International Review of Law and Economics (1990), 10(3-27) zyxwvutsrqponmlkjihgfedcbaZY THE EFFECT OF FRIVOLOUS LAWSUITS ON THE SETTLEMENT OF LITIGATION AVERY KATZ Department of Economics and Law School, University of Michigan, Ann Arbor, MI 48109, U.S.A. 1. INTRODUCTION It is commonly alleged that a substantial proportion of lawsuits are frivolous or “strike” suits, that is, lacking merit and filed only in the hopes of obtaining a favorable settlement.’ The handling of such suits has given rise to popular and scholarly criticisms of American civil procedure, on grounds both of efficiency and fairness. Indeed, in certain areas such as medical malpractice, antitrust, and corporation law, the asserted prevalence of frivolous suits is commonly cited as an argument for law reform. For example, recent critiques of treble damages in antitrust have emphasized the supposed encouragement such damages give to strike suits. The fairness objection to frivolous lawsuits is that such suits can result in opportunistic persons obtaining payments to which they are not entitled, at the expense of innocent defendants who may be viewed as defrauded or under duress. The efficiency objection is that the rent-seeking occasioned by frivolous suits wastes resources both directly and indirectly. Direct costs include resources used in filing and defending such suits, as well as costs of investigation and discovery as defendants attempt to distinguish frivolous from genuine claims. Indirect costs stem from the additional trials required because the presence of frivolous plaintiffs in the population of litigants interferes with the settlement of genuine claims. This article develops a model of litigation and settlement in the presence of frivolous lawsuits, which I define as suits that have a sufficiently low chance of prevailing at trial that they would not be brought but for the prospect of settlement. The analysis does not address suits in which the prospect of judicial error or jury confusion at trial permits a plaintiff to obtain a settlement that is undeserved according to some external normative standard. Instead, I take a strictly positive view of the law and treat all suits expected to prevail at trial as genuine. Neither do I address suits that turn out ex post to have little basis in law, but that ex ante seemed plausible. There are undoubtedly many such cases brought, but it is I am grateful to Richard Caves, Sharon Feldman, Louis Kaplow, Joseph P. Kalt, Gregory Mankiw, Stephen Salant, Steven Shavell, Michelle White, and an anonymous referee for helpful comments and discussions. This paper is based on chapter III of my Ph.D. dis- sertation (1986). ‘See, e.g., the discussion in Rowe (1984), at p. 151. 0 1990 Butterworth Publishers