Impact of loser pays vs American rule

Question

The rationale for the American rule, as I understand it, is that you should be able to file a lawsuit that you think has merit without having to worry that you might lose and be on the hook for the other side's expensive lawyers.

In loser pays, on the other hand, you could be on the hook if you decide to litigate an issue and lose. The advantage, it seems, is that you're less likely to litigate issues that you won't win.

If we look at studies investigating the impact of the two rules, quantifying the economic costs and benefits of the lawsuits filed or not based on rule differences, is one of them a clear winner? Or perhaps, one of them wins in certain types of cases, but not in all types of cases?

Answer 1

Several scholars have addressed this issue. Here's a quick bibliography. It appears that the most relevant "experiments" are the imposition of loser pays in medical malpractice suits in Florida for the first half of the 1980s, and Alaska's loser pays system. The Gryphon article below includes and discusses a decent amount of empirical data; the Di Pietro et al report is very extensive and has a lot of data.

The Florida experiment resulted in a significant increase in suits dropped without settlement or trial, a significant decrease in the number of trials, and, apparently, one spectacular fee award in favor of a plaintiff, which impelled the Florida medical establishment to torpedo the law.

Susanne Di Pietro et al, Alaska's English Rule: Attorney's Fee Shifting in Civil Cases (1995), http://www.ajc.state.ak.us/reports/atyfee.pdf.

Marie Gryphon, Assessing the Effects of a "Loser Pays" Rule on the American Legal System: An Economic Analysis and Proposal for Reform, 8 Rutgers J. L. & Pub. Pol'y 567 (2011).

Douglas C. Rennie, Rule 82 & Tort Reform: An Empirical Study of the Impact of Alaska's English Rule on Federal Civil Case Filings, 29 Alaska L. Rev. 1 (2012).

David A. Root, Attorney Fee-Shifting in America: Comparing, Contrasting, and Combining the "American Rule" and "English Rule", 15 Ind. Int'l & Comp. L. Rev. 583 (2005) (student article) (not available online).

James R. Maxeiner, Cost and Fee Allocation in Civil Procedure, 58 Am. J. Comp. L. 195 (2010) (not available online).

Answer 2

It's not as simple as just "American System" and "Loser Pays". When Americans hear "Loser Pays" they assume (incorrectly) that the loser would have to pay the practically unlimited cost of the winner. That need not be so.

In Germany, the first thing that the judge does is establish how much the parties are arguing about. If I ask for a million in damages, and you are willing to pay half a million, then we argue about half a million. The judge then consults a table that states clearly how much each side's lawyers may charge, and how much the court charges. The side with the expensive lawyers is blocked by the fact that we are arguing about half a million only, so when the judge decides they had their money's worth of work done by the court, he'll just stop them. Then a judgement is made, and whether I win or lose depends on how much the judgement is. If you are ordered to pay 600,000 after offering 500,000 and me demanding 1,000,000 then you "lost" 20% and pay 20% of the cost, while I pay 80%.

So in Germany, I could afford to sue Microsoft for €1,000. Would cost me a few hundred at most if I lose. The case would be over very quickly because the judge wouldn't allow either me or the company to argue for days over €1,000.

It does remove demand for spectacular damages. I just read that some US inmate tries to sue an ISP for $75 million because they didn't prevent him from committing identity theft (he committed the crime and sues the ISP for not preventing it!). That would be very unwise in Germany - even in the bizarre case that he was awarded say $750,000 he would have to pay 99% of the total cost.

Answer 3

There are some classes of cases with fee shifting and some without it.

The big disadvantages of the fee shifting where it is present are:

1. In a significant subset of cases, particularly in tort law and in cases involving novel legal questions, it is very hard to predict in advance, even with the best available information, whether someone will win or not, and loser pays is a serious discouragement to people who in good faith think they have a claim.

This is a particular problem in U.S. litigation where decisions on the merits are deferred until late in the process and the judge does not announce resolution of particular factual or legal issues not sufficient by themselves to throw out a claim early on in the case. I have had cases in U.S. federal courts litigated for a year with full discovery and settlement before an answer to the initial complaint is filed because it can take a very long time for a court to rule on an initial motion to dismiss.

2. The American rule is one factor among many motivating people to settle cases before trial because litigation costs that can be avoided could not have been shifted to the other party even in the event of a win. It makes the size of the pie for a "winner" greater when both parties settle and the savings from avoiding litigation costs on both sides often psychologically "finances" the settlement.

3. Fee shifting often leads the parties to incur costs disproportionate to the amount at stake on the merits of the dispute. The underlying dispute may be just $2,000, but if each side runs up $40K litigating it and there is fee shifting, the resolution of the merits has $82K at stake.

4. Contrary to theory, in practice, almost nobody during litigation deliberately behaves in a manner designed to reduce litigation costs to the other side to reduce exposure to a fee award. Everybody in litigation is blinded by the belief that they will win.

Of course, the downside to the American rule is that it encourages presentation of costly defenses regardless of their pertinence to the merits of the underlying case or likelihood of success (so long as not frivolous or groundless) to defer judgment and to create an economic incentive to settle at a discount. This means that someone whose rights are violated when the American rule applies often is not made whole.

In some areas of law (like personal injury) there are work arounds to solve the problems of the American rule. The plaintiff has a lawyer who sues on a contingent basis and pain and suffering awards end up covering legal fees leaving considerably hard compensatory damages for the victim of a tort, and the prospect of non-payment to the lawyer discourages frivolous PI plaintiffs litigation. Defense costs in PI litigation are typically financed by insurance companies that bear the lion's share of the risk for paying the judgment.

Most contracts have an attorneys' fee clause (often one sided for the creditor but not the person sued in states where that is permitted) and this discourages frivolous defenses of debt collection suits and makes the creditor whole, but still creates a problem when there is a bona fide dispute over a narrow issue that can expose someone fighting slight overreach by a creditor to huge attorneys' fee exposure even if the defendant wins on the disputed issue.

In my professional experience, a one size fits all solution is not appropriate and Coase's law reflects that in the agreements reached by the parties to contact around the default rule.

Even where fee shifting is appropriate, the means by which the amount of fees due is determined and the way that the prevailing party is determined is not ideal. A German type rule would be better in many circumstances (and German legal fees are also much more regulated than in the U.S.).