Nuts & Bolts of Lost Profit Cases

COMPLEX FINANCIAL LITIGATION FOR THE NON-EXPERT Premiere Date: February 23, 2017

This webinar is sponsored by: EisnerAmper 1  

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MODERATOR Erin Hollis Marshall & Stevens, Chicago

PANELISTS Don May DMA Economics, NY John Levitske Huron Consulting Group, Chicago Leland Chait Sugar Felsenthal Grais & Hammer, NY

MEET THE FACULTY

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SERIES SPONSOR

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ABOUT THIS WEBINAR

Expectations, we all have them.  Maybe a business partner, supplier or vendor didn’t live up to their end of the bargain and the business suffers. What is the remedy? What are the damages and how do you seek repayment of the loss profits?

Lost profits are an economic measure of damages a business suffers as a result of a wrongful act, and can only be claimed over the loss period. In this webinar we discuss types of wrongful acts that can lead to such damages, what makes an effective claim to recover lost profits, proactive solutions to prevent or reduce claims, and what the difference is between a reduction in business value and lost profits.  

Further complicating the understanding of damages are other remedies that are often confused with lost profits, which are also covered.

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ABOUT THIS SERIES Many people do not understand the specialization that the legal industry has undergone in the past several decades. Just as one would not go to a dermatologist for lung cancer, one would not ask a tax attorney to defend a DUI.

But the specialization goes even deeper: litigation over commercial disputes should be handled by someone with deep experience with such disputes; the best criminal defense attorney or divorce litigator is simply not the likely best choice because, among other reasons, issues tend to repeat themselves. This is not to say that once an attorney has done one “xyz case” she is an expert at all “xyz cases,” but the truth is that the expression “the practice of law” exists for good reason.

This webinar series explores four common litigation scenarios involving complex financial issues. Each episode is delivered in Plain English understandable to business owners and executives without much background in these areas. Yet, each episode is proven to be valuable to seasoned professionals. As with all Financial Poise Webinars, each episode in the series brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. And, as with all Financial Poise Webinars, each episode in the series is designed to be viewed independently of the other episodes, so that participants will enhance their knowledge of this area whether they attend one, some, or all of the episodes.

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EPISODES IN THIS SERIES

EPISODE #1 Common Issues and Strategies in Business Breakups 1/19/2017 EPISODE #2 Nuts & Bolts of Lost Profit Cases 2/23/2017 EPISODE #3 Resolving Shareholder Disputes 4/20/2017 EPISODE #4 Defending Against “Avoidance Actions” 5/11/2017

Dates shown are premiere dates; all webinars will be available on demand after premiere date

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WHAT ARE LOST PROFITS?

•  Revenues that would have been earned but for the wrongful act (‘but for’ revenues)

LESS

•  Incremental costs necessary to derive these revenues

EQUALS

•  Lost Profits

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WHAT ARE LOST PROFITS (CONT’D)?

The factual or “but for” causation showing needed for recovery of lost profits damages -- as with all damages -- requires a plaintiff to prove by a preponderance of the evidence that there is ‘some reasonable connection between the act or omission of the defendant and the damage which the plaintiff has suffered.’

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WHAT ARE LOST PROFITS (CONT’D)?

•  Profits must be shown to have been factually and legally caused by -- and a reasonably foreseeable result of -- the defendant’s wrongful conduct.

•  Further, a plaintiff must prove his or her estimate of lost profits to a “reasonable certainty,” establishing such damages through an adequate evidentiary foundation.

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WHAT IS THE DIFFERENCE BETWEEN LOST PROFITS AND LOST VALUE?

•  Lost Profits = Incremental profits the company would had have earned but for the wrongful act

•  Lost Value = The present value of lost profits over the life of the company discounted at the appropriate risk adjusted rate of return

•  How do you decide which analysis to utilize? !  When lost profits extend over the life of the company

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STANDARD FOR PROVING LOST PROFITS •  Tort or Contract must have:

!  Causation - Some reasonable connection between the act or omission of the defendant and the damage which the plaintiff has suffered.

!  Reasonable foreseeability – Lost profits must be shown to have been factually and legally caused by the defendant’s wrongful conduct.

!  Reasonable certainty - Establishing such damages through an adequate evidentiary foundation; applies only to the fact of damages, not to the amount of damages

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ESTABLISHED BUSINESSES

•  Provides evidence of a successful past track record of business, along with evidence establishing anticipated future net profits, offer the greatest likelihood of recovering lost profits

•  Use expert testimony based upon a solid evidentiary foundation addressing the underlying economic data quantifying gross revenue and variable expenses

•  May use outside or inside expert testimony

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WHAT ABOUT RECENTLY ESTABLISHED OR NEW BUSINESSES?

