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CHAPTER 17

SHOULD DAMAGE AWARDS IN LAWSUITS BE CAPPED?

Benefits and Costs of Limiting the Burden of Litigation

A doctor in Kentucky who stands accused of negligence in what he calls a frivolous malpractice lawsuit described his ordeal this way: As he struggles through the prolonged litigation, he works for several months each year simply to cover his six-figure legal and insurance costs. He sees each new patient as a potential litigant. He doesn’t enjoy his work the way he used to. What with the stress of the lawsuit, the expense, the lost sleep, and the loss of faith in humanity, the quality of his life has gone downhill.

The husband of a woman in Michigan who died as a result of what he calls a missed diagnosis described his ordeal this way: As his sons struggle with the absence of their mother, he works through the loss of his life partner. He sees malpractice litigation as a needed inducement for attentive medical care. He doesn’t enjoy his time at home the way he used to. What with the stress of single parenthood, the expense, the lost sleep, and the loss of faith in humanity, the quality of his life has gone downhill.

This doctor and this widower represent two valid sides of a debate that affects thousands of Americans who are involved in negligence lawsuits. The consequences of litigation are grave, as are the repercussions of human error. Is uncapped litigation a prudent and effective inducement to minimize error? We can invoke the economic way of thinking to guide public policy and foster virtuous litigation with checks on its emotional burden, frequency, and expense.

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Since the 1960s, a fruitful collaboration between legal scholars and economists has fashioned the new subfield of law and economics. To the analysis of law, economists lend tools with which to seek the optimal level of litigation, create incentive structures for swift and fair resolution of disputes, and evaluate schemes for punishment. The growing discipline of law and economics now boasts national and international professional associations and prominent journals as testaments to the popularity of applying economic reasoning to legal issues.

Consider disputes over liability for product failures. The challenge is to decide whether the manufacturer of a product that has caused harm, such as a soda bottle that exploded, an oil tanker that spilled oil, or an airplane that crashed, should be held responsible for the injuries. Courts now embrace “risk–utility” tests that essentially perform cost–benefit analyses on products that involve risk. This procedure for assessing liability, developed by legal scholar Dean Wade, evaluates the following seven factors:

The court adopted this procedure in the case of a helicopter pilot who noticed a loss of oil pressure and attempted an emergency landing. Fog in the area caused the landing to go awry: The helicopter crashed, and the passengers and crew were seriously injured. It turned out that the loss of oil pressure resulted from a loose oil-supply line that had been inadequately secured by a “lock tab” washer. Other helicopter engine manufacturers use safety wire, threaded through holes in the nut and bolt head, instead of lock tab washers to secure the nut against the constant vibration of a helicopter’s engine. At trial, an expert witness demonstrated how easy it would have been for the manufacturer to use safety wire to prevent the nut from unscrewing. The safety wire cost little more than the lock tab washer. The jury decided that the lock tab washer did not pass the risk–utility test: The washer served an important purpose, but the likelihood and degree of injury were high and safer products were available at little additional cost.¹

¹ See www.avweb.com/news/avlaw/181885-1.html.

Economic reasoning can be applied to legal issues in countless ways; the remainder of this chapter focuses on the economics of damage awards in tort litigation. A tort is a private wrong, or a wrongful act that—intentionally or not—causes injury to another person. Examples include injuring another person by driving recklessly, failing to warn consumers about product dangers, and taking insufficient care when practicing medicine. Tort law provides remedies for such injuries, allowing victims to seek compensation for harm. There is some overlap between torts and crimes, as, for example, when the crime of burglary involves the tort of trespassing. Torts differ from crimes in that (1) the victims of torts initiate litigation, whereas representatives of public bodies, such as the United States or the state of Maine, initiate criminal actions and (2) tort litigation cannot result in incarceration.

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It would be grand if we could do away with lawsuits—if everyone would show due respect and take all appropriate care not to harm others—but that is unlikely given the opportunity costs involved. One problem is that incentives often work against humanitarian interests. Manufacturers can save money by skimping on safety mechanisms. It takes time and money to remove tree limbs that dangle precariously above roadways and to fix dangerous cracks in sidewalks. And it often is financially rewarding for safety inspectors and health-care providers, like just about everyone else, to work quickly so that they can increase the volume of their work.

Financial damage awards in legal cases provide a countervailing incentive to manufacture safer products, to make streets and sidewalks safe, and to spend more time examining and treating each patient. Although most tort claims do not reach trial, it is the threat of damage awards at trial that motivates out-of-court settlements, which are the more common resolution. Punitive damages are awarded to punish the wrongdoer for his or her mistakes and to deter such behavior in the future. Compensatory damages are intended to compensate, or repay, the victim for the extent of the injury, pain and suffering, lost earnings, medical expenses, and lost consortium (love, care, affection, companionship, and other benefits from a relationship).

