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Lost Profits in Construction Litigation:
Proving and Defending Damages
Speakers:Jeffrey W. Spilker, JD, CPA/ABVJared C. Jordan, CFE
Presented to:
Speakers
Jeff Spilker is an Owner of Hill Schwartz Spilker Keller LLC (“HSSK”), a business valuation and
litigation consulting firm in Houston, Texas. Jeff leads the HSSK’s real estate consulting and
construction advisory practice.
Previously, Jeff was with a national accounting and consulting firm. He has also served as the
CFO of an engineering/construction company and Vice President/General Manager of a
construction and real estate development firm. Jeff has provided a wide range of financial and
economic consulting and financial forensics services to attorneys in matters involving intellectual
property and patent infringement claims, health care and professional practices, oil & gas issues,
construction disputes, professional liability claims, partnership disputes, real estate and business
valuation issues, environmental issues, personal injury and employment claims, lost profits
analyzes, fraud investigations and lender liability claims. He has provided expert testimony in
over 100 of these matters.
Jeff is a Certified Public Accountant, licensed attorney in the Commonwealth of Virginia and a
Texas State Certified General Real Estate Appraiser.
Jeffrey W. Spilker, JD, CPA/ABV
Speakers
Jared Jordan serves as Managing Director in the Litigation Consulting practice and is the leader of
HSSK’s Austin office. He is a Certified Fraud Examiner with over 14 years of experience assisting
clients with the financial and accounting aspects of disputes and investigations including serving
as an expert witness in litigation matters.
Jared’s experience includes developing and analyzing damage claims, conducting fraud and
financial forensics investigations, examining and assessing corporate governance practices and
internal controls, and evaluating complex data sets resulting from allegations of breach of
contract, financial misrepresentation, fraud, director and officer misconduct, misuse of corporate
funds and breach of fiduciary duty.
Jared previously served in a Director level position in the Disputes and Investigations practice of
an international publicly-traded consulting firm. He currently serves on the Advisory Council for
the Association of Certified Fraud Examiners. Jared also regularly presents on a wide range of
topics including conducting fraud, forensic and special investigations in and out of the litigation
setting.
Jared C. Jordan, CFE
Today’s Program
I. Lost Profits Damages – Overview
II. Evidence & Documentation – What do You Need?
III. Quantification of Lost Profits – Methods & Issues
IV. Defending Against Lost Profits – Areas of Focus
V. Daubert Expert Challenges – Historical Trends
Types of Construction Damages
• Types of construction damages
Direct Damages
Consequential Damages
• Today’s presentation is focused on lost profits
What are “lost profits”?
• 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.
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
Permanent or Temporary (cont.)
• 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.
Permanent or Temporary (cont.)
• “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.
Simple Lost Profits Example
0
100
200
300
400
500
600
700
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13
Expected Profit
Actual profit
Loss Period
Lost Profits
Event Recovery
Lost Profits Model – Delay Claim
$
Series1 Series2
1 Year 2 Years 3 Years
Excess Costs
Lost Profits
10 ½ Month Damage PeriodStabilized
NOI
10 ½ Month Delay Period
September 15, 2010July 31, 2011● ●
Expected Profit Actual Profit
Reasonable Certainty
• You must “prove” something that never happened
"I'd shut [Apple] down and give the
money back to the shareholders."—
Michael Dell, founder and CEO of Dell,
Inc., 1997
Apple’s stock price:
January 7, 2007 -- $ 21.12/share.
March 3, 2014 -- $ 523.42/share.
Reasonable Certainty (cont.)
• There are almost no law review articles
that discuss it other than student notes
• For an exhaustive analysis –
Robert M. Lloyd, Professor
at Univ. of Tennessee
Reasonable Certainty – Examples
Southwest Battery Corp. v. Owen, 115 S.W.2d (Tex. 1938)
• “The amount of the loss must be shown by competent
evidence with reasonable certainty” (at 1097, 1098-99)
• Industry was well established -- Sale of car batteries not
uncertain or speculative
• A short history of profits combined with an established
industry was sufficient
• However, the court referred to the “new business” rule
Texas Instruments, Inc. v. Teletron Energy Management,
Inc., 877 S.W.2d (Tex. 1994).
