Introduction To Risk Analysis In Litigation
Introduction to risk analysis inlitigationMichael SchaflerMichael BeeforthNovember 18 2015
Introduction to risk analysis in litigationIntroductions Presenter backgrounds Experience with risk analysis?November 2015Dentons Canada LLP
Introduction to risk analysis in litigation Presentation Outline: What is risk analysis? What it isn’t! When to use it? Example case: building a decision tree litigation risk / settlement analysis litigation strategy decisions Risk Analysis in the ADR context (Negotiation / Mediation) Privilege Software and Training Data elements QuestionsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigation What is risk analysis? What it isn’t! Decision analysis is a useful means of organizing uncertainties, regardless ofnumber, which helps counsel and clients feel more comfortable in assessingthe odds Typical assessment language: “good chance” “in all likelihood” “strong case” A method to systematically quantify the risks and uncertainties inherent in thelitigation process Breaks down a complex legal proceeding into its basic parts Allows counsel to think about and express themselves as to the value of thecase in a more rigorous, calculated manner Beware: Garbage in – garbage out! Requires careful and objectiveassessmentsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigation When to use it? Types / size of case Early case assessment Strategy decisions Settlement analysisNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigationClient’s Legal Problem Wrongful dismissal claim by a former executive P was paid 1M salary; 1M annual stock options Our defence: mandatory retirement policy P’s arguments: Didn’t know of policy Policy didn’t apply to him as an executive Legislation allowing such policies violates constitutional rights P says he is entitled to 24 months D says, if any, 12 monthsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigationTo Settle or Not to Settle Claim seeks 4M in damages P has offered to settle for 1.5M The client’s question: is this offer to settle a reasonable one?November 2015Dentons Canada LLP
Introduction to risk analysis in litigationTraditional Application of Professional Judgment:Gut feeling “good chance”, “in all likelihood”, “strong case”, “almost a sure thing”, “somepossibility”, etc.November 2015Dentons Canada LLP
Introduction to risk analysis in litigationAdvanced Application of Professional Judgment:Risk me5Outcome6Outcome7 Decision Uncertainty (External Event)Subjective judgment only Applying subjective judgment systematically“Just trust me”November 2015Dentons Canada LLP Empirically supported conclusion
Introduction to risk analysis in litigationApplied to our Wrongful Dismissal example 5-Step Process1. Identify Ultimate Issues and Significant Influencing Factors- Include assessment of uncertainties (e.g. evidentiary questions)2. Define Outcomes3. Assess and Assign Probabilities4. Do the Math5. Interpret and Refine the ResultsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigation1. Identify Ultimate Issues and Significant Influencing Factors (adjustableas the litigation progresses) Will D be held liable? Did P know of and agree to mandatory retirement policy? If not, did policy apply to executives? Is policy lawful? If liable, what are damages? 1 year notice or 2 years notice? Stock options or no stock options?November 2015Dentons Canada LLP
Introduction to risk analysis in litigationOther potential influencing factors (will change and appear/disappear aslitigation progresses): Availability and admissibility of evidence Impact of performance of witnesses Possible significant interlocutory determinations Who will be the judge Changes in law Appeals?November 2015Dentons Canada LLP
Introduction to risk analysis in litigation2. Define OutcomesOn Liability: wrongfully dismissed or not? P knew and agreed to retirement policy OR P did not know IF P didn’t know: Policy did not apply to executives OR Policy applies to everyone IF policy applies to everyone: Policy lawful OR Policy unlawfulOn Damages: If P wrongfully dismissed P entitled to 12 months notice OR 24 months notice P entitled to stock options OR P not entitled to stock optionsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigation2. Define Outcomes: LiabilityLiability Outcomes in Decision-Tree Format:EmployerSettle 1,500,000P knew andagreed. MRPolicy applied.DecisionWinsPolicy, in fact,did not apply toexecutives.LitigateLosesP did not know.Policy lawful.WinsPolicy unlawful.LosesPolicy appliesto everyone onface.November 2015Dentons Canada LLP
