Mediation Tip: The Need for Risk and Cost Assessment in Mediation

Evaluating Mediation Settlement Offers

To settle or not to settle. This is the ultimate question for mediation. Below is a mediation tip for improving mediation and settlement outcomes by calculating the risk-adjusted value of a case.

A settlement analysis at mediation starts with a very simple proposition. Can you do better at trial versus the amount offered at mediation? Or, stated another way, will the uncertain results of a future trial and the additional costs of continued litigation exceed the benefits of a certain settlement?

If you think you can do better at trial, the settlement offer is most likely rejected unless the client is risk aversive, requires the funds immediately, or just wants to end the litigation. If you think you might do the same or worse at trial, the settlement offer is most likely accepted unless the client is willing to take a risk for the possibility of a more significant recovery, wants his/her day in court, or is proceeding as a matter of principle.

So how does one know if they will do better, the same, or worse at trial compared to the amount offered at mediation?

Traditional Legal Evaluations

No one can guarantee success or a specific outcome at trial. Sometimes, lawyers win cases they believe they should lose and lose cases that they think they will win. As a consequence, lawyers are naturally hesitant to provide predictions as to trial outcomes and the value of a case.

The hesitation in providing specific predictions rests in the fact that lawyers do not want to be wrong, do not want to give clients the wrong impression (overconfident or underconfident), or feel uncomfortable providing an economic and statistical analysis.

As a result, when lawyers do provide a prediction of a trial outcome, they usually only provide a subjective opinion on the chances of success in a case or the overall value of the case that assumes they prevail in the matter. Sometimes, the subjective opinion or the overall value of the case is bolstered with jury verdict research showing the resulting verdicts of similar court cases.

Subjective Opinions for Success

When providing a subjective opinion for success in a case, lawyers may indicate that based on their experience, feeling, or hunch, a certain outcome is likely, has a chance, or is probable. The probability of these outcomes could be further described as ranging from high to low. In other words, the lawyer may state that based on past experience, there is a high probability or a great chance of prevailing at trial. The foregoing example is very common, but yet, as a subjective opinion, it can mean many different things to different people.

Typically, when giving a subjective opinion for success, a lawyer will also include a disclaimer that there is a possibility of another outcome or that anything can happen. Such disclaimers often negate, if not minimize, the initial subjective opinion for success, which can confuse clients. For instance, stating that there is a high probability of prevailing at trial but that anything can happen is as ambiguous as it gets.

Subjective Opinions for Value

When providing an opinion as to the value of the case, a lawyer will typically declare that a case is worth a dollar amount, provided that the client prevails at trial. The dollar amount chosen is usually the best-case scenario for that particular side or a range that includes the best-case scenario. For example, lawyers often rely upon jury verdict research for case value. While jury verdict research is certainly helpful in gauging the potential value of a case, it bears noting that it still is the best-case scenario for what another party was able to obtain after prevailing at trial.

Best-Case Scenario Assumption

In many cases, the analysis stops there, and the value of the case for the respective sides ends up being anchored near their best-case scenario. For Plaintiffs, that means the recovery of all conceivable damages, and for Defendants, either no damages or a small nuisance value for the case. In this typical scenario played out all too often at mediation, the gap between the parties as to how they value the case can be quite large. Now that each party has anchored and set the expectations for their clients as to their respective high and low values, each concession by them at mediation can feel like a loss.

The fundamental problem with a best-case scenario assumption is that each side has either overvalued or devalued the case for settlement purposes. They have overvalued or devalued the case for settlement purposes when they rely upon the best-case scenario, assuming they will prevail. Prevailing at trial means certainty or 100% chance, but we already know that cannot be guaranteed.

Arbitrary Risk Values

To get around that uncomfortable fact, some lawyers might provide a value range that incorporates the best-case scenario or make a discount from the best-case scenario to account for the risk. For example, where a lawyer determines the value of the case to be $100,0000, assuming a successful outcome, the lawyer may state the settlement value is in the range of $70,000 to $100,000. On the other hand, when using a discount to account for risk, the lawyer may state the same case has a value of $85,000 to account for risk. Generally speaking, lawyers do not rely on objective criteria or calculations when determining a settlement range or discount to account for risk. These are, once again, subjective and imprecise evaluations based on experience, feelings, and hunches.

