Preparing for mediation is a lot like preparing for a football game-it requires strategic thinking and careful planning. Yet oftentimes I see parties who refuse to recognize the strengths of the opposition or acknowledge any weaknesses in their own cases. They act as if no one will be contesting the outcome if the case goes to trial.  On the other hand, parties who prepare for mediation by conducting an objective risk analysis of the strengths and weaknesses of both sides of the case almost always find reasons to negotiate a successful resolution of the dispute.

A recent story reported in a business industry blog illustrates this point. By the way, I have deleted the names of the individuals and parties referenced in the story.

[Company X], a tugboat shipyard and barge repair facility, on Tuesday requested that …[the]Circuit Judge… prevent an economics expert from testifying on behalf of a man suing the company.
[Plaintiff], 41, is suing [Company X] claiming his right arm was mangled when a large metal ball attached to a crane fell on it while he was working on a barge on the upper Mississippi River.
The company disputes [the expert's] testimony in a 13-page motion to disqualify.
“[The expert's] calculation of lost earnings and fringe benefits lack an adequate and reliable foundation,” the motion reads. “At deposition, [the expert] acknowledged that Plaintiff returned to work for [Company X] on July 26, 2010. However, only her calculation of past lost wages accounts for this fact. With respect to future lost earnings and benefits, [the expert] inexplicably decided that Plaintiff would stop working on the first day of trial and would never work again. Such an assumption is unsupported in the evidence and is belied by reality.”
“She calculated [Plaintiff's] lost earnings at $1.7 million.”
“Even were the Court to accept [the expert's] figures and assumptions, her arithmetic is wrong. Using her own figures and assumptions, [the expert] overstates Plaintiff’s alleged future lost wages by $251, 700,” the motion states.
“As the foregoing illustrates, [the expert's] opinions do not bear sufficient indicia of reliability and the bases for her opinions are simply not trustworthy.”

A party who ignores the possibility that such key evidence could be excluded will not be able to objectively consider the reasonable settlement value of the case, and the litigants will almost always be forced to go to trial because at least one side’s settlement value is based on unrealistic assumptions.  So on the question of lost earnings in this example, what are the chances that the motion will be granted? If it is fifty-fifty, the settlement value would be $850,000 (1,700,000 x .50), assuming 100% liability. What if liability is fifty-fifty? Then the settlement value of the lost earnings claim would be $425,000 (1,700,000 x .50 x .50). Even if the plaintiff got his expert testimony into evidence, what are the chances the damages will be reduced by $251,000 due to the alleged arithmetic errors? If there were a 25% chance of that, the plaintiff would have to do another calculation: $1,700,000 x .50 x .50 -251,000 x .25=$362,250. Under these circumstances from the plaintiff’s perspective the reasonable range of settlement of the lost earnings claim is $425,000 to $362,250.

Of course the defendant may have some different assumptions about the likelihood of having its motion granted, so that the defendant’s range of settlement may be different. That’s okay. It should be expected.  So, for example, what if the defendant believes there is a 50% chance on liability, a 75% chance the motion will be granted, and a 10% chance the court will agree the math is wrong? The defendant’s range of settlement would be $212,500 (1,700,000 x .50 x .25) to $187,500 (1,700,000 x .50 x .25-251,000 x .10).

Now we see a range of settlement that includes the plaintiff’s high of $425,000 and defendant’s low of $187,500. There is still a large gap but the parties are now within a reasonable range to get a deal done. By comparison, if plaintiff had assumed he had a 100% chance of defeating the motion and defendant assumed it had a 100% chance of having its motion granted, the range would have been $1,700,000 to $0. I can hear it now, “I am not going to dignify that number with a response. You tell him to get real or we will see him at trial!” And the plaintiff, “Zero? Are you kidding me? I’ll see them in court!” Such failure to make reasonable assumptions about the likelihood of success almost always forces the parties into a trial that neither one really wants.

There are many variables that go into determining the settlement value of a case, and the more of them you take into consideration the more realistic the numbers will become. You would, of course, always factor in the likelihood of success on the questions of liability and damages, but what about the chances of winning or losing a summary judgment motion; a motion to preclude evidence; or some other dispositive motion? What about litigation costs and the possibility of having to pay the other side’s attorney fees if you lose? When two sides carefully think through these types of issues, they almost always come to the mediation within striking distance of each other’s settlement range and when that happens-TOUCHDOWN! Both sides win.

The hot coffee case is reported in Wikipedia. Using the facts reported in the article, let’s consider what risks were involved in the case and identify some of the barriers to settlement. What was it about the settlement negotiations that made trial a better option for the parties than a settlement? In other words, using Fisher and Ury’s term from their national bestseller Getting to Yes, what was the BATNA-the best alternative to a negotiated agreement-for each party, and why was trial deemed to be a better option than the settlement terms that were offered? This is a question every litigant must consider in order to properly prepare for settlement negotiations.

