Toyota’s Billion Dollar Legal Liability

The congressional hearings on the Toyota recalls have left many uncertain of where to step.  The only clear thing is that no one wants to step inside a Prius.

Washington has dealt with automotive recalls before, but the investigation of Toyota has sparked fervent upheaval from unexpected angles.  For one thing, the government has openly acted for the benefit of the opposition, making the congress appear less like lady justice with blindfold intact and more like a trader spearheading his investment.  Certainly from the perspective of American auto-makers, Toyota’s blunder couldn’t have come to light at a better time.

Furthermore, there are certain legal aspects of the case against Toyota that suggests Detroit’s elation is much more than wishful thinking.  Under the law, there is a marked difference between ordinary “negligence” and what has been termed “gross negligence.”  The law requires “reasonable care” or “ordinary prudence”, and negligence is a cause of action that arises when one party’s conduct simply falls short somehow.  However, “gross” negligence is a wrong of a higher magnitude.  It is negligence plus the additional element of some “willful and wanton” misconduct.

In other words, Toyota will be on the hook for simple negligence if congress finds that it should have known about the defects but didn’t; but if the company actually knew about them the whole time, congress can find gross negligence.

So, did Toyota know about the defects all along?  The plaintiffs’ pleadings say “yes”, and a few former insiders agree.  In a release to the Los Angeles Times, many former Toyota employees have blamed the company’s lack of procedural controls.  While handling a regulatory compliance issue in 1979, Laurence Boland recalled submitting a report about sticking gas pedals to Toyota’s engineering operation in Japan.  However, the official submission to the National Highway Traffic Safety Administration lacked several key admissions.  Boland believes the Japanese office covered up the details.

Other former Toyota managers opined that the connections of Toyota Corporate in Japan to U.S. subsidiaries were designed to be so thin that such issues could be swept aside at whim by the central office.  Legal experts also say that certain cultural sensibilities in Japan may clash with duties imposed by the law. Cover-ups don’t seem unlikely at all in light of Toyota’s announcement that the SEC has subpoenaed several documents, suggesting a criminal securities investigation.  If Toyota’s awareness of the safety issues exceeds a certain threshold, it may be found liable, not just for the garden variety negligence, but for “gross” negligence.

Why the distinction?  Aside from the damage to the company’s image from the more severe charge, Toyota could face expansive liability.  The company could stand to lose up to several billion.  And while ten-digit verdicts are rare enough themselves, consider the magnitude of Toyota’s potential exposure in the context of other cases involving gross negligence.  In the notorious Firestone Tire case, the verdicts were around a measly 30 million.  Even in the largest cases, the damage award never got over $400-million, and those verdicts were reduced on appeal. This is about a quarter of some of the awards sought from Toyota.

Several factors contribute to this massive difference.  First, the cases of sticky brake pedals are much more numerous.  In the last decade, about 2,600 legal complaints have been filed by plaintiffs, including more than 30 wrongful deaths.  Also, many have pled the particular harm of impaired resale value, and Toyota buyers have been exceptionally ready to organize into classes behind their claims.

Most importantly however, the “gross negligence” charge allows a court to award punitive damages.  Ordinarily, courts are limited in the money awards they can grant by the amount necessary to address the injury actually suffered by victims of the wrong.  However, punitive damages are intended to, as the name suggests, punish exceptionally heinous conduct, operating like a judicial fine on the party found culpable.  Although there are certain limits in many jurisdictions, the massive judicial verdicts that have generated so much notoriety were mostly punitive awards.  The charge of gross negligence opens the door for the court to consider such punitive damages.

Aside from how much is to be paid, there is also the question of who will pay.  As many became painfully aware during the AIG bailout, businesses often enlist insurers to shelter them during sudden downpours, passing the losses on.  Unfortunately for Toyota, these insurance policies often do not extend to the principal when it is found guilty of gross negligence.  Congress may have fed AIG the money to fulfill its responsibilities to its undersigned, but if Toyota cannot even prevail on a claim to its insurer, it will have to do what many American companies have avoided: pay the bill from its own coffers.

Some may consider a multi-billion dollar verdict a drop in the bucket for a company posting sales of $200 billion last fiscal year, but in a business world of narrowing margins, a sum this large can be pivotal.  Just ask the Toyota executives who reported the company’s 1.5 billion dollar operating loss for the first half of Fiscal Year 2010.  My guess is that the second half will not be much better.  One thing is clear: the arena of gladiatorial combat for Toyota’s future will not be the sales floor.  It will be the courtroom.