To be successful in the United States, a loser-pays
reform must be designed to reduce the number
of nuisance lawsuits, control overall litigation
costs, promote settlement, and ensure access
to justice for plaintiffs with strong legal
claims. To achieve these disparate goals within
the existing American legal system, this new
Manhattan Institute proposal incorporates a
modified offer-of-judgment rule, which ties
the amount of any fee award to the size of the
parties' settlement offers, and advocates the
removal of legal barriers to the establishment
of a robust litigation insurance industry in
new loser-pays jurisdictions.
About
The Author
Marie Gryphon is a Senior Fellow with
the Center for Legal Policy. As an attorney
in private practice, she worked on ERISA, securities,
class action, commercial contract, legal malpractice,
and constitutional law cases. She has also been
a legal and policy analyst with the Cato Institute,
working on issues related to education policy.
Her articles have appeared in The Washington
Post, Forbes, and National Review
Online. She holds a J.D. from the University
of Washington School of Law and is a Ph.D. candidate
in public policy at Harvard University.
Acknowledgments
Sincere thanks for helpful comments are due
to Ted Frank, Michael Krauss, Robert Levy, Clark
Neily, Walter Olson, and Alexander "Sasha"
Volokh, and to Gabriel Cahn for valuable research
assistance, none of whom should be assumed to
be in full accord with this report and none
of whom bears responsibility for any errors
or omissions.
The author would like to thank also the Cortopassi
Institute and Paul Singer for generous financial
support.
Findings presented in Manhattan Institute
publications are those of our scholars and are
not influenced by the individuals, foundations,
and corporations that support the Manhattan
Institute and its research.
*********************************************************
Foreword
A Principled Proposal for Tort Reform
By Rudy Giuliani
America needs tort reform, and this new report
published by the Manhattan Institute is an important
part of the road map leading us there. Civil
litigation consumes 1.87 percent of America's
gross domestic product, roughly twice that of
almost all other industrial countries. The price
tag for a family of four came to $3,300 in 2006.*
Only 16 percent of Americans say they trust
our civil justice system "to defend them"
if someone should bring a baseless lawsuit against
them.** This is evidence of a broken system
that needs to be fixed.
Here's just one example of the real cost of
abusive lawsuits. A family dry cleaning business
was recently dragged through two years of litigation
by a customer seeking $54 million as compensation
for a lost pair of pants. To make matters worse,
the person who brought this irresponsible lawsuit
was a judge. Though the case was dismissed,
the dismissal is now being appealed, and the
cleaning business's legal costs so far have
been almost $100,000.
In the health-care industry, many doctors report
ordering unnecessary tests to avoid lawsuits—in
Pennsylvania as many as 93 percent of doctors
have—costing up to $100 billion annually.
Doctors call this "defensive medicine."
I call it a "trial lawyer tax."
To reduce the impact of the trial lawyer tax,
we should reform the system by adopting rules
that discourage meritless lawsuits—rules
such as "loser pays," which is well
articulated in Marie Gryphon's timely report
for the Manhattan Institute. Gryphon's proposal
is recommended reading for policy analysts,
and food for thought for more casual observers,
as the issue of meritless lawsuits becomes even
more urgent and in need of real solutions.
At its core, loser pays seems fair. Under the
current, American rule, each party to a lawsuit
pays its own legal bills, win or lose. Because
it's so expensive to go to court, someone who
is sued loses even when he wins, as the family
dry cleaners found out. Knowing that the rules
are stacked against them, defendants settle
meritless claims, and these settlements in turn
fuel baseless new cases. For example, the dry
cleaner offered $12,000 to settle the case against
it—a sum far higher than the actual replacement
cost of the pants.
Loser pays, while unfamiliar to many Americans,
is not a radical idea. It is the rule in virtually
every other developed nation, across all of
Western Europe as well as Canada and Australia.
While loser pays would help stem the tide of
lawsuit abuse, it isn't a cure-all. We also
need to establish limits on punitive and non-economic
damages, which are too often used to turn the
legal system into a lottery. The possibility
of winning millions or even billions of dollars
encourages attorneys to file lawsuits with a
low probability of success.
In Texas, lawmakers and voters adopted a $250,000
cap on non-economic damages such as pain and
suffering in medical malpractice cases. The
law dramatically reduced doctors' malpractice
insurance premiums and cut in half the number
of lawsuits against them. Now, a flood of doctors
is moving to Texas in order to escape the unnecessarily
high cost of doing business elsewhere.
The integrity of our legal system is under
assault. Establishing loser-pays rules and other
tort reforms can help restore citizens' faith
in the bedrock of society—justice, fairness
and the rule of law.
* Towers Perrin, 2007 Update on U.S. Tort
Cost Trends, p. 3.
** Harris Interactive, “Public Trust of
Civil Justice,” June 20, 2005.
*********************************************************
I. INTRODUCTION
Although the American justice system
is derided as expensive, capricious, and prone
to abuse, Americans go to court more often—and
more expensively—than any other people
in the world.[3] While
all litigation is costly, this paper will focus
on the high cost of "abusive litigation":
litigation filed by a plaintiffs' attorney who
has good reason to believe that he is legally
in the wrong but who sues anyway in order to
exact revenge or coerce a settlement from the
lawsuit's target.
The purpose of this paper is to explore the
possibility of reducing the incidence of abusive
litigation in the United States through the
adoption of a loser-pays rule. Part I of this
paper reviews evidence of the high cost of the
current system; summarizes the state of the
debate between proponents and opponents of loser
pays; and proposes standards for the evaluation
of legal procedural reforms. Part II describes
the current state of the legal marketplace and
how some of its participants profit from abusing
it. Part III summarizes the best theoretical
research into what kinds of effects we could
expect loser pays to have on litigation. Part
IV builds on the hypotheses developed in Part
III by examining evidence from overseas as well
as from two important loser-pays regimes here
in America. Part V explores the possibility
of preserving access to justice for plaintiffs
with strong lawsuits through a system of litigation
insurance. Part VI offers guidelines for loser-pays
reform implementation. Part VII provides a final
loser-pays reform proposal and states our conclusions.
PART I: REFORMING A COSTLY SYSTEM
The United States struggles with a uniquely
costly civil justice system. The direct costs
of tort litigation—including payments to
plaintiffs, legal expenses and fees, and the
administrative cost of insuring the system—reached
$247 billion in 2006. Moreover, tort costs have
grown more quickly than the rest of the U.S.