Your BATNA becomes evident through rigorous risk analysis of the legal, economic, and emotional aspects of the dispute. You should also consider these things from your opponent’s perspective. Unless you attempt to view the case from the other side’s perspective of the risks and rewards of the case, you may force your opponent to engage in a trial that no one really wants. Therefore the key to effective negotiations is finding a reasonable settlement range that takes into account the risks and rewards of trial for both sides. The plaintiff will not agree with the lowest number in the settlement range and the defendant won’t agree with the highest, but once both parties find themselves in the same settlement range, settlements almost always happen. It is the mediator’s job to help them get there. Unfortunately, it appears the parties in the hot coffee case were never in the same range until after the trial.

The Accident

• A 79-year-old woman ordered a 49-cent cup of coffee from a drive-in window at a McDonald’s restaurant. The cup had a warning label about the hot coffee.
• McDonald’s served coffee at 180-190 degrees. At that temperature, the coffee would cause third-degree burns in two to seven seconds.
• While sitting in the passenger seat of a parked car, the woman placed the cup between her legs and pulled the lid toward her to remove it. In the process, she spilled the coffee on her lap.
• She suffered third-degree burns on six-percent of her skin and lesser burns over sixteen percent. She was hospitalized for eight days, underwent skin grafting, and spent the next two years receiving medical treatment.
• Her past medical expenses were $10,500; her future medical expenses were $2500; and her lost income was $5000 for a total of approximately $18,000.

Pre-trial Settlement Negotiations

The plaintiff made a pre-lawsuit offer of settlement in the sum of $20,000. McDonald’s offered $800.  McDonald’s also rejected a pre-trial offer of $90,000, and then a $300,000 offer, and a final pre-trial mediator’s proposal of $225,000.

Trial, Verdict, and Post-Trial Settlement

At trial, the plaintiff introduced evidence of measures that could have been taken to reduce the risk of burning and evidence of 700 other burn victims. The jury returned a verdict that awarded the plaintiff $200,000 in compensatory damages and $2.7 million in punitive damages. The punitive damages were apparently based on plaintiff’s counsel’s argument that McDonald’s took in $1.35 million in coffee sales per day, and the jury awarded two days worth of sales as a punishment for what happened. The jury did find the plaintiff was 20% at fault, so the compensatory damages were reduced to $160,000. The judge reduced the punitive damages to three times the compensatory amount, for a total of $640,000.

Eventually the parties entered into a confidential settlement prior to the filing of an appeal, presumably in an amount that substantially exceeded McDonald’s initial offer of $800.

Observations

The settlement value of the hot coffee case must be analyzed from a pre-trial and post- verdict perspective.

Pre-trial: What were the chances the jury would find McDonald’s liable? Was the warning on the cup sufficient? Did the plaintiff have any comparative fault? McDonald’s pre-trial offer of $800 seems to indicate that it did not believe a jury would find the company liable under the facts of the case. In addition, the $800 was more than the $714 average settlement given to 700 other burn victims. The defense may have also factored in the high cost of litigation the plaintiff would face and expected a considerable discount from the plaintiff as a result.

The plaintiff though had real injuries and verifiable damages of $18,000. The plaintiff may have felt that the initial settlement offer of $20,000 was reasonable given her actual damages and considerable pain and suffering. Two-thousand dollars for pain and suffering would be more than fair and reasonable, plaintiff must have thought. But did the plaintiff factor in the possibility that a jury would not find McDonald’s liable? Did she really have a 100% chance of success? Could it have been a 75% chance, or some other number? Even if she was 100% certain that McDonald’s would be liable, did she consider that a jury might find that she was also at fault and that her damages could be reduced by some amount on a comparative fault basis?

McDonald’s turned down plaintiff’s pre-trial settlement offer of $90,000. Given the $160,000 of compensatory damages actually awarded by the jury, it seems the $90,000 offer was within a reasonable range. Without more information it is hard to tell the dynamics at this point, but it seems McDonald’s had a totally different view of the case, probably because the medical expenses were only $10,500. McDonald’s probably thought that even if it were found to be liable, an award for pain and suffering would not be more than 3 or 4 times the medical expenses, so the cap on the damages would be limited to no more than $52,000. Therefore, a settlement of $90,000 was unacceptable to McDonald’s because it represented a valuation that was almost two times the amount plaintiff was likely to get on her best day of trial.

McDonald’s then turned down plaintiff’s pre-trial settlement offer of $300,000 and the mediator’s settlement proposal of $225,000. Very interesting: generally the plaintiff would have attempted a compromise by going below her last number which was $90,000. Why did the next offer go up, and not down? Probably because the plaintiff uncovered evidence to support a claim for punitive damages, so the price of settlement went up. It is a funny thing though-most businesses do not want to settle a case based upon potential punitive damages. That is because the burden of proof is so high that it is hard to get punitive damages, so businesses adopt the attitude, “if you want punis you’re going to have to take them from me at trial.” It is a business risk they are often willing to take.

McDonald’s may have thought they could keep evidence of the other burn victims out of the trial by filing a motion to exclude such evidence. I noticed in the court docket numerous motions to exclude filed by McDonald’s, including a “Motion to Exclude Prior Deposition Testimony and Photographs of other Burn Injuries at Trial. (08/04/1994)” Apparently the motion was denied which then let the jury consider McDonald’s prior knowledge of the danger of the 190 degree coffee which apparently led to an award of punitive damages.

