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The Risks Of Ligitation And Its Costs

Litigation is like coming down with the common cold. There are things we can do to lower the risks: we can take vitamins, wash our hands and stay out of drafts, but we can’t altogether eliminate the prospect of catching one anyway, although if this should happen, we hope that because of our actions, it will be less severe.

To reduce the risks of litigation or the costs of litigation when it occurs involves establishing constructive relations with your client, assessing its transactional partners and paying close attention to the manner in which risks are allocated in the contractual relationships it is considering.

1. The Mindset: Limiting Tangible Risks

Managing litigation risks, like managing other kinds of risks, entails making a dispassionate assessment of reality. This may seem obvious, but, in practice, cajoling a client into facing the risks of a transaction can be the most formidable challenge to the practitioner. Deals are achieved by accentuating the positive and de-emphasizing the negative. In the worst situation, a lawyer can be perceived of as a gadfly; a Cassandra that can place a damper on the enthusiasm for a deal. This kind of relationship can be a source of substantial attorney-client tension.

For the lawyer, therefore, evaluating the personality of the client is a significant first step toward evaluating tangible risks. A client who is likely to lie to counsel or conceal material information creates for itself the highest level of litigation risk. In the American system, which adorns the lawyer with the mantel of a gladiator, the attorney is under tremendous pressure to kowtow to the client, which often entails shying away from addressing the weaknesses of a course of action, especially where the outcome, at least in the short term, is expected to be very profitable.

To limit litigation risk it is therefore critical for the client to perceive counsel as being not merely a tool to get things done, but as an objective and dispassionate advocate for reason and prudence. In sum, the more honest counsel can be with the client and vice versa the more likely it is that an effective strategy for limiting litigation risk can be devised. Such a plan necessarily will entail balancing the prospect of short-term financial gains of a course of action against the risks of long-term litigation costs.

It is important that in making a risk assessment at the outset of a transaction, general counsel adopts the litigator’s perspective, which assumes that at the beginning of any deal, litigation adversaries are almost always friends or friendly business associates who have the utmost confidence in one another’s integrity. And yet how fragile these relationships are, regardless of their lengthy history and depth. Where important terms of a transaction are intentionally left ambiguous because it is believed that, in the end result, the parties will do the morally correct thing, this is the kind of transaction which presents significant litigation risk.

The litigation perspective is necessarily more cynical than the corporate attorney’s perspective which is defined by a much narrower time frame. Corporate attorneys are often left to viewing a snapshot of the business relationship at a point in time; the litigator, on the other hand, is compelled to viewing the relationship as one would view a motion picture, with a beginning, where the parties have high expectations, a middle, where there are signs of disillusionment and an increasing sense of injustice, and an end, where personal and professional relationships are torn asunder by mistrust.

Accordingly, assessing litigation risk requires an appreciation for the changing currents of times and circumstances. Contracts, after all, are only balance sheets of risks, which are allocated in accordance with how the parties perceive them at the time that the contract is entered into. To the extent that counsel can prevail upon the client to take the long view of its business associations, the greater the prospect that risks will be more easily identified and provided for. Counsel must always keep in mind that personalities in an organization can change, that personal relationships do not stay static and that whether a business relationship can survive often has less to do with personal loyalties than with bottom line profits. In the contemporary world in which we live– business is business.

2. The Environmental Risk of Litigation

Assuming that there exists a constructive relationship between client and counsel such that there is a near perfect flow of material information between them, the next source of risk is the litigation environment in which the transaction is taking place.

The American market has a breadth and depth unique in the world. Political and economic stability prevail, creating predictability in economic relations that makes for a generally positive business climate. One important real or imagined source of unpredictability is the extent to which a business is vulnerable to litigation and therefore is exposed to an unanticipated level of litigation-related costs. While the American market has a world-wide reputation for imposing high levels of litigation costs on market participants, there has not been a decisive study showing conclusively that lawsuits are far more prevalent in the United States than elsewhere. One overly simplistic statistical correlation equates the number of lawyers that are in active practice as a percentage of the entire population.

In the United States, there are over 912,000 lawyers in a population of about 280 million, roughly 3.0 lawyers per thousand people. By comparison, Canada has only 71,000 lawyers nationwide in a population of about 28 million or roughly 2.6 lawyers per thousand people, almost 30% less. It is impossible to know what these statistics mean, except that it would appear that Americans need relatively more legal advice than Canadians do. At the same time, it is impossible to control for many variables that could statistically impact on such a comparison.

It could be that Canada and the U.S. count their lawyers differently (what does it mean, for example, to “actively” practice law); it could be that most lawyers in the U.S. are not engaged in litigation; it may also be that Americans need lawyers more than Canadians to navigate a more difficult legal terrain. As such, there could be a higher level of pro se litigation in Canada than in the U.S. accounting for a good deal of this discrepancy. Because no carefully crafted cross-country analysis of litigation risk has been done, our perceptions are based principally on anecdotal evidence, drawn from the popular literature which depicts the American people as a highly litigious group, facilitated in their thirst for easy money by attorneys working on contingency.

