Avery W. Katz

Judicial decisionmaking and litigation expenditure

Recent years have borne witness to a striking increase in expenditures on legal services.’ Various critics of the U.S. legal system have accordingly argued that amounts currently spent on or in anticipation of disputes are socially excessive, and several writers have attempted to address the issue through economic analysis.’ Much of the economic literature has centered on the choice between litigation and settlement, and most of the models either assume a fixed exogenous level of litigation costs or treat such costs as the reduced-form outcome of litigants’ maximization decisions.? This article abstracts from the possibility of settlement to focus on the parties’ behavior at trial. While much of the recent literature on litigation has emphasized suit and settlement, that research strategy is not the only useful one. Though most disputes do not rise to the level of a lawsuit and though the great majority of lawsuits end in settlement, decisions at earlier stages of a lawsuit depend on the parties’ estimates of the ultimate consequences of litigation. Analysis of the litigation stage is therefore logically prior to any analysis of the decision to sue or of settlement negotiation. Furthermore. the relatively small but absolutely large number of cases that go to trial consume substantial resources in doing so, and many cases that settle do so only after substantial expenditure has been incurred in preparation for trial.4 Accordingly. I developed a model of litigation expenditure based on the assumption that the parties are already engaged in a dispute. Within the model, the outcome of litigation is a probability y(X. v) that the defendant will be found liable. with the probability increasing with the plaintiff’s expenditure on legal resources and decreasing with defendant’s expenditure. More specifically, the parties expend resources on legal research to produce arguments or favorable facts to a court or other decisionmaking body such as a jury or administrative agency. The court finds for the plaintiff if and only if a certain function of the parties’ arguments, plus a random variable, exceed a liability threshold. The framework yields some interesting comparative statics predictions about the judicial process. Section II of this article outlines the basic approach to modeling the litigants’ expenditure decision and describes the model of judicial decisionmaking that is the focus of the analysis. Section III analyzes the behavior of maximizing litigants. Section IV analyzes the Nash equilibrium in expenditure and the determinants of

The effect of frivolous lawsuits on the settlement of litigation

It is commonly alleged that a substantial proportion of lawsuits are frivolous or “strike” suits, that is, lacking merit and filed only in the hopes of obtaining a favorable settlement.’ The handling of such suits has given rise to popular and scholarly criticisms of American civil procedure, on grounds both of efficiency and fairness. Indeed, in certain areas such as medical malpractice, antitrust, and corporation law, the asserted prevalence of frivolous suits is commonly cited as an argument for law reform. For example, recent critiques of treble damages in antitrust have emphasized the supposed encouragement such damages give to strike suits. The fairness objection to frivolous lawsuits is that such suits can result in opportunistic persons obtaining payments to which they are not entitled, at the expense of innocent defendants who may be viewed as defrauded or under duress. The efficiency objection is that the rent-seeking occasioned by frivolous suits wastes resources both directly and indirectly. Direct costs include resources used in filing and defending such suits, as well as costs of investigation and discovery as defendants attempt to distinguish frivolous from genuine claims. Indirect costs stem from the additional trials required because the presence of frivolous plaintiffs in the population of litigants interferes with the settlement of genuine claims. This article develops a model of litigation and settlement in the presence of frivolous lawsuits, which I define as suits that have a sufficiently low chance of prevailing at trial that they would not be brought but for the prospect of settlement. The analysis does not address suits in which the prospect of judicial error or jury confusion at trial permits a plaintiff to obtain a settlement that is undeserved according to some external normative standard. Instead, I take a strictly positive view of the law and treat all suits expected to prevail at trial as genuine. Neither do I address suits that turn out ex post to have little basis in law, but that ex ante seemed plausible. There are undoubtedly many such cases brought, but it is

Your Terms or Mine? The Duty to Read the Fine Print in Contracts

This article examines the legal rules that govern the interpretation of standardized form contracts. Different legal rules induce different bargaining games between buyers and sellers, and they can influence the efficiency of exchange when communication is costly. The traditional common-law rule, which binds an assenting recipient of a form contract to fine-print terms he has not read, has little effect in encouraging parties to read contracts, contrary to the conventional wisdom among lawyers. Instead, there is little practical difference between a rule that nominally holds the drafter of a form contract responsible for communicating its terms and one that holds the receiving party responsible. Moreover, the traditional rule may be Pareto inferior to a rule providing presumptive warranties when negotiation is costly.

