The law and economics of punitive damages in

							                                           The Law and Economics of Punitive Damages
Rotterdam Institute of Law and Economics




                                                   Ius Commune Conference Leuven
                                                   Workshop Liability and Insurance
                                                          November 26, 2010

                                                             Louis Visscher
                                            Rotterdam Institute of Law and Economics (RILE)
                                                        Erasmus School of Law
                                                           Visscher@frg.eur.nl
                                           The Law and Economics of Punitive Damages
                                           Outline
Rotterdam Institute of Law and Economics




                                           • Introduction
                                           • Economic goals of tort law and damages
                                           • Economic reasons for punitive damages in tort law
                                           • Intentional torts; losses or gains; insurance
                                           • Economic goals of contract law
                                           • Economic analysis of puntive damages for deliberate breach
                                           • Conclusions
                                           The Law and Economics of Punitive Damages
                                           Introduction
Rotterdam Institute of Law and Economics




                                           • Many elements from the ‘call for papers’ return in the economic
                                           approach:
                                             • Why punitive damages?  goals of law are important
                                             • Public versus Private Enforcement  ‘optimal enforcement’
                                             • Divide between private and penal law  punishment goal?
                                             • Deliberate breach and punitive damages
                                             • Debunking the myth?

                                           • To start with the last point:
                                             • Enormous amounts are often reduced by court;
                                             • Punitive damages in <5% of cases where victim prevailed;
                                             • Generally not very high amounts;
                                             • Positively correlated with compensatory damages.
                                           The Law and Economics of Punitive Damages
                                           Economic goals of tort law and damages
Rotterdam Institute of Law and Economics




                                           • Legal view: compensation
                                           • Economic view: deterrence and risk spreading
                                             • Compensation is not a goal, but a means
                                             • Damages are the instrument
                                           • Threat of liability gives incentives  ‘full compensation’
                                           • Several problems frustrate deterrent potential of tort law 
                                           punitive damages as possible way to solve these problems!
                                           • Punishment as goal in tort law?
                                           The Law and Economics of Punitive Damages
                                           Economic reasons for punitive damages in tort law (I)
Rotterdam Institute of Law and Economics




                                           1. Too low probability of being held liable
                                           • Basic model: full expected liability
                                           • But:
                                              • problems of proof;
                                              • rational apathy;
                                              • injurer may try to avoid detection (intentional torts!)
                                           • Punitive damages to offset this  ‘damages multiplier’
                                           • Example: intentional torts; double/treble damages in antitrust
                                           The Law and Economics of Punitive Damages
                                           Economic reasons for punitive damages in tort law (II)
Rotterdam Institute of Law and Economics




                                           2. Underestimation of Harm
                                           • Esp. with subjective and immaterial losses  underdeterrence!
                                           • Punitive damages as solution. But:
                                              • Same problems of estimation;
                                              • Less fine-tuned rules for calculation;
                                              • Some losses may be deliberately excluded!
                                           3. Socially unaccepted costs/benefits
                                           • Compensatory damages may then be too low to deter
                                           • Punitive damages as solution. But:
                                              • How relevant? (rare situation);
                                              • Assuming the conclusion
                                           • Intentional torts often are undesirable!
                                           The Law and Economics of Punitive Damages
                                           Economic reasons for punitive damages in tort law (III)
Rotterdam Institute of Law and Economics




                                           4. Encourage voluntary transfers
                                           • Voluntary transfers are preferred (subjective valuations included)
                                           • If low transaction costs: do not accept involuntary transfers
                                           • Punitive damages make involuntary unattractive



                                           Question: punishment as goal of punitive damages?
                                           • Most literature: deterrence (even punishment arguments aim at
                                           deterrence)
                                           • But: punishment as such can be a goal: desire to see blameworthy
                                           people adequately punished  reprehensibility and wealth matter
                                           The Law and Economics of Punitive Damages
                                           Specific topics
Rotterdam Institute of Law and Economics




                                           1. Intentional torts
                                           • Injurer lowers probability of being held liable;
                                           • Often in settings of low transaction costs;
                                           • Almost by definition undesirable:
                                              • Gains smaller than losses (sometimes even illicit!)
                                              • ‘Negative care costs’
                                           • No risk of overdeterrence  punitive damages warranted
                                           The Law and Economics of Punitive Damages
                                           Specific topics
Rotterdam Institute of Law and Economics




                                           2. Gains or losses?
                                           • Many European countries allow gain-based damages
                                           • L&E: preference for loss-based  internalization (goal: give
                                           correct care and activity incentives)
                                           • However: if losses are underestimated or other social losses exist
                                            deter behavior altogether  gain-based

                                           3. Insurance against punitive damages?
                                           • Punishment goal: no!
                                           • Deterrence goal: yes
                                           • Moral hazard?
                                           The Law and Economics of Punitive Damages
                                           Economic goals of contract law
Rotterdam Institute of Law and Economics




                                           • Facilitate voluntary transfers, because they increase welfare:
                                             • Lower transaction costs (default rules; standard terms; good
                                               faith)
                                             • Solve problem of sequential contracts  remedies for non-
                                               performance
                                           • ‘Complete contract’: everything is agreed upon, also when the
                                           debtor does not have to perform (plus price to pay)
                                           • Real contracts: incomplete. Law should mimic the complete
                                           contract
                                           • Therefore: allow ‘efficient breach’  expectation damages
                                           • Both parties benefit from this!
                                           The Law and Economics of Punitive Damages
                                           Economic analysis of punitive damages for deliberate breach
Rotterdam Institute of Law and Economics




                                           • Efficient breach is often deliberate  punitive damages would
                                           result in excessive performance
                                           • Expectation damages may be too low (subjective; uncertain) 
                                           too little performance. But: punitive damages are not a good
                                           solution (just as in torts)
                                           • If ‘willful’ etc. only includes inefficient behavior  punitive
                                           damages possible. But: mistakes lead to excessive performance!
                                           • Standard reasons (rational apathy and obscure wrongdoing) not
                                           relevant for deliberate breach  no punitive damages!
                                           • Recent paper: wilfull breach shows opportunistic nature. Punitive
                                           damages sanction for the undetected behaviour. Problematic
                                           calculation!
                                           The Law and Economics of Punitive Damages
                                           Conclusions
Rotterdam Institute of Law and Economics




                                           • Punitive damages in torts may correct several problems:
                                             • Too low probability of being held liable;
                                             • Too low compensatory damages (problematic);
                                             • Socially unaccepted costs/benefits (problematic);
                                             • Induce voluntary transfers.
                                           • Punitive damages for intentional torts makes sense;
                                           • Damages based on losses for internalization; damages based on
                                           gains for totally deterring the behaviour;
                                           • Insurability: tension between punishment and deterrence;
                                           • Punitive damages for intentional breach not desirable