It has also been said that litigiousness in the U.S. may also reflect contemporary American culture, which has de-emphasized in commercial relationships moral concepts such as loyalty and honor. Consequently, litigation in the United States is less frequently about right or wrong, and more likely to be concerned about re-rationalizing the risks of business relationships that have proven to be unprofitable for one or both partners. Litigation in America, in short, has become merely another cost of doing business.

Of all the unique characteristics of American legal culture, litigation apparently driven by contingency fee arrangements is particularly disturbing to foreign lawyers. Attorneys working with the expectation of obtaining an award of damages at the end of the day are frequently perceived of as being more likely to initiate frivolous litigation, increasing litigation risk. There is no question that in certain litigation areas, such as personal injury, products liability and class actions, that contingency arrangements drive the legal market. In commercial litigation, however, where contract damages are capped and there is no component of pain and suffering, litigators are far more reluctant to work on contingency.

It cannot be denied, however, that where the purpose of the litigation is to harass, and the quality of legal work is not a high priority, a party may be able to retain a young and eager lawyer on contingency. For the most part, however, I would say that most contingency–fee based lawyers are more discriminating than is popularly believed and are more likely to take on a client only when the prospects of victory are significant. Time is, after all, money even to lawyers on contingency who must in each case weigh the prospects of a substantial recovery or settlement against the value of the time needed to achieve it.

On balance, therefore, it is unclear that contingency fee arrangements promote a greater percentage of truly frivolous litigation in the U.S. than elsewhere, although such arrangements may make it more likely that a party with a bonafide cause of action will resort to litigation. For counsel trying to assess the risks of attracting contingency-based litigation the rule of thumb is that the risk of litigation is less where the dispute is complex factually and legally, and where damages are limited, and enhanced in disputes that are predominantly factual, where motion practice and discovery are likely to be minimal and where damages are not capped. In the latter category are disputes relating to most kinds of personal injury and work place discrimination.

One way of addressing the environmental risk of litigation is to include in any contractual framework choice of law and choice of forum provisions. In virtually all American jurisdictions, such provisions are enforceable and therefore provide an opportunity for the parties consensually to avoid the American forum or cause to be applied more advantageous legal rules.

It is relatively rare that these provisions are heavily negotiated, because the principals view litigation at the time of contracting as a remote possibility, but counsel should be wary about conceding such provisions without considering their impact and consulting with local counsel regarding the legal rules the courts of a certain jurisdiction are likely to apply to certain disputes. In making this assessment, counsel should be conscious of the fact that state rather than Federal law is likely to be applied in commercial relations, subject to the qualification that international treaties are binding on state courts. In cases involving trademarks and copyrights that involve Federal statutes, ancillary state law claims may also be involved.

Provisions providing alternative dispute resolution mechanisms may discourage or encourage litigation depending on circumstances, but, in general, can lower litigation costs. In considering forum selection and choice of law provisions and the prospects of alternative dispute resolution, counsel should not discount the possibility that while such provisions may ultimately be enforceable, it may not prevent a party from challenging their validity on the basis of unreasonableness, unfairness, overreaching or fraud. What the corporate client often fails to appreciate is the lesson that just because a party may have a weak or non-existent case does not necessarily preclude it from commencing an action. The purpose of this kind of litigation is not necessarily to win on the merits but to create costs that will be so burdensome that a favorable settlement can be extracted. Again, the point is not whether a party is right or wrong but whether the economics of the dispute make it worth the fight.

The second lesson is that litigation is sometimes unavoidable and should therefore be considered a cost of doing business in the United States. Under this approach, the challenge to counsel is how to determine the relative costs and benefits of initiating, defending or settling a litigation. There is no easy way of doing this since the kinds of disputes are potentially innumerable and the range of complexity impossible to gage. Nevertheless, there are some worthwhile approaches. For one thing, counsel can make a cost assessment based on experience with past litigation. For example, if a corporate client has been involved in trade secrets litigation, and is currently considering a transaction involving the licensing of a trade secret, the costs of the past litigation may provide a bench mark for the costs of any similar future litigation.

Still another method of determining potential future costs is to outsource litigation services to local counsel under a fee arrangement that allows the client to budget for litigation costs on a long-term basis. The point of accepting litigation costs as an ordinary cost of doing business is to reduce uncertainty and at the same time retain a higher level of resources to respond to litigation initiated for the sole purpose of extracting favorable settlement terms. Although the client may in the short term possibly be paying local counsel for doing little work, over the long term, such fixed fee arrangements should result in lower and predictable costs when litigation does raise its ugly head.

Related to the strategy of allocating litigation costs is determining a priori the circumstances under which the client is prepared to engage in a litigation for the purpose of discouraging other litigations. Indeed, it has been said by litigators interviewed by the writer that the best way of lowering litigation risk is to be prepared to litigate to the full certain cases that could have substantial deterrence value.

For example, one way of discouraging leaks of confidential information is to sue aggressively individuals who have been found responsible for such leaks. Such litigation is often uneconomical, costing the litigant in absolute terms far more than what it could ever realistically expect to recover in compensatory damages, nevertheless, such actions have a deterrent value that more than makes up for their short term costs. In the area of products liability, certain manufacturers have cleverly built reputations for litigation toughness that they believe have markedly discouraged litigation over the long run.

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