A market in litigation risk

University of Chicago Law Review

Volumn 76, Issue 1, 2009, Pages 367-439

  Molot, Jonathan T ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 66249127929     PISSN: 00419494     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (191)

1. O.W. Holmes, The Path of the Law, 10 Harv L Rev 457, 461 (1897).
2. See Jonathan T. Molot, How Changes in the Legal Profession Reflect Changes in Civil Procedure, 84 Va L Rev 955, 969 (1998).
3. See William B. Rubenstein, A Transactional Model of Adjudication. 89 Georgetown L J 371, 372 (2001);
4. Molot, 84 Va L Rev at 971 (cited in note 2).
5. See also Robert J. Rhee. Tort Arbitrage, 60 Fla L Rev 125, 140 (2008) ("[T]he dispute resolution process is an exercise in risk management wherein risk and return are traded.").
6. See Joseph Grundfest and Peter Huang, The Unexpected Value of Litigation: A Real Options Perspective, 58 Stan L Rev 1267, 1269 (2006) ("Lawsuits and investment projects have much in common.").
7. For a discussion of changing attitudes toward legal risk management a generation ago, see Detlev F. Vagts, Legal Opinions in Quantitative Terms: The Lawyer As Haruspex or Bookie?, 34 Bus Lawyer 421, 421-29 (1979). For a discussion of just how unsophisticated the financial modeling of litigation remains when compared to the modeling of other business decisions, see Grundfest and Huang, 58 Stan L Rev at 1271 (cited in note 4).
8. See notes 30-31 and accompanying text.
9. I do not weigh in on the question of how lawyers can best manage risk by reaching a cost-effective resolution with the opposing party. For a discussion of those issues, see Ronald J. Gilson and Robert H. Mnookin, Disputing through Agents: Cooperation and Conflict between Lawyers in Litigation, 94 Colum L Rev 509, 512 (1994) (arguing that by applying their skills, lawyers "can play an extraordinarily constructive role in disputes-as peacemakers who facilitate efficient and fair resolution of conflict when their clients do not do so for themselves");
10. Rubenstein, 89 Georgetown L J at 372 (cited in note 3) (discussing how modern litigation efforts require lawyers to broker deals, not conduct traditional courtroom work). Instead, I focus on how lawyers might change their self-conception so as to find ways to dispose of litigation risk while disputes remain pending.
11. See Geoffrey Miller, On the Costs of Civil Justice, 80 Tex L Rev 2115, 2115 (2002) ("In most cases, the plaintiff can sell res judicata only to the defendant, and the defendant can buy it only from the plaintiff").
12. See J.B. Heaton, The Risk Finance of Class Action Settlement Pressure, 4 J Risk Fin 75, 80 (Spring 2003) (explaining that while companies are better situated to bear the financial risk of litigation than typical defendants, they "simply do not have the specialized and case-specific knowledge necessary to price the risk").
13. See also In re Rhone-Poulenc Rorer Inc, 51 F3d 1293, 1298 (7th Cir 1995) (discussing how the defendant, a large corporation, might be pressured to settle rather than contest plaintiffs' claims given the dramatic uncertainty with respect to the value of the final judgment);
14. Rhee, 60 Fla L Rev at 150-54 (cited in note 3) (discussing settlement pressures in tort litigation and suggesting a "direct connection between the theory of valuation and the underlying structure of accident law").
15. See generally Guido Calabresi, The Costs of Accidents (Yale 1970).
16. See id at 26.
17. See id at 27-28.
18. See id at 39-67.
19. See Calabresi, The Costs of Accidents at 28, 251 (cited in note 10).
20. See, for example, Stephen B. Burbank and Linda J. SUberman, Civil Procedure Reform in Comparative Context: The United States of America, 45 Am J Comp L 675, 676 (1997) ("Litigation reform efforts in the United States have sounded a consistent theme of the need to reduce expense and delay.").
21. Some would say that it is inefficient for public companies to buy any sort of insurance, as their investors can hold a diverse portfolio of stocks and in this manner spread the risk of a catastrophic event befalling any one company. For a discussion of why companies nonetheless insure, see generally Louis De Alessi, Why Corporations Insure, 25 Econ Inq 429 (1987).
22. See also Rhee, 60 Fla L Rev at 153 (cited in note 3) (discussing reasons for insurance in the context of risk management in litigation);
23. Robert Cooter, Towards a Market in Unmatured Tort Claims, 75 Va L Rev 383, 394 (1989). It is beyond the scope of this Article to make a broader argument on why companies are willing to pay premiums for insurance policies or hedge contracts of any sort. Proceeding from the reality that companies do hedge or insure against all sorts of risks, this Article asks whether lawyers might create a market mechanism for the transfer of legal risk that is of the sort widely available today for a variety of other risks. It may be worth noting, however, one argument in favor of insuring legal risks in particular: namely, that litigation risk is a specialized risk that a specialized legal insurer might be better suited to price and manage than the companies that currently must bear it. If companies are forced to bear litigation risk themselves, markets may misprice it (artificially depressing a company's share price, for example), and corporate managers may mismanage it (for example, by allowing risk aversion to lead them to pay more to settle a suit than it is worth so as to resolve the matter and put it behind them).
24. See, for example, Jonathan T. Molot, A Market in Litigation Claims: A Market Alternative to Judicial Settlement Efforts *28-30 (unpublished manuscript, 2008).
25. For an example of how plaintiffs' claims might not only be transferred, but securitized and traded on an exchange, see Benjamin C. Esty, The Information Content of Litigation Participation Securities: The Case of CalFed Bancorp, 60 J Fin Econ 371, 394 (1999).
