by Robert J. Kerwin, Esq. & Matthew S. Furman, Esq.
Originally presented for the Massachusetts Bar Association's CLE Program "Lifecycle of the Business" on May 15, 2012.
Increasing numbers of business ownersand in-house counsel are requesting, in addition to a budget for the rendering of legal services, some evaluation of the uncertainties and exposure of a case even at the early stages of litigation. Counsel defending a lawsuit are well aware that the process of dismissing a complaint or complying with discovery are costs which cannot often be recovered absent a showing that the matter was frivolous. This article addresses the risk/cost evaluative process. The process, if effectively undertaken, may also be used to manage the expectations of the client, a mediator or, in certain circumstances, the other side.
The process is also known by some as a ‘decision tree’ analysis. Many decision trees are segmented according to the ‘outcomes’ or ‘influencing factors’ at various stages of a litigation case. Values are assigned based upon the projected costs. Projected costs may include the direct costs of employing litigation counsel and the indirect costs such as the temporary loss of a key employee who might otherwise be subsumed in the litigation. The potential outcomes are assigned probabilities of occurrence, and a numerical value is assigned based upon the probability and cost.
Uncertain Issues and Influencing Factors
Identifying the ‘ultimate’ issues and ‘influencing’ factors gives both counsel and client a clearer understanding of dispositive issues (i.e. the uncertainties in the case and the downside of continuing the litigation). The analysis can also help counsel gain settlement authority or authority to proceed from the client. In addition, the risk analysis maybe used to gain leverage and convince the other side to accept a proposal of settlement. At a minimum, it helps in producing a cost-effective legal strategy.
Elements of A Decision Tree Analysis
Creating and utilizing this tool involves four steps: “(1) listing the various possible events which might occur in the course of litigation (or beyond); (2) considering the costs or gains associated with each possibility; (3) discounting each possibility by its probability [if appropriate] – estimated likelihood that it will occur; and (4) evaluating the overall picture by [assessing] each possibility by its probability.”
Creating The Decision Nodes
Listing all of the possible events that could occur moving forward in litigation is itself a challenging task. Every realistic possibility could be included or one could reduce each strategy choice or ‘node’ that is within the client’s power to control. Common possibilities that may be considered are: (1) potential motions brought by or brought against the client, including motions to dismiss or for summary judgment; (2) expert reports and expert witnesses; (3) determinations on the admissibility of each parties’ evidence; (4) how each side’s witnesses will present at trial and whether they would be credited or discredited; (5) the causes of action of all of the parties at issue in the suit and their respective elements; and (6) the different types of damages awards that a litigant could end up with from a judge or jury. All of the possible events and their outcomes are mapped out as decision tree nodes or branches with alternative outcomes. When analyzing whether all of the possible events have been included, it is important to make sure that when combined, these decision tree branches are both “mutually exclusive” and “collectively exhaustive.” Each possible combination of branches from left to right is often called a ‘scenario.’
Using The Decision Nodes
Once all the various scenarios are identified, dollar values can be assigned based on their total cost. These dollar values could include attorney fees, litigation costs, potential liability and any other cost that could affect your client, such as the loss of a key employee as described above.
Perhaps the most challenging aspect of creating a decision tree is assigning probabilities. Lawyers are admittedly adverse to assigning numerical values and prefer to speak in phrases that leave them some room to adjust their opinions. However, assigning percentages to each of the different possible events in the scenarios is crucial to decision tree analysis. There are a couple of guidelines to consider when attempting this task. One guideline is that the “emphasis should be on providing realistic assessments . . . . It is counter-productive to be intentionally ‘conservative’ orintentionally ‘aggressive’ with one’s assessments.” Second, the issues that you are assigning probabilities to do not exist on there own or in a vacuum and are often conditional on how other issues are resolved, both before and after that event.
Once the decision tree is presented and the percentages are assigned, simple calculations make the settlement value at a given time attainable. Each scenario will have a combined probability based on the percentages assigned at each step. The probabilities in the scenario are multiplied together to achieve that combined probability. Using this combined probability and the total cost of that scenario, a Probability-Adjusted Value (“PAV”) can be calculated by simple multipication. Adding all of the PAVs together determines the Expected Monetary Value (“EMV”).
The EMV represents the settlement value of the case at the moment. Of course, as the litigation proceeds, new issues or events will arise and impact the potential scenarios moving forward. As a result, the decision tree must be updated as the state of the litigation case progresses.
A completed decision tree may illustrate to the client all of the possible litigation scenarios and their consequences, which will help in thedecision-making process. “[T]his is a powerful tool in communicating with the  client how the legal and factual uncertainties in a case could play out.” Additionally, when it comes to analyzing the decision at hand, perhaps an early settlement offer from the other side, contrasting the EMV with what is on the table can transform an otherwiseemotional decision in to one that is based upon an analytical determination of what makes the most sense in resolving the client’s dispute.
See Marc B. Victor’s article, Interpreting a Decision Tree Analysis of a Lawsuit, which was first published in 1988 and again in 2001, at 1.
Kathleen M. Scanlon, Esq., Mediator’s Deskbook 67 (CPR Institute for Dispute Resolution 1999).
Successful Partnering Between Inside and Outside Counsel § 12:20(Robert L. Haig ed.) (West Group & ACCA 2009).