1. Part A-I The Economic Theory of Legal Process
Why Sue?
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2. Objectives - understand why a party might decide to initiate a lawsuit
- understand what factors influence the number of lawsuits that are filed
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3. 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)
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4. 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exchange information charge withdrawn (end)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)
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5. 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.
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6. 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
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7. 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
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8. 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
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9. 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) = Award(win) = $ Costs(win) - $10.00
Prob(loss) = 0.4 Award(loss) = $ Costs(loss) - $10.00
Filing costs (FC) = $10.00
Then the expected value of the claim if it is filed is:
0.6 x ($ $10.00) x ($0 - $10.00) = $20.00
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10. EX. 1 Compulsory arbitration – each pays own costs
Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $10.00
lose 0.4 $ $10.00
$20.00
FC $10.00
Since EVC > FC the suit should be filed
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11. The decision to sue - changing the assumptions
EX. 2 Compulsory arbitration – lower probability of winning
Prob. Award Cost Expected
Value (EVC)
win 0.3 $ $10.00
lose 0.7 $ $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%
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12. EX. 3 Compulsory arbitration – higher legal costs
Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $30.00
lose 0.4 $ $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’
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13. EX. 4 Compulsory arbitration – higher filing costs
Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $10.00
lose 0.4 $ $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?
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14. EX. 5 Compulsory arbitration – lower award Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $10.00
lose 0.4 $ $10.00
$8.00
FC $10.00
Since EVC < FC the suit should not be filed
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15. EX. 6 Compulsory arbitration – loser does get ‘something’
Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $10.00
lose 0.4 $ $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.
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16. EX. 7 Compulsory arbitration – loser pays all costs (Canada)
Prob. Award Cost Expected
Value (EVC)
win 0.6 $ $ 0.00
lose 0.4 $ $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
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17. EX. 8 Compulsory arbitration – loser pays all costs (Canada)
combined with lower probability of winning
Prob. Award Cost Expected
Value (EVC)
win 0.4 $ $ 0.00
lose 0.6 $ $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
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18. 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:
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19. 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 $ $10.00
lose 0.4 $ $10.00
$8.00
FC $10.00
Since EVC > FC the suit should not be filed
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20. 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 $ $ 0.00
lose 0.5 $ $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.
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21. 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 $ $10.00
lose 0.4 $ $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
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22. 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.
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23. 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)
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24. 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
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25. 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
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26. 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)
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