Lost Profits Reviewed by Momizat on . Moving Forward During COVID-19 The COVID-19 pandemic has brought difficulties and major lifestyle changes for most of us. This is particularly true for the busi Moving Forward During COVID-19 The COVID-19 pandemic has brought difficulties and major lifestyle changes for most of us. This is particularly true for the busi Rating: 0
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Lost Profits

Moving Forward During COVID-19

The COVID-19 pandemic has brought difficulties and major lifestyle changes for most of us. This is particularly true for the business world. Some firms have been negatively impacted. Some businesses have benefitted from the change in our lifestyles. Because causation is an important consideration in commercial damages cases, experts assigned to estimate lost profits must consider the impact of COVID-19 on a business or industry when calculating damages for 2020 and 2021. Courts are aware of the impact COVID-19 has had on the economy and the public. This article addresses issues experts should consider when assessing lost profits running through 2020 and 2021. It also provides a list of questions that may be used for gathering information needed for completing such assignments.

Lost Profits: Moving Forward During COVID-19

Courts are aware of the impact COVID-19 has had on the economy and the public as a whole. This article addresses issues experts should consider when assessing lost profits that allegedly occurred in 2020 and 2021. It also provides a list of questions that may be used for gathering information needed for completing such assignments.

The COVID-19 pandemic brought new difficulties for those estimating lost profits. Optimistically, economists have anticipated 2021 providing an easier path as many industries return to some form of normal. Any optimism needs to be tempered with a dose of reality as it appears the first half of 2021, and perhaps even more of the year, will find businesses and specific industries struggling to any form of “return to normal.” As we move through 2021, I believe it is time to consider how the pandemic has and will affect an expert’s calculations and how best to address the impact of COVID-19.

Court Standards for Economic Damages

Courts look for three standards to be addressed when considering economic damages: foreseeability, proximate cause, and reasonable certainty. Financial experts are almost never asked to address foreseeability. In personal damages cases, experts need only address reasonable certainty. For these type assignments, the causation issue is seldom, if ever, discussed by the damages expert. The expert will project the pre-injury income stream and subtract anticipated offsetting post injury income to show the plaintiff’s “but for” loss.

The US Supreme court outlined this process in its Pfeifer decision. In the decision, Justice Stevens wrote, “In calculating damages, it is assumed that if the injured party had not been disabled, he would have continued to work, and to receive wages at periodic intervals until retirement, death, or disability. … The lost stream’s length cannot be known with certainty; the worker could have been disabled or even killed in a different non-work-related accident at any time … Given the complexity of trying to make an exact calculation, litigants frequently follow the relatively simple course of assuming that the worker would have continued to work up until a specific date certain.”[1]

For these calculations, it is assumed the disability was caused by the alleged wrongful act. It is rare for the defense to argue underlying conditions or other factors would have led to economic damages.

However, the need to show the economic damages were caused by the actions of the alleged wrongdoer is critical in commercial damages cases, especially lost profits. While the US Supreme Court has not addressed these issues, the 5th and 8th  Circuit Courts of Appeal have addressed the importance of an expert considering other causations.

The 5th Circuit Court of Appeals noted, “The comparison of profits before and during a period of alleged illegal activity, without proof, does not prove causation.”[2]

The 8th Circuit Court of Appeals has also affirmed this position. While overturning a plaintiff’s verdict, the court stated the 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.”[3]

Therefore, if experts are to consider other causations, COVID-19 is an external source of potential damages. So, any report including lost profits from 2020, 2021, and possibly 2022 must consider the impact of COVID-19.

Methodology for Measuring Lost Profits

Financial literature speaks of three specific methods for measuring lost profits: before and after, yardstick, and but for.[4] Applying the before and after analysis during COVID-19 may cause serious problems for an expert. The basic assumption for a before and after analysis is that the injured business would have performed during the loss period as it has in the past. If the lost profits period includes 2020 and 2021, an expert estimating lost profit with this method must be prepared for an aggressive counter from the opposing expert or opposing attorney. This would be especially true if the business were considered non-essential in its geographic area. The use of a before and after analysis appears to be a sure way to “buy trouble” until the injured business’ industry and market return to normal activity.

