So here is a question, if you instigate litigation and lose, should you pay the winners legal bills? Or, vice versa, if you win should the loser pay your bills? By way of background, the general rule in the U.S.A is that win, lose or draw, each party pays its own bills. This rule, if you want to call it that, may be a contributing factor to the massive amount of litigation this country engages in. In the U.K., I am told, the rule is the opposite. In any event, it is a matter of choice since you can write a contract to provide for loser pays. Loser pays seems to me to have risen in popularity in recent years. It seems like a good idea since it would seem to discourage litigation, but is it really?

One way to think about this issue is to consider the nature of the parties and the amount at issue. In a broad brush way the possibilities fall into two categories: small amounts at issue and large amounts at issue. 

With respect to either small or large amounts at issue, you might have two parties with tight budgets (small parties for ease of reference), you might have one small party and one big budget party (a big party for ease of reference), or you might have two big parties.

In cases where there is asymmetry between the parties, that is one big with lots of dough and one small with limited resources, the loser pays provision places a greater burden on the small party. Even if you assume that the legal bills on both sides will be the same (an assumption that is highly likely to be false), the cost of litigation expressed as a percentage of revenue will be far greater for the small company than the large one. Back to my point about the assumption about the equality of legal bills: Large companies are far more likely to hire large expensive law firms that will run up enormous bills. Small companies are far more likely to watch their pennies. As a consequence the way the loser pays rule operates in reality is that if the small company loses, it pays double and if the big company loses it pays half. All in all these concerns suggest that the loser pays rule strongly stacks the deck against the small company (I really mean the litigant with the more limited budget).

In the case where there is symmetry between the parties, the outcome seems different to me. Here you might want to consider whether you want to discourage litigation and encourage settlements. It is a commonplace that most people think settlement is good because it diminishes risk and cost. If the negotiating space is small enough so that the cost of litigation is a real consideration, then you might want to encourage settlement with a loser pays provision. If the negotiating space is large, so large that no one cares how much they spend on litigation, it wont matter what rule you have agreed to. 

In any event, entrepreneurs and small companies should think carefully about who the litigants might be before they sign up to a loser pays provision.