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The relevance of law and economics for the development of judge made rules: Examples from German case-law
EUROPEAN ECONOMIC REVIEW ELSEVIER
European Economic
Review 40 (1996) 989-998
The relevance of law and economics for the development of judge made rules: Examples from German case-law Hans-Bernd Schiifer Erasmus
*
Programm fiir Recht und ijkonomie, Uniuersitiit Hamburg, Fachbereich Rechtswissenschaft Il. Edmund-Siemers-Allee I, D-20146 Hamburg, German?:
Abstract
Judge-made rules play a significant role in the development of civil law. In Germany large parts of accident law and of contract law are today influenced by judge-made rules. Judges often refer to principles of medium range (‘Prinzipien mittlerer Reichweite’) when they develop new rules. It can be shown that these principles are often very close to economic principles, such as economic efficiency. The paper describes the relationship between the legal principles and the economic principles. It also explains how economic arguments can be introduced into legal reasoning. In this respect the concept of negligence is used as an example: interpretation of this concept is necessary before it can be used for a solution of hard cases. The paper presents some cases showing that the interpretation of negligence in judge made law comes very close to economic principles. The same applies for precontractual disclosure rules which generate incentives to produce useful information. JEL classification: R12; RI3 Kqwordst Judgement rules: Negligence;
Precontractual
1. The need for an interdisciplinary
disclosure
approach
in legal science
Much of the law and economics literature is positive science. One branch of this literature analyses wether a certain legal rule, that can be found in a legal
* Tel.: 4940.4123.5781;
fax: 4940.4123.6794.
0014-2921/96/$15.00 0 1996 Elsevier Science B.V. All rights reserved SSDI 0014.2921(95)00109-3
990
H.-B. Schbfer/ European Economic Reciew 40 (19961989-998
order meets efficiency targets or wether it hampers efficiency. Another branch investigates wether and under which conditions legal norms are driven towards efficiency either through the democratic process and parliamentary activities by sudden changes of rules or by the evolution of judge-made rules or by other evolutionary developments. Another set of literature is interested in the question, under which conditions actors like judges, bureaucrats or politicians become interested in decisions that increase the level of efficiency. This literature is not confined to efficiency but includes other principles of justice such as equality or social justice and asks basically the same questions. These approaches all have in common that they provide theories about the law, its functions and its development. In that sense they are very similar to legal philosophy, legal sociology, political science or research on legal fact (Rechtstatsachenforschung). But they remain distinct and separated from the corpus of legal science itself. They cannot penetrate legal science itself. Instead, the core of legal science is concerned with deciding legal cases by interpreting the law. How can economics influence legal science itself? According to a notion widely held, especially among non-lawyers. legal decisions are logical deductions. The court. so the notion is, finds the right decision by looking into the law hoofs for an appropriate rule, then applying it according to approved legal methods to the case in litigation. Thus, finding the answer of the law to a certain lawsuit appears to be a process of analysis of a legal text and of logical deduction (Syllogismus der Rechtsfolgenbestimmung ‘1. The legal text provides a rule (T + R; to each case of T, R shall apply), to which the facts of the case are related by logical means (S is a case of T; ‘Subsumption’), leading to the conclusion (S + R; R shall apply to S). Of course, the real structure of legal reasoning is more complex, because the premises, the introductory propositions of the syllogism, are in most real cases not ready for logical deduction, but yet have to be worked out. Jurisprudence is therefore concerned with methods of interpretation to establish the meaning and the content of the rule or methods to overcome ambiguities or to remedy a gap in the law. Judge-made law plays a prominent role in all modern law systems, common law systems as well as civil law systems, due to considerable structural limits of statutory law. Hence, the courts are seen as quasi-legislators 3 or quasi-regulators ‘, filling gaps where legal rules do not provide sufficient criteria to decide a case. When filling gaps of the black letter law or even acting as quasi regulators,
’ The importance of observing legal methods as a precondition of judicial rule making is stressed by the Bundesverfassungsgericht (Federal Constitutional Court); see BVerfGE 34, 269 = NJW 1973, 1221; BVerfG E 59, 104, 114; BVetfG DB 1984, 189; Picker (1984. pp. 153-200). 2 Expression used by Larenz (1992,p. 160). ’ Cf. Art 2 SchweizOligR: Larenz (1974); Pawlowski (1986. Rn. 117). 4 See Rose-Ackerman (1993. p. 118).
H.-B. Schiifer / European Economic Reuiew 40 (1996) 989-998
991
neither syllogism nor systematic interpretation of the law helps. Legal science then has to ask two questions in order to decide a hard case. First: Which consequences will a certain court decision, which later may become a rule have not only on the parties in the courtroom, but for the society at large? Second: Are these consequences socially preferable to those consequences that emerge, if a different decision is taken? If such a teleological view is taken by judges and by the legal science it is inevitable that contrary to a traditional understanding of what lawyers do they have to resort to social sciences including economics and to ethics. If the economic analysis of law can sort out different consequences of alternative rules it can become part of legal reasoning, the same holds for utilitarianism or welfare economics or other ethical concepts developed within economics.
