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Why Most Major Litigation Is Settled For Less Than the Maximum Potential Liability

There are three reasons lawsuits are launched for money.. They are 1) Compensation 2) Deterrence and 3) Retribution

Compensation is the easiest to understand. I spilled oil onto your land. It will cost X to clean it up and Y to restore the land more or less to its original condition. Therefore, you want the sum of X+Y as compensation.

In addition to compensatory damages, punitive damages are often sought in lawsuits. These are typically a doubling or tripling of compensatory damages. The reason is deterrence, to prevent the wrongdoer from playing the law of averages. If someone were a serial oil spiller, and  were sued only every second or third time, they would pay some and "get away" with some. Meaning that the bad behavior would be only a cost of doing business. The doubling or trebling of damages is to punish the party for the times that it didn't get caught.

The third thing sometimes sought in a lawsuit is retribution. That is to make some pay for the "insult" over and above one or two above. Many lawsuits are launched on that basis, but few are settled that way.

Punitive damages (and fines,etc.) are usually waived when the original judgment threatens to put the party into bankruptcy, and punitives would put the company over. "Bankruptcy" is the exception to the rule of multiple damages. A company in, or on the brink of bankruptcy, is usually presumed to "get it," and therefore not in need of further deterrence.

Likewise, retribution beyond the point of bankrtuptcy is frowned on. The classic case is in "Merchant of Venice," where the judge upheld the banrkruptcy of the defendant, but refused to uphold the "retributive" clause in the contract of "one pound of flesh nearest the heart." Instead, the judge saw it for what it was, and threatened the plaintiff with a charge of attempted murder.

That's why American Express was able to settle the $160 million liabiilty in the "Salad Oil" scandal for its net worth of $60 million. A larger settlement would have bankrupted the company. The company clearly "got it." And in court, the banks would have been faced with the embarrassing question of "why did you accept guarantees of $160 million beyond the $60 million capacity of American Express to pay?"

Ditto, ultimately for Texaco, whose filing for bankruptcy showed that it finally "got it." "Public opinion" (other oil companies) forced Pennzoil to settle for the $3 billion economic value of the tort, not the $10 billion-plus judgment. Had it proceeded further, Pennzoil's name would have been mud.  And Pennzoil launched the lawsuit, in part because it had been "dissed." The $3 billion took care of that.