Settling A “Winner Takes All” Arbitration Through Mediation (Part I)

February 12, 2020

Some of the most difficult arbitrations to settle are those in which completing the arbitration will result in a 100% winner and a 100% loser – and both parties believe they will win. Resolution of the key legal and factual issues will support only one party’s theory of the case – all or nothing. 

The Toolbox Looks Empty

In particular, much of traditional negotiation and mediation theory goes out the window when the case must have a winner and a loser, and

– The dispute really is just about money

– There are no “interests” to satisfy other than each party’s desire to win the case 

– There is no ongoing relationship to repair, preserve or expand

– There are no other, unrelated transactions to bundle with a settlement deal

– Neither party is concerned with precedent or publicity

– Neither party is worried about confidentiality

– Both parties believe the reward of winning will justify the costs of arbitration

Both Parties Think They Will Win

Parties and their mediator facing this scenario will often employ a risk/probability analysis to generate a range of settlement proposals that make sense. Theoretically, assuming the parties agree on the amount of money at stake, a settlement should result if the parties agree on their chances of winning. Of course, reaching that agreement is the hard part.

Each party will typically assign a probability to their chances of winning and multiply that percentage by the amount at stake. Assume a claimant has a demand for $1 million in damages, the respondent denies all liability, and there is no counterclaim. If claimant believes she has a 70% chance of winning, she should be willing to accept a settlement of anything more than $700K. So far so good. But if the respondent also believes he has a 70% chance of winning, or only a 30% probability of losing, there would be a $400K difference between their acceptable settlement proposals – a number too large to overcome by “splitting the difference.”

A Different Way To Look At Risk

At this point, one way to address an impasse is to have each party reconsider its assessment of probability on the merits using a different metric. When parties in a “winner takes all” arbitration assess their probability of success at anything over 50%, they are really saying “I believe it is more likely than not that the arbitrator will find in my favor.” In reality, any given arbitrator in this scenario will either rule in their favor or not – 100% up or down. The better risk analysis to deploy here is one that asks: “Of the ten possible arbitrators that may hear this case, how many will rule in my favor?” I suggest 10 because it makes the math easier and because it coincides with the number of candidates often offered to the parties by the AAA (under Rule 12) and the AHLA DR Service.

This is more than a semantic difference. It illustrates the distinction between probability and frequency. In her excellent book on understanding  risk, An Economist Walks Into A Brothel, Allison Schrager cites research (at page 107) by psychologist Gerd Gigerenzer showing that “frequencies, the actual number of times something happens, resonate better than probabilities because they are more consistent with how humans think and provide the salience we need to make sense of risk.”

Two outstanding athletic teams going into a big game may truly believe they are going to win, but only one will. On the other hand, if the same two teams play ten games, each will likely win some and lose some. Parties in “winner takes all” arbitrations should think like the teams that will play ten games, and develop their settlement proposals on that basis. 

Generating Risk Adjusted Proposals

The range of potential risk adjusted proposals resulting from the likelihood analysis of our hypothetical $1 Million claim would look like this:

Arbitrators Predicted To Find For Claimant X Claim = Settlement Offer

10 of 10  (1.0)                                               $1 Million                                   $1M                 

9 of 10      (.9)                                                $1 Million                                    $900K

8 of 10      (.8)                                                $1 Million                                    $800K

7 of 10      (.7)                                                $1 Million                                    $700K

6 of 10      (.6)                                                $1 Million                                    $600K

5 of 10      (.5)                                                $1 Million                                    $500K

4 of 10      (.4)                                                $1 Million                                    $400K

3 of 10      (.3)                                                $1 Million                                    $300K

2 of 10      (.2)                                                $1 Million                                    $200K

1 of 10      (.1)                                                $1 Million                                    $100K

Using this method better enables our respondent to accept the possibility that he will win less than 50% of the time. It does not require him to acknowledge his case is a “loser.” Indeed, it affirms that some number of arbitrators will find in his favor, albeit fewer than five of ten. 

This also makes the mediator’s reality testing role far easier. It is difficult for a mediator to tell our respondent: “I think it is likely you will lose,” and then get them to agree. Contrast telling them: “I think you have a good case and that some arbitrators would find in your favor, but I also think more of them will find in favor of the claimant.” The discussion becomes an assessment of how many arbitrators are likely to “get” the theory of his case rather than whether the respondent’s argument is “right,” or a “winner.”

Our hypothetical respondent will have a difficult time agreeing to pay $600K to avoid the risk of an arbitration he thinks he should win. That same respondent would far more easily accept an assessment that 4 of 10 arbitrators will find in his favor. 

Once our claimant agrees she will prevail with 7 of 10 arbitrators and our respondent agrees he will prevail with 4 of 10, the $1 million gap has been reduced to $100K, and settlement becomes possible.

UP NEXT: Part II – Closing The Gap By Accounting For Costs And Fees

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