Failure to Account for Continued Litigation Costs

The final issue with a subjective opinion on value is that it often fails to account for the cost of continued litigation. Rather, the subjective opinion on value presumes a best-case scenario but frequently fails to deduct as Plaintiff or add as Defendant all the litigation costs to complete the trial. Litigation costs should include both tangible (legal fees, legal costs) as well as intangible costs to the client (value of time, lost business opportunities, value of reputation and relationships, stress).

For example, in the best-case scenario value of $100,000 for a Plaintiff case, it may well cost $20,000 for both tangible and intangible costs to complete the trial. In that instance, the actual net value is $80,000, not $100,000, since costs must be deducted from the Plaintiff's recovery. Accordingly, an offer of $80,000 or more would appear to be a better and more rational option than spending the money and taking the risk of trying to recover the same net recovery in the future.

Conversely, in the best-case scenario value of $50,000 for a Defendant case, it could cost $20,000 for both tangible and intangible costs to complete the trial. In that instance, the actual net value is $70,000, as costs must be added for the Defendant side. As such, any demand of $70,000 or less would be appealing as it limits the risk of a larger recovery and accounts for costs that must be paid to continue litigation through trial.

Objective Evaluation for Mediation

Given the state of a typical evaluation for trial outcomes and value, it is no wonder that it is difficult to evaluate and make informed decisions as to settlement options at mediation.

The Disconnect at Mediation

A subjective evaluation of the value of a case based on the best-case scenario, or a range or discount from the best-case scenario, and nothing more, also does not appropriately or objectively value the case. Also, the failure to account for both the tangible and intangible costs for continued litigation does not provide a reality-based value of the case.

These subjective evaluations can appear arbitrary to the parties as they often lack objective criteria. Negotiations under such circumstances can be confusing and frustrating, akin to the haggling that can be found in a bazaar.

The evaluation of a specific dollar offer in exchange for a vague chance to win or lose leads to a cognitive disconnect. The exchange is not aligned. You are not comparing apples to apples. Quantitative versus qualitative. This disconnect feels uncomfortable and unnatural. In our daily lives, we are used to exchanging a certain number of funds (quantitative) for a specific tangible product or service (quantitative) that can be valued. The key is value, and that is what is often missing in the evaluation of trial outcomes.

A Better Way: Risk-Adjusted Value

The key to aligning settlement offers at mediation so parties feel comfortable making informed decisions is to put an objective and quantitative value on the uncertain trial outcome. In other words, calculating the risk-adjusted value of the case.

The risk-adjusted value of a case is a mathematical calculation that takes into account a probability calculation for success, a separate probability calculation as to recovery value, and the deduction of continued litigation costs (both tangible and intangible). This is an objective analysis and mathematical exercise the parties can do on their own or with the help of a mediator.

The risk-adjusted value of the case replaces the traditional subjective analysis commonly seen at mediation. This objective analysis better informs the parties as to their adjusted risk for the case as well as a guidepost and measuring stick for their expectations. By calculating the risk-adjusted value of a case, the parties can appropriately compare the value of the settlement offer to the net value of the probable trial outcome. Now, we are comparing apples to apples.

In a separate follow-up to this article, I will guide you step by step on calculating a case's risk-adjusted value. These formulas are simple, and you do not need to be a mathematical wizard or spend an extraordinary amount of time processing them. I am currently working on a simple tool and calculator that parties will be able to use at my mediations to do just this.

Until then, feel free to review the resources I have provided below that I found helpful on litigation risk assessment and evaluation for mediation.

Less conflict. More resolution.

Article: Litigation Interest and Risk Assessment

Article: Litigation Risk Analysis

Article: BATNAs and the Emotional Pains