Part A-I The Economic Theory of Legal Process Why Sue? 25/11/08 Process_A

Objectives - understand why a party might decide to initiate a lawsuit - understand what factors influence the number of lawsuits that are filed 25/11/08 Process_A

Stages in a legal dispute - civil SOME EVENT OCCURS Decision of plaintiff (private party) leading to continuance of process injury no injury (end) sue (file complaint ) no complaint filed (end) exchange information settle (end) bargain settle (end) trial win (end) appeal win( end) lose (end) 25/11/08 Process_A

Stages in a legal dispute - Criminal SOME EVENT OCCURS Decision of plaintiff (state) leading to continuance of process investigate no investigation (end) laying of charge no charge laid (end) exchange information charge withdrawn (end) bargain plea agreement (end) trial win (end) appeal win( end) lose (end) 25/11/08 Process_A

Civil matter decision makers are private parties Criminal matter decision makers are the state and a private party There are costs to be considered at each stage These costs must be weighted against the probabilities of the various outcomes Each of the process stages provides interesting problems with respect to predicting behaviour of the plaintiff and defendant and analyzing applicable legal rules. 25/11/08 Process_A

The value of a civil claim – why sue? Filing a complaint (making a legal claim) against another party creates something of value There are costs associated with initiating a claim (your time and effort, legal fees, court filing fees, etc.) The decision to file a complaint will depend on an assessment of the expected value of the claim versus the cost of creating that claim 25/11/08 Process_A

Let: EVC represent the expected value of the claim FC represent the filing costs (the cost of starting the process) if EVC > FC, then the complaint should be filed EVC < FC, then the complaint should not be filed Simple enough, but how is the EVC determined? (FC is easy, your lawyer will give you an estimate) In order to determine the expected value of the claim we must know what will happen at all subsequent stages of the process - initial attempts to settle to the final appeal 25/11/08 Process_A

The arithmetic of a legal claim The Expected Value of the claim is calculated as: Prob of win x (award if you win - costs if you win) + Prob of loss x (award if you lose - costs if you lose) Recall: probability of winning + probability of losing = 1 25/11/08 Process_A

Compulsory Arbitration – a simple example Under compulsory arbitration the suit (legal process) must end after one hearing Consider the American System - each side pays their own costs no matter who wins Let: Prob(win) = 0.6 Award(win) = $50.00 Costs(win) - $10.00 Prob(loss) = 0.4 Award(loss) = $0 Costs(loss) - $10.00 Filing costs (FC) = $10.00 Then the expected value of the claim if it is filed is: 0.6 x ($50.00 - $10.00) + 0.4 x ($0 - $10.00) = $20.00 25/11/08 Process_A

EX. 1 Compulsory arbitration – each pays own costs Prob. Award Cost Expected Value (EVC) win 0.6 $50.00 $10.00 lose 0.4 $ 0.00 $10.00 $20.00 FC $10.00 Since EVC > FC the suit should be filed 25/11/08 Process_A

The decision to sue - changing the assumptions EX. 2 Compulsory arbitration – lower probability of winning Prob. Award Cost Expected Value (EVC) win 0.3 $50.00 $10.00 lose 0.7 $ 0.00 $10.00 $5.00 FC $10.00 Since EVC < FC the suit should not be filed A suit might be started even though the probability of wining is less than 50% 25/11/08 Process_A

EX. 3 Compulsory arbitration – higher legal costs Prob. Award Cost Expected Value (EVC) win 0.6 $50.00 $30.00 lose 0.4 $ 0.00 $30.00 $0.00 FC $10.00 Since EVC < FC the suit should not be filed If lawyers charge ‘too much’, there should be fewer lawsuits Note that only private costs matter – court time is ‘free’ 25/11/08 Process_A

EX. 4 Compulsory arbitration – higher filing costs Prob. Award Cost Expected Value (EVC) win 0.6 $50.00 $10.00 lose 0.4 $ 0.00 $10.00 $20.00 FC $100.00 Since EVC < FC the suit should not be filed FC can act as a filter for nuisance suits Do FC represent the court’s costs of a suit? 25/11/08 Process_A

EX. 5 Compulsory arbitration – lower award Prob. Award Cost Expected Value (EVC) win 0.6 $30.00 $10.00 lose 0.4 $ 0.00 $10.00 $8.00 FC $10.00 Since EVC < FC the suit should not be filed 25/11/08 Process_A

EX. 6 Compulsory arbitration – loser does get ‘something’ Prob. Award Cost Expected Value (EVC) win 0.6 $50.00 $10.00 lose 0.4 $20.00 $10.00 $28.00 FC $10.00 Since EVC > FC the suit should be filed Any partial award to the plaintiff will increase the value of the suit. ‘Giving them something to just go away’ will generally not be a good strategy – just encourage more suits. 25/11/08 Process_A

EX. 7 Compulsory arbitration – loser pays all costs (Canada) Prob. Award Cost Expected Value (EVC) win 0.6 $50.00 $ 0.00 lose 0.4 $ 0.00 $20.00 $22.00 FC $10.00 Since EVC > FC the suit should be filed How costs are allocated does not appear to matter, but 25/11/08 Process_A