I recommend that every trial risk analysis include the possibility of favorable and unfavorable outcomes for law and motion matters. For example, what are the chances of excluding certain evidence and if the motion fails, could the potential damages increase? From the plaintiff’s side, a risk analysis may include the possibility of losing a motion for summary judgment or the impact on damages if a motion to exclude evidence is granted.

A final thought about punitive damages:  court’s have the authority to reduce awards for punitive damages if the amount is deemed to be excessive on constitutional grounds. Here, the trial court reduced punitive damages to three times the compensatory damages. The days of huge punitive damage awards of ten, fifteen, or a hundred times the amount of the compensatory damages are long gone. The U.S. Supreme Court opinion in the State Farm v. Campbell case (where the compensatory/punitive damages ratio was 145:1) a few years ago changed all of that. Plaintiffs need to account for that in their risk analysis and expectations. Trial courts seem to be limiting punitive damage awards in most cases to three or four times the compensatory damages, and if they don’t, an appellate court probably will.

Post-Verdict: at this stage the dynamics have shifted in plaintiff’s favor. McDonald’s will have to pay $640,000 plus interest unless the verdict is reversed on appeal. Why then would plaintiff settle for an amount less than $640,000? Because there is a chance the she could lose on appeal. Then she would have to retry the case with a different jury which means an uncertain outcome and additional litigation expense. As a result, the parties settled the case.

Final Thoughts

There are other factors to consider when evaluating the settlement value of a case: the costs of litigation, the possibility of having to pay the other side’s costs and attorney fees if you do not prevail,  the time value of money, etc.. There are also other costs that are harder to gauge:  the emotional toll of participating in a trial, the time commitment, added pressures on family and business colleagues, and much, much more.

I am a great believer in the benefits of settling disputes prior to trial. It requires a realistic view of the facts and the law by both parties. That view must be shaped by realistic assumptions. You cannot compare the strongest parts of your case with the weakest parts of your opponent’s case and expect to have a meeting of the minds.

Disputes happen but reasonable people can usually find ways to resolve them in a cost-effective manner. When they cannot even agree on a possible settlement range, settlement is not possible and the dispute will spill into court. Who will wipe up the mess? A jury of your “peers”-strangers really-who may not even know what it is like to drink hot coffee.

NUMBER ONE: Exchange with your opponent salient information about the case well in advance of the mediation. If you represent the plaintiff you may want to ask defense counsel what additional information, if any, is necessary for the defense to be fully prepared for the mediation. If you represent the defendant you will want to be sure the plaintiff’s counsel is fully informed about your view on the liability and damages issues. Last minute exchanges of information frustrate the mediation process because there has been insufficient time to analyze the information and review it with experts, management, and other people of influence.

NUMBER TWO: Set a target settlement range prior to mediation. Your settlement range should be analyzed by considering your alternative to a negotiated agreement (BATNA). Your BATNA “is the standard against which any proposed agreement should be measured. This is the only standard which can protect you both from accepting terms that are too unfavorable and from rejecting terms it would be in your best interest to accept. (Robert Fisher & William Ury, Getting to Yes: Negotiating Agreements Without Giving In ( Penguin Books 1991).

NUMBER THREE: Analyze in advance your risk versus concession points. You should consider at what point the risks of trial outweigh the concessions you must give to reach a resolution of the dispute. This is your ROCR point (Risks Outweigh Concessions for Resolution), and its confluence leads to settlements.

NUMBER FOUR: Prepare an effective mediation brief. Your brief should focus on the key facts of the case pertaining to liability and damages. While briefs are very helpful to mediators they serve the dual purpose of informing your opponent about the strengths of your case. Some lawyers do not exchange their briefs with opposing counsel. I think that is a mistake. A well-written brief sent to opposing counsel well in advance of the mediation allows you to inform the decision makers on the other side about your view of the world. If there is some information for the mediator’s eye’s only, you can add a confidential section to the mediator’s brief. For example, you may have some information you intend to use at trial that you don’t want the opponent to know about but could be useful information for the mediator.

NUMBER FIVE: Prepare your client for the mediation. You should have a pre-mediation meeting with your clients to discuss your settlement strategy, the risks of trial, the costs of litigation, including attorneys fees and expert fees, the implications of a statutory offer to compromise and the possibility of paying the other side’s fees and costs, evidentiary problems and motions in limine that could limit your ability to put on your case, the possibility of an appeal and the length of time and the costs associated with an appeal, collectability issues, and any other fact that would help your client make an informed decision with regard to the settlement value of the case.

NUMBER SIX: Ensure the presence of the decision makers. Nothing sinks a mediation faster than not having the captains on board and engaged in the process.

NUMBER SEVEN: Show respect for other parties. The objective in mediation is to find a solution to a problem. People who feel disrespected are generally more interested in saving face than they are in resolving the dispute. While you do not have to agree with the things that are being said by your opponent, you should show respect for the other side’s point of view.

NUMBER EIGHT: Be willing to listen. Effective listening may be the greatest skill-set you can bring to the mediation. Unless you attempt to see things from the other side’s point of view, you will not be able to see your case from the most important vantage points: the jury box and the bench. After all, the judge and the jury are duty bound to carefully listen to the other side at trial; you should be equally engaged and attuned in mediation.

