Medasys Acquisition Corp. v. SDMS, P.C.

SUPREME COURT OF ARIZONA
En Banc

MEDASYS ACQUISITION CORPORATION, ) Arizona Supreme Court
dba MEDASYS DIGITAL SYSTEMS, ) No. CV-02-0045-PR
)
Plaintiff, Counterdefendant- ) Court of Appeals
Appellant, ) Division One
) No. 1 CA-CV 00-0472
v. )
) Maricopa County
SDMS, P.C., an Arizona profes- ) Superior Court
sional corporation, ) No. CV 98-011575
)
Defendant, Counterclaimant- )
Appellee. ) O P I N I O N
)

Appeal from the Superior Court of Maricopa County
The Honorable Jonathan H. Schwartz, Judge

Court of Appeals, Division One
Memorandum Decision

VACATED IN PART AND REMANDED

WARNICKE & LITTLER, P.L.C. Phoenix
by Thomas E. Littler
and
FINE & ASSOCIATES, P.A. Coral Gables, Florida
by Edward A. Licitra
Attorneys for Plaintiff, Counterdefendant-Appellant

BURCH & CRACCHIOLO, P.A. Phoenix
by Bryan F. Murphy
and John D. Curtis
Attorneys for Defendant, Counterclaimant-Appellee

B E R C H, Justice

¶1 We granted review to determine whether a party’s election

of the equitable remedy of rescission automatically precludes it

from also receiving an award of punitive damages. We conclude that

it does not.
 BACKGROUND

¶2 In January 1998, SDMS, a medical practice, contracted to

purchase computer-assisted diagnostic nuclear imaging equipment

from Medasys Acquisition Corporation. The contract required that

SDMS trade in its old diagnostic imaging equipment and make a down

payment of $10,900. SDMS was to pay the balance of $98,100 in

three installments after Medasys installed the equipment and

trained SDMS personnel to use it. Medasys understood SDMS’s

requirements that the equipment perform “head to toe” whole body

imaging, that the software perform “renal function studies at all

ages with age-corrected nomograms for all age groups,” and that the

equipment perform three-dimensional studies. Medasys representa-

tives assured SDMS that the equipment could perform these func-

tions.

¶3 After Medasys delivered the imaging equipment, SDMS

discovered that it did not perform the required functions. The

whole body imaging function, which was supposed to generate a

computer image of a subject’s body, would produce an image on which

the subject’s feet would appear on the top of the subject’s head on

subjects taller than 1.9 meters. The renal software could not

provide age-corrected nomograms for individuals over sixty years of

age – a group that comprised a large portion of SDMS’s practice –

and the camera head did not pivot freely, thus preventing it from

making three-dimensional studies.

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¶4 SDMS exchanged several letters with Medasys attempting to

resolve the problems. On April 21, 1998, Medasys demanded that

SDMS begin making payments on the balance of the contract. When

SDMS refused to pay until the problems with the equipment were

corrected, Medasys sued for breach of contract and unjust enrich-

ment. SDMS counterclaimed for breach of contract, breach of

warranty, and consumer fraud,1 seeking consequential damages,

punitive damages, and rescission. SDMS offered to return Medasys’s

equipment in exchange for the return of its down payment and SDMS’s

original equipment.

¶5 During a three-day trial, SDMS presented damaging

testimony from former Medasys employees regarding that company’s

fraudulent business practices. A former Medasys field engineer

testified that Medasys routinely delivered equipment that the

company knew was not functioning properly. Indeed, he testified

that Medasys knew that the whole body imaging function on the

diagnostic imaging machine sold to SDMS was not working properly

before it was delivered to SDMS. An independent contractor who

handled sales for Medasys testified that he was instructed to

“[g]et the sale. Promise [SDMS] whatever you need to. We’ll worry

about it later.” He characterized such promises as routine and

1
Although SDMS requested an instruction on consumer fraud,
a cause of action that would have supported punitive damages, the
trial court did not give one. The court of appeals did not address
the issue because SDMS did not object to the failure to give the
instruction.

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customary business practices for Medasys.

