Proving and Defending Lost Profit
and Business Interruption Damages
CLM003
Monday April 28, 2014
2:00 PM - 3:00 PM
CCC, 501/502
Recording of this session via any media type is strictly prohibited.
Page 1
Lee Wertz is a Partner at
Harrison Bettis McFarland LLC
whose practice includes civil
litigation and insurance matters.
Jeffrey (Jeff) W. Spilker, JD,
CPA/ABV is a partner at Hill
Schwartz Spilker and Keller, LLC.
Jeff specializes in financial
forensics, economic damage
analysis, and real estate and
business
valuation
Recording of this session via any media type is strictly prohibited.
Page 2
What to Expect
After attending this session you should be able
to:
1. Understand generally accepted lost profit
calculation models;
2. Understand the difference between lost
profit and business interruption claims;
3. Use these models to evaluate lost profit
claims.
Recording of this session via any media type is strictly prohibited.
Page 3
Lost profits are damages for the loss of net
income to a business.
The claim is for income from lost business
activity, less expenses that would have been
attributable to that activity.
Recording of this session via any media type is strictly prohibited.
Page 4
Permanent or Temporary
Permanent Loss means no resumption of
operations. The measure of damages for a
permanent loss is diminished value:
Value at Event
- Value After the Event
Damages
Recording of this session via any media type is strictly prohibited.
Page 5
Permanent or Temporary
Temporary Loss means that the business will
resume normal operations in the future.
There can be cases of mixed loss, i.e., loss of
profits until business terminates.
Recording of this session via any media type is strictly prohibited.
Page 6
Permanent or Temporary
“Damage Period” defines the time it will take
Plaintiff to be put back into the position prior to
the wrongful event.
Facts: Contract period, historical relationships,
historical retention rates, etc. If no case facts
establish a damage period,
future losses
become more speculative
Recording of this session via any media type is strictly prohibited.
Page 7
Simple Lost Profits Example
700
Recovery
Event
600
500
Lost Profits
400
Expected Profit
Actual profit
300
Loss Period
200
100
0
Jan-13
Feb-13
Mar-13
Recording
of this session
any media
type isSep-13
strictly prohibited.
Apr-13
May-13
Jun-13 viaJul-13
Aug-13
Oct-13
Nov-13
Dec-13
Page 8
You must prove something
that never happened!
Recording of this session via any media type is strictly prohibited.
Page 9
Reasonable Certainty
Profits that would have been obtained, “but
for”… [the breach, interference, etc.]
… to a “reasonable certainty”
… more than a scintilla of reasonable
certainty
Recording of this session via any media type is strictly prohibited.
Page 10
The Standard
Restatement (Second) of Contracts §352
(1981)
“Damages are not recoverable for loss beyond an
amount the evidence permits to be established
with reasonable certainty.”
Recording of this session via any media type is strictly prohibited.
Page 11
The Standard
New York – “It must be demonstrated with
certainty that such damages have been caused
by the breach …” Kenford Co., Inc. v. County of Erie,
67 N.Y.2d 57, 493 N.E.2d 234, 502 N.Y.S.2d 131 (1986)
Texas – “Uncertainty as to the fact of legal
damages is fatal to recovery, but uncertainty as
to the amount will not defeat recovery.”
Southwest Battery Corp. v. Owen, 131 Tex. 423, 115
S.W.2d 1097, 1099 (1938)
Recording of this session via any media type is strictly prohibited.
Page 12
California – “Lost profits … Not only must
such damages be pled with particularity …,
but they must be proven to be certain both
as to their occurrence and their extent, albeit
not with ‘mathematical precision.’” Greenwich
S.F., LLC v. Wong, 190 Cal.App.4th 739, 754, 118
Cal.Rptr.3d 531 (2010)
But case law also references “reasonable
certainty.”
And BAJI 3903N – “The amount of lost
profits need not be calculated with
mathematical precision, but there must be a
reasonable basis for computing the loss.”
Recording of this session via any media type is strictly prohibited.
Page 13
BUT. . . . .
New York Federal Court Anomaly: Tractabel
Direct Damages: “stable foundation for a
reasonable estimate.”
Consequential Damages: “reasonable certainty.”
Defendant intentionally breached contract to
avoid larger loss over time. Not likely to change
New York law.
Recording of this session via any media type is strictly prohibited.
Page 14
Southwest Battery Corp. v. Owen,
115 S.W.2d 1097, 1098-99 (Tex. 1938)
“The amount of the loss must be shown by competent
evidence with reasonable certainty.”
