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«JOURNAL OF LAW, ECONOMICS & POLICY VOLUME 10 SPRING 2014 NUMBER 2 EDITORIAL BOARD 2013-2014 Steve Dunn Editor-in-Chief Crystal Yi Meagan Dziura Sarah ...»

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JOURNAL OF LAW, ECONOMICS & POLICY

VOLUME 10 SPRING 2014 NUMBER 2

EDITORIAL BOARD

2013-2014

Steve Dunn

Editor-in-Chief

Crystal Yi Meagan Dziura Sarah Mernin

Executive Editor Publications Editor Managing Editor

Michael Rogers Maxwell Slackman Kelly Fryberger Senior Articles Editor Senior Notes Editor Senior Research Editor David Dubin Erica Peterson Victoria Clarke Preston Wise Ian Rothfuss Senior Notes Editor Articles Editors Research Editors Preston Wise Kevin Hill Articles Selection Editor Symposium Editor

MEMBERS

Josh Branson Ryan Leavitt Jonathan Stapor Marie Keiko Breyan Mariam Noori Charles Thresher Brady Cummins Catherine Oryl Allison Walsh Kyra Smerkanich

CANDIDATE MEMBERS

Ian Baldwin Jason Langford Daniel Russell Sam Banks Damian Martin Daniel Schneider James Beaty Daniel McCain Karen Schroeder Roger Gibboni Jenny Min David Scott Jacob Hamburger Samantha Morelli Tamta Zhorzholiani Jeff Kuhlman Temitope Odusami Rebecca Schumm

BOARD OF ADVISORS

Lisa E. Bernstein Francesco Parisi Henry N. Butler Eric Posner Judge Guido Calabresi Judge Richard A. Posner Lloyd R. Cohen Roberta Romano Robert D. Cooter Hans-Bernd Schäfer Robert C. Ellickson Steven M. Shavell Richard A. Epstein Henry E. Smith Judge Douglas H. Ginsburg Vernon L. Smith Mark F. Grady Gordon Tullock Michael S. Greve Thomas S. Ulen Bruce H. K

–  –  –

INTRODUCTION

In economics literature, it is well settled that there is a divergence between the private and social incentives for persons to file suit. Beginning roughly thirty years ago, Steven Shavell described in a series of articles how plaintiffs do not fully internalize the social consequences of engaging in civil litigation.1 In particular, Shavell identified two externalities—one negative and one positive2—from the use of the civil justice system. On one hand, when initiating suit, plaintiffs do not fully internalize the social costs of using the courts.3 Rather, plaintiffs only internalize their own litigation costs and neglect the costs of opposing parties and those of the public system generally.4 This negative externality suggests that there is an * We wish to thank the participants of the 23rd Annual Meeting of the American Law and Economics Association, May 2013, for their insightful comments. We also wish to thank Verity Winship and the attendees of the 12th Annual Meeting of the Midwestern Law and Economics Association, October 2013.

** Assistant Professor of Economics, Quinnipiac University. J.D., University of Connecticut School of Law, 2005; Ph.D. Economics, University of Connecticut, 2010.

*** Professor of Economics, University of Connecticut. Ph.D. Brown University, 1988.

1 See Steven Shavell, The Social Versus the Private Incentive to Bring Suit in a Costly Legal System, 11 J. LEGAL STUD. 333, 333–34 (1982) [hereinafter Shavell, Social Versus Private Incentive];

Steven Shavell, The Fundamental Divergence Between the Private and the Social Motive to Use the Legal System, 26 J. LEGAL STUD. 575, 575 (1997) [hereinafter Shavell, Fundamental Divergence];

Steven Shavell, The Level of Litigation: Private Versus Social Optimality of Suit and of Settlement, 19 INT’L REV. L. & ECON. 99, 99–101 (1999). For a discussion on the topic by different authors, see, e.g., Louis Kaplow, Private Versus Social Costs in Bringing Suit, 15 J. LEGAL STUD. 371, 371 (1986); Peter S. Menell, A Note on Private Versus Social Incentives to Sue in a Costly Legal System, 12 J. LEGAL STUD. 41, 41 (1983); Susan Rose-Ackerman & Mark Geistfeld, The Divergence Between Social and Private Incentives to Sue: A Comment on Shavell, Menell, and Kaplow, 16 J. LEGAL STUD. 483, 483 (1987).