NUMBER NINE: Remain flexible. Enough said.

NUMBER TEN: Don’t hold onto unreasonable expectations. You should not expect to settle the case based on the terms you might receive on your best day of trial. You should go into the mediation with a settlement range based on a realistic risk analysis that considers the strengths and weaknesses of your case and even takes into account the things you cannot control, like an unfavorable jury, the exclusion of a key piece of evidence, or a disastrous witness.

NUMBER ONE: Exchange with your opponent salient information about the case well in advance of the mediation. If you represent the plaintiff you may want to ask defense counsel what additional information, if any, is necessary for the defense to be fully prepared for the mediation. If you represent the defendant you will want to be sure the plaintiff’s counsel is fully informed about your view on the liability and damages issues. Last minute exchanges of information frustrate the mediation process because there has been insufficient time to analyze the information and review it with experts, management, and other people of influence.

NUMBER TWO: Set a target settlement range prior to mediation. Your settlement range should be analyzed by considering your alternative to a negotiated agreement (BATNA). Your BATNA “is the standard against which any proposed agreement should be measured. This is the only standard which can protect you both from accepting terms that are too unfavorable and from rejecting terms it would be in your best interest to accept. (Robert Fisher & William Ury, Getting to Yes: Negotiating Agreements Without Giving In ( Penguin Books 1991).

NUMBER THREE: Analyze in advance your risk versus concession points. You should consider at what point the risks of trial outweigh the concessions you must give to reach a resolution of the dispute. This is your ROCR point (Risks Outweigh Concessions for Resolution), and its confluence leads to settlements.

NUMBER FOUR: Prepare an effective mediation brief. Your brief should focus on the key facts of the case pertaining to liability and damages. While briefs are very helpful to mediators they serve the dual purpose of informing your opponent about the strengths of your case. Some lawyers do not exchange their briefs with opposing counsel. I think that is a mistake. A well-written brief sent to opposing counsel well in advance of the mediation allows you to inform the decision makers on the other side about your view of the world. If there is some information for the mediator’s eye’s only, you can add a confidential section to the mediator’s brief. For example, you may have some information you intend to use at trial that you don’t want the opponent to know about but could be useful information for the mediator.

NUMBER FIVE: Prepare your client for the mediation. You should have a pre-mediation meeting with your clients to discuss your settlement strategy, the risks of trial, the costs of litigation, including attorneys fees and expert fees, the implications of a statutory offer to compromise and the possibility of paying the other side’s fees and costs, evidentiary problems and motions in limine that could limit your ability to put on your case, the possibility of an appeal and the length of time and the costs associated with an appeal, collectability issues, and any other fact that would help your client make an informed decision with regard to the settlement value of the case.

NUMBER SIX: Ensure the presence of the decision makers. Nothing sinks a mediation faster than not having the captains on board and engaged in the process.

NUMBER SEVEN: Show respect for other parties. The objective in mediation is to find a solution to a problem. People who feel disrespected are generally more interested in saving face than they are in resolving the dispute. While you do not have to agree with the things that are being said by your opponent, you should show respect for the other side’s point of view.

NUMBER EIGHT: Be willing to listen. Effective listening may be the greatest skill-set you can bring to the mediation. Unless you attempt to see things from the other side’s point of view, you will not be able to see your case from the most important vantage points: the jury box and the bench. After all, the judge and the jury are duty bound to carefully listen to the other side at trial; you should be equally engaged and attuned in mediation.

NUMBER NINE: Remain flexible. Enough said.

NUMBER TEN: Don’t hold onto unreasonable expectations. You should not expect to settle the case based on the terms you might receive on your best day of trial. You should go into the mediation with a settlement range based on a realistic risk analysis that considers the strengths and weaknesses of your case and even takes into account the things you cannot control, like an unfavorable jury, the exclusion of a key piece of evidence, or a disastrous witness.

The uncertainty of trial and the power of the state were illustrated in Garbell
v. Conejo Hardwood Floors, a recent decision published by the California
Court of Appeals, where the jury did not view the expert testimony the way one
of the parties expected. The trial court did not view the law the way the other
party expected. And the appellate court took away the cost award, including
consultants and experts fees, of the party that lost the case but was deemed the
prevailing party by the trial court. The purpose of this post is to summarize
the salient points of the decision and in the LESSONS LEARNED section below,
apply them to a hypothetical mediation and pre-trial risk analysis.

Here’s what
happened: The Garbells had an $822,000 fire loss at their home, only half of
which was covered by insurance. The insurance company paid $424,000 to the
Garbells for the covered part of the loss and filed a subrogation action against
the flooring contractor who was accused of starting the fire. The homeowners
also filed a claim against the flooring contractor to recover the $400,000 of
personal property destroyed in the fire that was not covered by insurance. The
flooring contractor settled with the insurance company in the subrogation action
but defended itself against the claims of the homeowners at trial. The jury
found that the damages were $822,000, with the flooring contractor being
responsible for fifty-five percent of the loss and the homeowners being
responsible for forty-five percent on comparative fault principles. . As a
result, the trial court awarded $28,000 in damages to the homeowners,
representing the net amount after the subrogation payment and the homeowners’
comparative fault were taken into account. In addition, the trial court awarded
costs to the flooring contractor because the homeowners had rejected a $100,000
settlement offer from the flooring contractor and only received a net award of
$28,000. Both sides appealed the judgment.