2. Some problems of introducing economics into law To give up the formalistic approach to law puts the judges into the role of quasi legislators, as long as parliaments remain inactive. They take a policy oriented view. This is a position not without dangers and pitfalls. This can especially be seen in the case of Germany during the Nazi period. The black letter civil law during this period was not substantially changed. But jurisdiction changed in favour of Nazi ideology by making use of the legal concept of the ‘Volksgemeinschaft’ which is a Nazi term for the community of the German people. This concept was introduced into the interpretation of contracts. Contracts were declared as void, when directed against the ‘Volksgemeinschaft’, and this term could be given a meaning that contained almost every policy target of the Nazi party. In a now classical study Bemd Riithers has shown how this allowed the judiciary to give up the established formalistic methods of interpretation of the law and resort to what he called the ‘unlimited interpretation’. 5 The contamination of the German judiciary by Nazi ideology paved the way for a distinctly formalistic approach of the interpretation of law immediately after the second World war. A narrow and formalistic interpretation of the law, however, has large costs too. The law is petrified and cannot react to new social, technical and economic developments. It seems that in a stable democracy and liberal state there is more public acceptance vis-a-vis a policy-oriented judiciary. Today large parts of the German civil law are based on judge-made rules that tilled gaps left open by the legislator. Completely new concepts were developed by the judiciary such as the control of standard form contracts, products liability or the protection of personal rights by damage compensation vis-‘a-vis the media. This development was partly criticised but seems now generally accepted.
5 Riithers (1968).
992
H.-B. Schiifer/European
Economic Review 40 (1996) 989-998
Even though a teleological interpretation of the law is now widely accepted and even though this should lead to an interdisciplinary approach in law, this cannot be observed in wide areas of the civil law except for some areas such as competition law in which cooperation of lawyers and economists has a tradition. There is hardly a cooperation in the classical fields of civil law such as tort law, contract law or property law. The reasons are manyfold. Until recently, economic theory has not analysed the consequences of legal norms in detail. When economic theory reasoned about the law order this reasoning was mainly about the basic features of the legal and economic order. This was of great importance but had little to do with the much more detailed research of most lawyers. The economic analysis of law and the theory of property rights were the first economic theories that analysed legal norms in the same detailed manner as lawyers do. But even the economic analysis of law did not spread easily within the science of law. Lawyers and economists work with different concepts. The language of both sciences is completely different. The efficiency concept is often flatly rejected by lawyers. The same holds for the analysis of consequences of legal norms for which economists are used to work with the standard behavioural assumption of rational self-interested actors. Moreover practical difficulties arise. Economic reasoning, especially when formal models are used, is not readily accepted within the legal profession. It can, however, be shown that legal concepts and economic concepts when they are related to the analysis of legal norms are not very far from each other and often even converge although the used terminology is completely different. In this paper some examples are presented to underpin this proposition and to show that economic concepts can be used to decide hard cases when a court adopts a policy-oriented approach.
3. The economic and legal concept of negligence ‘Negligence’ plays an eminent role in contract law as well as in tort law as a precondition for civil liability. Economic analysis has developed a definition of negligence, the marginalized Learned Hand Formula. An actor whose activity might be harmful to others should expand his damage prevention measures up to the point when an additional unit of damage prevention costs equals the expected value of the corresponding damage reduction. The courts should find a damage prevention project that meets this condition and is therefore efficient. They should define this project as the due level of care. Whenever this level of care - or more - is reached the actor should not be held liable, otherwise his action should be labelled as negligent with liability as a consequence. It can be shown, that if the courts adopt such a rule, proper incentives for a rational self-interesting actor are given to reach the socially efficient level of care. In this concept courts would act similar to standard setting authorities and regulatory agencies.
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A somewhat different approach is the concept of ‘untaken precaution’. Here judges do not fix a standard and then ask wether it has been violated. They ask wether a tortfeasor could have done more than he has actually done. If the plaintiff can show an alternative damage prevention project in the trial whose damage prevention capacity is more efficient than the one actually carried out the tortfeasor should be held liable, otherwise not. Even though the marginalized Learned Hand Formula and the concept of untaken precaution are quite different, especially with regard to their informational requirements, they both are based on economic efficiency and the notion that civil liability and damage compensation should serve the purpose of reducing damages to an efficient level. No other targets such as social justice or damage compensation as an intrinsic value are included in this concept. If one looks at the legal definition of negligence, it seems to be quite different from the economic. In Common Law countries the ‘reasonable man’ standard is used. The judges are guided to ask what level of care this artificial figure of a reasonable man would have used. If the defendant meets this requirement the case should be dismissed. In Germany there is a legal definition of ‘negligence’ in section 276 of the Civil Code (Biirgerliches Gesetzbuch) according to which a person acts negligently if he disregards the necessary care. This definition comes close to a blanket clause which has to be completed by jurisdiction. The High Court (Bundesgerichtshof) has developed so-called principles of medium range, which are aimed at giving this definition a more precise meaning and serving as a guideline for judges. One of these principles is the foreseeability principle. Negligence should be denied if the tortfeasor could not foresee the harmfulness of his activity. 6 What is foreseeable is made dependent on the informational requirements needed to foresee the possible harm. Note that this legal concept is very close to how an economist would argue on efficiency grounds. If the harmfulness of a particular activity cannot be foreseen by the tortfeasor, liability cannot influence the cost and the level of care and therefore would not result in any damage prevention capacity of the liability rule; it would then be better to let the damages lie where they fall. A second important principle of medium range is that the amount of care which is necessary to avoid ‘negligence’, is independent from the wealthiness of the tortfeasor. A court decision about negligence should be completely independent on wether the tortfeasor was rich or poor. This rules out utilitarian principles that discriminate on the ground of income and wealth. Even though it is never said so in any court decision this principle is implicitly based on the ethics of wealth maximization or efficiency. There is a close relationship to the economic concept of negligence in which there is also no room to make the due level of care a function of the tortfeasor’s wealth.