economy, rising at an average annual rate of
9.2 percent between 1951 and 2006, a period
during which GDP grew at an average rate of
only 7 percent.[4]
The $54 million claim that Washington, D.C.,
administrative judge Roy Pearson filed against
his local dry cleaner last year typifies the
problem of abusive litigation in the eyes of
millions of Americans.[5]
Pearson's allegation: that Jin and Soo Chung
had lost a pair of trousers that he had left
at the store for alterations. Not only had the
Chungs failed to alter and return his pants,
Pearson claimed; they defrauded him and other
D.C. residents by posting a sign in their window
reading "satisfaction guaranteed,"
for which the Chungs should pay millions of
dollars in noneconomic and punitive damages
and (though Pearson represented himself) attorneys'
fees.[6]
The Chungs' lawyer knew that Pearson's legal
arguments were as specious as his damages claims
were outrageous. Nonetheless, he advised the
Chungs to offer Pearson $12,000 to settle the
case—far more than the value of the pants—since
he knew that the costs of defending the case
would be high. Pearson declined this generous
settlement offer and litigated his case so aggressively
that the Chungs eventually owed almost $100,000
in legal fees.[7] Unsurprisingly,
Pearson lost at trial, and extensive media coverage
galvanized public support for the Chungs, who
received donations to cover their legal bills.[8]
Still, the Chungs had been damaged both emotionally
and financially, since Pearson had aggressively
advertised his complaints to the neighborhood
in an effort to find other unsatisfied customers,
and business had dropped off as a result. The
Chungs shut down the store that Pearson had
patronized and laid off staff members.[9]
The Chungs were forced to return full-time to
the smaller store, Happy Cleaners, where they
had started their business.[10]
And the Chungs' ordeal is not yet over: Pearson
has appealed the ruling against them.[11]
The so-called pants suit of 2007 was extraordinary
in the frivolousness of its claims and the amount
it demanded.[12] But abusive
litigation—lawsuits against defendants
who are known to be, or expected to be found,
innocent of legal wrongdoing—is tragically
common. Most such cases settle for a few thousand
dollars, but the time lost and stress inflicted
far surpass that amount.[13]
The Chungs reported finding it difficult to
return every day to the dry-cleaning store that
Pearson had patronized.[14]
Other small-business owners report feeling less
trustful of employees and customers after being
sued.[15]
Though determining the exact breakdown of all
lawsuits nationwide is difficult, the proportion
of litigation targeting small businesses is
sizable, between 36 and 52 percent of all lawsuits
filed against businesses, according to the Klemm
Analysis Group.[16] Moreover,
suits against small firms are expensive: of
the approximately 30,000 small businesses sued
in 2002, two-thirds spent more than $10,000
in attorneys' fees in addition to any settlement
or judgment.[17]
Large businesses are frequently sued, but they
expect, and are able to budget for, a certain
amount of litigation every year. For small businesses,
by contrast, litigation, and especially its
associated legal fees, is a shock that can make
it suddenly impossible for them to meet their
ongoing financial obligations.[18]
Small-business owners say that they are reluctant
to recoup their litigation losses by raising
prices because price increases risk hurting
their competitiveness.[19]
Klemm reports: "Owners mentioned that the
payment of damages nearly put them out of business."[20]
Debating loser pays
Some legal reformers advocate replacing the
American rule for attorneys' fees with a loser-pays
rule in order to reduce the high costs of litigation—especially
abusive lawsuits. Under the American rule, each
party to a lawsuit must bear the cost of his
own legal representation, win or lose. Virtually
every other civil justice system in the world
has a loser-pays rule (sometimes called the
English rule in American legal circles) for
attorneys' fees, under which the loser in a
civil suit must cover the reasonable legal expenses
of the winner.[21]
The American rule makes the civil justice system
as a whole unnecessarily costly by encouraging
the filing of dubious lawsuits, which defendants
must either settle quickly or defend against
at significant cost. Such low-merit legal cases
clog the American legal system and raise the
cost of goods and services to consumers by forcing
businesses that are sued to cover their legal
expenses by raising prices.
The American rule also makes most victories
for defendants Pyrrhic ones. As Professor Jon
Langbein told ABC News's John Stossel, "When
you win, you lose under our system. I win, I
defeat your claim … but it has cost me
tens, hundreds of thousands, sometimes millions
of dollars. I have a victory that has brought
me to the poorhouse."[22]
Our legal system would be more equitable if
it required an unsuccessful plaintiff to compensate
a prevailing defendant.
Our present system can be just as unfair to
a deserving plaintiff. In theory, a negligent
defendant must "make whole" an injured
plaintiff by restoring him as nearly as possible
to his position before the injury occurred.
In reality, American contingent fees and litigation
costs paid by the plaintiff frequently soak
up 40 percent or more of any judgment or settlement.
Also, potential plaintiffs with injuries that
are significant but worth less than their lawyers'
cost of going to trial can be denied access
to justice entirely.
Despite these defects, the American rule has
a large cadre of defenders, who argue that the
costs of the current system are exaggerated
and that adopting a loser-pays rule would replace
current injustices and inefficiencies with graver
ones. Primary among the concerns of these scholars
and commentators is the worry that injured parties
might be unwilling to run even a small risk
of incurring liability for ruinous attorneys'
fees.[23] Those not so
deterred could still be induced by veteran defendants
to settle for far less than their claim is worth.[24]
Thus, these critics say, compensation under
a loser-pays rule is usually only partial, just
as it is under the American rule, for a plaintiff
who settles.[25] The benefits
of a loser-pays rule will not become evident
unless its advocates deal with such concerns.
Goals of Procedural Reform
What can we all agree that we want from our
system of justice? The following four goals
reflect widely shared values about how procedural
rules of law should function, regardless of
the underlying substantive law. This paper will
evaluate the American rule and the alternatives
to it on the basis of how well they serve these
four very general and widely endorsed criteria.
If a loser-pays reform proposal is superior
to the American rule on those grounds, it should
command broad support.
Compliance with the Law
Procedural reforms should have the effect of
promoting compliance with the law. Although
the merits of specific substantive legal rules
might be debatable, if a body of law is generally
just, the premise that procedural rules ought
to promote legal compliance should be uncontroversial.
Compensation for Victims
All else being equal, a legal procedure is
preferable to the extent that wrongfully injured
victims are returned as nearly as possible to
their uninjured states at the expense of the
injurer. We may disagree about how costly such
reparation must be before it becomes unduly
punitive, but this paper will assume that full
compensation for wrongful injuries is generally
a desirable goal of procedural reform.
Low Transaction Costs
If a given procedure can uphold the law and
compensate victims as well as or better than
a different procedure, and do so at less cost,
then it should be adopted and the alternative
rejected.
Equitable Distribution of Costs
In general, a system that imposes heavy costs
on a defendant who is not liable is inferior
to one that does not do so. By the same token,
a system that imposes heavy costs on a deserving
plaintiff is inferior to a system that does
not. Costs are equitably distributed, in this
view, if they are borne by the wrongful parties
or, to the extent that they are not, if they
are shared by the society that benefits from
the existence of a system of civil justice.
PART II: THE STATUS QUO
R eporting on frivolous litigation tends to
focus on the most outrageous claims, often involving
enormous sums of money, such as the multimillion-dollar
lawsuit against the Chungs' dry-cleaning business
previously described. The media also report
on cases in which plaintiffs are awarded large
sums for injuries they suffered after assuming
commonly understood risks, as was the plaintiff
who was served a hot cup of McDonald's coffee
that she promptly spilled, scalding herself.[26]
Other kinds of suits that get major press attention
are typically class actions or government-led
claims that target companies for, among other
things, selling high-calorie foods or violent
video games.
Such cases get media attention because they
involve particularly bizarre claims, colorful
characters, or millions of dollars. But abusive
lawsuits that are not so lurid or absurd are
not unusual. Most of them cost the individual
defendants little, but collectively they drive
up the prices we pay for groceries, automobiles,
health care, and other goods and services. This
section will describe how the legal marketplace
currently works, why abusive lawsuits are filed,
and how the lawyers who file them make a living.
Lawsuits vary in the amount of money they seek,
the complexity of the underlying facts (which
often determines how many hours a lawyer must
spend on a case), and the merits of the case
(defined here as the likelihood that the plaintiff
will win at trial).
Figure 1 depicts the litigation universe in
two dimensions by holding the number of hours
worked constant. The curved line represents
a contingent-fee lawyer's financial break-even
point (or "opportunity cost") for
a given case, assuming that it goes to trial.