On appeal, Canejo Hardwood contended there was insufficient evidence for the Garbell’s
expert to conclude that a carelessly discarded cigarette caused the fire and
even if the fire was caused by a cigarette, there was no evidence that the
cigarette belonged to one of its workers. Canejo Hardwood also argued that it
did not have control over the garage where the fire started after its men left
for the day. The Court of Appeal noted, “The jury disbelieved this theory. While
we might have reached a different conclusion based upon the evidence, we do not
second guess the jury. We therefore conclude there was sufficient evidence of
causation to support the jury’s finding of negligence.”

The Appellate
Court also rejected the Garbell’s argument that the trial court miscalculated
their damages by deducting the insurance payment they received after determining
comparative fault for the total property loss. The court reached this decision
following an extensive review of subrogation laws and the collateral source
rule, with the court concluding there was no error in the damage calculation.

Finally, the
Appellate Court did agree with the Garbell’s that the trial court erred in
awarding costs to Canejo Floors. The court determined that for purposes of
awarding costs, the trial court should have looked at the gross amount of the
judgment-$452,000-instead of the net award of $28,000. Since the judgment of
$452,000 exceeded the Code of Civil Procedure section 998 offer to compromise,
costs should not have been awarded to Canejo Floors, and the case was remanded
to the trial court for a reconsideration of the motion for costs.

LESSONS LEARNED

A pre-trial risk analysis of the legal and economic implications of going to trial is always
appropriate. You want to see if you can negotiate a settlement that is better
than an uncertain result at trial. The term negotiators often use is BATNA: what
is your best alternative to a negotiated agreement? In other words, what are
your chances of getting a better result at trial than you can through
negotiations. Here are a few things you might consider in a hypothetical
pre-trial assessment:

• Plaintiff has damages that exceed
  $822,000.
• If plaintiff gets everything he wants,
  he will be awarded $398,000 after the insurance company gets compensated
  $424,000 on its subrogation claim.
• Defendant offers to settle the case for
  $100,000.
• Plaintiff does not want to accept the
  $100,000 but knows there may be a settlement range of $398,000 to $100,000. This
  is where a good mediator can help the parties bridge the gap.
• How can Plaintiff justify taking less
  than $398,000 and convince the defendant to pay more than $100,000?
• Plaintiff must realize that his claim
  could be reduced through comparative fault principles. Is it possible that a
  jury could find the plaintiff at fault for 45% of the $822,000 loss? If so, is
  there some percentage of your claim that you would discount to take this
  possibility into account? Is it possible that the jury could find the plaintiff
  entirely at fault because the defendant did not have control over the garage at
  all times?
• Defendant must realize that it is
  possible that the jury will find that the plaintiff has no comparative fault. Is
  there some amount more than $100,000 that you would be willing to pay to take
  this into account?
• If there is comparative fault, what is
  the likelihood that the court would deduct the subrogation payment from the net
  amount after the comparative fault calculation?
• Even if you think there is no
  implicating evidence because the fire destroyed the evidence of the cause of the
  fire, what are the chances that a jury will believe the testimony of plaintiff’s
  expert witness?
• Given these factors, is there a way to reach a compromise? If you are the defendant, do you want to spend more on
  experts and consultants when you realize you may not get your costs of litigation back because the plaintiff need only prove damages above your 998 offer when it is undisputed that the loss exceeded $822,000 and even after the subrogation claim is paid off, the plaintiff will still have a good shot at getting a damage award above $100,000.01? And if you are wrong, plaintiff will
  be the prevailing party so that you won’t get your costs back and there will be a chance you will have to pay the plaintiff’s costs
• Is there an attorney fee provision that you should consider? What are the chances that the other side will be deemed the
  prevailing party? What are your chances of being the prevailing party? Do you want to take the risk of paying your own attorneys fees, and those of your opponent?
• If there is an appeal, what are the chances of prevailing, how long will it take, and how much more money will you have to spend?

There is no doubt that some cases must be resolved by trial. This usually happens when the
parties’ pre-trial valuations of the case are wildly disparate. But in most
cases, reasonable, objective people can find a way to look at the legal and
economic factors to find a way to reach a compromise. Sometimes the gap is
closed when an additional factor is taken into account: the emotional toll of a
trial on litigants, including the pressure felt by families, shareholders, and
partners, and the diversion of time, money, and energy from the people and goals
that matter most in life.

Given our adversary system of jurisprudence in America, I would acknowledge that conflicts between lawyers can get downright messy. When a dispute arises, the parties have to figure out what to do about their rights and obligations under the terms of the contract, and if they cannot resolve the issues, they hire lawyers (and sometimes mediators) to help them resolve the dispute, and if they are unable to do so, a trial court judge may be called upon to decide who is right, once and for all, unless there is an appeal, then appellate justices may be asked to sort it all out. Such was the case in Kirk Crawford, et. al. v. Weather Shield Mfg.(2008) 44 Cal. 4th 541, a breach of the duty to defend case between a contractor and a subcontractor. Ben Franklin might have summarized the dispute like this:

A duty to defend provision between two lawyers is like a fish between two cats.

