United States: Game Theory Explains How Mediation Can Trump Litigation

When mathematician John von Neuman and economist Oskar Morgenstern invented "game theory" more than fifty years ago, they by happenstance opened a window to greater understanding of the power of mediation to trump litigation as a means to resolve business disputes.

With game theory, von Neuman and Morgenstern made a distinction between "zero-sum" games where one party's win is another party's loss and "non-zero sum" games where one participant's gain need not be a loss to the others. Over the years that game theory has been around it has hardly been limited to explaining mere games. It has often shed profound insight into various human interactions, even nuclear war.

Successful businesses know to seek non-zero sum opportunities out on the "upside" of business transactions. You know the "upside" of a deal, where the plan is for each party to profit, backs are slapped, and the drinks flow. The phrases "win-win" and "strategic partnerships" describe such non-zero sum business relationships.

But what about the "downside" of such deals? The downside is where things don't go as planned, there are losses instead of profits, often followed by recriminations and the concomitant litigation. This is where one or more of the parties move the planned for "win-win" of the deal to the "I win-you lose" of litigation. But alas, if only litigation were often as good as "win-lose." It is not.

Commercial litigation for both the plaintiff and the defendant is routinely worse than win-lose, i.e., "zero-sum." But what is worse than zero-sum? In discussions of game theory the alternatives typically considered are zero-sum and non-zero sum. The "non-zero sum" most frequently referred to is actually a "positive sum" activity where both sides can benefit. The upside of business deals, where there actually is an upside, are everyday examples of positive sum activities. What is typically left out of the discussion of game theory are activities in which both the winner and loser can end up significantly worse off than when they started. These I call "negative-sum." Negative-sum because even for the "winner" the prize won is often worth less than the transaction costs of winning it.

So, there is more to game theory than typically discussed. Not only are there "positive sum" or "win-win" and the zero-sum "win-lose." Worse, there is also "lose-lose." All too often commercial litigation is just that, "lose-lose."

Most businesses instinctively dread being drawn into litigation. They recoil at the thought of being mired in what they intuitively assume is a classic zero-sum. However, often at the end of protracted commercial litigation, particularly after trial, and even more so after appeal, there is a party with a net loss and another party with an even greater net loss. Even the "winner" in the litigation often has the loss of thousands of person-hours of its most important executives and managers, has spent expert witness fees, what can be tens of thousands in the costs of deposition transcripts, hundreds of thousands or more in attorneys' fees, document search and production costs, and other expenses of litigation. Too often, what a plaintiff has to show for it is an empty judgment against an opponent. If the opponent is big enough, it has by its aggressive defense driven up the cost of the litigation to where the cost to get the judgment approaches the amount of the judgment. If the opponent is not big enough, then, as experienced litigants know, the judgment often is against an entity whose resources and talent have been exhausted by defending itself, rendering the judgment uncollectable. Even when it is collectable, the true costs of getting the judgment discount its value considerably.

Businesses make profits doing business, not suing or being sued. Almost nobody makes money at the courthouse but lawyers and judges.

All of this is what often makes commercial litigation "lose-lose." This is not new to any executive who has been involved in extended commercial litigation.

Unfortunately, the temptingly simple conclusion that commercial litigation should be avoided at all costs itself solicits what can be an even worse result. For a potential plaintiff, there are costs for not litigating. Avoiding litigation altogether will make for a defenseless business victim in the marketplace. For the defendant, there is no choice.

But if it cannot be avoided, is there no reasonable alternative? Fortunately, there is. That is to engage in litigation when you should or must, but when possible attempt to shift it to the more positive-sum playing field of mediation. Yes, the power of mediation in resolving commercial litigation is that it shifts it from a "zero-sum" or worse activity to one that is "non-zero sum" because it is in significant part "positive-sum."

How is it possible for the controversy to shift from zero-sum to the positive version of "non-zero" sum?

