ECONOMIC ANALYSIS OF TORT LAW
January 23, 2007(Revised)
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
• Two Related Motivations For Tort Rules:
• The tort law “problem” is to minimize the
social costs of accidents by providing
incentives to avoid accidents
• As well the tort law “problem” is to provide
compensation to accident victims.
ECONOMIC ANALYSIS OF TORT LAW
BILATERAL AGENCY
“SUPER”
Principal
= Judge
Its “problem” is to maximize
social surplus
TORTS
AGENT 1
AGENT 2
ECONOMIC ANALYSIS OF TORT LAW
• The Court “imposes” a rule that
establishes a “standard of care” for legal
conduct, breach of which triggers the
imposition of damages.
ECONOMIC ANALYSIS OF TORT LAW
NEGLIGENCE LIABILITY:
Product Liability
ECONOMIC ANALYSIS OF TORT LAW
• A major change did indeed occur, but not
until 1934. In 1934 with the landmark
House of Lords ruling in Donohue v
Stevenson, [1932] A.C. 532 (H.L.)
• This case determined that defendants
could be liable to “strangers” when their
injury fell within the scope of precaution
the defendant was required to adopt as a
“reasonable” party
ECONOMIC ANALYSIS OF TORT LAW
•
•
Perfectly Competitive-Agent
Market – Agents
P
D
S
S
MC
SATC
a1
ECONOMIC ANALYSIS OF TORT LAW
•
•
Agent 1 - PC
Agent 2 - Monopoly
P
D
S
Private MC
PM
PLR
Social MC
Coasean or
Bargained MC
Negligence
Rule and MC
x
a1
ECONOMIC ANALYSIS OF TORT LAW
• Negligence – Defence of Contributory
$ Negligence
At common
Strict Liability Portion
Of The Negligence
Rule
law, beyond
this point a
single
Defendant was
not liable
Precaution Cost Component
Of The Negligence Rule
a1*
ECONOMIC ANALYSIS OF TORT LAW
• Negligence – Comparative Negligence
$
Under Contributory Negligence statutes,
liability or fault is now apportioned
(shared) among parties
a1*
ECONOMIC ANALYSIS OF TORT LAW
•
•
Agent 1 - PC
Agent 2 - Monopoly
P
D
S
Private MC
PM
PLR
Social MC
Negligence
Rule and MC
x
a1
ECONOMIC ANALYSIS OF TORT LAW
•
•
Agent 1 - PC
Agent 2 - Monopoly
P
D
S
PM
PLR
Coasean or
Bargained MC
Negligence
Rule and MC
x
a1
ECONOMIC ANALYSIS OF TORT LAW
NEGLIGENCE LIABILITY:
Employer and Employee Liability
Torts - History
• Modern Developments
• Protecting employers from workers
» Doctrine of Respondeat Superior
» Doctrine of Volenti Non Fit Iniuria
» Horwitz thesis – Emergence of negligence rules
• Protecting workers from employers
»
»
»
»
»
1830’s – Factory Acts
1860’s – Fatal Accidents Act
1880’s – Employer Liability Act
1910’s – Workers Compensation
1920’s – Comparative Negligence
ECONOMIC ANALYSIS OF TORT LAW
•
•
Agent 1 - PC
Agent 2 - Monopoly
P
D
S
PM
PLR
Coasean or
Bargained MC
Negligence
Rule and MC
x
a1
ECONOMIC ANALYSIS OF TORT LAW
• A mere opportunity to commit a wrongful act
does not suffice to show vicarious liability;
• one must consider the job-created power and
the nature of an employee's duties as a
fundamental component of determining if a
particular enterprise increased the risk of
particular wrongdoing in relation to a claimant by
the employee complained about. (SCC)
• In this case, the employee's limited role and
duties "fell short" of what is required to prove
vicarious liability.
ECONOMIC ANALYSIS OF TORT LAW
CATASTROPHIC
TORTS
ECONOMIC ANALYSIS OF TORT LAW
• Between the 1930’s to the 1980’s,
thousands of workers who had been in the
asbestos industry came down with terrible
sicknesses as a result of exposure to
asbestos dust
• Question: Did the lawsuits of the 1980’s,
which bankrupted many producers, serve
as a precautionary deterrent?
ECONOMIC ANALYSIS OF TORT LAW
• Professor Dewees, who did the Sudbury
pollution study we examined in Term I, did
another study on the John-Mansville
asbestos plant that operated at Port Union
from 1948 to 1984
ECONOMIC ANALYSIS OF TORT LAW
• He found that the tort system in
conjunction with workers compensation
rules in Ontario were sufficiently clear that
liability would be imposed on JohnsManville for the deaths (p. 310)
• Why did the firm not act?
