Settlement Negotiations ➲ Gambling in the Shadow of the Law

18/11/2021

Litigation + Dispute Resolution

Settlement Negotiations ➲ Gambling in the Shadow of the Law

When findings from Gambling Theory Research such as the Fourfold Pattern are applied to Settlement Negotiations in civil legal disputes the long-term $$$ impacts of our tendency toward risk aversion can be substantial. This article focuses on the compelling findings of legal scholar Chris Guthrie when he applied the Fourfold Pattern to two situations in which the plaintiff and defendant in a civil suit consider a possible settlement. 1️⃣ Plaintiff has a strong case; and 2️⃣ Frivolous Litigation …

James D. Ford GAICD

Founder, M.D. & General Practice Lawyer

Contents

The Fourfold Pattern

1️⃣ Plaintiff with a strong case seeking a large sum in damages

Defendant in the same case …

2️⃣ Frivolous Litigation

🤔 Conclusion

The Fourfold Pattern

Findings from Prospect (that is, Gambling) Theory …

This article shares insights about how experts consider Settlement Negotiations really work.

In order to share the insights I have extracted heavily from the book "Thinking, Fast and Slow" by Nobel Prize Winner: Daniel Kahneman.

Studies of Prospect Theory have shown that people attach values to gains and losses rather than to wealth, and the decision weights they assign to outcomes are different from probabilities.

This combination of findings has been coined the Fourfold Pattern.

If these observations don't make a lot of sense at first reading then you are not alone. It is difficult to follow.

It is only when the findings are applied to a very familiar legal scenario for both clients and lawyers, a Settlement Negotiation, that we can come to fully grasp their significance.

Fortunately for us, legal scholar Chris Guthrie has outlined two scenarios in which the plaintiff and defendant in a civil suit consider a possible settlement.

1️⃣ Plaintiff has a strong case; and 2️⃣ Frivolous Litigation … and then applied the Fourfold Pattern to show us how it works as well as its long-term impact.

For many clients + lawyers, the patterns outlined in this blog article as well as their results may seem very familiar.

How does the Fourfold Pattern apply to the Settlement Negotiation of a civil dispute?

The following table summarises the four quadrants.

When analysing a parties negotiating perspective in a civil dispute it is useful to consider in which quadrant the party in negotiating from and what they means in terms of their willingness to trade risk for $$$.

The Fourfold Pattern extracted from pg. 317

Top Right Quadrant ➲ Why seek to turn a manageable failure into a disaster or reject a Favourable Settlement?

"The top right quadrant is where people who face very bad options take desperate gambles, accepting a high probability of making things worse for a small hope of avoiding a large loss.
The thought of accepting a large loss is too painful and the hope of complete relief too enticing to make the sensible decision that it is time to cut one's losses.
This is where businesses that are losing ground to a superior technology (or business strategy) waste their remaining assets in futile attempts to catch up. Because defeat is so difficult to accept, the losing side in wars often fights long past the point at which the victory of the other side is certain, and only a matter of time."

1️⃣ Plaintiff with a strong case seeking a large sum in damages

The trial is going very well for the Plaintiff and the lawyer cites expert opinion that the Plaintiff has a 95% chance to win outright, but adds the caution, "You never really know the outcome until the jury comes in".
The lawyer urges the Plaintiff to accept a settlement in the amount of circa 90% of the amount claimed.
The Plaintiff is in the top left quadrant of the Fourfold Pattern.
The question on the Plaintiff's mind is "Am I willing to take even a small chance of getting nothing at all? Even 90% of the claim is a great deal of money, and I can walk away with it now."
Two emotions are evoked, both driving in the same direction: the attraction of a sure (and substantial gain) and the fear of intense disappointment and regret if the settlement is rejected and the case is lost in Court.
The pressure that typically leads to cautious behaviour in this situation means the Plaintiff is likely to be risk averse and accept the settlement offer.

Defendant in the same case …

The Defendant may not have completely given up hope of a decision in their favour, but realises that the trial is going poorly.
The Plaintiff's lawyers have proposed a settlement in which the Defendant would have to pay circa 90% of the claim and it is clear the Plaintiff will not accept less.
Will the Defendant settle, or will they continue to pursue the case?
Because the Defendant faces a high probability of loss, their situation belongs in the top right quadrant of the Fourfold Pattern.
The temptation to fight on is strong, the settlement that the Plaintiff has offered is almost as painful as the worst outcome being faced.
There is still hope of prevailing in Court.
Here again, two emotions are involved: the sure loss is repugnant and the possibility of winning in Court is highly attractive.
A Defendant with a weak case is likely to be risk seeking, prepared to gamble rather than accept a very unfavourable settlement.

Predicted Outcome

In the face-off between the risk-averse Plaintiff and the risk-seeking Defendant, the Defendant holds the stronger hand.
This means that we can expect or predict that the Plaintiff will settle for less than the statistically expected outcome of the trial.

2️⃣ Frivolous Litigation

The contrasting scenario shows what changes when the Plaintiff has a weak, frivolous suit almost certain to fail.

The parties are both aware of the probabilities, and both know that in a negotiated settlement the Plaintiff will get only a small fraction of the amount of the claim.
The Plaintiff is in the bottom left quadrant of the Fourfold Pattern, with a small chance to win a very large amount; the frivolous claim is a lottery ticket for a large prize.
Overweighting the small chance of success is natural in this situation, leading the Plaintiff to be bold and aggressive in the negotiation.
For the Defendant, the suit is a nuisance with a small risk of a bad outcome.
Overweighting the small risk of a loss favours risk aversion, and settling for a modest amount is equivalent to purchasing insurance against the unlikely event of a bad verdict.
The shoe is now on the other foot: the Plaintiff willing to gamble and the Defendant wants to be safe.
Plaintiffs with frivolous claims are more likely to obtain a more generous settlement than the statistics of the situation justify.

🤔 Conclusion

⚖️ Taking the long view

All of the above is interesting to note and makes a lot of sense.

What really makes an impact is taking the long-term view of what happens when parties pay a premium to avoid a small risk of a large loss.

If you consider a large organisation.
In the example given the City of New York was used.
Let's relocate the scenario to Australia and instead say it's the City of Sydney facing frivolous lawsuits.
Suppose the City of Sydney faces 200 "frivolous" law suits each year, each with a 5 % chance to cost the city $1 million.
Routinely, overweighting the small risk of loss the City of Sydney settles these lawsuits for a payment of $100,000.
The long-term implications of adopting this policy are illustrated using the following divergent outcomes (excluding legal costs) in line with the idea that in order to avoid a small chance of a $1 million verdict, the City will pay a premium which adds up over time.
If the city litigates all 200 cases, based on the 5 % chance of loss, it will lose 10 cases with $1 million verdicts for a total loss of $10 million.
If the city settles every frivolous case for $100,000 its total loss will be $20 million.

Source:

pp. 318-321 of "Thinking, Fast and Slow" by Nobel Prize Winner: Daniel Kahneman.

Social Sharing Image: Courtesy of Charles Deluvio on Unsplash

Credits: This blog article was written by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.

Important Notice:

This blog article is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.