COVID-19—Proximate Cause
and its Impact on Lost Profits Calculations
These are challenging times. Financial experts are faced with economic uncertainty and differing projections from various sources as to what the “new normal” will look like. Regardless of the economic circumstances, financial experts are hired to estimate lost profits. These calculations must be made with reasonable certainty. But to be reasonably certain, proximate cause must be considered. To properly consider causation during these current times, an expert must consider the impact of the COVID-19 pandemic and the economic shutdown. Without such consideration, an expert’s report will not reflect reality and could be construed as speculative. This article discusses the standard for proximate cause and if it must be addressed by financial experts. It also discusses problems experts may face when considering causation as they navigate the court system during these uncertain economic times. It will also consider possible solutions and tools for moving forward.
To recover lost profits in commercial litigation, three legal standards must be met: foreseeability, proximate cause, and reasonable certainty. Seldom is an expert asked to address foreseeability. Reasonable certainty states the expert’s calculations do not have to be based on absolutely certainty but must show the results to be more probably than not. The proximate cause standard refers to causation. It is the standard with which many experts have problems. This standard will cause experts even more problems as we face the economic impact of the COVID-19 pandemic.
This article will discuss the standard for proximate cause and if it must be addressed by financial experts. It will also discuss problems experts may face as they navigate the court system during these uncertain economic times. It will also provide avenues for addressing the current economic uncertainty in a report.
Proximate Cause[1]
The proximate cause standard generally states, “damages must be proximately caused by the defendant.”[2] In other words, the damages brought about by the alleged wrongful act must have been caused by the action (or inaction) of the defendant. This principal is true in all compensatory damage cases.
Proximate causation is a straight-forward concept. Did the defendant’s wrongful conduct produce the damages alleged by the plaintiff?
Experts working in personal damages litigation, seldom, if ever, are asked to address causation. Whether the person was injured or killed by the actions of the defendant are not the concern of the financial expert estimating lost earning capacity or lost economic support.
This is not true in commercial damages cases. The failure of a financial expert to consider causation may jeopardize the admissibility of an expert’s report and prevent him or her from testifying. Courts have refused “to find causation when an expert neglects to consider other factors that could have caused—or at least contribute to—the plaintiff’s damages, even when the defendant has indisputably engaged in legally actionable misconduct.[3]
The Fifth Circuit Court of Appeals has noted, “The comparison of profits before and during a period of alleged illegal activity, without proof, does not prove causation; post hoc ergo propter hoc is not a valid method of damages calculation, especially with other market forces at work.”[4] The Seventh Circuit Court of Appeals also has a decision expressing the same opinion toward lost profit calculations and causation.[5]
These other market forces are factors not related to the alleged wrongful act that may have caused a reduction in sales and/or profits. They encapsulate the “other” reasons a busines may have lost sales or profits during the estimated loss period.
The Eighth Circuit Court of Appeals addressed this in 2000. It overturned a plaintiff’s verdict stating the plaintiff expert’s model “was not grounded in the economic reality of the … relevant market, for it ignored inconvenient evidence. [The model] failed to account for market events that both sides agreed were not related to any anticompetitive conduct.”[6]
In a separate opinion, the Eighth Circuit Court of Appeals excluded an economist’s opinion as to the cause of a market value decline because “the expert considered only the alleged wrongful act of the defendant and did not take into account any other independent variables that might affect the conclusion.”[7]
When financial experts have taken causation into consideration, verdicts based on their calculations have been upheld. In 2019, a Texas appeals court affirmed a jury award of lost profits. The appellant court noted, the forensic accounting expert’s testimony was based on “downturn of plaintiff’s surgical business following defendant’s defamatory conduct on plaintiff’s business records showing volume of patients before and after defendant’s conduct, and used evidence of lack of market decline to show causation.”[8]
Causation and COVID-19
The COVID-19 pandemic has created a veil of uncertainty over the near and possibly long-term future of the U.S. economy. All business sectors of the economy have been impacted. Particularly impacted negatively were retail stores, restaurants, bars, hotels and tourist attractions. Even professionals like dentists and physicians that work in non-essential fields have felt the impact of the various stay at home orders.
While economic uncertainty may not affect the book of business for financial experts working in the litigation area. The impact to financial forensic experts is more direct. It affects their work in two ways. First, it affects how experts adjust estimates prepared prior to the economic shutdown that show losses in 2020 and beyond. Secondly, the affect is how experts make calculations for new assignments that estimate losses incurred during the pandemic.