‘See
BGH NJW, 1988. p. 909 and BGH NJW. 1990. p. 2885
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Another principle of medium range was developed in a high court decision on road clearing by the road authorities (Ruhrschnellwegentscheidung). 7 A truck driver suffered an accident in the middle of the night after rain and subsequent frost had caused an icy road. He claimed damage compensation from the highway authorities on the ground that it had not organized a round the clock service during winter times to clear the road. The court ruled that damage prevention measures should be limited to appropriate measures. These measures should be dependent on the extent of the imminent danger. The imminent danger in this case was described as being relatively small as only a few cars used the highway at the time of the accident. It would be an overdrawing of the care level to oblige the highway authorities to clear the road with high “organizational. personal and material cost” in favour of only “a small number of drivers”. The principle that the cost of care should be dependent on the imminent danger comes very close to the Learned Hand Formula which compares the cost of care and the expected damage. It would be possible to give a more systematic view on high court decisions, which result in principles of medium range, that are compatible with the wealth maximizing deterrence approach of the economic analysis of law. It seems that the main difference between the economic analysis of law and the principles developed by high court decisions is that in high court decisions the teleology behind these principles remains unspoken. It is seldom if ever said that negligence should lead to optimal deterrence. However, it is inconceivable that the concept of negligence developed in court decisions may serve any other goal. This leads to the following conclusion. If propositions to define ‘negligence’ on economic grounds, using the Learned Hand Test, are made by economists they certainly do not impose anything on the legal dogma of negligence which is not already there. There is nothing external or alien, when economics is used within the science of law. However, the economic concepts are more precise and more systematic and may serve at least in some cases to avoid erroneous court decisions. I will give an example of how explicit economic reasoning can be used in solving a hard case. 3.1. The case of a protection fence against dangers ,from wild animuls
On 6 August 1985 the plaintiff took his motorbike for a night drive on a road south of Frankfurt which led him through a forest. He collided with a wild dam, fell down and suffered substantial injuries. He claimed damage compensation from the state of Hessen which was responsible for maintaining the road. He argued that the defendant had acted negligently by not erecting a fence to prevent animals from causing injuries on the road. The defendant had warned by traffic sign but the plaintiff argued that this was not enough. In the two years before 50-60
’ BGH NJW 1972 p. 903
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995
accidents had occurred there every year in spite of the warning. Nevertheless the case was dismissed in all successive stages of appeal. * The federal court argued that the traffic sign was sufficient. It would be unreasonable to generally impose a duty to fence all roads with crossings of wild animals. This could be a different matter for highways. In this case, however, it was a road of second order. Even in such cases a fence could be justified if the wild animals crossed the road at a certain spot. In the present case, however, the crossing of animals took place on a length of several kilometres which made fencing too costly. This decision would certainly be correct, if a warning sign would reduce the number of accidents to a tolerable level. But in spite of the sign this was not the case and therefore the question arises wether to put up the sign is the best possible damage prevention project. If one adopts the Learned Hand criterion, the question arises whether to put up a fence would reduce yearly damages by more than the additional damage prevention cost. My colleague Hein Kiitz and myself have made this calculation ’ and arrived at the result that the fence leads to a better cost-benefit ratio than the traffic sign. that therefore the fence should have been built and that the defendant should have been held liable to give incentives to build the fence. The average costs of an accident resulting from road crossings of wild animals are - according to information from the insurance company - 2000 DM. The annual costs of accidents at the place where the accident occurred are therefore 100 to 120 thousand DM. We estimated the additional losses of animals at 20.000 DM per year. The resulting costs of accident do not include losses resulting from pain and suffering and the immaterial 10s of life and limb which are normally not included into damage compensation under German civil law but have nevertheless to be included in a social cost-benefit analysis. The police station in Moerfelden Walldorf where the accident happened, informed us that severe personal injuries were caused in l-2% of all cases reported. In some cases, especially with wild hogs, even very grave injuries had been observed. Taking this roughly into account the yearly costs of damages are not lower than 150 thousand DM. We then calculated the yearly costs of accident prevention by erecting a fence. They amounted (in DM) to 30.000 12.250 4.000
yearly depreciation yearly opportunity (lost interest earnings) yearly maintenance costs
46 200
yearly total costs of the fence
’ BGH NJW 1989 pp. 2808. ’ Kiitz and Schifer (1992, pp. 35.5)
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This shows that accident costs of damage prevention are much lower than the costs of accidents that could be prevented by building a fence. If one adopts the Learned Hand formula it is clear that the defendant had acted negligently. But this result is not alien to legal thinking either. It is quite clear that one can arrive at the same result by adopting the principles of medium range developed by the federal high court during the last 30 years. The difference might simply be that the economic approach leads to a more systematic calculation of the costs and benefits of damage calculation. Let me add some further information to this case. As the police of Moerfelden Walldorf informed us, a fence has been built in the meantime and the number of accidents has been reduced to zero. This result, however, was not achieved by the deterrence effects of the legal order but by political pressure of the owners of the forests. They kept complaining on the high number of animals they lost as a result of the accidents. In the end the state of Hessen gave in and payed the money, however, for the protection of animals.
