Addressing the problem of abusive lawsuits remains a necessary, yet unrealized, state and federal reform.

Perhaps nowhere are the costs from abusive lawsuits more evident than in the health care industry. The risk of frivolous medical malpractice litigation raises insurance costs and incentivizes doctors to practice defensive medicine.  According to the American Medical Association, defensive medicine adds hundreds of billions of dollars in additional costs every year.

The costs from abusive lawsuits are not confined to the health care sector either.

Every year the Institute for Legal Reform surveys in-house corporate lawyers to assess the legal climate across the 50 states. The results over the past decade and a half consistently find that each state’s legal climate meaningfully impacts economic activity. As the 2015 study documents, “75 percent of respondents reported that a state’s litigation environment is likely to impact important business decisions.”[1]

Instead of correcting this problem, however, many state governments are worsening it. As extensively documented in a December 18, 2014 New York Times article, the problem of abusive litigation is now entrenched in many state AGs’ offices.[2]

In this growing business practice, private lawyers scour the landscape actively seeking out possible litigation cases in a process reminiscent of a private investor scouring the landscape for profitable investment opportunities.

Once the private lawyers find a target, they proposition the AG. For a fee, typically 10 to 20 percent of the judgement, the private lawyers offer to effectively perform the AG’s role. These private entities fund the majority of the state’s investigation costs, fund the majority of the state’s litigation costs, and perform most of the state’s legal work.

While state AG offices may be undermanned, such arrangements create a serious economic incentive problem. Each state’s Attorney General is the top law enforcement officer of the state and is responsible for protecting the legal rights of all individuals, businesses, and charities living or operating in the state.

Private law firms are not responsible for protecting these legal rights. The private law firm has the incentive to find as many potential lawsuits as possible, in particular those cases where the defendant has deep pockets. Once a deep-pocketed defendant has been found, and a contingency arrangement with the AG has been made, the private law firm’s incentive is to extract as high a judgement (or settlement) from the defendant of the lawsuit as possible regardless of the case’s ultimate merits.

Due to the contractual arrangements, the AG’s office now has these same adverse incentives. As an AG’s use of the contingency fee arrangement increases, the likelihood that more frivolous lawsuits are filed increases as well. More frivolous lawsuits leads to greater losses for the state economy.

As a current example of these contingency arrangements, Pennsylvania AG Kathleen Kane has hired D.C.-based law firm Cohen Milstein, which has filed suit against Golden Living Centers, one of Pennsylvania’s largest providers of nursing homes. Cohen Milstein’s lead attorney, Linda Singer, has represented states in litigation against many Fortune 100 companies, including Bank of America.

According to documents filed with the court, Cohen Milstein’s contingency arrangement in this case pays the law firm 17% of any money recovered up to $100 million, 10% for a recovery of between $100 million and $200 million, and 5% for any recovery over $200 million – a $27 million payday if a judgement or settlement of $200 million can be reached.

Cohen Milstein now has a very strong financial incentive for a legal judgement or settlement in this case, regardless of the merits of the complaint. By association, AG Kathleen Kane’s role of “protecting the legal rights of all Pennsylvanians” is compromised as well. From an economic perspective, this arrangement exemplifies how contingency contracts create a much larger incentive for abusive lawsuits.

An effective court system enforces contracts and ensures that individuals and companies that have suffered legitimate economic harms has the opportunity for restitution. Abusive lawsuits, on the other hand, exploit the value created by the state and federal court systems for personal gain. The result is a less vibrant, higher cost, economy particularly in those sectors ripe for exploitation such as the health care industry.

Allowing the legal enforcement of state laws to be turned into an opportunity for a private party to earn a financial jackpot expands the economic cost from tort abuse. Addressing these costs is easy, however. Attorney Generals’ should reject private law firm contracts that rely upon contingency arrangements.

 

Wayne Winegarden, PhD is a Sr. Fellow in Business and Economics at the Pacific Research Institute and a Contributing Editor to EconoSTATS.

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