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					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


                          x1
                          a
    ECONOMIC ANALYSIS OF TORT LAW

• Negligence – Defence of Contributory
 $ Negligence                At common
       Strict Liability Portion           law, beyond
       Of The Negligence                  this point a
       Rule                               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




                          x1
                          a
             ECONOMIC ANALYSIS OF TORT LAW

      •   Agent 1 - PC         •       Agent 2 - Monopoly

                                   P
                                          D

                                                               S

                               PM
PLR
                                                       Coasean or
                                                       Bargained MC
                                                       Negligence
                                                       Rule and MC


                          x1
                          a
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


                          x1
                          a
  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 Johns-
  Manville 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 2
               AGENT 1
                            (Insured)
               (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        Garnier Residential
  by the insured) during the    School, Spanish, Ontario
  term of the policy.
       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

                                                           PARETO
                        Utility Curve For Insured 1
                                                           OPTIMAL
                                                           EQUILIBRIUM




      NASH 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

                                                       PARETO
                       Utility Curve For Insured 1
                                                       OPTIMAL
                                                       EQUILIBRIUM




      NASH 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    Zoe Childs
  said no
 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

				
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