Aggregation by Acquisition: Replacing Class Actions with a Market for Legal Claims

Aggregation by Acquisition: Replacing Class Actions with a Market for Legal Claims Charles R. Korsmo  & Minor Myers  ABSTRACT: The traditional class action is broken, and we propose to replace it with a new mechanism for structuring mass claims: aggregation by acquisition. We argue that legal causes of action should be freely alienable, such that even small claims could be bought and sold. In such a world, financiers could purchase claims (or shares of claims) directly from individual claim holders, assembling a mass of claims that may be negative-value if litigated individually but positive-value when litigated together. Aggregation in this way would solve the same collective action problems as class actions and derivative actions, but without generating the serious pathologies that plague those procedural devices. Our proposal may sound like a fanciful thought experiment, but in fact it is already at work in one small corner of corporate litigation: stockholder appraisal. We present the example of appraisal here—where claims effectively trade with shares of stock and where litigation appears strongly meritorious— as a microcosm of how aggregate litigation would work under our proposal. As we explain in this Article, our proposal would improve the deterrent effect of private litigation, would deliver faster and more concrete relief to injured persons, and would minimize the volume of nuisance litigation. While  Associate Professor, Case Western Reserve University School of Law.  Professor, Brooklyn Law School. We have received helpful comments from Hannah Buxbaum, Robin Effron, Jill Fisch, Brian Fitzpatrick, Keith Hylton, Avery Katz, Jim Lindgren, Sean Griffith, Geoffrey Miller, Dana Remus, Suzanna Sherry, Kathryn Spier, Gordon Smith, Ryan Williams, and participants in the 2016 AALS Section on Securities Law Annual Meeting, the 2015 American Law & Economics Association Annual Meeting, the 2015 Vanderbilt New Voices in Civil Justice Scholarship Workshop, the Federalist Society 2015 Young Legal Scholars Workshop, and the 2014 Corporate & Securities Litigation Workshop. We are the principals of Stermax Partners, which provides compensated advice on stockholder appraisal and manages appraisal-related investments, and we have economic interests in the outcome of appraisal proceedings. We received no compensation for the preparation of this Article, and none of the views expressed here were developed directly out of our advisory work. A2_KORSMO.DOCX (DO NOT DELETE) 4/13/2016 10:59 AM 1324 IOWA LAW REVIEW [Vol. 101:1323 aggregation by acquisition may hold promise across a broad swath of substantive law, it could most easily be put into practice in corporate and securities litigation. We outline the reforms necessary for doing so. Extending our proposal to other spheres of litigation would be more complex, raising many serious but potentially surmountable obstacles. I. INTRODUCTION ........................................................................... 1325 II. COLLECTIVE ACTION PROBLEMS AND AGENCY COSTS ................ 1330 A. P ROCEDURAL S OLUTIONS TO C OLLECTIVE A CTION P ROBLEMS : T HE C LASS A CTION AND D ERIVATIVE S UIT .............................. 1330 B. A GENCY P ROBLEMS IN A GGREGATE L ITIGATION ..................... 1333 C. F IXING P ROCEDURAL A GGREGATION WITH M ORE P ROCEDURE .......................................................................... 1337 III. THE PURCHASE AND SALE OF LEGAL CLAIMS .............................. 1342 A. H ISTORIC P ROHIBITIONS ON S ALE OF L EGAL C LAIMS .............. 1343 B. S ETTLEMENT AND C ONTINGENCY F EES AS A S ALE .................... 1344 C. T HE R ISE OF L ITIGATION F INANCE ......................................... 1346 D. T HE L IMITED P ROMISE OF L ITIGATION F INANCE FOR A GGREGATE C LAIMS .............................................................. 1348 IV. AGGREGATION BY ACQUISITION: OUR PROPOSED MARKET FOR LEGAL CLAIMS ............................................................................. 1353 A. A M ARKET FOR L EGAL C LAIMS .............................................. 1354 B. V ALUING L EGAL C LAIMS ........................................................ 1355 C. A GGREGATION BY A CQUISITION IN C ORPORATE L ITIGATION .... 1357 D. T HE B ENEFITS OF A M ARKET FOR L EGAL C LAIMS .................... 1360 1. The Diminished Problem of Attorney Agency Costs ............................................................................. 1360 2. Improved Compensation for Those Harmed ........... 1361 3. Improved Deterrence ................................................. 1363 4. Increased Accuracy and Access in Civil Justice ......... 1364 5. Equalized Influence on Legal Rules .......................... 1366 6. Diminished Litigation Costs ....................................... 1368 E. A CQUISITION V ERSUS A UCTIONS ............................................. 