¶6 The jury returned a verdict in favor of SDMS. The jury,

sitting in an advisory capacity on the equitable claims, recom-

mended awarding SDMS $20,488 in rescissory damages and $275,000 in

punitive damages. The rescissory damages equaled the down payment

of $10,900 and an additional $9,5882 to compensate SDMS for its old

imaging equipment, which Medasys had either thrown away or

disassembled for parts and thus was unable to return. The trial

court adopted the jury’s recommendation, finding that “the evidence

was clear and convincing that Medasys consciously disregarded the

risk [to] . . . SDMS [by] not getting equipment capable of

performing the functions Medasys knew SDMS required.”

¶7 Medasys appealed, arguing among other things that the

trial court erred as a matter of law by awarding punitive damages

where no actual damages had been awarded. The court of appeals

agreed and vacated the portion of the judgment awarding punitive

damages to SDMS. Medasys Acquisition Corp. v. SDMS, P.C., 1 CA-CV

00-0472, slip op. at ¶ 27 (Jan. 3, 2002) (mem. decision). We

granted review to determine whether punitive damages were properly

awarded.

DISCUSSION

¶8 Whether punitive damages are awardable on an equitable

2
The parties’ contract had provided this value for SDMS’s
old machine.

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claim is a legal issue, which we review de novo. Hall v. Lalli,

194 Ariz. 54, 57, ¶ 5, 977 P.2d 776, 779 (1999).

¶9 Citing Hubbard v. Superior Court (American Alliance Life

Insurance Co.), 111 Ariz. 585, 535 P.2d 1302 (1975), the court of

appeals held that SDMS’s election of the equitable remedy of

rescission precluded its claim for punitive damages. This court’s

summary disposition in Hubbard, however, did not foreclose an award

of punitive damages in an equity case. It simply reaffirmed the

traditional rule that actual damages must be proved before punitive

damages may be recovered. Id. at 586, 535 P.2d at 1303. The court

of appeals evidently concluded that SDMS had not proved actual

damages.

¶10 This court’s two-paragraph per curiam decision in Hubbard

must be read in light of the expanded opinion on the subject in

Starkovich v. Noye, 111 Ariz. 347, 529 P.2d 698 (1974), decided

just six months earlier. In Starkovich, we concluded that Arizona

courts may award punitive damages in an equitable action and

construed broadly the “actual damages” needed to support the award

as including the alteration of one’s position to one’s detriment.3

See id. at 352, 529 P.2d at 703.

3
In seeming to require that monetary damages be proved,
the court in Hubbard failed to give effect to the well-considered
rationale in Starkovich for expanding the definition of “actual
damages” to allow Arizona courts to provide more complete relief in
equity cases. To the extent that Hubbard may be read to conflict
with Starkovich, Hubbard is overruled.

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¶11 Starkovich informs the disposition of this case. The

plaintiff in Starkovich had sued for a declaratory judgment,

seeking reformation of a contract (an equitable claim) and punitive

damages (a legal claim) for the defendants’ alleged fraud. Id. at

348, 529 P.2d at 699. The trial court found reformation appropri-

ate and awarded punitive damages. Id. at 350, 529 P.2d at 701.

The court of appeals reversed. Id. Agreeing with the trial court,

this court noted that “Arizona ha[d] long abolished the distinction

between legal and equitable action[s],” id. at 351, 529 P.2d at

702. We thus reasoned on review that courts should be able to

award the relief appropriate in each case “without distinction as

to the nature of the relief demanded” and further directed that

courts “shall give all the relief either in law or equity to which

a party may show himself entitled.” Id. (quoting McRae v. Lois

Grunow Memorial Clinic, 40 Ariz. 496, 14 P.2d 478 (1932)). We

found no “reason in logic to deny a complete remedy for a fraud,”

Starkovich, 111 Ariz. at 352, 529 P.2d at 703, and therefore

allowed the recovery of punitive damages.

¶12 Much as Medasys does in this case, the defendants in

Starkovich objected that the award of equitable relief did not

satisfy the requirement that “actual damages” be proved before

punitive damages can be awarded. They argued that the reformation

could not be “construed as compensatory damages sufficient to

satisfy the requirement that actual damages must be awarded in

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order to support [the] punitive damages [award].” Id. at 350, 529

P.2d at 701. We disagreed and expanded the definition of actual

damages to include not only pecuniary loss, but also “the alter-

ation of one’s position to his prejudice.” Id. at 351, 529 P.2d at

702 (quoting Nab v. Hills, 452 P.2d 981, 987 (Idaho 1969) (emphasis

in original)).

