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Mediation Tip: Calculating the Risk-Adjusted Value of a Case

Settlement Value

At mediation, parties often struggle with how to value their case for settlement. While the parties may have an idea of what a case may be worth for trial, things get trickier as to what the case is worth for settlement purposes.

Settlement value should take into account the risk of an adverse or lesser result. The whole purpose of a settlement is to resolve the case now to avoid the future risk of an unfavorable result and the expense and time needed for a trial.

The Traditional Mediation Negotiation

Rather than objectively calculating risk and the costs for a future trial, many parties begin their mediation negotiations with a value that represents their best day in court. These opening moves at mediation are often extreme anchors with very high demands and very low offers. In this typical mediation scenario, the opening divide between the two offers is often very large. This represents the start of traditional positional bargaining and its negative baggage.

The negative baggage from positional bargaining includes initial anger over the extreme positions and the endless and seemingly arbitrary small concessions each side makes until they hope to meet in the middle. Many parties feel the whole process is like haggling at a bazaar. Given the extreme anchoring from the start, the parties feel that each concession is a personal loss, further fueling agitation, confusion, and frustration.

Negative Consequences for the Traditional Mediation Negotiation

Clients and lawyers often have vague hunches regarding expected outcomes and costs. Expected outcomes may only be a range of percentages at which they think recovery will occur. Also at play is that clients and lawyers can be overly confident in their positions, resulting in a natural bias in increasing their expected outcome predictions.

Without advance risk and cost assessment, clients and lawyers may only be guessing at possible outcomes and recovery. In this instance, settlement offers are compared to vague, overconfident beliefs and feelings. An otherwise good settlement offer is rejected when it may yield a better result for the client. The client continues with litigation, expends additional resources, and does worse at trial than what could have been had a mediation. We now have an unhappy client and an unhappy lawyer.

The Case for Risk-Adjusted Value

There can be a better way. Rather than playing the traditional positional bargaining game at mediation, I suggest the parties calculate the risk-adjusted value for their case. The risk-adjusted value will mathematically account for the risk of the future trial, its probable outcomes, and the costs of having the trial.

The risk-adjusted value of the case can then be used as an objective guide for the parties to consider, make, and weigh offers at mediation. With this additional information, the parties are empowered to make informed decisions based on probability and risk, so they are not guessing or haggling at mediation.

The risk and cost assessment is an objective math-based tool. The elements of an objective risk and cost assessment evaluation include a simple probability calculation for expected outcomes and a total of all tangible and intangible costs for continued litigation.

When a risk and cost assessment is done properly, the client and lawyer work as a team and are informed with data when making decisions. In this way, clients and lawyers can operate confidently and not simply guess when they either accept or reject a settlement offer that is above or below their risk-adjusted value of the case.

Creating a Risk and Cost Assessment

A litigation risk and cost assessment requires three steps.

The first step is calculating a probable recovery. A probable recovery is a value that incorporates the overall probability of liability along with probable recoverable damages. To obtain probable recovery, you simply multiply probable recoverable damages by probable liability.

The second step is determining the costs for continued litigation, which should include direct tangible costs as well as indirect intangible costs.

The third step is subtracting the costs of continued litigation (step two) from the probable recovery (step one) if you are the Plaintiff to arrive at a risk-adjusted value of the case. A Plaintiff subtracts the costs of continued litigation to account for what must be expended to get to trial. On the other hand, if you are the Defendant, you add the costs of continued litigation (step two) to the probable recovery (step one) to likewise account for what must be expended to get to trial.

Step One: Probable Recovery Calculation

Calculate Probable Liability

The probable liability in a case is determined by a probability calculation for the possible outcomes of the case. To ensure accuracy and not devalue the probability calculations, you should keep this simple by assigning only a few possible outcomes for liability per case. Typically, this would entail, at most, the chance for a dispositive motion and verdict. Below, I will provide a sample case with possible calculations from both the Plaintiff's and Defendant's perspectives.

Plaintiff Probable Liability

In this sample commercial case, the Plaintiff could assign a 75% chance that a jury will find liability. If that is all the possibilities for liability in the case, 75% would be the overall probability for recovery for the Plaintiff. In the same instance, the Defendant may feel that there is a 50% chance for a jury to find liability.

Not all cases are so simple. If there is a pending defense motion for summary judgment, you can also account for that by assigning a separate probability of whether it will be granted. In that case, a Plaintiff could assign a 75% chance to beat the summary judgment. In this example, the overall probability of the Plaintiff obtaining a jury verdict would use the mathematical Product Rule of Probability, which multiplies both probabilities (75% x 75% = 56.25%) to arrive at 56.25% for probable liability. The overall probability is an objective math calculation, yet it may surprise many people who assume the probability of liability should be higher in this instance.

Defense Probable Liability

Conversely, a Defendant in the same case could assign a 50% chance that a jury will find liability and a 50% chance that its motion for summary judgment will be granted. In that example, the overall probability using the Product Rule for Probability (50% x 50% = 25%) results in 25% for probable liability.

Calculate Probable Recovery

The next step is to calculate the probable damages that could be recovered. There are two ways to do this. The simple method is to add all the claimed damages that a Plaintiff will seek and could be awarded at trial. That number would then be multiplied by the probable liability calculated above to determine the probable recovery.

Plaintiff Simplified Probable Recovery

Using our Plaintiff example from earlier, let's assume the Plaintiff believes that $100,000 is a reasonable amount that could be awarded after trial. The Plaintiff would then multiply the $100,000 claim of damages by the probable liability of 56.25% to yield a probable recovery of $56,250.00.

Defendant Simplified Probable Recovery

Similarly, using our Defendant example from earlier, let's assume the Defendant feels the damages are only $50,000. In that case, you would multiply $50,000 by the Defendant's probable liability of 25.00% to yield a probable recovery of $12,500.00.