The answer to the preceding question lies in understanding what often makes commercial litigation negative-sum in the first place. Commercial litigation has hidden costs often not fully recognized until after they are incurred. These hidden costs include:

1) Decision Costs. In a litigated dispute the ultimate decision-makers, the judge and jury, must be taught the facts at trial through a rigid set of rules of evidence. The evidence at trial is based on extensive formal discovery. Typically this is through depositions, written interrogatories, requests for production of documents, and requests for admissions. Each step in the discovery process must be done with care, otherwise an issue or opportunity may be foreclosed. For example, a lawyer's preparation for a deposition of a potentially hostile witness requires thorough preparation by, at a minimum, reviewing all the potentially relevant documents, and reviewing the theories of the case and how the deposition witness can help support or undermine each of them. It also requires reviewing all prior depositions or statements of other witnesses that might bear on what the deposition witness can testify about. Deposition preparation may also require interviewing available friendly witnesses about the areas of prospective testimony of the deposition witness. Often legal research on a point of law or evidence may be required as part of the preparation. Throughout the preparation, a plan of approach and an outline of areas of examination, often in considerable detail, must be prepared. This is all part of the "preparation that meets opportunity" that is the foundation for a deposition that will be as successful as possible. The preparation takes time and is, therefore, expensive.

There is more to decision costs than just the cost of the lawyers’ time. Often experts must be retained to study some portion of the facts and explain the significance of those facts in light of the complexities of a particular field. For example, this can be a field such as accounting, business valuation, damages, or a science or technology. Believe it or not, experts hourly rates often make the lawyers rates look modest.

The formal and rigid process of educating the judge and jury is expensive for both sides. Lawyers, whose fees comprise a significant part of the expense of educating the judge and jury, control the process. If there is an appeal, the decision costs include the cost of the trial transcript and protracted appellate litigation.

2) Distraction Costs. The executives and managers of the parties spend hundreds and sometimes thousands of person hours engaged in the production of documents, meetings with attorneys, preparation for depositions, attending depositions, testifying in depositions, strategy discussions, decision making, hearings and trial.

3) Self-education Costs. Rarely does a party in litigation see the case as the opponent will be attempting to have the third-party decision-maker see it. Therefore, each party will spend considerable time reading depositions, documents and expert reports generated by the opposition. This self-education on the opponent's case is necessary, inevitable and time consuming.

4) Emotional Wear and Tear Costs. Executives and managers involved in litigation suffer emotional wear and tear from involvement in the process of litigation. It often exists throughout the litigation but peaks as they are subjected to vigorous cross-examination in what can be days of deposition and trial. For those not accustomed to facing the presumption of bad faith or the even worse, but nevertheless common, outright accusations of intentional wrongdoing and deceit, the experience of being cross-examined is at best distracting but more often it is difficult and sometimes traumatic.

5) Lost Opportunity Costs. When a company's executives and mangers are tied up by litigation, not only are they being distracted as discussed above, they aren't creating and executing their business plan. Opportunities are passing them by. Worse, and also likely, their business competition is taking advantage of the open field.

6) Business Relationship Costs. Where the parties in commercial litigation are ongoing business partners the integrity of the ongoing relationship is inevitably affected. If loss of the value of the ongoing relationship is often a cost to both parties.

7) Pending Litigation Costs. This cost is often confused with the Lost Opportunity and Distraction Costs described above but it is decidedly different. This is the cost of the avoidance by other potential investors, customers or strategic alliance partners as a consequence of an enterprise having the litigation pending. In short, this is the cost of others staying clear of your business until the litigation is over. This may be a result of the uncertainty of the outcome, or a desire by others not to be embroiled in the conflict by having their records subject to discovery, or similar motivations. While the motivations can be varied, the result is the same. Your firm is being avoided because the litigation is pending.

