Your Choice: Model Your Litigation, or Overpay

It’s time for some math. Modeling math! No, don’t stop reading! Most law firm pitches are heavy on the lawyers’ records but leave out a crucial part of the litigation: its resolution. This article is about using analytics to pick the right counsel and demonstrate a legal department’s value as a profit-generator, not a cost center. Math is a big part of that.

Every case, plaintiff or defendant, should start with a model that includes expected costs and a target resolution. There is no way to measure success, by which I mean delivering incremental value, if you haven’t defined your expectations. You will also lack the tools needed to decide how much to spend, and when or if to settle.

How Does a Model Help?

As a defendant, a model tells you the cost of a full defense, and helps you better understand your settlement incentives. Success as a defendant does not mean $0. For one thing, you have litigation costs. For another, outside counsel saying “We can win” doesn’t mean “100% guaranteed.” It normally means, “we have a 60%-70% chance.” That means a 30%-40% chance of paying damages.

Hence, math. A 40% chance of losing $50M is an expected cost of $20M, plus the $5M it will cost you to litigate through trial. That means your baseline assessment is that this litigation will cost you $25M. A company’s litigation department didn’t cause the $25M cost, but it is their job to mitigate it. And when they do, they deliver value and profit.

Delivering value on an expected $25M cost means that a settlement on Day 1 for $10M is saving your company $15M. If a settlement of $20M is on the table after you have spent $2M in fees, that option is coming in under budget. It makes a big difference when presenting options to be able to say, “we’re $3M under budget” rather than only being able to say, “please authorize spending $20M.” This is why buy-in from the C-suite on modeling litigation helps align incentives internally and improve your financial results.

Models also help you evaluate the time value of money. There is a temptation to postpone the payment of an inevitable settlement because having money on hand is valuable. A model helps you calculate how valuable. But it also changes your attitude. It is easier to postpone making a payment when you are hoping you will never need to. But if you think about your chance of paying damages not in a binary way (win or lose) but in a probabilistic way (40% chance), you are thinking about the risk-reward profile of delay more accurately.

Math also helps with choosing counsel. Does law firm A convince you that it can improve your chance of winning by 10% versus law firm B? Great! 10% of your $50M liability is $5M. If law firm A is charging $3M more in fees than B, they are projected to save you money. But if they’re only increasing your chance of winning by 5%, then you should go with the cheaper firm. This is value investing. (You’re probably wondering how you can generate these percentages—I’ll get there.)

As a plaintiff, the same math applies but with an added emphasis. Bringing litigation is a choice to allocate scarce capital to a chance of generating a return. That’s investing. If you plan to invest $5M to seek $50M, you cannot make an informed decision without knowing if the chance of success is 10% (expected value of $50M*0.1-$5M=$0) or 90% (expected value of $50M*0.9-$5M=$40M).

Regardless of whether you are a plaintiff or defendant, there are more modeling benefits. You need to set up legal reserves. You need to manage disclosure obligations and measure materiality. You need to project your legal costs and cash flows into the future as a basic of corporate monitoring and financial management. All of that will be done better and more efficiently if you have consistent treatment of your litigations and target resolutions.

How To Generate a Model

The standard rejoinder is that litigation is too uncertain to sustain sensible models. This is nonsense. Litigation funding companies raise $100s of millions modeling litigation and projecting returns. The success of that industry is proof that through diligence and experience, modeling litigation is a winning strategy. Moreover, every capped fee, hybrid contingency, and success fee you’ve ever had pitched to you is implicitly based on estimates of the resolution value and risk of a litigation. The fact that those assumptions don’t get written down in Excel doesn’t mean they don’t exist or that large bets aren’t being made on them.

So how do you do it? First, you’re not on your own. Most litigation funders would be delighted to help you work through your choices. Second, though, you’re not flying blind. Maybe you have a history of litigation at your company that you can use to work out your historical costs, and how your cases resolved relative to the initial damages demands or projections. Litigation funders’ models are more accurate in aggregate than they are on individual cases—which makes sense because investing in one litigation might be a 70%-30% win-loss proposition, but investing in 20 with sufficient returns on the 70% wins to make up for the 30% losses is a business. You may be better off modeling your litigation portfolio in the aggregate than case-by-case.

You also have other sources of data. Your outside counsel that claims they can improve your resolution outcome has a track record. Ask them how their resolutions compare to their pre-litigation estimates in past cases. If they don’t know, then ask them to compare their demands in their complaints (on the plaintiff side) or the first damages demands or complaint numbers (on the defense side) to their final resolutions. Look at their budgets—there are tools out there to help you understand what a reasonable budget looks like. But also, are they confident enough in their budget that they are willing to stick to it? And look at case resolution schedules. Law firms chronically underestimate the time to resolution, but objective information is available through subscription databases.

If most of your litigation is defense, you might think the lessons from the funding industry are harder to apply, but that isn’t really true. Once you define success on the defense side, your ability to model, plan for, and finance that success open up. Again, let’s check the math. If you are facing $5M in fees and costs and a 40% chance of $50M in liability, you are looking at a 60% chance of spending $5M and a 40% chance of spending $55M for a weighted average (40%*$55M + 60%*$5M) liability of $25M.

But if you finance the litigation costs to get better counsel and give yourself a 70% chance of winning, reducing your out of pocket litigation costs to zero, and pay a success fee of $14M if you win, your weighted average liability has decreased to $24.8M and you are protected on the downside by not bearing the risk of litigation budget cost overruns. Modeling is agnostic about whether something is a cost (defense liability) or revenue (plaintiff claims). You are not! But the math works either way.

Bottom Lines

Sometimes the math doesn’t capture everything. Maybe you prefer law firm A because they know your business well and will be less disruptive. Maybe you like working with them. Maybe you want to avoid settling not because of this litigation but because of the next one or the twenty after that. Maybe you were truly wronged or you are offended by the claims brought against you and a resolution that doesn’t reflect that is just not acceptable. That’s all fine. Modeling tells you how much you are paying for those positions. (Roughly speaking, rejecting a settlement at $20M in a litigation projected to cost $25M costs at least $5M, and probably exposes you to the risk of trial.) If you are comfortable with the cost, you go for it, it’s your business. But before you decide, do the math so that you know what the cost is.

Litigation is going to be on an upswing in the coming months as the courts re-open and COVID litigation continues. Take the time to model your litigation—individually or as a portfolio—and make the right, cost-effective decisions for your business. Picking counsel, deciding whether to bring a claim or when and for how much to settle, and deciding how to finance your litigation are all decisions that need to be informed by a full picture of the costs and benefits. Bring in a funder as a consultant or to help manage costs. And give credit for good litigation management where it is due! Every other department has graphs and models showing that they beat expectations and generated value and the legal department should too, because that is what they do every day.

Joshua Libling is a former portfolio counsel at Validity Finance in New York.