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ECONOMIC ANALYSIS OF TORT LAW January 23, 2007(Revised)

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

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ECONOMIC ANALYSIS OF TORT LAW January 23, 2007(Revised)

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  1. ECONOMIC ANALYSIS OF TORT LAW January 23, 2007(Revised)

  2. 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

  3. 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.

  4. ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY “SUPER” Principal = Judge Its “problem” is to maximize social surplus TORTS AGENT 2 AGENT 1

  5. 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.

  6. NEGLIGENCE LIABILITY: Product Liability ECONOMIC ANALYSIS OF TORT LAW

  7. 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

  8. ECONOMIC ANALYSIS OF TORT LAW • Perfectly Competitive-Agent • Market – Agents P D S S MC SATC a1

  9. ECONOMIC ANALYSIS OF TORT LAW • Agent 1 - PC • Agent 2 - Monopoly P D S S Private MC Social MC Coasean or Bargained MC Negligence Rule and MC PM PLR x1 a1

  10. ECONOMIC ANALYSIS OF TORT LAW • Negligence – Defence of Contributory Negligence $ At common law, beyond this point a single Defendant was not liable Strict Liability Portion Of The Negligence Rule Precaution Cost Component Of The Negligence Rule a1*

  11. ECONOMIC ANALYSIS OF TORT LAW • Negligence – Comparative Negligence $ Under Contributory Negligence statutes, liability or fault is now apportioned (shared) among parties a1*

  12. ECONOMIC ANALYSIS OF TORT LAW • Agent 1 - PC • Agent 2 - Monopoly P D S S Private MC Social MC Negligence Rule and MC PM PLR x1 a1

  13. ECONOMIC ANALYSIS OF TORT LAW • Agent 1 - PC • Agent 2 - Monopoly P D S S Coasean or Bargained MC Negligence Rule and MC PM PLR x1 a1

  14. NEGLIGENCE LIABILITY:Employer and Employee Liability ECONOMIC ANALYSIS OF TORT LAW

  15. 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

  16. ECONOMIC ANALYSIS OF TORT LAW • Agent 1 - PC • Agent 2 - Monopoly P D S S Coasean or Bargained MC Negligence Rule and MC PM PLR x1 a1

  17. 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.

  18. CATASTROPHIC TORTS ECONOMIC ANALYSIS OF TORT LAW

  19. 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?

  20. 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

  21. 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?

  22. 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)

  23. ECONOMIC ANALYSIS OF TORT LAW • Converted use • Residential Development at Port Union (Scarborough) on top of the site of the Johns-Manville asbestos plant

  24. LIABILITY:Limitation Periods ECONOMIC ANALYSIS OF TORT LAW

  25. ECONOMIC ANALYSIS OF TORT LAW • Basic limitation periodsOntario’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.

  26. LIABILITY:Duty To Mitigate ECONOMIC ANALYSIS OF TORT LAW

  27. 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

  28. LIABILITY:Insurance Contracts – Single Defendant ECONOMIC ANALYSIS OF TORT LAW

  29. ECONOMIC ANALYSIS OF TORT LAW • The efficient operation of liability insurance markets will indirectly effect the “solution” of the tort problem

  30. ECONOMIC ANALYSIS OF TORT LAW “SUPER” Principal = Judge Its “problem” is to maximize social surplus TORTS – Bilateral Agency AGENT 2 (Insured) AGENT 1 (Insured) CONTRACTS – Principal Agency Insurer 2 Insurer 1

  31. 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

  32. 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

  33. 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.

  34. 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.

  35. ECONOMIC ANALYSIS OF TORT LAW • . Utility Indifference Curve Of A Single Risk Averse Insured w - pI1 E U1 w

  36. ECONOMIC ANALYSIS OF TORT LAW • The “Insurance” Problem: • EU = pU(w + I1 – pI1 – D) + (1-p)U(w – pI1)

  37. 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

  38. 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)

  39. 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.

  40. 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.

  41. NEGLIGENCE LIABILITY:Insurance Contracts – Multiple Defendants ECONOMIC ANALYSIS OF TORT LAW

  42. 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.

  43. 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

  44. 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.

  45. 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)

  46. 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

  47. 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

  48. 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”

  49. ECONOMIC ANALYSIS OF TORT LAW I2 = Insurance Purchased By Insured 2 Bilateral Positive Externalities – Example: The “Insurance” Game PARETO OPTIMAL EQUILIBRIUM Utility Curve For Insured 1 NASH EQUILIBRIUM Utility Curve For Insured 2 I1 = Insurance Purchased by Insured 1

  50. 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

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