Mediation and the Science of Decision Making Part II: People Act Rationally, Don’t They?

You may not have heard of Daniel Kahneman, but his work has had a tremendous impact on the way that we understand human decision making. Kahneman won the 2002 Nobel Prize in Economic Sciences for his work on this topic with Amos Tversky. (Tversky passed away in 1996, and they do not award the Nobel posthumously.) In his 2011 book, Thinking, Fast and Slow, Kahneman explains many of the factors that lead people to make the decisions that they do.

People act rationally, don’t they?

One of the pillars of modern economic theory is the idea that individuals act rationally: they seek to maximize their satisfaction based on their preferences and the information available to them, in a way that changes little over time or in different contexts. 

The “rational choice theory” holds that a person faced with a decision regarding money will choose the option that maximizes financial gain and minimizes losses. For example, given the choice between a gift of $50 and a gamble that offers a 75% chance of winning $100, a rational person should choose the gamble. The value or “expected utility” of the gamble equals the amount of the potential gain multiplied by its likelihood: in this case, the expected utility of the gamble is 75% of $100, or $75. Because the value of the gamble ($75) exceeds the value of the sure thing ($50), rational choice theory predicts that a rational person will choose the gamble. 

In the settlement context, the rational choice theory predicts that parties will evaluate their cases the same way, based on the likelihood of the anticipated outcomes. Remember Adam from last week? Although he had a weak case, he rejected a reasonable settlement offer, took his case to trial, and -- predictably -- lost. 

Adam should have evaluated his case by looking at the judgment that he was most likely to recover multiplied by the likelihood of achieving that judgment. So if he believed that he had a 10-20% chance of winning a $300,000 judgment, he should have evaluated the case as having a value of $30,000 to $60,000. If the defendant offered him a figure in this range, the rational choice theory predicts that he would accept it. 

But human beings in the real world do not make such rational decisions. Kahneman and Tversky revolutionized economics by showing that a number of behavioral patterns and cognitive errors play an important role in the way that people make decisions. Understanding these cognitive errors will improve your decision-making and your results in litigation and mediation. 

Next week, we will start looking at these cognitive errors.  

Mediation and the Science of Decision Making Part I: Introduction

Very frequently in mediation, as in life generally, we observe people making decisions that that seem irrational, overly emotional, too timid, or unnecessarily risky. Why? Why would intelligent, thoughtful, successful people take courses of action that seem to make no sense?

As it turns out, the field of behavioral economics holds a number of extremely interesting insights into these questions, as well practical lessons that we can use in mediation to help people make better decisions.

Over the next several weeks, I will post a series of short articles addressing these issues.

I'll start with some examples. As you read through them, consider whether you think these people are making the right decisions.

Adam files an action for sexual orientation discrimination and retaliation. Both sides agree that he likely has enough evidence to survive summary judgment, but serious problems with his credibility make success at trial extremely unlikely. If he can succeed, he has a possibility of recovering more than $300,000 in damages. Adam's attorneys tell the mediator in private caucus that Adam is a difficult client, and they do not want to take the case to trial. The defendant offers Adam a reasonable amount that reflects both the potential exposure and the small likelihood of such a result. Adam rejects the offer against the mediator's and his attorneys' advice, takes the case to trial, and loses.

Beth works as an executive for Company C, a mid-sized and growing company. After her termination, she files suit alleging quid pro quo sexual harassment, retaliation, and defamation. Beth has not been able to find a new job, and she has evidence that her former employer’s CEO has defamed her to potential employers. Beth has good evidence, including smoking gun emails that the company attempted to destroy. Three years after her termination, her economic damages are in the mid six figures, her emotional distress is well documented and credible, and the company and its CEO have strong financials, making substantial punitive damages a possibility. Beth's final demand at mediation is at the high end of the reasonable settlement range, with an indication of negotiation flexibility. The defendants realize that they face serious risks at trial, but they decide to take their chances, against their attorneys' advice. The jury brings back a seven-figure verdict, including punitive damages against both defendants, and the Court of Appeal affirms.

Denise is a highly-paid salesperson. She does not make policy decisions or supervise other employees. She is paid a salary plus quarterly bonuses (not commissions), and she works 15 to 20 hours of overtime per week. After she leaves the company, she brings a wage and hour claim for unpaid overtime compensation. Her attorneys calculate her unpaid wages at over $200,000. After Denise wins summary adjudication of the defendant’s exemption defenses, the parties engage in mediation. Late in the day, the defendant makes its “last, best, and final” offer of $50,000. Although Denise's attorneys feel very strongly that she will succeed at trial, and her claim (including penalties, interest, and attorney fees) now exceeds $400,000, Denise feels that the best choice is to take the sure thing and she accepts the offer.

