Words of Wisdom On the Practice of Law From Our Sixteenth President

Discourage litigation -- Persuade your neighbors to compromise whenever you can -- Point out to them how the nominal winner is often a real loser, in fees, expenses, and waste of time -- As a peace-maker, the lawyer has a superior opertunity of being a good man -- There will still be business enough --

Abraham Lincoln

Advice to Young Lawyers 

Undated

President Lincoln's hand-written notes can be seen here.  They are transcribed here.  Slate.com has an article here.  

Thank you to Carl Botterud for bringing this to my attention.  

Mediation and the Science of Decision Making Part IV: People Evaluate Gains and Losses Relative to Their Reference Points

I spoke earlier about the idea that individuals act rationally. In other words, 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. One of the reasons that Daniel Kahneman won the Nobel Prize in 2002 is because he and his colleague, Amos Tversky, challenged this idea of rationality.  

For example, Kahneman and Tversky realized that -- contrary to modern economic theory -- gains and losses are not absolute. They are not perceived in the same for all people, and they are not perceived consistently over time. They change depending on one’s circumstances, or reference points. In Thinking, Fast and Slow, Kahneman illustrates this with a simple example. Hold one hand in a bowl of hot water and the other in a bowl of cold water, then put both in a bowl of room temperature water. One feels warm, the other cold. The starting (reference) point for each is different, and so is the perception of the ending point.  

Reference points play a very important role in financial situations. Consider Jack and Jill. Each has $5 million. Yesterday, Jack had $1 million, and Jill had $9 million. Classical economics holds that the $5 million has the same utility for each, and they are equally happy. But are they? Obviously not. Kahneman and Tversky, who brought human psychology to economics, recognized that Jack and Jill’s happiness depends not only on what they have, but also on what they had – their reference points. Jack is happy with his $5 million; Jill is not at all happy with hers.

This simple idea that reference points are relative and may change over time may seem obvious, but it revolutionized economic theory and it plays an extremely important role in understanding both how people make decisions in reality and how to help them make better decisions. 

In later posts, I will discuss the importance of reference points in mediation and the use of reference points to help seal the deal.  Next time: The Greater the Loss or Gain, the Less Any Additional Incremental Change Matters.

Mediation and the Science of Decision Making Part III: People Avoid Risk When They Stand to Gain and Seek Risk When They Stand to Lose

In my last post, I said that Kahneman and Tversky revolutionized economics by showing that people do not act rationally when making economic decisions. As I explained, classical economic theory predicts that people will analyze risk rationally, regardless of the circumstances.  As it turns out, people don't do this. Instead, they try to avoid risk when they stand to gain, but they seek risk when they stand to lose. 

Try this mental exercise, and you'll see what I mean.  

Which would you choose? (A) a sure gain of $750 or (B) an 80% chance of winning $1,000 and a 20% chance of winning nothing?

The rational choice theory predicts that people will choose Option B, which has the higher expected value. The expected value of an 80% chance of winning $1,000 is $800. That obviously is greater than the value of the $750 sure thing. Any rational person seeking to maximize his financial gain should choose Option B.

But if you are like most people, you chose Option A and you didn't even have to think about it. Your automatic reaction was that you would rather have the sure thing than take the gamble. If you did the math, you likely noticed that the gamble offered only an incremental gain over the sure thing, but it also left you with the possibility of getting nothing. You likely saw this and figured, “Why risk it?”

Now try this one. Which would you choose? (C) a sure loss of $750 or (D) an 80% chance of losing $1,000 and a 20% chance of losing nothing?

Here, the rational actor theory predicts that people will take the sure thing, which is more likely to minimize financial loss.  The gamble here, Option D, has an expected value of negative $800, versus the sure thing’s value of negative $750. Taking the risk here is the worse choice, rationally speaking.

But again, if you are like most people, you chose Option D, and again, you didn't even have to think about it. You had an instant and very negative reaction to the idea of losing $750. The thought actually caused a number of physical stress reactions that you probably did not notice: your pupils dilated, your heart rate increased, the hair on your arms rose slightly, and your sweat glands were activated. The gamble offered you the possibility, even if small, of owing nothing, and thinking about this possibility reduced your stress level. You decided to take your chances on the gamble, even if you realized that it was the worse option, rationally speaking.  

Put these two mental exercises together, and you see what Kahneman and Tversky found: when people stand to gain, they prefer to avoid risk; but when they stand to lose, they prefer to take risks.

If you go back to the examples that I gave in my first post, you can see that this risk-avoiding and risk-seeking behavior helps explain why Adam and Company C fail to take advantage of reasonable settlement opportunities. They have no option that leads to gain – or a sufficiently substantial gain in Adam’s case – and they choose to take the risk instead by taking their cases to trial. They do this even though they recognize that the odds of winning at trial are small, and the likelihood is that they will do worse than in a settlement.

This also helps why Denise takes a relatively low settlement offer when she likely could do better. Being in a position of likely gain, she seeks the certainty of the settlement, rather than risk everything at trial.  

Next week: Reference Points.  

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.