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Litigation Tariff

Thursday, June 1, 1995

Friends of federalism are right to celebrate the recent Supreme Court decision striking down the federal law banning guns on school grounds. While we certainly must work to keep guns out of our schools, this is a state and local concern, one which almost all states already have addressed through their own legislation.

In United States v. Lopez, the court ruled that Congress had relied on an indefensibly broad interpretation of the Constitution's interstate-commerce clause in claiming that possession of a firearm in a school zone could interfere with interstate trade. Chief Justice William Rehnquist wrote that the Gun-Free School Zones Act "is a criminal statute that by its terms has nothing to do with 'commerce' or any sort of economic enterprise, however broadly one might define those terms."

Though correct in claiming that Congress had—for nearly 60 years—used the commerce clause to justify the gradual encroachment of federal power over our lives, conservatives err when they pretend there are no serious threats to interstate commerce legitimately subject to congressional regulation. On the contrary, there is a growing and ravaging menace to interstate commerce that forces good products off the market, stifles innovation, hurts our ability to compete in the world marketplace, and is unjust both to consumers and manufacturers. It is embodied in the uncontrolled liability rulings and legal expenses that characterize the civil-justice system of most states in the nation. Despite conservative fears of legal reform at the national level, true federalists should embrace limited federal tort reform to rescue a court system that is helping to undermine the economic base of numerous businesses and industries.

First Principles

We must, however, limit intervention from Washington according to the principles of federalism and with an understanding that the potential risks of national intervention always are high.

When our Founding Fathers met in Philadelphia in 1787 they were faced with two major problems: The Continental Congress was having trouble raising money to conduct a national defense; and the states were engaging in the economically and socially destructive practice of taxing goods coming from all other states. The Framers solved the first problem by giving Congress the power to impose certain taxes. They solved the second by establishing national jurisdiction over interstate commerce, with the aim of promoting what Federalist 11 calls "a free circulation of the commodities of every part" of the union.

Today we face threats to interstate commerce analogous to those faced by the Founders. Interstate commerce is restrained and even stifled by state-based liability rulings and legal transaction costs as destructive as the taxes about which the Founders were so concerned. The clearest example is in product liability, in which rulings and their costs create not a series of competitive state markets, but rather a restrictive, illogical, and inefficient national market. Moreover, we effectively already have a single unitary tort system in the law of products liability. Unfortunately, our unitary system comprises not a coherent, consistent body of laws, but the most commercially restrictive features of the tort laws of individual states.

It is not difficult to see how this has come about: The law of the state in which the alleged harm occurs generally decides tort cases. Yet our market for products is national, so every company must be prepared to be sued in any state in which its product might be used. If a car built and sold in Michigan by a Michigan corporation is in an accident on a California freeway, California's tort law will determine whether the car maker is liable. If the California legislature decides that side air bags are a necessary safety feature, it could impose strict liability on the manufacturer of any car made anywhere in the United States without one.

No Experimenting Here

Michigan cannot prevent this with tort reform. As a result, insurance companies already set their product-liability rates nationally, because under the current system all companies must abide by the law of the state with the strictest rules.

Under these circumstances, how can states serve as "laboratories of democracy" in the area of product liability? No state will know or have any real incentive to find out whether its product-liability "experiment" has succeeded or failed. Why? Because liability costs—in the form of higher prices for goods and services—are spread nationwide. Meanwhile, the benefits of the state's product-liability system flow primarily to its residents, who constitute the vast majority of potential plaintiffs. A state that elects a less costly set of product-liability rules will see the benefits of that system shared by in- and out-of-staters alike, while its residents will continue to pay almost as much for products because of more costly out-of-state tort systems. Congress does not face the same obstacles in enacting product-liability legislation. It, and it alone, can develop a set of national rules designed to maximize the common good whose costs and benefits will be shared by all citizens.

But, while Congress is uniquely qualified to undertake this task, that does not mean that it will in fact perform it well. Legislative efforts might be hijacked by one or another faction, leading to either excessive or insufficient liability being imposed. Indeed, virtually all political scientists and theorists agree that the Framers systematically underestimated the risks of national factions, largely because modern communication has profoundly changed politics.

Nevertheless, product-liability reform presents fewer risks in this area than do most issues. The reason is that the status quo is bad enough that congressional intervention probably will make it better, and is quite unlikely to make it worse. We need federal action because the system is not just broken, it is falling apart.

Personal and Social Costs

One obvious problem with our system: It keeps even real victims, who have been injured and need financial help, from collecting their fair share of damage awards. Tillinghast Research reports that 57 cents of every dollar spent on civil suits in this country go to pay lawyers and other legal costs like the public expendses of the court system.

Consumers also suffer. The huge costs of our legal system create a "liability tax" of 2.5 percent on the average product, built into the selling price by manufacturers. The figure is much higher for other products, such as step-ladders (30 percent) and vaccines (95 percent) that tend to attract lawsuits.