• “New business” rule clarified –
• The enterprise is the “activity” not the entity. “The focus is
on the experience of the persons involved in the enterprise
and the nature of the business activity, and the relevant
market.” (at 276, 279-280)
Reasonable Certainty – Examples (cont.)
Evidence & Documentation…
What do You Need?
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
Types of Evidence / Documentation
• Business Records … Literally
• Business financial forecasts –
Management budgets (New Business)
• Historical Financial Statements
(for every entity, subsidiary, etc.)
Types of Evidence / Documentation (cont.)
• Tax Returns for the same period as Financials – Request all the
schedules
Types of Evidence / Documentation (cont.)
• Debt and credit documentation -- Subpoena third-party
banks
Contracts – (customer, equipment, facilities, long term obligations)
Corporate Formation Documents / operating capacity limits
Meetings with management
Deposition testimony
Industry trade publications/professional associations
Federal and government economic data
Public company and competitive resources
Economic / market / local events
Quantification of Lost Profits –
Methods & Issues
• Causation is often assumed by the expert
Proof of causation is on the lawyer
Proof of foresee ability too
• Demonstrate Lost Profits with Discounted Cash Flow
Damages = Liability + Causation
Methods
• Before and After
• Yardstick
• Market Share or Specific Contract
Before and After Approach
$0
$100
$200
$300
$400
$500
$600
1995 1996 1997 1998 1999 2000 2001 2002
Before After
Lost Sales
$0
$100
$200
$300
$400
$500
$600
1995 1996 1997 1998 1999 2000 2001 2002
Before Projected (but-for) After (Actual)
Lost Sales
Before and After Approach (cont.)
$0
$100
$200
$300
$400
$500
$600
$700
1995 1996 1997 1998 1999 2000 2001 2002
Before After (but-for) After (Actual) Like Company Index
Lost Sales
Yardstick Approach
Determining But-For Costs
• Incremental costing
• Some methods for
determining but-for costs:
Fully allocated costs
Comparative costs
Line item classification
Cost engineering
Regression analysis
0
10
20
30
40
1998 1999 2000 2001 2002
Lost Sales
Incremental Costs
Lost Profits
Discount Period
Projecting Costs
• Variable, Semi-variable
and Fixed can vary
with location
Stabilized Earnings
“The first step in a delay study for an income-
producing property is for the appraiser or
analyst to be provided with an extraordinary
assumption that the subject property
sustained a delay. This information should be
based on calculations by a qualified
construction expert. The change in timeline
then supplies the analyst with the foundation
for the number of days, weeks, or months that
will form the basis for the ultimate damage
calculation.”
Stabilized Earnings (cont.)
“The appraiser or analyst must then establish pro forma income and
expense statement, which would include market-based income, vacancy
rates, and fixed and variable expenses from which adjusted daily lost
revenues can be derived. The analyst should be aware that it is not
appropriate to use the initial absorption period for calculating the
damage estimate. Revenues relating to stabilized occupancy should be
used instead. Ultimately, the estimated daily lost revenue is multiplied by
the total number of days of delay, as provided by the construction expert,
to form an opinion of damages.”
Issues
• Discount rates and Growth rates
Example: Knox v. Taylor – 992 S.W.2d 40 (Tex. App. – Houston
[14th] 1999, no pet.) - Libel and tortuous interference with surety
business
(same model) Growth Rate Discount Rate Damage
Plaintiff Expert 25% 7% $11,000,000
Defense Expert 2.8% 30% $1,000,000
Defending Against Lost Profits –
Areas of Focus
Qualified, Relevant & Reliable
• The Expert
• The Data
• The Assumptions
• The Methodology
• The Opinions
• The Report
• The Disclosure/ Designation
Analytical gap…Capital Metro v. Central Tennessee
• Freight service provider on rail line; contract terminated,
counterclaim
Analytical gap…(cont.)Capital Metro v. Central Tennessee (cont.)
