Legal Ethics and Reform

The Indirect Cost of Civil Lawsuits to the U.S. Economy

Jim Cramer, the lawyer and CNBC host, regularly mentions that civil litigation in America costs the economy 2% of GNP (Gross National Product) each year. In other words, the sum of goods and services produced in America is reduced by 2% because of the economic confusion, distractions, delays, and dislocations caused by the American method of handling civil litigation

Two percent (2%) does not seem like much but consider that economists believe that one percent of GNP translates into about 1.2 million jobs. So it could be said that the American civil litigation system causes about 2.5 million people to be unemployed who would otherwise have jobs.

Civil litigation does two things: (1) it causes money to change hands; this in theory has no effect on the GNP, and (2) it causes people to behave differently, to pull in their horns as it were. This latter effect is what causes the confusion, distractions, dislocations, and delays that hurt the economy. Perhaps a hypothetical case might illustrate how this works in practice; take the case of the ABC Shirt Illustration Co. in Toby NY.

ABC is a company that silk screens tee shirts for tourist shops and as promotional items for various organizations. The company has seven employees: a president, a office manager, an art manager, a foreman, and a production crew of three. The company’s sales are about $900,000 per year and it has about $200,000 in working capital. The company has been very busy. Its largest customer is pushing the company to increase its capacity, so ABC is about to close on a bank loan to acquire a $600,000 automatic tee shirt silk screening machine that would expand capacity dramatically. The company has placed a tentative order for this special purpose machine, and the manufacturer has placed ABC’s order in its order back log and issued a tentative delivery date..

A lawsuit alleging racial discrimination and $250,000 of actual damages is filed naming two respondents, ABC Corporation and its foreman. This case is filed by one of the three man crew who happened to be black. The filing is reported in the local newspaper on page 3 as a two inch news item. The president of the company contacts his attorney, Lawyer Bob, and is told that he will need to get a different lawyer to represent his foreman. Lawyer Bob recommends Lawyer Jim. So the president suggests Lawyer Jim to his foreman and he tells the foreman that ABC will pay his legal bills. The president is told that he shouldn’t worry, Lawyer Bob knows Lawyer Don who is representing the black plaintiff; Lawyer Bob is sure something can be “worked out” pretty soon. Lawyer Bob recommends that the black employee be kept at work but if that is not possible he should be put on a paid leave of absence.

The president after talking to the foreman decides that the disruption to morale would be too great if the black employee stayed on the job so ABC puts him on paid leave and hires a temporary replacement. Other than the jump in the payroll expense, the president is happy and goes back to his planning for the arrival of his new machine. He arranges to meet with his bankers about his loan and is told the loan will have to be put on hold until the $250,000 lawsuit is sorted out. The big customer calls wanting to know when the new equipment would be installed so he can start getting more shirts. The customer is stunned to learn about the lawsuit and bank’s decision. The president assures him the problem will get solved

The president calls Lawyer Bob and explains that things have gotten urgent. Lawyer Bob says that the other side is prepared to settle for $200,000 right away. The Lawyers come and interview the foreman and the other crew members. The president listens to it all and announces nothing wrong was done to the black employee. The president thinks the basic problem was the personalities of the foreman and the black. The black is a naturally talkative guy while the foreman was a naturally taciturn man with an abrupt way of speaking. Certainly not a difference that deserves a $200,000 payment. Anyway the only $200,000 available is the working capital in the business. The lawyers are not sure the president’s analysis is exactly correct. They feel that perhaps some settlement is due, but everyone agrees $200,000 is certainly too much

At this point the president is confused and alarmed. He is about to lose his best customer, his payroll has gone up, his foreman is distracted, production rates are down, rework rates are up because more mistakes are being made in the shop. The president should be out looking into a new banking relationship where he might get the needed loan, but he feels he should stick around the shop hoping to catch errors before they occur. He is losing sleep.

After 45 days of this the first bills come in from Lawyer Bob and Lawyer Jim. Each lawyer wants $15,000. The president notices that quite a bit of the billings are for the two lawyers to talk to each other about the case. It is apparent that the Lawyers will bankrupt the company in less than a year if these bills keep coming. With all this on his mind the president gets a call from his best customer saying he has decided to buy his future tee shirts from a low cost Chinese supplier; he says the delivery times are horrible but at least they are cheap and reliable. The president calls the machine manufacture and cancels his order for the new automated machine. He also calls the bank and tells them he won’t be needing the loan after all. ABC’s prospects have turned from bright to dire in a few weeks.

