Presentation on theme: "ECONOMIC ANALYSIS OF TORT LAW January 23, 2007(Revised)"— Presentation transcript:
ECONOMIC ANALYSIS OF TORT LAW January 23, 2007(Revised)
ECONOMIC ANALYSIS OF TORT LAW Private Bads Torts Intentional Pollution Assault Fraud Unintentional Negligence THEOREM OF COASE Same efficiency under rival allocation of rights EXCEPTIONS: High Transaction Costs Asymmetric Information Empty Core
ECONOMIC ANALYSIS OF TORT LAW Two Related Motivations For Tort Rules: The tort law problem is to minimize the social costs of accidents by providing incentives to avoid accidents As well the tort law problem is to provide compensation to accident victims.
ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY AGENT 1 AGENT 2 SUPER Principal = Judge TORTS Its problem is to maximize social surplus
ECONOMIC ANALYSIS OF TORT LAW The Court imposes a rule that establishes a standard of care for legal conduct, breach of which triggers the imposition of damages.
ECONOMIC ANALYSIS OF TORT LAW NEGLIGENCE LIABILITY: Product Liability
ECONOMIC ANALYSIS OF TORT LAW A major change did indeed occur, but not until 1934. In 1934 with the landmark House of Lords ruling in Donohue v Stevenson,  A.C. 532 (H.L.) This case determined that defendants could be liable to strangers when their injury fell within the scope of precaution the defendant was required to adopt as a reasonable party
ECONOMIC ANALYSIS OF TORT LAW Perfectly Competitive-AgentMarket – Agents S S D P a1a1 MCSATC
ECONOMIC ANALYSIS OF TORT LAW Agent 2 - Monopoly S D P a1a1 PMPM Private MC Social MC Coasean or Bargained MC Negligence Rule and MC Agent 1 - PC S x1x1 P LR
ECONOMIC ANALYSIS OF TORT LAW Negligence – Defence of Contributory Negligence a1*a1* $ Strict Liability Portion Of The Negligence Rule Precaution Cost Component Of The Negligence Rule At common law, beyond this point a single Defendant was not liable
ECONOMIC ANALYSIS OF TORT LAW Negligence – Comparative Negligence a1*a1* $ Under Contributory Negligence statutes, liability or fault is now apportioned (shared) among parties
ECONOMIC ANALYSIS OF TORT LAW Agent 2 - Monopoly S D P a1a1 PMPM Private MC Social MC Negligence Rule and MC Agent 1 - PC S x1x1 P LR
ECONOMIC ANALYSIS OF TORT LAW Agent 2 - Monopoly S D P a1a1 PMPM Coasean or Bargained MC Negligence Rule and MC Agent 1 - PC S x1x1 P LR
ECONOMIC ANALYSIS OF TORT LAW NEGLIGENCE LIABILITY: Employer and Employee Liability
Torts - History Modern Developments Protecting employers from workers »Doctrine of Respondeat Superior »Doctrine of Volenti Non Fit Iniuria »Horwitz thesis – Emergence of negligence rules Protecting workers from employers »1830s – Factory Acts »1860s – Fatal Accidents Act »1880s – Employer Liability Act »1910s – Workers Compensation »1920s – Comparative Negligence
ECONOMIC ANALYSIS OF TORT LAW Agent 2 - Monopoly S D P a1a1 PMPM Coasean or Bargained MC Negligence Rule and MC Agent 1 - PC S x1x1 P LR
ECONOMIC ANALYSIS OF TORT LAW A mere opportunity to commit a wrongful act does not suffice to show vicarious liability; one must consider the job-created power and the nature of an employee's duties as a fundamental component of determining if a particular enterprise increased the risk of particular wrongdoing in relation to a claimant by the employee complained about. (SCC) In this case, the employee's limited role and duties "fell short" of what is required to prove vicarious liability.
ECONOMIC ANALYSIS OF TORT LAW CATASTROPHIC TORTS
ECONOMIC ANALYSIS OF TORT LAW Between the 1930s to the 1980s, thousands of workers who had been in the asbestos industry came down with terrible sicknesses as a result of exposure to asbestos dust Question: Did the lawsuits of the 1980s, which bankrupted many producers, serve as a precautionary deterrent?
