ECONOMIC ANALYSIS OF TORT LAW January 9, 2007

ECONOMIC ANALYSIS OF TORT LAW Private Goods Public Goods Public Bads Private Bads

ECONOMIC ANALYSIS OF TORT LAW Private Goods Property Rights Right To Pollute Right To Enjoy Property Free of Pollution Right To Contract on Property Rights Right To Damages and/or an Injunction for Breach of Contract Public Goods Public Bads Private Bads Harms or Wrongs

ECONOMIC ANALYSIS OF TORT LAW Private Goods Property Rights Right To Pollute Right To Enjoy Property Free of Pollution Right To Contract on Property Rights Right To Damages and/or an Injunction for Breach of Contract THEOREM OF COASE Same efficiency under rival allocation of rights EXCEPTIONS: High Transaction Costs Asymmetric Information Empty Core

ECONOMIC ANALYSIS OF TORT LAW The alternative strategy to judicial intervention is to (1)attack the impediments to bargaining directly by fashioning legal rules which reduce transaction costs, (2)increase the information available to the parties, or (3)reduce incentives for strategic bargaining.

ECONOMIC ANALYSIS OF TORT LAW Private Goods Public Goods Intellectual Property Patents Copyright Trade Marks Trade Secrets Other Public space Public Bads Crime Divorce Private Bads Torts Intentional Pollution Assault Fraud Unintentional Negligence

ECONOMIC ANALYSIS OF TORT LAW In contracts, the agents may agree to adopt a sharing rule In torts, the “social planner” or “law- making agency” acts to “impose” an optimal sharing rule on the agents

ECONOMIC ANALYSIS OF TORT LAW In the case of perfect information the rule of strict liability against agents of externalities is socially optimal because it internalizes the cost of the externality to the producer

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 Tort law is often said to be concerned with the deterrence of accidents and the compensation of victims. Tort law is also said to be concerned for minimizing administrative costs of recovery.

ECONOMIC ANALYSIS OF TORT LAW This implies a concern with compensation. Accident costs include the costs of bearing a large loss, which, because of risk aversion, is greater than the quantum of the loss itself.

ECONOMIC ANALYSIS OF TORT LAW In the case of contracts, the existence of asymmetric information made the application of a single rule in all cases sub-optimal In the case of tort liability, the existence of asymmetric information makes the rule of strict liability socially sub-optimal as the rule will fail to internalize all the relevant costs In some cases the rule of strict liability may internalize the wrong costs

ECONOMIC ANALYSIS OF TORT LAW Private Bads Asymmetric Information Forces of Nature Imperfect Allocation of Information

ECONOMIC ANALYSIS OF TORT LAW Private Bads Asymmetric Information Forces of Nature

ECONOMIC ANALYSIS OF TORT LAW In contracts the common law made implied insurers out of agents whose efforts to perform contracts were frustrated by forces of nature In torts the common law usually imposed a rule of strict liability on agents whose efforts to perform without injury to others were frustrated by forces of nature

ECONOMIC ANALYSIS OF TORT LAW Protection of Possession Common law actions for trespass and nuisance were governed by the “strict liability” property rule for damages until the industrial revolution encouraged its replacement by a different rule in tort cases (Horwitz Thesis) Horwitz, Morton, "The Transformation in the Conception of Property in American Law ', (1980) 40 U. of Chi. L. Rev Schwartz, Gary, "Tort Law and the Economy in Ninteenth-Century America: A Reinterpretation', (1981) 90 Yale L. J

ECONOMIC ANALYSIS OF TORT LAW Private Bads Asymmetric Information Imperfect Allocation of Information

ECONOMIC ANALYSIS OF TORT LAW The Asymmetry Exception To Coase Theorem Strict Liability Rule – No longer efficient No Liability Rule – No longer efficient Expectation Damages Rule »Contract – Selected Through Disclosure »Torts – Selected by Imposition By Court As Principal

ECONOMIC ANALYSIS OF TORT LAW PRINCIPAL – AGENCY Agent Principal promisepayment “SUPER” Principal = JudgeIts “problem” is to maximize social surplus CONTRACT

ECONOMIC ANALYSIS OF TORT LAW Parties that enter contracts fully informed through bargaining enter an optimal contract.