26. For market-based proposals under which plaintiffs' attorneys and/or third-party capital providers would bid for class action lawsuits in an auction setting, see Jonathan R. Macey and Geoffrey P. Miller, A Market Approach to Tort Reform via Rule 23, 80 Cornell L Rev 909, 913-15 (1995) (suggesting that one of the benefits of such a system would be to better align the interests of plaintiffs' attorneys with the interests of the class members);
27. Jonathan R. Macey and Geoffrey P. MUler, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U Chi L Rev 1, 105-16 (1991).
28. Consider David B. Wilkins and G. Mitu Gulati, What Law Students Think They Know about Law Firms, 69 U Cin L Rev 1213, 1213 (2001) ("Although the majority of legal scholarship continues to focus on law, a number of academics have begun to investigate the norms, institutions, and practices of lawyers.");
29. David B. Wilkins, The Professional Responsibility of Professional Schools to Teach about the Profession, 49 J Legal Educ 76, 76 (1999) (lamenting "the law school's systematic and pervasive failure to study and to teach about the profession").
30. See Part III.D.2.
31. See Part I.A.2.
32. Many litigation-triggering events are not covered by conventional liability insurance policies, which exclude "business risks" and conventional commercial contract disputes. See notes 25-27 and accompanying text.
33. See Miller, 80 Tex L Rev at 2116 (cited in note 8) ("[T]he value of the claim to be sold is often very difficult to appraise. Litigation claims are unique, not fungible, and often involve important elements of value known only to one party at the outset of the transaction.").
34. For a discussion of the effects on the plaintiffs' side of substituting a third-party capital provider for a contingent-fee plaintiffs' attorney, see Samuel R. Gross, We Could Pass a Law ... What Might Happen If Contingent Fees Were Banned, 47 DePaul L Rev 321, 325-30 (1998).
35. See Molot, A Market in Litigation Claims at *9 (cited in note 17).
36. In the companion paper on plaintiff-side risk transfers, I highlight the shortcomings of contingent fee arrangements and the need for a more robust market in litigation claims that would enable plaintiffs to monetize portions of their claims and offload the risk of collecting nothing. See id at *24-25.
37. In England, plaintiffs and defendants alike can buy "after-the- event" litigation insurance to cover their opponents' legal fees in case they should lose and be subject to fee shifting. See, for example, David Wilkinson and Adam Blanchard, Mass Tort Treatment of Pharmaceutical Product Liability Cases in England, 73 Defense Counsel J 264, 273-74 (2006).
38. See also Gross, 47 DePaul L Rev at 330-35 (cited in note 23);
39. Richard W. Painter, Litigating on a Contingency:A Monopoly of Champions or a Market for Champerty?, 71 Chi-Kent L Rev 625, 631-32 (1995) (suggesting that British rules against champerty-allowing third parties to insure a plaintiff for the cost of the defendant's legal fees - increases the market power of contingent-fee plaintiffs' lawyers, and often leads to higher fees).
40. Of course, conventional liability insurance covers the risk both of a litigation-triggering event and of a range of potential judgments or settlements, just as fire insurance covers the risk both of a fire starting and of the fire doing more or less damage. When an insurer writes liability insurance policies or fire insurance policies, it knows that among those few policyholders who end up suffering fires or accidents covered by their policies, it will pay small claims to those who suffer small losses and large claims to those who suffer large losses. But actuaries pricing these policies in the first instance can lump policyholders into large homogenous categories and need not consider the array of distinguishing features that a lawyer would consider in pricing a lawsuit after a litigation-triggering event has occurred.
41. See, for example, Jack H. Friedenthal, et al, Civil Procedure: Cases and Materials 966-70 (9th ed 2005) (discussing Denman v Spain, 135 So2d 195 (Miss 1961), in which the court held that verdicts could not be based on "possibilities").
42. See Charles Nesson, The Evidence or the Event: On Judicial Proof and the Acceptability of Verdicts, 98 Harv L Rev 1357, 1379 & n 70, 1380 (1985) (noting that probabilistic evidence is insufficient to support a verdict);
43. Lawrence Tribe, Trial by Mathematics: Precision and Ritual in the Legal Process, 84 Harv L Rev 1329, 1340-43, 1349 (1971) (presenting various hypothetical situations involving statistical evidence and noting that none would be sufficient to support a verdict).
44. See, for example, Richard A. Nagareda, Aggregation and Its Discontents: Class Settlement Pressure, Class-wide Arbitration, and CAFA, 106 Colum L Rev 1872, 1905-06 (2006).
45. Settlements do not require complete agreement on the value of the suit. So long as the plaintiffs and defendant's values do not differ by more than the combined legal fees to be saved by a settlement, there will be a range within which settlement is feasible. See generally George L. Priest and Benjamin Klein, The Selection of Disputes for Litigation, 13 J Legal Stud 1 (1984);
46. Steven Shavell, Suit, Settlement, and Trial: A Theoretical Analysis under Alternative Methods for the Allocation of Legal Costs, 11 J Legal Stud 55 (1982) (performing a cost-benefit analysis of whether and when plaintiffs will bring suit under the American, British, plaintiff-favoring, and defendant-favoring systems of adjudication).
47. See Samuel Gross and Kent Syverud, Don't Try: Civil Jury Verdicts in a System Geared to Settlement, 44 UCLA L Rev 1, 7 (1996) ("[J]ury verdicts are rarely compromises ... When a civil dispute ends in trial there is almost always a clear loser, and usually a clear winner as well.").
