Vermont Bar Journal
Which is Better? The Deal or the Ordeal? An Examination of Some Challenges of Case Valuation
THE VERMONT BAR JOURNAL Volume 36, No. 3 Fall 2010 Which is Better? The Deal or the Ordeal? An Examination of Some Challenges of Case Valuation by Michael Palmer, J.D., Dr. Phil. For it is a habit of mankind to entrust to careless hope what they long for and to use sovereign reason to thrust aside what they do not fancy.
Off by Only $24,900,000
Five-year old Valerie Lakey is horribly and permanently injured when the water recirculation system traps her at the bottom of a wading pool. Her medical care, including as many as a dozen surgeries and a long line of specialists, will cost millions of dollars, not to mention the loss of any chance for a normal life. Her parents file suit on her behalf against various defendants, including the manufacturer of the missing drain cover.
Shortly before trial, the plaintiffs settle with all but one the defendants for $5.9 million. The plaintiffs demand $4.7 million from Sta-Rite, the manufacturer of the defective drain cover. Despite having $22.5 million of insurance coverage, Sta-Rite offers only $100,000. The case goes to trial. Three weeks later, the jury awards the plaintiff $25 million before the punitive damages phase. At this point, Sta-Rite agrees to settle for the jury verdict.(fn1)
Both Sides Miss the Mark
A homeowners association alleges that a real estate broker/developer violated the state's consumer fraud statute and made negligent misrepresentations concerning units at a condominium development. The plaintiff claims that the broker breached his fiduciary duty as a member of the association board by failing to disclose what he knew about deficiencies in the design and construction of the exterior walls of the building and about the use of improper fill (stumps and construction debris).
The defendant's final offer to settle is $25,000. Plaintiff says it will go away for $300,000. The jury returns a verdict for $3,300,000.
Legal Malpractice Compounded by Settlement Malpractice
The defense rejects the plaintiff's $325,000 settlement proposal, waiting until the day before trial to make a $50,000 counteroffer. Not long thereafter, the jury renders its verdict: $7 million for plaintiff. With interest, the defendant law firm pays $10 million to satisfy the judgment.(fn2)
Statistical Studies Say These Cases Were Not Aberrations
In all three cases, at least one side blundered in the settlement phase of the case. In the drain cover case, the defense completely misjudged the case, and the plaintiffs wisely rejected the paltry $100,000 settlement offer. In the suit against the broker, perhaps both sides erred, each appearing to have wildly underestimated the likely verdict.(fn3) And in the legal malpractice drama, each side mispredicted the outcome, but the plaintiff appears to have been in a fog of total denial.
But, you might be saying, these cases are aberrations. Most cases settle at about the right amount of money or, if not, the trial results in a reasonably just result. Courtroom lawyers generally know what they are doing when they settle cases. Or so we might think.
Well, consider the scientific studies conducted by Randall Kiser, published earlier this year in his monumental book Beyond Right and Wrong.(fn4) Kiser studied over two thousand cases in California and approximately the same number in New York, conclusively showing that many parties erroneously reject settlement proposals, obtaining significantly worse results at trial. About 61% of plaintiffs and 24% of defendants who reject settlement offers receive worse results after taking the case to trial.(fn5) In such cases, the parties (or their attorneys or both) have made what Kiser calls "decision errors," rejecting an offer that would have made them financially better off.
On average, plaintiffs who committed a decision error received a judgment that was $43,100 less than the last offer they rejected in settlement negotiations. Although defendants made bad decisions less frequently than plaintiffs, when they did, the average differential was a whopping $1,140,000. And those statistics do not include the additional legal fees, out-of-pocket expenses, diverted executive time, and emotional costs associated with continued litigation.
If there is so much discrepancy between rejected settlements and eventual verdicts, perhaps we should ask how close we get to the correct numbers the other 95% of the time-when we reach agreement. Routine cases handled by seasoned practitioners are probably resolved on or around the right number much of the time because experienced practitioners and insurance claims adjusters have a large database of knowledge about how such cases will likely end up after trial. But what about the unusual cases or those in which one or both attorneys have minimal or no experience? How close do we get to the correct amount in such cases?
It is my view that we get it wrong too often. Plaintiffs accept too little or defendants pay too much. I have held that view for years, supporting it with anecdotal evidence in workshops and articles. It was only with the publication of Randall Kiser's research that my intuition was confirmed with statistical evidence.
But whether we get it wrong 50% or only 25% of the time, getting it wrong is unacceptable.(fn6) The first step to solving the problem is to diagnose why it exists. What factors contribute to decision error in the settlement context?
The Main Causes of Decision Error in the Settlement Context(fn7)
The possible causes of sub-optimal settlements in any given case are many, ranging from lack of preparation, to poor understanding of the case, to pigheaded settlement tactics, to unrealistic clients, to a positional bargaining style, to a variety of subconscious emotional drives, and more. But many of these are secondary factors- symptoms of more basic problems.
In my view, there are three underlying causes of settlement failure: (1) insufficient understanding of the parties' respective interests; (2) positional bargaining and the competitive struggles that it intensifies(fn8); and (3) inaccurate estimates of the Net Present Expected Financial Value of the case.(fn9)
Although all three causes of settlement failure relate to and affect each other, the remainder of this article focuses solely on the last: ignorance of what the case is really worth.
"The Net Present Expected Financial Value" of the case (NPEFV) is a long mouthful for what the case is worth today given the remaining costs, the remaining contingencies (including the likelihood of a liability finding and collectability of a judgment), and the weighted average of a range of damages the judge or jury might award if they find the defendant liable. In negotiation parlance, if the trial is my Best Alternative to a Negotiated Agreement (BATNA),(fn10) what is my BATNA worth today-not yesterday and not tomorrow, but today.
The research by Randall Kiser suggests that one or the other side misestimates its BATNA even in cases that settle. Why? What causes us to get the number wrong? Why do we offer $50,000 in a case the jury thinks is worth $7,000,000 or $100,000 when the jury ultimately awards $25,000,000? Is there something wrong with us? Or with how we go about determining the financial value?
As I see it, there is both something wrong with how we are wired and with how we determine case value, and the two are related.
To understand the value of our best alternative to a negotiated agreement (BATNA)-typically, the trial-we must use predictive judgment. We make (mostly unconscious) predictive judgments many times throughout every day, continually predicting what we believe is likely to happen at any given moment. To predict is to project what we do know (evidence and experience) onto the future. Predictions are guesses of what the future might be like. Predictions are paradoxical in that they represent a kind of knowledge about something that we do not yet know.
Uncertainty and Complexity
Two basic problems plague our predictive judgments in litigation and other settings: uncertainty and complexity.
Uncertainty is the absence of information. The more information we have effective use of, the less uncertainty we ex-perience.(fn11) Uncertainty may be the result of (a) ignorance of data we could obtain, (b) unawareness of data we have already gathered but have forgotten, or (c) events that have not yet occurred. The discovery process is designed to reduce the first type of ignorance. Good information collection and processing procedures (file folders, organizational structures, case management software, and the like) help reduce the second. As to the third, we can reduce uncertainty arising from events that have not yet happened in one of two ways: either we can allow the events to unfold, thereby becoming certain as a result of actual occurrences, or we can organize and analyze the available information, using it to make reasoned guesses about what is likely to happen. This article is concerned primarily with such guesses.
Complexity - too much data - overwhelms our unassisted judgment and decision-making processes. Our conscious brains can manage only a limited amount of information at any one time.(fn12) The vast majority of our predictive judgments come about as a result of subconscious processes, commonly called intuition. Our intuition uses recurring patterns to...