Introduction to risk analysis in litigation3. Assign Probabilities: LiabilityEmployerSettle 1,500,000P knew andagreed. MRPolicy applied.0.2DecisionWinsPolicy, in fact,did not apply toexecutives.0.6LitigateP did not know.0.8Policy appliesto everyone onface.0.4November 2015Dentons Canada LLPLosesPolicy lawful.0.6WinsPolicy unlawful.0.4Loses
Introduction to risk analysis in litigation4. Do the Math: LiabilityEmployerSettle 1,500,000P knew andagreed. MRPolicy applied.0.2DecisionWins20%Policy, in fact,did not apply toexecutives.0.6LitigateP did not know.0.8Policy appliesto everyone onface.0.4Loses48%Policy lawful.0.6Wins19.2%Policy unlawful.0.4Loses12.8%Win 40%Lose 60%November 2015Dentons Canada LLPTotal100%
Introduction to risk analysis in litigation2. Define Outcomes: DamagesDamages Outcomes in Decision-Tree Format:PaymentD WinsDecision 0No StockOptions 1,000,000Stock Options 1,000,000 2,000,000No StockOptions 2,000,000Stock Options 2,000,000 4,000,0001 Year Notice 1,000,000D Loses2 Year Notice 2,000,000November 2015Dentons Canada LLP
Introduction to risk analysis in litigation3. Assign Probabilities: DamagesPaymentD Wins0.4 01 Year Notice 1,000,0000.4DecisionD Loses0.62 Year Notice 2,000,0000.6November 2015Dentons Canada LLPNo StockOptions0.5 1,000,000Stock Options 1,000,0000.5 2,000,000No StockOptions0.5 2,000,000Stock Options 2,000,0000.5 4,000,000
Introduction to risk analysis in litigation4. Do the Math: DamagesPaymentD Wins0.4 040%1 Year Notice 1,000,0000.4DecisionD Loses0.62 Year Notice 2,000,0000.6No StockOptions0.5 1,000,00012%Stock Options 1,000,0000.5 2,000,00012%No StockOptions0.5 2,000,00018%Stock Options 2,000,0000.5 4,000,00018%Total100%November 2015Dentons Canada LLP
Introduction to risk analysis in litigation5. Interpret the Results: Probability DistributionExpected Value 0(*40%) 1(*12%) 2(*12%) 2(*18%) 4(*18%) 1,440,000November 2015Dentons Canada LLP
Introduction to risk analysis in litigation5. Interpret the Results: “Zone of Agreement” AnalysisFactor in: Legal costs, cost of parties’ time, “risk premium”, etc.November 2015Dentons Canada LLP
The excel perspectiveBlended Weighted Exposure(s)Risk of Fixed Term Contract (%) **Likelihood ofMisrep Win(%)10075675033250100 0 725,000 957,000 1,450,000 1,943,000 2,175,000 2,900,00075 0 609,180 804,117 1,218,359 1,632,602 1,827,539 2,436,71967 0 572,117 755,195 1,144,234 1,533,274 1,716,352 2,288,46950 0 493,359 651,234 986,719 1,322,203 1,480,078 1,973,43833 0 414,602 547,274 829,203 1,111,132 1,243,805 1,658,40625 0 377,539 498,352 755,078 1,011,805 1,132,617 1,510,15612.5 0 238,066 314,248 476,133 638,018 616,055 1,641,016** Weighted exposure where no fixed term: (i) valid termination (1/3); (ii) one year notice required (2/3 of 2/3); (iii) novalid termination until 2009 - (1/3 of 2/3).Lose Misrep/Win ContractLose Misrep/Lose ContractWin MisrepWin Misrep(67%)/Lose Contract(67%) 1,046,875 2,900,000 0 755,195Weighted Exposure Based Upon Chances of Alternative OutcomesOutcomeLoseMisrep/LoseContractLose Misrep/ 1Year NoticeWin MisrepLose Misrep/Win ContractLose Misrep/Notice to end2009Exposure(millions)Weight 1Amount 1(millions)Weight 2Amount 50.1210.8528311.1025Weighted TotalNovember 2015Dentons Canada LLP0% 0 261,719 345,469 523,438 701,406 785,156 1,046,875
DefiniteExposureItemopening EBITDASignificant Exposure Significant 1872,112,0002,155,661802,187management bonuses0683,938683,938foreign exchange gain on long-term debtforeign exchange loss on working capital000001,465,000management ,000all other associated costssection 2.8 exclusion000000termination costs000license royaltystock compensation to execsperformance-based stock planacquisition costpayroll expenseR. & D. Expensesrefurbishment expenseswarranty reserve000professional feesdeferred revenue104,6000254,6000254,6000allowance for doubtful accountsinventory reserveSSL technology0000061,94600business closure123 Parts sales123 added margin project salesrelated party transactions: 123 sales through 123000134,7390134,7390Small ExposureNotes9,013,000 accounts for items listed by KPMG as"Material misstatements'4,224,000 2.8 (h), (j) or (k)2,155,661 2.8 (j); per KPMG Audit, note 4(a)802,187 2.8 (j); whole amount, less 589,000already deducted955,809 allocation of 2005 second half perKPMG/ allocation over 12 months0 definition of Aggregate Earnout EBITDA1,465,000 based on hedging argument; 1.465based on difference44,000 TCR charges excluded above; 44,000based on 65-35 allocation per KPMG0402,279 admitted in S/D0800,000 unnecessary R&M; KPMG2005 audit, p. BB500 based on analysis that Xcontributed to EBITDA0 paid on arm's length basis andreasonable500,000 based on analysis that warranty reserveinsufficient based on experience254,600 stock plans, per KPMG2,246,730 error from recogition of start-up costs atproject inception; upgrade on completedK