The Witness Box

Commenting on expert evidence, economic damages, and interesting developments in injury, wrongful death, business torts, discrimination, and wage and hour lawsuits

Friday, May 16, 2008

CFO as own firm's financial expert in tortious interference lawsuit

Fox in the hen house?

In business cases, some attorneys like to use the CFO or other financial person from the company that is claiming damages as an damages expert. Clearly, there are advantages. Very few persons will know the company's books as well as the CFO or similar persons. However on the flip side the issue of credibility must be weighed against those advantages.

Below is a case study of a case where the plaintiff in a tortious interference case used the CFO of the injured firm as their sides expert.

The report

In the case the plaintiffs alleged that the defendant undertook a number of illegal actions and unrightfully stole some of the plaintiff's clients. To calculate the damages in the case, the plaintiff's expert, the company's CFO, based the damages on the the previous year's revenue from the customers that the defendant allegedly stole. The CFO took the income for the customers that they identified (it was about 17 firms) and calculated the the percentage of the unit's revenue that the 17 firms comprised. She found that the 17 firms comprised about 83% of the unit's revenue.

The CFO then subtracted the unit's share of the direct expenses from the total revenue to arrive at the yearly damages. She assumed that the expenses that were attributable to the 17 firms was equal to the firms % share of the units total revenue. That is she assumed that the cost to service the 17 firms was equal to 83% of the unit's total measured direct cost.

She estimated that the plaintiffs damages were $6.56 million per year. She then multiplied the damages by 9, 12, and 15 years to arrive at her final damage analysis. Her implicit assumption was that the clients that the defendant allegedly stole would have been long term clients.

The problems


There are several problems with the CFO's analysis.

1. There was no explanation as to how the 17 firms were selected. According to the defendant not all of the firms, actually only 5 of the 17, ultimately ended up as clients. It is not clear where the 12 other firms went.

2. For the 5 clients that ended up with the defendant, most had not been long term clients before the alleged illegal acts took place. Some had only been clients for less than 1 year. In short it is not clear where the justification is for the assumption that they were long term clients

3. There was no discounting of the alleged damages. In damages cases, all future losses must be discounted. The discount factor, which takes into account of the risk associated with the future revenue stream, is in excess of 20% per year. Using the discount factor lowers the damages.

4. It is not clear all cost were accounted for. After a quick review of the income statements, it appeared some of the cost that were being classified as indirect (i.e. overhead) are related to the unit in question's operation. The CFO esential took out all overhead cost and did not allocate any to the unit in question. If damages are approriate then the net income, not the ad-hoc net income measure of the CFO.

5. It is not clear that the ratio approach to calculating the cost and expenses is appropriate. It may be more correct to use industry standards instead of the ad-hoc assumption the CFO used

6. Most importantly, an average of revenue needs to be used. Using the last year is problematic because the 17 firms that were identified had account balances that were higher in the previous year than in previous years. Using an average will account for this issue.

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Saturday, November 03, 2007

Are replacement costs = economic damages?

The issue:

In a case involving a self-employed business owner injured in a motor vechicle accident. His injuries prevent him from performing some of the activities he performed pre-injury. In response to his limitations, the business has changed so that he’s managing the business more and marketing the business to continue growing the operation.

In order to do some of th ework he previously performed and to maintain the business, he hired an assistant.

The question is, in a business, can the loss be calculated as the cost (wages and benefits) to hire the additional help?

Economist 1:

I don't see why you can't calculate your client's loss by estimating the cost of hiring additional help. Is the additional help more, or less, skilled than your client? And is he doing more, or less, work that your client was? 2. Is your client doing more management activities than before Are any such additional activities of value to him? 3. What happens if the cost of hiring the help exceeds the profit the injured person was previously earning?

Economist 2:

See: Brown R.J. (1995). Loss of Earning Capacity in the Case of a Farmer, Litigation Economics Digest, (1)1. He discussed using the cost of replacement labor as a measure of economic loss for self-employed persons.

