Punitive Damages Class Action Defense Issues–City of Hope v. Genentech: California Supreme Court Affirms $300 Million Compensatory Award For Breach Of Contract But Reverses $200 Million Punitive Damage Award For Breach Of Fiduciary Duty

May 5, 2008 | By: Michael J. Hassen

Punitive Damages for Breach of Fiduciary Duties Improper because Evidence Established Merely Contractual Relationship even though Plaintiff Entrusted Secret Scientific Discoveries to Defendant for Commercial Exploitation California Supreme Court Holds

Plaintiff City of Hope filed suit (not a class action) against Genentech alleging breach of contract and breach of fiduciary duties arising out of an agreement whereby “City of Hope, in return for royalties, entrusted a secret scientific discovery to Genentech to develop, to patent, and to commercially exploit.” City of Hope v. Genentech, Inc., ___ Cal.4th ___ (Cal. April 24, 2008) [Slip Opn., at 1]. Plaintiff prevailed at trial, and the jury awarded $300 million in compensatory damages and $200 million in punitive damages. Id. In a case of critical importance to class action and non-class action cases alike, the California Supreme Court addressed “whether, as the jury found, a fiduciary relationship necessarily arose” between City of Hope and Genentech. Id. The High Court held that it did not and, accordingly, reversed the punitive damage award. However, in a portion of the opinion that we do not summarize, the Supreme Court affirmed the $300 million damage award, concluding that “the evidence that City of Hope introduced at trial to prove that Genentech had breached a fiduciary duty [did not] so prejudice[] the jury as to require setting aside the jury’s award of compensatory damages for breach of contract.” Id., at 2. We again stress that this lawsuit was not a class action, but it involves a topic of significant importance to class action litigation.

In brief, scientists employed by City of Hope “developed a groundbreaking process for genetically engineering human proteins,” and filed a confidential application with the National Institutes of Health for a grant. City of Hope, at 2-3. Genentech was formed by a doctor who learned of the discovery and a venture capitalist “to commercially exploit biotechnology.” Id., at 3. Genentech contacted the City and offered to fund additional research and to secure the patents required for commercialization of the products developed; these discussions led to a draft agreement that left open the royalty rate because Genentech had not yet decided whether to accept the City’s proposal of a 2% flat rate. Id. Ultimately, the parties entered into a contract, see id., at 4-6 (summarizing salient terms), and “the rest is history,” so to speak. Genentech obtained various patents and granted various licenses, but it did not inform the City of all of those licenses. Id., at 6. Genentech also filed a lawsuit, which it settled for $20 million, alleging infringement of patents held by the City’s scientists, but it refused to share any of that award with the City. Id., at 8. That refusal precipitated the lawsuit by the City against Genentech for breach of fiduciary duty and breach of contract, id. As noted above, while the first trial ended deadlocked at 7-5 in favor of Genentech, the jury at the second trial ruled in favor of the City, id., at 8-9.

On appeal, defense attorneys argued that the contract between Genentech and the City did not give rise to a fiduciary relationship; the Supreme Court agreed. City of Hope, at 9. Under California law, “before a person can be charged with a fiduciary obligation, he must either knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that undertaking as a matter of law.” Committee on Children’s Television, Inc. v. General Foods Corp., 35 Cal.3d 197, 221 (Cal. 1983). The Supreme Court found no evidence in the contract that Genentech “entered into it with the view of acting primarily for the benefit of City of Hope.” City of Hope, at 9. On the contrary, the agreement reflected an intent to achieve a “mutually beneficial arrangement,” not one in which Genentech would act for the benefit of the City. Id., at 10. Further, the jury was not instructed and so did not find that Genentech “knowingly” undertook to on of and for the benefit of the City, id. The issue, then was whether the relationship itself – “whether an agreement to develop, patent, and commercially exploit a secret scientific discovery in exchange for the payment of royalties” – is one for which the law will impose an obligation to act as a fiduciary. Id.

The City argued that under existing California law the trial court properly instructed the jury that a “fiduciary relationship arises when a person entrusts a secret idea or device to another under an arrangement whereby the other party agrees to develop, patent and commercially exploit the idea in return for royalties.” City of Hope, at 11 (citing Stevens v. Marco, 147 Cl.App.2d 357 (Cal.App. 1956)). Stevens was the City’s “one theory” of fiduciary duty liability from day one. Id., at 12. The City argued that a fiduciary relationship exists because “(1) one party entrusts its affairs, interests or property to another; (2) there is a grant of broad discretion to another, generally because of a disparity in expertise or knowledge; (3) the two parties have an “asymmetrical access to information,” meaning one party has little ability to monitor the other and must rely on the truth of the other party’s representations; and (4) one party is vulnerable and dependent upon the other.” Id. The Supreme Court held, however, that the four factors relied upon by the City were common to contractual relationships, and “do not necessarily give rise to a fiduciary relationship.” Id.,a t 13.

The facts of this case revealed that both parties were sophisticated, possessed substantial bargaining power, and were represented by counsel, and that the City “was to be an independent contractor.” City of Hope, at 14. The mere fact that the City “had to rely on Genentech’s superior ability in obtaining patents and in marketing products” did not alter this fact, as that, too, as a common aspect of a contractual relationship. Id. So, too, is the fact that, as the City claimed, “it reposed trust and confidence in Genentech.” Id., at 15. Thus, the City’s “evidence” of a fiduciary relationship consisted of little more than the identification of characteristics common to contractual relationships. The Supreme Court held that “fiduciary obligations are not necessarily created when one party entrusts valuable intellectual property to another for commercial development in exchange for the payment of compensation contingent on commercial success,” id., at 18, and that the trial court erred in instructing the jury otherwise, id. Accordingly, it struck the award of punitive damages against Genentech. Id., at 28.

NOTE: We do not discuss the Supreme Court’s analysis and affirmance of the jury’s $300 million compensatory damage award; that discussion may be found at pages 19-28 of the slip opinion.

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