The existence of damage awards can encourage safety precautions, and when that fails, such awards can help victims recoup their losses. Court cases involving accidental shootings offer a dramatic example. As of 1995, no major gun manufacturer included an internal lock in its guns to prevent accidental or unauthorized use. In that year, victims of accidental shootings began filing lawsuits against gun manufacturers to challenge the inadequacy of safety features on guns. Today, although no federal statute requires internal locks, more than a dozen gun makers offer guns with internal locks. The entire line of handguns made by Taurus Firearms, for example, features internal locks. The Brady Campaign to Prevent Gun Violence² describes this trend as “the most significant safety advance in firearm design in decades,” and its members worry that legislation limiting the liability of gun manufacturers would eliminate the incentive for manufacturers to implement such safety-related innovations.

² See www.bradycampaign.org.

In the 2002 case of Grunow vs. Valor Corp. of Florida, a West Palm Beach jury awarded $24 million to the widow of a teacher who had been shot and killed by a middle school student. The jury placed 45 percent of the blame on the school board because the student was able to enter campus with a gun; 50 percent on the owner of the gun, who kept it in an unlocked drawer; and 5 percent on the gun distributor, who was found negligent for supplying the gun without appropriate safety measures.

We’d like to think that people would never place time, money, or other interests ahead of risks to health and life. Consider, however, the number of deaths that could be avoided with adequate care. In a typical year in the United States, about 43,000 people die in motor vehicle crashes, 29,000 die in incidents involving firearms, and 20,000 die as the result of illnesses associated with sexual behavior (primarily HIV, hepatitis B and C, and cervical cancer).³ It takes time to label medicines legibly and to check labels carefully, and an Institute of Medicine study estimates that 7,000 U.S. deaths are caused by medication errors each year. The United States Pharmacopoeia, the official public standards-setting authority for all medicines sold in the United States, tracked medication errors from 1999 through 2003 and recorded a total of 235,139 errors. Given the number of fatalities that occur despite high damage awards, any reduction in the incentives for safety should be applied with great care.

³ See Ali H. Mokdad et al., “Actual Causes of Death in the United States, 2000,” Journal of the American Medical Association (2004), 291, 1238–1245.

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In previous chapters, it was explained that the burden of even a small risk of large losses is intolerable. For instance, despite the roughly 1-in-300 chance that your home will catch fire this year, your family probably purchases fire insurance because, tiny though the risk may be, the remote chance of losing the value of a home must be eliminated. Litigation poses similarly small risks of tremendous losses for everyone who could be sued. The top 100 U.S. verdicts in 2005, as compiled by www.verdictsearch.com, all exceeded $17 million, and the highest verdict was $1.4 billion.

Most businesses, doctors, governments, and schools can’t afford the small-but-conceivable risk of a devastating lawsuit, and so they make large expenditures on insurance, limit their services, or reduce innovation. Litigation costs can drive firms out of business or out of the country and can drive doctors out of states with high insurance premiums or a record of large jury awards. According to the American College of Obstetricians and Gynecologists, the average ob-gyn is sued 2.5 times during his or her career and the average claim takes 4 years to resolve.⁴ As of 2004, the median award in medical liability cases was $3.5 million.⁵

⁴ See www.acog.org.

⁵ See www.msms.org/grpa/federalgov/MedicalLiability.html.

Don’t think that doctors, institutions, and firms are the only ones paying the cost of litigation. Even if you stay far afield from litigation, you pay a share of the costs. The litigation burden is woven into the prices paid for health care, education, and almost every product or service. An organization called Citizens against Lawsuit Abuse in Orange County, California, claims that every year nearly $1,200 in litigation costs is passed on to each U.S. consumer.⁶ Before the closing of the Clark forklift manufacturing plant in Danville, Kentucky, company executives explained that $1,000 of the price of each forklift went to cover litigation expenses.

⁶ See www.occala.org/facts.html.

As important as the tort system is to decisions that promote safety and health, there may be too much of a good thing. The potential for large damage awards provides incentives for frivolous lawsuits as well as meritorious ones, and some steps taken to avoid litigation have unfortunate results. We can live with the sporadic loss of homecoming parades, Junior Achievement birdhouse projects, and diving boards at hotel pools for fear of litigation; it is of greater concern when doctors shy away from high-risk services, such as delivering babies, and pharmaceutical companies hesitate to introduce new medications.

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Opponents to legal reform correctly argue that most lawsuits are settled out of court, plaintiffs often lose, and many exorbitant damage awards are reduced on appeal. For example, when a jury awarded an Alabama couple $581 million in punitive damages and $975,000 for mental anguish because they were overcharged $1,200 for the installation of two satellite dishes, the trial court reduced the award to $300 million and the case was settled. Even when settlement occurs or plaintiffs get nothing at trial, however, the legal wrangling can take many years, cause many tears, and cost fortunes.

