Professors Theodore Eisenberg (Cornell) and Geoffrey P. Miller (NYU) conclude that neither the American Rule nor the English Rule dominates the contracting practices of sophisticated firms
This empirical study of attorney fee clauses in publicly-held companies’ contracts, guaranteed to enchant law and economics wonks, examines a data set of 2,350 contracts contained as exhibits in Form 8-K filings – contracts likely to be negotiated by sophisticated parties. The authors’ study “is premised on the idea that at the time of entering into a contract, sophisticated parties have incentives to adopt terms that maximize joint value.” Do sophisticated parties, with an opportunity to consider and weigh the advantages and disadvantages of particular contractual fee provisions prefer the American Rule (each party pays its own fees in litigation) or the English Rule (loser pays)?
The surprising conclusion is that “neither the American Rule nor the English rules dominates the contracting practices of sophisticated firms.” Patterns did emerge from the study – some of which were predicted, others of which were counter-intuitive. But there is “no single overarching pattern.”
For example, the authors hypothesized that sophisticated foreign parties would tend to opt out of the American Rule, because the English Rule is more common outside the United States. But the opposite turned out to be the case, and the authors do not have a clear explanation for that result.
The authors predicted that highly standardized contracts would tend to opt for the American Rule, because it is the norm in the United States, but their data did not confirm that hypothesis.
As predicted, contracts in which the parties have a long-term relationship tend to prefer the American Rule – explained by the desire of parties who trust one another to avoid an outcome that underscores that one of the parties was wrong from a legal point of view.
The authors also predicted that loser-pay rules would be more frequently observed where there is a jury waiver – and this was confirmed. Loser-pay rules tend to increase risk, and litigants may perceive that a jury waiver decreases risk.
The authors also found that particular types of contracts favored one rule over the other – perhaps simply the result of the drafting histories of specific types of contracts.
As interesting as the authors’ own empirical study is their review of the theoretical and empirical literature. One conclusion: “Overall, the theoretical literature is indeterminate as to the practical effects and social utility of attorney fees regimes.” The authors summarize the reasons for this conclusion by quoting the work of another scholar (Avery Katz [1990]):
“The reason for this agnostic conclusion is straightforward. Legal costs influence all aspects of the litigation process, from the decision to file suit to the choice between settlement and trial to the question whether to take precautions against a dispute in the first place . . . . The combination of all these external effects is too complicated to be remedied by a simple rule of ‘loser pays.’ Instead, indemnity of legal fees remedies some externalities while failing to address and even exacerbating others.”
The authors’ summary of empirical studies is about as inconclusive as their summary of theoretical studies:
“Overall, perhaps the most that can be said is that academic research have [sic] generated few clear-cut results other than the (obvious) conclusion that the English Rule is relatively more risky than the American Rule, and the somewhat less obvious) proposition that the English Rule will stimulate greater expenditures on litigation.”
The article is available online at http://lsr.nellco.org/nyu_lewp/241
This is a sobering article. Those who long, like Harry Truman did, for advice from “one-handed economists”, will be disappointed. Though exuberant proposals to “reform” our legal system by imposing an English Rule circulate all the time, caution is desirable in this area, if policy-making is to be based on solid evidence. The real-life behavior of sophisticated contracting parties suggests that imposing a “one size fits all” solution to the issue of allocating litigation fees is not a solution that sophisticated contracting parties themselves would appreciate, and furthermore, that the benefits and costs of the English and American Rules are far from obvious given the complicated economic externalities involved. To sum up: on the one hand, on the other hand . . . .