Settlement Offers – An Approach for Assessing

The mediator delivers the defendant’s offer to the plaintiff and their attorney. It is half the amount claimed by the plaintiff in the lawsuit. The plaintiff reacts with anger and indignation. This is the best offer so far but it is received like the previous ones were, as an insult. Emotions are running high, time is short as the session is due to conclude and the trial starts soon. The mediator sees the offer as not unreasonable. The plaintiff is angry at the offer and confused on why they are being asked to consider it. After all, the plaintiff is suing for the actual amount of damage and anything less, in their eyes, is unjust.

With gentle questioning the mediator realizes that the plaintiff has no grasp of the risk of going to trial. Plaintiffs lose. Awards are less than the claims. These are all real possibilities. But the plaintiff is not thinking of them. And there is no tool or framework that can help them see an objective evaluation of the offer.

Anchoring and Perspective

That strong mix of emotions and lack of framework can lead to poor decisions. They could reject an offer when running the numbers would show that doing so is counter to their interests. They could also accept an offer not knowing that a risk analysis would have shown that it is a bad deal.

Plaintiffs often anchor on a number.[1][2] They focus on one number to the point that other numbers are rarely considered as options. When a litigant is anchored on a number, offers substantially different from that number can induce emotional reactions and a quick dismissal of the offer. This anchoring tendency is a hurdle to settlements. To make the situation even more complex, the emotions related to anchoring exist in tension with those of anticipated regret.

Anticipated regret is the knowledge that there is a possibility of losing the case or receiving an award that is significantly less than the settlement offer.[3][4] For the plaintiff deciding on a settlement offer, they face the real prospect of future regret if they turn the offer down and then either lose the case or obtain a lesser outcome.

These competing forces of anchoring and anticipated regret cause anxiety due to the often time-constrained nature of the settlement activity (a mediation session), the stakes (a major financial event) and the confusion of how to methodically approach the decision.

When people make investment decisions, there are all sorts of aids to help understand the financial implications and to aid them in making the best decision for their risk comfort level. When buying a house, there are mortgage calculators. When setting up a 401K, there are  portfolio modeling tools for balancing risk with growth. When planning retirement, there are calculators for help in balancing budgets with risk.

A plaintiff’s decision to accept or reject a settlement offer is similar to these financial situations. Rejecting an offer is the equivalent of investing that money in a trial in hopes of producing a better result. The question that naturally occurs is: if the offer is rejected and the money is “invested” in a trial, what are the chances that the result would be better and how much more can reasonably be expected? The flip side of that is also relevant: what is the probability of doing worse and how much worse?

Consider the example where the plaintiff is seeking $270,000 from the defendant. In the extreme, if the defendant offers just $1, the decision to reject is easy. The plaintiff has a high probability of getting much more than the offer. Now take the other extreme where the offer is $269,999. The decision to accept is easy. The upside to a trial is $1 and the chance of losing $269,999 due to a defeat at trial is too much to entertain.

But what about offers in between those two. How does the plaintiff assess those?

A Tool That Analyzes an Offer and Informs the Accept or Reject Decision

Recently introduced, Theo is a tool that produces a risk report for any settlement offer in real time. Here is an example.

OfferRisk in Rejecting the Offer and Going to Court
$405,000DownsideUpside
Probability41%59%
Loss / Gain-$410,000$175,000

The Upside column shows the probability of getting more money than the settlement offer through a trial. The Downside column shows the probability of getting less money.

In the Upside column there is a Gain amount. The Upside probability represents outcomes that result in more money to the litigant than the settlement offer amount. A weighted average of those outcomes is subtracted from the offer amount and represents a gain beyond the offer.

For example, if the settlement offer is $405,000, the weighted average of the Upside outcomes is $580,000. The related gain is $175,000 ($580,000 – $405,000).

Similarly, the Loss amount is the difference between the settlement offer amount and the weighted average of outcomes with lesser amounts.

With the Risk Report, the litigant can view the potential gains and losses of rejecting the offer and going to trial. A decision on how much downside risk is too much risk is a personal one. The tool just provides the analysis. The litigant can then use risk analysis to guide their decision making.

Theo is available as a web application. It serves plaintiffs and defendants alike. Theo serves traditional and contingency arrangements. Theo evaluates offers quickly, in real time. And it produces a final report showing the sequence of offers and their risk characteristics.  Learn more about it at www.theo-law.com.


[1] Harvard Law School PON Staff, The Anchoring Effect and How it Can Impact Your Negotiations, Harvard Law School Program on Negotiation Daily Blog, November 26, 2019, www.pon.harvard.edu

[2] “Anchoring (cognitive bias), Anchoring in Negotiations”, Wikimedia Foundation, last modified June 5, 2022, 00:24, https://en.wikipedia.org/wiki/Anchoring_(cognitive_bias)#Anchoring_in_negotiations

[3] Harvard Law School PON Staff, The Regretful Negotiator, Harvard Law School Program on Negotiation Daily Blog, December 13, 2010, www.pon.harvard.edu

[4] “Regret (decision theory”, Wikimedia Foundation, last modified January 14, 2022, 05:16, https://en.wikipedia.org/wiki/Regret_(decision_theory)#Applications

author

Paul Stutler

Launched www.theo-law.com to help people decide on settlement offers often presented in mediations. MORE

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