Whodunit — and how much is at stake?

When a company is a victim of a civil wrongdoing — such as breach of contract, negligence or patent infringement — profits frequently suffer. Courts may award monetary damages to make the injured party “whole” again.

In most jurisdictions, it’s the plaintiff’s responsibility to provide the court with financial data on which to base damage awards. Plaintiffs may provide written damage calculation reports and verbal expert witness testimony. But defendants can protect their financial interests by providing separate damage calculations or issuing rebuttal reports in response to the plaintiffs’ estimates.

Interrelated variables - Estimating damages starts with a basic theoretical position: If not for Mr. Smith’s breach of contract, ABC Co. would have sold more units - Experts refine their theory as they review financial evidence. In this case, a damages expert might estimate the quantity of lost sales and the incremental profit per unit. He or she also would take into account the length of time the company sustained the loss.

Many variables factor into an expert’s damage calculation, including:

Operating history and industry trends - A company’s operating history — or that of its competitors — often provides insight into future performance. For example, a valuation expert might track a company’s historic gross profit trends using regression analysis. Damages may be quantified as the difference between actual results and what may have been expected based on regression analysis, discounted to its net present value.

Valuation variances - Similarly, a company’s value may decline following a tortious act. The expert may quantify damages as the value impairment resulting from the defendant’s actions.

Offsetting external factors - In any damage calculation, the valuator considers the extent to which external factors — such as poor economic conditions or obsolete technology — impaired performance.

Mitigating factors - Most jurisdictions require plaintiffs to attempt to mitigate damages. Valuation experts evaluate whether management took all possible steps to minimize losses.

Tax issues - The objective in any damage case is to make the plaintiff whole again. So as part of the estimate, a valuator considers whether the plaintiff’s damage award will be subject to state and federal taxes.

Recipe for disaster - Some companies attempt to minimize court costs by calculating damages themselves and providing their own in-court testimony. A recent Tenth U.S. Court of Appeals case demonstrates the perils of do-it-yourself damage calculations.

In Chavez Properties–Airport Parking Albuquerque L.P. v. Lorentzen, one of the partners in an Albuquerque Airport parking lot joint venture was found liable for various transgressions that reduced the partnership’s profits.

Plaintiff-partners testified regarding lost profits. Because this testimony contained many errors, it provided an inadequate basis on which to calculate lost profits. Accordingly, the court awarded just $1 in damages.

In addition to having a financial interest in the outcome of the case, the plaintiffs were unfamiliar with the nuances of business valuation. If they had engaged a qualified, objective valuation professional, they might have increased this nominal award.

Professional guidance - Many of the same principles that underlie business valuations are important in damage calculations. For example, both types of assignments may rely on discounted cash flow, guideline companies, benchmarking and financial statement analyses.

In civil wrongdoing litigation, damages usually center around the testimony or valuation reports of the experts representing both sides of the case. Experienced valuation professionals not only offer unbiased opinions, but also understand complex financial issues, relevant case law, and the ins and outs of serving as an expert witness.