3.) Your firm has been sued for $3 million by a supplier for breach of contract.

Question

3.) Your firm has been sued for $3 million by a supplier for breach of contract. Your lawyers believe that there are three possible outcomes if the suit goes to trial. One, which the lawyers term “highly improbably,” is that your supplier will win the lawsuit and be awarded $3 million. Another, which the lawyer term “unlikely,” is that your supplier will win the lawsuit and be awarded $500,000. The third which the lawyers term “likely,” is that your supplier will lose and the lawsuit and be awarded $0. You have to decide whether to try to settle the case. To do so you need to assign probabilities to “highly improbable,” “unlikely” and “likely”. What probabilities correspond to these statements? Going to trial will cost you $100,000 in legal fees. One of your lawyers believes that your supplier will settle for $100,000 (and you will have legal fees of $25,000). Should you settle?

Explanation / Answer

It is not clear what probabilities correspond to these statements, and different people will have different ideas about what they are. Settling will cost you $125,000. Going to court will cost you $100,000. Assume for the moment that a highly improbable outcome is half as likely as an unlikely outcome. If an unlikely outcome has more than a 0.005 chance of happening, settling will be less expensive.

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