48. To take a simple example, if the plaintiff and defendant think there is roughly a 50 percent chance of a $1 million verdict and a 50 percent chance of a defense verdict, the settlement range might be around $500,000 (between $450,000 and $550,000 if each side expects $50,000 in legal fees), and yet a jury verdict would likely come in well outside that settlement range (either at $1 million or $0).
49. For a discussion of how imbalances in risk preferences may skew settlements away from the merits - and render settlements between plaintiffs and defendants less accurate than the sale of claims to third-party capital providers - see Molot, A Market in Litigation Claims at *6 (cited in note 17). Whereas a one-time, risk-averse plaintiff forced to sell to a repeat-player, risk-neutral defendant may be coerced into an unduly low settlement, a plaintiff free to shop her claim around and sell it in the open market will not be as easily coerced into a low settlement.
50. See, for example, Alan R. Bromberg and Lewis D. Lowenfels, 1 Bromberg and Lowenfels on Securities Fraud & Commodities Fraud § 2.18 (West 2d ed 2008) (discussing Rule 10b-5, which prohibits insider trading);
51. Joseph M. Perillo, 7 Corbin on Contracts § 28.20 (Matthew Bender rev ed 2002) (discussing the implications of nondisclosure on the enforceability of contracts).
52. I discuss below the conflicts of interest that would arise if the lawyers representing the defendant were to absorb risk from the client-and become the client's counterparty rather than simply its agent. See notes 75-77 and accompanying text.
53. For a discussion of the ethical problems lawyers would face, and might try to overcome, if they were to serve both as client representatives and market participants, see Molot, A Market in Litigation Claims at *39-40 (cited in note 17).
54. I discuss below the most promising possible structures See notes 58-65 and accompanying text.
55. The effect of information sharing on privilege and work product is addressed below. See notes 109-10 and accompanying text.
56. This solution is not ideal as it could yield additional litigation between the defendant and counterparty after the suit with the plaintiff is complete.
57. See Parts I. C and III.D.1.
58. In contrast, where there is no business deal pending-and the defendant does not need to satisfy a third party who is more concerned about the litigation than it is-there may be an insurmountable "bid-ask spread" between the defendant (who would want to dispose of the lawsuit at a low price) and a potential litigation insurer (who would only be willing to accept the liability at a comparatively high price).
59. Consider Michael Klausner, Geoffrey Miller, and Richard Painter, Second Opinions in Litigation,84 Va L Rev 1411, 1418 (1998) (discussing costs of obtaining "second opinions" on litigation).
60. See id at 1420 (noting that "[s]econd opinions will tend to be more attractive" when larger stakes are involved).
61. In fact, the few insurers who offer litigation buyout policies typically charge diligence fees up front to look at the risk. See, for example, American Insurance Group, Inc, Litigation Buyout Insurance: Questions and Answers 3, online at http://www.aig.com/aigweb/internet/en/files/Mkt-LBG- Questions%20and%20Answers-tcm20-73192.pdf (visited Jan 11, 2009).
62. See Part I.A.2.
63. See, for example, Hewlett-Packard Co v Bausch & Lomb Inc, 115 FRD 308, 312 (ND Cal 1987) (holding that attorney-cUent privilege was not waived when a party voluntarily disclosed its attorney's opinion letter to a nonparty with whom it was in the process of negotiating a transaction).
64. Although some courts have distinguished between "common business interests" and "common legal interests" and afforded protection only to the latter, when one entity purchases another and assumes its habilities, this generally will create a common legal interest between the defendant and the potential purchaser assuming its liabilities.
65. See id at 308. The same should be true when a company's liabilities are divided among a purchaser and a litigation-specific risk bearer.
66. A private-equity firm purchasing a company need not only evaluate pending or threatened lawsuits but also must value the target company's other assets and liabilities.
67. See Kandel v Tocher, 256 NYS2d 898, 899 (App Div 1965) (protecting privilege for liability insurer);
68. Ogden v Allstate Insurance Co, 441 NYS2d 667, 668-69 (Sup Ct, Chenango County 1982) (distinguishing between "liability insurance" or "litigation insurance," where common interest privilege would apply, and "coverage other than liability insurance").
69. See Ogden, 447 NYS2d at 668-70 (discussing treatment of litigation-risk transfers under insurance law).
70. Figure 1 is based on a Monte Carlo simulation with five thousand runs of forty lawsuits accumulated over five years (The model assumes some ramp up, with four suite taken in the first year, six in the second year, eight in the third year, ten in the fourth year, and twelve in the fifth year.) The model uses a lognormal distribution of damages awards for each lawsuit - with a remote chance of a very large award and a much higher probability of a smaller award - as that reflects experience in many cases where plaintiffs use the remote possibility of a large damages award to induce defendants to settle. The actual shape of distributions for each suit depends upon three core variables: chances of liability, size of mean damages award, and range of awards surrounding that mean. To simplify the model, I allowed three potential values for each variable. Thus, each suit in the pool had a likelihood of liability of 25 percent, 50 percent, or 75 percent, even though in reality the chances of liability for a suit might range from 0 (in a frivolous suit) to 100 percent. The mean damages award for each suit was $20 million, $50 million, or $100 million, though in real life the mean might be anywhere. Finally, to represent the range of possible damages awards surrounding the mean - and to see whether the case is more predictable and has only a narrow range of possible outcomes, or less predictable and has a broader range of possible outcomes - there was a volatility (or standard deviation) assigned to each case ranging from multiples of 0.5, 1.0, or 1.5 times the mean. Because a litigation insurer would not know in advance how many cases will be small, medium, or large, and whether those cases will be more or less risky in terms of the range of damages awards and the chances of liability, I allowed the computer to select the value for each of these three variables at random. Further variables assigned by the computer included likelihood of going to trial (10 percent, 30 percent, 50 percent), duration of litigation (one, two, or three years for settled cases versus two, three, or four years for tried cases), and premium levels (which were set at a 20 percent premium over the actuarially fair level).
