A Market in Litigation Risk
74 Pages Posted: 22 Nov 2011 Last revised: 12 Dec 2011
Date Written: April 2, 2009
Why do people hate litigation? Corporate America, in particular, complains that litigation is too expensive, time consuming, and unpredictable. But these are not distinguishing features of litigation. When a company launches a new product or enters into a new business line, it may face a process that is just as expensive, time consuming, and risky as litigation. The company will invest time and money in product development and market research and will bear the risk that the product ultimately will fail and its efforts will result in a loss.
What makes litigation seem so daunting, and distinguishes litigation risk from most other risks, is that litigants lack a mechanism to dispose of litigation risk. Virtually any other risk that a business faces can be spread or eliminated via the market. If a new business line is too costly or risky for a company to pursue on its own, it can find a larger partner and undertake a joint venture, or it can raise capital for the project through public or private markets, in the form of debt or equity. Moreover, companies not only spread business risks through the capital markets, but also dispose of some risks that they simply do not want to bear at all. An airline that does not want its annual profits to turn on fluctuations in oil prices can use hedge contracts to offload that risk to someone else. So too can a farmer offload risk through the futures markets and insurance policies and make sure that his annual income does not turn on fluctuations in crop prices or on a catastrophic fire. When it comes to litigation risk, however, a company that is sued generally is stuck with the risk. Insurance companies do not sell after-the-event insurance policies for lawsuits that already have been filed and there isn’t a market in which litigants can trade away litigation risk. Neither the legal profession, the insurance industry, nor the capital markets has yet found a way to relieve litigants of risk.
This Article highlights the costs of this failure of risk management and seeks to develop a mechanism to relieve litigants of litigation risk. Moreover, in developing a new market for legal risk, the Article sketches out a new role for lawyers as market participants. Instead of working for clients with legal problems, some lawyers might work for investment funds, investment banks, or insurers that invest in, and profit from, legal risk. Indeed, upon departing from their traditional role as agents for risk-bearing clients, lawyers might even use their skills to trade in legal risk for their own account—as principals, rather than agents. Lawyers can benefit litigants and society not only by serving clients, but also by making markets in legal risk.
Keywords: litigation, litigation risk, risk management
JEL Classification: K41, K49
Suggested Citation: Suggested Citation