To Curb Abuse In Civil Court, Loser Must Pay

Even as the financial crisis has businesses, consumers and governments pinching pennies, litigation costs in America continue to swell. The direct costs of tort litigation reached $247 billion in 2006, and contract disputes cost many billions more.

As a percentage of GDP, Germany spends only half as much on litigation as does the U.S., and France and the United Kingdom spend roughly one-third what we do.

While some litigation is necessary, too many American lawsuits are filed by plaintiffs' attorneys who know they have no legal merit, but who hope to extract a settlement payment from the targeted defendant anyway. This kind of extortion is possible because the U.S., virtually alone in the world, usually requires all parties in a lawsuit to cover their own legal expenses, regardless of who wins the case.

When dry cleaners Jin and Soo Chung were infamously sued for $54 million over an allegedly lost pair of pants, they won their case, but paid out almost $100,000 in legal fees. Most other countries including Germany, France, and the U.K. have a "loser pays" rule for legal fees: The loser of a case must reimburse the winner for reasonable legal expenses.

Our legal system differs in many ways from those of other countries, so the difference between our legal expenses and those of other western democracies cannot be attributed solely to our idiosyncratic "American rule" for attorneys' fees. But as I have documented in a new study for the Manhattan Institute, the American rule is certainly part of our problem.

Virtually every economist who has studied loser pays agrees that it would reduce the number of lawsuits filed that have little legal merit. Cleaning these bad cases out of our legal system would reduce the financial burden of litigation on both business and the courts, and would free all parties to focus on more meritorious suits.

Defenders of the current system worry that loser pays would bar the courthouse door to plaintiffs who have strong legal cases but modest means, because these deserving claimants would be unwilling to run even a small risk of losing a case and having to pay a ruinous fee award.

But this concern is successfully addressed around the world by legal expenses insurance, which insures plaintiffs against the possibility of having to pay a defendant's legal fees. Because over 90% of cases settle before trial, insurance is surprisingly affordable in loser-pays countries, and in many cases no premium is charged unless the plaintiff wins or settles the insured case.

Evidence suggests that legal expenses insurance markets can develop quickly, as they did in the U.K. over the last decade after the government restricted publicly financed legal aid.

Far from banishing deserving litigants from the courtroom, loser pays opens the courthouse doors for the first time to deserving plaintiffs who have suffered relatively small injuries. The American rule makes justice unaffordable in such cases unless injuries can be lumped into a class action or mass tort claim. Under loser pays, claimants who are truly in the right can press even small claims. Most potential defendants, understanding this, would appropriately compensate deserving small claimants without any legal process.

Loser pays has an additional benefit. Because it simultaneously makes innocence cheaper and negligence or fraud more expensive, companies large and small are more motivated to comply with legal standards of care in a loser-pays system. More legal compliance means that fewer potential litigants suffer from negligent injuries or other mistreatment in the first place an unambiguous social benefit.

Though loser pays is largely foreign to America, there is no reason it could not work here. Alaska has long had a modified version of loser pays (and the percentage of its court docket devoted to tort lawsuits, interestingly, is only half that in the rest of the country).