Now I’m in-house, and I’m still fretting about two words: “probable” and “estimable.”
The accounting rules require corporations to take a reserve (which causes an immediate hit to revenue) when a “loss contingency” (which is accountant-speak for lawsuits, among other things) becomes probable and estimable. If it’s likely that you’re going to lose, and if you can estimate the amount (or, at least, the lower bound of the amount) of the loss, then it’s time to take a reserve.
This can make in-house life odd….
Suppose your mistaken judgment causes you to take a $3 million reserve for a case. You then try the case and lose only $2 million. Foolish people — like outside counsel fretting about winning and losing — might be disappointed by having suffered a $2 million loss. But, if you reserved the case for $3 million and lost only 2, you’re an in-house hero: You just brought a million bucks back into revenue! (It’s like Eddie Murphy breaking the expensive vase in the movie “Trading Places” and being told that his clumsiness would yield a huge insurance recovery: “You want me to break something else?”)
But enough of that. As an in-house litigator, you have (among others) two jobs: One is minimizing the costs of defense and judgment. The other is predicting when costs will be incurred, so that the folks in finance don’t receive nasty surprises at inopportune times. That second task is harder than it seems, and it’s made harder still by the words “probable and estimable.” It’s often possible to predict when you’ll win or lose, which tends to occur (in the United States) as a trial ends. It can be much harder to predict when a loss contingency may become probable and estimable.
Think about it: Plaintiff files a product liability case against you. The case is defensible; you figure you have a 60 percent chance of winning. That’s not a “probable” loss; that’s a “probable” win, so you don’t take a reserve. At trial, the jury hits you for $5 million. Presto — instant probability and estimability!
Or the other side of the coin: You make a blatant arithmetic error that indisputably causes a customer precisely $1 million in damages. On those facts, the customer doesn’t necessarily have to file a complaint for the loss to become probable and estimable; the first nasty phone call may do the trick and prompt a reserve.
In that environment, how are in-house litigators to avoid inflicting nasty surprises on finance at inopportune times?
You can’t, of course. You don’t know who in your organization is screwing things up in ways that may cause immediately probable and estimable losses to pop up tomorrow. But you can do things to minimize the surprises, and you should think hard about that.
Consider creating reports that estimate when losses may become probable and estimable. Those reports won’t be complete, because surprises happen. But those reports are surely better than nothing.
What would the reports say? They would provide dates (or date ranges) of events that may cause losses to become probable and estimable. Some of those events are obvious: If we have a $0 reserve on a case, and the case is set for a two-week trial in November, then there’s a chance that a loss will become probable and estimable during the fourth quarter. Let finance know.
Arbitrations are akin to trials; they may cause loss contingencies to become probable and estimable. Let finance know when arbitrations will occur.
Mediations are similar. You can’t “lose” at a mediation, in the sense of being ordered to pay a judgment. But mediations are meant to, and occasionally do, prompt settlements. Thus, a mediation might prompt you to offer money to settle even a case that you have a 70 percent chance of winning. The loss would not be “probable” before the mediation, but would become probable no later than the instant the case settled for a sum certain. Alert finance to upcoming mediations.
What else goes on the calendar? Anything that may crystallize the amount of a payment. Will you take a stab at settlement while your motion for summary judgment is pending? If so, that may be an event (or a time period) that concerns finance. Has the plaintiff filed a motion for partial summary judgment on liability? If that motion is granted, improbable liability may turn probable pretty darned quick. Let finance know when the argument will occur and when the judge may issue a decision.
And so on.
You can’t guarantee victory in all pending cases, and you can’t predict with any precision when losses may become probable and estimable. But you can think hard about upcoming events that may affect the “probable and estimable” calculus, and you can let finance know when those events may occur.
That’s not fun; it’s not fun to project when you may suffer a defeat or choose to settle a case. But it’s often possible, and it’s part of your job. You owe it to the folks in finance to make those projections regularly.
Mark Herrmann is the Vice President and Chief Counsel – Litigation at Aon, the world’s leading provider of risk management services, insurance and reinsurance brokerage, and human capital and management consulting. He is the author of The Curmudgeon’s Guide to Practicing Law (affiliate link). You can reach him by email at [email protected].