Judgment-Contingent Settlements

Asymmetric information is widely considered to be a major obstacle to settlements. We argue that litigants facing asymmetric information can use a simple add-on to the settlement offer in order to overcome the information barriers to settlements. In particular, the informed party can promise to pay a multiplier on the judgment should it lose at trial (if the settlement proposal is rejected and a trial takes place) in exchange for a payment from the other party. We refer to this class of provisions as Judgment-Contingent Clauses (JCC). While JCCs are costly to informed parties who misrepresent themselves, they are costless if parties reveal their true type. Accordingly, JCCs can decrease trial rates and at the limit eliminate them altogether. The model also gives rise, under certain conditions, to inverse-JCCs, which decrease rather than increase the stakes of a trial in exchange for a payment to the uninformed party, and resemble the more familiar high-low agreements.