In another couple of months Lawyer Jim is able to get the foreman dropped from the case by order of the local circuit court judge, but the case against the company goes forward. Lawyer Jim is out of the picture and the company has only had to pay him $29,000. Lawyer Bob’s bill to this point is $24,000. Eight weeks later depositions were held and the evidence from the foreman, the black, and the other crew members leave little doubt that the plaintiff’s case is very weak. Lawyer Bob suggests that since it will cost about $30,000 to finish up and go to trial it might be a good idea for ABC offer the plaintiff a settlement of $25,000. The plaintiff accepts the offer on the condition that he gets his job back. The president accepts the offer even though the foreman is threatening to quit if the black man is reinstated. Lawyer Bob submits his final bill which brings the total for Lawyer Bob to $55,000

The direct cost to ABC is $55,000 to Lawyer Bob, $29,000 to Lawyer Jim, $25,000 to the plaintiff in a settlement payment, and seven months of pay to the plaintiff for no work. But all this transferring of money does not effect GNP. The president hears a rumor later that Lawyer Don got 40% of the $25,000 settlement. A dollar in Lawyer Bob’s checking account is as helpful to the economy as a dollar in ABC Corp’s checking account. However, the indirect costs are significant. In this case the indirect costs are: (1) the big customer’s decision to take his business to China helps China’s GNP and hurts the American GNP, (2) the canceled order for the automatic machine disrupts the machine manufacturing company’s order schedule and makes them slightly less efficient, (3) the canceled loan at the bank hurts the bank’s profits and slightly reduces the nation’s money supply, and (4) the productivity at ABC is hurt by the extra payroll expense of having a crew member on paid leave for several months. These four are major economic hits to ABC, its suppliers and/or its customers, but they are also minor hits to the nation’s economy. ABC ends the process a shadow of its former self; its sales are greatly reduced but so is its pool of working capital. Repeat this story thousands of times across America and the 2% reduction in overall GNP is very believable.

There is a silver lining. Every society needs a aristocracy, and the legal fraternity serves as America’s aristocracy in every corner of this great nation. This aristocracy has to be supported in a upper middle class fashion so it can provide the leadership the local community needs. The current civil litigation system serves as a very efficient “pump” to extract money from the broader society to support this aristocracy. Looked at from the perspective, not of the ABC Corp or the nation as a whole, but from the perspective of Toby NY. Lawyer Bob, Lawyer Don, and Lawyer Jim and their wives and children are now financially stronger and better able to provide the leadership Toby NY needs. ABC Corp may go out of business and 7 people may end up unemployed because of this fiasco of a law suit, but that might be an very acceptable price for Toby to pay given its need for a healthy, functioning aristocracy.

Some have argued that America’s adversary litigation system should be replaced with an inquiry system as found in Continental Europe. Under this system the plaintiff’s complaint would have been investigated by a young lawyer, an employee of the government, who was in training to be a judge later in life. This young lawyer working under the supervision of an older judge would prepare a full report of the facts and this report would have gone to a three judge panel who would decide what testimony they wanted to hear in addition to the report and once satisfied they had the needed facts would check the applicable laws and issue a decision. (It should be noted that the laws in Continental Europe are generally quite broad and are contained in a couple of large books.) It is readily apparent that this European approach is much faster, cheaper, and likely to yield better results; however, it turns lawyers involved in the litigation process into government functionaries. If lawyers are to be viewed as society’s aristocrats, as white knights sallying forth to protect, and defend the embattled litigant, it is important that they be seen a independent agents not as government functionaries. If America adopted the European model, the lawyer’s role as society’s aristocracy would be severely compromised probably eliminated and America might have to function without an aristocracy. Edmund Blake, the great English political thinker, warned that a democracy without the stabilizing influence of a aristocracy has a tendency to become unstable in the same way the French Republic was unstable in the late 18th century immediately following the French Revolution. Things got so bad in France that the country was happy to accept the dictatorship of Napoleon and the restoration of order.

Perhaps the high costs of our current inefficient civil litigation system are acceptable in light of the consequences that might follow the installation of a more efficient system.

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