ECONOMIC ANALYSIS OF TORT LAW Professor Dewees, who did the Sudbury pollution study we examined in Term I, did another study on the John-Mansville asbestos plant that operated at Port Union from 1948 to 1984
ECONOMIC ANALYSIS OF TORT LAW He found that the tort system in conjunction with workers compensation rules in Ontario were sufficiently clear that liability would be imposed on Johns- Manville for the deaths (p. 310) Why did the firm not act?
ECONOMIC ANALYSIS OF TORT LAW The workers compensation levies on the plant were not high enough to induce the firm to institute dust controls (p. 317) Aerial view of the Johns-Manville asbestos plant (Scarborough)
ECONOMIC ANALYSIS OF TORT LAW Converted use Residential Development at Port Union (Scarborough) on top of the site of the Johns-Manville asbestos plant
ECONOMIC ANALYSIS OF TORT LAW LIABILITY: Limitation Periods
ECONOMIC ANALYSIS OF TORT LAW Basic limitation periods Ontarios new Limitations Act, 2002 came into force January 1, 2004. The basic limitation (for starting a court action, not for giving notice) is now two years for most claims. The new law does not eliminate the various short notice periods, which require that notice be given within a few short days to municipalities for slip and fall on a roadway, for example.
ECONOMIC ANALYSIS OF TORT LAW LIABILITY: Duty To Mitigate
ECONOMIC ANALYSIS OF TORT LAW When one party suffers damages at the hands of another, the injured party generally has a duty to act to minimize his or her losses. This principle is known as the duty to mitigate. It generally applies to cases concerning bodily injury, damages to property and breach of contract, but not to debt collections
ECONOMIC ANALYSIS OF TORT LAW LIABILITY: Insurance Contracts – Single Defendant
ECONOMIC ANALYSIS OF TORT LAW The efficient operation of liability insurance markets will indirectly effect the solution of the tort problem
ECONOMIC ANALYSIS OF TORT LAW AGENT 1 (Insured) AGENT 2 (Insured) SUPER Principal = Judge TORTS – Bilateral Agency Its problem is to maximize social surplus Insurer 1 Insurer 2 CONTRACTS – Principal Agency
ECONOMIC ANALYSIS OF TORT LAW DUTY TO DEFEND The Supreme Court of Canada in Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada, 2006 SCC 21 has ruled that an insurer's duty to defend in a claims-made policy covers only those claims actively made (rather than merely discovered by the insured) during the term of the policy.Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada Garnier Residential School, Spanish, Ontario
ECONOMIC ANALYSIS OF TORT LAW When a single defendant has limited wealth, its insurance decisions are the outcome of a single-agent decision problem. This is the familiar contract problem reviewed in the first term
ECONOMIC ANALYSIS OF TORT LAW What might persuade a single agent to switch from a full insurance contract to no insurance when the level of activity risk that agent faces increases? The defendant, an individual or a corporation, has limited liability because of the option to declare bankruptcy.
ECONOMIC ANALYSIS OF TORT LAW Given a liability rule, a defendant chooses an amount of insurance, I 1, to maximize its expected utility. The defendant pays premium p for this insurance, where p = probability that an accident will occur.
ECONOMIC ANALYSIS OF TORT LAW. w - pI 1 w E U1U1 Utility Indifference Curve Of A Single Risk Averse Insured
ECONOMIC ANALYSIS OF TORT LAW The Insurance Problem: EU = pU(w + I 1 – pI 1 – D) + (1-p)U(w – pI 1 )
ECONOMIC ANALYSIS OF TORT LAW First Order Condition – No limited liability EU/dp = 0 p(1-p)U(w + (1-p)I 1 – D) = p(1-p)U(w – pI 1 ) marginal benefit of insurance = marginal cost of insurance
ECONOMIC ANALYSIS OF TORT LAW First Order Condition – Limited liability EU/dp = 0 p(1-p)U(w + (1-p)I 1 – D) = p(1-p)U(w – pI 1 ) Limited Liability Constraint: p(1-p)U(w + (1-p)I 1 – D) = 0 up to I 1 * = (D-w)/(1-p)
ECONOMIC ANALYSIS OF TORT LAW An increase in the probability of an accident, p, decreases the critical damages award level, D. So the damages award for the plaintiff is lowered.
