Decision Tree Analysis: a Means of Reducing Litigation Uncertainty and Facilitating Good Settlements
| Citation | Vol. 31 No. 4 |
| Publication year | 2015 |
Decision Tree Analysis: A Means of Reducing Litigation Uncertainty and Facilitating Good Settlements
Marc B. Victor
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When most attorneys think about litigation uncertainty and how it impacts settling cases, they think mostly about two types of uncertainty: first, the uncertainty regarding what evidence will be available to present at trial; and second, the uncertainty regarding how the judge and jury will react to that evidence and the witnesses—both fact and expert—that present it. And while both of these play an important role in an attorney's and client's willingness to settle, there is also a third type of uncertainty that has a tremendous impact on their willingness—and ability—to settle cases: the uncertainty regarding whether they have valued their case appropriately.
In the face of this last uncertainty, lawyers are nervous about making specific settlement recommendations to their clients. And even in those instances when they feel they have valued their cases appropriately, most lawyers are unable to explain their reasoning convincingly to their clients, mediators, or ultimately their opponents, dragging out the time to achieve acceptable settlements.
Why are lawyers uncertain about whether they have valued their case appropriately? There are two potential reasons: a fear of garbage-in and a fear of garbage-out.
"Fear of garbage-in" is the concern that one might not have thought about all the important procedural and substantive issues—related to both liability and damages—that the judge and
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jury will consider.1 It is also the concern that one might fail to appreciate all of the arguments and evidence the trier will give weight to in deciding those issues, and that counsel's assessments of the chance of prevailing on at least some of those issues might not be realistic.2
"Fear of garbage-out" is the concern that the settlement value counsel is arriving at might not be truly consistent with the issues counsel has identified and the odds counsel has assessed on each issue.3 In other words, even if counsel has avoided garbage-in, are they reaching the right conclusion from their analysis of each litigation uncertainty?
The focus of this article is on avoiding garbage-out—reducing the uncertainty surrounding the quality of the settlement values attorneys assign to lawsuits.4
A simple hypothetical will illustrate how difficult it is to avoid the uncertainty of garbage-out if cases are valued without the help of decision tree analysis—and thus how difficult it is to convince
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yourself, your client, your mediator, and ultimately your opponent, so the case can be settled on reasonable terms. The article will then explain how the use of this tool in the evaluation of litigation eliminates garbage-out, thus facilitating earlier—and better—settlements. Consider the facts below:
The lawsuit is for breach of contract: Defendant was to supply a component necessary for Plaintiff's launch of a new product line. Plaintiff claims Defendant's component did not meet the contract specifications, causing Plaintiff to incur losses arising from (i) the need to replace the component and (ii) the delays that Defendant's breach caused in the launch of Plaintiff's new product line. Defendant counters that its component did meet the contract specs, and further that the contract does not allow for delay damages, and even if the judge rules that it does, any delays were due solely to Plaintiff's own mismanagement of the new product launch and were completely unaffected by the time it took to swap out Defendant's component.
Now, after reviewing the evidence and witnesses, the law, your experience with judges, juries and verdicts in this venue, and your opinion of opposing counsel, you conclude as follows:
• Plaintiff has a sixty percent chance of convincing the jury that the component did not meet the contract specifications, though Defendant has a forty percent chance of convincing the jury otherwise and walking away with a defense verdict.
• There is a seventy-five percent chance the judge will interpret the contract as excluding delay damages, but Plaintiff has a twenty-five percent chance of a ruling in its favor on this issue.
• If the judge rules that delay damages are permitted, there is an eighty percent chance the jury will find that the need to replace the component caused at least some of the delays, but there is a twenty
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percent chance the jury will find the delays were solely due to Plaintiff's missteps.
• If the jury is awarding both delay damages and component replacement costs, there is a fifty percent chance it will award $13 million in total, a twenty-five percent chance it will award just $10 million, but a twenty-five percent chance it will award the full $20 million being sought by Plaintiff for all its losses. On the other hand, if the jury is awarding only the component replacement costs, it is undisputed these were $4 million.
In light of these trial risks, and initially ignoring the costs of litigation that could be avoided by settling, what would be an appropriate settlement amount for this case? Once you have decided on, and written down a value, ask yourself these questions: How certain are you? Are you certain enough to convince your colleagues, your client, or your mediator? Or are you so uncertain that you would be uncomfortable trying to explain how you picked your number, or why it should not be ten percent or even twenty percent different?
In fact, try giving the same fact pattern with the same set of probabilities and verdicts to a number of your colleagues, and ask them to value the case. Do not be surprised if their valuations are pretty evenly distributed from $2 million to $8 million. So, even if you at first felt comfortable with your valuation, how sure are you now? Which of your colleagues have misvalued the case by millions? Is it you? How does the client know whose opinion should be relied on? The wrong choice and the client might be vastly overpaying if defendant or leaving millions on the table if plaintiff. Or, the client might be rejecting what is in reality a good deal and heading into court having misjudged the true risks of litigating. And in light of this experiment, the next time you and your opponent come up with different case values, is it necessarily because you have different views of the chances of success on each issue or is it just as likely
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that your disagreement over an appropriate settlement value is due instead to the garbage-out problem?5
Decision tree analysis offers a sound solution to the problem of garbage-out, thus eliminating one of the major sources of litigation uncertainty and one of the major impediments to settling cases, especially in the early stages. Here is our hypothetical lawsuit in the form of a decision tree:
Decision tree analysis is the analytical discipline universally used to make better decisions in the face of uncertainty and complexity. In
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addition to being taught for decades in business and engineering schools, it has been taught for years in medical schools to enable doctors to make better life-and-death decisions.6
Decision tree analysis is relied on because it has been repeatedly shown that even very smart and very intuitive people are not good at juggling multiple uncertainties in their heads to reach sound conclusions—conclusions that are fully consistent with their analysis of the important underlying issues.
This is especially the case when getting a good overall result for a problem—be it a new business venture, a medical procedure, or a lawsuit—requires (1) success on more than one uncertain factor (especially when these factors might be interrelated); (2) success on any one of several alternative but uncertain paths (especially when these alternative paths might be somewhat interrelated); or (3) doubly so when both of these prior conditions exist. For example, imagine how tricky it is to determine your overall chance of success in a lawsuit where:
Plaintiffs can prevail (a) if they succeed on either their contract or their tort cause of action—though failure on one may have some influence on the chance of success on the other—but (b) where success on each cause of action requires success on both of two or more underlying elements—though success on one element may have some influence on the chance of success on the other(s).
Without employing the tools of decision tree analysis in such situations, one is far too likely to reach the wrong conclusions and make bad decisions.
There are two primary steps in performing a decision tree analysis of a piece of litigation: (1) creation of a decision tree and (2) use of basic probability arithmetic.
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A. Ordering the Issues
In a good litigation decision tree, the issues the judge and jury are likely to decide are laid out, from left to right, usually in the order in which counsel feels they will be decided. This is typically guided by the law, prior appellate decisions, standard jury instructions, the likely verdict form, and so on. But it should also reflect the experience of counsel, since jurors and even judges do not necessarily decide issues in the order they "should"—and putting issues in the wrong order can sometimes have a major effect on counsel's probability assessments. To illustrate, consider a securities fraud case in which the two major items in dispute are whether the information that was not disclosed was "material," and whether the company had the requisite "scienter" when it decided not to make the disclosure. Case law and jury instructions would typically talk first about the materiality element of the cause of action and later about the scienter element. And defense counsel might...
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