basis61,946 analysis based upon experiencebased on challenge to estimate0 admitted in S/D; deleted aboverelated party transactions: 123 project workbased on KPMG draft exposure analysisbased on KPMG draft exposure analysisWeightedAggregate Weighted ExposureAdditional CostsTotalNovember 201501,358,066949,162 claim lessamount in auditdifference letter00357,135 157,000 TCR; 200,000allocation adjustment3,415,593301,9920328,0001,070,191 based on upgradesover 50,000 on POCbasis1,209,70900 included in auditadjustment0 all business went to 123134,739242,648based on KPMG draft exposure analysisrelated party transactions: 123 purchases fromABCrelocation costsEBITDA after adjustmentsContingent considerationInterest @ 6% to December 31, 2007Payment of Legal CostsTotal payable by (- to) 988,169.74Dentons Canada LLP18,211,231
Introduction to risk analysis in litigationAlternatively other hard and soft costs can be factored directly into theoutcomes with risks assigned: Legal costs – incurred, payable to other side, recoverable Internal costs (actual plus opportunity costs) Time value of money – calculate present value of outcomes (afterexpected number of years in litigation)These “transaction costs” can have a significant impact on both plaintiff’sand defendant’s expected valuesAlso perform the risk analysis from the perspective of the other side (asbest as you can)November 2015Dentons Canada LLP
Introduction to risk analysis in litigationAdvantages of Risk Analysis An indispensable tool for arriving at an informed settlement position Enhances counsel’s professional judgment “Gut feeling” analysis is difficult to explain to client, and does not alwaysinspire confidence Enables strategic settlement offers Helps to sort out relative importance of different issues in a case Software programs can conduct “sensitivity analysis” on each factor Identifies most important issues of which to persuade opposition (and mediator)November 2015Dentons Canada LLP
Introduction to risk analysis in litigationFrailties Have the right issues? Have the right relationships between the issues? Developing the right probabilities and verdict outcomes. Overreliance on numbers without holistic overview of case. “Garbage in – garbage out.”November 2015Dentons Canada LLP
Introduction to risk analysis in litigationRisk Analysis in the ADR Context (Negotiation / Mediation) One of goals of ADR: to encourage each side to make a more realisticappraisal of the strengths/weaknesses of its case Asking parties to develop a joint risk analysis of the case advances thisgoal Narrows issues and focuses debate over specific uncertainties Issue-by-issue discussion vs. sweeping generalities Focus on objective assessments and probabilistic thinking helps removeemotions from the process Quantification exercise forces both sides to acknowledge that total defeat andtotal victory are unlikely Helps to erode entrenched positionsNovember 2015Dentons Canada LLP
Introduction to risk analysis in litigationRisk Analysis in the ADR Context cont’d Can be used to better assess BATNA and WATNA, and likelihood oflitigated outcomes in between A powerful tool to persuade settlement conference judge Establishes counsel’s good faith and ability to compromise (as long as haven’tinput 100% at every branch!) Effectively conveys the complexities of a case to a mediator The more educated the mediator is of the case, the better Visual, numeric advocacy far more powerful than verbal, qualitative advocacyNovember 2015Dentons Canada LLP
Questions?22 November 201529
Further reading Marjorie Corman Aaron and Wayne Brazil, “Shaking Decision Trees for Risks andRewards”, Dispute Resolution Magazine Fall 2015 (22:1) William F. Coyne, Jr., “The Case for Settlement Counsel”, (1999)14 Ohio State J. on Dispute Resolution 367 James E. McGuire, “Why Litigators Should Use Settlement Counsel”,Alternatives: CPR Institute for Dispute Resolution 18:6 (June 2000) The Honourable George W. Adams, Mediating Justice: Legal DisputeNegotiations (Toronto: CCH Canadian Limited, 2003) Marc B. Victor, “Litigation Risk Analysis and ADR” in John H. Wilkinson, Ed.,Donovan Leisure Newton & Irvine ADR Practice Book (Toronto: Wiley LawPublications, 1990) Evan Slavitt, “Using Risk Analysis as a Mediation Tool” (2005) 60 Disp. Resol. J.18 David P. Hoffer, “Decision Analysis as a Mediator’s Tool” (1996) 1 Harv. L. Negot.L. Rev. 113November 2015Dentons Canada LLP
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Example case: building a decision tree litigation risk / settlement analysis litigation strategy decisions Risk Analysis in the ADR context (Negotiation / Mediation) Privilege Software a
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