Can Mediators Add Value in the Transactional Context by Rescuing Deals at Risk of Falling Apart?

Traditionally, mediators have helped parties resolve disputes already in litigation. Some of our recent blog posts, however, have discussed how mediators can help nip disputes in the bud before they escalate into litigation in contexts such as estate planning, family businesses, and the workplace. The idea being that lawyers should consider using mediation preemptively to keep their clients out of court in the first place.

Let’s explore another non-litigation context in which mediators can add value — saving deals at risk of falling apart. In a groundbreaking 2004 article in the Ohio State Journal of Dispute Resolution, Professor Scott Peppet posed this simple question: can mediators “be helpful in deals, just as they are in disputes?” He concluded the answer is yes because many of the same informational, psychological and emotional barriers to settlement in litigation also exist in the transactional context. To validate his thesis, Peppet surveyed 122 practicing mediators. He found that approximately 40% of them reported mediating at least one transaction. The transactions ranged in value from $100,000 to $26 million, including:

• The formation of a partnership of practicing physicians
• Creation of a joint venture to produce software
• The formation of a partnership to own an airplane
• The negotiation of “angel funding” for a privately held business
• Mergers between two or more corporations.

To be sure, as Peppet concedes, there are important distinctions between litigation and transactions. In litigation, the relationship between the parties is inherently adversarial; in transactions, it’s generally amicable (at least at the outset). Additionally, in litigation, parties cannot easily disengage if they don’t like how the litigation is unfolding; in the transactional context, a party fed up with the other side can simply walk away (absent negotiations having reached the stage where restrictions such as breakup fees deter repudiation).

Nevertheless, Peppet makes strong arguments for the use of mediation in the transactional context to rescue deals at risk. His points resonate with particular force in connection with transactions that contemplate an ongoing relationship between the parties where contentious negotiations either might cause a party to reconsider whether it still wants the relationship to go forward, or generate so much bad blood that even if the deal closes, the relationship is rocky from the start. In such scenarios, a mediator can intervene to save a deal that might have otherwise fallen apart because the parties found it too challenging to negotiate sensitive issues impacting their future relationship. Additionally, mediator intervention can substantially reduce the risk of a post-deal breakdown in the relationship by preventing the mistrust and animus that might have otherwise developed absent the mitigating influence of the mediator.

Peppet identifies several barriers to settlement in litigation that can also threaten deals:

What’s Fair?

As Peppet observes, “people care about fairness and are sometimes willing to kill a deal over it.” That is, parties may walk away from an otherwise economically sound deal if they feel disrespected or insulted by certain terms or provisions proposed by the other side.

The problem, however, is that parties’ assessments of “fairness” are frequently biased and self-serving, depending heavily on their role in the transaction. For example, in one experiment, even when provided with identical information, participants randomly assigned to either the labor or management side in a simulated collective bargaining negotiation differed substantially in their assessment of what constituted a “fair” wage. Thus, a wage offer deemed generous by a participant playing the role of “management” might have been perceived as “insulting” by that same participant had they instead played the role of union negotiator.

As a trusted neutral without a stake in the outcome, a mediator can objectively assess each side’s assumptions about “what’s fair,” and craft a compromise that strikes a balance between the parties’ respective perceptions. To be sure, transactional lawyers also sometimes play this role. But as Peppet notes, “a lawyer’s task is to represent a client vigorously,” and thus lawyers may be predisposed to the same biases as their principals.

Reactive Devaluation

A key bias affecting both principals and agents in negotiations is the psychological phenomenon known as “reactive devaluation” under which parties devalue an objectively fair proposal “merely because their opponent made it.” As Peppet explains:

Imagine that a disputant is considering two possible agreements that would resolve her dispute: Solution A and Solution B. If the disputant knows nothing about the origin of the two solutions, and does not know which solution her opponent favors, she would, all things considered, prefer Solution A. It meets her interests more completely than Solution B. Now imagine that the disputant discovers that Solution A is in fact the offer proposed by her opponent. Research shows that this information about the offer’s origin will often taint a disputant’s evaluation of the merits of the two proposals. She may no longer prefer Solution A, merely because the other side proposed it.

Mediators can neutralize the effects of “reactive devaluation” by presenting a proposal from one side to the other party, but without telling the other party that the proposal originated with its adversary. In other words, parties will generally be more willing to consider and accept proposals for compromise that the mediator presents as his or her own. A creative mediator might also modify proposals previously presented by one side to make them more palatable to the other party (in effect, validating the other party’s objections to the original proposal and presenting an alternative approach that originates with the neutral).

Endowment Effects

Peppet cites additional research suggesting that attorneys may also be susceptible to overvaluing contract terms that they have originated. In contrast, a mediator who brings no pride of authorship to the table will be more willing to innovate by tinkering with the language used in a standard form to better match the nuances of a particular deal.

Misattribution

Another psychological barrier often bedeviling negotiating parties is the tendency to attribute objectionable conduct to malice when there is actually a more benign explanation. The example Peppet gives is of a person who cuts you off in traffic. Studies show you are more likely to think “they are driving that way because they are inconsiderate” rather than “they may be driving that way because they are late to their child’s medical appointment.” As we discussed in a prior post, Hanlon’s razor is a philosophical construct that encourages us to give people the benefit of the doubt absent evidence of ill will. But in tense negotiations, participants often lack the presence of mind to judge their adversaries favorably. At the same time, Peppet notes, people often let themselves off too easily by evaluating their own conduct favorably.

The tendency to misinterpret an adversary’s conduct negatively, and deny one’s own contributions to a deterioration in civility, can lead to a downward spiral in which anger and resentment take hold, the urge to retaliate grows, and each side becomes increasingly guarded and distrustful and less willing to compromise. A neutral mediator can break this destructive cycle by separately conferring with each party in confidence to understand the sequence of events that led to the breakdown. By listening empathetically, but also gently testing past assumptions and interpretations, a mediator can help parties dial down the tension, and get negotiations back on track. Once involved, a mediator can also screen future proposals to filter out elements that might rekindle mistrust.

Contingencies

A deal element that often generates mistrust in negotiations are contingencies. In a seminal 1999 article entitled “Betting on the Future: The Virtues of Contingent Contracts”, Max Bazerman and James Gillespie offer the following example:

A television production company was recently trying to sell the syndication rights for a popular sitcom to an independent station in one of the three largest U.S. broadcast markets. Both parties were eager to close the deal, but they had very different expectations about the program’s ratings. The producer was confident that the sitcom would grab at least a 9% share of the audience in its early-evening time slot. The station felt the show wouldn’t garner more than a 7% share. Because each share point was worth about $1 million in advertising revenue, the difference in expectations translated into very different ideas about what the rights to the show were worth. After many heated debates, the negotiations broke down. The producer forfeited the market, and the television station bought a less attractive program to fill out its schedule.

It’s easy to understand how different expectations about the future engendered mistrust in the negotiation described above. The station likely suspected the producer was fabricating overly rosy forecasts to justify an unreasonable sales price while the producer probably felt the station was cynically downplaying the show’s prospects to drive down the price. As Bazerman and Gillespie suggest, the solution in that situation would have been to implement a “contingent” contract that left a portion of the purchase price dependent on the ultimate performance of the show. It seems like an obvious solution in hindsight, but when parties deeply mistrust each other it is hard to craft compromises.

In contrast, a mediator without the parties’ emotional baggage can more readily fashion a proposal to address a seemingly intractable dispute over a contingency. Indeed, my colleague David previously wrote about one such a mediation where he employed a “contingency” arrangement to settle a long running insurance litigation. The solution was obvious in hindsight but had eluded the parties due to their mistrust.