ECONOMIC ANALYSIS OF TORT LAW January 16, 2007

ECONOMIC ANALYSIS OF TORT LAW Private Goods Property Rights Public Goods Public Bads Private Bads Harms or Wrongs

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 Private Bads Asymmetric Information Forces of Nature Imperfect Allocation of Information

ECONOMIC ANALYSIS OF TORT LAW In contracts, the agents may agree to adopt a sharing rule In torts, the “social planner” or “law- making agency” acts to “impose” an optimal sharing rule on the agents

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY A principal in a private bilateral contract relationship writes a contract that may serve to “sort” or “separate” agents into more efficient contracts A court in a private bilateral agency relationship writes a rule that may serve to “sort” or “separate” contracts into more efficient outcomes

ECONOMIC ANALYSIS OF TORT LAW Cooter, in his article, poses the following question: Can the goal of compensating the victim be reconciled with the minimization of social costs? What tort system fully internalizes the social costs of precaution to the private costs of each individual?

ECONOMIC ANALYSIS OF TORT LAW INTENTIONAL TORTS Pollution Assault Fraud

ECONOMIC ANALYSIS OF TORT LAW Intentional torts involve "express" intention. A party willfully inflicts harm on another. Assaults and batteries are examples. As well, one may recall the torts of trespass, interference with property rights and nuisance. (See KVP case)

ECONOMIC ANALYSIS OF TORT LAW Intentional torts generally carry the standard of "strict liability“ in the awarding of compensation to victims. In terms of establishing legally liability, such torts require proof of who the parties are causation (physical cause and effect) and damages. The rule of strict liability with perfectly compensatory damages gives the victim no incentive to take precaution. [Cooter (p. 323)]

ECONOMIC ANALYSIS OF TORT LAW In the typical tort, the plaintiff suffers a loss that depends on the amounts of care taken by both the plaintiff and the defendant Legal rules of the form L(e 1,e 2 ) emerge L(e 1,e 2 ) = 0No fault L(e 1,e 2 ) = 1Strict liability e 1 = action of “injuror” defendant e 2 = action of “victim” plaintiff

ECONOMIC ANALYSIS OF TORT LAW First Example – Collateral Proceedings Criminal Tort Private Bads Public Bads

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

ECONOMIC ANALYSIS OF TORT LAW First Example Criminal Tort Ontario Court of Justice (Criminal court) Ontario Superior Court (Civil court) Ontario Court of Appeal

ECONOMIC ANALYSIS OF TORT LAW First Example – Collateral Proceedings Criminal Tort AssaultAssault MurderWrongful Death

ECONOMIC ANALYSIS OF TORT LAW O. J. Simpson was tried for the murder of ex-wife Nicole brown Simpson and her friend Ronald Goldman in He was acquitted in a Los Angeles criminal court in 1995 after a lengthy trial. In 1997, Simpson was found liable for their deaths in civil court, but to date has never paid the judgment

ECONOMIC ANALYSIS OF TORT LAW Second Example – Collateral Defences Criminal CourtCivil Court Contributory Negligence »Still an absolute defence Not an in some cases absolute defence

ECONOMIC ANALYSIS OF TORT LAW Third Example The tort of appropriation of personality is not only alive and well in Canada but appears to survive the death of a celebrity. The tort was first recognized by the Ontario Court of Appeal in Krouse v. Chrysler Canada Ltd. in 1972

ECONOMIC ANALYSIS OF TORT LAW Where a celebrity is the subject matter of a work, the public's interest in knowing about the celebrity will defeat a claim for appropriation of personality. Where the celebrity has consented to the use of his or her likeness, a claim for appropriation of personality will not succeed. The right to exploit a celebrity's personality commercially may be transferred to a third party, and the celebrity and his or her estate will have no right to restrain such exploitation by the transferee.

ECONOMIC ANALYSIS OF TORT LAW Related torts Passing Off Defamation Malicious falsehood Copyright infringement Provide sanctions against the unauthorised use of an individual's persona in commercial enterprises in particular and special circumstances.

ECONOMIC ANALYSIS OF TORT LAW UNINTENTIONAL TORTS Negligence

ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY A second category of tort involves the infliction of unintentional harm. The most frequent situation involves negligence.

ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY In addition to the three (3) components requiring proof in the intentional torts - identification, causation and damage - two further components are required. A plaintiff ("injured party") must also show that a "standard of care" is owed and that this "standard" was breached. This second requirement answers the question“ to whom is the duty of care owed"?

ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY So the infliction of harm on the plaintiff, though required, is not sufficient to establish liability. This "weaker" standard of liability is called "ordinary negligence". This form of tort liability grew in importance throughout the nineteenth century due to expanding industrialization.

ECONOMIC ANALYSIS OF TORT LAW This is sometimes referred to as the “precautionary” principle

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 STRICT LIABILITY In 1974, Professor Morton Horwitz at Harvard advanced the thesis that industrialization in the West had motivated a trend in law to prove intent or negligence against parties who in pre-industrial societies would have been found strictly liable for harms committed.

ECONOMIC ANALYSIS OF TORT LAW In the early "common law" cases for negligence, the parties had to have some pre-existing relationship between the injured and the injuror. This would include a contract (retailer - customer) or status (parent - child). A "duty of care" was owed parties within relationships.

ECONOMIC ANALYSIS OF TORT LAW The Butterfield v. Forrester decision was the origin of this common law defence that, if proved, amounted to a bar of any recovery by a plaintiff irregardless of the conduct of the defendant if the plaintiff was a part cause of the tort. Butterfield v. Forrester (1809) 11 East 60, 103 E.R. 960 Cooter, pp , 2003.

ECONOMIC ANALYSIS OF TORT LAW The plaintiff, Butterfield, was thrown from his horse when it hit a pole that Forrester had temporarily laid cross the highway. The "contributory negligence" of Butterfield was riding his horse too fast, preventing him from seeing Forrester's obstruction soon enough to avoid it. Notwithstanding that Forrester was negligent, so was Butterfield. This constituted a complete defence for Forrester.

ECONOMIC ANALYSIS OF TORT LAW According to Cooter, neither the “no liability” rule nor the “strict liability” rule, can be optimal in joint accident cases. This was exactly the conclusion common law judges reached in such cases

ECONOMIC ANALYSIS OF TORT LAW A major change did indeed occur, but not until In 1934 with the landmark House of Lords ruling in Donohue v Stevenson, [1932] A.C. 532 (H.L.)

ECONOMIC ANALYSIS OF TORT LAW A customer was permitted to sue "up the chain of production" (wholesaler, manufacturer) for a "ginger ale” purchase contaminated with the remains of a dead mouse. So the "duty of care" was extended to such parties as could have been "reasonably foreseen" by the injurors.

ECONOMIC ANALYSIS OF TORT LAW The common law rule that combines negligence with the defence of contributory negligence is defined as follows: L(a 1,a 2 ) = { 1 if a 1 a 2 * {0 if a 1 > a 1 * and a 2 < a 2 *

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY a 1 = level of precaution invested by the agent- promisor (Agent 1) against breach of contract against (Agent 2) a 2 = level of reliance invested by the agent- promisee (Agent 2) in Agent 1 a 1 = level of precaution invested by the agent- promisor (Agent 1) against wrongs causing damages a 2 = level of precaution invested by the agent- promisor (Agent 2) against wrongs causing damages

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY p(a 1 ) = Probability of No Breach Probability of Performance A Completed Contract p’(a 1 ) > 0 More effort results in more precaution against breach p’’(a 1 ) < 0 Diminishing “returns” to precaution as more effort invested p(a 1, a 2 ) = Probability of No Breach Probability of Performance A Completed Contract p’(a 1 ), p’(a 2 ) > 0 More effort results in more precaution against breach p’’(a 1 ), p’’(a 2 )< 0 Diminishing “returns” to precaution as more effort invested

ECONOMIC ANALYSIS OF TORT LAW p(a 1 U a 2 ) = Probability of No Breach p(a 1 U a 2 ) = p(a 1 ) + p(a 2 ) - p(a 1 ∩ a 2 ) p(a 1 U a 2 ) = p(a 1 ) + p(a 2 ) - p(a 1 )p(a 2 )

ECONOMIC ANALYSIS OF TORT LAW 1 - p(a 1 U a 2 ) = Probability of Breach p(a 1 U a 2 ) = 1 - p(a 1 ) - p(a 2 ) + p(a 1 )p(a 2 )

ECONOMIC ANALYSIS OF TORT LAW This is an example of double moral hazard

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY P 2 cannot observe a 1 A 1 knows that P 2 cannot observe a 1 A 1 will apply less that optimal a 1 unless it can be assured that doing so will not minimize TOTAL expected damages A 2 cannot observe a 1 A 1 cannot observe a 2 Both parties know this Both parties will apply less than optimal efforts a 1,2

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY The critical difference is the assumption in all contract cases that the parties are "known" through each of the stages of the contract. In tort cases the parties are "known" only after the harm is committed.

