When Do Economic Damages Accrue?

The Case of the Delayed Real Estate Development

In a situation where there is a claim of wrongdoing and one party suffers pecuniary damages, it is incumbent on the economic damages expert to precisely define the period of such claimed damages to properly quantify them. The outcome is largely dependent on the expert’s processes for determining damages, the components of the Expert Report, and the ability to remain unbiased and issue opinions independent of the client’s interests.

[su_pullquote align=”right”]Resources:

The Reasonable Certainty Requirement in Lost Profits Litigation—Best Practices for Proving Your Damages Calculation

Economic Damages Calculations

10 Common Errors in Lost Profits Calculations and Business Damages

Commercial Damages and Lost Profits

Adding Economic Damages (Individual) to Your Practice

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In a situation where there is a claim of wrongdoing and one party suffers pecuniary damages, it is incumbent on the economic damages expert to precisely define the period of such claimed damages to properly quantify them.  The outcome is largely dependent on the expert’s processes for determining damages, the components of the Expert Report, and the ability to remain unbiased and issue opinions independent of the client’s interests.

Case Study

A developer and his contractors began work on a residential complex after obtaining a signed development agreement, pre-approvals, and permits from the town.  The project, which included a residential complex, religious school, and recreation center, was quickly met with hostility from residents of the surrounding community.  They used political power, economic pressures, zoning laws, and intimidation in a concerted attempt to prevent this particular group of people from joining their community.  In a real way, they were trying to prevent an influx of people who were different from them out of fear that it would lead to major changes in the ways the community was run.  Due to the contentious circumstances, the construction work had to be abruptly stopped, causing the project to be stalled and the work to be postponed.

In this case study, the developer was religiously discriminated against by the town, driven by the influence of a group of outspoken residents.  The town caused a delay in the construction by stalling the approval process, imposing unreasonable zoning restrictions, and establishing unwarranted building moratoriums, with the sole motivation of frustrating the developer’s plans.  The town did not provide any legitimate explanation for denying what should have been a routine approval.  Because of the delay, the developer incurred additional expenses and economic damages.  But how and when do the economic damages accrue?

Determining Economic Damages

A claim for economic damages is widely defined by a sense of harm to physical property; impairment or infringement of a patent or other intellectual property; harm to personal, corporate, or organizational reputation; reduction of future net profits; or diminution of the value of a business enterprise.  In some cases, the damage is so severe that it causes irreparable harm to the enterprise, money damages are quantifiable, and complete or even partial restoration of the business is deemed impossible.

For an expert in economic damages, it is critical to define, with as much certainty and as early as possible in the analytical phase of an engagement, when the damaging event(s) occurred.  Evidence supportive of these event(s) should be introduced by counsel for plaintiff and should be referred to by the damages expert.  For example, an employee or partner who stole proprietary information about customers (in breach of written company policy, employment contract, or partnership agreement), thereby causing loss of revenue to the company, can be sued for recovery of lost current and future net profits.  Defining the date of alleged improper conduct, followed by a timeline of subsequent actions, is helpful and necessary to support a quantification of pecuniary damages that resulted from the improper conduct.

How are these events determined, and what is the responsibility of the economic damages expert to consider all available evidence?  In our previous case study, the developer would need to establish proof that its building costs increased (or will increase) as a result of the protracted delay in obtaining the necessary building permits.

When a breach occurs, establishing lost profits can be straightforward.  Some types of profits are lost while others are delayed or, possibly, just reduced.  In the case of a truly lost profit, the damages expert would need to show a calculation of profit that the non-breaching party would reasonably have made on future transactions, reduced by the saved costs of transactions that did not happen.  It is preferable to rely on robust sales and profit projections developed well ahead of the litigation, rather than forecasts made after litigation is considered or filed.  The ultimate claim should be for lost net profits, not lost gross revenue.  Many experts fail to properly discount future lost profits by saved costs that will not be incurred without the extra revenue.  Doing so imperils the credibility of the entire claim and can be grounds for a Daubert challenge.

Regarding the calculation of the lost profits, the damaged party must also consider ways to mitigate their loss.  The Mitigation of Damages Doctrine states that “…anyone who has suffered a loss or injury of some sort is expected to take realistic steps to prevent further loss or injury, except when doing so would be impossible financially or result in severe hardship” (see, for example, Kreuter, 2016, p. 1).[1]  A damaged party cannot just sit back after perceived harm and file a claim if, reasonably, it could act to minimize the losses.  There are situations where mitigation is either not possible or would require excessive funds to achieve, in which case, the damaged party would not be required to demonstrate achieved levels of mitigation.

Compiling Expert Reports

An Expert Report claiming economic damages must use sound reasoning, avoid bias, consider all relevant available information, and present the most reasonable damage argument possible, given the type of company and the data available, inclusive of conducting independent and relevant research with application of facts to the method(s) chosen for the quantification of damages.  “The most persuasive types of evidence include verifiable data, corroborated profit history, and comparative profit performance.”^[2]  Expert Reports supported by relevant literature are superior.

To support a claim for economic damages in an arbitration hearing or court proceeding, the following persuasive evidence must be shown: verifiable data showing a connection between specific acts of the breaching party, leading to the loss; verifiable history of profit; and the actual profit performance after the alleged breach.  If possible, the verifiable data should be from a third-party source; for example, bank statements, credit card statements or accountant’s workpapers, statistics from industry, etc.

