Product Liability Act would be in vain.

 

Ⅳ. Conclusion

Those who opposed the implementation of punitive damages in Korean PL Act argued that consolation money is already functioning as additional compensation in Korean civil law, and therefore implementing punitive damages to prevent future harms is not necessary[xvi]. On the contrary, those who proposed the implementation of punitive damages claimed that in order to acknowledge consolation money as an alternative to punitive damages, harms that exceed perfect compensation such as psychiatric damages need to be covered, further legislating measure is required. However, even without the reasons mentioned above, economically speaking, punitive damages achieve social optimum better than perfect compensation, that is to say, increases overall social welfare.

Even though there can be worrying voices over the limitation of the revision, nevertheless, major changes have been made and the fact that these changes happened after 15 years of enforcement itself is already significant. In practice, if strict requirement clause is interpreted more flexibly by the court and applied rather broadly, it would make difference. More cases need to be accumulated for possible problems to get revealed and to be discussed. Also, should there breaks out problems, further discussions and changes can be carried out by the Korean public as well as legislation party.

 

References

Varian, Hal R. Intermediate Microeconomics: a Modern Approach. W.W. Norton & Company, 2003.

Posner, Richard A. Economic Analysis of Law. Wolters Kluwer Law Et Business, 2014.

Chulyoung Kim, Law and Economics: Issues in Liability and Litigation, Yonsei University, 2017.

 

[i] Seven years after Oxy Humidifier Scandal, what have left to us, SBS News (March 18, 2018).

[ii] Seo, Heesok, Task of improving related legislation to rescue collective consumer damages after humidifier sterilizer scandal, Cheongpa Law Journal, Vol. 13, 10 (July. 2016).

[iii] Seo, Heesok, Implications and Limitations of the revised Product Liability Act, Science Technology and Law, Vol. 8, No. 1, 137 (June 2017).

[iv] Varian, Hal R. Intermediate Microeconomics: a Modern Approach. W.W. Norton & Company, 34 (2003).

[v] A. Mitchell Polinsky and Steven Shavell, Punitive Damages: An Economic Analysis, Harvard Law Review, Vol. 111, No. 4, 869, 873 (Feb. 1998).

[vi]. Robert D. Cooter, Punitive Damages, Social Norms, and Economic Analysis, 60 Law & Contemp. Probs, 73, 91 (1997).

[vii] Id. at 76.

[viii] Id. at 79.

[ix] Kim, Min-Joong, Amendments to the New Korean Product Liability Act, Northeast Asian Law Journal, Vol. 9, No. 3, 289, 327 (2016).

[x] Robert D. Cooter, Economic Analysis of Punitive Damages, 56 S. Cal. L. Rev, 79-101 (1982).

[xi] Id. at 89.

[xii] Id. at 98.

[xiii] supra note3, at 144.

[xiv] supra note3, at 147.

[xv] supra note3, at 148.

[xvi] supra note3, at 156.

 

 

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