4. Information
disclosure
in precontractual
relations
Precontractual disclosure rules is another field of the law, into which economics can be introduced with some gain. Since the enactment of the German civil code in 1900 but especially during recent years certain duties of contracting parties to disclose private information to the other party have been formulated by the courts. According to the German civil code the parties themselves have principally to collect all information necessary to decide wether they want to conclude a contract is a legal or not on their own cost and risk. lo Fraudulent misrepresentation exception (section 123 BGB). This, however. includes only cases in which one partner in a contract knows certain facts and also knows that if these facts were revealed, the other side would not conclude the contract. The jurisdiction of German courts, however, has constituted a large catalogue of precontractual disclosure requirements that go far beyond the statutory definition of fraudulent misrepresentation. This legal definition has been transcended by jurisdiction in many cases. In cases of consumer protection for instance the courts not only constituted duties to disclose existing information but also to collect information, sometimes at high cost, and to disclose them to the potential buyer. A very complicated case law has developed, which according to critics lacks coherence and clear principles and even shakes private autonomy and freedom of contract, the pillars of civil law. ” Economics can help to develop a more systematic framework than the principles so far developed in case law.
“I Ott (1991, p. 143). ” Lieb (1988. pp. 251).
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Some of the problems arising here can be found in the Daktari-Case. l2 The buyer of the exploitation rights for the popular television series on animal life ‘Daktari’ had paid the sum of 10.000 DM to the owner of 50% of the rights for a transfer of these rights. When the contract was concluded, the buyer knew that he could resell these rights to a foreign TV-station for 8 Mio $. The federal court decided that this information should have been disclosed in the precontractual situation and declared the contract void. It made special reference to the fact that the two partners had a long lasting friendly relation. This decision is wrong from an efficiency point of view. Assume that the owner of the exploitation rights is a dealer of TV-programmes and the seller is a producer. The dealer tries to find out at considerable cost who and where TV-programmes can be sold. Sometimes he is successful. Assume now that whenever he can make a so-called big deal, he has to disclose this information to the producer which would substantially reduce his profit. The result will be that less effort and cost is put into finding out the highest valued use of a particular TV-programme. The disclosure rule here destroys the incentives for generating and spreading valuable information. I3 The efficient solution might, however, change completely if the facts are slightly different. Take the following case. The owner of a piece of farmland sells this land for a price of one Deutschmark to a buyer. The buyer, who is a member of the city council and insider knows that the city council is determined to change the development plan during the next session one week later. The farmland will then be transformed into building land. Consequently the price of the land will substantially increase. A week later the transformation of the land is publicly announced. The farmer denies implementation of the contract. This case is different from an economic perspective. In the first case the dealer had collected information which was very profitable for him and was also socially productive. Without his information gathering there would be a good chance that nobody would ever come to know that the TV series is very valuable for others. This is different in the case of the land purchase. The insider used a foreknowledge (Hirschleifer, 1973) which is very profitable for him personally but has no value for the society at large, because everybody gets this information a week later at no cost. If this contract is valid, it becomes very profitable to engage in local politics and invest much time and effort in collecting insider information. This effort, however, even though it would then be privately very profitable, is a pure waste of resources from a societal point of view because it allows only for an unproductive game between the seller and the buyer. The legal order therefore should discourage people from getting involved in such activities. If one compares the Daktari case and the insider case it is very difficult for a
” BGH MDR, 1979, p. 730. I3 This problem has been discussed
by Hayek (1945. p. 519).
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lawyer with no economic training to see any difference between them. In both cases the buyer has withheld information which he knew was of extreme importance for the seller. Nevertheless the incentive structure should be different in both cases, and this can only be found out by differentiating between socially productive information and socially unproductive foreknowledge. These few examples show that economics of law is not restricted to providing a theory of property rights or in general a theory of the law and about the law. It can and in fact should influence the science of law itself. This becomes a necessity because of the overwhelming importance of judge-made rules in modern society. Even though this development is sometimes criticized, as it destroys the traditional division of labour between the parliaments and the jurisdiction, it seems to be unavoidable. Many problems in complex societies with a rapidly changing social, economic and technical environment cannot possibly be solved by decisions of a central legislator, who issues clear and strict orders to the administration and to the courts. But when administrators and lawyers have - to a certain extent - to take their own decision, they have no other choice than to ask: which decision would a good legislator have taken, had he not left it to the court? Economics helps him a lot to overcome these problems.
References Hayek, F.A., 1945, The use of knowledge in Society, The American Economic Review 35, 519. Hirschleifer, G., 1973, The private and social value of information and the reward of inventive activity, American Economic Review, Papers and Proceedings 63, 31. K&z, H.. and H.-B. Schafer. 1992, Judex Calcula!, JZ 7, 355. Larenz. K.. 1974, Der Richter als Gesetzgeber. Festschrift fur Heinrich Henkel (De Gruyter, Berlin, New York). Larenz, K., 1992, Methodenlehre der Rechtswissenschaft, Studienausgabe. 2nd ed., 160. Lieb, M.. 1988, Vertragsaufhebung oder Geldersatz, In: Festschrift der Rechtswissenschaften zur 600-Jahr-Feier der Universitat zu Koln, 25 I. Ott. C.. 1991, Vorvertraglich Autl&rungspflichten im Recht des Guter- und Lcistungaustauschs, In: C. Ott and H.-B. Schafer, eds., Gkonomische Probleme des Zivilrechts (Springer, Berlin, Heidelberg, New York). Pawlowski, H., 1986, Einfuhrung in die juristische Methodenlehre (C.F. Miller, Heidelberg). Picker, E., 1984, Richterrecht und Richtetrechtsetzung. JZ, 153-200. Rose-Ackerman, S., 1993, Rethinking the progressive agenda: The reform of the American regulatory State (Free Press. New York). Riithers, B., 1968, Die unbegrenzte Auslegung. Zum Wechsel der Privatrechtsordnung im Nationalsozialismus (Mohr. Tubingen).
