How to Determine and Demonstrate the Reasonable Settlement Value of Your Case

An Overview of Expected Value Methodology

In the typical lawsuit, there is a multitude of potential outcomes, some being more likely and others being more remote. The mathematical methodology of expected value uses the various potential outcomes of the trial of a plaintiff’s claims (or sometimes only the most likely potential outcomes) in combination with an estimated probability for each potential outcome and then “calculates” the expected value of a plaintiff’s claim using the various potential outcome values and assigned probabilities as the components of the calculation. By taking into account all (or at least the most likely) potential outcomes of a trial of the plaintiff’s claims, including the potential outcome that the plaintiff will recover nothing after trial, and by estimating the likelihood of each potential outcome, an expected value calculation gives “credit” for both the best and worst results of trial and does so on a “due credit” basis, meaning that each potential outcome of trial is weighted according to the probability it would be the actual result of a trial.

A simple illustration of expected value methodology. An example of calculating an expected value not involving litigation will aid in understanding this methodology. For this purpose, assume that there are only 10 tickets held by 10 separate individuals for a lottery drawing and that the single ticket among the 10 that is ultimately drawn will win $1,000,000, with the other ticketholders receiving nothing. For the holder of any one of the 10 tickets in this lottery, there are only two possible outcomes: winning $1,000,000 or winning $0. With respect to probability, the odds of winning $1,000,000 for any holder of one lottery ticket are 1 in 10 because there are nine other tickets and the random nature of the drawing ensures that no particular ticket has any better chance of winning than any other ticket. Otherwise stated, the holder of one ticket in this lottery has a 10 percent probability of winning $1,000,000. Conversely, the holder of a single ticket in this lottery has a 9-in-10 chance of winning nothing or a 90 percent probability of a zero payment. The use of expected value methodology can be demonstrated under this scenario by assuming that the holder of one of the 10 tickets in this lottery decides to sell her ticket before the lottery drawing takes place.

If the holder of a single ticket in the above-described lottery offers to sell her ticket, the price she should expect to get, and the price that anyone should be willing to pay, is necessarily based on the possibility that the ticket acquired could be worth $1,000,000, while also accounting for the much greater likelihood that this lottery ticket will ultimately be worth nothing. The determination of what should be offered and paid for such a lottery ticket is ideally suited to an “expected value” analysis and calculation, accomplished as follows:

Possible Outcomes                Probability                             Expected Value

$1,000,000.00                       x .10                =                    $100,000.00

 $ 0.00                                     x .90                =                    $ 0.00

Total Expected Value:                                                          $100,000.00

The foregoing expected value calculation establishes that $100,000 is the fair value for selling or for acquiring a 1-in-10 chance of winning $1,000,000 while simultaneously acquiring or selling a 9-in-10 probability of winning nothing (and actually of losing the price paid for the $1,000,000 chance). As demonstrated by this example, the “expected value” price for acquiring a ticket in this hypothetical lottery is derived by considering all possible returns any individual ticket could possibly provide ($1,000,000 or $0) and then taking into account the relative probability (10 percent versus 90 percent) of each potential return.

Expected Value in the Context of Litigation

There are, of course, significant differences in assessing and attempting to value the potential outcomes of trying a claim in litigation and valuing a lottery ticket based on the illustration presented above. For example, and most notably, the possible outcomes from the trial of a plaintiff’s claim are usually more than only two in number, and determining the respective values of the various possible outcomes of litigation involves considerable subjectivity, requiring the use and exercise of judgment, experience, and, ultimately, educated estimation. However, while disagreement between the parties and their respective counsel about the value of the various potential outcomes from a trial of the plaintiff’s claims and the probability of each possible trial result—the two component inputs for any expected value calculation—is to be expected, these disagreements do not necessarily preclude an ultimate settlement agreement. To the contrary, using an expected value approach to explore settlement should provide a highly productive framework by which, it is hoped, settlement can ultimately be achieved.

An illustration of expected value as applied to litigation. An essential premise of expected value methodology is that 100 percent is the “total” probability that must be allocated among all potential outcomes used in an expected value calculation. Therefore, once all possible (or likely) results from the trial of a plaintiff’s claim have been defined, and at the point when probabilities are being assigned to each possible (or likely) outcome, the total of all probabilities assigned must equal 100 percent—no more and no less. For example, if the determination is made that the likely possible outcomes of the trial of a plaintiff’s claim are $100,000, $50,000, $20,000, and $0 (a defense verdict), the probabilities assigned to these potential outcomes might be 25 percent each. Alternatively, either or both parties might conclude that the appropriate probabilities for the same possible outcomes are 10 percent for $100,000, 50 percent for $50,000, 20 percent for $20,000, and 20 percent for $0. Again, the respective probabilities “assigned” to these variant “likely” outcomes could be any number of other possible combinations, just as long as the sum of all probabilities equals 100 percent.