1. Business sold car batteries
2. Industry was well established -- Sale of car batteries not
uncertain or speculative
3. A short history of profits combined with an established
industry was sufficient
Recording of this session via any media type is strictly prohibited.
Page 15
Causation
Plaintiff has the burden to prove proximate
cause:
1. But-For
2. Foreseeable
Causation is often assumed by the expert.
Recording of this session via any media type is strictly prohibited.
Page 16
Quantifying Lost Profits
Recording of this session via any media type is strictly prohibited.
Page 17
Accepted Models
1. Discounted Cash Flow (Before and After):Compare
historical trend -- past profits, growth rates,
assumed growth rates, markets, competition,
infrastructure, etc.
2. Yardstick: Comparable companies, industry
trends or data.
3. Market Share or Specific Contract.
Recording of this session via any media type is strictly prohibited.
Page 18
Discounted Cash Flow
700
Recovery
Event
600
500
Lost Profits
400
Expected Profit
Actual profit
300
Loss Period
200
100
0
Jan-13
Feb-13
Mar-13
Recording
of this session
any media
type isSep-13
strictly prohibited.
Apr-13
May-13
Jun-13 viaJul-13
Aug-13
Oct-13
Nov-13
Dec-13
Page 19
Discounted Cash Flow
• Astrostaff – an established PEO wants to
go independent
• Seeks Worker’s Compensation coverage
from broker
• You don’t need a policy, you just need a
number!
• UNTIL someone gets hurt.
Recording of this session via any media type is strictly prohibited.
Page 20
Discounted Cash Flow
Basic Economic Research – industry, markets, etc.
Specific PEO Industry Research
• NAPEO Surveys
• Articles
• Data from public companies
• Interviewed PEO WC Insurance expert
• Analyzed WC Market and Issues
Construction & Manufacturing Industry Research
(industries served by AstroStaff)
Recording of this session via any media type is strictly prohibited.
Page 21
Company
• Interviewed all management
• Reviewed all financial data
• Reviewed all operating history – client list, retention,
revenues per site
Business Plan
•
•
Infrastructure – Sales Rep’s
Computer hardware and Software
Expansion Plan
•
•
Compared growth in past to plan
Compared growth to industry and other data
Compared to other public PEOs (Administaff, etc.)
Recording of this session via any media type is strictly prohibited.
Page 22
Discounted Cash Flow
1. Expert had been used by nation’s largest PEO
when valuing the business for Initial Public
Offering. Deep knowledge.
2. Models ranged from $34 million to $68 million.
3. Defense expert claims negative value.
4. Documents in Defendant’s expert file suggested
after-tax sales “value” of $7.3M, which converted
to a pre-tax lost profits value of $38M.
Recording of this session via any media type is strictly prohibited.
Page 23
Discounted Cash Flow Issues
Discount Rates
• Start with “risk free” rate then build up
• Can dramatically effect result
Growth Rates
• Why do they always grow?
• Support with historical rates, industry data,
economic forecasts for the area or the market
Recording of this session via any media type is strictly prohibited.
Page 24
Yardstick Method
America’s Favorite Chicken Co. v. Samaras
929 S.W.2d 617 (Tex. App. – San Antonio 1996, writ denied)
•
•
•
•
Two build-to-suit restaurants.
Never opened because of company finances.
Used data from Popeye’s other franchises
“… more than a scintilla of evidence…”
Recording of this session via any media type is strictly prohibited.
Page 25
Market Share
Brennan’s Inc. v. Dickie Brennan &
Company, Inc., 376 F.3d 356 (5 Cir. 2004)
• No “Reasonable Royalty”- Not licensing
dispute.
• Used customer counts as a percentage of
attendance at the New Orleans
Convention Center.
th
Recording of this session via any media type is strictly prohibited.
Page 26
New Business
Recording of this session via any media type is strictly prohibited.
Page 27
New Business
The success of a new and unproven enterprise.
“The focus is on the experience of the persons
involved in the enterprise and the nature of the
business activity, and the relevant market.”
The enterprise is the “activity” not the entity.
Recording of this session via any media type is strictly prohibited.
Page 28
New Business
Speculative:
1. An activity dependent on uncertain or
changing market conditions
2. Chancy business opportunities,
3. Promotion of untested products
4. Entry into unknown or unviable markets
Texas Instruments v. Teletron, 877 S.W.2d at 279
Recording of this session via any media type is strictly prohibited.
Page 29
Teletron
The T-2000 – a voice-prompted programmable
thermostat
No sales, no production, not even a prototype
“Teletron’s expectations were at best hopeful, in
reality, they were little more than wishful.”
Recording of this session via any media type is strictly prohibited.