The higher the stakes are, the lower the legal
merit of a case could manage to be while still
offering a lawyer an economic incentive. The
most profitable cases are located at the top
right corner of the figure.
"Abusive lawsuits"—represented
by the shaded area on the left in Figure 1—have
little legal merit, regardless of the magnitude
of the recovery sought. "Lottery suits"
are defined by a combination of low legal merit
and very high stakes. Many of these cases meet
or exceed a lawyer's break-even threshold for
trials simply because there is so much money
at stake that a contingent-fee lawyer can make
a good living by winning only a small minority
of them.
Professor Herbert Kritzer of the University
of Wisconsin Law School describes the practices
of three lawyers who can be located in Figure
1: "Brown handles mostly larger cases involving
significant damages; he prides himself on taking
and winning large recoveries in cases that other
firms decline as too risky. Adams and Clarke
handle a lot of very routine cases, most of
which would not be economical to take to trial."[27]
We can infer from Kritzer's description that
Brown at least sometimes takes lottery suits.
Adams and Clarke, on the other hand, handle
primarily cases below the break-even line on
Figure 1 for trials—that is, Adams and
Clarke would lose money on these cases if forced
to litigate them. Some of these cases will be
the kinds of small, meritorious claims found
in the bottom right-hand corner of Figure 1.
Others are likely to be nuisance suits,[28]
characterized by modest stakes and little legal
merit. They are filed for the sole purpose of
inducing a defendant to settle them in order
to avoid the expense of going to trial. Nuisance
suits, by this definition, fall below any contingent-fee
lawyer's break-even threshold for taking a case
to trial. Therefore, such cases must be settled
early in order to be lucrative enough for the
lawyers who file them.
This paper will explore the possibility that
loser-pays reforms can reduce or eliminate abusive
lawsuits, especially nuisance suits.
Who Files Nuisance Suits?
We usually imagine that nuisance suits are
filed by struggling lawyers operating alone
or in a small firm, "chasing ambulances"
or otherwise aggressively marketing their services
to disoriented or hesitant clients. We don't
think of them as being filed by the kinds of
lawyers who labor at complex, multiyear disputes
in elite downtown offices. Economists Eyal Zamir
and Ilana Ritov offer a model of the legal marketplace
that suggests that these stereotypes are largely
correct: there is a clear pecking order among
plaintiffs' lawyers.[29]
Contingent fees are fairly uniform within a
given geographic area: most plaintiffs' lawyers
charge a percentage of a recovery in any case
they take—usually about 33 percent, though
in some jurisdictions the going rate is higher.[30]
Zamir and Ritov show that standard pricing of
contingent-fee legal services is possible in
part because simple, strong cases afford lawyers
higher effective hourly rates than do complex,
weak cases. As a result, successful lawyers
(who can be extremely selective about the cases
they take) accept only those cases that can
produce very high effective hourly compensation.
Zamir and Ritov write: "[T]he standard
rate endures in the market thanks to a process
of assortative matching, that is, the process
through which plaintiffs with very strong cases
contract with the very best lawyers, second-best
cases are handled by second-best attorneys,
and so forth."[31]
Indeed, most plaintiffs' lawyers decline most
of the cases offered them, and the rate at which
the most successful of them turn down cases
is far above the average.[32]
There is also evidence that an elite subset
of lawyers is able to attain exceptionally high
effective hourly rates through careful selection
of cases.[33] Figure 2
illustrates how, according to Zamir and Ritov,
cases and lawyers are matched.
The
dotted line in the top right corner of Figure
2 delineates a portfolio of highly lucrative
cases that would be representative of a top
plaintiffs' lawyer's. The Zamir-Ritov model
implies that, just as there is an upper echelon
within the ranks of plaintiffs' lawyers, there
is also a lower echelon, whose portfolio is
defined by the curved series of dashes in the
bottom left section of Figure 2. Such "nuisance
lawyers" can attract only the weakest cases.
Kritzer describes the investment strategy that
such a lawyer can be expected to adopt: "The
lawyer can be relatively nonselective. Under
this approach, the lawyer may want to minimize
the investment in most cases. The goal is to
achieve lots of small recoveries, with relatively
little investment."[34]
The two great exceptions to the rule that struggling
lawyers file dubious suits are low-merit mass
torts and class action suits. These kinds of
cases concern hundreds or thousands of similarly
injured plaintiffs and are usually settled en
masse. Because these cases require lawyers to
spend little or no time on any individual claim,
they offer enormous efficiencies of scale, making
them attractive to the most elite members of
the plaintiffs' bar, even if each individual
case would have little value on its own.[35]
How Do Nuisance Lawyers Remain in Business?
Experts have struggled to explain how a lawyer
can make money by filing lawsuits that cost
more money to try than the lawyer can hope to
recover in fees. If the defendant knows that
the cost to the plaintiff of taking the case
to trial is sure to exceed the amount he can
recover, it seems to follow that the defendant
will refuse to settle, knowing that the plaintiff
is likely to drop the case.
Nonetheless, nuisance suits do sometimes culminate
in a settlement offer from a defendant. Economists
David Rosenberg and Steven Shavell have shown
that a defendant will settle a nuisance suit
if the cost of filing an initial response to
a complaint is significant, since the cost of
replying itself makes settlement attractive.[36]
Even for cases in which the initial response
is not prohibitively expensive, a defendant
may not be able to tell whether a particular
suit is a nuisance suit, according to lawyer
and economist Lucian Bebchuk.[37]
For certain types of claims, like mass torts,
this explanation seems particularly compelling:
the transaction costs of sifting through thousands
of claims to separate the good cases from the
bad can exceed the cost to settle each claim.
Plaintiffs' lawyers who file nuisance suits
may also be helped by ethics rules that prohibit
them from withdrawing from cases if doing so
would impose a substantial hardship on a client.[38]
While lawyers may sometimes refuse to try cases
if a plaintiff has "unreasonably refused"
a settlement offer, such refusal must be contrary
to the plaintiff's self-interest, not the lawyer's.[39]
These ethical constraints enable a plaintiff's
lawyer to credibly commit in advance to trying
any case that he files on behalf of a client.
Bebchuk and Andrew T. Guzman have shown that
contingent-fee arrangements enhance the pre-trial
bargaining power of plaintiffs by relieving
them of almost all of the considerable costs
of going to trial, which are borne by the contingent-fee
attorney and, of course, the defendant.[40]
(Plaintiffs' bargaining power would be diminished
if ethics rules allowed plaintiffs' lawyers
to drop cases that do not settle.)
Still, if a distinct class of lawyers is responsible
for most nuisance litigation, it should be theoretically
possible for defendants to identify the class's
members and systematically refuse to settle
the cases that they file—at least those
cases that do not demand an unusually costly
initial response or whose outcome is not highly
uncertain. Presumably these lawyers would stop
filing such cases, since they would not be lucrative
enough to justify the cost of going to trial.
A MODEL OF DEFENDANTS’ COLLECTIVE
ACTION PROBLEM
Defendants in nuisance suits filed
by a single nuisance lawyer or firm
face a classic collective action problem
often referred to as the “Stag/Hare
game.” Here it is in reduced form:
If all defendants refuse to settle
nuisance suits, they will drive the
nuisance lawyer out of business: the
best outcome. But if some defendants
settle, those who do not settle will
incur trial expenses unnecessarily:
the worst outcome. There are two Nash
equilibriums in this game: [litigate,
litigate] and [settle, settle]. However,
[litigate, litigate] is not “trembling
hand perfect.” That is: universal
litigation is not a stable equilibrium
in this game if the players occasionally
make errors. Therefore only [settle,
settle] survives dominance refinement
analysis and is the expected equilibrium
in this game.
