The Economic Waste Doctrine

Experts Beware…

Financial experts that handle construction defects claims should be familiar with the doctrine of economic waste, the potential limitations on a damages claim, and recognize the potential of this doctrine arising in a damages engagement. The author shares how this doctrine may arise and what to look for before accepting a damages engagement.

“Economic waste is the label that courts have adopted as justification for not awarding an aggrieved party the cost of performance as damages for breach of a construction contract”.[1] This topic generally arises when a repair in a construction defect matter requires significant reconstruction or, despite a high cost, would not improve the property’s value. “In ensuing litigation over the defects, an owner most often wants to maximize recovery by getting enough money to fully repair the defects. On the other hand, a contractor generally wants to minimize damages by arguing that because the alleged defects have little or no effect on the structure’s value, and the repair costs are disproportionately higher than any loss in value, the court should invoke what is commonly known as the economic waste doctrine and award damages based on diminished value rather than the cost to repair.”[2]

Unless a financial expert is aware or made aware of this doctrine, the individual could find themselves in cross-examination having to explain or “talk away” the economic waste doctrine. In today’s heightened litigation environment wherein Daubert is consistently mentioned as a threat, financial experts need to arm themselves with information to avoid mishaps or situations wherein the expert’s credibility is questioned. Imagine you have prepared a construction damages analysis that calculates repair costs and costs related to closure of the site more than $5 million. Now, imagine having prepared this analysis to come and find out that according to your calculation for every $1 spent, it correlates to an increase in value of $0.10. To be caught on your “toes” trying to explain your rationale and methodology, while in your head and stomach the anxiety charges through your veins, is a situation that anyone who has testified will tell you that you work to avoid at all costs. While the cost analysis is not wrong, per se, the financial expert was unaware how or why their damages analysis is being used and in what context. Back to our example, at the deposition, the financial expert became aware of the property’s value as currently constructed and its maximum value being approx. $2 million with a fair market value currently of $1.5 million. Spending $5 million will increase the value of the property by approx. $500,000. Does that seem like a sound financial recommendation?

That last question is one the financial expert wants to avoid; especially while on the stand in front of the decision maker(s). Reading this article is one way to mitigate such events, but there are others. Financial experts need to pre-screen clients just like any other professional service provider. Yes, financial experts want to help, but not at the cost of their credibility or deviations from professional standards. The following are suggested process techniques financial experts may want to consider:

1. Reviewing the complaint prior to engagement acceptance;
2. Having a financial and non-financial expert prepared to review your deliverable for subject matter relevance and not just mathematical accuracy; and
3. Requiring or budgeting time for research related to the matter and/or its industry. Too many times, financial experts “jump” to their spreadsheets. Documents are requested and Excel cells are populated, but I do not observe what is sometimes referred to as “engagement risk acceptance” or “engagement planning”.

Adding any of the above or other steps to protect the credibility of financial experts is a sound move in protecting not only yours, but the profession’s credibility. Do not fall trap to being the expert who suggested economic waste is defensible or makes economic common sense.

[1] “Avoiding Economic Waste in Contract Damages: Myths, Misunderstanding, and Malcontent”. Daniel, Juanda and Marshall, Kevin. Nebraska Law Review, Volume 85 Issue 4. 2007.

[2] “Repair or Replace? The Economic-Waste Doctrine in Construction Defect Cases”. Hinkston, Mark. Wisconsin Lawyer, August 1, 2011.

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Joshua Shilts, CPA, ABV, CFF, CGMA, CFE, is president of Shilts CPA, PLLC. Mr. Shilts’ practice is focused on assisting attorneys, individuals and businesses with complex financial matters and disputes. He has held roles with international consulting and public accounting firms in Miami and New York City as well as positions with large public organizations. Mr. Shilts is a frequent lecturer on a variety of forensic accounting matters. He has been involved with hundreds of forensic investigations dealing with a variety of matters involving personal and business disputes as well as the identification and mitigation of fraudulent activities. Clients have sought Mr. Shilts’ advice and services because of his unique industry experience and knowledge.

Mr. Shilts has provided expert testimony in commercial and family matters surrounding business valuation, economic damages, fraud, and other applicable disciplines surrounding economic and accounting issues. He has been qualified as an expert and testified in State and Federal courts.

Mr. Shilts can be contacted at (844) 850-6166, ext. 101, or by e-mail to Josh@shiltscpa.com.