•  May use alternative forms of proof to establish lost profits, such as industry averages, governmental standards

•  Must still meet the “reasonable certainty” standard

•  Damages for lost profits are confined to the period in which it would be reasonable to replace the profits

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WHAT ABOUT RECENTLY ESTABLISHED OR NEW BUSINESSES (CONT’D)?

•  Alternative Tools !  The Wrongdoer Rule !  Lost Opportunity

"  Loss of Chance Doctrine "  Loss of Earnings Opportunity "  Loss of Business Opportunity

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GENERAL FLOW OF CALCULATING LOST PROFITS

•  Understand which lost profits damages model is appropriate •  Use evidentiary standards •  Calculate lost profits •  Develop the causal economic link between defendant’s action

(event) and the loss •  Select the period to examine •  Estimate the relevant lost revenues and associated costs •  Utilize assumptions that have reasonable certainty

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LOST PROFIT METHODS

•  Before-and-After Approach •  Yardstick Approach •  Sales Projection Approach •  Market Share Approach •  Alternative methodologies

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HISTORICAL DAMAGES

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BEFORE-AND-AFTER APPROACH

•  Method !  Estimate of lost profits based on the plaintiff’s sales (and sales

trends) before the damaging event with a projection of sales (based on sales and sales trends) that would have been achieved had the damaging act not occurred (“but for” sales) reduced by incremental costs

•  When Appropriate ! When reliable historical data exists ! When growth trends are steady and predictable !  In relatively stable economic environments

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HISTORICAL DAMAGES & FUTURE DAMAGES

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BEFORE-AND-AFTER APPROACH

•  Strengths ! Relies on plaintiff’s actual, historical financial results as basis

for comparison to estimated future results ! Courts often favor financial projections based on past results

•  Limitations ! Requires sufficient historical data ! May not account for industry changes that occur subsequent to

damages date

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BEFORE-AND-AFTER APPROACH (CONT’D)

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Plaintiff Company - Sales

1998 1999 2000 2001

EVEN

T

2002 2003 2004

Actual Sales $180,000 $219,000 $262,000 $317,000 $298,000 $295,000 $302,000

Growth Rate 21.7% 19.6% 21.0% -6.0% -1.0% 2.4%

Projected Sales - - - - 383,570 464,120 561,585

Growth Rate 21.0% 21.0% 21.0%

Lost Sales - - - - ($85,570) ($169,120) ($259,585)

Total Lost Sales ($514,275)

YARDSTICK APPROACH

•  Method ! Estimate of the plaintiff’s profits based on a yardstick – e.g., a

comparable company, division or industry benchmark - that is not affected by the damaging act

•  When Appropriate ! When a reliable yardstick exists ! With newly established firms ! Accounts for differences in time periods ! When market conditions may have changed subsequent to the

damages event date

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YARDSTICK COMPARISON

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YARDSTICK APPROACH

•  Strengths •  Can provide objective, reliable benchmark for estimating •  Yardstick is independent of effects from damaging act •  Accounts for changes in the industry or market that may have

occurred subsequent to the damages event date •  Limitations

•  Lack of comparability between plaintiff and yardstick (e.g., size, sales channels)

•  Yardstick data may not be available

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MARKET SHARE APPROACH

•  Method !  Calculates lost profits based on the difference between the

plaintiff’s “but-for” market share and its market share after the damaging act.

•  When Appropriate !  When reliable market share data exists !  When plaintiff company products/services fit within “market”

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MARKET SHARE APPROACH (CONT’D)

•  Strengths !  Can provide objective, reliable basis for estimating !  Other companies in “market” are independent of damaging act !  Accounts for changes in the industry during relevant period

•  Limitations !  Difficult to determine market share – lack of data,

comparability !  May be difficult to assess due to dynamic markets

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SALES PROJECTION APPROACH

•  Method !  Utilizes company-specific forecasts the company has prepared in

the ordinary course of business or for some purpose other than the litigation

•  When Appropriate !  If plaintiff has prepared the documentation contemporaneously or

prior to the occurrence of the alleged harmful event !  When projections have been historically reliable !  When calculation is for expert who is not engaged by party who

has made the projections !  If no other approach is reliable

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EXPECTED IMPAIRMENT OF FCFs

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SALES PROJECTION APPROACH

•  Strengths !  May allow the expert to incorporate more easily the effects of

other factors (beyond the harmful act) that might increase or decrease the estimated economic damages