2 A positive externality is one that imposes a benefit upon a third party. For instance, when one properly maintains one’s home, it is likely that this behavior will increase (or at a bare minimum, not strictly decrease) the property values of neighboring homes. A negative externality imposes a cost upon a third party. A common example is pollution. By “internalizing an externality,” we mean that a party’s private losses (or gains) are identical to the social losses (or gains) associated with a particular externality. See BLACK’S LAW DICTIONARY 664 (9th ed. 2009).

3 Shavell, Social Versus Private Incentive, supra note 1, at 333.

4 Shavell, Fundamental Divergence, supra note 1, at 577–78.

3302 JOURNAL OF LAW, ECONOMICS & POLICY [VOL. 10:2

excessive level of litigation.5 But on the other hand, plaintiffs do not consider a positive externality that may arise from litigation—namely, its deterrent effect upon potential injurers.6 Plaintiffs are driven by their own self-interest to seek compensation.7 Thus, when plaintiffs do not have the correct incentives to pursue a legal remedy, they may not file suit when it is otherwise socially beneficial for them to do so.8 In other words, plaintiffs do not take into account the possibility that litigation may induce future potential injurers to exercise greater care or precaution—a hallmark of the legal concept of deterrence.9 The failure to fully internalize this positive externality may possibly result in an insufficient level of litigation.10 Due to these competing externalities, there is a divergence between the private and social incentives for plaintiffs to file suit.





Despite this observation, few would advocate for an increase in the number of lawsuits. Indeed, there appears to be a widespread belief that there is excessive litigation generally, and that the civil justice system is plagued by frivolous lawsuits. Putting the normative questions pertaining to frivolous litigation aside, an unresolved descriptive issue is whether frivolous lawsuits are capable of exerting a positive externality upon persons or businesses engaged in risky activities. A proper positive evaluation of frivolous lawsuits therefore requires an examination of their impact on deterrence.

Economists have previously examined the deterrence externality under different liability rules—in particular, negligence and strict liability.

Ordover found that negligence would result in some potential injurers exercising an insufficient, or suboptimal, level of care.11 Indeed, if all potential injurers complied with the negligence standard of reasonable care under similar circumstances, then no plaintiffs would ever file a costly lawsuit.12 But without the threat of suit, some potential injurers would not have the correct incentives to comply with the standard of care.13 The result is that some potential injurers must exercise suboptimal levels of care under negliShavell, Social Versus Private Incentive, supra note 1, at 333. In other words, there are too many lawsuits from a social perspective.

6 Id. at 333–34.

7 Shavell, Fundamental Divergence, supra note 1, at 578.

8 See Shavell, Social Versus Private Incentive, supra note 1, at 334.

9 It is not necessarily true that the social deterrence benefit of suit always exceeds the private benefit. It is possible for the private benefit to exceed the social benefit. See id.

10 Id. This competing force has the potential to suggest that there are too few lawsuits from a social perspective.

11 Janusz A. Ordover, Costly Litigation in the Model of Single Activity Accidents, 7 J. LEGAL STUD. 243, 243–45 (1978).

12 See id. at 244.

13 Id. at 244–45.

2014] THE IMPACT OF FRIVOLOUS LAWSUITS ON DETERRENCE 303 gence.14 Hylton affirmed Ordover’s original negligence findings and extended the analysis of the deterrence externality to strict liability.15 He argued that potential injurers also exercise insufficient levels of care under strict liability since they do not fully internalize two social costs—the litigation costs of the plaintiffs they harm, and the magnitude of the harm suffered by those victims who did not have the correct incentives to file suit.16 Therefore, under strict liability with pure compensatory damages, potential injurers do not exercise the optimal level of care because they do not fully internalize all of the costs borne by accident victims.17 These two papers illustrate that there is generally a problem of underdeterrence in tort law.

The underdeterrence problem begets an analysis of appropriate corrective policies, but we ask a different question—namely, is it possible, despite the “bad press” they ordinarily receive, that frivolous lawsuits may sometimes actually serve to enhance deterrence? Put another way, as a positive (or descriptive) matter, can frivolous lawsuits potentially, though perhaps imperfectly, correct for the problem of underdeterrence? If so, they may have some redeeming social value. Having raised these questions, it is important to note at this juncture that we will not advocate for an increase in the frequency of frivolous litigation. Nor will we attempt to justify plaintiffs who file frivolous lawsuits. Our theoretical model, when properly interpreted, does not provide an adequate normative foundation to suggest that policymakers should enact rules to encourage (or at least not discourage) frivolous litigation. This is true because, practically speaking, it may be difficult to determine exactly when frivolous lawsuits induce beneficial deterrence.18 And in addition, we recognize that the existence of frivolous lawsuits may cause some to call into question the integrity of the civil justice system. As a result, our model only describes how, as a descriptive matter, frivolous lawsuits affect deterrence. Our conclusions therefore 14 Id. at 245.