ECONOMIC ANALYSIS OF TORT LAW
• The workers’
compensation levies
on the plant were not
high enough to induce
the firm to institute
dust controls (p. 317)
• Aerial view of the
Johns-Manville
asbestos plant
(Scarborough)
ECONOMIC ANALYSIS OF TORT LAW
• Converted use
• Residential
Development at Port
Union (Scarborough)
on top of the site of
the Johns-Manville
asbestos plant
ECONOMIC ANALYSIS OF TORT LAW
LIABILITY:
Limitation Periods
ECONOMIC ANALYSIS OF TORT LAW
• Basic limitation periods
Ontario’s new Limitations Act, 2002 came into
force January 1, 2004.
• The basic limitation (for starting a court action,
not for giving notice) is now two years for most
claims.
• The new law does not eliminate the various
short notice periods, which require that notice be
given within a few short days to municipalities for
slip and fall on a roadway, for example.
ECONOMIC ANALYSIS OF TORT LAW
LIABILITY:
Duty To Mitigate
ECONOMIC ANALYSIS OF TORT LAW
• When one party suffers damages at the hands of
another, the injured party generally has a duty to
act to minimize his or her losses.
• This principle is known as the duty to mitigate.
• It generally applies to cases concerning bodily
injury, damages to property and breach of
contract, but not to debt collections
ECONOMIC ANALYSIS OF TORT LAW
LIABILITY:
Insurance Contracts – Single Defendant
ECONOMIC ANALYSIS OF TORT LAW
• The efficient operation of liability insurance
markets will indirectly effect the “solution”
of the tort problem
ECONOMIC ANALYSIS OF TORT LAW
“SUPER”
Principal
= Judge
Its “problem” is to maximize
social surplus
TORTS –
Bilateral
Agency
AGENT 1
(Insured)
AGENT 2
(Insured)
CONTRACTS – Principal
Agency
Insurer 1
Insurer 2
ECONOMIC ANALYSIS OF TORT LAW
• DUTY TO DEFEND
• The Supreme Court of
Canada in Jesuit Fathers
of Upper Canada v.
Guardian Insurance Co.
of Canada, 2006 SCC 21
has ruled that an insurer's
duty to defend in a
claims-made policy
covers only those claims
actively made (rather
than merely discovered
by the insured) during the
term of the policy.
Garnier Residential
School, Spanish, Ontario
ECONOMIC ANALYSIS OF TORT LAW
• When a single defendant has limited
wealth, its insurance decisions are the
outcome of a single-agent decision
problem.
• This is the familiar “contract” problem
reviewed in the first term
ECONOMIC ANALYSIS OF TORT LAW
• What might persuade a single agent to
switch from a full insurance contract to no
insurance when the level of activity risk
that agent faces increases?
• The defendant, an individual or a
corporation, has limited liability because of
the option to declare bankruptcy.
ECONOMIC ANALYSIS OF TORT LAW
• Given a liability rule, a defendant chooses
an amount of insurance, I1, to maximize its
expected utility.
• The defendant pays premium p for this
insurance, where p = probability that an
accident will occur.
ECONOMIC ANALYSIS OF TORT LAW
• .
Utility Indifference
Curve Of A Single
Risk Averse Insured
w - pI1
E
U1
w
ECONOMIC ANALYSIS OF TORT LAW
• The “Insurance” Problem:
• EU = pU(w + I1 – pI1 – D) +
(1-p)U(w – pI1)
ECONOMIC ANALYSIS OF TORT LAW
• First Order Condition – No limited liability
EU/dp = 0
p(1-p)U’(w + (1-p)I1 – D) = p(1-p)U’(w –
pI1)
marginal benefit of insurance = marginal
cost of insurance
ECONOMIC ANALYSIS OF TORT LAW
• First Order Condition – Limited liability
EU/dp = 0
p(1-p)U’(w + (1-p)I1 – D) = p(1-p)U’(w –
pI1)
Limited Liability Constraint:
p(1-p)U’(w + (1-p)I1 – D) = 0
up to I1* = (D-w)/(1-p)
ECONOMIC ANALYSIS OF TORT LAW
• An increase in the probability of an
accident, p, decreases the critical
damages award level, D.
• So the damages award for the plaintiff is
lowered.
ECONOMIC ANALYSIS OF TORT LAW
• An increase in p will cause some
individuals to drop their insurance
coverage completely.
