The American Export You Don't Want

America, the land of pioneers, has become known for its innovation. When Thomas Edison invented the light bulb and when Neil Armstrong walked on the moon, the spirit of America’s ingenuity changed…

America, the land of pioneers, has become known for its innovation. When Thomas Edison invented the light bulb and when Neil Armstrong walked on the moon, the spirit of America’s ingenuity changed the world. But there are a few American ideas that other countries would rather quarantine to our borders – among them, America’s failed experiment with class action lawsuits.

Indeed, the body of evidence against America’s class action lawsuit system is vast, which is why it is so troubling that, today, Europe seems on the verge of adopting a very similar system. In recent months, two Directorates General in the European Commission have forwarded proposals to create a class action system vulnerable to the same type of abuse we face in the U.S.

The class action lawsuit was created in the 1960s, as the U.S. federal courts attempted to make the American legal system more accessible and less expensive for consumers by creating a legal mechanism that allowed many plaintiffs with similar claims to file one collective lawsuit.

Class action lawsuits held great promise of benefit for the broad society. For business, it seemed practical to address identical cases at one time, saving years and millions in added legal costs. Consumers would have access to high quality legal counsel in a collective manner without up-front costs. And the plaintiffs’ lawyers would get paid a share of the winnings on contingency fee if they prevailed in the case.

But, in the ensuing forty years, America’s experiment with the class action lawsuit has belly flopped. Of the three parties involved, trial lawyers have benefitted substantially, while consumers and businesses pay the price for frequent abuse of the system.

Instead of creating efficiencies in the lawsuit process, class actions have increasingly been used as a weapon to extract mega settlements from businesses that often must decide between the risky “bet the company” path of a trial with a possible crippling jury award or agreeing to settle for a certain—and certainly large—amount.

Consumers also have not reaped the benefits first envisioned in class action lawsuits either. In fact, 74 percent of Americans believed the class action system drives up prices and should be restrained (Penn, Schoen & Berland Associates). We see the impact of those costs not only in American bank accounts but on a macroeconomic scale as well. Class actions are one of the primary reasons tort costs amount to 1.9 percent of the GDP in the United States as compared to 0.5-0.7 percent in other OECD countries.

Lawyers, however, make out very well, as they receive much of the money consumers pour into the class action system. Often, plaintiffs’ lawyers arrange settlements that provide for millions of dollars in lawyers’ fees and leave the plaintiffs themselves with relatively small awards, or, in some cases, coupons for products or future services from the very company by which they were supposedly wronged.

For example, a class action suit was filed against the manufacturers of BlueTooth headsets, alleging that they should have warned that high volume could result in hearing loss. The plaintiffs’ lawyers negotiated a settlement in February 2009 by which the defendant companies have to pay $1.2 million to issue warnings about hearing loss, $100,000 to the charities of the plaintiffs’ lawyers’ choice, and up to $850,000 to the plaintiffs’ lawyers themselves. However, the consumers, on whose behalf the suit was filed in the first place, got nothing at all.

For those reasons, European policymakers repeatedly promise their constituents that they have no intention of recreating the American class action system. Unfortunately, if the EU implements the proposal to create class actions in antitrust or consumer cases, it may face similar consequences, as the proposals contain many of the U.S. system’s most problematic features.

Most importantly, they allow for a variety of litigation financing schemes that incentivize plaintiffs, plaintiffs’ lawyers, and consumer organizations to file myriad lawsuits with the promise of sizeable profits. Mechanisms like third party funding – which permits a third party to invest in the outcome of the lawsuit by fronting costs – create incentives to file lawsuits. If the suit fails, it costs the plaintiffs nothing. However, if they prevail, the plaintiffs and their lawyers stand to reap enormous profits. And, unfortunately, the plaintiffs often prevail in even the most frivolous of suits. Many defendants will fork over settlements – no matter how ridiculous the claim – because it is cheaper than enduring a long, costly legal process.

These proposals take a similar approach to forum shopping – by which parties could file in the most plaintiff-friendly member country forums, each of which would be empowered to make damaging, EU-wide decisions. Furthermore, the proposals would allow for duplicative litigation that negates the “efficiency” the EU hopes to achieve with class actions. The proposals may even allow for the same case to be pending in all 27 countries on behalf of the same group of plaintiffs. Some of the European Commissions’ reports on the topic acknowledge the “danger” of forum shopping. Yet, they do not propose significant preventive measures. 

The proposals also claim to recognize the value of alternative dispute resolution (ADR) – an out-of-court procedure that has helped prevent countless abusive lawsuits in the U.S. – but they do not take any steps toward implementation. According to the European Parliamentary Report on one of the proposals, ADR procedures are “an efficient alternative to collective redress, offer fair and quick out-of-court settlement, and should be encouraged.”  Yet, the proposals do not propose any specific ADR procedures, and, in the absence of concrete recommendations, ADR is unlikely to play a significant role in the new framework.

Not only do the proposals invite the same abuses we contend with in the U.S., they would likely attract the U.S. plaintiffs’ bar that has created them. Policymakers contend that European lawyers do not have the same exploitive, entrepreneurial tendencies as does the American plaintiffs’ bar. But what they seem to have overlooked is that American plaintiffs’ lawyers are looking to file class actions in Europe themselves.

U.S. trial lawyers are well aware of the progress towards class actions in Europe, and they are anxiously awaiting the opening of a new market. Some are calling European embassies to see if any bills have passed yet. And others are already opening European offices.

Hausfeld LLP, a U.S.-based class action firm, opened a London office and has been actively advocating for U.S.-style class actions in Europe. Likewise, a New York-based plaintiffs’ firm, Labaton Sucharow & Rudoff, formed an alliance with Italian and German law firms to represent European investors in complex securities cases and class actions. The list goes on.

Just as the U.S. federal courts did fifty years ago, European public officials have the best of intentions. But Europe also has the advantage of America’s experience, and the failed experiment of class actions proves that this is one American innovation Europe should not want to import.