Why would Adam and Company C reject reasonable opportunities to settle and instead take bad bets at trial? Conversely, why would Denise take a relatively low settlement figure, rather than pursuing a strong case at trial? 

Next week, we will start looking at the answers to these questions.  

Steven G. Pearl Joins ADR Services, Inc., as Mediator

Steven G. Pearl has joined the award-winning panel of neutrals at ADR Services, Inc. He is available immediately to resolve matters throughout California.

Mr. Pearl began his litigation career practicing as a defense attorney at Orrick Herrington before founding his own firm in 1994. As Principal of The Pearl Law Firm, Mr. Pearl has litigated hundreds of individual and class action wage & hour, employment, unfair competition, and consumer protection suits on behalf of plaintiffs. His prolific writings on negotiation, employment, wage & hour, and class action law, along with his successful litigation practice, earned him a place on the 2011 “Super Lawyers” list.

Mr. Pearl began mediating in 2007. He received his mediator training at the Straus Institute for Dispute Resolution at Pepperdine Law School. He quickly earned a reputation as a tenacious, creative settlement professional, and his scholarly legal knowledge and compassion and respect for both parties at mediation have allowed him to broker settlements in over 100 disputed matters.

“Steve Pearl has the drive, knowledge, and skill set our firm seeks when recruiting new panelists,” explained Lucie Barron, President and founder of ADR Services, Inc. “He is a great addition to our group of employment mediators, and we strongly believe that putting our firm behind his excellent reputation and substantial litigation and mediation experience will further build his ADR practice.”

"I am honored to be selected to join ADR Services," Mr. Pearl said. "I have always appreciated the professionalism and competency of ADR's leadership, staff, and neutrals. I look forward to working with them and continuing to provide my clients with the highest level of mediation services."

Facebook and The Winklevoss Twins: Ninth Circuit Upholds Contractual Mediation Confidentiality

Over the last several years, California courts have clarified and strengthened mediation confidentiality. In Cassel v. Superior Court (2011) 51 Cal.4th 113, Radford v. Shehorn (2010) 187 Cal.App.4th 852, and Simmons v. Ghaderi (2008) 44 Cal.4th 570, California courts have construed mediation confidentiality very broadly, refusing to allow statements made in the course of mediation into evidence.

But mediation confidentiality in California courts is based on the California Evidence Code. Do the same rules apply in federal court?

The Ninth Circuit addressed this issue in The Facebook, Inc. v. Pacific Northwest Software, Inc., --- F.3d ----, 2011 WL 1346951 (9th Cir. 4/11/11). The case concerns allegations that Mark Zuckerberg stole the idea for facebook.com from Cameron and Tyler Winklevoss, as depicted in the film, The Social Network.

The district court ordered the parties to mediation. Before mediation, they signed a confidentiality agreement, stipulating that all statements made during mediation were privileged, non-discoverable and inadmissible "in any arbitral, judicial, or other proceeding." At mediation, the parties signed a "Term Sheet & Settlement Agreement."

The Winklevosses agreed to give up ConnectU in exchange for cash and a piece of Facebook. The parties stipulated that the Settlement Agreement was “confidential,” “binding” and “may be submitted into evidence to enforce [it].” The Settlement Agreement also purported to end all disputes between the parties.

The settlement fell apart during negotiations over the form of the final deal documents, and Facebook filed a motion with the district court seeking to enforce it. ConnectU argued that the Settlement Agreement was unenforceable because it lacked material terms and had been procured by fraud. The district court found the Settlement Agreement enforceable and ordered the Winklevosses to transfer all ConnectU shares to Facebook. This had the effect of moving ConnectU from the Winklevosses' to Facebook's side of the case.

Slip op. at 1.

The Court held that the settlement agreement was enforceable. First, it contained all necessary material terms, even though it contemplated additional documents to complete the deal.

California allows parties to delegate choices over terms, so long as the delegation is constrained by the rest of the contract and subject to the implied covenant of good faith and fair dealing. Delegation isn't necessary for a contract like the Settlement Agreement to be enforceable, as the court may fill in missing terms by reference to the rest of the contract, extrinsic evidence and industry practice. But the clause quoted above leaves no doubt that the Winklevosses and Facebook meant to bind themselves and each other, even though everyone understood that some material aspects of the deal would be papered later.

Slip op. at 2.

The Court then reached the confidentiality issue.

After signing the Settlement Agreement, Facebook notified the Winklevosses that an internal valuation prepared to comply with Section 409A of the tax code put the value of its common stock at $8.88 per share. The Winklevosses argue that Facebook misled them into believing its shares were worth four times as much. Had they known about the $8.88 valuation during the mediation, they claim, they would never have signed the Settlement Agreement. The Winklevosses charge Facebook with violating Rule 10b–5, and they seek rescission of the Settlement Agreement under Section 29(b) of the Securities Exchange Act of 1934 (the Exchange Act).

