Financial experts are often hired to measure economic damages in contract breach, patent infringement and other tort claims. Here's an overview of how experts quantify damages, along with some common pitfalls to avoid.
Where would the plaintiff be today "but for" the defendant's alleged wrongdoing? There are three ways experts address that question:
Experts will consider the specific circumstances of the case to determine the appropriate method (or methods) for the situation.
After experts have estimated lost profits, they discount their estimates to present value. Some jurisdictions have prescribed discount rates, but, in many instances, experts subjectively build up the discount rate based on their professional opinions about risk.
Small differences in the discount rate can generate large differences in valuators' final conclusions. As a result, the discount rate is often a contentious issue.
Another key step is to address mitigating factors. In other words, what could the damaged party have done to minimize its loss? For example:
Most jurisdictions hold plaintiffs at least partially responsible for mitigating their own damages. Similar to discount rates, this subjective adjustment often triggers widely divergent opinions among the parties involved.
Some key factors need to be considered to avoid over- or underestimating a plaintiff's loss. For example, the taxation of damages can have a significant impact on an expert's conclusion. If the plaintiff must pay taxes, an after-tax assessment wouldn't be equitable. Also realize that some parts of a damages award, such as return of capital, may be nontaxable and require an after-tax estimate.
Taxes also need to be handled properly when lost profits are discounted to present value. In other words, if damages need to be calculated on a pretax basis, the expert should use pretax discount rates. Mismatching after-tax discount rates to pretax cash flows would overstate damages, all else being equal.
In addition, it's important to not assume that damages will occur into perpetuity. Economic damages generally occur over a finite period. They have a beginning and an end. Eventually most plaintiffs can overcome the effects of the defendant's alleged wrongdoing.
When calculating economic damages, there isn't a one-size-fits-all approach. What's right depends on the facts of your particular case. Contact an expert to develop an estimate that avoids potential pitfalls and can withstand scrutiny in court.
A class of limited partners in a publicly traded master limited partnership recently sued the general partner for breaching the partnership agreement when executing a $10 billion unit-for-unit merger with another publicly traded master limited partnership. The partnership agreement included a provision requiring that a merger be "fair and reasonable" to the partnership. (Dieckman v. Regency GP LP, C.A. No. 11130-CB, Del. Ch. 2021.)
When estimating damages, the plaintiff's expert used an income-based "dividend discount" model to value what was given in the merger and then used the market price on the merger date to value what was received in the merger. The expert concluded that the plaintiffs incurred a loss of roughly $1.68 billion (or $5.23 per unit).
The Delaware Chancery Court rejected this conclusion in its entirety, however. The Chancellor found that the plaintiff's expert had made an "apples-to-oranges" comparison.
The court didn't rule out apples-to-oranges comparisons in all cases, but it did show a preference for consistent comparisons. The takeaway from this this case is that experts should be cautious when combining approaches in damages cases.
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