Conflict Resolution|Negotiation

Simple Methods to Determine the Value of Claims

Many parties in mediation — and many of their counsel — consider that a “win” is a deal that gets them the number they asked for, or close to it.  In fact that’s not so, and a mediator provides important value to disputants by assisting them to determine, in a claim that will go to trial in two years and subsequent appeal,  what the “right” number is today.

Here are three easy steps towards assisting parties to value their claims.

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Step One: Discount Transaction Costs.  Every good lawyer will advise the client of the litigation budget in the event that the mediation is unsuccessful.  A business-oriented claimant understands that transaction costs diminish the “real” return.  A claim for $100,000 that costs $30,000 to get to verdict and another $10,000 to defend on appeal will net the claimant $60,000.  (Statutory claims that provide for fee-shifting are exempt from this step, but most business-related claimants must bear their own costs.)  So accepting $60,000 today is the same as a complete win at the conclusion of the litigation.

Step TwoDiscount for Likelihood of Success on the Merits.  No lawyer ever counsels a client that the claim is certain to prevail at trial.  An experienced trial lawyer once told me that, in any trial, there’s a 10% chance that an elephant will walk into the room and take the oath as a witness.  

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An aggressive counsel might advise 80% likelihood of success; most advise more like 70% or 60%.  If there is a 75% chance of success at trial (which is to say, a very good chance indeed), then reduce the $60,000 (see Step One) by the 25% chance of losing, and you come up with $45,000.  That’s the number that accurately reflects the value of the claim if you were to wrap it up today and end any uncertainty about the outcome.

Step Three: Determine the Present Value of the Recovery.  Remember that the $45,000 net recovery (reflecting uncertainty) won’t be in the cash till for another three years or more.  At 4% interest, compounding daily, $45,000 in three years is equal to $39,911.68 today.  (A handy-dandy present value calculator is available at http://www.uic.edu/classes/actg/actg500/pfvatutor.htm.) 

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All we’re trying to do in a mediation is to help the claimant and the defendant to get out of the lawsuit: to eliminate uncertainty, shut off the costs of the legal action, monetize the claim, release the reserves against the liability, and redirect their resources back to support for their core business.  The three steps outlined above help in this effort.  In this hypothetical, a claimant receiving $40,000 on the day of the mediation is getting one hundred cents on the dollar of her $100,000 claim.  That’s a helpful fact for a claimant to have in her pocket before negotiation begins. 

Who knows?  The defendant’s opening offer might be close to that number, thinking it would represent a 60% “haircut.”  And if that’s the bid, I hope the claimant recognizes its value.

2 Comments
  1. Isn’t it more accurate to take the maximum verdict and multiply by the probability of success first, and then subtract the anticipated attorneys’ fees and costs to trial? Because costs are the same regardless of whether you win or lose at trial. And if the plaintiff’s lawyer is working on a contingent fee, the legal fee would be applied after assessing the likely amount of the judgment at trial. You might also factor in the time value of money before you subtract costs, because in most cases clients are paying the costs as they go. Of course you also have to factor in probabilities of success and costs at various stages of litigation, such as summary judgment, trial and appeal. And it’s also helpful to get each side to consider the other side’s different assessment of the probability of success.

  2. Great post, Peter!

    Although I’ve used various kinds of Risk Analysis in business, I learned about applying this particular kind of Risk Analysis to mediation from an ADR Day presentation on Decision Trees given by James E. McGuire, Esq.

    For the benefit of other readers, I would like to make several observations about the excellent technique you presented:

    (I’m going to abbreviate “Discount for Likelihood of Success” as DLS, and “Transactional Costs” as TXC.)

    a) The steps you present are to be used in discussion ONLY with the Plaintiff/claimant. I’ll explain further in my point d), below.

    b) From the perspective of the Mediator, I would reverse the order of Steps 1 and 2: First do the DLS, and then deduct the TXC. The TXC is a budgeted number and therefore fixed, so deducting it from the DLS amount instead of the initial claim produces a lower number. I’ll explain why that’s desirable to a mediator in my point d) below.

    In your example, the claim of $100K was first reduced by the $40K TXC to give us $60K. Applying the 25% DLS to that $60K gave us $45K.