Slip op. at 3. The Court held that contractual mediation confidentiality -- not any common law privilege, Federal Rule of Evidence, or Local Rule -- prohibited introduction of evidence of anything said during the mediation.

The district court excluded this evidence under its Alternative Dispute Resolution (ADR) Local Rule 6–11, which it read to create a “privilege” for “evidence regarding the details of the parties' negotiations in their mediation.” But privileges are created by federal common law. See Fed.R.Evid. 501. It's doubtful that a district court can augment the list of privileges by local rule. In any event, the parties used a private mediator rather than a court-appointed one. Their mediation was thus “not subject to the ... ADR Local Rules,” including Local Rule 6–11.

Slip op. at 5.

Nevertheless, the district court was right to exclude the proffered evidence. The Confidentiality Agreement, which everyone signed before commencing the mediation, provides that:

All statements made during the course of the mediation or in mediator follow-up thereafter at any time prior to complete settlement of this matter are privileged settlement discussions ... and are non-discoverable and inadmissible for any purpose including in any legal proceeding.... No aspect of the mediation shall be relied upon or introduced as evidence in any arbitral, judicial, or other proceeding.

This agreement precludes the Winklevosses from introducing in support of their securities claims any evidence of what Facebook said, or did not say, during the mediation. The Winklevosses can't show that Facebook misled them about the value of its shares or that disclosure of the tax valuation would have significantly altered the mix of information available to them during settlement negotiations. Without such evidence, their securities claims must fail.

Slip op. at 5.

The moral of the story for us -- mediators and parties going to mediation -- is to be sure that everyone signs a mediation confidentiality agreement before the mediation starts. And if you reach a settlement agreement at mediation, make sure you get the signatures on the dotted line before anyone leaves.

The opinion is available here.

Cassel v. Superior Court: Cal. Supremes Uphold Mediation Confidentiality

In Cassel v. Superior Court (Wasserman, Comden, Casselman & Pearson, L.L.P.) (1/13/11) 51 Cal.4th 113, the California Supreme Court continued a trend of enforcing strictly California's policy in favor of mediation confidentiality, holding that communications between attorney and client during the course of mediation cannot come into evidence in the client's subsequent malpractice action against the attorney and that all discussions conducted in preparation for a mediation as well as all mediation-related communications that take place during the mediation itself are protected from disclosure, even if these do not occur in the presence of the mediator or other disputants. The Court summarized the case as follows:

Petitioner Michael Cassel agreed in mediation to the settlement of business litigation to which he was a party. He then sued his attorneys for malpractice, breach of fiduciary duty, fraud, and breach of contract. His complaint alleged that by bad advice, deception, and coercion, the attorneys, who had a conflict of interest, induced him to settle for a lower amount than he had told them he would accept, and for less than the case was worth.   

Prior to trial, defendant attorneys moved, under the statutes governing mediation confidentiality, to exclude all evidence of private attorney-client discussions immediately preceding, and during, the mediation concerning mediation settlement strategies and defendants' efforts to persuade petitioner to reach a settlement in the mediation. The trial court [L.A. Superior, Judge McLaughlin] granted the motion, but the Court of Appeal vacated the trial court's order. 

Slip op. at 1. 
The Court began its analysis by stating the purposes of mediation confidentiality: 

As noted above, the purpose of these provisions is to encourage the mediation of disputes by eliminating a concern that things said or written in connection with such a proceeding will later be used against a participant. “Toward that end, ‘the statutory scheme ... unqualifiedly bars disclosure of communications made during mediation absent an express statutory exception.’ “ Judicial construction, and judicially crafted exceptions, are permitted only where due process is implicated, or where literal construction would produce absurd results, thus clearly violating the Legislature's presumed intent. Otherwise, the mediation confidentiality statutes must be applied in strict accordance with their plain terms. Where competing policy concerns are present, it is for the Legislature to resolve them. 

Slip op. at 6 (citations omitted). The Court then reviewed a number of recent decisions upholding mediation confidentiality: Foxgate Homeowners' Assn. v. Bramalea California, Inc. (2001) 26 Cal.4th 1 (barring evidence that party refused to mediate in good faith); Rojas v. Superior Court (2004) 33 Cal.4th 407 (mediation confidentiality applies broadly to all "writings" "prepared for the purpose of, in the course of, or pursuant to, a mediation"); Fair v. Bakhtiari (2006) 40 Cal.4th 189 (written settlement agreement reached in mediation can be disclosed only if it includes, on its face, "a statement that it is ‘enforceable’ or ‘binding,’ or a declaration in other terms with the same meaning"); Simmons v. Ghaderi (2008) 44 Cal.4th 570 (judicial doctrines of equitable estoppel and implied waiver are not valid exceptions to the strict technical requirements set forth in the mediation confidentiality statutes for the disclosure and admissibility of oral settlement agreements reached in mediation). 