European Economic
Review 40 (1996) 989-998
The relevance of law and economics for the development of judge made rules: Examples from German case-law Hans-Bernd Schiifer Erasmus
*
Programm fiir Recht und ijkonomie, Uniuersitiit Hamburg, Fachbereich Rechtswissenschaft Il. Edmund-Siemers-Allee I, D-20146 Hamburg, German?:
Abstract
Judge-made rules play a significant role in the development of civil law. In Germany large parts of accident law and of contract law are today influenced by judge-made rules. Judges often refer to principles of medium range (‘Prinzipien mittlerer Reichweite’) when they develop new rules. It can be shown that these principles are often very close to economic principles, such as economic efficiency. The paper describes the relationship between the legal principles and the economic principles. It also explains how economic arguments can be introduced into legal reasoning. In this respect the concept of negligence is used as an example: interpretation of this concept is necessary before it can be used for a solution of hard cases. The paper presents some cases showing that the interpretation of negligence in judge made law comes very close to economic principles. The same applies for precontractual disclosure rules which generate incentives to produce useful information. JEL classification: R12; RI3 Kqwordst Judgement rules: Negligence;
Precontractual
1. The need for an interdisciplinary
disclosure
approach
in legal science
Much of the law and economics literature is positive science. One branch of this literature analyses wether a certain legal rule, that can be found in a legal
* Tel.: 4940.4123.5781;
fax: 4940.4123.6794.
0014-2921/96/$15.00 0 1996 Elsevier Science B.V. All rights reserved SSDI 0014.2921(95)00109-3
990
H.-B. Schbfer/ European Economic Reciew 40 (19961989-998
order meets efficiency targets or wether it hampers efficiency. Another branch investigates wether and under which conditions legal norms are driven towards efficiency either through the democratic process and parliamentary activities by sudden changes of rules or by the evolution of judge-made rules or by other evolutionary developments. Another set of literature is interested in the question, under which conditions actors like judges, bureaucrats or politicians become interested in decisions that increase the level of efficiency. This literature is not confined to efficiency but includes other principles of justice such as equality or social justice and asks basically the same questions. These approaches all have in common that they provide theories about the law, its functions and its development. In that sense they are very similar to legal philosophy, legal sociology, political science or research on legal fact (Rechtstatsachenforschung). But they remain distinct and separated from the corpus of legal science itself. They cannot penetrate legal science itself. Instead, the core of legal science is concerned with deciding legal cases by interpreting the law. How can economics influence legal science itself? According to a notion widely held, especially among non-lawyers. legal decisions are logical deductions. The court. so the notion is, finds the right decision by looking into the law hoofs for an appropriate rule, then applying it according to approved legal methods to the case in litigation. Thus, finding the answer of the law to a certain lawsuit appears to be a process of analysis of a legal text and of logical deduction (Syllogismus der Rechtsfolgenbestimmung ‘1. The legal text provides a rule (T + R; to each case of T, R shall apply), to which the facts of the case are related by logical means (S is a case of T; ‘Subsumption’), leading to the conclusion (S + R; R shall apply to S). Of course, the real structure of legal reasoning is more complex, because the premises, the introductory propositions of the syllogism, are in most real cases not ready for logical deduction, but yet have to be worked out. Jurisprudence is therefore concerned with methods of interpretation to establish the meaning and the content of the rule or methods to overcome ambiguities or to remedy a gap in the law. Judge-made law plays a prominent role in all modern law systems, common law systems as well as civil law systems, due to considerable structural limits of statutory law. Hence, the courts are seen as quasi-legislators 3 or quasi-regulators ‘, filling gaps where legal rules do not provide sufficient criteria to decide a case. When filling gaps of the black letter law or even acting as quasi regulators,
’ The importance of observing legal methods as a precondition of judicial rule making is stressed by the Bundesverfassungsgericht (Federal Constitutional Court); see BVerfGE 34, 269 = NJW 1973, 1221; BVerfG E 59, 104, 114; BVetfG DB 1984, 189; Picker (1984. pp. 153-200). 2 Expression used by Larenz (1992,p. 160). ’ Cf. Art 2 SchweizOligR: Larenz (1974); Pawlowski (1986. Rn. 117). 4 See Rose-Ackerman (1993. p. 118).
H.-B. Schiifer / European Economic Reuiew 40 (1996) 989-998
991
neither syllogism nor systematic interpretation of the law helps. Legal science then has to ask two questions in order to decide a hard case. First: Which consequences will a certain court decision, which later may become a rule have not only on the parties in the courtroom, but for the society at large? Second: Are these consequences socially preferable to those consequences that emerge, if a different decision is taken? If such a teleological view is taken by judges and by the legal science it is inevitable that contrary to a traditional understanding of what lawyers do they have to resort to social sciences including economics and to ethics. If the economic analysis of law can sort out different consequences of alternative rules it can become part of legal reasoning, the same holds for utilitarianism or welfare economics or other ethical concepts developed within economics.
