Paper on Risk Analysis for ABA Forum on Franchising.pdf -...

American Bar Association
27
th
Annual Forum on Franchising
THE ROLE OF RISK ANALYSIS
IN DISPUTE AND LITIGATION MANAGEMENT
Robert B. Calihan
Nixon Peabody LLP
Rochester, New York
and
John R. Dent
Hilton Hotels Corporation
Beverly Hills, California
and
Marc B. Victor
Litigation Risk Analysis, Inc.
Kenwood, California
October 6 – 8, 2004
The Sheraton Wall Centre Hotel
Vancouver, British Columbia
©2004 American Bar Association

- i -
TABLE OF CONTENTS
Page
I. THE PROBLEM: LITIGATION IS COSTLY, INEFFICIENT AND UNPREDICTABLE ........ 1
II. RISK ANALYSIS APPLIED TO LITIGATION ..................................................................... 5
A. Principles of Risk Analysis – An Overview .............................................................. 5
1. Hypothetical ................................................................................................. 5
2. How Lawyers Value Cases .......................................................................... 6
3. How Businesses Value Risky Ventures ....................................................... 6
a. Solving a Tree Using the Compound Probability Method ................ 7
b. Solving a Tree Using the Roll-Back Method .................................... 9
4. Using Decision Trees to Correctly Value More Complex
Problems – and to Better Analyze the Legal Issues .................................... 10
5. The Role of Decision Tree Software ............................................................ 12
6. Other Benefits from Performing a Formal Risk Analysis ............................. 12
B. The Risk Analysis Process ...................................................................................... 13
1. Capture the Key Issues and Their Interrelationships with a
Dependency Diagram .................................................................................. 13
2. Convert the Dependency Diagram into a Decision Tree ............................. 15
3. Assess Realistic Probabilities and Verdict Ranges ..................................... 18
4. Calculate the Expected Value of Litigating .................................................. 21
C. Using Risk Analysis to Make Better Decisions ........................................................ 23
1. Settle versus Litigate Decisions ................................................................... 23
a. The Impact of Litigation Costs ......................................................... 23
b. The Effect of Risk Aversion .............................................................. 24
c. The Consequential Effects of a Lawsuit ........................................... 25

Page
- ii -
2. Resource Allocation Decisions .................................................................... 27
a. Overall Case Budget ........................................................................ 27
b. Issue-by-Issue Spending Levels ...................................................... 28
3. Communication Decisions ........................................................................... 33
D. Timing and Cost of Performing a Risk Analysis ...................................................... 33
III. BUDGETS, FORECASTS AND RISK ANALYSIS .............................................................. 33
A. The Role of Forecasting in Risk Analysis ................................................................ 33
B. The Mechanics of Forecasting ................................................................................ 36
1. Step I: Staffing ............................................................................................ 37
2. Step 2: Spell Out the Assumptions ............................................................. 37
3. Step 3: Assign Hour and Cost Estimates to Each Category ....................... 39
4. Step 4: Create a Timeline of Anticipated Expenses ................................... 40
IV. PRACTICAL CONSIDERATIONS ....................................................................................... 41
A. Implications for Financial Disclosure ....................................................................... 41
B. Implications for Audit Inquiry Responses ................................................................ 46
C. Discoverability ......................................................................................................... 47
D. Client Relations – One Client’s Perspective ............................................................ 48
V. CONCLUSION .................................................................................................................... 51

THE ROLE OF RISK ANALYSIS
IN DISPUTE AND LITIGATION MANAGEMENT
Litigation is generally recognized as being costly, unpredictable and inefficient – the
antithesis of profitable business activity. Yet it is also a fact of life that any business activity,
including franchising, inevitably involves litigation. Risk analysis is a powerful tool for
maximizing the efficiency with which franchisors and franchisees conduct litigation – or any
other form of dispute resolution. By maximizing the efficiency of dispute management,
franchisors and franchisees can reduce their relative costs while increasing their returns –
whether these returns are measured in terms of maximizing the size of a favorable judgment or
settlement, minimizing the size of an unfavorable judgment or settlement, or achieving some
other objective.