The question presented in the Crawford case was whether, under the terms of the subcontract, the subcontractor was obliged to defend the general contractor/developer for construction defects allegedly caused by the subcontractor even though (1) the jury ultimately found the subcontractor was not negligent, and (2) the parties accepted an interpretation of the subcontract that gave the builder no right of indemnity unless the subcontractor was negligent.This was a huge issue in the building industry and here’s where the two cats fighting over a fish comes into the picture. Actually, as you will see, the two cats attracted a bunch of other cats because this particular fish was so big.

The general contractor was represented by an excellent law firm and its position on appeal was supported by three other law firms who, in representing the interests of general contractors, filed amicus curiae or friend of the court briefs. Such briefs are filed by people who want to weigh in on a case that could later affect their interests. The subcontractor was also well represented by a fine law firm, and with five amicus curiae briefs filed by other law firms representing the interests of various subcontractor groups.

The California Supreme Court summarized the defense and indemnity provisions of the subcontract as follows:

We focus on the particular language of the subcontract. Its relevant terms imposed two distinct obligations on Weather Shield. First, Weather Shield agreed “to indemnify and save [JMP] harmless against all claims for damages to persons or to property and claims for loss, damage and/or theft … growing out of the execution of [Weather Shield's] work.” Second, Weather Shield made a separate and specific promise “at [its] own expense to defend any suit or action brought against [JMP] founded upon the claim of such damage … loss, … or theft.” (Italics added.)

When the home owners filed suit against the contractor for a variety of construction defects and the contractor filed a cross complaint against its subcontractors, Weather Shield took the position that it was not responsible for the window leaks, and refused to defend or indemnify the contractor. This kind of decision is made every day by subcontractors. But this is where the “ounce of prevention” comes into play. Instead of scrambling around to decide what rights and duties are owed at the commencement of litigation, it would be much better if some time (and even attorneys fees) were invested in the contract phase to have a clear understanding of the terms and conditions of the contract. If you want the job badly enough, maybe it will not bother you that you may be taking on the contractor’s defense obligations, even if you are not negligent. The point is to make an informed risk analysis at the beginning of the project to avoid suprises later.

The contractor JMP and the other subcontractors, except Weather Shield and the framing subcontractor, settled with the home owners before trial for an amount in excess of a million dollars.That left the contractor to press its cross complaint against Weather Shield, the window manufacturer and supplier, and the framer who installed them. The jury found that the framer was liable for a million dollars in damages, and that Weather Shield was not responsible.

Since Weather Shield was not negligent it had no indemnity obligations, but the contractor JDM claimed Weather Shield had a duty to defend the contractor against the window claims from the commencement of the litigation. In essence, the contractor said to Weather Shield, you refused to defend us in violation of the subcontract, and we want to be reimbursed $131,000 for the cost of defending your portion of the window issue and we want another $46,000 for attorneys fees we spent trying to force you to pay us our defense costs. The Court held Weather Shield had an immediate duty to assume the contractor’s defense as soon as the case was tendered to it. The Court said:

By virtue of these statutory provisions, the case law has long confirmed that, unless the parties’ agreement expressly provides otherwise, a contractual indemnitor has the obligation, upon proper tender by the indemnitee, to accept and assume the indemnitee’s active defense against claims encompassed by the indemnity provision. Where the indemnitor has breached this obligation, an indemnitee who was thereby forced, against its wishes, to defend itself is entitled to reimbursement of the costs of doing so.

Here, the subcontract at issue not only failed to limit or exclude Weather Shield’s duty “to defend” JMP, as otherwise provided by subdivision 4 of section 2778, it confirmed this duty. In language similar to that of the statute, the subcontract explicitly obligated Weather Shield both to indemnify JMP against certain claims, and “at [its] own expense to defend” JMP against “any suit or action … founded upon” such claims. (Italics added.) The duty “to defend” expressly set forth in Weather Shield’s subcontract thus clearly contemplated a duty that arose when such a claim was made, 8 and was not dependent on whether the very litigation to be defended later established Weather Shield’s obligation to pay indemnity.

LESSONS LEARNED

Most contracts will have at least two provisions in anticipation of third party claims. There will be an indemnity provision which covers losses caused by the subcontractor’s negligence. There may also be a duty to defend provision which may or may not be triggered as soon as the third party claim is made, depending on the contract language. Both provisions deserve an “ounce of prevention” in the contracting phase of a project. These indemnity and defense provisions can be complicated, and they can vary in terms of what is required and when it is required. Don’t assume what you see in your subcontracts is just “standard stuff”. Words in a contract have meaning, and they may mean something you did not anticipate at the beginning of the project. In this case, the “pound of cure” for Weather Shield included the cost of paying for its own defense, the cost of reimbursing the general contractor for its defense of the window issue, and the cost of paying the attorneys fees incurred by the contractor to prosecute the duty to defend claim.

FINAL NOTE

California Civil Code 2782(c) provides that construction contracts for residential construction entered into after January 1, 2006, that include provisions that require subcontractors to indemnify builders and their agents against liability for claims for construction defects are unenforceable to the extent the claims arise out of the negligence of the builder or its agents.