2. Some problems of introducing economics into law To give up the formalistic approach to law puts the judges into the role of quasi legislators, as long as parliaments remain inactive. They take a policy oriented view. This is a position not without dangers and pitfalls. This can especially be seen in the case of Germany during the Nazi period. The black letter civil law during this period was not substantially changed. But jurisdiction changed in favour of Nazi ideology by making use of the legal concept of the ‘Volksgemeinschaft’ which is a Nazi term for the community of the German people. This concept was introduced into the interpretation of contracts. Contracts were declared as void, when directed against the ‘Volksgemeinschaft’, and this term could be given a meaning that contained almost every policy target of the Nazi party. In a now classical study Bemd Riithers has shown how this allowed the judiciary to give up the established formalistic methods of interpretation of the law and resort to what he called the ‘unlimited interpretation’. 5 The contamination of the German judiciary by Nazi ideology paved the way for a distinctly formalistic approach of the interpretation of law immediately after the second World war. A narrow and formalistic interpretation of the law, however, has large costs too. The law is petrified and cannot react to new social, technical and economic developments. It seems that in a stable democracy and liberal state there is more public acceptance vis-a-vis a policy-oriented judiciary. Today large parts of the German civil law are based on judge-made rules that tilled gaps left open by the legislator. Completely new concepts were developed by the judiciary such as the control of standard form contracts, products liability or the protection of personal rights by damage compensation vis-‘a-vis the media. This development was partly criticised but seems now generally accepted.
5 Riithers (1968).
992
H.-B. Schiifer/European
Economic Review 40 (1996) 989-998
Even though a teleological interpretation of the law is now widely accepted and even though this should lead to an interdisciplinary approach in law, this cannot be observed in wide areas of the civil law except for some areas such as competition law in which cooperation of lawyers and economists has a tradition. There is hardly a cooperation in the classical fields of civil law such as tort law, contract law or property law. The reasons are manyfold. Until recently, economic theory has not analysed the consequences of legal norms in detail. When economic theory reasoned about the law order this reasoning was mainly about the basic features of the legal and economic order. This was of great importance but had little to do with the much more detailed research of most lawyers. The economic analysis of law and the theory of property rights were the first economic theories that analysed legal norms in the same detailed manner as lawyers do. But even the economic analysis of law did not spread easily within the science of law. Lawyers and economists work with different concepts. The language of both sciences is completely different. The efficiency concept is often flatly rejected by lawyers. The same holds for the analysis of consequences of legal norms for which economists are used to work with the standard behavioural assumption of rational self-interested actors. Moreover practical difficulties arise. Economic reasoning, especially when formal models are used, is not readily accepted within the legal profession. It can, however, be shown that legal concepts and economic concepts when they are related to the analysis of legal norms are not very far from each other and often even converge although the used terminology is completely different. In this paper some examples are presented to underpin this proposition and to show that economic concepts can be used to decide hard cases when a court adopts a policy-oriented approach.
3. The economic and legal concept of negligence ‘Negligence’ plays an eminent role in contract law as well as in tort law as a precondition for civil liability. Economic analysis has developed a definition of negligence, the marginalized Learned Hand Formula. An actor whose activity might be harmful to others should expand his damage prevention measures up to the point when an additional unit of damage prevention costs equals the expected value of the corresponding damage reduction. The courts should find a damage prevention project that meets this condition and is therefore efficient. They should define this project as the due level of care. Whenever this level of care - or more - is reached the actor should not be held liable, otherwise his action should be labelled as negligent with liability as a consequence. It can be shown, that if the courts adopt such a rule, proper incentives for a rational self-interesting actor are given to reach the socially efficient level of care. In this concept courts would act similar to standard setting authorities and regulatory agencies.
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A somewhat different approach is the concept of ‘untaken precaution’. Here judges do not fix a standard and then ask wether it has been violated. They ask wether a tortfeasor could have done more than he has actually done. If the plaintiff can show an alternative damage prevention project in the trial whose damage prevention capacity is more efficient than the one actually carried out the tortfeasor should be held liable, otherwise not. Even though the marginalized Learned Hand Formula and the concept of untaken precaution are quite different, especially with regard to their informational requirements, they both are based on economic efficiency and the notion that civil liability and damage compensation should serve the purpose of reducing damages to an efficient level. No other targets such as social justice or damage compensation as an intrinsic value are included in this concept. If one looks at the legal definition of negligence, it seems to be quite different from the economic. In Common Law countries the ‘reasonable man’ standard is used. The judges are guided to ask what level of care this artificial figure of a reasonable man would have used. If the defendant meets this requirement the case should be dismissed. In Germany there is a legal definition of ‘negligence’ in section 276 of the Civil Code (Biirgerliches Gesetzbuch) according to which a person acts negligently if he disregards the necessary care. This definition comes close to a blanket clause which has to be completed by jurisdiction. The High Court (Bundesgerichtshof) has developed so-called principles of medium range, which are aimed at giving this definition a more precise meaning and serving as a guideline for judges. One of these principles is the foreseeability principle. Negligence should be denied if the tortfeasor could not foresee the harmfulness of his activity. 6 What is foreseeable is made dependent on the informational requirements needed to foresee the possible harm. Note that this legal concept is very close to how an economist would argue on efficiency grounds. If the harmfulness of a particular activity cannot be foreseen by the tortfeasor, liability cannot influence the cost and the level of care and therefore would not result in any damage prevention capacity of the liability rule; it would then be better to let the damages lie where they fall. A second important principle of medium range is that the amount of care which is necessary to avoid ‘negligence’, is independent from the wealthiness of the tortfeasor. A court decision about negligence should be completely independent on wether the tortfeasor was rich or poor. This rules out utilitarian principles that discriminate on the ground of income and wealth. Even though it is never said so in any court decision this principle is implicitly based on the ethics of wealth maximization or efficiency. There is a close relationship to the economic concept of negligence in which there is also no room to make the due level of care a function of the tortfeasor’s wealth.