Maintaining Independence as an Unbiased Expert

Importantly, when considering the claims, the damages expert must look beyond the alleged causal issues for lost profits to ascertain other potential or contributory factors that fall outside of the defendant’s alleged wrongdoing.  An example is a significant change in the economy that impacts the company’s business, internal changes in key personnel, an environmental issue, or some other event with ramifications on the operations of the company.  Lloyd (2014)[3]:

It will seldom be the case that the defendant’s conduct was the only reason the plaintiff’s results varied between the two periods being compared.  The sales and revenues of most businesses will be affected by changes in the industry and by changes in economic conditions generally, as well as by technological changes, personnel changes, and a myriad of other factors (p. 6).

If other causal factors are identified, the damages expert must make the appropriate adjustments.  If this is not done, the expert witness for the defense will surely consider such impact and attempt to use the failure of the plaintiff’s expert to impeach the credibility of that expert’s findings and conclusions.  Bias in expert reports is made clear in cases where the expert either willfully or negligently overlooks important issues beyond the claimed impact in cases where such consideration might affect the value of the claim.  Often, the expert is in a difficult position to challenge his or her own client’s perception of their claim, especially in situations where uncontrollable factors might have caused or, at least contributed to the loss, are recognizable.  When the client just wants to pin the blame on another party and ignore such factors, the expert should withstand the pressure to back off logical refutations.  Otherwise, the expert risks becoming part of a poorly presented claim.

In a careful analysis of before and after factors, the damages expert must demonstrate an effort to establish how much of the claimed loss was due to the alleged activities of the defendant, as opposed to unrelated business factors.  Commonly known as the “post hoc fallacy,” some damages experts erroneously conclude in their reports—and subsequent testimony—that since event Y followed event X, event Y must have been caused by event X.  The long Latin version is “post hoc ergo propter hoc” or “after this, therefore because of this.”

Perhaps a more egregious error in a damage quantum is basing damages and the length of the damage period solely on the plaintiff’s perspective.  In doing so, the expert exposes him or herself to accusations of bias towards the plaintiff’s view without the necessary vetting or careful consideration of the facts of the case, applied to the composition of the damage claim.  When this happens, the expert’s findings start to resemble the position of the plaintiff rather than the independent analysis of the expert.  Too many references to verbatim language from the complaint, followed by inadequate independent testing and work, will open the expert report to challenge and possible impeachment.

The perspective of the client can be arbitrary and also substantially guided by post-litigation thinking and also emotions, such as anger and resentment.  Therefore, such input received by the damages expert from the client must be treated as potentially accurate, but also, potentially self-serving.  Therefore, a thorough verification is warranted to support client-generated positions or claims.  Through a careful process of weighing the case facts to the available evidence, the expert will be in a better position to independently ascertain the damage period and the resulting econometrics for the claim.  As a result, the report and testimony of the expert has a much better chance of being credible, independent, and free from bias.

It is also important to separate the damages that resulted from the lawful conduct of a strong competitor in the market from the damages that resulted from the claimed misconduct committed by that same competitor.  For example, if sales are lost to one or more competitors, it may not necessarily be due to improper sharing of trade secrets, but rather to normal aspects of competition.  Therefore, a drop in sales does not necessarily equate to cognizable damages (i.e., the fault of another party).

Therefore, fact witnesses are tasked with proving or disproving the claim with regard to cause.  The economic expert’s reported findings and conclusions of damages will be based on professional assessment of the facts, as well as prior testimony available in the case, such as deposition transcripts.

Certain baseline assumptions may be necessary to compose damages in cases where the monetary claim hinges on one or more specific issues not determinable by the damages expert.  An example of such an assumption is in the case of a patent or patent application where there is claim of diminution of the value of the product or process, resulting from a tort action.  In this case, the plaintiff’s expert may wish to begin the quantification of damages on the foundational position that the patent application will result in a valuable patent or that the actual patent can, in fact, be successfully monetized.

Usually, in cases of controversy concerning economic damages, the opinions and findings of one expert can be adjusted subject to the varying perspectives of rebuttal experts.  As a result, it is not uncommon to have differing opinions on the same set of facts.

In the case study mentioned earlier, the unbiased, carefully calculated Expert Report led to a favorable outcome for the developer, who was awarded money for damages that had accrued due to the actions of the town and the resulting delay in its efforts to complete the project.

[1] Kreuter, E. (2016). Avoiding damages done by damages experts. Metropolitan Corporate Counsel, December 2016.

[2] Zachary G. Newman and Anthony Ellis (2012): A Primer on Recovering Lost-Profit Damages, Litigation – Business Torts & Unfair Competition, American Bar Association
http://apps.americanbar.org/litigation/committees/businesstorts/articles/fall2012-1012-primer-recovering-lost-profit-damages.html

[3] Lloyd, R.M. (2014). Proving damages for lost profits: The before-and-after method. May 2014. University of Tennessee College of Law. Date retrieved: July 19, 2017: http://trace.tennessee.edu/cgi/viewcontent.cgi?article=1074&context=utk_lawpubl

Eric Kreuter, PhD, CPA, CGMA, CFE, CBA, is a Partner in the Financial Advisory Services group at Marks Paneth LLP. He specializes in litigation and forensic services including commercial damages and fraud investigations. His background also includes management, human resources, and other consulting services. He is also a specialist in all facets of the construction industry. Dr. Kreuter has worked in professional services firms since 1983 and served as a founding shareholder. He has testified in state courts and the U.S. Bankruptcy Court as well as arbitrations and depositions. He has written seven books, several book chapters, and numerous articles covering a wide range of topics.

Dr. Kreuter and Lana Wong can be contacted at (212) 201-3117 or respectively by e-mail to EKreuter@markspaneth.com or LWong@markspaneth.com.