    Instead, applying the 25% DLS against the initial claim of $100K would give us $75K, and then deducting the $40K TXC would give us $35K.

    c) I’d like to emphasize what you mention in your Step 2 calculation: the DLS reduces the claim amount by the chance of losing. While we may talk about the chance of winning, it’s important to perform the calculation using the chance of losing.

    From experience, we know that everyone is right and is absolutely going to win at trial. For the claimant, a win would be the full amount; for the defendant, a win would be zero. They come in with absolute certainty, and there is no room for negotiation. We mediators help the parties see their situation more realistically and help them soften their position so they are open to negotiate. One way we can help them see the benefit of sincere negotiation is to express things in terms of what might be lost.

    d) Now I’ll address my reference in point b) above, as to why it is desirable to a mediator that the claim number be calculated to be as low as possible when working with the claimant.

    As we address the parties’ interests and concerns, we’re on the lookout for a “Zone of Possible Agreement” (ZOPA). (This is not my term, and I would give appropriate credit if I could remember who coined it.)

    The ZOPA is not just a range of numbers, it includes the entire range of terms that might bring about a settlement. For example, it might include the performance of some action, or the rendering of an apology. But for this discussion, let’s presume that the only thing left is to find “the number.”

    We want the ZOPA to be broad enough so that each party can find within it a number to which they can agree.

    HOWEVER, there’s more we can do!!! Not only can we use the process above to work with the Plaintiff, we can also use this Risk Analysis technique to help the Defendant!

    Defendants also come to mediation with a number in their mind of what they think they will “win”, and often it is zero: “I’m right, and I owe nothing!”

    As we work with the issues and interests, maybe they begin to see that perhaps just maybe, they might actually have to contribute some money… We use Risk Analysis to help them see how much might be involved.

    Only now, we’re going to come up with the highest possible number that the Defendant might reasonably be required to pay.

    The process is similar to the one presented above, but there is a slight difference… (and that involves adding the TXC rather than deducting it, as we did with the Plaintiff; more on this in a moment…)

    First, we get a realistic DLS for the defendant: let’s say that they realistically think they’ll prevail 60% of the time (= lose 40%); we reduce the claim from $100K to $40K.

    NOTE that while we may talk about their winning 60% of the time, we actually perform the calculation as a 40% chance of losing. Remember: to the Defendant, zero would be considered a 100% win…so in this case, the chance of losing is 40% of the time, making their possible exposure $40K.

    Next we *include* the defendant’s TXC. Let’s say that their TXC is the same for our defendant as for our plaintiff; we add $40K, which gives us $80K.

    So the bottom of the ZOPA is $35K, and the top is $80K.

    Now we apply Step 3, the Present Value calculations. Using your values of 4% for 3 years compounded daily (365 days), the ZOPA shifts to a range of $31,042.41 to $70,954.10.

    Hopefully, that provides enough room for both parties to find agreement.

    I hope that’s helpful!
    -John Montenigro

    Sidebar I: It doesn’t matter if the TXC number is accurate; the fact that it is budgeted means we can use it as a fixed amount. Even if an attorney says they’re working on contingency, there is likely a budget for expert witnesses and other court-related fees.

    Sidebar II: We deduct TXC for the Plaintiff on the presumption that it’s their burden for bringing the case, and that paying the TXC negates the equivalent amount from an award they might win. For the Defendant, we add TXC on the presumption that it will increase what they might be assessed.

    Thus, the mediator can address the dismissive argument sometimes encountered that “transaction costs are a wash, everyone has them” by pointing out that they affect the parties differently and must be accounted for.

    For the purpose of this example, we’re not considering the impact of cases that involve fee-shifting or treble damages, etc.

    Sidebar III: Naturally, the given example could be expanded for more complex conditions. For example, where applicable, we could perform one DLS for Liability, and follow it with a DLS for Damages. The same logic applies as given above, and you handle fixed TXC and Present Value afterward.

    Sidebar IV: There may be many cases where the first calculations do not reveal a clear ZOPA. By “expanding the pie” (including more perceived value), the mediator may be able to eventually identify a ZOPA. But this is not part of the Risk Analysis; it is a mediator skill.

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