In addition to making things more expensive, liability taxes make necessary goods scarce or even unavailable. Lawyer and engineer Peter Huber reports that between 1965 and 1985, the number of U.S. vaccine manufacturers shrank by more than half; by 1986, we relied on a single supplier for vaccines against polio, rubella, measles, mumps, and rabies. Our own Senate Commerce Committee reported that two of the three companies making the Diphtheria-tetanus-pertussis, or DPT, vaccine stopped production because of liability costs: They could not afford all the suits arising from the now clearly discredited theory that the vaccine might in very rare instances cause brain damage.

The results of such policies can be devastating, particularly to the sick and helpless. There are some 5,000 diseases that affect small numbers of Americans. Many of these diseases, including leprosy, are extremely serious. But a number of them have gone untreated, because pharmaceutical companies cannot afford the risk. A West German chemical company, for example, at one time supplied Americans with botulinum. A paralytic poison, the drug controls a rare but incapacitating disease that affects the control of eye muscles. The company cut off American supplies to avoid being held liable should people misuse its product.

Dozens of examples like this one prompted the federal government in 1983 to enact the Orphan Drug Act. This act provides special incentives and waivers to companies researching and manufacturing drugs for rare diseases. One of its purposes is to overcome the disincentives to produce needed products that have been built into our legal system, and it has done some good in this area. But orphan drugs are only the most visible signs of a deeper problem. Research and development are undercut when companies are afraid to enter the market for fear of massive, unfounded lawsuits. The result is a lack of innovation and improvement as well as a lack of competition among companies—that is, a loss of the best means by which to keep quality up and prices down.

The system also hurts our economic competitiveness. A 1994 Business Roundtable survey of 20 major U.S. corporations reveals that they receive 55 percent of their revenue from inside our country, but incur 88 percent of their total legal costs here. Clearly such discrepancies in legal costs put our companies at a disadvantage in the world market. So does our yearly litigation-related costs of $300 billion, or 4.5 percent of our gross domestic product.

Given the nature of the American economy, then, our product-liability system can best be reformed at the national level. We need uniform standards encouraging safe conduct and discouraging frivolous lawsuits aimed only at garnering unjust rewards. In particular, we must limit punitive damage claims and bar joint liability. At the same time, we need a provision holding each defendant accountable for that portion of the damage for which he or she actually was responsible.

State Reforms

Product-liability reform will not address all of our problems, however. The National Federation of Independent Business reports that product-liability reform will help only 35 percent of small businesses. The other 65 percent are not involved in these cases and so will not benefit—and even may suffer worse harm by being brought into lawsuits under joint and several liability rules.

Product manufacturers and sellers do not shoulder all of the burden of unjust tort claims and awards. According to Inside Litigation, there were 50 cases in the United States in 1994 in which jury verdicts exceeded $17.5 million. Of these, only seven were product-liability cases. The remaining 43 involved disputes concerning employment, securities, lenders, accountants, environmental claims, insurers, business torts, state and local governments, volunteer firefighters, medical claims, and personal injuries not involving products.

What, then, should we do about these other suits? How should we protect volunteers, lenders, and others from our flawed legal system?

We could devise a national standard for all civil litigation. In this way we could ensure uniformity in standards of conduct and thus much more uniform results. But national standards are neither necessary nor proper, in my view, outside the field of product liability. This is because other types of civil cases do not produce the same disproportionate consequences across states as do product-liability suits. Suits against hospitals are mostly by local patients, suits against volunteer firefighters are mostly by local litigants. Most of the rules for such litigation should properly be determined by the states.

Even so, there are some implications for interstate commerce—and therefore grounds for some federal involvement. Some of these lawsuits do involve cross-state litigants, and a dynamic similar to that in product-liability law has led to a systematic bias in favor of plaintiffs that is harmful to interstate commerce. States are unable to protect in-state defendants from unreasonable suits by out-of-state plaintiffs, because the plaintiff in an interstate suit can choose which state to litigate in, and therefore which state's laws apply. By contrast, states can easily establish rules that benefit in-state plaintiffs—and they frequently do so. Thus the same pattern the Founders feared—by which state taxes are used against out-of-state goods and interfere with economic productivity—is at work.

Ending Windfall Profits

Rather than taking over underlying liability laws, we should use federal power judiciously—and humbly—in order to make modest changes in the structure or legal machinery by which decisions and judgment awards are made. We should replace state law with federal rules, however, only when we are dealing with clear cases—bearing in mind the risks, as well as the benefits, of federal action.

Here is my prescription. First, national lawmakers should extend to all civil cases the replacement of joint liability with proportionate liability for non-economic damages. Under the current system, partially responsible parties must pay for more than their fair share of the damages because other defendants have become judgment-proof. For example, in Walt Disney World Co. v. Wood, a woman was injured when her fiancé struck the go-cart she was driving at Disney World. The jury found her 14 percent at fault, her fiancé 85 percent at fault and Disney only 1 percent at fault. But, under the doctrine of joint liability, Disney was required to pay 86 percent of the plaintiff's claimed damages.

Second, the existing structure of punitive damages is rife with abuse. The courts have rightly regarded punitive damages as the equivalent of a state-imposed fine. Huge punitive damage awards can put a company or individual into bankruptcy. Such awards are meant to be rare and aimed only at particularly egregious conduct. They also are supposed to be awarded only in addition to economic and non-economic damages.