For general background, see Douglas
G, Baird,
Robert H. Gertner and Randal C. Picker,
Game
Theory and the Law (Cambridge: Harvard
University Press, 1994), p. 36.
|
|
This has not happened, however, because, in
what is known as a collective-action problem,
defendants cannot count on each other to litigate
every nuisance claim. Therefore, at least some
settle. The nuisance lawyers are able to use
the proceeds to pursue other blameless defendants,
which also settle, since they know that nuisance
lawyers have the means to go forward in the
face of a refusal to settle (see box). Thus,
settlement of nuisance suits is the norm under
the American rule. Indeed, the empirical literature
shows that the United States has developed a
culture of nearly universal settlement.[41]
Only about 7-9 percent of lawsuits filed actually
proceed to trial.[42] Lawyers
and policymakers praise high settlement rates
because settlement avoids the public and private
expenses of a trial. Still, it must be acknowledged
that the certainty of trial would keep some
number of suits from being filed.
PART III: WHAT TO EXPECT
FROM LOSER PAYS
While researchers differ on what some of the
effects of a loser-pays rule might be—and
certainly differ on the overall advisability
of adopting one—there is broad consensus
that a loser-pays rule would reduce the number
of nuisance suits.[43]
A reduction would occur because defendants would
be unwilling to pay as much to settle them as
they currently do.
A simple example will illustrate why a defendant
would insist on paying less to settle a nuisance
suit under loser pays. Suppose a plaintiff has
suffered a loss of $10,000 (an amount that is
not in controversy in this example), but his
suit has very little legal merit because the
defendant probably did not cause his injury,
giving the plaintiff only a 20 percent chance
of winning at trial. Suppose that the plaintiff's
lawyer (who is working under a contingent-fee
agreement for 33 percent of any recovery) and
the defendant would each have to invest $5,000
worth of legal services in order to try the
case. The plaintiff's lawyer could expect a
fee of only $667, since 20 percent of $10,000
is $2,000, and 33 percent of $2,000 is $667,
for $5,000 worth of work if the case goes to
trial.
The plaintiff's lawyer, therefore, plans to
settle the case. Under the American rule, he
may extract between $2,000 and $7,000 from the
defendant in settlement, because the defendant
knows that it will have to spend $5,000 on unrecoverable
legal costs if it fails to settle and because
the case has an additional expected value of
$2,000 for the plaintiff.
Under loser pays, however, defendants would
either refuse to settle or would offer far less
in settlement. In our example, the defendant
has an expected cost of going to trial of only
$3,667 under a loser-pays rule, reflecting its
20 percent chance of losing the case and paying
damages and both parties' legal fees.[44]
Therefore, the defendant would never pay more
than $3,667 to settle this case—just over
half of the maximum of $7,000 that a plaintiff
could extract from the same suit under the current
system. Because loser pays would make nuisance
suits less valuable, the effective hourly rates
of nuisance lawyers would decline. In the face
of reduced earnings, some nuisance lawyers would
surely choose to file different kinds of cases
(such as meritorious small claims), or they
would migrate to other specialties or careers.
Loser pays should also have some impact on
the settlement prospects of mass-tort claims
by deterring some of the thousands of low-merit
individual claims that are based on more or
less the same facts. Under the American rule,
mass-tort lawyers have an incentive to recruit
thousands of plaintiffs with dubious claims,
since they know that the cost to defendants
of ferreting out the weak or even fraudulent
cases and taking them to trial is prohibitively
high. Under loser pays, mass-tort lawyers would
be less able to force settlements by pointing
to the enormous transaction costs of conducting
thousands of individual trials. Without this
leverage, mass-tort lawyers would have less
incentive to include weak claims in their portfolios.
Loser pays would also reduce the number of low-merit
class action lawsuits, but not to the extent
that it would individual cases, in which legal
fees and expenses are bound to be a higher proportion
of a defendant's total exposure.
More Meritorious Small Claims
In addition to reducing the number of nuisance
suits, a loser-pays rule should increase the
viability of small, highly meritorious lawsuits
that cannot be profitably tried in the current
system, a point on which most researchers agree.[45]
Figure 3 illustrates how a loser-pays rule would
shift the break-even line for suits taken to
trial and therefore, by inference, the viability
of all meritorious suits, including those that
settle.[46]
The increased viability of small, meritorious
claims would have costs as well as benefits.
On the one hand, a person with a modest but
meritorious claim should be compensated. Critics
of loser pays who worry that the rule would
limit access to the courts often fail to acknowledge
that the American rule essentially eliminates
court access for small but strong claims of
injury, unless the claims can be grouped into
a class action. On the other hand, a significant
influx of small, meritorious claims under loser
pays could keep the overall amount of litigation
from going down, and thus the overall cost of
administering the legal system.
There is reason to think that the reduction
in nuisance suits following the adoption of
loser pays would be greater than the increase
in small, highly meritorious claims. While it
is true that many such claims are too small
to be worth taking to trial under the current
system, many nuisance claims are small as well.
Yet nuisance claims of this kind are filed,
anyway, for their settlement value—just
as are, undoubtedly, substantial numbers of
meritorious claims that are not too insignificant
to be worth pursuing. Also, many small claims
are currently litigated as class actions.
Responses
from Kritzer's survey of contingent-fee lawyers
in Wisconsin suggest that the number of nuisance
filings deterred under a loser-pays rule would
be larger than any increase in the number of
small, meritorious cases filed. Figure 4 shows
how prevalent are the various reasons that contingent-fee
lawyers give when they decline a case. It shows
that in 46 percent of the cases declined by
the surveyed lawyers, there was, in their view,
a low probability of a finding of liability.
Only 19 percent were declined because the expected
size of the recovery was too low.[47]
These responses (combined with statistical
principles) imply that of all the cases that
lawyers are asked to pursue—on either
side of their accept/reject threshold—a
greater number have little legal merit than
have merit but promise only modest recoveries.[48]
If that is so, the largest category of case
that loser pays discourages should be that of
low-merit cases.
High-merit, low-damages injuries are also unlikely
to be litigated to trial under loser pays because
defendants would have no financial incentive
to resist compensating those they have genuinely
harmed in small ways. Loser pays may therefore
be more likely to promote immediat
e,
and appropriate, handling of small injuries
than to trigger a tide of small suits. Under
the American rule, defendants are more likely
to treat many small, high-merit claims as no
different from nuisance claims and under-compensate
genuinely injured victims, since they know that
it is unprofitable for plaintiffs' lawyers to
litigate such cases to trial.[49]
Settlement Rates
Research is deeply split on the issue of whether
a loser-pays rule would increase or decrease
the rate at which lawsuits are settled rather
than tried.[50] Loser pays,
by increasing the amount of money in dispute
in any given case (that is, by "raising
the stakes" of litigation), may reduce
settlement rates by magnifying differences of
opinion between the parties about what each
is likely to gain by going to trial.[51]
On the other hand, higher stakes could induce
risk-averse parties to settle.[52]
Experiments designed to predict the effect that
a loser-pays rule would have on settlement rates
have yielded mixed results. Economists Kevin
McCabe and Laura Inglis found that loser pays
would lower rates of settlement,[53]
while two older experiments suggest that settlement
rates would increase.[54]
The question of the effect of loser pays on
settlement rates, however, may not be as consequential
as the extent of academic interest in the subject
implies. Only about 7–9 percent of lawsuits
filed go to trial.[55]
The rest are resolved by settlement, by dismissal
or summary judgment, or by the plaintiff's decision
to drop the suit.