• Plaintiff’s expert -- $6.6 million Historical revenues;
Estimate of carloads and charges;
Projection of costs
• Court -- $0 History of losses;
No identifiable contracts;
Forecasts based on “old” contract with
Capital Metro;
No independent confirmation of 7,550
carloads he assumed;
No evidence they could even do 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
Apartment Complex Example
• Water loss delays opening of new apartment complex
• Case brought by subrogating insurance carrier
• Complex sues for its uninsured losses, including business
interruption claim arising out of delayed opening
Apartment Complex Example (cont.) Expert Qualifications
• 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
Apartment Complex Example (cont.) Saved ExpensesQ. 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.
Apartment Complex Example (cont.) Absorption
• Number of apartments rented per month.
• Loss related to water event vs. loss due to other factors?
Speculation!
• Absorption rate: 20
• The higher the rate,
the higher the damages
i.e., apartments would
have leased more quickly.
Apartment Complex Example (cont.) Absorption (cont.)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.
Correct?
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.
Apartment Complex Example (cont.) Absorption (cont.)
The alternate source for absorption rate was a
database compiled by the company to track
occupancy rates at other properties.
Red River Roberston 404 Rio Amli Amli on Gables 300 N. Greystar The The
Week ended Flats Hill Grande Downtown 2nd West Avenue Lamar South Congess Monarch Crescent Comments
April 7, 2008 0 7 1 3 0 3 3 0 5
April 14, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
April 21, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
April 28, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
May 5, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
May 12, 2008 0 7 1 3 0 3 3 0 5
May 19, 2008 2 8 2 6 6 4 5 0 5
May 26, 2008 2 8 2 4 6 0 2 2 11
June 2, 2008 0 0 0 0 0 0 0 0 0
June 9, 2008 1 8 0 5 471 3 4 5 10 Unusually high number.
June 16, 2008 0 8 2 7 6 5 2 0 13
June 23, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
June 30, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
July 7, 2008 0 1 3 6 2 5 5 2 8
July 14, 2008 3 2 2 5 3 7 7 5 11
July 21, 2008 4 10 5 2 11 6 4 9 3
July 28, 2008 4 10 5 2 11 6 4 9 3 Same as prior month?
August 4, 2008 3 3 6 7 6 5 4 2 2 5
August 11, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
August 18, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
August 25, 2008 10 4 2 3 5 4 3 7 4
September 1, 2008 1 4 1 4 3 5 2 3 2 1
September 8, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
September 15, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
September 22, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
September 29, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
October 6, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
October 13, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
October 20, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
October 27, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
November 3, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
November 10, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
November 17, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
November 24, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
December 1, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
December 8, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
December 15, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
December 22, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
December 29, 2008 0 0 0 0 0 0 0 0 0 No information on sheet
Daubert Expert Challenges –
Historical Trends
PWC’s Daubert Challenges to
Financial Experts • 14-year trend w/ cases citing Daubert/Kumho Tire
• Economists, accountants, and appraisers challenged the most
• Economists and accountants most likely to survive.
• Case type affects the frequency and outcome
• Lack of Reliability is the top reason to exclude financial experts
• Exclusions more common due to the misuse of accepted
methodologies than from the introduction of unusual or untested
analytical methods
PWC’s Daubert Challenges to
Financial Experts (cont.)• Challenges raised every year from 2000-2013.
• Plaintiff’s experts are challenged approx. three times as often as
defense experts, but their exclusions rates were lower in eight of
the past 14 years.
• The Circuit Court matters, with 57% of all Daubert challenges
being adjudicated in the Second, Fifth, Sixth, Seventh, & Ninth
circuits.
Questions?