Yet Yale Professor George Priest reports that punitive damage claims have become "almost routine." According to Professor Priest, lawyers increasingly use punitive damage claims to bully even innocent defendants into settling cases for higher amounts. Our high and unpredictable punitive damage claims thus encourage litigation because in too many cases they produce "windfall profits"—huge unearned rewards.

A federal cap on punitive damages at some reasonable level would take nothing essential away from the plaintiff. It would, however, protect defendants and society from unfair and financially disastrous awards. These awards hurt all of us by raising prices for goods and services, sometimes so high as to make them effectively unavailable. They hurt, even bankrupt, small businesses in particular, and so cost jobs.

Rediscovering Discovery Costs

Finally, we must do something about the enormous transaction costs incurred under the present system, which nobody can defend. Eighty percent of the cost of the average lawsuit is incurred during discovery. Sifting through documents, taking depositions and so on—all of these practices consume massive amounts of time and money. And discovery costs relate as much to issues of courtroom tactics as to actual questions of fault and damage. The process is so costly because attorneys seek to "discover" absolutely everything about their opponents that might possibly be useful in the battleground of the courtroom.

One way to attack this problem would be to change the incentives in the system to encourage parties to settle their disputes early. By encouraging settlement before discovery is complete, we will save everyone a great deal of time, money, and aggravation.

How can we do this without infringing on anyone's right to full compensation? No one wants to deny any Americans the right to their day in court if they feel they are not being fully compensated for their damages. But just as surely, none of us wants to continue with the wasteful, unfair status quo.

We should reward defendants for making full and fair offers early on, without declaring that the plaintiff must accept just any offer. We should increase and speed up recoveries for meritorious claimants. At the same time, we should reduce both the incentives of defendants to drag out these disputes through whatever means available and the costs of those recoveries to defendants.

The method would be simple: Provide protection to defendants who quickly promise to pay the plaintiff's full economic damages, plus, perhaps, an additional amount set by a state schedule based on the severity of the injury. This helps plaintiffs by restoring in full their economic losses without months or years of legal struggle. It helps defendants by protecting them against unlimited non-economic damages claims if they make a fair offer early on.

Faced with such a system, defendants will offer fair compensation more quickly, and plaintiffs will be less likely to turn down a fair offer. Both sides would benefit from early settlements by avoiding long, expensive, and perhaps unsuccessful litigation. Thus lawyers and litigants no longer would hold out for more money and higher fees unless they clearly are warranted. And defendants and their insurance companies would no longer drag out litigation in hopes of making plaintiffs give up their suits and go away.

All of these reforms will increase the fairness and efficiency of our legal system. Moreover, all are amply justified under federalist principles by the peculiar incentives in our present system—incentives that encourage states to develop laws benefiting in-state plaintiffs at the expense of the public interest.

A Federalist Escape Clause

We still should take care to protect and nurture federalism, however. In the case of my early-offer recommendation, for example, I would allow a state to opt out of the federal reform—in whole or in part—for disputes entirely between citizens of that state. This would encourage those states that feel strongly about the issue to retain their own legal machinery, but only if they can justify to their own people that the machinery is sound and only if its costs and benefits are allocated to their own citizens.

Some may not be convinced that other reforms (including barring of joint liability and punitive-damage caps) are justified by federalist principles. These people should consider going along with the reforms, but attaching a state opt-out provision. If a large number of states opts out of a particular reform under these circumstances, it would serve as a strong signal to Congress and the people that the national "reform" may in fact have been the product of national faction, rather than a necessary preemption of an illegitimate burden imposed by the states on interstate commerce.

An escape mechanism of this sort could also be useful in other areas beyond legal reform, where there are legitimate differences of opinion on whether federal intervention is needed or desirable. In particular, Congress should consider allowing this opt-out provision whenever it exercises its commerce power to remove burdens on interstate commerce caused by a systemic bias that state competition cannot correct (see Easterbrook, "Madison, the State, and Public Choice," University of Chicago Law. School Record [Spring 1995]). Professor Akhil Amar also suggested an inquiry along these lines in a conversation with a member of my staff. If widely used by the states to evade provisions of federal law, the provision also would help us identify areas in which Congress was wrong to intervene, because the burden imposed on interstate commerce was in fact a legitimate state interest.

This leads us back to Lopez. I have no doubt that civil-justice reforms crafted along the lines I have discussed would pass muster with the Supreme Court. The link between the legislation and interstate commerce would be quite clear. In addition, an opt-out feature of the sort I have described would eliminate cases in which there is no real connection between interstate commerce and the practice in question. Finally, an escape provision for close cases—where there is some reason to believe that competition among the states' legal regimes is not functioning properly, but the evidence is not overwhelming—would allow the system to send a useful signal to the Court. It would show that the underlying law was intended as a legitimate exercise of Congress's power to alleviate perverse burdens on interstate commerce, and not as a grab for power in the interests of some national faction.

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