Abstract: What is the socially optimal level of litigation given its expense, and how does it compare to the privately determined level of litigation? The former and the latter levels of legal activity generally differ, and the reasons involve 2 fundamental types of externality. The first is a negative externality: When a party spends on litigation, he does not take into account the litigation costs that he induces others to incur. The 2nd is a positive externality: When a party engages in litigation, he does not take into account the effect that this has on incentives to reduce harm. This paper investigates the standard model of potentially harmful behavior and the liability system, but it allows for the costliness of litigation.