Finding a formula for settlements

Regardless of how well you think you could do on the show "Are You Smarter Than a 5th Grader?," I can virtually guarantee that none of us are smarter than a high school senior honors student. The other night my daughter was explaining a formula that she intended to use to solve a complex statistics problem (I love that she thought I could actually understand it). It got me thinking whether there's a formula that could apply to the mediation environment.

First, a disclaimer: If I was good at math, I would have been a doctor. Second, a further disclaimer: my real purpose in this discussion isn't really to "model" a mathematical formula to help settle cases - it is to use the concept of a formula to help parties and their counsel focus on the essential issues that affect the mediation process. But as it turns out, a formula may have some merit after all.

At the simplest level, a formula for settlement might look something like this: S = E/R, where S = settlement; E = exposure and R = risk. That's simple enough and pretty easy to understand: A settlement occurs when there's a rational analysis of the exposure to the defense (and to the plaintiff for the potential loss or the "swing" created by an attorney fees provision), measured by the risk that both parties face. Of the two main elements in the formula, exposure and risk, exposure is the easiest to measure and it's always the best starting point in any settlement analysis. In my mediation practice, I usually suggest that defense counsel measure exposure starting with the worst case, which is the plaintiff's "wish list" of damages, plus defense fees and costs, plus the potential to pay all or substantially all of the plaintiff's fees and costs if there's an attorney fees provision or some statutory provision that the prevailing party can recover those fees and costs. From there, we can work backwards toward two other scenarios: a "middle case" scenario and a "low case" scenario. In the middle case scenario, I try to focus the defense counsel and client on what the numbers might look like if the plaintiff only recovered in the range of half what the plaintiff seeks. In the low case scenario, the focus is on what happens if the plaintiff only recovers 20 percent or less of the "wish list" numbers.

This simple formula, however, needs further refinement. First, on the issue of attorney fees, the "E," or exposure, in our formula must reflect time, because fees (and costs) increase over time. So, in the context of fees and costs, "E" becomes E(T). This is a more formulaic way of saying something that we all know but sometimes tend to forget: the longer the fight continues, the greater the fees and costs, and the greater the risk that the fees and costs become the tail that wags the dog. Sometimes, the force of the tail wagging the dog shakes the poor dog so hard that it becomes impossible to settle the case. Second, there's a direct correlation between the fees and costs and our worst case, middle case and low case scenarios. The fees and costs accumulate at their own rate, independent of the ultimate recovery of the plaintiff. This means that the percentage of fees and costs, measured against the plaintiff's recovery, can vary dramatically. In a case where the plaintiff spends $100,000 in fees and costs and recovers a million dollars, the fees and costs represent 10 percent of the case. In the same case, but this time where the plaintiff only recovers $100,000 dollars, the fees and costs represent 100 percent. Let's see what impact this has on a case where the plaintiff "blackboards" a million dollars but only recovers $100,000 and the case could have settled in the "low case" range, for $200,000. In that scenario, even if the defense does quite well by limiting the plaintiff's recovery to "only" $100,000, the actual cost to the defense is likely at least $275,000: $100,000 in damages, $100,000 in fees and costs and at least $75,000 in defense fees and costs. The defense could have saved $75,000 by settling for $200,000. Assume also that the plaintiff is awarded $100,000, but the court "cuts" the fees and costs by half. The plaintiff's net recovery is $50,000 - a poor result in the big picture of the case when the plaintiff could have settled for $200,000.

Third, while it's easy to say that "R" should stand for risk, it's not that easy to quantify the risk in any given case. This is certainly a mix of art and science, with probably more art than science on any given day. There are, however, some objective elements that we could factor into our formula that might assist us in evaluating risk. Some of the risk factors that we could use in our formula would include: (1) are there strong legal defenses to the case (such as a statute of limitations defense or a statute of frauds defense); (2) are the damages readily quantifiable, readily provable, or are they esoteric, difficult to substantiate and difficult to prove; (3)are the parties credible or have they been impeached during deposition or likely to be impeached at trial; (4) will the trier of fact feel that the plaintiff is the innocent victim of wrongdoing on the part of the defendants, and the plaintiff has real damages - if so, the plaintiff will likely do better, if not, the plaintiff will likely not do as well; (5) do the "stories" of both parties make common sense, or will one party have to persuade the trier of fact to accept a story that is inconsistent with the trier of fact's own life experience - if the stories are consistent with the life experiences of a judge or jury, it's substantially easier to persuade the judge or jury, if not, it's more like rolling a rock uphill; (6) is there a pot of gold at the end of the rainbow - meaning, is there an insurance carrier or a defendant who is capable of paying a judgment and will do so; (7) are there "intangibles" that will materially affect the outcome of the case - i.e., are the parties particularly sympathetic (or particularly unsympathetic), do the lawyers have experience in the issues at hand or are they out of their element, do the parties have the financial ability to litigate the case, do the parties have wildly unrealistic views or expectations; and (8) does the outcome of the case depend on "technical" legal issues - if so, is the case in front of a "legally oriented" judge, or an "equity oriented" arbitrator.

Taking all this into account, we could further refine the risk part of our formula by adding "M" for multiple, to the formula. Now our formula looks more like this: S = E(T)/R(M). But we need to add one or two more elements to our formula. The first would be the "transactional cost" of the litigation process (let's label that "TC"). Transactional cost is the cost of lost opportunities and the emotional strain of being involved in a lawsuit. The lost opportunity occurs when a party to a lawsuit loses a new project, or a promotion, or a sale, because the emotional and physical energy of that party is drained away by the lawsuit. If we add this to our formula, it looks like this: S = E(T)/R(M) TC. Second, we have to factor in the ultimate fact that nobody in a lawsuit can predict the outcome. We could label this as the "uncertainty factor," or "UF." No matter how confident the parties or their counsel may be the reality is that there are simply too many variables, too many intangibles and too many things that can, and often do, go wrong in a lawsuit - and all of these together make it impossible to predict the outcome.

The final version of our formula looks like this: S = E(T)/R(M) TC/UF. It's still relatively simple, but the next time you are evaluating the wisdom of resolving your litigated dispute, a careful analysis of all the factors in the formula may help you arrive at a winning solution.