Page 30
VingCard v. Merrimac
VingCard gives Merrimac exclusive right build
workstations with hotel keycard readers.
Merrimac has plans to modify for food service
industry with Ibertech.
VingCard terminates agreement.
Lost profits for hotel business AND food service
business.
Recording of this session via any media type is strictly prohibited.
Page 31
Merrimac
Through its president, Merrimac put on evidence of:
1. Experience in the industry
2. Established customer base
3. Production and sales of the product
4. Marketing and distribution capability of VingCard
and Ibertech
Recording of this session via any media type is strictly prohibited.
Page 32
It’s the facts …
Look at the activity. Is it an established activity?
• Yes! --fried chicken, car batteries, hotel door key/credit
card readers
• No! – voice prompted thermostats
What are the facts of the entity/activity? Things your expert
needs to “drill down into.”
• Management Expertise and Experience
• Availability of labor
• Availability of capital
• The Business Plan
• Competition and Markets
Recording of this session via any media type is strictly prohibited.
Page 33
Evidence and Documentation
Recording of this session via any media type is strictly prohibited.
Page 34
Evidence /Documentation – What do you need?
Business Records … Literally
Business financial forecasts -- Management budgets (New
Business)
Historical Financial Statements (For every entity,
subsidiary, etc.)
• Balance Sheets, Profit & Loss Statements
• Revenue by Customer Reports
• General Ledger
• Three to five years prior to the event (annually)
• 12 months prior to the alleged event (monthly)
• Monthly financial statements since the date of the event
to current Recording of this session via any media type is strictly prohibited.
Page 35
Evidence /Documentation
Historical Financial Statements. Depends on the
accounting software/ version:
•
Native format (Quick books, Peachtree etc.)
•
Excel Download (MAS 90/2000, etc.)
•
Fail Safe – pdf. format
Tax Returns for the same period as Financials – Request
all the schedules
• Use to support financial statements that were produced
• Possible differences due to cash versus accrual basis
accounting
Recording of this session via any media type is strictly prohibited.
Page 36
Evidence /Documentation
1. Contracts – (customer, equipment, facilities, long term
obligations)
2. Debt and credit documentation -- Subpoena third-party
banks
3. Corporate Formation Documents/ operating capacity limits
4. Meetings with management
5. Deposition testimony
6. Industry trade publications/ professional associations
7. Federal and government economic data
8. Public company and competitive resources
9. Economic/ market / local events
Recording of this session via any media type is strictly prohibited.
Page 37
Business Interruption
Recording of this session via any media type is strictly prohibited.
Page 38
Business Interruption Claims
Similar, but tied to language in insurance policy.
Must be familiar with policy to know what kind
of damages to document.
Often has limitations of period of recovery.
Recording of this session via any media type is strictly prohibited.
Page 39
Quality Oilfield
Quality's workplace was burglarized and
engineering drawings, computer media disks,
and design information used by Quality to
process orders were stolen. “Nerve Center”.
“loss resulting directly from the necessary
interruption of business caused by damage to or
destruction of real or personal property ...”
Recording of this session via any media type is strictly prohibited.
Page 40
Quality Oilfield
What does interruption of business mean?
“interruption of business” is an unambiguous
term meaning “cessation or suspension of
business.”
Quality Oilfield Products, Inc. v. Michigan Mut. Ins. Co.,
971 S.W.2d 635, 639 (Tex. App.- Hou. (14th) 1998)
Recording of this session via any media type is strictly prohibited.
Page 41
GBP Partners
“GBP is in the business of owning and renting shopping
center space. It is also undisputed that at least some of
the tenants at Gulfbrook continued to pay rent,
including one that continued to pay rent with no
abatement.”
“Suspension of operations clause requires business to
have completely ceased for some interval.”
GBP Partners, Ltd. v. Maryland Cas. Co., 505 F. App'x 389, 392 (5th Cir. 2013)
Recording of this session via any media type is strictly prohibited.
Page 42
Other Coverage
1. Extra Expense.
2. Contingent Business Interruption:
Reimburses lost profits and extra expenses
resulting from an interruption of business at
the premises of a customer or supplier.
Recording of this session via any media type is strictly prohibited.
Page 43
Contingent Business Interruption
“The covered loss is caused by property damage that prevented
the flow of goods or services to or from the insured and
necessarily interrupted the insured's business.”
No evidence of an interruption (only generalized revenue
shortfall)
No evidence of disruption in flow of goods and services
Arthur Andersen LLP v. Fed. Ins. Co., 3 A.3d 1279, 1288 (App. Div.
2010)
Recording of this session via any media type is strictly prohibited.