!  Can be very effective if used by expert for party opposing the party who made the projection

•  Limitations !  Does not control for market events that may have occurred

subsequent to the damages event !  Difficult to independently support the underlying foundation for

the projections !  Speculative or nothing more than a “wish list”

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ESTIMATING INCREMENTAL COSTS •  Costs should only be those costs related to the the lost

incremental revenues (“Avoidable or incremental Costs”)

•  Examples of costs that may be included (Incremental) !  Direct costs (materials, commissions) !  Other variable or semi-variable costs

"  Salaries "  Infrastructure

•  Examples of costs that should not be included !  Corporate overhead !  Other fixed costs (depreciation, amortization)

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EVIDENTIARY SUPPORT

•  Informed opinion - Lost profits may be established by evidence of past experience or expert testimony sufficient to quantify the extent of loss, either of which must be properly supported by admissible evidence.

•  Judgmental approximation - Plaintiff's owner provided evidence of the company's past experience and lost profits; owner has substantial experience.

•  Credible evidence – Industry averages, governmental information, official statistics, etc.

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WHAT EVIDENCE IS NECESSARY?

•  “The Company’s profits would have been $XXX,XXX, based on…” !  Examine financial statements for history !  Demand for product !  Consistent pricing trends over time !  Industry trends over time !  Competitive risk is low !  Technology risk is low !  Customer retention is constant/high

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WHAT EVIDENCE IS NECESSARY? (CONT’D)

•  “The risk the Company would NOT achieve $XXX,XXX in profits is very low, based on …”

!  Customer and product demand !  Low risk of product/service obsolescence !  Industry trends that support achievability !  Backlog orders

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WHAT EVIDENCE IS NECESSARY? (CONT’D)

•  “The Company’s profits are now only $X,XXX, due to …”

!  Customer cancellations of orders or contracts !  Lost customer or documented market share !  Lost productivity

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WHAT EVIDENCE IS NECESSARY? (CONT’D)

•  “The Defendant’s actions are directly responsible for the loss in profits, based on …”

!  Customers lost as a direct result of the defendant’s actions "  Cancellation documentation/letters

!  Inability to gain new customers "  Documentation of futile efforts

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WHAT EVIDENCE IS NECESSARY? (CONT’D)

•  “No other factors contributed the Company’s ability to earn $XXX,XXX in profits, as proved by …”

!  Industry stability !  Economic stability !  No new competitive entrants into market place !  No new governmental or regulatory issues

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QUALIFIED EXPERT

•  Must be a qualified expert, experienced in field (highly recommend credentialed individual) !  Accounting Professional (CPA) !  Valuation expert (ASA, ABV, CFA) !  Economist

•  Must use proper methodology •  Must be objective •  Must have sufficient evidentiary support

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DEFENDING AGAINST AN ACTION

•  What defenses exist to a lost profit action?

•  What can a party do to challenge the lost profits findings of an expert?

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CONCLUDING THOUGHTS

•  Applicable standards •  Burden of proof •  Evidentiary challenges •  Remedies •  Methodologies •  Qualified expert •  Other remedies

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ABOUT THE FACULTY

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ERIN  HOLLIS  ehollis@marshall-­‐stevens.com  

Ms.  Hollis  is  a  Financial  ValuaAon  and  ConsulAng  Director  of  Marshall  &  Stevens  Incorporated.  Her  valuaAon  experience  includes  sale/purchase,  insurance,  financing,  and  estate  planning  and  corporate  planning.  She  also  has  special  purpose  appraisal  experience  with  specific  types  of  feasibility.  Her  other  professional  acAviAes  include  authoring  numerous  arAcles  on  valuaAon  in  several  publicaAons,  speeches,  and  being  a  member  of  the  American  Society  of  Appraisers,  where  she  parAcipates  as  a  Business  ValuaAon  CommiTee  member.  She  is  also  a  past  (2012-­‐-­‐2013)  President  and  current  member  of  the  American  Society  of  Appraisers  Chicago  Chapter.  