1368 F. A N E XAMPLE OF A GGREGATION BY A CQUISITION : A PPRAISAL A RBITRAGE ........................................................................... 1370 V. OBJECTIONS TO CLAIM PURCHASE AND AGGREGATION BY ACQUISITION ............................................................................... 1373 A. P ERSONHOOD AND C OMMODIFICATION ................................... 1373 B. P REDATORY P RACTICES ......................................................... 1375 C. M ERITLESS AND V EXATIOUS L ITIGATION ................................ 1376 A2_KORSMO.DOCX (DO NOT DELETE) 4/13/2016 10:59 AM 2016] AGGREGATION BY ACQUISITION 1325 D. C LAIM P URCHASE W OULD N OT B E S UITABLE FOR C LAIMS S EEKING N ON -M ONETARY R ELIEF .......................................... 1377 E. A GGREGATION BY A CQUISITION W OULD R ESULT IN I NSUFFICIENT D ETERRENCE .................................................... 1378 F. A GGREGATION BY A CQUISITION I S I MPRACTICAL ..................... 1379 VI. NECESSARY REFORMS FOR ENABLING AGGREGATION BY ACQUISITION ............................................................................... 1381 A. E LIMINATE R EMAINING R ESTRICTIONS ON C LAIM A LIENATION .......................................................................... 1382 B. E LIMINATE THE C ONTEMPORANEOUS O WNERSHIP R EQUIREMENT ...................................................................... 1382 C. E LIMINATE C LASS A CTIONS IN S TOCKHOLDER L ITIGATION ...... 1384 D. R EQUIRE C LASS A CTIONS TO B E S UPERIOR TO A GGREGATION IN O THER C ONTEXTS ............................................................. 1385 VII. CONCLUSION .............................................................................. 1386 I. INTRODUCTION The class action—the principal mechanism in our civil justice system for dealing with mass claims—is a brilliant but fundamentally flawed procedural device. When a large number of people have suffered an injury arising out of a common set of facts, many or all of the individual victims may have suffered harms that are small in relation to the cost of bringing a lawsuit. In the face of collective action problems, the injured parties may go uncompensated and—perhaps more problematically—private litigation can provide little deterrence against conduct that generates substantial aggregate harm. Scenarios abound where collective action problems threaten to paralyze litigation, ranging from mass tort actions involving toxic exposures to products liability actions to consumer antitrust actions to stockholder suits. To solve this problem, American law currently relies on procedure. The primary procedural mechanisms are the class action and, for certain types of stockholder suit, the derivative action. 1 In such actions, an individual plaintiff 1. As discussed below, the derivative action device is an attempt to solve a somewhat different problem than the class action. In a derivative action, a stockholder in a corporation seeks to remedy an injury that is suffered, in the first instance, by the corporation. In theory, there should already exist a mechanism—the corporation itself—for overcoming the collective action problems that would otherwise plague dispersed shareholders. What the derivative action mechanism seeks to address is not so much a collective action problem as an especially acute agency problem as a result of the conflict of interest that arises when the alleged wrongdoers are the directors and officers who control the corporation. Despite these somewhat different purposes, derivative actions and class actions have sufficient similarities to be taken together for most of the purposes of this Article. A2_KORSMO.DOCX (DO NOT DELETE) 4/13/2016 10:59 AM 1326 IOWA LAW REVIEW [Vol. 101:1323 with claims that are ostensibly “typical” of the larger group seeks to bring an action on behalf of the entire group. Absent parties are bound by the resolution of the claim unless, where possible, they affirmatively opt out. 2 In theory, this individual plaintiff can represent the aggregate group unhampered by collective action problems. Although the class action has in recent years been in reputed decline, 3 it is still regarded as one of the most important innovations of modern civil procedure. 4 In practice, however, entrepreneurial plaintiffs’ attorneys in pursuit of a contingency fee are almost always the key players in aggregate litigation. The plaintiffs’ attorneys typically identify and seek out a representative plaintiff, rather than the other way around. Virtually all of the key decisions—including the decision to bring a suit, the litigation strategy, and the decision to settle— are made, for all practical purposes, by the attorneys and not by the putative client. The plaintiffs’ attorney will almost always have a vastly greater economic stake in the outcome of the litigation than any individual plaintiff, and will often have incentives that diverge sharply from those of the class. The tragedy of the class action is that the very same collective action problems that gave rise...