‘See
BGH NJW, 1988. p. 909 and BGH NJW. 1990. p. 2885
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Another principle of medium range was developed in a high court decision on road clearing by the road authorities (Ruhrschnellwegentscheidung). 7 A truck driver suffered an accident in the middle of the night after rain and subsequent frost had caused an icy road. He claimed damage compensation from the highway authorities on the ground that it had not organized a round the clock service during winter times to clear the road. The court ruled that damage prevention measures should be limited to appropriate measures. These measures should be dependent on the extent of the imminent danger. The imminent danger in this case was described as being relatively small as only a few cars used the highway at the time of the accident. It would be an overdrawing of the care level to oblige the highway authorities to clear the road with high “organizational. personal and material cost” in favour of only “a small number of drivers”. The principle that the cost of care should be dependent on the imminent danger comes very close to the Learned Hand Formula which compares the cost of care and the expected damage. It would be possible to give a more systematic view on high court decisions, which result in principles of medium range, that are compatible with the wealth maximizing deterrence approach of the economic analysis of law. It seems that the main difference between the economic analysis of law and the principles developed by high court decisions is that in high court decisions the teleology behind these principles remains unspoken. It is seldom if ever said that negligence should lead to optimal deterrence. However, it is inconceivable that the concept of negligence developed in court decisions may serve any other goal. This leads to the following conclusion. If propositions to define ‘negligence’ on economic grounds, using the Learned Hand Test, are made by economists they certainly do not impose anything on the legal dogma of negligence which is not already there. There is nothing external or alien, when economics is used within the science of law. However, the economic concepts are more precise and more systematic and may serve at least in some cases to avoid erroneous court decisions. I will give an example of how explicit economic reasoning can be used in solving a hard case. 3.1. The case of a protection fence against dangers ,from wild animuls
On 6 August 1985 the plaintiff took his motorbike for a night drive on a road south of Frankfurt which led him through a forest. He collided with a wild dam, fell down and suffered substantial injuries. He claimed damage compensation from the state of Hessen which was responsible for maintaining the road. He argued that the defendant had acted negligently by not erecting a fence to prevent animals from causing injuries on the road. The defendant had warned by traffic sign but the plaintiff argued that this was not enough. In the two years before 50-60
’ BGH NJW 1972 p. 903
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accidents had occurred there every year in spite of the warning. Nevertheless the case was dismissed in all successive stages of appeal. * The federal court argued that the traffic sign was sufficient. It would be unreasonable to generally impose a duty to fence all roads with crossings of wild animals. This could be a different matter for highways. In this case, however, it was a road of second order. Even in such cases a fence could be justified if the wild animals crossed the road at a certain spot. In the present case, however, the crossing of animals took place on a length of several kilometres which made fencing too costly. This decision would certainly be correct, if a warning sign would reduce the number of accidents to a tolerable level. But in spite of the sign this was not the case and therefore the question arises wether to put up the sign is the best possible damage prevention project. If one adopts the Learned Hand criterion, the question arises whether to put up a fence would reduce yearly damages by more than the additional damage prevention cost. My colleague Hein Kiitz and myself have made this calculation ’ and arrived at the result that the fence leads to a better cost-benefit ratio than the traffic sign. that therefore the fence should have been built and that the defendant should have been held liable to give incentives to build the fence. The average costs of an accident resulting from road crossings of wild animals are - according to information from the insurance company - 2000 DM. The annual costs of accidents at the place where the accident occurred are therefore 100 to 120 thousand DM. We estimated the additional losses of animals at 20.000 DM per year. The resulting costs of accident do not include losses resulting from pain and suffering and the immaterial 10s of life and limb which are normally not included into damage compensation under German civil law but have nevertheless to be included in a social cost-benefit analysis. The police station in Moerfelden Walldorf where the accident happened, informed us that severe personal injuries were caused in l-2% of all cases reported. In some cases, especially with wild hogs, even very grave injuries had been observed. Taking this roughly into account the yearly costs of damages are not lower than 150 thousand DM. We then calculated the yearly costs of accident prevention by erecting a fence. They amounted (in DM) to 30.000 12.250 4.000
yearly depreciation yearly opportunity (lost interest earnings) yearly maintenance costs
46 200
yearly total costs of the fence
’ BGH NJW 1989 pp. 2808. ’ Kiitz and Schifer (1992, pp. 35.5)
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This shows that accident costs of damage prevention are much lower than the costs of accidents that could be prevented by building a fence. If one adopts the Learned Hand formula it is clear that the defendant had acted negligently. But this result is not alien to legal thinking either. It is quite clear that one can arrive at the same result by adopting the principles of medium range developed by the federal high court during the last 30 years. The difference might simply be that the economic approach leads to a more systematic calculation of the costs and benefits of damage calculation. Let me add some further information to this case. As the police of Moerfelden Walldorf informed us, a fence has been built in the meantime and the number of accidents has been reduced to zero. This result, however, was not achieved by the deterrence effects of the legal order but by political pressure of the owners of the forests. They kept complaining on the high number of animals they lost as a result of the accidents. In the end the state of Hessen gave in and payed the money, however, for the protection of animals.