8) Gamesmanship Costs. Commercial litigation is often full of opportunities for exploitation by the opposition. Even if not, the better a case is, the more likely the opposition will make the process difficult, complicated and expensive because this

often-used "defense" is almost always available and often used. In addition, lawyers often posture to attempt to set the stage for seeking a later court order barring certain evidence, for example, because certain information was not produced earlier. This requires defensive lawyering, often requiring that the opposing lawyer go overboard to avoid it and to be certain to make a record to protect against it. All of this adds to the expense and aggravation of litigation. In a perfect world, gamesmanship costs would not exist. It is not a perfect world.

9) Risk of Loss Costs. In litigation there is always the risk of loss. For a plaintiff there is the risk that its claim will not be vindicated or the risk of loss on a defendant's counterclaim. Lawsuits typically take years to get to trial when many key employee witnesses can be gone and memories have faded. A party may have to call a troublesome ex-employee as a key witness. Defendants face analogous risks of loss. No matter how good a case looks, even on the eve of trial, a key witness might turn sour, a juror who turns out to be very persuasive with other jurors may harbor an undisclosed prejudice, or some other destructive form of ‘lightning' may strike. Courthouse lore is full of examples of great cases tried by great trial lawyers that were lost for a reason that no one could have anticipated or that no one can fathom. But even then, most cases aren't that good. There are other more subtle and more frequently encountered risks. There are many ways a judge and jury can make incorrect decisions that nevertheless cannot be overturned on appeal.

10) Public Record Costs. In litigation a written record is created and it is public. Many companies hire professionals to put their best face forward as part of its public relations plan. The process of litigation is the opposite. Each side's opponent is hiring professionals to dig up negative facts, put the worst plausible spin on them, grind noses into them and make both part of an indelible public record. Often, in spite of efforts to keep trade secret information confidential, the public record will contain commercial information of value to competitors. Forever, others desiring to exploit such information, or discredit one of the parties, will have that record, the result of perhaps thousands of hours of expensive digging, made conveniently available in the public records of the courthouse for future use.

In any given case there are other hidden costs unique to it. The controversy often spreads via counterclaims that exacerbate each of the above costs in a sideshow only tangentially related to the real dispute. Decisions to litigate or counterclaim made in the heat of the moment can have lasting effects. Each of the above costs can become tarbabies that grow and become stickier as the litigation evolves.

So, how can mediation shift commercial litigation to a non-zero sum resolution? Now that the above "hidden costs" have been explored, an understanding the shift requires only a basic understanding of the mediation process.

First, mediation is not binding unless all parties come to an agreement. In mediation in effect the parties "decide the case."

For starters also, mediation should be distinguished from arbitration. Arbitration is another form of dispute resolution in which a private judge or panel decides the case, after very limited discovery and after an abbreviated hearing, followed by very limited appeal rights. Arbitration has its place. Unfortunately, those with experience with it often conclude that its place is often near full-blown litigation.

Mediation is significantly different from both litigation and its close cousin, arbitration. In mediation the mediator does not "decide the case" but is nevertheless an important ingredient. He or she serves as the lubricant to continued communication toward a settlement acceptable to the parties. The mediator does this while avoiding the locking of horns that often takes place where parties and their attorneys are in direct, posturing, aggressive, and defensive communication. By separate sessions with the parties, the classic "shuttle diplomacy," a good mediator filters out the posturing, aggressiveness, and defensiveness. The mediator therefore acts as a semipermeable membrane in the communication between the parties allowing only useful communication void of communication styles and behaviors that otherwise inhibit progress toward a resolution.