The yardstick method provides for comparing the injured business’ performance during the lost period with other firms offering the same products and/or services over the same period. This method provides some protection in that it may be assumed the other businesses suffered through the same economic environment as the injured firm. This may be a good assumption if the comparable firms are in the same geographic area. This may be important because each state made its own rules about who could stay open (essential) or had to stay closed (non-essential) at the start of the pandemic.

As an example, in Texas, the Dallas, Fort Worth, and Houston areas found construction work to be essential. The state capital, Austin, found construction work to be non-essential and sent workers home for several weeks until pressure from the Governor’s office caused the city to change its mind and make construction essential in Austin as well. For any construction business in Austin claiming lost profits during 2020, a yardstick measure comparing it with Dallas, Fort Worth, or Houston construction firms might show lost profits that were caused by government shutdowns as opposed to other causations.

The but for method appears to provide the best option for estimating lost profits during this time. By showing the profits that could have been made “but for” the alleged wrongful act, the expert takes into consideration how other causations would have impacted the business’ performance. With these other causations already considered, the remaining difference between the “but for” performance and the expected performance is the lost profits brought about by the alleged wrongful act.

COVID-19 Contrasts

Some of the potential impacts from the COVID-19 pandemic are obvious. Restaurants, bars, and movie theatres are among the businesses greatly impacted by the various lockdowns throughout the country. The travel and hospitality industries have also seen significant drops in demand for their products and services. Data are readily available to estimate the impact on these industries.

The definition of essential and non-essential businesses affected by lockdowns varied from state to state. As an example, many states declared liquor stores non-essential. Texas placed liquor stores in the essential category. So, an expert needs to check to determine on which list (essential, non-essential) a business fell.

Also, some businesses flourished during the pandemic. Labs that processed COVID-19 tests have seen large increases in revenue. Emergency and Urgent Care facilities that provide walk-up COVID-19 tests also saw increases in income. Food delivery services also saw increased demand. And of course, businesses that had large online footprints and delivery services saw record business.

It has been my experience that many non-retail businesses struggled during the first half of 2020 but found their footing during the second half of the year. This does not mean they were as profitable as the prior year but were profitable at a lesser level.

Expert Analysis

In a prior QuickRead article, I stated, “Courts may be open to provide some flexibility in assessing an expert’s results but will not move away from ensuring the reasonable certainty of the opinions.”[5]

This seems to have been confirmed by the In Re: Body Transit, Inc. decision.[6] In this case, the bankruptcy judge had to decide “the question of how to value a fitness club in the context of COVID-19, and the economic uncertainty that comes along with it.”[7] The debtor’s expert provided a liquidation value even though the business wanted to continue operating at least one location. The creditor’s expert “did not fully consider the economic conditions of the industry and the effects of COVID-19.” In the end, the judge calculated his own value relying on pre-COVID-19 multipliers and then discounting them for the current uncertainty. This decision provides one example of how judges are viewing expert reports and their current expectations.

To enhance my current reports, both personal damages, and commercial damages, I include two or three paragraphs discussing the COVID-19 pandemic and how it has or has not affected my calculations. For those cases where the impact is greater, a more detailed explanation of how the pandemic affected the performance of the injured business is necessary.

Not only does an expert need to consider the varying impact the pandemic had on businesses, but also the assistance/stimulus programs provided by the US Government. The Payroll Protection Program (PPP) offered businesses an opportunity to make payroll and retain employees. It also provided the opportunity for the loan to be forgiven if used to pay for specific expenses (wages, benefits, etc.). Other programs (like the CARES Act) allowed specific businesses to borrow additional money from government agencies to pay wages, benefits, and lease or mortgage expenses. These loans may also be forgiven. However, if the funds are not spent or used properly, the money must be repaid to the federal government.