71. The model assumed a capitalization in line with that of many insurance companies (1.4 premium-to-surplus ratio), and permitted an insurer either to be fuUy capitalized in advance ("paid-in capital") or to allocate capital to this line of business as cases come in ("callable capital"). See, for example, Hanover Insurance Group, Inc, Q1 2008 Earnings Results slide 18, online at http://www.hanover.com/thg/investors/pdf/2008Q1.pdf (visited Jan 11, 2009).
72. The model permitted capital and premiums to be invested "passively" at a 5 percent fixed risk-free rate or "actively" at a floating rate that a more aggressive capital provider, like an investment fund, might employ. One can see from the shapes of the curves - the narrow band of outcomes for passive strategy and wider spread of outcomes for the active investment strategy - that investment risk may very weU exceed litigation risk. (To approximate investment fund returns, the model used data from the actual investment performance of one investment fund manager whose performance has produced a mean rate of return in the 10 to 15 percent range and a volatility of about 5 to 6 percent.)
73. The model simply assumed a premium that was 20 percent in excess of what would be actuarially fair for the risk involved.
74. The risk reflected in the Figure 1 flows from the fact that an underwriter will know there is a range of possible outcomes for each case. This Figure 2 reflects the further risk that an underwriter may make mistakes when it evaluates a suit and fixes a premium. The various dots on the Figure indicate the average return and standard deviation from that mean that a risk bearer would expect if, instead of pricing things accurately (the "Base Case"), it charged too low a premium (50 Percent Premium), was unable to settle (No Settlements), was forced to pay more than expected in settlements or judgments (Outcomes 1.5x), or was to lose when it proceeded to trial (D Loses All Trials). The remaining dots reflect the risk of a case pool half as large as expected (50 Percent Case Pool) and of poor investment returns (Investment 50 Percent Lower).
75. An insurer likely would not want to take a case, however, where the threatened judgment might be large enough to drive the original defendant into insolvency. In such a case, the very provision of insurance - and substitution of a deep-pocketed target - would increase the likely settlement value.
76. Consider Kathryn E. Spier and Alan O. Sykes, Capital Structure, Priority Rules, and the Settlement of Civil Claims, 18 Intl Rev L & Econ 187, 187 (1998) ("[T]he presence of debt may directly dilute the value of the tort claim, may narrow the bargaining range in negotiations, and may lead to a failure to settle.").
77. Insurance companies can insure litigation risk by relying on lawyers, rather than actuaries, as their underwriters, and they have done so in some instances. See, for example, Russ Banham, Parrying the Litigation Threat, CFO Mag (November 2000) (discussing the expansion of the pending-litigation insurance market).
78. See also notes 28-30 and accompanying text. Anecdotal evidence reveals, however, that insurance capacity is available only in narrow categories of cases and only in relatively small amounts, in part because of the pricing problems identified above and in part because insurers' reinsurance arrangements do not cover these risks.
79. See, for example, Todd V. McMillan, Securitization and the Catastrophe Bond: A Transactional Integration of Industries through a Capacity-enhancing Product of Risk Management, 8 Conn Ins L J 131, 141 (2001) ("[A]n investor's return on investment depends on the occurrence or nonoccurrence of the event specified within the risk period covered by the catastrophe bond.... [S]hould a catastrophe occur within the risk period, the bondholders will indemnify the insurance company.");
80. Robert J. Rhee, Terrorism Risk in a Post-9/11 Economy: The Convergence of Capital Markets, Insurance, and Government Action, 37 Ariz St L J 435, 496-509 (2005) (discussing securitization of terrorism risk).
81. See also Robert J. Rhee, Catastrophic Risk and Governance after Hurricane KatruuvA Postscript to Terrorism Risk in a Post-9/11 Economy, 38 Ariz St L J 581, 581-82 (2006).
82. See National Flood Insurance Act of 1968, Pub L No 90-448, 82 Stat 572, codified at 42 USC § 4001 et seq. It may be that the absence of private insurance for flood damage is the result of people deciding in some instances to (re)build in places where the risks are too large and it is not economically rational to do so (or at least where an actuarially fair insurance premium would be prohibitively expensive).
83. See, for example, James P. George, Access to Justice, Costs, and Legal Aid, 54 Am J Comp L 293, 306 (2006) (noting that the insurance industry paid for the Towers Perrin Report, an oftcited study focusing on the costs incurred by insurance companies in annual tort claims, as part of the "tort reform battle").
84. Id ("Tort costs as a percentage of GDP has ... increased by .041 of a percentage point over 20 years, and the [Towers Perrin] Report predicts the increase will continue absent continued tort reform legislation.").
85. See, for example, Och-Ziff Capital Management Group LLC, Form Sl 94 (July 2, 2007), online at http://www.secinfo.com/d14D5a.u4G9w.htm (visited Jan 11, 2009).
86. See Josh Friedlander, Hedgies Expand Reach in Reinsurance, Investment Dealers' Dig 8, 9 (May 30, 2005) ("[CAT] bonds have proved to be a bridge connecting the massive world of insurance risk to the capital markets.").