• An increase of either damage awards or
liability standards can reduce the
compensation to accident victims when a
defendant abandons liability insurance.
ECONOMIC ANALYSIS OF TORT LAW
NEGLIGENCE LIABILITY:
Insurance Contracts – Multiple Defendants
ECONOMIC ANALYSIS OF TORT LAW
• Linking insurance decisions to the tort
system shows that more liability in tort can
lead to less compensation for the accident
victim, and less deterrence against
accidents.
ECONOMIC ANALYSIS OF TORT LAW
a2 = Output of Agent 2
Bilateral Negative Externalities – Example: Cournot Duopoly
Iso-Profit Curve For Agent 2
NASH EQUILIBRIUM
Iso-Profit Curve For Agent 1
PARETO OPTIMAL EQUILIBRIUM
a1 = Output of Agent 1
ECONOMIC ANALYSIS OF TORT LAW
• In the case of only two multiple parties A1
and A2, if both were equally involved in the
accident, the parties would split the
damages, provided there are no limitations
on wealth.
ECONOMIC ANALYSIS OF TORT LAW
• However, when two agents with limited
wealth are subject to the joint and several
liability (common law) rule, the agents’
insurance decisions are the outcome of a
game of bilateral positive externalities.
• See Winter, Ralph, “Liability Insurance, Joint Tortfeasors and Limited
Wealth”, v. 26, Issue 1, International Review of Law and Economics,
p. 1 (March, 2006)
ECONOMIC ANALYSIS OF TORT LAW
• The “Deep-Pockets” Effect:
• As Agent A1 buys more insurance, it confers a
positive externality on Agent A2
• Agent A2 believes a plaintiff will go after A1 first
because there is a “deeper pocket”
• Why would a plaintiff pursue the “deeper
pocket”?
• The plaintiff makes an outlay of transaction costs
to its lawyer so it will be seeking a greater return
for its outlay
ECONOMIC ANALYSIS OF TORT LAW
• If Agent A2 believes A1 will be sued before
A2, then A2 may reduce its effort towards
precaution
• A2 may also reduce the level of its
insurance coverage
ECONOMIC ANALYSIS OF TORT LAW
• The “Cascade” Effect:
• But A1 sees what A2 is doing and decides it
will reduce its exposure as well – rationally
it does not want to be the “deep pocket”
• A1 instead receives a “positive externality”
from A2 being the “deep pocket”
ECONOMIC ANALYSIS OF TORT LAW
I2 = Insurance Purchased By Insured 2
Bilateral Positive Externalities – Example: The “Insurance” Game
Utility Curve For Insured 1
NASH EQUILIBRIUM
PARETO
OPTIMAL
EQUILIBRIUM
Utility Curve For Insured 2
I1 = Insurance Purchased by Insured 1
ECONOMIC ANALYSIS OF TORT LAW
• It is the combined wealth and insurance that is
targeted by a plaintiff or claimant
• A defendant may strategically react by reducing
both its insurance coverage (as explained) and
its wealth
• Because wealth and insurance are strategic
substitutes it would not make any sense for a
defendant to simply reduce insurance coverage
and leave its wealth exposed
ECONOMIC ANALYSIS OF TORT LAW
• The potential defendant could very well
decide on the following wealth reduction
strategies because it believes insurance
premiums, although fair, may be too high
• Dissipate the wealth so that it can opt for
bankruptcy to limit its liability if sued
• Transfer its wealth to another party or to another
jurisdiction in a bid to increase the plaintiff’s
transaction costs should the plaintiff choose to
pursue the wealth as a judgment creditor
ECONOMIC ANALYSIS OF TORT LAW
• Rules such as joint-and-several liability,
which would appear to broaden the scope
of an accident victim to collect damages.
• Yet such a rule may reduce the
compensation available once the impact
on insurance decisions plays out.