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY In a "hypothetical" sense, as Demzetz states in his article, the "transaction costs“ of determining in advance who the parties to the tort and how the tort could be prevented will be is so "astronomically high" that such a determination will not occur. Demsetz, Harold, "When Does the Rule of Liability Matter?", (1972) 1 J. of Leg. Stud. 13 at p. 26

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY Out of high transaction costs, the possibility of voluntary agreements are negligible, so as in the case of automobile accidents, rules of the road evolve and are imposed. Demsetz, at p. 26 Out of low transaction costs, the possibility of voluntary agreements are greater, so rules of negotiation develop. Demsetz, at p. 26

ECONOMIC ANALYSIS OF TORT LAW Also, according to Cooter, a simple negligence rule requires the victim be compensated by the injuror – provided if and only if the injuror is at fault

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY “Liability rule” or “liability marginal cost curve” for Agent 1 is added in orange to the joint social surplus of the parties Max [p(a 2 )R P (a 1 ) + [1 - p(a 2 )]R NP (a 1 )] - a 1 - a 2 - [1-p(a 2 )]D e [1 - p(a 1, a 2 )] = Probability of Breach

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY Strict Liabilty Rule –MC 1 Contracted Liability Rule – MC 1 Expected Liability – MC 1

ECONOMIC ANALYSIS OF TORT LAW The parties will choose that level of effort which minimizes their respective costs: Min (Social Costs) = Min[a 1 + a 2 - (1 - p(a 1,a 2 ))D]

ECONOMIC ANALYSIS OF TORT LAW CONTRACT TORT PRINCIPAL - AGENCY BILATERAL - AGENCY Marginal Cost Curve of Agent 1 Expected Marginal Cost Curve of Agent 1 under Expectation Damages a 10 a 1 * a 11  NP  P

ECONOMIC ANALYSIS OF TORT LAW Axes a 2 a* 2 a1a1 P P  NP y 0 a 1 * y 1

ECONOMIC ANALYSIS OF TORT LAW Professor Osborne argues that the Nash equilibrium induced by this rule Is unique Reflect the socially desirable efforts for which each party should strive The injuror-defendant’s effort is a best response to the victim-plaintiff’s effort The victim-plaintiff’s effort is a best response to the injuror-defendant’s effort (Osborne, 93-94)

ECONOMIC ANALYSIS OF TORT LAW Axes a 1 a* 1 a2a2 a 2 + [1 –p(a 1,a 2 )]D a 1 + [1 –p(a 1,a 2 )]D a* 2

ECONOMIC ANALYSIS OF TORT LAW The "strict liability" branches of law became increasingly confined to intellectual property infringement actions and anomalous cases that found their rationales in pre-industrial societies. Could we be witnessing a reversal?

ECONOMIC ANALYSIS OF TORT LAW Negligence – Defence of Contributory Negligence a1*a1* $

ECONOMIC ANALYSIS OF TORT LAW During the 1920's and 1930's most provinces and states passed statutes that altered the contributory negligence defence to that of comparative negligence. The rule a 1 = E is still the effort that minimally meets the injuror's standard of care. Unless the victim applies a 2 = E < SC, then the injuror will be 100% liable if a 1 < SC.

ECONOMIC ANALYSIS OF TORT LAW Negligence – Comparative Negligence a1*a1* $

ECONOMIC ANALYSIS OF TORT LAW Modern Developments The Horwitz thesis “in reverse” – moving back to strict liability »1930’s - O’Donoghue v. Stevenson »1960’s – Hedley Byrne v. Barclay’s Bank »1970’s - Economic loss – Seaway Hotel case »1970’s – Economic experts – CUPE v. AIB »1980’s – Central Trust v. Rafuse »1980’s – International Corona v. Lac Minerals »1990’s – “Historical” tort cases

ECONOMIC ANALYSIS OF TORT LAW The tort of negligent misrepresentation was first recognized by the House of Lords in Hedley Byrne & Co. v. Heller & Partners Ltd., [1964] A.C. 465 (H.L.). This case is now an established precedent in Canadian tort law. Malpass v. Morrison (November 9, 2004) Superior Court - Grossi J. (Sault Ste. Marie)

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 a1*a1* $