Understanding and Calculating Lost Profit Damages


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Understanding and Calculating Lost Profit Damages

  1. 1. A Global Reach with a Local Perspective www.decosimo.comUnderstanding and Calculating LostProfits Damages
  2. 2. Agenda  Elements of Lost Profits Damages Claims  Defining Lost Profits  Methods of Calculating Lost Profits  Timing Considerations
  3. 3. Elements of Lost Profits Damages Claims  Caused by Defendant   What’s the link?  Foreseeable by Defendant   Should Defendant have known that damages would occur?  Reasonably Certain   Is the fact of damages (not necessarily the amount of damages) reasonably certain?
  4. 4. Reasonable Certainty  Damages are not rendered uncertain because they cannot be calculated with absolute exactness. It is sufficient if a reasonable basis of computation is afforded, although the result be only approximate. Eastman Kodak Co. v. Southern Photo Materials, 273 U.S. 359 (1927)  Once an injured party proves that it has been damaged, the amount of the damages need not be proved with certainty or mathematical precision. After the fact of damages has been established, less certainty is required with regard to the amount of the damages. Waggoner Motors, Inc. v. Waverly Church of Christ, 159 S.W.3d 42 2004 Tenn. App.
  5. 5. Defining Lost Profits  The difference between what you should have made on whatever transaction or series of transactions occurred or should have occurred and what you actually made on whatever transaction or series of transactions actually occurred
  6. 6. Definition of Profit … the difference between the purchase price and the costs of bringing to market whatever it is … in terms of the component costs of delivered goods and/or services and any operating or other expenses http://en.wikipedia.org/wiki/Profit_(accounting)6
  7. 7. Michael Scott on Wikipedia Wikipedia is the best thing ever. Anyone in the world can write anything they want about any subject. So you know you are getting the best possible information. --- Michael Scott – The Office
  8. 8. Five Aspects of Lost ProfitsLost profits are: 1.  Net 2.  Incremental 3.  But-for 4.  Pre-tax 5.  Reasonably certain
  9. 9. Net Profits  In Tennessee, the recovery of lost profits must be based on net profits and not on gross profits. American Buildings Company v. DBH Attachments, Inc. 676 S.W.2d 558; 1984 Tenn. App  In cases involving the loss of expected profits from the sale of goods, the expected net profits equals the expected revenue from the sale of the goods minus the cost of the goods sold minus all of the seller’s expenses fairly attributable to the sale of the goods. Waggoner Motors, Inc. v. Waverly Church of Christ, 159 S.W.3d 42 2004 Tenn. App.
  10. 10. Incremental Profits  Do “fairly attributable” expenses include fixed overhead items?  In Waggoner Motors v Waverly Church of Christ, Appeals Court says (in a footnote), “Fixed overhead expenses, i.e., expenses that the injured party would have incurred notwithstanding the wrongful act, should not be deducted from gross revenue.” In agreement with most cases that have considered the argument that fixed overhead must be included (per Dunn, Recovery of Damages for Lost Profits)
  11. 11. Pretax Profits  Lost profits damages awards are taxable to the recipient  An award of after tax lost profit would be further reduced by taxes when received by the Plaintiff  An award of pretax profits makes the Plaintiff whole
  12. 12. Methods of Calculating Lost Profits  Before and After  Sales Projection  Accounting for Profits  Yardstick  Market Share  Economic Modeling
  13. 13. Before and After Calculations  Based on time series data  Compares profit before bad act to profit after bad act  Typically more suited to stable businesses or contractual relationships  Did other things change during that time?
  14. 14. Before and After Calculations  Method used by expert in Waggoner Motors   Post incident performance of plaintiff was compared with performance by the plaintiff during the 3 preceding calendar years  Did other things change during that time?   Appeals Court determined that there were other factors and time periods to take into consideration. Use of plaintiff’s financial records deemed appropriate, but must take other factors into consideration
  15. 15. Sales Projection Method  Compares actual performance after the bad act with a forecast of performance before the bad act  How reliable is the forecast? Who prepared it and what is it based on?  Can be applicable to –   existing company opening a new line, new product, new service   new company entering business or industry
  16. 16. Accounting for Profits Method  Relies on the accounting records of a party other than the Plaintiff (typically the Defendant) to establish sales or profits  Common in cases where the Defendant is accused of breaching a purchase/supply contract and made the purchases in question from another supplier  Can break down if the profits of the third party are not reasonably related to the but for profits of Plaintiff
  17. 17. Yardstick Method  Compares profits in each period to a yardstick  More relevant for companies without an established history of operation and for which relevant yardstick entities can be found  Requires the ability to argue that the entity in question would also have experienced essentially the same results as the industry statistics or other yardstick used
  18. 18. Market Share Method  Assumes a certain market share would have been achieved or maintained  Uses market share information to determine lost sales  How reliable is data on the size of the total market?  How reasonable is the assumption regarding Plaintiff’s share?
  19. 19. Economic Modeling Method  Catch all for other ways of determining lost sales or lost profits  How reasonable is the model?
  20. 20. Timing Considerations  Damages happen over time  A dollar tomorrow is worth less than a dollar today  A dollar yesterday should have grown to be more than a dollar today  Future cash flows are not certain
  21. 21. Timing Issues and Lost Profits  Damage Period   What is the appropriate period over which the lost profits should be calculated?  Past lost profits were lost prior to trial  Future lost profits are expected after the trial  Making the injured party whole is therefore complicated by timing issues
  22. 22. Timing Issues Terminology  Ex Ante Calculation   Damages are calculated as of the date of the breach   Expected future damages are based on what was known or reasonably knowable as of the date of the bad act   Damages are discounted to the date of the bad act
  23. 23. Timing Issues Terminology  Ex Post Damages   Damages calculated as of a date after the breach (typically an assumed trial date)   Damages that occurred between date of breach and trial informed by intervening events   Post trial damages discounted to trial date   Pretrial damages brought forward at prejudgment interest or some other rate
  24. 24. CONTACT  US   D.  Michael  Costello,  CPA•ABV•CFF,  ASA,  CFE   Principal     mikecostello@decosimo.com   www.linkedin.com/in/mikecostello   Sharon  P.  Hamrick,  CPA•CFF,  CFE   Senior  Manager,  Decosimo  Advisory  Services   sharonhamrick@decosimo.com   www.linkedin.com/in/sharonhamrick   423-­‐756-­‐7100  The   contents   and   opinions   contained   in   this   ar/cle   are   for   informa/onal   purposes   only.   The   informa/on   is   not  intended  to  be  a  subs/tute  for  professional  accoun/ng  counsel.  Always  seek  the  advice  of  your  accountant  or  other  financial  planner  with  any  ques/ons  you  may  have  regarding  your  financial  goals.