Contractual Enforcement Institutions and the Structure of Information

Many economic writers on contract theory have assumed that legal institutions are simply unable to do the job of enforcement, and have thus attempted to devise arrangements that motivate the parties to keep their commitments even though a government tribunal would be unable to tell whether they had performed. But non-legal enforcement mechanisms operate both as substitutes and complements for legal mechanisms (and as substitutes and complements for each other). This essay sketches how parties should choose among available enforcement mechanisms, based on the costs of information and other transaction costs.

Chapter 1 Contract Law

Abstract This chapter surveys major issues arising in the economic analysis of contract law. It begins with an introductory discussion of scope and methodology, and then addresses four main topics that correspond to the major doctrinal divisions of the law of contracts. These divisions include freedom of contract (the extent of private power to create binding obligations), formation of contracts (the procedural mechanics of exchange, and the rules that govern pre-contractual behavior), contract interpretation (the consequences that follow when agreements are ambiguous or incomplete), and enforcement of contractual obligations (the choice between private and public enforcement, and the legal remedies that follow from breach of contract). In each of these sections, we provide an economic analysis of relevant legal rules and institutions, and of the connections between legal arrangements and corresponding topics in microeconomic theory, such as welfare economics and the theory of contracts.

The incentive effects of litigation fee shifting when legal standards are uncertain

Abstract In recent years, various commentators have argued that adopting the British rule for litigation costs, which requires the losing party to pay the winners reasonable legal expenses, would reduce the cost of litigation in the United States. The economic literature on litigation so far has failed to support this claim. This paper considers the effects of the British rule, not on litigation costs, but on the incentives to engage in efficient primary substantive behavior. To do this, we bring together two branches of the literature that previously have been analyzed separately: the relation between litigation costs and substantive behavior, and the effect of legal uncertainty on substantive behavior, as analyzed by Calfee and Craswell. Our analysis shows that when legal standards are administered imperfectly, the efficiency of fee shifting is a problem of the second best. In some cases, the British rule corrects the distortions created by legal error and improves incentives to take care. In other cases, however, the British rule can exacerbate the inefficiencies created by legal error. We conclude that just as there is no reason to believe that the British rule generally reduces the procedural costs of litigation, there is also no good reason to think that it generally promotes efficient substantive behavior.

Fee Shifting in Litigation: Survey and Assessment

Should the party who loses in litigation be forced to pay the legal fees of the winner? This paper surveys the economic literature regarding the effects of legal fee shifting on a variety of decisions arising before and during the litigation process. Section 2 provides a brief survey of the practical situations in which legal fee shifting does and does not arise. Section 3 analyzes the effects of indemnification on the incentives to expend resources in litigated cases. Section 4 examines how indemnification influences the decisions to bring and to defend against suit, and Section 5 assesses its effects on the choice between settlement and trial. Section 6 addresses the interaction between the allocation of legal fees and the parties’ incentives for efficient primary activity behavior. Section 7 considers two important variants on simple indemnification: rules that shift costs based on the parties’ settlement negotiations (such as US Federal Rule 68 and the English practice of payment into court), and rules that shift costs based on the margin of victory (such as US Federal Rule 11 and the common law tort of malicious prosecution). Section 8 reviews the brief but instructive empirical literature on legal cost shifting, and Section 9 summarizes the discussion and offers conclusions.

The Option Element in Contracting

I. THE IMPORTANCE OF OPTION CONTRACTS ............................ 2191 A. Special Doctrinal Treatment of Option Contracts............ 2192 1. Consideration and Mutuality........................................ 2192 2. Offer and Acceptance.................................................... 2196 3. Performance, Breach, and Damages ........................... 2198 a. Anticipatory Repudiation ....................................... 2198 b. Duty to Mitigate....................................................... 2199 c. Liquidated Damages and Penalties ....................... 2200 B. Remedial Rules Generally................................................... 2201 II. A THEORETICAL ACCOUNT OF OPTION DESIGN.................... 2205 A. Three Essential Terms: Option Premium, Strike Price, and Option Life ................................................................... 2205 B. The Relationship Among Option Premium, Strike Price, and Option Life ................................................................... 2207 C. Efficient Option Design ...................................................... 2211 III. DETERMINANTS OF COMPARATIVE ADVANTAGE IN OPTIONS TRADING..................................................................... 2212 A. Nonefficiency Considerations............................................. 2212 1. Bounded Rationality ..................................................... 2212 2. Market Exclusion .......................................................... 2214 3. Regulatory Arbitrage..................................................... 2216 B. Efficiency Considerations ................................................... 2217 1. Differential Beliefs About the Future or Differential Risk Aversion................................................................. 2217 2. Ex Post Incentives ......................................................... 2218 C. Mixed Explanations............................................................. 2221 1. Ex Ante Information Signaling .................................... 2222