ECONOMIC ANALYSIS OF TORT LAW An increase in p will cause some individuals to drop their insurance coverage completely. An increase of either damage awards or liability standards can reduce the compensation to accident victims when a defendant abandons liability insurance.
ECONOMIC ANALYSIS OF TORT LAW NEGLIGENCE LIABILITY: Insurance Contracts – Multiple Defendants
ECONOMIC ANALYSIS OF TORT LAW Linking insurance decisions to the tort system shows that more liability in tort can lead to less compensation for the accident victim, and less deterrence against accidents.
ECONOMIC ANALYSIS OF TORT LAW Bilateral Negative Externalities – Example: Cournot Duopoly a 2 = Output of Agent 2 a 1 = Output of Agent 1 NASH EQUILIBRIUM Iso-Profit Curve For Agent 1 Iso-Profit Curve For Agent 2 PARETO OPTIMAL EQUILIBRIUM
ECONOMIC ANALYSIS OF TORT LAW In the case of only two multiple parties A 1 and A 2, if both were equally involved in the accident, the parties would split the damages, provided there are no limitations on wealth.
ECONOMIC ANALYSIS OF TORT LAW However, when two agents with limited wealth are subject to the joint and several liability (common law) rule, the agents insurance decisions are the outcome of a game of bilateral positive externalities. See Winter, Ralph, Liability Insurance, Joint Tortfeasors and Limited Wealth, v. 26, Issue 1, International Review of Law and Economics, p. 1 (March, 2006)
ECONOMIC ANALYSIS OF TORT LAW The Deep-Pockets Effect: As Agent A 1 buys more insurance, it confers a positive externality on Agent A 2 Agent A 2 believes a plaintiff will go after A 1 first because there is a deeper pocket Why would a plaintiff pursue the deeper pocket? The plaintiff makes an outlay of transaction costs to its lawyer so it will be seeking a greater return for its outlay
ECONOMIC ANALYSIS OF TORT LAW If Agent A 2 believes A 1 will be sued before A 2, then A 2 may reduce its effort towards precaution A 2 may also reduce the level of its insurance coverage
ECONOMIC ANALYSIS OF TORT LAW The Cascade Effect: But A 1 sees what A 2 is doing and decides it will reduce its exposure as well – rationally it does not want to be the deep pocket A 1 instead receives a positive externality from A 2 being the deep pocket
ECONOMIC ANALYSIS OF TORT LAW Bilateral Positive Externalities – Example: The Insurance Game I 2 = Insurance Purchased By Insured 2 I 1 = Insurance Purchased by Insured 1 PARETO OPTIMAL EQUILIBRIUM Utility Curve For Insured 1 Utility Curve For Insured 2 NASH EQUILIBRIUM
ECONOMIC ANALYSIS OF TORT LAW It is the combined wealth and insurance that is targeted by a plaintiff or claimant A defendant may strategically react by reducing both its insurance coverage (as explained) and its wealth Because wealth and insurance are strategic substitutes it would not make any sense for a defendant to simply reduce insurance coverage and leave its wealth exposed
ECONOMIC ANALYSIS OF TORT LAW The potential defendant could very well decide on the following wealth reduction strategies because it believes insurance premiums, although fair, may be too high Dissipate the wealth so that it can opt for bankruptcy to limit its liability if sued Transfer its wealth to another party or to another jurisdiction in a bid to increase the plaintiffs transaction costs should the plaintiff choose to pursue the wealth as a judgment creditor
ECONOMIC ANALYSIS OF TORT LAW Rules such as joint-and-several liability, which would appear to broaden the scope of an accident victim to collect damages. Yet such a rule may reduce the compensation available once the impact on insurance decisions plays out.