A more nuanced and better approach is calculating a blended probable recovery to account for a greater range of outcomes. To calculate a blended probable recovery, you assign separate ranges of recoveries (high, medium, and low) with their independent probabilities.

Plaintiff Blended Probable Recovery

Using our Plaintiff example from above, the Plaintiff could assign a $200,000 high recovery with a 25% chance of success, a $100,000 medium recovery with a 50% chance, and a $50,000 low recovery with a 25% chance. Remember, the probable outcome for a blended probable recovery must add up to 100%. These results are then reduced to a weighted average to calculate damages. For this example, the calculation is ($200,000 x 25% = $50,000) plus ($100,000 x 50% = $50,000) plus ($50,000 x 25% = $12,500) for a total of $112,500.00. The weighted average of $112,500.00 is then multiplied by the probable liability of 56.25% to yield a blended probable recovery of $63,281.25.

Defendant Blended Probable Recovery

In the case of the Defendant, the Defendant could assign a $100,000 high recovery with a 25% chance of success, a $50,000 medium recovery with a 50% chance, and a $20,000 low recovery with a 25% chance. The weighted average calculation is ($100,000 x 25% = $25,000) plus ($50,000 x 50% = $25,000) plus ($20,000 x 25% = $5,000) for a total of $55,000.00. The weighted average of $55,000.00 is then multiplied by the probable liability of 25% to yield a blended probable recovery of $13,750.00

Step Two: Continued Litigation Cost Calculation

Now that we know the probable recovery, the next step is calculating the continued litigation costs. Simply relying upon the probable recovery fails to account for the additional costs that must be expended for a trial if a settlement is not accepted.

The client and the lawyer should work together to list all costs for continuing the litigation. This would include the direct tangible costs for legal expenses (experts, reports, transcripts) and legal fees. The client should also attribute a value to the indirect intangible costs for the time, resources, stress, damaged relationships, or lost business opportunities during litigation. The total of the tangible and intangible costs represents the total cost for continued litigation in the event a settlement is not accepted.

Step Three: Risk-Adjusted Value Calculation

The final step in calculating the risk-adjusted value of the case is to account for the costs of continued litigation in Step Two. For a Plaintiff, the costs of continued litigation must be subtracted from the probable recovery in Step One. For a Defendant, the costs of continued litigation must be added to the probable recovery in Step One. In both instances, the parties are accounting for the anticipated costs of continuing the litigation through trial.

Plaintiff Risk-Adjusted Value

If we go back to our Plaintiff, the risk-adjusted value of the case would be the probable recovery of $63,281.25 minus the costs for continued litigation. For this example, let us assume the legal fees are $10,000.00, legal costs are $4,000.00, and the client adds $5,000 for intangible costs for a total of $19,000.00. Subtracting $19,000 as the costs for continued litigation from the earlier probable recovery of $63,281.25 would yield a risk-adjusted value of $44,281.25. The risk-adjusted value represents the net recovery the Plaintiff would obtain after a trial while accounting for risk, probable outcomes, and costs.

Defendant Risk-Adjusted Value

For our Defendant, the risk-adjusted value of the case would be the probable recovery of $13,750.00 plus the costs for continued litigation. Here, let's assume the legal fees on the defense side are $7,500.00, legal costs are $4,000.00, and the client adds $2,500 for intangible costs for a total of $14,000.00. Adding $14,000 to the earlier probable recovery of $13,750.00 would yield a risk-adjusted value of $27,750.00. In this case, the risk-adjusted value represents the net amount the Defendant would expect to pay after a trial while accounting for risk, probable outcomes, and costs.

Impact of Risk-Adjusted Value

There are some notable observations from the example case. In a traditional mediation negotiation, we could expect the Plaintiff to open with a demand of $100,000 or more. Likewise, we could expect the Defendant to offer $10,000 or less initially. The gap between these two offers could be $90,000 or more. From here, the parties will then make small concessions back and forth. Given the extreme anchors the parties have set from the start, each concession will eventually feel painful to each side, and the gap may never be narrowed.

However, if the parties prepared a data-driven analysis of their claims using a risk-adjusted value calculation, they would find that they are much closer to resolution than they thought. The gap between the risk-adjusted values in our example is less than $17,000. This would be the space where the parties can strike a settlement, and it is much easier to overcome than the $90,000 gap they started with. I intentionally created the case example so as to emphasize a more favorable view of the case from each side's perspective. If the parties were closer to each other in their assessment of liability and damages, the gap would be even smaller.

Using Risk-Adjusted Value at Mediation

Parties that calculate a risk-adjusted value of their case are in a better position to evaluate offers and negotiate at mediation. They have created an objective guidepost for what their case is worth at mediation in order to account for the risk of a future trial, its probable outcomes, and all the expenses for the trial.

Rather than relying on hunches, guesses, or being swayed by emotions, the parties can make informed decisions about whether a proposed offer at mediation makes sense to them. The calculated risk-adjusted value is an objective guideline that can be used as a bottom line for mediation.

From the Plaintiff's perspective, offers significantly below the Plaintiff's risk-adjusted value of the case can be confidently rejected unless the client is risk-averse, and those above can be viewed as good deals. Conversely, from the Defendant's perspective, offers significantly above the Defendant's risk-adjusted value can be rejected unless the client is risk-averse, and those below can be viewed as good deals. In the end, knowing your bottom line using a calculated risk-adjusted value of the case will help frame your offers and moves during mediation so you can maximize your results.

Information is power, and the calculation of the risk-adjusted value of a case is one additional tool to maximize outcomes at mediation.

Less conflict. More resolution.