The "Rainmaker's Dilemma": Bad Debt Loss Insurance in Settlement and Litigation

In this paper, we analyze the impact of Bad Debt Loss Insurance on settlement outcomes. A huge success in a settlement or trial may turn into a disaster when the defendant goes bankrupt. "Rainmakers" face the following dilemma: the greater the success in court, 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 as well as Bad Debt Loss Insurance for both the settlement and the trial stage. We demonstrate that trial insurance and settlement insurance may have different impacts on the 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, can under certain conditions have the opposite effect: it may decrease the settlement result.