Calculations in Reports Offered Prior to the COVID-19 Pandemic
Estimates made prior to March/April 2020 will be subject to more probing cross examination by opposing attorney and/or rebuttal from opposing financial experts. I believe financial experts should admit that the events relating to the COVID-19 outbreak and the resulting economic shutdown could not have been foreseen when the report was prepared. The financial expert should be prepared to provide an updated set of new projections based on current economic conditions. If unable to update the report, the financial expert should be prepared to update his or her report from the witness stand.
Opposing counsel may object to the new projections or amended testimony due to not being able to examine these changes prior to trial. However, I believe most judges will not only be aware of the unusual circumstances causing these new projections but will allow for some level of correction. I also believe judges will allow time for the opposing counsel to review the expert’s new opinions before crossing. This may mean being called to appear in court more than once. This is not any different than a plaintiff’s financial expert being asked to testify during the plaintiff’s case in chief and then returning to testify as a rebuttal witness after the testimony of the defense’s financial expert.
Calculations for Reports Offered During the COVID-19 Pandemic
Estimates made during the COVID-19 pandemic (beginning March 2020) should adjust for the economic downturn brought about by the economic shutdown. While not all businesses have suffered during this pandemic, almost all, in one way or another, have felt the impact of the stay at home orders. As an example, retail stores deemed non-essential have suffered. However, many retailers with significant online presence have not suffered like those without strong online presence.
Because of the economic uncertainty, a financial expert should consider offering more than one scenario for 2020 and future losses. These scenarios could show an array of future losses. They could range from an estimate of the injured business’ lost profits based on its performance prior to the pandemic to an estimate showing lost profits based on a significant downturn in the injured business. Additional scenarios would then be bracketed by these pre and post pandemic estimates. These additional scenarios might provide additional information, based on facts related to the litigation, which show the demand for the injured business’ products or services slowly or quickly returning
As time goes by, the financial expert should be able to update his or her report or advise his or her client as to which scenario most closely reflects the performance of the injured business’ industry.
Failure to consider current economic factors can create a situation like the following example. In late May, I was hired by a defense attorney to critique a lost profits report prepared by the plaintiff’s financial expert. The report was dated May 01, 2020. This date was well after the beginning of the stay at home orders. The owner of the injured business had been deposed more than a week before the date on the lost profits report. During the deposition, the owner testified that his business was considered non-essential and had been closed since the second week in March. The financial expert showed increasing revenue and profits for 2020 beginning in January and running through December. The expert’s 2021 and 2022 losses showed increased revenue and profits based on the projected increases in 2020.
The critique wrote itself. There was no revenue or profits for April and May for this business. The loss in revenue and profits was not because of the alleged wrongful act of the defendant but due to stay at home orders. As the economy reopened, the demand for the injured business’ services was uncertain. In addition, prior to the stay at home orders, a new competitor had opened in its market. The lost profit estimates from 2020 forward could easily be labeled speculative.
This situation showed a lack of communication between the attorney and the expert. It also showed a lack of understanding by the expert of the injured business’ status (essential or non-essential) and the impact the stay at home orders would have on its industry.
In the end, I expect to see a new report later this year addressing these issues and providing a lesser loss figure. But the expert’s credibility has already been damaged. This may take longer to rebuild than the lost profits calculations.
Data for Adjusting Calculations for the COVID-19 Industry
The following are some ideas to assist an expert from getting into a situation like the one just discussed. When assessing the commercial damages for an injured business, it is always good to understand the injured firm’s industry, its market, and how demand for its product or service is impacted by the general economy. This information is even more important during the time of the COVID-19 pandemic.
To better understand how the current economic conditions have impacted the injured business, its market, and the demand for the injured business’ services or products, the following questions should be considered.
- Was the injured business considered essential or non-essential?
- If essential, how did the injured business’ industry perform during the stay at home orders?
- How did the injured business perform during the stay at home orders?
- If non-essential, how was the industry allowed to reopen (25 percent, 50 percent, full capacity, etc.)?
- How did the injured firm reopen? (curbside sales, 25 percent, 50 percent etc.)
- How has the injured business’ market been impacted by the stay at home orders?
- What was the demand for the injured business’ products or services during the stay at home orders?
- What has the demand for its products or services been since the economy started to reopen?
- How were the injured business’ suppliers impacted by the stay at home orders?
- Can the injured business get needed products or services to provide its services or products to its customers?
- Does it appear the “new normal” will be beneficial or detrimental to the injured business and its industry?
