Economic Damage Measurements

Lost Profits and Loss of Business Value—Differences and Correlation in Terms of the Harmful Impact to Plaintiff’s Claims

When a plaintiff suffers, or believes to have suffered, economic damages as a result of a defendant’s actions in a civil matter he/she and their attorney are faced with determining the amount of economic damage suffered. A damages remedy is provided to restore the plaintiff to the same economic position they were in prior to the act. The selection of the appropriate economic damage is a factual one based on various elements including causation and timing. While this may appear relatively straightforward, there are various aspects that need to be considered. Those aspects are discussed in this article.

When a plaintiff suffers, or believes to have suffered, economic damages as a result of a defendant’s actions in a civil matter he/she and their attorney are faced with determining the amount of economic damage suffered. A damages remedy is provided to restore the plaintiff to the same economic position they were in prior to the act. The selection of the appropriate economic damage is a factual one based on various elements, including causation and timing. While this may appear relatively straightforward, there are various aspects that need to be considered.

As an expert, it is important to remember that a plaintiff is able to recover damages only if it can be demonstrated that the breach or other wrongful act committed by the defendant was the proximate cause of the loss.[i] This is generally termed as “causation” and is an important consideration by all parties in determining which calculation is more appropriate as the effects will usually lend assistance in determining which economic damage calculation aligns with the alleged harmful act.

Causation is a critical element in establishing the plaintiff’s cause of action by linking the defendant’s alleged misconduct to the claimed economic harm.[ii] In other words, by understanding the cause, or harmful act, the expert can determine its impact and ultimately the appropriate economic damage calculation. For example, if the defendant’s act caused a slowdown in production, then plaintiff may be entitled to lost profits. On the other hand, if the action caused cessation operations, a loss of business value calculation may be appropriate.

In my opinion, the duration of the impact on the business is just as important as the cause. Lost profits are for a finite period whereas lost business value occurs when the impact is indefinite or permanent. Experts must also address the plaintiff’s mitigation efforts. Mitigation should not be measured simply by determining the amount of a reduction in lost profits or loss of business value, but also how those efforts impacted operations and the way business is conducted.

If the harmful act had such an impact that it required a change of business, then that tangible or intangible segment may be assessed as a loss of business value in addition to lost profits. However, if the change led to an internal change (technology, new CFO, etc.), these change items will need to be addressed by the expert. For example, what if a salesperson violates their non-compete causing a loss of sales to the plaintiff? Not only is there a potential impact on sales, but the impact may fall into a loss of business value. This individual may affect various intangible assets not on the financial statements. Workforce, marketing efforts, or a distributor network may be impacted in addition to the plaintiff’s customer list. The expert must be aware of these not only to account for it, but also to ensure that values and losses are not double counted. They also must determine if lost profits only accounts for a portion of the asset affected by the harmful act and determine how tangible and intangible assets are also affected.

The day the plaintiff is subject to the harmful act is the beginning of the “damage period”. This period is used as a measurement for lost profits and may be defined by contractual agreements or prior company history. During the damage period, experts must also determine management’s mitigation efforts and the corresponding impact on their analysis and future impact to the plaintiff’s operations. A claim may be made during a “down” period or “in the midst” of a total decline. If the business will recover is short-sighted. The expert must be aware of the impact, now and in the future, to assist the client and counsel in determining the appropriate damage period and economic damage measurement.

If a business incurs lost revenue or increased expenses (remember to check if those expenses are business or litigated) due to a harmful act, then a lost profits calculation may prove worthwhile. If a business ceases to operate or its value is permanently reduced, a loss of business value calculation may be appropriate. In theory, the value of an asset (in this case, a business) is the present value of its future earnings. If the future earnings (or profits) of a company is impacted by the past harmful act, then it could make a claim for loss of business value by measuring the value pre-event vs post-event. Many people assume that lost profits are what measures the difference between the two; however, as many experts are aware of, the damaged asset may be impacted not only by revenues, but potentially increased costs in the form of recreation or reproduction.

Timing and the cause and impact are just two variables to be aware of. Discount rates, contract terms, technological changes, taxes or management turnover (e.g., key personnel) add to the complexity of these calculations. Experts must have reasonable certainty in their calculations and, assuming that the cause is the sole reason for the lost profits or loss of business, value may come with the cost of a Daubert challenge or Motion in Limine. This can harm your client’s case as well as your reputation.

It is the job of the litigation team, and the expert’s counsel while adhering to guidance, to determine the appropriate and applicable measurement. Every litigation case has its own unique set of facts and circumstances that guide the damages expert use of calculation methods and the expert’s role is to make counsel and the client aware of these, preferably prior to discovery.

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Josh Shilts, CPA, ABV, CFF, CGMA, CFE, is president of Shilts CPA, PLLC. He 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 his advice and services because of his unique industry experience and knowledge.

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

[i] Causation is Key to Developing Credible Economic Damages: Are you up to Speed? Gray, Robert. August 11, 2008. Found at https://www.aicpastore.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/CPA/Aug/causation.jsp

[ii] Financial Experts: Bridging the Gap Between Causation and Economic Damages. Cunningham, Jay. November 14, 2008. Found at https://www.ksmcpa.com/blog/financial-experts-bridging-the-gap-between-causation-and-economic-damages