In part because so few cases proceed to trial,
most resources devoted to litigation are spent
at its earlier stages, including settlement
negotiations. Figure 5 is a breakdown of the
time that litigation attorneys report spending
on various activities related to the resolution
of lawsuits. Because attorneys' fees are by
far the largest cost of litigation, these figures
are a reasonable proxy for overall legal costs.
Importantly, litigation attorneys report that
they spend only 9 percent of their time on hearings
and trials. Most of their time is devoted to
activities that may precede serious settlement
discussions: client interviews, case investigation,
pretrial motions, and settlement negotiations.
While an early settlement would avoid many of
these expenses, a settlement on the eve of trial
would avoid very few of them.
All
else being equal, therefore, legal reforms that
reduce filings are likely to reduce costs more
than legal reforms that increase settlement
rates, which are already high. Nonetheless,
a loser-pays rule should be carefully designed
not only to discourage low-merit filings but
also to promote settlement.
Litigation Costs per Case
Critics of loser pays warn that even if the
rule should reduce the number of lawsuits filed,
the cost of litigation per case may increase
because each party no longer necessarily and
exclusively bears its own costs.[56]
Under a loser-pays rule, each dollar of additional
spending by either party is discounted by the
probability that the other side would assume
those costs upon losing the case. Whereas $1,000
in additional spending under an American rule
would be borne wholly by the party making the
decision to spend, a party under a loser-pays
regime that estimated its chance of winning
at 50 percent would bear only $500 of the additional
$1,000 spent.[57] Assuming
that increased spending on legal services enhances
a party's chances of prevailing, parties will
spend more on legal services under loser pays,
loser-pays critics argue, than they would under
a system employing the American rule.
While this "cost-internalization"
critique of loser pays is not without merit,
the charge that loser pays would generally increase
costs per case is less than convincing, closer
analysis reveals. A party's decision to increase
spending on litigation under loser pays reflects
not merely its expectation that such spending
will improve its odds of success at trial. It
reflects as well what it understands to be the
odds that such spending will encourage additional
spending by the other side, and it reflects
a view as to how different amounts of additional
spending by both sides are likely to affect
either side's chances of winning or losing at
trial.
All studies that predict higher per-case expenditures
under loser pays than under the American rule
assume that a party that spends more on litigation
increases its chance of prevailing, especially
if the opposing party does not match those expenditures.
But, in reality, a loser-pays rule would not
necessarily motivate either party to spend more.
Rather than increasing a party's chance of success
at trial, much legal spending may be what economist
Avery Katz calls "provocative expenditure,"[58]
spending that merely induces the opposing party
to respond with additional spending of its own.
While Katz argues that loser pays would increase
trial expenditures, his argument assumes that
legal spending is not provocative. If it were,
his doubts about loser pays would, he concedes,
be misguided.[59]
In fact, most decisions to spend money on litigation
are provocative because they trigger
a litigation event, such as a motion, discovery
request, or pretrial conference, that requires
the opposing party to undertake a costly activity
in response.[60] Serious
analysts of the legal system, even those who
typically defend the status quo, admit as much.
For instance, Kritzer notes that lawyers' efforts
in litigation are "largely determine[d]"
by "the actions of the opposing party."[61]
He adds: "Each decision to invest additional
effort will then influence the defense side,
which in turn may make investments that require
further investment by the plaintiff's side."[62]
Empirical analysis supports what theory would
predict. Data from the Wisconsin Civil Litigation
Research Project confirm that in litigation
conducted under the American rule, case complexity
and associated litigation "events,"
not the sums at stake, are the main drivers
of litigation spending—a result that is
at odds with the simplistic hypothesis embraced
by critics of loser pays that parties under
such a regime will keep spending more in order
to improve their chances of prevailing.[63]
Practically speaking, there is reason to believe
that it has been the American rule that more
often provokes increased legal spending per
case, due to the provocative nature of legal
expenditures, particularly at the pretrial stage.
Plaintiffs' attorneys in the United States bury
defendants in onerous discovery requests, knowing
that their clients bear none of the costs of
document production; the cost of discovery itself
increases cases' settlement value. Similarly,
defendants flood plaintiffs with motions; regardless
of the motions' probability of success, the
expected settlement value of the case falls,
given the costs that plaintiffs must incur in
responding and that they might seek sooner rather
than later to avoid. Because motions and particularly
discovery requests are far cheaper to draft
than the responses they trigger, the American
rule promotes provocative legal spending. A
loser-pays rule would discourage it.
Thus, there is reason to believe that a loser-pays
rule would not generally increase litigation
expenditures per case very much and may, indeed,
have the opposite effect. Nevertheless, under
at least some conditions, the critics' concern
that loser-pays rules would encourage higher
spending is well-founded. For instance, a party
that estimates its probability of success to
be very high might refuse reasonable settlement
offers and run up costs, confident that the
other side will end up bearing those costs.
While judicial fee reviews are the means by
which other countries' loser-pays systems deter
such tactics, an American loser-pays reform
could best deal with such tactics by relying
on offer-of-settlement rules already in place
in most states. Such rules encourage settlement
by reducing recovery if the ultimate judgment
does not exceed an earlier, rejected offer by
a substantial margin.
Compliance Effect
The "compliance effect" is one of
the most interesting and salutary results of
a loser-pays rule: potential defendants, facing
the risk of having to pay a winning plaintiff's
legal fees, can be expected to try harder to
comply with the law.[64]
In effect, loser pays makes innocence cheaper
and legal culpability more expensive, disposing
a potential wrongdoer to spend additional resources
on ensuring the blamelessness of its behavior.
Loser pays does so by simultaneously lowering
the cost of law-abiding behavior and raising
the cost of negligence, as the following example
illustrates.
Like most successful shopkeepers with many daily
customers, shopkeeper Susan occasionally faces lawsuits
from customers who slip and fall on her property.
Susan learns that she can install a new, nonskid surface
on her front steps at a cost of $600. She predicts
that if she installs the surface, she will have a
75 percent chance of winning at trial the next time
she is sued. If she does not install the surface,
she predicts that she will have only a 25 percent
chance of prevailing at trial. On the basis of her
personal experience and local news reports, she predicts
that a trial would cost her about $300 in legal fees,
and a judgment against her $1,000.
But Susan soon discovers that under the American
rule still prevailing, an investment in safety
would not pay. If she installs the surface,
a lawsuit would cost her an expected $550 (legal
fees of $300 plus a 25 percent chance of losing
the case and paying a $1,000 judgment) if she
went to trial. She would therefore be willing
to pay a plaintiff almost that much to settle
the case. If Susan does not install the surface,
a lawsuit would cost an expected $1,050 (legal
fees of $300 plus a 75 percent chance of paying
a $1,000 judgment), and she would be willing
to pay almost that much to a plaintiff to settle
the case. Under the American rule, therefore,
she has no financial incentive to make a $600
investment in customer safety that yields a
benefit of only $500.