A good mediator also adds other value. He or she can help the parties find creative solutions that aren't even in the realm of possibility within the strictures of litigation. For example, there may be other areas in which each side can benefit from more not less interaction with one another. Is one party a source of supply of goods or services that the other needs in some area of activity where they can work together? Is there a licensing or cross-licensing opportunity that would benefit the parties? If so, perhaps a settlement could include the supply or purchase of such goods and services through which a party would compensate another less painfully than with a money judgment. When particular obstacles to resolution present themselves during mediation, creative options can arise that are not even on the radar screen in litigation. For creative solutions, there is no one size fits all. At best it is one size fits one. Sometimes. While the precise creative solution is typically unique to the particular dispute, the opportunities for creative solutions to provide the avenue to agreement are not. They occur frequently enough that it is on the list of options that good mediators routinely explore. What it takes is some "outside the box" thinking on the part of the mediator, and often the parties. Money is rarely the whole answer. Business oriented solutions that can surface in mediation can solve commercial disputes in ways that can’t even be contemplated in the litigation process. Litigation is simply the application of the law to the facts followed by the regimented application of the legally prescribed remedy. And the devil, and litigation counsel, take the hindmost. Creative solutions are not explored, they are eschewed in the "I win-you lose" battles that comprise the litigation war.

There can be more. A few mediators even walk each party through the application of Risk Analysis to the significant issues in the case, so the parties can see the probable outcome based on their own assessment of the various issues and risks. While Risk Analysis is taught in engineering and MBA programs, lawyers generally aren't trained in Risk Analysis. Those mediators who use it, essentially apply Risk Analysis to reveal the "risk of loss" costs defined above. This can be a potent tool for a realistic assessment of the probable outcome, which is often significantly less favorable than what a party assumes before applying this technique. Having the parties and their counsel separately work through the application of Risk Analysis to their own assessment of the strengths and weaknesses of their respective cases issue by issue can be revealing and useful towards a resolution.

The full power of Risk Analysis, however, can be exploited by applying it beyond the issues in the litigation itself. While powerful, it is the most often overlooked even by those few mediators who use Risk Analysis to assess the issues in the litigation. Taken beyond the application to the litigation issues, it can help reveal and make palpable all of the hidden costs discussed above. Before you can assess the potential future impact of a cost and the likelihood of incurring it you have to first estimate what it will be. For example, the "decision cost" can be estimated if the case goes through trial. Then the risk of actually incurring that cost can be determined under several potential circumstances. What is the chance that the other party will concede an important issue, join you in waiving a jury trial, etc. The same can be done for the "distraction" and "self-education costs." Also, the "lost opportunity costs," "pending litigation costs" and "public records costs" described above can similarly be estimated with the attendant percentage risk of actually incurring each. Based on actual experience, when applying this process the cost estimates that are derived are likely to be conservative even when you do a rigorous job of estimating them by careful analysis. Somehow, no matter how carefully we estimate, the fact that litigation tends to have a life and mind of its own makes even careful estimates pale in the face of the actual costs.

Ah, but can’t each party do the above assessment on their own and won’t that have the same prophylactic effect to lead them to a rational settlement? Perhaps. But even if they do so independently, a fact that is not necessarily so, a mediator provides something that is otherwise left to chance if no mediation takes place. It is this. The mediator insures that the parties have thought through the full implications of the hidden "costs" described above and understands how a mediated resolution wipes out those costs for both sides. Thinking through the above hidden costs is not as simple as it may appear. It is endemic among business executives to gloss over the reality of the hidden costs until they are encountered and incurred. Indeed many counsel who attempt to enlighten their clients on the reality of the hidden costs are often rebuffed by a combination of righteousness, the heightened chutzpa born of the fray, inexperience with litigation and a notion that "the truth," their truth, will prevail. Fortunately, there is a certain chemistry to the atmosphere of a mediation session that allows a party to have the reality of the hidden costs set in. Perhaps it is because it somehow makes it easier for one party to accept their reality if they know that the other party has to do the same in their own private sessions with the mediator.

Effective mediators of commercial disputes also do something else that neither party is likely to get any other way. Even if one side has thought creatively about alternative resolutions, thoroughly considered the "hidden costs" described above or applied risk analysis, a mediator can insure that the opponent has too. Good lawyers know all of this. That's why they often recognize the benefits of mediation for their clients.

