"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well." -Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Friday, October 29, 2010

Costs in Litigation and Arbitration (Part II)

In the last post, we had stated that the law on costs in litigation and arbitration requires reforms. The purpose, which would be achieved through a series of posts, was to provide pointers for a proper costs policy. We had, in the previous post, pointed a few problems with the costs policy. Before we look at further critique on the existing law, we jump one step ahead (for the time being) and analyse the potential of a proper costs policy and its influence on frivolous litigation. Once we are through with that, we would move on to offer further critique on the costs policy and offer pointers for reform.

One of the ways of filtering unmeritorious litigation is by imposing costs on a litigant filing such a case. An example would be the number of applications filed for appointment of arbitrator under S 11 of the Arbitration and Conciliation Act, 1996 when parties had previously agreed on a specific procedure which one of them failed to follow (S 11 provides a mechanism when the parties-chosen appointed procedure fails). Though some High Courts in the past have imposed costs on unmeritorious petitions [Larsen and Toubro Ltd. v. Sunfield Resources Pvt. Ltd MANU/MH/0880/2005; A & A Restaurant v. Dwarikajeet Restaurant 2005(1) Arb. LR 526 (All.); T.K. Aggarwal v. Tara Chand Jain 2005(Suppl.) Arb. LR 13 (Del.). In v/o Tvazhpromexport v. Mukand Ltd. 2005(3) Arb. LR 406 (Bom.)] the Court ordered the Petitioner to pay the Respondent’s costs even when the award was partially set aside), it would seem that the courts have imposed costs only in exceptional cases; non-imposition of costs on the basis of results has been the norm and imposition of costs, an exception [See, for example, the following cases where petition for setting side was dismissed but no costs levied: Delhi Jal Board v. Reliance Diesel Engineering 2005(3) Arb. LR 602(Del.); Avinash Bawa v.State of Himachal Pradesh 2005(Suppl.) Arb. LR 184 (HP); Ennore Port Trust v. Hindustan Construction Co. 2005 (Suppl.) Arb. LR 129 (Mad.)(DB); Union of India v. Pradeep Vinod Construction Co. 2005(Suppl.) Arb. LR 33 (Del.); Hindustan Copper Ltd. V. Bhagwati Gases Ltd. 2005(3) Arb. LR 622 (Rajasthan); Kanha Credit & Holding Pvt. Ltd. v. Janacim Electronics 2005(1) Arb. LR 338 (Del.); Krishna Bhagya Jal Nigam Ltd. V. G. Harishchand 2005(Suppl.) Arb. LR 470 (Kar.)(DB); Union of India v. Deccan Enterprises 2006(4) Arb. LR 444 (Del.); Haryana State Agricultural Marketing Board v. Dharam Puri 2006(3) Arb. LR 285 (P & H); Delhi Development Authority v. Manohar Lal 2006(1) Arb. LR 132 (Del.)]

For a long time, academicians have argued that the costs to borne by the parties influence the incentive to file suits [See, for example, STEVEN SHAVELL, FOUNDATIONS OF ECONOMIC ANALYSIS OF LAW, note 146, at 429 (2004); Avery Weiner Katz, Indemnity of legal Fees, in, BOUDEWIJN BOUCKAERT & GERRIT DE GEEST (EDS.), ENCYCLOPEDIA OF LAW AND ECONOMICS (VOLUME V: THE ECONOMICS OF CRIME AND LITIGATION) 63- 94 (2000)], the rationale being that the decision whether to file an appeal or a suit is an economic question [Steven Shavell, Suit, Settlement and Trial: A Theoretical Analysis under Alternative Methods for the Allocation of Legal Costs, 11 J. Legal. Stud. 55, 58 (1982)]. The general opinion seems to be that the plaintiff will sue if the expected cost is less and the expected benefit is more. If so, an increase or a decrease in the cost or benefit would alter the plaintiff’s incentive to sue. In the past, fee shifting has been used in USA to increase or decrease the number of suits on certain laws. Hence fee shifting has the potential of becoming a potent device in reducing the number of reckless suits like petitions under S 11 to appoint arbitrators when there was nothing wrong about the agreed scheme or reckless challenge to arbitral awards.

There are primarily two models of fee shifting: (1) American Rule, (2) English Rule. In American Rule, the parties bear their own costs of the litigation and the costs are not imposed on the basis of success in the suit. Under the English Rule, the losing party bears the cost of the winning party. The assumption is that the probability of winning is 50 %. If so, under the American Rule, the plaintiff would sue where cost (Direct costs such as attorney fee, court fee and indirect fee such as the time spent on pursuing a suit and so on) incurred is lesser than the benefit received.

If, EC (Expected Costs) > EB (Expected Benefit), the plaintiff would not sue;
Conversely, if the EC < EB the plaintiff would sue.

Under the English Rule, a plaintiff would sue if the probability of winning is equal to or more than 50 % and the benefit, which is the sum of benefit received from the Defendant and the fee incurred by the plaintiff, outweighs the cost, the plaintiff would sue. Under the American Rule, even if the Plaintiff loses, litigation expenses incurred by the Defendant would not be imposed on him. Therefore, the plaintiff would sue if there is a remote possibility of winning. In the English Rule regime, the plaintiff might not sue if the probability of winning the case is less than 50 % because the expected cost might overweigh the expected benefit if he loses. Therefore adopting the English Rule would minimise the incentive to sue provided the probability of winning is less than 50 %. In the subsequent post on this topic, we will look at other models of fee shifting.

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