Under a loser-pays rule, Susan would make a
different calculation. If she installs the nonskid
surface, a lawsuit would cost her an expected
$400 (a 25 percent chance of paying the sum
of $1,000, the amount of a judgment, and $600,
the legal fees of both parties), and she would
be willing to pay nearly that much to settle.
If she fails to install the surface, a lawsuit
will cost her an expected $1,200 (a 75 percent
chance of losing and paying both a $1,000 judgment
and $600 for the legal fees of both parties),
and she would be willing to pay nearly that
much to settle. Under loser pays, therefore,
Susan would be happy to pay $600 to install
the nonskid surface because doing so would save
her an expected $800 the next time she is sued.
In the real world, compliance and investment
decisions are far more complicated than this
simple narrative suggests. For example, an investment
in safety equipment might reduce the frequency
with which a defendant is sued, as well as improve
his chances of prevailing at trial. Even in
the absence of such considerations, loser pays
gives people and businesses incentives to try
harder to meet legal standards.
Economist Keith N. Hylton estimated the effect
of a loser-pays rule on legal compliance. His
model assumed that potential defendants would
analyze compliance decisions on the basis of
the probability of injury; parties' likelihood
of filing suit, settling, or litigating; and
likely trial judgment.[65]
The results of Hylton's simulation suggest that
a loser-pays
rule would significantly increase the resources
that defendants devote to complying with legal
standards, and thus reduce the number of people
injured.[66]
Hylton also attempted to determine which of
four alternative fee-shifting rules maximized
overall social welfare by adding up the costs
of injury, compliance, and litigation under
alternative regimes. Hylton found that litigation
costs rose under loser pays because fewer cases
settled, but that those increases were dwarfed
by the welfare-enhancing effect of greater compliance
with the law. Hylton concluded that loser pays
did better than alternatives, including the
American rule, at conserving resources and avoiding
injuries.[67]
PART IV: LOSER PAYS IN ACTION
A merica's litigation habit far exceeds that
of other nations. The share of our economy spent
on litigation is at least twice that of Germany's,
France's, England's, and Northern Ireland's.[68]
It is perhaps not coincidental that America
is also nearly alone in clinging to the American
rule. Nonetheless, it is difficult to determine
to what extent the American rule is to blame.
As Judge Richard Posner has observed, it is
very difficult to conclude from levels of litigation
in Europe and elsewhere what effect a loser-pays
rule would have here in America, because the
huge variety of other ways in which nations
and their legal systems differ may affect the
amount of litigation they experience.[69]
But international comparisons usefully refute
claims that loser pays cannot work well with
other features of the current American system,
such as contingent fees, civil jury trials,
and class action mechanisms. In fact, as Figure
6 shows, other nations with these features have
combined them successfully with loser pays,
as evidenced by their far lower rates of litigation.
Indeed, to assess the compatibility of loser
pays with the rest of U.S. law, it is not necessary
to look abroad. Alaska has always had a loser-pays
rule, and Florida once applied a loser-pays
rule to medical-malpractice suits.
The Alaskan Experience
Uniquely among the states, Alaska has had a
nearly universal loser-pays rule since 1884,
well before statehood. Alaska's Civil Rule 82
provides: "Except as otherwise agreed to
by the parties, the prevailing party in a civil
case shall be awarded attorneys' fees calculated
under this rule." The rule calculates fee
awards for plaintiffs as a percentage of money
damages recovered: 20 percent of the first $25,000
and 10 percent of any additional sums recovered
at trial.[70] Prevailing
defendants are awarded 30 percent of their actual
attorneys' fees for tried cases and 20 percent
of actual fees for cases terminated by other
means.[71] Loser-pays systems
in most foreign countries award much higher
percentages of legal fees incurred, although
those fees are subject to some judicial discretion.
Evidence of the effect of Alaska's loser-pays
rule on its rate of civil filings is ambiguous.
Alaska recorded 5,793 civil filings per 100,000
inhabitants in 1992. This number was only slightly
below the national median of 6,610 per 100,000
that year and was very close to the filing rates
of other relatively rural states.[72]
The composition of civil filings, though, differs
somewhat from the national pattern.[73]
As Figure 7 shows, domestic relations and probate
matters, which are not governed by loser pays,
form a much larger share of total civil litigation
in Alaska than in the United States generally.
By the same token, Alaska's tort claims constitute
a smaller share of Alaska's litigation mix than
they do elsewhere. These statistics suggest,
but certainly do not prove, that loser pays
is responsible for more selective filing of
tort claims in Alaska than in other jurisdictions.
Most
attorneys surveyed by the Alaska Judicial Council
thought that Alaska's loser-pays rule did not
significantly reduce the number of filings of
"frivolous" suits because most of
them are filed by litigants for "emotional,"
rather than financial, reasons.[74]
They also observed that many frivolous litigants
are judgment-proof (i.e., without sufficient
means to pay shifted fees).[75]
But the Council's survey question, in asking
about "frivolous" suits, was misleading,
since "frivolousness" is a legal term
of art denoting truly flagrant cases, as opposed
to merely weak ones. In fact, the Council concluded,
on the basis of interviews with Alaska attorneys,
Alaska's loser-pays rule reduced the number
of low-merit cases filed by rational, middle-income
plaintiffs.[76] The Council's
finding was merely qualitative, not quantitative,
but nevertheless important, especially since
defendants are able to recover only 20 to 30
percent of their actual fees under Alaska's
rule. The Alaska Judicial Council also collected
evidence indicating that small meritorious claims,
particularly those seeking to collect on an
unpaid debt, were filed more frequently in Alaska
than in the rest of the country.[77]
This finding is consistent with the theoretical
literature.
It is difficult to generalize from Alaska's
experience with loser pays on account of Alaska's
uniqueness. The state has enormous natural resources
reserves, a large indigenous population, and
substantially more men than women. Any one of
these factors could affect the rate of tort
litigation alone or in combination in ways that
are not fully understood. For example, there
is some evidence that men are more likely than
women to be involved in legal disputes.[78]
Nonetheless, the available evidence suggests
that Alaska has under-implemented a fundamentally
sound policy, which better compensates deserving
small claimants and discourages the kinds of
filings that have a low probability of success.
While fee shifting is standard in Alaska, the
state's fee schedules fail to compensate prevailing
parties fully for their litigation costs, reducing
the rule's salutary effects.
The Florida Experiment
In 1980, Florida embarked on an important experiment.
In response to escalating medical-malpractice
insurance rates, the state legislature adopted
a loser-pays rule exclusively for medical-malpractice
lawsuits.[79] The Florida
Medical Association and the insurance industry
lobbied for the provision, which they hoped
would reduce the rate of abusive litigation
and thus the insurance premiums paid by doctors
and hospitals.[80] However,
both groups quickly discovered a problem with
the new system—the frequent inability of
victorious defendants actually to collect their
attorneys' fees from insolvent plaintiffs[81]—and
they were taken aback by the multimillion-dollar
plaintiff's attorneys' fee that a Florida doctor
who had lost the case against him was ordered
to pay.[82] With every
interest group lobbying for its repeal, Florida's
loser-pays law was wiped from the books in 1985.[83]
The first rigorous analysis of the Florida
law's effects was published five years later,
and its findings suggest that the loser-pays
experiment was given short shrift by policymakers
and its erstwhile advocates. Economists Edward
A. Snyder and James W. Hughes found that 54
percent of medical-malpractice plaintiffs voluntarily
dropped their lawsuits under Florida's loser-pays
rule, while only 44 percent of plaintiffs dropped
their suits when the American rule was in force
both before and after the loser-pays rule was
in effect. Loser pays also almost halved the
share of medical-malpractice lawsuits that went
to trial—from 11 percent to 6 percent
(see Figure 8).