ECONOMIC ANALYSIS OF TORT LAW This is why small or gradual increases in liability risk, through changes in tort laws or the liability risk environment (the aftermath of 9-11), can lead to sudden and volatile changes in insurance markets
ECONOMIC ANALYSIS OF TORT LAW Countering the Insurance Game: Many types of insurance coverage are mandatory By law »There is a mandatory minimum of insurance coverage required for motor vehicles »Professionals such as doctors, lawyers, accountants, engineers, etc are required to carry regulated minimums in malpractice coverage By contract »Creditors such as banks requires borrowers such as mortgagors (homeowners) to carry insurance to at least the value of the property
ECONOMIC ANALYSIS OF TORT LAW The Insurance Game – Impact of credible mandatory insurance minimums I 2 = Insurance Purchased By Insured 2 I 1 = Insurance Purchased by Insured 1 PARETO OPTIMAL EQUILIBRIUM Utility Curve For Insured 1 Utility Curve For Insured 2 NASH EQUILIBRIUM
ECONOMIC ANALYSIS OF TORT LAW Countering the Insurance Game – Limits on Damages Awards: Historically, the common law was not entirely oblivious to the insurance game Rules prevented disclosure of insurance levels to plaintiffs or juries during the conduct of lawsuits However, Ontario relaxed some of these rules in 1984 to enable plaintiffs to investigate the liquidity of a potential defendant
ECONOMIC ANALYSIS OF TORT LAW In 1978 the Supreme Court of Canada imposed a ceiling on particular types of damages, such as damages for pain and suffering In 2006 the Ontario Court of Appeal rolled back a $500,000.00 award for punitive damages to $100,000.00, explaining this amount was sufficient for deterrence
ECONOMIC ANALYSIS OF TORT LAW Since 1990, Ontarios Insurance Act limits the recovery of persons injured as a result of a motor vehicle accident. The traditional ability to sue at fault drivers or the owner of the vehicle for general damages for pain and suffering or loss of enjoyment of life, is not available, unless a Plaintiff shows serious permanent disfigurement, or a serious permanent limitation of an important bodily function.
ECONOMIC ANALYSIS OF TORT LAW In effect, the joint and several liability rule was replaced by a procedure whereby injured parties recovered exclusively from their own insurers provided their injuries fell below a certain threshold In theory this would counteract the insurance game and provide more compensation to motor vehicle accident victims
ECONOMIC ANALYSIS OF TORT LAW The traditional ability to sue at fault defendants in non-motor vehicle negligence actions for general damages, for pain and suffering or loss of enjoyment of life, is still available. Other developments follow
ECONOMIC ANALYSIS OF TORT LAW The Supreme Court had ruled in 1995 that bars, restaurants and other commercial establishments that serve alcohol are legally liable if, for instance, they continue to serve obviously inebriated customers and then do nothing to stop them from getting into their cars.
ECONOMIC ANALYSIS OF TORT LAW ZOE CHILDS The question is: should average Canadians have the same legal responsibility? May 5, 2006 The Supreme Court said no Zoe Childs
ECONOMIC ANALYSIS OF TORT LAW But a question remains – How credible are such measures? Insurance may still run dry especially in the aftermath of such disasters as Hurricane Katrina (2005) or the asbestos catastrophe explained earlier
ECONOMIC ANALYSIS OF TORT LAW TORT LIABILITY: Strict Liability Revisited
ECONOMIC ANALYSIS OF TORT LAW The re-imposition of "strict liability in contractual and tort situations is being accomplished with the superimposing of fiduciary duties, "implicit agency", which impose strict liability, in an increasing number of cases.
ECONOMIC ANALYSIS OF TORT LAW STRICT LIABILITY – Asymmetric Information a1*a1* $ Strict Liability Rule Cost of Precaution
ECONOMIC ANALYSIS OF TORT LAW Modern Developments The Horwitz thesis in reverse – moving back to strict liability »1930s - Donoghue v. Stevenson »– One owes strangers a duty of care »1960s – Hedley Byrne v. Barclays Bank » – Words as well as actions can attract liability »1970s - Seaway Hotel case »– Damages extended to include loss of profits
ECONOMIC ANALYSIS OF TORT LAW Modern Developments »1980s – Central Trust v. Rafuse »– Strict Liability imposed on professionals such as lawyers »1980s – International Corona v. Lac Minerals »– Strict Liability imposed on businesses such as mines if critical information withheld or exploited »1990s – Historical tort cases – Strict Liability imposed on institutions to address historical wrongs: »Incest Cases »Residential Schools »Wrongful Convictions
ECONOMIC ANALYSIS OF TORT LAW How does this trend impact on the insurance game? By increasing the potential for higher recovery of damages for plaintiffs, the insurance game can arise for some potential defendants who reduce insurance and move their wealth The availability of compensation is reduced
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