4. Information
disclosure
in precontractual
relations
Precontractual disclosure rules is another field of the law, into which economics can be introduced with some gain. Since the enactment of the German civil code in 1900 but especially during recent years certain duties of contracting parties to disclose private information to the other party have been formulated by the courts. According to the German civil code the parties themselves have principally to collect all information necessary to decide wether they want to conclude a contract is a legal or not on their own cost and risk. lo Fraudulent misrepresentation exception (section 123 BGB). This, however. includes only cases in which one partner in a contract knows certain facts and also knows that if these facts were revealed, the other side would not conclude the contract. The jurisdiction of German courts, however, has constituted a large catalogue of precontractual disclosure requirements that go far beyond the statutory definition of fraudulent misrepresentation. This legal definition has been transcended by jurisdiction in many cases. In cases of consumer protection for instance the courts not only constituted duties to disclose existing information but also to collect information, sometimes at high cost, and to disclose them to the potential buyer. A very complicated case law has developed, which according to critics lacks coherence and clear principles and even shakes private autonomy and freedom of contract, the pillars of civil law. ” Economics can help to develop a more systematic framework than the principles so far developed in case law.
“I Ott (1991, p. 143). ” Lieb (1988. pp. 251).
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Some of the problems arising here can be found in the Daktari-Case. l2 The buyer of the exploitation rights for the popular television series on animal life ‘Daktari’ had paid the sum of 10.000 DM to the owner of 50% of the rights for a transfer of these rights. When the contract was concluded, the buyer knew that he could resell these rights to a foreign TV-station for 8 Mio $. The federal court decided that this information should have been disclosed in the precontractual situation and declared the contract void. It made special reference to the fact that the two partners had a long lasting friendly relation. This decision is wrong from an efficiency point of view. Assume that the owner of the exploitation rights is a dealer of TV-programmes and the seller is a producer. The dealer tries to find out at considerable cost who and where TV-programmes can be sold. Sometimes he is successful. Assume now that whenever he can make a so-called big deal, he has to disclose this information to the producer which would substantially reduce his profit. The result will be that less effort and cost is put into finding out the highest valued use of a particular TV-programme. The disclosure rule here destroys the incentives for generating and spreading valuable information. I3 The efficient solution might, however, change completely if the facts are slightly different. Take the following case. The owner of a piece of farmland sells this land for a price of one Deutschmark to a buyer. The buyer, who is a member of the city council and insider knows that the city council is determined to change the development plan during the next session one week later. The farmland will then be transformed into building land. Consequently the price of the land will substantially increase. A week later the transformation of the land is publicly announced. The farmer denies implementation of the contract. This case is different from an economic perspective. In the first case the dealer had collected information which was very profitable for him and was also socially productive. Without his information gathering there would be a good chance that nobody would ever come to know that the TV series is very valuable for others. This is different in the case of the land purchase. The insider used a foreknowledge (Hirschleifer, 1973) which is very profitable for him personally but has no value for the society at large, because everybody gets this information a week later at no cost. If this contract is valid, it becomes very profitable to engage in local politics and invest much time and effort in collecting insider information. This effort, however, even though it would then be privately very profitable, is a pure waste of resources from a societal point of view because it allows only for an unproductive game between the seller and the buyer. The legal order therefore should discourage people from getting involved in such activities. If one compares the Daktari case and the insider case it is very difficult for a
” BGH MDR, 1979, p. 730. I3 This problem has been discussed
by Hayek (1945. p. 519).
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lawyer with no economic training to see any difference between them. In both cases the buyer has withheld information which he knew was of extreme importance for the seller. Nevertheless the incentive structure should be different in both cases, and this can only be found out by differentiating between socially productive information and socially unproductive foreknowledge. These few examples show that economics of law is not restricted to providing a theory of property rights or in general a theory of the law and about the law. It can and in fact should influence the science of law itself. This becomes a necessity because of the overwhelming importance of judge-made rules in modern society. Even though this development is sometimes criticized, as it destroys the traditional division of labour between the parliaments and the jurisdiction, it seems to be unavoidable. Many problems in complex societies with a rapidly changing social, economic and technical environment cannot possibly be solved by decisions of a central legislator, who issues clear and strict orders to the administration and to the courts. But when administrators and lawyers have - to a certain extent - to take their own decision, they have no other choice than to ask: which decision would a good legislator have taken, had he not left it to the court? Economics helps him a lot to overcome these problems.
References Hayek, F.A., 1945, The use of knowledge in Society, The American Economic Review 35, 519. Hirschleifer, G., 1973, The private and social value of information and the reward of inventive activity, American Economic Review, Papers and Proceedings 63, 31. K&z, H.. and H.-B. Schafer. 1992, Judex Calcula!, JZ 7, 355. Larenz. K.. 1974, Der Richter als Gesetzgeber. Festschrift fur Heinrich Henkel (De Gruyter, Berlin, New York). Larenz, K., 1992, Methodenlehre der Rechtswissenschaft, Studienausgabe. 2nd ed., 160. Lieb, M.. 1988, Vertragsaufhebung oder Geldersatz, In: Festschrift der Rechtswissenschaften zur 600-Jahr-Feier der Universitat zu Koln, 25 I. Ott. C.. 1991, Vorvertraglich Autl&rungspflichten im Recht des Guter- und Lcistungaustauschs, In: C. Ott and H.-B. Schafer, eds., Gkonomische Probleme des Zivilrechts (Springer, Berlin, Heidelberg, New York). Pawlowski, H., 1986, Einfuhrung in die juristische Methodenlehre (C.F. Miller, Heidelberg). Picker, E., 1984, Richterrecht und Richtetrechtsetzung. JZ, 153-200. Rose-Ackerman, S., 1993, Rethinking the progressive agenda: The reform of the American regulatory State (Free Press. New York). Riithers, B., 1968, Die unbegrenzte Auslegung. Zum Wechsel der Privatrechtsordnung im Nationalsozialismus (Mohr. Tubingen).