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May 26, 2004

Loser pays: clearing up some confusion

During yesterday's Manhattan Institute program Trial Lawyers, Inc.: Myths and Realities, a number of the audience questions directed toward John Stossel after his luncheon speech centered around "loser pays" provisions and how they might work in practice. Many of the questioners could have benefited from reading some of the writings of our editor Walter Olson on the topic, including the basic introduction he's posted on this site and, or his more extensive treatment in chapter 15 of The Litigation Explosion.

The questioners focused on: (1) whether it was fair for plaintiffs themselves, as opposed to the lawyers representing them, to be responsible for paying fees if their suit did not prevail, and (2) whether such a system might prevent individuals from filing suit against large corporations who could run up very high legal expenses.

On the first point, it doesn't matter much whether the burden falls, as a matter of default, on the plaintiff or his attorney. It's really a classic example of the Coase Theorem, the basic principle underlying the field of law and economics. As Ronald Coase explained in his seminal 1960 article, "The Problem of Social Cost," in such situations, assuming zero transaction costs, it matters not where liability lies -- because the private parties can contract to reallocate the liability based on their preferences. In this context, if it makes more sense for an attorney to bear the burden of legal expenses upon loss at trial, the parties could so contract in the initial contingency fee arrangement.

Of course, one might argue that unknowing plaintiffs would be hoodwinked by trial attorneys into assuming liabilities of which they're unaware. Indeed, the recent work by Lester Brickman showing that contingency fees are not price competitive gives some reason for pause. But there's no reason that a loser pays system couldn't set as the default rule that attorneys assume the risk of loss and that individuals must be given clear notice of a shift in that risk. Moreover, a loser pays regime might require "unsophisticated" plaintiffs (probably lower-net-worth individuals, with a threshold similar to that used in federal securities law) to acquire insurance to cover potential losses, if not indemnified by their attorneys.

The reality that legal expenses under a loser pays system could be insurable seems lost upon critics of the system who contend that loser pays would reduce court access. As our editor makes clear in his essay on loser pays on, there is a robust market for insuring legal expenses in the event of loss in Europe. Typically, individuals can purchase "legal expense insurance" as an addendum to their home or auto insurance, and/or "after-the-event insurance" upon inception of a claim. Obviously, insurance companies will price premiums according to the quality of a claim and its expected return, which is quite the point -- weak claims that exist under the "American rule" by virtue of defendants' willingness to settle to dispense with unrecoverable defense fees are driven out of the system, whereas more tenable claims remain affordable to pursue.

Posted by James R. Copland at 03:18 PM | TrackBack (0)

Loser Pays



Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.