I worked recently with a business that was having to return between two to five million dollars in 2021 because it was not spent on covered expenses. That repayment had to be included as part of the analysis.

Therefore, beyond the traditional questions generally asked in a lost profits assignment, an expert will need to include COVID-19 questions as well. The expert will need to interview the management of the plaintiff company. If that is not possible (possibly because the expert is working on the defense side), the expert will need to research the industry and possibly speak with businesses competing in the same market about the impact of COVID-19.

Specific questions relating to the pandemic should include:

  • How did the pandemic and subsequent lockdowns affect your business?
  • How did it affect your competitors?
  • Was your business considered essential or non-essential?
  • Were you able to get a Payroll Protection Program (PPP) loan or some other form of government assistance (like through the CARES Act)?
  • If you received assistance, has the loan been forgiven?
  • If still open, how has your business recovered from the pandemic limitations?
  • If closed, how has your competition recovered from the pandemic and lockdowns?

By asking these questions, an expert may stay away from the misfortune that befell the opposing expert in a case I had last year. The expert offered a report dated late May 2020. In the report, he projected profit losses throughout 2020. He provided a month by month estimate of these losses running from late 2019 to 2022.

Unfortunately, the business owner testified at his deposition that his business had been declared non-essential and was closed for three months in early 2020 and was still closed. It appears his business would have been able to reopen in July 2020. By then, the business would have been closed for approximately five months. Obviously, the closure, the re-opening, and rebuilding of the business’ customer base was a causation not considered. Therefore, the expert’s results were not reasonably certain.

My critique noted the failure to consider COVID-19 related causation. The case settled after that for much less than calculated by the expert.

This is a precautionary tale reminding all of us to consider the pandemic in any analysis containing 2020 and 2021 lost profits.

Conclusion

The COVID-19 pandemic has brought difficulties and major lifestyle changes for most of us. This is particularly true for the business world. Some firms have been negatively impacted. Some businesses have benefitted from the change in our lifestyles. Experts assigned to estimate lost profits must consider the impact of COVID-19 on a business or industry when calculating damages for 2020 and 2021.

Additional questions need to be asked and the causational impact of the lockdowns or demand changes to various industries considered before providing a loss figure with reasonable certainty. The courts are well aware of the impact COVID-19 has had on the economy and the public as a whole. Inclusion of COVID-19 in an analysis will enhance the credibility of the expert showing he or she has tried to eliminate other causations to locate the lost profits brought about by the alleged wrongful acts claimed in the lawsuit.

[1] Pfeifer v Jones Laughlin Steel, Co., 462 U.S. 523 (1983).

[2] Arthur J. Gallagher & Co. v Babock, 703 F.3d 284 (5ht Cir, 2012).

[3] Concord Boat Corp. v Brunswick Corp., 207 F.3d 1039 (8th Cir 2000).

[4] This is not an exhaustive list but most methodologies fall under one of these three methods.

[5] Chapter 11 Bankruptcy | QuickRead | News for the Financial Consulting Professional QuickRead | News for the Financial Consulting Professional (quickreadbuzz.com).

[6] In Re: Body Transit, Inc., 20-10014. Eastern Pennsylvania Bankruptcy Court, 8/7/2020.

[7] Accounting for COVID-19 in Valuation | QuickRead | News for the Financial Consulting ProfessionalQuickRead | News for the Financial Consulting Professional (quickreadbuzz.com).


Allyn Needham, PhD, CEA, is a partner at Shipp Needham Economic Analysis, LLC, a Fort Worth-based litigation support consulting expert services and economic research firm. Prior to joining Shipp Needham Economic Analysis, he was in the banking, finance, and insurance industries for over twenty years. As an expert, he has testified on various matters relating to commercial damages, personal damages, business bankruptcy, and business valuation. Dr. Needham has published articles in the area of financial and forensic economics and provided continuing education presentations at professional economic, vocational rehabilitation, and bar association meetings.

Dr. Needham can be contacted at (817) 348-0213, or by e-mail to aneedham@shippneedham.com.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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