87. See Robert G Sterne and Robert F. Redmond, Surviving the Rocket Docket, The Daily Deal (Mar 13, 2006) ("RIM stock was depressed by the legal uncertainty as shown by the surge in Blackberry shares after the [federal court hearing] and in after-market trading.").
88. See also Shares Hit by Suit over E-mail Patents, Chi Trib C2 (Nov 7, 2006) (noting that the stock for Palm Inc, the maker of the Treo smart phone, decreased by 7.6 percent following the news of a patent infringement lawsuit).
89. But see note 69 (discussing changes brought on by a worldwide credit crisis).
90. An insurance company might be willing to "front" for a hedge fund if it could become comfortable with the fund's credit risk. Moreover, if the hedge fund were to set up its own regulated reinsurer - something many hedge funds have done-this might enable the fronting insurer to receive full reinsurance credit from regulators for risk passed on to the hedge fund.
91. The investment bank could either guarantee payment or else itself do the deal with the defendant and then, in turn, pass along the risk to the investment fund.
92. The credit crisis that began while this Article was in the editing stages has changed the landscape of the financial world, forcing Lehman Brothers into bankruptcy, bringing American International Group to the brink of bankruptcy, and casting doubt upon the creditworthiness of a wide array of institutions previously thought to be safe credit risks. With Bear Stearns's acquisition by J.P. Morgan and the decisions of Morgan Stanley and Goldman Sachs to become bank holding companies, the days of the stand-alone investment bank may now be over. AU of the investment banks that serve as prime brokers for hedge funds may now be affiliated with traditional banks.
93. See text accompanying note 63.
94. Gwyneth Rees, Bulging Pockets-The Increasing Use of Side Pockets in Alternative Investment Vehicles 1 (Walkers May 2007), online at http://www.walkersglobal.com/pubdocs/ Hedge%20funds%20and%20Bulging%20Side%20Pockets-G.Rees.pdf (visited Jan 11, 2009).
95. Id.
96. For a discussion of the value of diversification, see note 52 and accompanying text. See also Figure 1.
97. For one example of a similar fee structure imposed on law firms by an insurance company, see Carrie Menkel-Meadow, Culture Clash in the Quality of Life in the Law: Changes in the Economics, Diversification and Organization of Lawyering, 44 Case W Res L Rev 621, 655 n 163 (1994).
98. Consider Carrie Menkel-Meadow, Ethics and the Settlement of Mass Torts: When the Rules Meet the Road, 80 Cornell L Rev 1159, 1182 (1995) ("Like their brothers and sisters who have conflicts over contingent fees, hourly fee lawyers also have conflicts with clients over lavish hourly billing that can almost equal the huge verdicts plaintiffs' lawyers trade on.").
99. See Part I.A.
100. For a discussion of how such conflicts should be handled under the ABA Model Rules of Professional Conduct, see notes 140-42 and accompanying text.
101. See note 16 (explaining why corporations insure even if their shareholders hold diverse portfolios of investments).
102. See, for example, Duane Reade, Inc v St Paul Fire and Marine Insurance Co, 279 F Supp 2d 235, 238-39 (SDNY 2003) (discussing the calculation of business interruption losses).
103. See, for example, Weedo v Stone-E-Brick, Inc, 405 A2d 788, 791 (NJ 1979) (noting that the "business risk" exclusion in commercial liability insurance policies excludes coverage for insured's faulty contract performance but covers incidental property damage caused by that faulty performance).
104. See also Modern Equipment Co v Continental Western Insurance Co, Inc, 355 F3d 1125, 1131 (8th Cir 2004);
105. McGowan v State Farm Fire and Casualty Co, 100 P3d 521. 525-26 (Colo App 2004).
106. See Samuel R. Gross and Kent D. Syverud, Getting to No: A Study of Settlement Negotiations and the Selection of Cases for Trial, 90 Mich L Rev 319, 371-72 (1991) (noting that as compared to personal injury litigation, insurance is far from universal in commercial transaction litigation).
107. But consider Eric L. Talley, Public Ownership, Firm Governance, and Litigation Risk, 76 U Chi L Rev 335, 338 (2009) (finding that, at least for securities litigation, "the predictive relationship ... between governance choices and prospective litigation risk is relatively (and somewhat surprisingly) modest").
108. See id.
109. See Schlagenhauf v Holder, 379 US 104, 114 (1964) ("The chain of events leading to an ultimate determination on the merits begins with the injury of the plaintiff").
110. See Louis Kaplow, The Value of Accuracy in Adjudication: An Economic Analysis, 23 J Legal Stud 307, 308 n 1 (1994) ("Some changes in the legal system might make it simultaneously more accurate and cheaper, but it is usually obvious that such changes are desirable (from the economic perspective employed here) and thus analytically uninteresting to consider them.").
111. See Jonathan T. Molot, Principled Minimalism: Restriking the Balance between Judicial Minimalism and Neutral Principles, 90 Va L Rev 1753, 1799 (2007).
112. See Jonathan T. Molot, An Old Judicial Role for a New Litigation Era, 113 Yale L J 27, 40 (2003). Moreover, with the evolution of the class action device, judges have had to take on the additional responsibility of checking its excesses and guarding against both partisanship and agency problems.
113. See, for example, William B. Rubenstein, The Fairness Hearing: Adversarial and Regulatory Approaches, 53 UCLA L Rev 1435, 1444 (2006);
114. Bruce Hay and David Rosenberg, "Sweetheart" and "Blackmail" Settlements in Class Actions: Reality and Remedy, 75 Notre Dame L Rev 1377, 1400 (2000).
