LOST PROFITS & ECONOMIC DAMAGE CLAIMS

LOST PROFITS AND ECONOMIC DAMAGE CLAIMS

In commercial litigation, economic damage awards are meant to restore the plaintiff to the financial position the plaintiff would have been in, “but for” the defendant’s alleged harmful acts. Financial experts are often asked to quantify the economic damages that may have been suffered by the plaintiff or to defend against such claimed damages in matters ranging from contract disputes to intellectual property infringement claims, construction delay, and product liability.

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LOST PROFITS AND ECONOMIC DAMAGE CLAIMS

In commercial litigation, economic damage awards are meant to restore the plaintiff to the financial position the plaintiff would have been in, “but for” the defendant’s alleged harmful acts. Financial experts are often asked to quantify the economic damages that may have been suffered by the plaintiff or to defend against such claimed damages in matters ranging from contract disputes to intellectual property infringement claims, construction delay, and product liability.

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The determination of economic damages relies on various potential approaches , including lost profits or lost business value:

Lost Profits Approach

In certain circumstance the harm is for a defined period of time and a separately identifiable cash flow, allowing for use of a lost profits analysis. Lost profits represents the difference between profits the plaintiff would have achieved, “but for” the harmful event, and profits actually achieved.  The calculated lost profits are adjusted for mitigation, if any. A lost profits analysis is commonly employed in breach of contract, intellectual property and general commercial litigation cases.

There are five methods often used in calculating lost profits: sales projection, before and after, accounting for profits, yardstick and market share methods.

  1.  The sales projectionmethod compares forecasted profits before the harmful event to actual profits after the harmful event.
  2.  The before-and-aftermethod compares profits before the harmful event to profits after the harmful event.
  3.  The accounting for profitsmethod is based on incremental sales or profits achieved by the defendant as the result of the harmful event. Use of this method is premised on the assumption that the plaintiff would have attained the same amount of sales or profits as the defendant, “but for” the harmful event.
  4.  The yardstick methodcompares profits to a quantifiable yardstick, before and after the harmful event. This method is typically used in industries where profit margins are closely tied to a measurable yardstick such as the price of raw material.
  5.  The market share methodis based on the market share the plaintiff would have attained, “but for” the harmful event. This method may be suitable for industries where reliable data regarding the overall market is readily available.

Lost Business Value

When the loss of earnings is considered or assumed to be permanent and into perpetuity, or where a business is destroyed completely, a lost business value approach may be appropriate. This approach is commonly applied in business destruction, shareholder oppression, dissenting shareholder and tax court.

In determining lost business value, three commonly used approaches are the asset-based, market and income. In consideration of each of these approaches, a business valuation is performed before the date of harm and after the date of harm, with the resulting difference regarded as the lost business value.

  1. The Asset-based approachinvolves analyzing the plaintiff’s tangible and intangible assets net of liabilities.
  2. The Market approachuses pricing multiples taken from guideline companies or transactions and applies these multiples to the appropriate performance measure of the company being valued.
  3. The Income approach calculates a business’s value by applying a discount or capitalization rate to a measure of its expected future earnings to arrive at a present value of the future benefit streams.