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Toward Procedural Optionality: Private Ordering of Public Adjudication

Posted By Robert J. Rhee On October 14, 2009 @ 1:01 am In Contract Law, Law & Economics, N.Y.U. Law Review | No Comments

Private resolution and public adjudication of disputes are seen as discrete, antipodal processes.  The essence of private resolution is that the parties can arrange disputed rights and entitlements without judicial intervention.  In public adjudication, the sovereign mandates the substantive and procedural laws.  This understanding is axiomatic in courthouses and academic halls, but it is curious nonetheless.  Why shouldn’t important procedural rules be subject to a degree of private ordering even in public adjudication?

To reject the axiom of fixed procedural laws, we must make only a small, but crucial conceptual leap.  If we can envision a hybrid process—a public adjudication capable of some degree of private ordering—then perhaps a party should be allowed to opt in or out of certain important procedural laws.  The idea of optional laws seems counterintuitive, if not oxymoronic.  But it is informed by Ronald Coase’s work.  The Coase Theorem proposes that absent transaction cost, parties can efficiently rearrange rights irrespective of their initial assignment.  Like substantive entitlements, procedural laws set forth an initial assignment of rights and obligations that have significant consequences on the value of the suit and the cost to the litigation system.  My thesis is simple:  The immutability of certain procedural rules in public adjudication imposes significant cost and risk on parties, and private rearrangement of procedural rights and duties can yield more efficient dispute resolution.


I.
Proposal

Procedural optionality can mitigate persistent inefficiencies in the litigation system.  Two well-known subsets of the larger problem are studied here, both stemming from the American rule of attorney fees (i.e., absent statute or contract, each party is responsible for his own attorney fees) (hereinafter American Rule).  In the first subset, low value cases, characterized by high probability of liability with low damage amount, are not prosecuted because litigation cost can impose an insurmountable cost barrier.  This problem has an inverse.  In the second subset, plaintiffs pursue low probability frivolous cases to extract an extortionate settlement.  These inverse problems share the same fundamental dynamic:  In each case, the merits may not sufficiently influence the ultimate disposition because the standard of proof and the rule of attorney fees are fixed as legal constants.  Compare this situation to the potential prospects of optional laws.  If the defendant in a frivolous action were able unilaterally to opt for a scheme in which the loser indemnifies the winner’s cost, he could avoid settling with the frivolous plaintiff.  Likewise, if an aggrieved plaintiff in a clearly meritorious but low value action could unilaterally opt for fee shifting, she could economically pursue her claim in court.

The goal is to implement an incentive structure that optimizes enforcement and cost.  To show the efficacy of procedural optionality, I propose a scheme in which each party has the unilateral power to shift fees to the other side (hereinafter English Rule) as long as she bonds her good faith belief by voluntarily assuming a higher standard of proof.  The baseline assumption is that the action is governed by the American Rule and that the civil standard of proof is the preponderance of the evidence standard (hereinafter Default Standard).  The Default Standard can be elevated to a higher standard:  the clear and convincing evidence standard (hereinafter Heightened Standard).  The rules of election are simple.  In a two-party suit, there are two standards of proof and two rules of attorney fees, leaving four possible combination scenarios.

Scenario 1 – No Party Elects: The status quo remains, i.e., the Default Standard and the American Rule apply.

Scenario 2 – Both Parties Elect:  Both the Default and Heightened Standards apply.  Where either party proves his case under the Default Standard, the American Rule applies.  The election of the Heightened Standard becomes a nullity because both parties failed to meet it.  Fee shifting occurs only when one party prevails under the Heightened Standard, in which case fees are shifted to the loser in a manner consistent with the English Rule.

Scenario 3 – Plaintiff Elects:  The plaintiff unilaterally imposes a one-way fee shifting rule on the defendant but can only win by proving her case under the Heightened Standard, upon which fees are shifted to the defendant.  This means that if the plaintiff proves her case only under the Default Standard, the defendant still prevails, though he is not entitled to fee shifting.

Scenario 4 – Defendant Elects: The defendant unilaterally imposes a one-way fee shifting rule on the plaintiff, but can only win by proving his case under the Heightened Standard, upon which his fees are shifted to the plaintiff.  This means that if the defendant fails to meet the voluntarily assumed Heightened Standard, the plaintiff will win even if she fails to prove her case under the Default Standard, though she will not be entitled to fee shifting.

These simple rules of election and bonding allow the parties to reorder the value, cost, and risk of a case.  The following table summarizes these election rules and their consequences.

nyu-a20090911-rhee


II.
The Bond

A scheme of optional laws would quickly unravel into an anarchist’s impasse absent bonding of the parties’ good faith.  The bond must be priced correctly.  There must be proportionality between incentive and deterrence such that the effects of self-interested and strategic behavior serve a normative social goal, or at least minimally conflict with it.  The bonding proposed here facilitates better conveyance of information.  The act of election signals that the electing party has significant information, is confident of the completeness of that information such that variance is not a large concern, and believes in good faith he is likely to succeed.  This information is valuable.  It is reliable because a party voluntarily imposes a substantial cost on himself to communicate it, namely the assumption of a higher standard of proof.

An election materially changes the prospects of a case, and as such the decision to elect is no small matter.  It requires a complex calculus involving several factors.  An election necessarily reduces the expected success of a case, and there is a net benefit only if the benefit of fee indemnity outweighs this risk-related cost.  An election also reconfigures the risk profile of a case.  Parties will elect only when they are highly confident in their assessments of the case, which corresponds to a high level of probability and information.  Moreover, attorneys have significant say in the management of a case, and they will generally not be inclined to opt for a reduction in the probability of success.  Where probability of success is not a significant issue or fee shifting would create a new business opportunity (i.e., open up a class of cases that are otherwise economically infeasible), an attorney’s incentive is more closely aligned with the client’s interest.  This set of unique conditions is met in two types of cases—low value but highly meritorious actions and patently frivolous actions.