A large body of economic literature suggests that people respond to incentives in rational ways. The trick is to find the best ways to deliver incentives that reduce frivolous lawsuits and bring disputing parties to swift and fair resolutions. England is among many countries with loser-pays policies that require losing parties to assist with winners’ legal fees. This effectively reduces the number of frivolous lawsuits because plaintiffs whose cases lack merit must foot the hefty bill for the defense team. The trade-off (there’s always a trade-off!) is that the threat of being held liable for the legal fees of the other side can also deter meritorious plaintiffs who are uncertain of a win. In the United States, losing parties generally pay the relatively negligible court costs, but not the legal fees, of the winning party. Stronger versions of loser-pays rules have appeared in legislative proposals but have not been adopted.⁷

⁷ See Thomas D. Rowe, Jr., and David A. Anderson, “One-Way Fee Shifting Statutes and Offer of Judgment Rules: An Empirical Experiment,” Jurimetrics Journal of Law, Science, and Technology (1996), 36, 255–273.

President George W. Bush and many state legislators have endorsed a $250,000 cap on damage awards. By limiting awards for pain and suffering, caps can rein in the limitless uncertainty of litigation. States with such caps have experienced relatively slow growth in medical malpractice insurance premiums. The problem with a cap at that level is that it erodes desired incentives for safety and prevents adequate compensation for victims of the worst harms. A $250,000 award might be acceptable for a lost limb but not for a lost life. Or as Senator Edward M. Kennedy (D-MA) puts it, “It is absurd to suggest that $250,000 is fair compensation for a person paralyzed for life.”⁸ A cap that applies to all injuries must be high enough to compensate all victims and to motivate an efficient level of precaution. If applied only to noneconomic damages, such as pain and suffering, as is often proposed, caps could coincide with full coverage for medical care and lost earnings; this means that no victim would have to struggle to pay bills or put food on the table as the result of caps. In May 2006, the U.S. Senate blocked two separate bills that would have capped awards for pain and suffering damages in most cases to $250,000.

⁸ See www.latimes.com/news/nationworld/nation/la-na-medmal9may09,1,2717190.story?coll=la-headlines-nation.

Damage caps reduce uncertainty but threaten unfair treatment of those who receive the worst injuries. An attractive solution is to set relatively high caps that differ according to the type of injury received. For example, caps on noneconomic damages for each type of injury could be set at the 95th percentile of awards granted over the past 10 years. That means that, if the future resembled the past, only the highest 5 percent of awards for even the worst injuries would be affected by the caps. The cap might be $50,000 for a lost finger and $5 million for a lost life. These caps would allow courts the latitude to grant more compensation to those who suffer more but would eliminate awards in the hundreds of millions or billions of dollars.

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High, graduated caps would permit the incentives and justice of most awards. They would allow potential defendants, including drivers, home and business owners, coaches, and teachers, to sleep easier knowing that a mind-numbing jury award wouldn’t ruin their lives. The incentives for lawyers to sponsor billboards and advertisements that encourage litigation would be reduced. Fewer doctors would curtail their services, and fewer producers would think twice about innovating. High caps are a compromise between the extremes of unconstrained litigation and unchecked capitalism. Some will complain that even these caps are too low because the only cap should be infinity. Others will say that they’re too high to solve all the existing problems. The real question is whether there’s a better set of incentives among the viable alternatives. The fact is that high, graduated caps aren’t without risk, but they may well pass the risk–utility test.

Spurred by the importance of economic incentives in our litigious society, the new subfield of law and economics is changing the way people think about legal policy. Lawsuits create tremendous benefits and tragic costs; the optimal level of litigation would include only those cases from which the benefit exceeds the cost. There is widespread belief that current caseloads include frivolous lawsuits, meaning that the optimal level has been exceeded, but a moderate volume of litigation would promote safety and justice well worth the cost. If that’s true, public policy should focus on reducing the burden of lawsuits and dispensing with baseless cases, without undermining the incentives, restitution, and accountability that protect society from selfishness run amok.

Caps on damages would reduce the risk burden of litigation by eliminating the possibility of awards that eclipse common expectations. Graduated caps could achieve these goals without limiting severely injured individuals to the same maximum award as those whose injuries are less serious. Reduced awards would also decrease the incentives to litigate and, therefore, the volume of litigation, as would loser-pays rules, among other proposed legal reform measures.⁹

⁹ See, for example, www.whitehouse.gov/news/releases/2005/01/20050105-2.html.

There is no consensus among economists about whether caps on damages are warranted, but the economic way of thinking helps narrow the advisable options. Graduated caps provide a viable compromise between the weighty risk burden of uncapped awards and the inefficient incentives and unjust compensation provided by a single modest cap.