To demonstrate the calculation of the expected value of a litigation claim using the possible outcome alternatives and probabilities set out in the immediately preceding paragraph, if it was decided that the probabilities of each of the four potential outcomes ($100k/$50k/$20k/$0) were equal (each was 25 percent), the expected value of the plaintiff’s claim would be $42,500 (i.e., the sum of $25,000 [$100,000 x .25] + $12,500 [$50,000 x .25] + $5,000 [$20,000 x .25] + $0 [$0 x .25]). Using the alternative assumptions—$100,000/10 percent probability, $50,000/50 percent probability, $20,000/20 percent probability, and $0/20 percent probability—the expected settlement value of the plaintiff’s claim is $39,000 (i.e., the sum of $10,000 [$100,000 x .10] + $25,000 [$50,000 x .50] + $4,000 [$20,000 x .20] + $0 [$0 x .20]).

Obviously, the end result of any expected value calculation will change as either the possible outcome inputs or the probability inputs change (or as both change). In fact, it should be noted in this regard that opposing parties in litigation could possibly arrive at the same or similar expected value calculation result even though they use different possible outcome inputs or different probability factors.

Addressing multiple claims, counterclaims, and defenses. Although this article’s discussion has thus far used a singular “claim” in explaining expected value analysis, plaintiffs frequently bring multiple claims or at least multiple claim theories, and defendants sometime assert counterclaims in addition to their affirmative defenses to the plaintiff’s claims. Multiple claims or claim theories are also readily amenable to valuation by expected value methodology. More specifically, an expected value calculation may be based on the monetary award amounts a plaintiff might possibly recover as a result of the totality of the claims brought or, if more appropriate (e.g., when different claims could yield separate and non-duplicative relief), based on a separate expected value analysis performed for each of the plaintiff’s claims or claim theories, which are then cumulated (as long as the cumulation does not add potential recoveries that are redundant).

The expected value calculation methodology for a counterclaim (or cross-claim) is exactly the same as for a principal claim. Once the required component variables (i.e., the possible counterclaim or cross-claim value results and the relative probability of each result) are determined, the expected value of any counterclaim can be computed and the counterclaim’s expected value amount can then be subtracted from the expected value of the plaintiff’s claim or claims, thereby arriving at a net settlement value for the case.

Defenses to a plaintiff’s claims, whether legal or factual, are taken into account for expected value calculation purposes either by increasing the probability of a zero or low verdict result, by decreasing the amount of the plaintiff’s likely maximum recovery, and/or by reducing the plaintiff’s projected recoveries across the range of the plaintiff’s possible positive awards. Lower potential recovery amounts as components of an expected value calculation, as well as assigning higher probabilities to lower or zero recovery possibilities, result, of course, in a lower computed expected value.

The effect of risk sensitivity. The foregoing discussion concerning expected value methodology as applied to litigation assumes both parties are risk-neutral or, alternatively, have an equal tolerance for risk. This assumption, of course, may not be true; accordingly, differing degrees of risk tolerance may affect and skew the settlement one party or the other is willing to accept, even if more or less than the expected value of the claims at issue.

Conclusion

The settlement of a lawsuit, reduced to its essence, is a purchase and sale transaction. The use of expected value methodology will almost certainly facilitate more productive and meaningful settlement discussions in any case, even if the parties begin those discussions with vastly divergent views regarding the likely outcome of a trial of the claims at issue or a significant difference of opinion concerning the relative likelihood of a low verdict versus a high verdict. At a minimum, an expected value approach requires each side to consider whether there are alternative or variant possible outcomes from the trial of a plaintiff’s claims; it requires each side to quantify the recovery alternatives it believes are possible from a trial of the plaintiff’s claims; and, hopefully, it requires that each side be able to explain how it arrived at the quantifications it contends are the probable alternative results of a trial and offer support for its “belief” that certain results are more probable than others.

Although settlement discussions grounded on an expected value approach may or may not ultimately lead to an agreement about what the most likely outcomes of a trial would be, or agreement about the relative probabilities of the possible alternative outcomes of trial, the use of expected value methodology for settlement discussions still offers a framework for negotiation that may foster compromise by narrowing the initial difference gap between the parties’ positions or that could even lead the parties to the same or a very similar ultimate valuation of a case, even if by use of different expected outcomes and divergent probability factors. In sum, expected value methodology as a settlement negotiation framework promotes logical and rational discussions of the potential risks and rewards of resolving claims by trial, thereby encouraging a realistic resolution by negotiated settlement. Stated differently dialogue between litigants based on the expected value approach may well facilitate an ultimate agreement about a reasonable price for the plaintiff’s sale and for the defendant’s purchase of the claims at issue.

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