Once the hidden costs facing each party are revealed, the real risks for each are rigorously analyzed and the creative resolutions are identified during the separate discussions with each of the parties, the dispute is then ready to translate from negative-sum, or at best zero-sum, to the non-zero sum possibilities opened up by a mediated resolution. The remarkable differences between the litigation and mediation processes enable this translation.

Now finally, the answer to the question: How can mediation shift commercial litigation to a non-zero sum resolution? With the understanding of the above described "hidden costs" and the mediation process, the answer comes into focus. It is that the mediated resolution allows both parties each to avoid the hidden costs.

While the core of the dispute "who did wrong to whom and how much are the damages" remains a zero-sum game, through mediation much of what makes commercial litigation negative-sum is avoided for both parties. Therefore, as to these elements, it becomes a non-zero sum game. When you mix a "win-lose" or "lose-lose" transaction with a "win-win" the result is more "win." With more "win" on the table, there are more opportunities for a successful resolution for all parties over what could be achieved by either party in litigation.

To understand the full impact of the shift, consider the above "hidden costs" in the context of a mediated resolution. Unlike litigation, in mediation the parties are the ultimate decision-makers. There is no resolution unless all parties agree to its terms. The mediator doesn’t decide the case but facilitates helpful communication toward a resolution. As stated above, the parties decide. Therefore, the "decision costs," i.e., the costs of educating the judge and jury through the slow, time consuming and expensive discovery and trial process is eliminated. Poof, that significant cost ends. The earlier in the litigation that mediation is attempted the more the "decision cost" can approach zero.

Now consider the "distraction costs." Again, once a mediated resolution is achieved, the distraction costs end too. The executives and managers of both parties can go back to their respective businesses and devote 100% of their time and attention to their attracting and satisfying customers and warding off their competitors. Similarly for each of the parties, executive and manager time and attention lost given to educating themselves as to the facts their litigation opponent is trying to persuade a judge or jury are more likely than not true, come to an abrupt halt. These are the "self-education costs" discussed above. Also, for the executives and managers of the parties, both sides, the "emotional wear and tear costs" are over too. They can go back to not just attending to business but they can also leave behind the sleepless nights, and family time made empty by the emotional wear and tear costs. That is, the anxiety induced by the awareness that counsel for the other side is being paid handsomely to apply a combination of advocacy skills, preparation, education, "spin" and sheer competitive desire to win to make them out at a minimum to be stupid, incompetent, venal, corrupt and possibly perjurious.

Not only do the decision, distraction, self-education and emotional costs end with a mediated solution but the "opportunity costs," "risk of loss costs" and "pending litigation costs" described earlier are gone in a snap too. And, to top it off, there is at least one more great advantage. The "public record costs," the potential for dirt to be easily dug up in the future and published, is also avoided.

All of these are good things for a party to put behind them. But notice something else. A mediated resolution extinguishes these collateral but nevertheless substantial costs for both parties simultaneously.

Through mediation, a litigated dispute changes from a matter which the parties do not control to one which the parties do control. It is translated into what is fundamentally a business decision. What's more it comes with the maximum possible assurance that all of each party’s own pros and cons are properly perceived by each party.

It is the fact that the collateral costs are extinguished for all sides simultaneously that creates areas of win-win. There lies the heart of the power of mediation to convert litigation from the lose-lose game it often becomes. In the mediation process both parties can come face to face with how much they stand to lose in decision, distraction, self-education, wear and tear, lost opportunity, business relationship, pending litigation, risk of loss, and public record costs. This tends to put the importance of the right-wrong of litigation into its full context. A context that only arises in litigation after the fact, when the costs are incurred and it's too late to do anything about them.

So game theory not only explains why the only winners of a nuclear war are those that don't fight it, it also explains why nearly 90 percent of all disputes mediated by a skilled mediator are successfully resolved.