Clients come to lawyers asking simple questions about complicated problems:
What is the risk? What are my chances? Do I have a case? Clients want to know
what will happen to them if they proceed through trial. And they should be
worried, according to the late Oliver Wendell Holmes, Jr.,
because the power of the state to enforce court judgments and degrees
is looming over every trial. Prediction, said he, is the object of the
study of law:

When we study the law… we are studying what we
shall want in order to appear before judges, or to advise people in such a way
as to keep them out of court. The reason why it is a profession, why people will
pay lawyers to argue for them or to advise them, is that in societies like ours
the command of the public force is intrusted to the judges in certain cases, and
the whole power of the state will be put forth, if necessary, to carry out their
judgments and decrees. People want to know under what circumstances and how far
they will run the risk of coming against what is so much stronger than
themselves, and hence it becomes a business to find out when this danger is to
be feared.The object of our study, then, is prediction, the prediction of the
incidence of the public force through the instrumentality of the courts. (The
Path of the Law, 10 Harvard Law Review 457 (1897))

A recent California Court of Appeals case exemplifies both the power of the state to enforce judgments and the important
role of risk analysis in civil litigation, and it also stands for an important principle of law, which I will address first.

In Gunderson v. Wall, a jury awarded plaintiff $1.7 million in compensatory damages
and $800,000 in punitive damages against Wall and Welded Fixtures, Inc. The
defendants paid the judgment and filed an appeal. In a November 2009
unpublished opinion, the Court of Appeal affirmed the compensatory
damages award, but ruled there was insufficient evidence to support the punitive
damages. (Click here to read the unpublished opinion.) The plaintiff voluntarily repaid the $800,000,
representing the punitive damage award. However, the defendants filed a
motion in the trial court seeking restitution of the interest that had
accrued on the punitive damage payment during the time of the appeal. The trial
court denied the motion, finding the defendant acted inequitably in response to
plaintiff’s post-judgment efforts to collect the judgment. Defendant filed an
appeal, and the court of appeal affirmed the decision not to reimburse the
defendants the accrued interest. As a result of this case, parties need to be
certain they have acted reasonably in the post-judgment process if they intend
to ask the court for equitable considerations, such as repayment of interest on
a reversed judgment.

The Gunderson opinion and its unpublished companion opinion provide some practical insight into Justice
Holmes’ statements about the power of the state over litigants and the
importance of risk analysis, or prediction.
PREDICTION AND THE POWER OF THE STATE

• Will you proceed through trial for the chance of being awarded punitive
  damages? In California, you will have to prove by clear and convincing evidence
  that someone committed malice, oppression, or fraud, and if you have a corporate
  defendant, that a corporate officer or managing agent was involved in the
  misconduct (Civil Code 3294). The jury will probably be instructed that
  plaintiff must prove the conduct was despicable which means conduct that was so
  vile, base, contemptible, miserable, wretched or loathsome that it would be
  looked down upon and despised by ordinary decent people.  In Gunderson,
  the jury awarded punitive damages, but the appellate court said there was
  insufficient evidence to support the award.
• Your risk analysis should consider the impact of potential motions in limine
  on the evidence you intend to introduce at trial. In the 2009 Gunderson
  opinion, for example, one of the defendants asserted his fifth amendment
  right against self incrimination. The trial court then issued an order that
  precluded the defendant from presenting any evidence or cross-examining any
  witnesses at trial. This order was reversed on appeal, giving the defendant the
  right to a new trial. This also brings up the need for predicting the likelihood
  and expense of an appeal and a second trial.
• Gunderson used the power of the state to enforce the original judgment which
  included writs of execution and the installation of a receiver at defendant
  Welded Fixtures. The court also issued a writ of body attachment requiring
  defendant Wall to personally appear to answer questions about the loss of
  computers and financial data at Welded Fixtures.

Prediction, then, is an important element in the practice of law. It is not
enough, however, to merely predict the outcome of the trial.  Each aspect of the
trial has parts and subparts that must be analyzed, including the possibility of
an appeal and a new trial, the costs and time associated with the litigation,
and the likelihood of collecting the judgment. Trial lawyers who analyze and
explain these risks to their client are the best of the best. They are true
counselors at law and trusted advisers to their clients.

Real estate developers often prefer arbitration over jury trials for various reasons, not the least of which is the belief that they would fair better in front of an experienced construction law arbitrator than they would in front of 12 jurors who probably have little or no understanding of the construction industry. As a result, developers will often include arbitration provisions in documents called conditions, covenants, and restrictions (referred to as CC&R’s) which are akin to by-laws for corporations. CC&R’s constitute the governing document for members of homeowner associations and tell  property owners what they can and cannot do within the development.

In California, the law on the issue of whether or not an arbitration provision in CC&R’s is enforceable is unsettled. Yesterday, the California Supreme Court granted review in the Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US) LLC case. Attorney Kathleen Carpenter of Luce Forward has provided a good summary of the relevant cases and issues which you can read by clicking here. You can read the Pinnacle case and two other cases, the Villa Vicenza case which is pending in the Fourth Appellate District, where the Court granted rehearing after holding that such provisions in CC&R’s are not enforceable, and the Villa Moreno HOA case, the first California case to address the issue (in 2000) by clicking here, here, and here.