Supporting
the hypothesis that more plaintiffs with weak
suits dropped them under Florida's loser-pays
rule, cases governed by loser pays were settled
for higher amounts ($94,489), on average, than
were cases governed by the American rule ($73,786).84
Most notably, settlements of less than $10,000
dropped from 49 percent of all settled cases
under the American rule to less than 37 percent
under loser pays,85 suggesting that some low-value
settlements under the American rule were paid
to the sort of nuisance complainant who did
not actually file suit or the sort of plaintiff
who dropped his lawsuit during the period when
loser pays was in force.
Similarly, while a smaller percentage of medical-malpractice
suits went to trial in the years that the loser-pays
rule was in effect, the average trial award
came close to tripling, from $25,190 to $69,390
in constant dollars,[86]
and plaintiffs more often prevailed at trial.
Hughes and Snyder concluded that the higher
average was the direct result of the loser-pays
rule's elimination of many weak cases: "Having
found that plaintiff prospects improve under
the English rule, we are able to establish that
these effects necessarily reflect an improved
selection of claims reaching the settle-versus-litigate
stage."[87]
Florida cases did experience an increase in
litigation expenses, both those that settled
and those that proceeded to trial during the
loser-pays experiment.[88]
However, costs relative to the size of the verdict
changed very little, and it would be worth exploring
whether the explanation is that defendants were
simply spending more on individual cases because
the pool of cases was smaller but stronger (i.e.,
the stakes were higher, and therefore the extra
effort put into defending them was well worth
making).
While the evidence from Florida's ambitious
experiment is ambiguous and complex, it confirms
to a striking degree predictions made in the
theoretical literature: litigants with weak
cases should be far more likely to abandon their
claims under loser pays, which allows lawyers
to focus on more meritorious suits. The increased
size of the average settlement and judgment
under Florida's temporary loser-pays regime
also tends to support this view. Attorneys'
fees per case did rise during this period, although
it remains possible that expenditures for cases
of similar size and merit were unchanged.
Did Florida's version of loser pays work better
or worse there than the American rule? The large
increase in dropped claims and the lower rate
of trials suggest that Florida's loser-pays
law was a promising experiment that lawmakers
abandoned too quickly. Doctors referred to anecdotal
evidence that the rule favored losing plaintiffs
with few assets, who couldn't afford to pay
the winning defendants' attorneys' fees.[89]
But, Hughes and Snyder surmise, loser pays actually
encouraged plaintiffs with assets to settle
or drop weak cases early in order to avoid having
to pay a fee award.[90]
Be that as it may, at least some percentage
of plaintiffs proved judgment-proof, preventing
winning defendants from collecting their fees
and blunting the incentive effects of the law.
In view of Florida's experience, those advocating
loser-pays rules should take into account the
problem of judgment-proof plaintiffs and consider
insurance or other devices to ensure that plaintiffs
without assets do not stop the rule from functioning.
PART V: PRESERVING ACCESS
THROUGH INSURANCE
A loser-pays rule should reduce the volume
of nuisance litigation and more fully compensate
plaintiffs with strong cases. These gains would
come at a heavy price, though, if the new rule
discouraged injured people of little means from
seeking justice out of fear that they might
be liable for a ruinous fee award. Proponents
of loser-pays reforms must explain how their
proposals will preserve functional access to
justice for poor and middle-income plaintiffs.
Loser-pays countries usually preserve access
by making available a combination of public-
and union-funded legal aid programs and insurance,
all of which indemnify participating plaintiffs
for attorneys' fees in the event of a courtroom
loss. Because the level of union membership
is lower in the United States than elsewhere
and because publicly funded legal aid has been
historically unpopular here, legal-expenses
insurance is the most likely of these mechanisms
to play the role of ensuring access to U.S.
courts if a loser-pays rule is widely adopted.
Legal-expenses insurance (LEI) takes two common
forms in loser-pays jurisdictions. The first
is "traditional" LEI, for which a
premium is charged every month and which covers
any legal expenses of either a future plaintiff
or a future defendant that might arise as the
result of events, such as an accident, that
occur after the policy is in place. These traditional
policies pay the legal expenses only of suits
initiated by the covered party, assuming that
the insurance company deems the suit in question
to have a solid basis.
The second type of LEI is "after-the-event"
(ATE) legal-expenses insurance, which a party
claiming injury can purchase at the time he
files a lawsuit and which will relieve him of
the obligation to pay the defendant's attorneys'
fees out of pocket if his suit is unsuccessful.
ATE premiums can be advanced by the plaintiff's
lawyer as costs, or they can take the form of
a percentage stake in any recovery; either way,
an upfront contribution by the plaintiff, particularly
one of limited means, is not required. In some
jurisdictions, the ATE premiums that a winning
plaintiff has paid can be recovered from a losing
defendant.91
Both types of litigation insurance—traditional
LEI and ATE—protect the viability of strong
cases while discouraging weak ones by denying
coverage or charging higher rates. Insurance
coverage spreads the cost of losing a good case
across many legitimate claimants, while careful
underwriting keeps poor cases from being filed.
Some will object to the notion of making insurance
companies, in effect, the courts' gatekeepers.
Such concerns would be overblown. Plaintiffs'
lawyers already screen potential cases as to
merit and decline to handle the majority of
prospective claims that they are offered. In
a competitive insurance market, plaintiffs'
lawyers could shop their cases among insurers.
And nothing in theory would prevent a plaintiff's
lawyer himself from assuming the risk of paying
a defendant's legal fees—that is, accepting
self-insurance, in effect, as an additional
contingent cost of taking a case.[92]
If a claim were denied both ATE coverage and
self-insurance by a plaintiff's attorney, it
would be because it was highly unlikely to succeed,[93]
making it the very type of claim that loser
pays was designed to discourage.
The experience of foreign countries suggests
that a market for legal-expenses insurance could
develop rather easily in the United States.
Traditional LEI is particularly popular in Germany,
where about 42 percent of all households have
policies.[94] By law, it
is a stand-alone product there, but it can be
offered as an add-on to homeowner's insurance
or auto insurance in other loser-pays countries,
as it usually is in England.[95]
The cost of LEI is generally modest.[96]
Some traditional LEI policies cover the hourly
fees that the plaintiff owes his attorney (unless,
of course, the losing defendant pays them),
eliminating the need to hire attorneys on a
contingent basis. Such policies also insure
plaintiffs against the risk of having to pay
an adverse fee award, at least up to some stated
limit. If American jurisdictions adopted loser
pays, traditional LEI policies would have a
market among middle-income Americans who have
assets to protect and commonly carry other forms
of insurance, such as life insurance, homeowner's
insurance, and traditional liability insurance.
Recent policy changes in England and Wales
have shown that insurers can quickly respond
to them by providing needed products. England
and Wales historically disallowed fee arrangements
that depended on the outcome of a lawsuit. In
1990, however, Parliament passed a measure legalizing
"conditional fee agreements" (CFAs)
for personal-injury claims and certain other
proceedings.[97] Under
a CFA, a client need pay his lawyer nothing
if his case is lost but must pay a "success
fee" (in addition to regular fees recovered
from the defendant) if the case is won.[98]
In 1998, the government extended the measure
to allow CFA agreements in all civil cases except
those involving family law.[99]
At the same time, Parliament phased out civil
legal aid entirely for personal-injury plaintiffs
and made other forms of aid available to only
a small minority of the population.[100]
The former eligibility of a majority may have
had the effect of stunting the market for legal-expenses
insurance.