¶13 The expanded definition applies here. SDMS has altered

its position to its prejudice in reliance upon Medasys’s false

representations that the new medical imaging equipment would

fulfill specific requirements. Although SDMS offered to return

Medasys’s equipment for return of its old machine and a refund of

its down payment, Medasys, having destroyed or parted-out SDMS’s

machine, was unable to return it. SDMS therefore was left with no

working machine and not enough money to buy a functioning one, an

alteration of its position to its detriment because of its reliance

on Medasys’s fraudulent promises.4

¶14 The traditional rule requires an award of actual damages

before punitive damages may be awarded, and we adhere to that rule.

But several reasons support expanding the definition of actual

damages to allow other types of harms to serve as the actual

4
The court of appeals characterized this state of affairs
as a return to the status quo ante. We disagree. Before it began
its dealings with Medasys, SDMS had functioning, though concededly
inferior, diagnostic imaging equipment. During its interaction
with Medasys and for some time afterward, SDMS was left without
vital diagnostic equipment.

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damages predicate that will support the recovery of punitive

damages.

¶15 First and foremost, Arizona authorities have long

subscribed to the notion that courts must be able to provide the

relief to which the parties before them are entitled. See, e.g.,

id. at 352, 529 P.2d at 702; Jennings v. Lee, 105 Ariz. 167, 173,

461 P.2d 161, 167 (1973) (affirming the court’s “ample authority”

to award a defrauded party not only “the consideration he gave,”

but also “any sums that are necessary to restore him to his

position prior to the making of the contract”); Fousel v. Ted

Walker Mobile Homes, Inc., 124 Ariz. 126, 129, 602 P.2d 507, 510

(App. 1979) (upholding an award of punitive damages on an equitable

claim of rescission where consequential damages were also awarded);

Dan B. Dobbs, THE LAW OF REMEDIES § 3.11(10) (2d ed. 1993); Ariz. R.

Civ. P. 54(d) (requiring Arizona courts to award appropriate relief

in any civil action, “even if the party has not demanded such

relief in the party’s pleadings”); Ariz. Rev. Stat. (“A.R.S.”) §

12-1838 (1994) (allowing “further relief” in a declaratory judgment

case); A.R.S. § 47-2720 (1997) (Uniform Commercial Code provision

stating that rescission of a contract “shall not be construed as a

renunciation or discharge of any claim in damages”).5 No reason

5
Although the parties did not raise the issue, this sale
would fall within the scope of the Uniform Commercial Code (“UCC”),
A.R.S. §§ 47-1101 to -9501 (1997). As noted above, under UCC § 47-
2720, rescission of a contract does not bar a claim for damages.

-8-
justifies allowing punitive damages for the tort of fraud, which by

its nature involves intentional wrongdoing, but denying such

damages for tortious fraud in connection with an equitable action.

See, e.g., Mehovic v. Mehovic, 514 S.E.2d 730, 734 (N.C. App.

1999); Black v. Gardner, 320 N.W.2d 153, 161 (S.D. 1982). Thus, if

a party has “pursued a course of conduct knowing that it created a

substantial risk of significant harm to others” and its conduct was

guided by evil motives, punitive damages should be available to

punish such behavior. See Rawlings v. Apodaca, 151 Ariz. 149, 162,

726 P.2d 565, 578 (1986).

¶16 Second, to deny punitive damages to prevent “double

recovery” of an item of contract damages protects against an

unfounded concern. See Fousel, 124 Ariz. at 129, 602 P.2d at 510

(quoting Dan B. Dobbs, THE LAW OF REMEDIES § 9.4, at 634 (1973)). An

award of punitive damages in an action for rescission does not

raise this double-compensation concern because “punitive damages do

not stem from enforcement of the contract and are not to compensate

the plaintiff for losses sustained, but rather to punish the

defendant for his conduct.” Id. at 130, 602 P.2d at 511.

Therefore, there is no fear of overcompensation for any element of

contract damages, which is the fear underlying the preclusion of

both compensatory damages and rescission.