III.
Result

Since most cases do not fit this profile, the most likely choice in the vast majority of cases is no election at all, resulting in the status quo of the American Rule and the Default Standard.  In a small but significant class of cases, one party will believe it has a strong chance of winning and will elect, resulting in potential one-way fee shifting.  Lastly, since belief that there is a high probability of success is a natural condition of election, the English Rule (with its corresponding Heightened Standard) will be seldom invoked through bilateral choice.

Any procedural innovation should be feasible and practical.  There are several aspects to administering this proposal.  First, simultaneous disclosure of election is required to ensure procedural symmetry.  Serial disclosure leads to information asymmetry, unfairness, gamesmanship, and possibly costly judicial intervention.  Second, an election must be irreversible.  A bond is worthless if it is redeemable by the obligor, whether at will or upon the occurrence of some contingency.  Third, the application of two standards of proof requires particular findings of facts as to different claims and defenses.  In a two-party, multi-claim litigation, each claim and defense must be individually subject to election (likewise in multi-party single-claim litigation).  As a result of this, complex multi-party litigation may be infeasible.  The complexity of multi-party, multi-claim litigation increases nonlinearly with additional claims and parties, and the administrative cost will quickly outweigh the benefits of private ordering.  Lastly, the timing of the election is crucial.  There are two competing policies at work:  Parties should make their election with the most complete information possible but should expend the least amount of transaction cost.  The balance of these competing policies suggests that an election should be made at some time during discovery and that discovery could, perhaps, be bifurcated to facilitate the process by allowing the parties to elect at the end of the first stage of information gathering.


IV.
Policy Implications

Procedural optionality raises several policy implications.  It solves two recurring problems of litigation:  prosecution of frivolous lawsuits and nonprosecution of low value cases.  These cases form the bookends of the spectrum of litigation.

Frivolous actions are most problematic in the early phases of litigation.  They are characterized by the occurrence of needless cost in the beginning followed by an extortionate settlement or dismissal later.  Parties, not courts, should determine the issue of frivolity.  The only justification for a judicial determination is that they are neutral arbiters, a rather uninspiring reason given the cost associated with achieving a degree of information parity between the parties.  Adjudication of frivolity is a blunt instrument that undermines the policy of cost mitigation.  In truth, the parties are in the best position to recognize a frivolous suit.  My proposal solves this problem by forcing the parties to reveal whether they believe the case is frivolous.  If the case is frivolous, the defendant will elect for fee shifting and the plaintiff will not.  The defendant’s election is a trustworthy signal because it comes at the cost of the voluntary assumption of a higher standard of proof, which will be the most efficient price of bonding if the action is indeed meritless.

Procedural optionality also facilitates better adjudication of the low value cases, essentially the inverse of the marginally frivolous suits.  The problem is that low value cases, while meritorious, are not economically feasible.  This means that the culpable defendant can systematically escape liability if the harm is sufficiently low.  If a plaintiff with the low value claim does not want to risk significant cost, she must find a means to spread the risk and cost.  The class action was designed for this type of situation.  But it is not a readily available option in many disputes, such as those in which plaintiffs are not similarly situated.  Procedural optionality provides an alternative to the traditional class action and the forced waiver of a legitimate action due to economic infeasibility.  It enables an entire class of valid suits by removing the economic barrier.  Moreover, procedural optionality as an alternative to class actions, at the margins of litigation, may help to reduce the agency cost problem of class attorney fee and settlement practices.


Conclusion

If the parties are allowed to privately order the procedural rules to better reflect the value, risk, and cost profile of a case, the system of public adjudication can help the parties reach a more efficient settlement.  A conceptual barrier between private resolution and public adjudication is needlessly formalistic.  The problem with the application of inalienable rules of law, such as the American and English Rules, is that each rule works well in some circumstances, but not in others.  Fixed rules of law can impart costs on the litigation system.  Once public adjudication is selected, many decisions affecting the allocation of value, cost, and risk should be subject to private ordering as long as strategic behavior is minimized through a bonding requirement.  It is a mistake to equate private ordering of disputes with settlement.  The former is a process, the latter an outcome.  Private ordering of a dispute is achieved when the parties are allowed to unilaterally rearrange the procedural rules governing public adjudication so as to reach an efficient result at the lowest private and social cost.

The theoretical potential of procedural optionality is seen when it is applied to the regime of attorney fee rules.  There is no reason why the criterion for the assignment of these rules should be limited to the class of the case or underlying substantive entitlement.  In the ideal world, an important consideration in the assignment of the fee rule would be case merit.  We have assumed thus far that rulemaking tailored to the unique circumstances of a case cannot be done in public adjudication.  The habit of thought has been to propose solutions requiring sovereign intervention through general rulemaking and uniform application.  This Editorial provides a different approach:  Instead of intervening directly, the sovereign can permit the parties to choose the procedural scheme in public adjudication.  When parties are allowed to reorder procedural rules after their initial assignment, dispute resolution can be more efficiently achieved, both at the settlement table and in the courtroom.dingbat

Acknowledgments:

Copyright © 2009 New York University Law Review.

Robert J. Rhee is Associate Professor of Law at University of Maryland School of Law.

This Legal Workshop Editorial is based on the following Article:   Robert J. Rhee, Toward Procedural Optionality: Private Ordering of Public Adjudication, 84 N.Y.U. L. REV. 514 (2009).


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