EX. 8 Compulsory arbitration – loser pays all costs (Canada) combined with lower probability of winning Prob. Award Cost Expected Value (EVC) win 0.4 $50.00 $ 0.00 lose 0.6 $ 0.00 $20.00 $8.00 FC $10.00 Since EVC < FC the suit should not be filed This suit might proceed under the ‘each pays own costs’ rule In general, suits with a lower probability of winning will proceed more frequently under the ‘each pays own’ rule 25/11/08 Process_A

Multiple Stages Procedures Under compulsory arbitration the decision to file or not file is based on the expected value of the suit in the arbitration (a one stage process) Most legal actions have two or more stages, each with their own costs, expectations of wining and losing an value of awards if you win of lose How does the second (and subsequent stages) affect the decision to file. (How do they affect the value of the claim? Recall for a one stage process (say, compulsory arbitration). The Expected Value of the claim is calculated as: 25/11/08 Process_A

EX. 5 Compulsory arbitration – each pays own costs Recall for a one stage process (say, compulsory arbitration) our EX. 5 was as follows: EX. 5 Compulsory arbitration – each pays own costs Prob. Award Cost Expected Value (EVC) win 0.6 $30.00 $10.00 lose 0.4 $ 0.00 $10.00 $8.00 FC $10.00 Since EVC > FC the suit should not be filed 25/11/08 Process_A

EX. Multi-2 Trial – loser pays all costs Prob. Award Cost Expected Now suppose that the suite is taken to mediation (parties retain the right not to settle) and the plaintiff believes the following (note the enormous amount of uncertainty in all of this) EX. Multi-2 Trial – loser pays all costs Prob. Award Cost Expected Value (at trial) win 0.5 $100.00 $ 0.00 lose 0.5 $ 0.00 $40.00 $30.00 This implies that if mediation fails the plaintiff can expected to get $30.00 at the next stage – trial. This changes how the first stage is valued. 25/11/08 Process_A

EX. Multi-1 Mediation – each pays own costs Prob. Award Cost Expected Our EX. 5 is the first stage in a two-stage process. It becomes ‘a loser gets something’ situation at the first stage. EX. Multi-1 Mediation – each pays own costs Prob. Award Cost Expected Value (EVC) win 0.6 $30.00 $10.00 lose 0.4 $30.00 $10.00 $20.00 FC $10.00 The $30.00 is what the plaintiff can expect to get (at trial) if the mediation fails. Now since EVC > FC the suit should be filed 25/11/08 Process_A

Some conclusions on a multi-stage process: 1. The above two-stage example can be extended to any number of stages (as your textbook does). 2. If the next stage in the process has a positive expected value, then the maximizing litigant will take it. 3. If the next stage in the process has a positive expected value, then this increases the expected value of previous stages and the initial claim itself. 4. Each party must assess the expected value of each outcome at each stage of the process before deciding how to act at any stage (both the plaintiff and the defendant negotiate given all expected future values). 5. The existence of ‘next steps’ might decrease the value of a claim (a friendly judge might get overturned). 6. The amount of uncertainty inherent in the initiation of a lawsuit is substantial. 25/11/08 Process_A

Determinants of the number of suits Number of injuries triggering the dispute (the ‘events’) - increases with the amount of risky activities, level of economic activity – a given (sort of) The cost of filing the complaint (starting the action) - decreases with the cost of filing, including courts fees and the initial cost of hiring a lawyer The expected value of the claim - increases with the expected value of the claim (because probability of winning is higher, size of awards are higher or costs of pursuing claim is lower) 25/11/08 Process_A

Filing Costs as a Filter We saw that as the FC increases relative to EVC fewer suits are filed. What FC (fees) should the courts set? Do citizens have an unrestricted right to ‘their day in court’? The court should set ‘optimal’ fees - filing fees such the ‘administration costs’ of the suit equal that the error costs of providing no remedy for the injury in the marginal case We will discuss this ‘optimal amount of justice’ notion later 25/11/08 Process_A

What about the size of awards -damages? Higher damages encourage injured individuals to file more complaints, since EVC increase. BUT higher awards cause potential defendant to ‘act differently’ - be more careful break fewer contracts, etc. Consider the following: - if damages are very low or zero, then very few complaints will be filed since EVC is very low - as the expected damages (based on previous awards) increases the number of suits increases - but at some point the increase in damages causes the potential defendants to become more litigation conscious and to provide fewer opportunities for lawsuits (decrease risk, honour contracts, etc.) number of suits decreases 25/11/08 Process_A

So many lawsuits – so few trials Most private disagreements do not end up going to trial. They are settled at some earlier stage of the legal process. (Perhaps only 5% or less of claims ever reach a court room.) What explains why some legal claims get settled and others go to court? - the cost of pursuing a claim at trial escalates quickly - the uncertainty concerning outcomes at trial is great (We have not really studied the impact of uncertainty- variance versus expected value – you can best think of uncertainty as an added cost) 25/11/08 Process_A