15 Keith N. Hylton, The Influence of Litigation Costs on Deterrence Under Strict Liability and Under Negligence, 10 INT’L REV. L. & ECON. 161, 161–62 (1990).

16 Id. at 161. Note that victims will not file suit if expected court-ordered compensation is outweighed by the victim’s cost of litigation.

17 On the topic of optimal deterrence, see Shavell, Fundamental Divergence, supra note 1, at 588 (arguing that optimal deterrence requires injurers to compensate victims for both their harm and litigation costs). Polinsky and Rubinfeld argue for an adjustment to the level of compensatory damages to ameliorate the problem of underdeterrence, though they allow for the possibility that injurers may exercise too much care from a social perspective. Their adjustment in the level of compensatory damages depends not only on the injurer’s level of care relative to the social optimum, but also on the impact of litigation costs on a victim’s incentives to file suit. A. Mitchell Polinsky & Daniel L. Rubinfeld, The Welfare Implications of Costly Litigation for the Level of Liability, 17 J. LEGAL STUD. 151, 151–53 (1988).

18 But see infra Part II.F for a numerical example demonstrating how frivolous lawsuits enhance deterrence in a socially valuable manner.

–  –  –

should not necessarily be interpreted as advocating for looser restrictions on the filing and litigating of frivolous claims.

With these considerations in mind, the remainder of the paper is organized as follows. In Part I, we describe how a certain subset of frivolous lawsuits can be characterized as “piggyback” lawsuits. Despite ambiguity regarding what constitutes a frivolous lawsuit, we observe that some frivolous claims piggyback on claims brought by legitimate accident victims. In Part II, we describe our theoretical model and provide numerical examples.

There we show that under certain circumstances, frivolous lawsuits are capable of generating beneficial deterrence. In Part III, we focus on how the many legal regimes governing frivolous lawsuits impact deterrence. In particular, we discuss how these legal regimes may or may not increase social welfare in the presence of frivolous suits.

I. FRIVOLOUS LAWSUITS AS PIGGYBACK LAWSUITS

Different groups perceive frivolous lawsuits in different ways, and hence, there is some ambiguity with respect to defining, and correspondingly evaluating, frivolous suits. For instance, some personal injury lawyers may argue that frivolous lawsuits are infrequently initiated under contingency fee agreements because lawyers cannot expect to realize profits by representing clients with low-expected-value claims.19 Indeed, if a contingency fee arrangement exists between a lawyer and a particular client, then the lawyer’s willingness to represent the client may signal the case’s inherent level of merit.20 Taking a different stance, some politicians have maintained that frivolous lawsuits pose a serious threat to the efficiency of the civil justice system.21 With the asserted goals of remedying judicial delay, mitigating a perceived litigation explosion, reducing excessive jury awards, and decreasing insurance premiums, some political platforms have focused on reducing the frequency of frivolous lawsuits (for example, by advocating 19 See, e.g., James D. Dana, Jr. & Kathryn E. Spier, Expertise and Contingent Fees: The Role of Asymmetric Information in Attorney Compensation, 9 J. L. ECON. & ORG. 349, 350 (1993) (arguing that rational lawyers will focus their efforts on meritorious claims as opposed to those cases with low expected returns). But see Thomas J. Miceli, Do Contingent Fees Promote Excessive Litigation?, 23 J.

LEGAL STUD. 211, 212 (1994) (recognizing that frivolous lawsuits can be profitable under contingency fee agreements if defendants prefer settlement to trial).

20 Avery Katz, The Effect of Frivolous Lawsuits on the Settlement of Litigation, 10 INT’L REV. L.

& ECON. 3, 26 (1990) (stating that “[t]he fact that an attorney is willing to take a percentage of a case as his compensation may be a good signal that the case has merit; accordingly, contingent fees may help to channel meritorious cases toward settlement, while screening out some frivolous claims”). Put another way, personal injury lawyers may serve as a screening mechanism.

21 See Robert S. Peck, Violating the Inviolate: Caps on Damages and the Right to Trial by Jury, 31 U. DAYTON L. REV. 307, 308 n.5 (2006).



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