Here, as in Foxgate, Rojas, Fair, and Simmons, the plain language of the mediation confidentiality statutes controls our result. Section 1119, subdivision (a) clearly provides that “[n]o evidence of anything said or any admission made for the purpose of, in the course of, or pursuant to, a mediation ... is admissible or subject to discovery....” As we noted in Simmons, section 1119, adopted in 1997, “is more expansive than its predecessor, former section 1152.5. Section 1119, subdivision (a), extends to oral communications made for the purpose of or pursuant to a mediation, not just to oral communications made in the course of the mediation. [Citation.]”   

The obvious purpose of the expanded language is to ensure that the statutory protection extends beyond discussions carried out directly between the opposing parties to the dispute, or with the mediator, during the mediation proceedings themselves. All oral or written communications are covered, if they are made “for the purpose of” or “pursuant to” a mediation. (§ 1119, subds. (a), (b) .) It follows that, absent an express statutory exception, all discussions conducted in preparation for a mediation, as well as all mediation-related communications that take place during the mediation itself, are protected from disclosure. Plainly, such communications include those between a mediation disputant and his or her own counsel, even if these do not occur in the presence of the mediator or other disputants. 

Slip op. at 8-9. 
Further, the Court held that while a represented party may waive the privilege for communications between that party and counsel, "the mediation confidentiality statutes do not create a “privilege” in favor of any particular person." Slip op. at 12. Rather, "all mediation participants involved in a mediation-related communication must agree to its disclosure." Ibid. As a result, the attorney defendants in this case could object to introduction of communications with their client that took place both preceding and during the mediation. 

The opinion is available here. 

More Comments from Satisfied Clients

I recently mediated a wage-and-hour case with Steven for a very difficult case involving a small business owner faced with a former employee's demand that could have forced her into bankruptcy for her struggling company. Steven showed incredible patience, tenacity, and creativity in getting the matter resolved, even in the face of a very scared and emotional defendant, and a determined former employee and opposing counsel. It wasn't an easy case to resolve, but he did it!

Nancy Yaffe
Partner Fox Rothschild LLP
Los Angeles, CA

My firm recently used Steven G. Pearl, Esq. as a mediator in a wage and hour case. Mr. Pearl is extremely knowledgeable in the area of wage an hour and has the ability of bridging the gap between the parties diverging positions. In this particular case emotions ran high; however, Mr. Pearl was able to deal with the emotions of the parties and got everyone to objectively focus on the potential exposure if the case were to proceed to trial. Mr. Pearl was able to come up with unique settlement options for the parties to consider. Mr. Pearl was not willing to give up until every option was explored and finally after a full day mediation, Mr. Pearl was able to get the parties to settle. Our firm unequivocally recommends Mr. Pearl as a mediator and we will not hesitate to use him again.

Michael Nourmand, Esq.
The Nourmand Law Firm, APC
Los Angeles, CA

Steve Pearl is extremely knowledgeable about labor and employment law. His experience as an attorney and his consistent work as a mediator in this field are invaluable. He is an excellent mediator who can handle and manage very difficult and complex cases and more importantly, relate to a broad spectrum of individuals. Steve’s knowledge of the law, and, most importantly, ability to bring the parties together is truly impressive. Also, through Steve’s skill, creativity, and perseverance, we reached a successful settlement. I recommend his services to any attorney or party, regardless of the subject matter.

Alexander Gareeb
Gareeb Law Group APC
Woodland Hills, CA

Comment from a Satisfied Mediation Client

We recently used Steve Pearl’s mediation services on a very contentious case with excellent results. This was a certified class action with 2,000 class members just two months away from trial.

Steve was able to bring the mediation together and keep both sides motivated and coming back to the table, despite our firm belief that the case would never settle. Steve dealt adroitly with hostile attitudes from some of the participants and corralled the parties into realistic negotiations.

The case would not have settled but for Steve’s follow up and persistence. Steve insisted that the parties come back for a second day of mediation -- even though neither side thought it would resolve the case -- and continued to assist the parties in hammering out the key terms to a settlement that was reached after two full, grueling days of mediation, plus several days of phone calls and emails.

(And to the delight of everyone, we were provided home-baked goodies each day).

I highly recommend Steve as a mediator for any type of case, especially those that require a tough backbone. He can handle the job.

Rene L. Barge
Class Action Litigation Group
Huntington Beach, CA