Page 44
Defending Against Lost Profits
Qualified, Relevant & Reliable
1. The Expert – Qualifications /Lack of Independence
2. The Data – Is there a “Fit” or an Analytical Gap?
3. The Assumptions – Same
4. The Methodology – Failure to follow accepted
methodologies – i.e. Discount to PV, faulty Yardstick,
faulty cost analysis
5. The Opinions – Oversteps Expertise/ Causation
6. The Report – Federal Court (failure to comply with Rule
26)
7. The Disclosure/
Designation – follow the rules!
Recording of this session via any media type is strictly prohibited.
Page 45
Defending
Recording of this session via any media type is strictly prohibited.
Page 46
Analytical gap …
Capital Metro v. Central Tennessee, 114 S.W.3d 573 (Tex. App.- Austin, 2003)
1.
2.
3.
4.
5.
6.
7.
8.
9.
History of losses;
No identifiable contracts;
Forecasts based on “old” contract with Capitol Metro;
No independent confirmation of 7550 carloads he assumed;
No evidence they could even process that many;
No verification of revenue per carload;
No investigation of management practices; whether it had a
business plan;
Admitted that variable costs were running 160% of revenue,
And other problems
Recording of this session via any media type is strictly prohibited.
Page 47
Apartment Expert
Not a CPA.
No education or classes in school regarding lost
profit claims
No real estate specialization or designation.
Only one other lost profit model, totally
unrelated to losses in this case.
Was “surprised” to learn that there are generally
accepted models within the industry.
Recording of this session via any media type is strictly prohibited.
Page 48
Saved Expenses
Q. Okay. It's also your belief that there are no saved expenses.
Is that correct?
A. That's right.
Q. All right. But just so that the jury understands your—the
model that you've created and the approach you've taken,
you have not undertaken to determine if there are any saved
expenses. Correct?
A. In this model. Right.
Recording of this session via any media type is strictly prohibited.
Page 49
Absorption
Number of apartments rented per month.
Loss related to water event vs. loss due to other
factors? Speculation!
Damage Model Absorption Rate: 20
The higher the rate, the higher the damages.
i.e., apartments would have leased more
quickly.
Absorption Rate in Financing Documents: 16
Recording of this session via any media type is strictly prohibited.
Page 50
Absorption
Q. Okay. So when you told me earlier that the number 20 came out of the
pro forma that was put together with GE at the time that y'all went to get
financing and do all that financial stuff, that was an incorrect statement.
A. It was related to -- you know, it was – that does not match this pro forma.
That's right.
Q. Okay. Well -A. Yeah, that's fair. And this pro forma that was provided was the originally
approved pro forma and we -- again, I guess I had assumed they were kind
of going through --and we -- well, I'd assumed that this schedule was what
Q. Okay. But it's not.
A. Right. You're right.
Recording of this session via any media type is strictly prohibited.
Page 51
The alternate source for absorption rate was a
database compiled by the company to track
occupancy rates at other properties.
Recording of this session via any media type is strictly prohibited.
Page 52
“Data”?
Roberston
404 Rio
Amli
Amli on
Gables
300 N.
Greystar
The
The
Flats
Hill
Grande
Downtown
2nd
West Avenue
Lamar
South Congess
M onarch
Crescent
The alternate source for absorption rate was a
database compiled by the company to track
occupancy rates at other properties.
Week ended
5-M ay-08
Red River
Comments
No information
on sheet
0
0
0
0
0
0
0
0
0
0
7
1
3
0
3
3
0
5
2
8
2
6
6
4
5
0
5
26-M ay-08
2
8
2
4
6
0
2
2
11
2-Jun-08
0
0
0
0
0
0
0
0
0
9-Jun-08
1
8
0
5
471
3
4
5
10
16-Jun-08
0
8
2
7
6
5
2
0
13
23-Jun-08
0
0
0
0
0
0
0
0
0
No information
on sheet
30-Jun-08
0
0
0
0
0
0
0
0
0
No information
on sheet
12-M ay-08
19-M ay-08
Unusually high
number.
Recording of this session via any media type is strictly prohibited.
Page 53
Questions, Final Comments and
Contact Information
B. Lee Wertz, Jr.
Harrison Bettis McFarland LLP
1415 Louisiana 37th Floor
Houston, Texas 77002
713-843-7889 Direct
lee.wertz@harrisonbettis.com
@leewertzlaw
Jeffrey W. Spilker
Shareholder
Hill Schwartz Spilker Keller
LLC
952 Echo Lane, Suite 200
Houston, TX 77024
(713) 771-5011 x211
jspilker@hssk.com
Recording of this session via any media type is strictly prohibited.
Page 54