The Lack of a Loser Pays System

April 13, 2006

	Visited: 134
	Not rated
	Rate:

For a small business owner navigating the court system, there are a number of inherent economic disadvantages when being sued.

Besides the contingent fee system that ensures a small business owner will be defending a suit with limited resources against an opponent who is not similarly limited, the outcome--win or lose--produces a third financial setback. The legal system does not allow for you to recoup your costs, even if you're right, except for some very limited contractual and statutory situations.

In a "loser pays" litigation system, the loser of the action is compelled to reimburse the other party for attorney's fees and related costs. This means that, if the plaintiff wins, he is awarded his regular monetary damages, plus his attorney's fees and other costs. If the defendant wins, he pays no damages to the plaintiff, and he is reimbursed by the plaintiff for his (the defendant's) attorney's fees and costs. Reimbursement does not result in any gain to the defendant. Instead, it just means that the defendant will not suffer any loss.

This outcome seems to make sense. For this reason, many people are surprised to learn that the United States does not have a "loser pays" system. In the United States, as a general rule, a plaintiff who wins collects only his compensatory damages. He must compensate his attorney at his expense, perhaps from the proceeds of the case. If the defendant wins, he must still pay his own attorney's fees and related costs. Despite the court victory, this is a loss in itself.

The system used in the United States is known as the American Rule. The theory behind the American Rule is that a risk of reimbursement might dissuade plaintiffs from bringing legitimate claims, thus causing losses not only to the plaintiffs themselves, but to society as well.

Warning

The lack of a loser pays system has serious implications.

In a contingent fee case, even the defendant with significant financial resources faces a serious dilemma. He must pay his attorney $150 to $250 per hour (or more), while the plaintiff's attorney will cost him nothing out of pocket.

A full trial, in a simple case, might cost the defendant $10,000 or more in attorney's fees. Even if the defendant wins the case, he does not get reimbursed for his attorney's fees, and thus loses $10,000. So, whether you win or lose the case, you ultimately lose in the long run.

This system provides a strong incentive for defendants to settle cases by offering to pay plaintiffs monetary damages, even when defendants are sure they will prevail at trial. If a defendant offers to pay the plaintiff $6,000 to settle the case, the defendant will actually save $4,000, as compared to "winning" the case at trial and paying his own attorney $10,000.

The combination of contingent fees for plaintiffs, hourly fees for defendants, and the lack of a loser pays system works to allow a type of legal extortion. Plaintiffs with frivolous claims can threaten to sue, unless they are given financial compensation. Faced with this type of threat, defendants have a strong financial incentive to meet the plaintiff's demands.

Of course, this combination also means that plaintiffs can sue (or threaten to sue) without risking anything whatsoever. If the suit is not successful, the loss will have cost the plaintiff nothing. This fact makes the use of such threats even more pervasive.