115. See, for example, Miller, 80 Tex L Rev at 2115 (cited in note 8) ("A lawsuit is essentially a sale. The defendant buys a valuable asset from the plaintiff, in the form of a release of claims if the case is settled, or a verdict with res judicata effect if the case goes to a verdict"); Rubenstein, 89 Georgetown L J at 372 (cited in note 3) ("In complex class actions, defendants purchase a commodity - finality. They buy from the plaintiffs' representative the plaintiffs' rights to sue.");
116. Robert H. Mnookin and Robert B. Wilson, Rational Bargaining and Market Efficiency: Understanding Pennzoil v. Texaco, 75 Va L Rev 295, 295 (1989) ("It is through negotiation, not adjudication, that legal conflict is typically resolved.").
117. But see Owen M. Fiss, Against Settlement, 93 Yale L J 1073, 1085 (1984) ("To be against settlement is only to suggest that when the parties settle, society gets less than what appears, and for a price it does not know it is paying.").
118. Consider Carrie Menkel-Meadow, Whose Dispute Is It Anyway?: A Philosophical and Democratic Defense of Settlement (in Some Cases), 83 Georgetown L J 2663, 2668 (1995) ("[H]ow can we tell good settlements from bad ones, and when should we prefer adjudication to settlement?").
119. See Part I.C.
120. For a general discussion, see Michael Abramowicz, On the Alienability of Legal Claims, 114 Yale L J 697 (2005).
121. I question the wisdom of these restrictions See Molot, A Market in Litigation Claims at *25 (cited in note 17).
122. Although one might fear that defense-side risk transfers might undermine deterrence, risk transfers that are priced accurately should have the same deterrent effects as settlements with plaintiffs Indeed, the prohibition in many jurisdictions against insuring punitive damages - based on a fear of freeing the insured ex ante to commit repugnant acts - might not apply to litigation-risk transfers effected after a litigation-triggering event already has occurred. See, for example, Northwestern National Casualty Co v McNulty, 307 F2d 432, 440 (5th Cir 1962) (noting that if the insured "were permitted to shift the burden to an insurance company, punitive damages would serve no useful purpose").
123. Scholars have observed how litigation dynamics and bargaining power may
124. This would not be true, however, if the original defendant could use the prospect of insolvency to negotiate a lower settlement. See note 57.
125. See, for example, David Rosenberg, Class Actions for Mass Torts: Doing Individual Justice by Collective Means, 62 Ind L J 561, 564 (1986) ("Because defendant firms are in a position to spread the litigation costs over the entire class of mass accident claims, while plaintiffs, being deprived of the economies of scale afforded by class actions, can not, the result will usually be that the firms will escape the full loss they have caused.");
126. Marc Galanter, Why the "Haves" Come Out Ahead: Speculations on the Limits of Legal Change, 9 L & Socy Rev 95, 124-25 (1974) (explaining that the "haves" enjoy certain advantages in the areas of legal services, institutional facilities, rules, and the parties involved).
127. See also generally David Rosenberg, Mass Tort Class Actions: What Defendants Have and Plaintiffs Don't, 37 Harv J on Legis 393 (2000) (exploring the "social costs of biasing the allocation of litigation power");
128. Herbert M. Kritzer and Susan S. Silbey, eds, In Litigation Do the "Haves" Still Come Out Ahead? (Stanford 2003).
129. For an exploration of what scholars mean by procedural "equality" or "inequality," see William B. Rubenstein, The Concept of Equality in Civil Procedure, 23 Cardozo L Rev 1865, 1867-68 (2002) (explaining the three types of equality: equipage equality, rule equality, and outcome equality).
130. See notes 73-77 and accompanying text.
131. See, for example, Molot, 84 Va L Rev at 973-74 (cited in note 2) ("To the extent that attorneys manipulate legal processes rather than apply the law, the social utility of the legal profession declines.");
132. Deborah L. Rhode, Institutionalizing Ethics, 44 Case W Res L Rev 665. 670 (1994) (noting a "wide range of partisan practices that obstruct the search for truth").
133. See, for example, Gross and Syverud, 90 Mich L Rev at 349-50 (cited in note 81).
134. I address plaintiff-side risk transfers in a companion article. See Molot, A Market in Litigation Claims at *9 (cited in note 17). Many states already have done away with restrictions on the sale of claims.
135. See Abramowicz, 114 Yale L J at 700 (cited in note 91 );
136. Peter Charles Choharis, A Comprehensive Market Strategy for Tort Reform, 12 Yale J Reg 435, 464 (1995);
137. Painter, 71 ChiKent L Rev at 641-42 (cited in note 26);
138. Marc J. Shukaitis, A Market in Personal Injury Tort Claims, 16 J Legal Stud 329, 330 (1987).
139. Although I reserve for another article the implications of plaintiff-side risk transfers, see Molot, A Market in Litigation Claims at *9 (cited in note 17), it is worth noting briefly why risk transfere on the plaintiffs' side generally could be expected to enhance plaintiffs' bargaining power. The range of jury awards for many types of lawsuits is thought by many to have a lognormal distribution - with a high incidence of small recoveries and a few large outliers that skew the mean toward a higher amount than the median. See note 52. A one-time plaintiff deciding how much to accept in settlement of such a suit will likely look at the median - asking his lawyer what most plaintiffs in his position would likely recover at trial. The one-time plaintiff will not likely forego an amount that exceeds what most plaintiffs are likely to collect at trial in the hope of winning the lottery and being one of the lucky few plaintiffs who wins a huge, windfall verdict. A repeat-player defendant like an insurance company, in contrast, would look at the mean, knowing that if it goes to trial every time, it will eventually lose one of the very large judgments. To the extent that the insurer can offer the plaintiff an offer just above the median, it should be able to strike a settlement for an amount that represents a significant savings off the mean. If we substitute a repeat-player plaintiff for a one-time plaintiff, however, this would enable those on the plaintiffs' side to bargain based on the higher mean, rather than the lower median, and hold out for higher settlements. See notes 93-94.