These twin reforms—liberalizing CFAs and
cutting legal aid—effectively privatized
personal-injury litigation in England and Wales.
Lawyers and insurers, rather than taxpayers,
are now underwriting litigation risk for plaintiffs,
and a variety of ATE policies have been introduced
by at least six insurance companies, which advertise
ATE policies online;[101]
at least two post applications, as well, online.[102]
They are four to six pages in length and are
filled out by plaintiffs' attorneys. The fee
is generally £100–200, which can
be advanced by the applicant's lawyer. If the
plaintiff prevails, he can also recover from
the defendant the premiums he has paid; at least
some advertised ATE policies do not charge the
premium until a verdict has been rendered and
unless it is in the plaintiff's favor.
In 2003, ATE constituted about 29 percent of
the larger LEI market in Britain and collected
some £110 million in premiums.[103]
A British trade publication recently estimated
that ATE insurance is now purchased for three
in four civil lawsuits filed under conditional
fee agreements.[104] The
rapid growth of the ATE insurance market in
England and Wales should help assure observers
of the American legal scene that legal-expenses
insurance can effectively preserve access to
justice in loser-pays jurisdictions.
PART VI: IMPLEMENTATION
GUIDELINES
T he Alaska and Florida experiences—and
the light they shed on the theoretical literature
on fee shifting—suggest that future loser-pays
reforms should incorporate the following three
features.
First, the size and percentage of the fee shifted
must be large enough to affect the behavior
of potential litigants. Alaska's loser-pays
rule allows prevailing defendants to be reimbursed
only 20 to 30 percent of their actual legal
expenditures, an amount too low to adequately
influence a plaintiff's decision about whether
to file suit.
Second, loser pays works best if defendants
can recover their fees in cases involving plaintiffs
with few personal assets. In many nations with
loser-pays rules, litigation insurance is available
to plaintiffs at a reasonable price. The United
States should require plaintiffs to purchase
insurance, and it should permit their lawyers
to advance the premium, as they do other litigation
costs, in order to preserve access to the courts.
Finally, loser-pays reforms should be designed
to minimize any increases in costs per case
and any negative effect on the prospects of
settlement. In order to accomplish this, loser
pays should be accompanied by a modified offer-of-judgment
rule (similar to those already present in many
state systems and in federal courts) that applies
to both plaintiffs and defendants. Offer-of-judgment
rules impose court costs on plaintiffs who pass
up a settlement offer in favor of obtaining
a judgment that turns out to be no more generous.
If such rules are extended to include attorneys'
fees, they should encourage timely settlement
of claims.
PART VII: A PROPOSAL FOR
REFORM
The Manhattan Institute proposal is designed
to bring the benefits of loser pays to both
the state and federal justice systems. It includes
a modified offer-of-judgment device. It is designed
to compensate winning litigants more fully and
reduce the number of abusive lawsuits, while
preserving access to justice for poor and middle-income
litigants with strong claims. It should also
limit any increases in litigation expenditures
and encourage the parties to make reasonable
settlement offers so as to limit their potential
liability for attorneys' fees.
Proposal
The non-prevailing party in any civil case
in which money damages are sought shall indemnify
the prevailing party for the costs of litigation
and reasonable attorneys' fees. Fees awarded
shall be the lesser of 1) actual fees, or 2)
30 percent of the difference between the final
judgment and the non-prevailing party's last
written offer of settlement tendered within
sixty days of the date that the initial complaint
was filed in the trial court.
Determining the Prevailing Party: The
plaintiff is the prevailing party if it obtains
an order for a net total judgment amount (including
all substantive claims and counterclaims and
excluding costs) in excess of the defendant's
last written offer of settlement tendered within
sixty days of the date that the initial complaint
was filed in the trial court. Otherwise, the
defendant will be deemed the prevailing party.
Ability to Pay: Within ninety days of
the date that the initial complaint is filed
in the trial court, the plaintiff shall file
proof that assets are available to pay a judgment
awarding costs. Such proof may be a litigation
insurance policy. The plaintiff's attorney may
advance the premium for such a policy, and the
plaintiff may recover the premium as costs if
the plaintiff is the prevailing party. If the
plaintiff does not file such proof, the complaint
will be dismissed without prejudice.
Voluntary Dismissal: A plaintiff will
be liable for costs as a non-prevailing party
under this section if it moves to withdraw a
lawsuit more than ninety days after the initial
complaint was filed.
Maintenance and Champerty: The provision
of litigation insurance in accordance with other
applicable law shall not be deemed maintenance
or champerty.[105]
The following goals of a loser-pays reform
are addressed by this proposal:
Compensating Winning Litigants
Like other loser-pays rules, this proposal
better compensates litigants who prevail at
trial by reimbursing them for at least a portion
of the considerable cost of litigation. Litigation
expenses of prevailing parties will be reimbursed
up to 30 percent of the difference between the
relevant settlement offer of the losing party
and the amount recovered at trial.
Reducing the Number of Abusive Lawsuits
By reducing the expected cost to defendants
of fighting abusive suits, this proposal should
weaken the ability of the plaintiffs and their
lawyers who file them to induce defendants to
settle. This proposal should also reduce the
volume of abusive lawsuits by requiring plaintiffs
to demonstrate that they have the means to pay
the defendant's attorneys' fees if they do not
prevail. This requirement would frequently be
met by litigation insurance, which would be
made available only to plaintiffs with reasonably
strong cases.
Promoting Early Settlement
This proposal should promote early settlement
in at least two ways. First, it should encourage
the parties to make settlement offers at an
early stage of litigation, before expenses have
mounted. Second, it should encourage the parties
to make their settlement offers as reasonable
as possible, because a party's settlement offer
limits its liability for attorneys' fees in
the event of a loss at trial.
Containing Litigation Costs
Our proposal should limit the incentives to
spend more on litigation that a different kind
of loser-pays rule might create. Ours does so
by capping recoverable fees at 30 percent of
the difference between the amount of the judgment
at trial and the amount of the non-prevailing
parties' relevant settlement offer. Additional
litigation expenses will be borne entirely by
the party that chose to incur them.
Promoting Litigation Insurance
As with any loser-pays rule, a healthy litigation
insurance market would be a crucial part of
ensuring access to justice for plaintiffs with
meritorious cases. Such access also benefits
society by promoting compliance with legal standards
of care. To promote the development of a litigation
insurance market, our proposal includes a provision
protecting insurance providers from liability
under traditional common-law doctrines of "maintenance"
and "champerty," which have traditionally
barred some forms of litigation financing in
the United States and other common-law jurisdictions.
CONCLUSION
The United States pays a high price for a system
of justice that uniquely encourages abusive
litigation, but it need not continue to do so.
Thoughtful reforms in state and federal law
can bring our civil justice system into sync
with the rest of the world by replacing the
American rule for attorneys' fees with a loser-pays
system. Loser pays need not close the courthouse
door to plaintiffs with modest means but legitimate
grievances. England's recent quasi-privatization
of civil justice demonstrates that markets for
litigation insurance can develop rapidly in
response to legal reforms, and that reasonable
limits to the parties' exposure to liability
for fees, if they are incorporated into an offer-of-judgment
mechanism, can promote early settlement.
APPENDIX
Formal Model of Loser-Pays Proposal
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