ECONOMIC ANALYSIS OF TORT LAW
• This is why small or gradual increases in
liability risk, through changes in tort laws
or the liability risk environment (the
aftermath of 9-11), can lead to sudden and
volatile changes in insurance markets
ECONOMIC ANALYSIS OF TORT LAW
• Countering the “Insurance Game”:
• Many types of insurance coverage are
mandatory
• By law
» There is a mandatory minimum of insurance coverage
required for motor vehicles
» Professionals such as doctors, lawyers, accountants,
engineers, etc are required to carry regulated minimums in
malpractice coverage
• By contract
» Creditors such as banks requires borrowers such as
mortgagors (homeowners) to carry insurance to at least
the value of the property
ECONOMIC ANALYSIS OF TORT LAW
I2 = Insurance Purchased By Insured 2
The “Insurance” Game – Impact of “credible” mandatory insurance minimums
Utility Curve For Insured 1
NASH EQUILIBRIUM
PARETO
OPTIMAL
EQUILIBRIUM
Utility Curve For Insured 2
I1 = Insurance Purchased by Insured 1
ECONOMIC ANALYSIS OF TORT LAW
• Countering the “Insurance Game” – Limits on
Damages Awards:
• Historically, the common law was not entirely
oblivious to the “insurance” game
• Rules prevented disclosure of insurance levels
to plaintiffs or juries during the conduct of
lawsuits
• However, Ontario relaxed some of these rules in
1984 to enable plaintiffs to investigate the
liquidity of a potential defendant
ECONOMIC ANALYSIS OF TORT LAW
• In 1978 the Supreme Court of Canada
imposed a ceiling on particular types of
damages, such as damages for pain and
suffering
• In 2006 the Ontario Court of Appeal rolled
back a $500,000.00 award for punitive
damages to $100,000.00, explaining this
amount was sufficient for deterrence
ECONOMIC ANALYSIS OF TORT LAW
• Since 1990, Ontario’s Insurance Act limits the
recovery of persons injured as a result of a
motor vehicle accident.
• The traditional ability to sue at fault drivers or the
owner of the vehicle for general damages for
pain and suffering or loss of enjoyment of life, is
not available, unless a Plaintiff shows serious
permanent disfigurement, or a serious
permanent limitation of an important bodily
function.
ECONOMIC ANALYSIS OF TORT LAW
• In effect, the “joint and several liability rule”
was replaced by a procedure whereby
injured parties recovered exclusively from
their own insurers provided their injuries
fell below a certain threshold
• In theory this would counteract the
“insurance game” and provide more
compensation to motor vehicle accident
victims
ECONOMIC ANALYSIS OF TORT LAW
• The traditional ability to sue at fault defendants
in non-motor vehicle negligence actions for
general damages, for pain and suffering or loss
of enjoyment of life, is still available.
• Other developments follow
ECONOMIC ANALYSIS OF TORT LAW
• The Supreme Court had
ruled in 1995 that bars,
restaurants and other
commercial
establishments that serve
alcohol are legally liable
if, for instance, they
continue to serve
obviously inebriated
customers and then do
nothing to stop them from
getting into their cars.
ECONOMIC ANALYSIS OF TORT LAW
• ZOE CHILDS
• The question is:
should average
Canadians have the
same legal
responsibility?
• May 5, 2006
• The Supreme Court
said no
Zoe Childs
ECONOMIC ANALYSIS OF TORT LAW
• But a question remains – How credible are
such measures?
• Insurance may still run dry especially in
the aftermath of such disasters as
Hurricane Katrina (2005) or the asbestos
catastrophe explained earlier
ECONOMIC ANALYSIS OF TORT LAW
TORT LIABILITY:
Strict Liability Revisited
ECONOMIC ANALYSIS OF TORT LAW
• The re-imposition of "strict liability“ in
contractual and tort situations is being
accomplished with the superimposing of
fiduciary duties, "implicit agency", which
impose strict liability, in an increasing
number of cases.
ECONOMIC ANALYSIS OF TORT LAW
• STRICT LIABILITY – Asymmetric
$
Information
Strict
Liability Rule
Cost of
Precaution
a1*
ECONOMIC ANALYSIS OF TORT LAW
• Modern Developments
• The Horwitz thesis “in reverse” – moving back to
strict liability
»
»
»
»
»
»
1930’s - Donoghue v. Stevenson
– One owes strangers a duty of care
1960’s – Hedley Byrne v. Barclay’s Bank
– Words as well as actions can attract liability
1970’s - Seaway Hotel case
– Damages extended to include loss of profits
ECONOMIC ANALYSIS OF TORT LAW
• Modern Developments
» 1980’s – Central Trust v. Rafuse
» – Strict Liability imposed on professionals such as
lawyers
» 1980’s – International Corona v. Lac Minerals
» – Strict Liability imposed on businesses such as
mines if critical information withheld or exploited
» 1990’s – “Historical” tort cases – Strict Liability
imposed on institutions to address historical wrongs:
» Incest Cases
» Residential Schools
» Wrongful Convictions
ECONOMIC ANALYSIS OF TORT LAW
• How does this “trend” impact on the
“insurance game?
• By increasing the potential for higher
recovery of damages for plaintiffs, the
“insurance game” can arise for some
potential defendants who reduce
insurance and move their wealth
• The availability of compensation is
reduced