140. For a discussion of how the participation of repeat-player institutional litigants changes the nature of litigation, see Tom Baker, Blood Money, New Money, and the Moral Economy of Tort Law in Action, 35 L & Socy Rev 275, 277 (2001) (noting that repeat players are motivated to reach a settlement within the liability insurance limits when the defendant would be paying with his own money).
141. See Robert H. Mnookin, Negotiation, Settlement and the Contingent Fee, 47 DePaul L Rev 363, 365 (1998) (indicating that under an hourly fee arrangement, "[i]f discovery is protracted and settlement comes late in the process, defense counsel will be compensated for additional time invested in the case");
142. Bruce L. Hay, Optimal Contingent Fees in a World of Settlement, 26 J Legal Stud 259, 260 (1997) ("[I]f the client controls the settlement decision, she is generally better off using a contingent fee instead of an hourly fee.");
143. Jonathan T. Molot, How U.S. Procedure Skews Ton Law Incentives, 73 Ind L J 59, 89-91 (1997) ("[I]f each hour of plaintiffs' and defendants' attorneys' time were of equal value (and both sides were equally optimistic about the benefits of proceeding), plaintiffs' attorneys would be more eager to settle than defendants.");
144. Geoffrey P. Miller, Some Agency Problems in Settlement, 16 J Legal Stud 189, 189 (1987) (noting that in a contingent fee arrangement, the lawyer is both the agent of the defendant and the principal with respect to his own interest in the claim).
145. See Molot, A Market in Litigation Claims at *29-30 (cited in note 17).
146. See, for example, Susan Saab Fortney, Soul for Sale: An Empirical Study of Associate Satisfaction, Law Firm Culture, and the Effects of Billable Hour Requirements, 69 UMKC L Rev 239, 247-48 (2000) (noting the increasing billable hour requirements since the 1960s);
147. Ronald J. Gilson and Robert H. Mnookin, Sharing among the Human Capitalists: An Economic Inquiry into the Corporate Law Firm and How Partners Split Profits, 37 Stan L Rev 313, 348 (1985) (discussing competitive pressures faced by firms).
148. Indeed, where a third-party litigation insurer prices litigation risk for deal participants, the deal participants may choose to use that price as a basis for their negotiations and retain the risk themselves, thereby avoiding having to pay the insurer a premium.
149. As noted earlier, the risk being transferred pursuant to a conventional contingent fee arrangement is somewhat different from that being transferred when defendants buy litigation insurance (or when plaintiffs sell claims). See notes 21-24 and accompanying text. Whereas I envision defendants buying protection against higher-than-expected judgments, contingent fee plaintiffs generally are buying protection against higher-than-expected litigation expenses That said, plaintiffs seek this protection in many instances because they fear that their recovery may be too small to cover litigation costs. In these instances the risk driving the risk-transfer decision for the plaintiff is thus the same one that motivates a defendant: namely, the risk that a judgment or settlement will come in higher or lower than expected. (In other instances, however, plaintiffs may be forced into a contingent fee even if they are confident of a large recovery because they simply do not have the cash to cover legal fees or the ability to borrow it.)
150. See notes 47-51 and accompanying text.
151. FRCP 26(a). But see note 110.
152. See Upjohn v Untied States, 449 US 383, 396 (1981) (holding that communications between attorneys and clients regarding responses to questionnaires and interview questions are privileged and not subject to discovery);
153. Hickman v Taylor, 329 US 495, 512 (1947) (holding that, under Rule 26, lawyers are not required to produce private memoranda and personal recollections as part of discovery).
154. Even without invoking work product protection, one can interpret the text of the federal rule governing insurance agreements to distinguish after-the-event litigation-risk transfers from conventional insurance policies and to exclude the former from discovery. Rule 26 provides for disclosure of: "(1) any insurance agreement under which (2) any person carrying on an insurance business (3) may be liable to satisfy part or all of a judgment which may be entered in the action or to indemnify or reimburse for payments made to satisfy the judgment" FRCP 26(a)(1)(C) (emphasis added). First, as the discussion of insurance regulation below explores, it is far from clear that a litigation-risk transfer agreement would count as an "insurance agreement," even if it were offered by a conventional insurance company. See notes 127-35 and accompanying text. Second, where the entity absorbing litigation risk is an investment fund, rather than an insurance company (as I envisioned in Part I), it arguably would not be a "person carrying on an insurance business." Third, to the extent that risk transfers are done to facilitate deals, then the risk transfer might be structured so that the risk bearer would not be "liable to satisfy part or all of a judgment," nor would it have "to indemnify or reimburse" the defendant "for payments made to satisfy the judgment." The hedge contract would protect, not the defendant company itself, but rather an investor in that company seeking to safeguard its investment against a decline in value attributable to a bad outcome in the lawsuit.
