Using Contract Terms to Detect Underlying Litigation Risk : An Initial Proof of Concept

This preliminary study examines whether the presence or absence of certain terms in a company's form contracts can reveal its level of litigation risk. First, I estimate the risk of independent contractor misclassification litigation for service-based “sharing economy” businesses by measuring the amount of control they exercise over their contractors. The estimates reveal that sharing businesses exercise varying amounts of control over their independent contractors, such that some businesses are exposed to a higher level of litigation risk than others.Next, I analyze each company's form contracts for provisions intended to mitigate misclassification-related litigation risk (“misclassification provisions”). I then test whether the presence of such provisions predict a company's estimated litigation risk on both in sample and out-of-sample data.Results suggest that the number of misclassification provisions in a company's form contract is generally predictive of its estimated litigation risk, although the sample used in this study was small. The regression model was predictive of risk estimates on out-of-sample data.Results tentatively support the hypothesis that the presence of certain contract provisions can signal greater underlying liability. Lawyers may inadvertently broadcast underlying liability when they add provisions intended to mitigate a perceived litigation risk