The answers to these questions should open the dialogue among the attorney, the attorney’s client, and the financial expert. Through these discussions, the expert should be able to develop a well-informed picture of the economic conditions impacting the injured business. In addition, the attorney and the attorney’s client will have a better understanding of the facts and assumptions being applied in the assessment of the injured business’ lost profits.
Conclusion
These are challenging times. And financial experts working in commercial damage cases are not exempt from these challenges. Financial experts are faced with economic uncertainty and differing projections from various sources of what the “new normal” will look like.
Regardless of the economic circumstances, financial experts are hired to estimate lost profits. These calculations must be made with reasonable certainty. But to be reasonably certain, proximate cause must be considered. To properly consider causation during these current times, an expert must consider the impact of the COVID-19 pandemic and the economic shutdown. Without such consideration, an expert’s report will not reflect reality and could be construed as speculative.
This article has discussed two situations in which experts may find themselves. One is defending a report prepared prior to the pandemic and the stay at home orders. The other is preparing a report after the stay at home orders began and the economy was shut down. To deal with this situation, experts need to remain flexible and willing to adjust calculations for the impact of the stay at home orders.
Communication with the hiring attorney is important. Everyone (the attorney, the attorney’s client, and the expert) should be on the same page regarding the pandemic’s impact on the injured business and its industry. I believe that during this unusual period, courts will be open to reports that show multiple scenarios due to the uncertainty of the future. I also believe juries will be more willing to accept reports and testimony from experts admitting their own uncertainty as to the future. To do that, the expert must be prepared with the best data available and be able to show how it fits with the lost profit calculations presented.
[1] This section reviews information contained in a previous QuickRead article, “Including Causation in a Lost Profits Analysis”, Allyn Needham, April 20, 2016.
[2] Causation Issues and Expert Testimony, Litigation Support Handbook, 5th Ed. The Role of the Financial Expert, Roman Weil, Daniel Lentz, David Hoffman, John Wiley & Sons, Inc., 2012, p. 3.11.
[3] Ibid., p. 3.2.
[4] Arthur J. Gallagher v. Babcock, 703 F.3d 284 (5th Cir. 2012).
[5] Isaken v. Vermont Castings, Inc., 825 F.2d 1158 (7th Cir. 1987).
[6] Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039 (8th Cir. 2000).
[7] Blue Dane Simmental Corp. v. American Simmental Association, 178 F.3d 035 (8th Cir. 1999).
[8] Memorial Herman Health System v. Gomez, 584 S.W.3d 590 (Tex. App, 2019).
Allyn Needham, PhD, CEA, has been a partner and testifying expert at Shipp Needham Economic Analysis, LLC since 1997. During that time, he has testified in cases involving personal injury, wrongful death, employment matters, commercial damages, business valuation, and matters relating to Chapter 11 bankruptcies. For personal damages litigation, Dr. Needham has expertise in calculating lost earning capacity, lost expected earnings, lost economic support, lost household services, and the present value of future medical expenses. For commercial damages, he has estimated lost profits, past and future out-of-pocket expenses, and lost business value. Dr. Needham has testified on behalf of attorneys representing plaintiffs and defendants in both state and federal courts and FINRA arbitrations. He has testified at trials or hearings in Texas, Oklahoma, Arkansas, Missouri, Illinois, Mississippi, California, Alaska and Washington D.C.
Dr. Needham brings more than 20 years of experience in the fields of banking, finance and risk management to his litigation support work. In addition, his experience as an Adjunct Professor of Economics at Texas Christian University and Weatherford College assists him explaining the methodology and calculations related to each specific case.
Dr. Needham received a BA in economics and business administration from Austin College, a MA in economics from Texas Christian University, and a PhD in business administration from California Coast University. He has continued to develop his expertise by becoming a Certified Earnings Analyst (CEA) in 2000.
Dr. Needham is active in several national organizations associated with litigation support and forensic analysis. He has served as the President of American Rehabilitation Economics Association (AREA) 2005–2006 and Collegium of Pecuniary Damages Experts (CPDE) 2016–2017. He is currently President Elect for AREA. Dr. Needham has made regular presentations on a variety of topics that provide continuing education to professionals in the litigation support field.
Dr. Needham has authored and co-authored various articles in the area of forensic economics. Subjects of his articles include personal damages, commercial damages and corporate bankruptcy.
Dr. Needham can be contacted at (817) 348-0213, or by e-mail to aneedham@shippneedham.com.