155. See FRE 408.
156. See notes 93-95 and accompanying text.
157. See, for example, In re Novak, 932 F2d 1397, 1405, 1407 (11th Cir 1991);
158. Heileman Brewing Co v Joseph Oat Corp, 871 F2d 648, 656 (7th Cir 1989).
159. Such arrangements are not as common on the defense side, for reasons I explore in Part I, see notes 22-23 and accompanying text, but they are by no means extraordinary. I have spoken to a number of lawyers at traditional hourly fee commercial litigation firms that offer what they call "alternative billing arrangements" along these lines.
160. I explore the consequences of plaintiff-side risk transfers to third-party capital providers in the next article in my broader project. See Molot, A Market in Litigation Claims at *9 (cited in note 17). Where plaintiffs shift risk through an outright sale of a portion of a claim, rather than through a conventional contingent fee arrangement, neither the introduction of a third-party capital provider nor the sale of more than one-third of the recovery should change the treatment under the discovery rules. My reason for facilitating plaintiff-side risk transfers is that without such a market in legal claims, disparities in resources and risk aversion can sometimes lead to lower plaintiff recoveries than the merits of lawsuits may warrant. By shifting risk to an entity with a diverse pool of litigation risk and ample resources, we can address these disparities and improve plaintiff recoveries where appropriate. Contingent fee arrangements certainly help on this count, but I argue that they do not do enough.
161. See id at *24-25.
162. See Part II.A.
163. FASB, Statement of Financial Accounting Standards No 5, online at http://www.fasb.org/pdf/fas5.pdf (visited Jan 11, 2009).
164. See Robert Cooter, et al, Bargaining in the Shadow of the Law: A Testable Model of Strategic Behavior, 11 J Legal Stud 225, 225 (1982).
165. A company that does not want to have to take a reserve for pending litigation might refuse even to consider a litigation-risk transfer for fear that once the lawsuit is priced by an impartial third party, the loss will then become reasonably estimable and it will have to take a reserve. See id. This poses yet another obstacle to the creation of a market in litigation risk.
166. A risk transfer might also help where a defendant has some conventional liability insurance coverage but its insurer has disputed its obligation to cover the loss A defendant that cannot take full accounting credit for the insurance - because the coverage is in dispute - can buy litigation insurance to cover the coverage dispute and then reduce its accrued liabilities accordingly.
167. See note 69 for a discussion of how the current credit crisis has affected AIG and the feasibility of a market for litigation-risk transfers.
168. See SEC SEC Charges American International Group and Others in Brightpoint Securities Fraud; AIG Agrees to Pay $10 Million Civil Penalty (Sept 11, 2003), online at http://www.sec.gov/news/press/2003-111. htm (visited Jan 11, 2009) (noting that AIG was fined $10 million for helping Brightpoint conceal $11.9 million in losses). The Brightpoint investigation may have contributed to the reluctance among conventional insurers to participate in the after-the-event litigation insurance market. See note 27 and accompanying text.
169. See notes 63-65 and accompanying text.
170. See notes 109-10 and accompanying text.
171. See 15 USC § 1011. The principal exception to this exemption from federal regulation is for a narrow category of antitrust violations, including boycotts. See 15 USC § 1012(b).
172. See, for example, Feinstein v Attorney General of New York, 326 NE2d 288, 293 (NY 1975).
173. NY Ins Law § 1101(b)(1)(A) (McKinney).
174. NY Ins Law § 1101(a)(1).
175. NY Ins Law § 1101(a)(2).
176. See notes 119-29 and accompanying text.
177. See Grundfest and Huang, 58 Stan L Rev at 1277 (cited in note 4) (noting that, under the real options model, "it makes sense for a plaintiff to pursue a risk claim with a negative expected value if... the possibility of uncovering some sort of smoking gun that will lead to a [high recovery] is large enough").
178. 326 NE2d 288 (NY 1975).
179. Id at 290-91.
180. Id at 293.
181. Id.
182. Regulators also consider the company's reinsurance policies to see how much of the risk it has passed on to reinsurers.
183. Indeed, insurance companies tend to use standard forms for most policies so that each company can look to statistics on claims for the entire industry when pricing policies and setting reserves, and insurance regulators can look to the same industry-wide sources in evaluating the health of each insurer.
184. But see note 69 and accompanying text.
185. See Part I.C.
186. Model Rules of Professional Conduct (MRPC), Rule 2.3(a) (ABA 2008).
187. Id at Rule 2.3(b).
188. Id at Rule 1.7(b)(4).
189. See David Luban, The Noblesse Oblige Tradition in the Practice of Law, 41 Vand L Rev 717, 721 n 18 (1988) ("Brandeis coined the term 'lawyer for the situation' at his confirmation hearings for the Supreme Court. When accused of unethical law practice for simultaneously representing several parties to the same transaction, Brandeis replied that he viewed himself as counsel for the situation rather than for any single party."), citing Jerome Frank, The Legal Ethics of Louis D. Brandeis, 17 Stan L Rev 683 (1965). See also Geoffrey C. Hazard, Jr, Ethics in the Practice of Law 58-68 (Yale 1978); John S. Dzienkowski, Lawyers As Intermediaries: The Representation of Multiple Clients in the Modem Legal Profession, 1992 U Ill L Rev 741, 744 n 11 (noting that Professor Hazard, as Reporter to the ABA Commission responsible for the Model Code of Professional Responsible, worked to include a provision addressing the lawyer as an intermediary, as argued by Justice Brandeis).
190. See Dzienkowski, 1992 U 111 L Rev at 744 n 11 (cited in note 143).
191. MRPC, Rule 1.2(d), comment 9 (cited in note 140).