ECONOMIC ANALYSIS OF TORT LAW In the case of contracts Moral Hazard Where the party acting as “agent” cannot observe what the principal “expects”, the courts motivate the agent to the expected level of performance through the imposition of damages against the agent for non-performance of an established standard of care in the absence of some express condition or incentive scheme in a contract between the parties

ECONOMIC ANALYSIS OF TORT LAW Recall also that in the case of contracts Adverse Selection Where the party acting as “agent” cannot observe what the principal “expects” in terms of the standard of performance and so performs below expectations unless the contract sets out the expectation The courts do not motivate the agent to the expectations of the Principal through damages against the agent for non- performance unless the principal “discloses” or “signals” its expected standard of performance

ECONOMIC ANALYSIS OF TORT LAW $C 1 a1a1 P P  NP Marginal Cost Curve of Agent 1 Expected Marginal Cost Curve of Agent 1 under Expectation Damages a 10 a 1 * a 11

ECONOMIC ANALYSIS OF TORT LAW Because the parties have better information about their own needs and circumstances than does the court, the arrangements which the parties make will be more optimal than those which the court could provide.

ECONOMIC ANALYSIS OF TORT LAW This is the reason for a presumption in favour of private ordering. The primacy of private ordering has been explicitly recognized by the courts. B.G. Checo Int'l Ltd. v. B.C. Hydro & Power Authority (1993), 99 D.L.R. (4th) 577.

ECONOMIC ANALYSIS OF TORT LAW Parties to a contract routinely insert clauses which are directed to circumstances that both parties hope will never arise, for example warranty provisions in case of defects, or a liquidated damages clause. The optimal contract, like tort law, will attempt to minimize the harm of any unanticipated occurrence, since both parties gain if such costs are minimized.

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 Agent 2 LEGALLY IMPOSED OBLIGATION 2 Agent 1 INCENTIVE COMPATIBILITY CONSTRAINT 1 LEGAL ANALYSIS ECONOMIC ANALYSIS Agent 1 LEGALLY IMPOSED OBLIGATION 1 Agent 2 INCENTIVE COMPATIBILITY CONSTRAINT 2

ECONOMIC ANALYSIS OF TORT LAW AGENT 1 AGENT 2 Obligation of Agent 1 to Avoid harming Agent 2 Obligation of Agent 2 to Avoid harming Agent 1

ECONOMIC ANALYSIS OF TORT LAW In the case of torts Moral Hazard Where the party as acting “agent” acts on the knowledge that the “principal” in the contract cannot observe the agent’s effort in performance because they may not even know the identity of the parties until after the harm occurs, the courts motivate the agent to the expected level of performance through the imposition two rules: (1)Impose a standard of care on the agent (2)Impose damages on the agent in the event that the duty to follow the standard of care is breached

ECONOMIC ANALYSIS OF TORT LAW So in the case of torts, as well Adverse Selection Where the party as acting “agent” cannot observe what the principal “expects” in terms of the standard of performance because they may not even know the identity of the parties until after the harm occurs and so performs below expectations. In torts, the link between adverse selection, disclosure and the standard of care is imposed by law Donoghue v. Stevenson The “Court” imposes the standard of care for performance applicable to the parties who are related to each other by “proximity”

ECONOMIC ANALYSIS OF TORT LAW In torts, if optimal contracting were possible, judicial intervention would never be necessary, since the parties would already have provided for all contingencies.

ECONOMIC ANALYSIS OF TORT LAW Concern with compensation for the costs of bearing large losses emphasizes the importance of insurance La Forest J. in his decision in Canadian National Railway Company v. Norsk Pacific Steamship Co., [1992] 1 S.C.R (Siebrasse, p. 253)

ECONOMIC ANALYSIS OF TORT LAW The role of the court in both tort and contract is to approximate the optimal contract. Professor Cooter describes "tort as a hypothetical contract“ R.D. Cooter, "Unity in Tort Contract and Property: The Model of Precaution" (1985) 73 Cal. L. Rev. 1.

ECONOMIC ANALYSIS OF TORT LAW Professor Winter described systems of tort rules as a social contract“ Winter and Neary, “Optimal Shares in bilateral