If you have a case involving the issue of the enforceability of an arbitration provision in CC&R’s, you may have to wait awhile to get a definitive answer to that question. As Ms. Carpenter notes in her summary, it may take 12 -24 months before the California Supreme Court issues its opinion in the Pinnacle Museum Tower case, and the Fourth Appellate District’s opinion in the Villa Vicenza case is not expected until January 2011. Meanwhile, she notes, it is likely the Supreme Court will grant review and stay other similar cases until it decides Pinnacle Museum Tower.

In Mepco Services, Inc. v. Saddleback Valley USD, the prime contractor sued the school district for breach of contract on a school modernization project. Like most contracts for public works, the contract at issue did not have a provision for attorney fees. However, the school district filed a cross-complaint against the contractor for breach of contract and asserted a claim against the contractor’s performance bond. 

The contractor prevailed at trial and requested, and was awarded,  attorney fees even though there was no provision for them in the prime contract. The Court of Appeal affirmed, holding that the prime contract required a performance bond, the bond provided that the school district would be entitled to an award of attorneys fees if it filed an action on the bond and, under California Civil Code section 1717, such provisions in contracts ( and now bonds which are incorporated into contracts) are reciprocal so that the prevailing party on the performance bond is entitled to an award of attorney fees.

Observations and Applications

• This decision could have a chilling affect on public owners filing cross-claims on performance bonds. Under Mepco Service, the public owners now face exposure to having to pay the attorney fees of contractors which removes an advantage public owners generally have when the prime contract does not have an attorneys fee provision.
• Public owners facing this situation should force the prime contractor to apportion at trial the attorney fees incurred in defending the performance bond claim from those incurred in prosecuting the breach of contract claim. The school district did not raise the apportionment issue at trial and the Court of Appeal ruled the argument was waived on appeal.
• Given the possibility of having to apportion fees, counsel for prime contractors should keep track of the fees incurred for prosecuting the breach of contract claim vs. defending the performance bond claim. If the owner raises the argument, you will be prepared to introduce the appropriate evidence at trial.

Real estate developers often prefer arbitration over jury trials for various reasons, not the least of which is the belief that they would fair better in front of an experienced construction law arbitrator than they would in front of 12 jurors who probably have little or no understanding of the construction industry. As a result, developers will often include arbitration provisions in documents called conditions, covenants, and restrictions (referred to as CC&R’s) which are akin to by-laws for corporations. CC&R’s constitute the governing document for members of homeowner associations and tell  property owners what they can and cannot do within the development.

In California, the law on the issue of whether or not an arbitration provision in CC&R’s is enforceable is unsettled. Yesterday, the California Supreme Court granted review in the Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US) LLC case. Attorney Kathleen Carpenter of Luce Forward has provided a good summary of the relevant cases and issues which you can read by clicking here. You can read the Pinnacle case and two other cases, the Villa Vicenza case which is pending in the Fourth Appellate District, where the Court granted rehearing after holding that such provisions in CC&R’s are not enforceable, and the Villa Moreno HOA case, the first California case to address the issue (in 2000) by clicking here, here, and here.

If you have a case involving the issue of the enforceability of an arbitration provision in CC&R’s, you may have to wait awhile to get a definitive answer to that question. As Ms. Carpenter notes in her summary, it may take 12 -24 months before the California Supreme Court issues its opinion in the Pinnacle Museum Tower case, and the Fourth Appellate District’s opinion in the Villa Vicenza case is not expected until January 2011. Meanwhile, she notes, it is likely the Supreme Court will grant review and stay other similar cases until it decides Pinnacle Museum Tower.

According to the California Fourth District Court of Appeal, when a written contract specifies that change orders on a public works project must be in writing, a design professional (or contractor) can not make a claim for payment for extra work done pursuant to an oral directive. Click here to read the case.

The court in P&D Consultants v. City of Carlsbad reasoned that such provisions must be enforced to protect the public fisc. Furthermore, design professionals and contractors are presumed to know the limitations and restriction regarding public works projects. "Persons dealing with a public agency are presumed to know the law with respect to any agency’s authority to contract.’ "One who deals with the public officer stands presumptively charged with a full knowledge of that officer’s powers, and is bound at his . . . peril to ascertain the extent of his . . . powers to bind the government for which he . . . is an officer, and any act of an officer to be valid must find express authority in the law or be necessarily incidental to a power expressly granted." Further, the court explained, "There is no provision in the City charter for execution of oral contracts by employees of the City who do not have requisite authority. The alleged oral statements by the associate city engineer and project manager are insufficient to bind the City. ‘ "No government, whether state or local, is bound to any extent by an officer’s acts in excess of his . . . authority." 

So there you have it. Construction professionals on public works projects in California must proceed with caution when change order work arises. I am not sure that the public fisc will necessarily be protected by the holding of this opinion. What happens when changes in the scope of work lead to delays while the public owner reviews the change order requests? Is it possible that the cost of promptly performing the extra work could be dwarfed by later claims for delay and disruption by the contractor? This may be the unintended consequence of this case.