A Theory of Loss Allocation for Consumer Payments

Robert D. Cooter, Boalt Hall, UC Berkeley
Edward L. Rubin, University of Pennsylvania Law School

Abstract

Current legislation allocating losses in the payment system embodies several different approaches. The payment system needs general rules to guide legislation and an analytic framework to develop those rules. Professors Cooter and Rubin use economic analysis to identify three general principles of economic efficiency: loss spreading, loss reduction, and loss imposition. Applying these principles, they develop general rules for allocating payment losses between consumers and financial institutions. The authors apply these rules to fraud, forgery, and error losses that can occur when a consumer uses a payment instrument. They conclude that when an invalid instrument is paid, the consumer should be strictly liable for the loss up to a relatively low, fixed limit, with the financial institution liable for the remainder("capped liability"); and when a valid instrument is not paid, the financial institution should be liable for a proportion of the face value of the loss, up to a fixed limit,with the consumer liable for the residual losses ('face value liability").