¶17 Finally, we do not believe, as Medasys asserts, that

allowing punitive damages in an equitable action will encourage

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parties to sue expecting a “windfall [of punitive damages] to the

recipient.” Punitive damages are awarded only “in the most

egregious of cases, where [a plaintiff proves by clear and

convincing evidence that the defendant engaged in] reprehensible

conduct” and acted “with an evil mind.” Linthicum v. Nationwide

Life Ins. Co., 150 Ariz. 326, 331-32, 723 P.2d 675, 680-81 (1986);

Fousel, 124 Ariz. at 130, 602 P.2d at 511. For that reason,

punitive damages should rarely be awarded. In those cases in which

they are appropriate, punitive damages should be available to deter

egregious conduct.

¶18 We therefore agree with those authorities that have

observed that an election of an equitable remedy need not preclude

an award of punitive damages. E.g., Dan B. Dobbs, THE LAW OF REMEDIES

§ 3.11(10) (2d ed. 1993); Gary L. Monserud, Rescission and Damages

for Buyer Due to Seller’s Fraudulent Inducement of an Article 2

Contract for Sale, 1998 Colum. Bus. L. Rev. 331, 404; Note, Recent

Developments: Punitive Damages Held Recoverable in Action for

Equitable Relief, 63 Colum. L. Rev. 175, 178-79 (1963); Madrid v.

Marquez, 33 P.3d 683, 686 (N.M. Ct. App. 2001); Mehovic, 514 S.E.2d

at 734; Black, 320 N.W.2d at 161. The critical inquiry should be

whether such an award is appropriate to penalize a party for

“outwardly aggravated, outrageous, malicious, or fraudulent

conduct” that is coupled with an “evil mind.” Linthicum, 150 Ariz.

at 331, 723 P.2d at 680. If it is, punitive damages should be

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available to allow the imposition of a remedy appropriate to punish

the wrongful act and to remedy the injury caused.

¶19 No reason justifies distinguishing between rescissory

damages and compensatory damages as a basis for allowing or denying

an award of punitive damages. Conduct so egregious as to warrant

punitive damages if compensatory damages are awarded should

similarly support an award of punitive damages if only rescissory

damages are awarded. See Dobbs, THE LAW OF REMEDIES § 3.11(10) (2d

ed. 1993); Note, Punitive Damages Held Recoverable, supra at 178-

79. This conclusion follows the modern trend of allowing “punitive

damages in equity in order to facilitate judicial administration,

to deter misconduct, and to completely serve justice.” Madrid, 33

P.3d at 686; see also Forster v. Boss, 97 F.3d 1127 (8th Cir. 1996)

(interpreting Missouri law); Village of Peck v. Denison, 450 P.2d

310 (Idaho 1969); Mehovic, 514 S.E.2d at 734. It also comports

with the Arizona policy of providing complete relief to injured

parties.

¶20 In the case before us, SDMS succeeded in proving

Medasys’s fraudulent conduct. The jury found that SDMS sustained

actual damages and recommended awarding SDMS rescissory damages.

In addition, the jurors found by clear and convincing evidence that

Medasys employees acted with evil intent in their dealings with

SDMS and therefore the jury recommended an award of punitive

damages to punish Medasys for its conduct. Our review shows that

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such an award may be appropriate.6

CONCLUSION

¶21 We vacate the portion of the court of appeals’ decision

reversing the award of punitive damages and remand to that court

for resolution of issues left undecided.

Rebecca White Berch, Justice

CONCURRING:

Charles E. Jones, Chief Justice

Ruth V. McGregor, Vice Chief Justice

Stanley G. Feldman, Justice

Joseph W. Howard, Judge*

*Pursuant to Ariz. Const. Article VI, Section 3, the Honorable
Joseph W. Howard, Judge of the Arizona Court of Appeals, Division
Two, was designated to sit on this case.

6
Medasys asserted in the court of appeals that there was
insufficient evidence that its employees acted with an “evil mind”
to support the punitive damages award. Because that court held
that punitive damages were not recoverable, it did not rule on the
sufficiency of the evidence issue. We therefore remand that issue
to the court of appeals for determination.

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