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May 27, 2004


More confusion: business-to-business lawsuits

Another point of confusion that arose at the Manhattan Institute's May 25th forum came from a question posed by Bill Tucker, a journalist who wrote a Weekly Standard cover story last year entitled, "In Defense (sort of) of Trial Lawyers." Tucker asked whether we should distinguish between personal injury suits, class action suits, and the like, and business-to-business lawsuits.

The implicit premise is that a business, unlike an individual, will not bring a meritless lawsuit. But while some of the problems in our civil justice system aren't applicable to business-to-business suits -- say, the problem of attorneys' ethics under contingency fee arrangements, or the problems inherent in class action litigation -- it's hardly clear that business are unlikely to use the legal system as a harrassment tool, given our peculiar "American rule."

To begin with, if we assume that the timing of litigation costs differs between plaintiff and defendant, as common sense tells us it does, any plaintiff could be expected to bring a claim with an expected return less than the total expected cost of litigating the claim, so long as initial filing costs were less than expected settlement value. See, e.g., Rosenberg and Shavell, "A Model in Which Suits are Brought for Their Nuisance Value," 5 Int'l Rev. of L. and Econ. 3-13 (1985). And, given that the defendant in our system has to pay substantial sums to go to court for ultimate vindication -- and is not reimbursed for those costs -- the rational defendant would in fact settle for some sum (though the defendant might be less likely to settle if it expects to be a repeat defendant facing similar meritless claims repeatedly, if the reputational gains from fighting the suit exceeded the costs of defending it).

Moreover, while meritless suits based on the timing of litigation costs could only extract relatively small sums in settlements -- those associated with legal costs -- much larger settlements are possible given the assymetric information that exists in reality. For a good and thorough (if technical) exploration of the law and economics of frivolous lawsuits, see chapter 9 of Thomas Miceli's Economics of the Law.

In some respects, businesses are better equipped than individuals to abuse the legal system against their peers. Businesses typically have inventories or monies owed to their suppliers or business customers that can be used as leverage. I.e., a business might hold as ransom cash or property value up to the other business's expected settlement value (or legal costs, if the harrassing business is in a defendant's role). (Such strategies could apply in contract as well as tort litigation -- and perhaps do with more frequency.)

Of course, a business is constrained by reputational effects. A business that regularly harrassed businesses with which it had commercial relations would have a hard time finding customers and suppliers. Thus, such abuses of the legal process are most likely in "end game" scenarios -- i.e., when a business is on the verge of bankruptcy, exiting a market, or the like.

In any event, there is little reason to exclude business-to-business litigation from a general critique of the civil justice system. Indeed, a "loser pays" rule would prevent much abuse in business-to-business litigation, as a business would be much more likely to pursue meritorious claims, and not pursue meritless claims, if the business knew the loser in the litigation had to pay the victorious side's expenses. Many businesses could and would self-insure -- any of the fears expressed by critics of loser pays systems vis-a-vis courtroom accessibility (ill-founded in my view) would not apply in litigation between businesses.


Posted by James R. Copland at 11:36 AM | TrackBack (0)



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