Ms.  Hollis  entered  the  appraisal  profession  in  2000.  Prior  to  becoming  a  Director  of  Marshall  &  Stevens,  she  held  the  Director  posiAon  of  Tax  &  ValuaAon  Services  with  ValuaAon  Advisory  Services  and  simultaneously  with  Strategic  Tax  Advisors  for  13  years.  In  her  posiAon,  Ms.  Hollis  oversaw  all  aspects  of  business  development,  producAon,  administraAon,  financial  planning,  quality  control,  revenue  and  client  development.  Ms.  Hollis  is  a  graduate  of  Michigan  State  University,  a  qualified  expert  witness,  and  an  Accredited  Senior  Appraiser  (ASA)  in  Business  ValuaAon  of  the  American  Society  of  Appraisers.  She  is  also  CerAfied  in  Distress  Business  ValuaAon  (CDBV)  with  the  AssociaAon  of  Insolvency  &  Restructuring  Advisors  

ABOUT THE FACULTY

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JOHN  LEVITSKE  jlevitske@huronconsulAnggroup.com  

John  Levitske  is  a  Senior  Director  in  the  Commercial  Dispute  Advisory  pracAce  of  Huron  ConsulAng  Group  in  Chicago.  He  has  three  decades  of  experience  in  business  valuaAon  and  forensic  accounAng.  He  focuses  on  complex  business  valuaAon,  economic  damages,  and  forensic  accounAng  maTers,  and  the  resoluAon  of  valuaAon  and  accounAng  (e.g.  working  capital,  earnouts  and  representaAons)  disputes  arising  from  M&A  transacAons,  commercial  and  shareholder  liAgaAon,  business  divorce  and  private  company  controversies.  

John  holds  an  MBA,  cum  laude,  from  the  University  of  Notre  Dame,  and  both  a  JD  and  BS  in  Business  AdministraAon  from  Duquesne  University.  He  also  is  a  CerAfied  Public  Accountant  licensed  in  Illinois  and  Pennsylvania,  Accredited  in  Business  ValuaAon  by  the  American  InsAtute  of  CerAfied  Public  Accountants,  Accredited  Senior  Appraiser  in  Business  ValuaAon  by  the  American  Society  of  Appraisers,  Chartered  Financial  Analyst  charterholder  with  the  CFA  InsAtute,  CerAfied  in  Financial  Forensics  with  the  AICPA,  CerAfied  Forensic  LiAgaAon  Consultant  with  the  Forensic  Expert  Witness  AssociaAon,  CerAfied  Insolvency  &  Restructuring  Advisor  with  the  AssociaAon  of  Insolvency  &  Restructuring  Advisors,  and  Chartered  Global  Management  Accountant  with  the  AICPA.  

ABOUT THE FACULTY

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DON  MAY  dmay@dmaeconomics.com  

Don  May  is  Managing  Partner  at  DMA  Economics  LLC  and  possesses  over  30  years’  experience  in  consulAng,  valuaAon  and  liAgaAon  support  as  well  as  researching,  publishing  and  teaching  at  the  university  level.    His  experience  includes  implemenAng  a  broad  range  of  damage  analyses  and  valuaAons  for  businesses  of  various  sizes  and  in  numerous  industries.    Prior  to  founding  DMA  Economics  LLC,  Dr.  May  was  Managing  Director  at  Berkley  Research  Group  and  the  Principal  in  charge  of  valuaAon  and  liAgaAon  support  services  for  a  regional  accounAng  firm,  a  Managing  Director  for  PricewaterhouseCoopers  and  a  professor  at  the  MassachuseTs  InsAtute  of  Technology  -­‐  Sloan  School  of  Management.  

Dr.  May  has  prepared  expert  reports  and  tesAfied  in  federal  and  state  courts  as  well  as  AAA,  JAMS,  and  FINRA  arbitraAon  hearings  and  has  effecAvely  communicated  as  an  expert  witness  tesAfier  and  consultant  in  several  mulA-­‐million  dollar  cases.  

ABOUT THE FACULTY

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LELAND  CHAIT  lchait@sfgh.com  

Leland  Chait  is  a  partner  with  Sugar  Felsenthal  Grais  &  Hammer  who  heads  the  Firm’s  Complex  LiAgaAon  PracAce  whose  pracAce  includes  Bankruptcy,  ReorganizaAon  and  Creditors’  Rights.  

As  a  problem  solver,  Lee  successfully  tries  business  disputes  in  state  and  federal  courts  throughout  the  United  States,  focusing  on  maTers  in  the  healthcare  and  insurance  fields,  and  in  resolving  business  divorces.    He  advises  individuals  and  businesses  with  complex  commercial  disputes,  including  cases  brought  on  a  class  acAon  basis,  in  the  employment,  insurance,  anAtrust,  regulatory  compliance  and  healthcare  fields.  

Visit www.eisneramper.com EisnerAmper. Let's Get Down to Business®

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