The "Rainmaker's Dilemma"

Bad Debt Loss Insurance in Settlement and Litigation

Abstract

In this paper, we analyze the impact of Bad Debt Loss Insurance on settlement outcomes. A huge success in a settlement or trial can turn into a disaster when the defendant goes bankrupt before paying the plaintiff's claim. "Rainmakers" face the following dilemma: the greater the success, the greater the defendant's bankruptcy risk. The starting point of our paper is a simple trial and litigation model with perfect and complete information. We add the possibility of a defendant's bankruptcy, and of buying Bad Debt Loss Insurance for both the settlement and the trial stage. We demonstrate that trial insurance and settlement insurance have different impacts on the predicted outcome of settlement negotiations. Trial insurance tends to increase the settlement result; therefore, it generates a contract rent for the insurer and the insured. Settlement insurance, however, may have the opposite effect, as it decreases the settlement result.