Also:
http://www.oswego.edu/%7Espizman/spizfloss.pdf

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Wednesday, August 01, 2007

Pee-wee Football League Sues City

Focus on business damages

In a lawsuit filed in a mid-sized southern CA city, the president of a pee-wee football league sued the City alleging that they interfered with a contract that the football league had with the local school district. The plaintiff alleges that in 2006 the City pressured the local school district to cancel the football field use contract that the pee-wee league had with the school district. The plaintiff is suing the City for tortuous interference and the school district for breach of contract.

In these types of cases, there are generally two types of damages that economists consider: reliance damages and lost profits.

Reliance damages are the 'damages covering foreseeable loss caused by reliance on the contract'. In a court room setting, calculating these damages involves identifying the items that the party spent as a result of relying on the contract. In essence the idea is to make the injured party in as good a position as he would have been in had the contract not been made.

In this case, the plaintiff purchased a number of items, advertised for participants, hired officials, and in part, help to renovate the districts football playing fields. Additionally they purchased uniforms and food concession items. Upon cancellation of the contract the league was forced to obtain alternative playing fields (at a higher cost) and had to refund about 33% of the enrollment fees due to cancellations.

Reliance damages in this type of case would include these types of expenditures and costs.

What items are needed to prove reliance damages:

Profit and Loss statements for 3 years prior to the cancellation of the contract.
Receipts and bank statements
Interviews of the key members of the organization can also be useful.

lost profits damages

Lost profits are related to the revenue that would have been earned had the event not occurred. In this case, the issue is a little more complicated because the organization was a non-profit organization. In this case, one way to measure the lost profits is to consider the net income that actually flowed to the plaintiff. In this case, the pee-wee league paid the plaintiff about $50,000 a year to run the organization

What items are needed to lost profits damages:

The same as above PLUS (in this case) any pay statements (1099's etc.) that showed what was payed to the plaintiff to run the organization

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Friday, January 26, 2007

What would Daubert say about those damages? (continued from 2.25.2007)

Here is are four things to think about (and documents to collect) to begin an analysis of the dairy company's lost profits in the the business interruption lawsuit (see 2.25.2007 post).

1. Daily production volumes for the 60 days before, the day of, and 60 days after the incident in the year of the incident and a year before the incident.

[Reason: allows the analyst to see if the company really incurred a lost production do to contimination or were they able to scale up production in other areas?]

2. A list of and documentation of any specific orders, such as copies
of purchase orders or contracts (including requirements contracts),
that went unfilled as a result of the contamination

[Reason: Was the company pre-selling orders or did they make the products and then sell and market them after they were produced? Can be a big factor]

3. How long was the plant production shut down to locate and clean up the contamination?

4. What is your typical production in a day? Does this fluctuate throughout the day?

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Thursday, January 25, 2007

What would Daubert say about those damages? 1.25.06 part I

Case Background:

In this business interruption case where the owner of a dairy company is demanding that supplier pay for lost profits that it incurred as a result of receiving contaminated input product from the supplier. There is little question that the supplier supplied the contaminated input to the dairy company.

At this point, the case is at the pre-lit stage and the attorneys, and the insurance company would like to settle with the diary company without proceeding to the litigation stage. However, to do this the attorneys and the insurer in the case must have a handle on what the economic damages look like.

What documents do you need in a case like this? Check back....we will discuss....

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Thursday, October 19, 2006

Exciting new business valuation resource for attorneys

Working on a Daubert motion in a business valuaton or lost profits case and need to learn what are really generally accepted methodologies? Attorneys will want to check out the latest peer reviewed journal from Berkeley Eletronic Press, tilted:

The Journal of Business Valuation and Economic Loss Analysis (JBVELA),
http://www.bepress.com/jbvela. I aopl

The Journal aims to bridge the significant gap between attorneys, academic and practitioner communities, each issue of the journal by featuring three types of articles:

*scholarly studies that advance the field of business valuation or economic loss analysis;
* case studies in accounting, finance, litigation, and strategic management; and
* studies of recent legal rulings.

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Thursday, September 28, 2006

Calculating economic damages in lost profits cases just got tougher...

At least in the state of MS....

In Webb v. Braswell,[NO. 2004-CA-01438-SCT] the Supreme Court of MS, which is a Daubert state, upheld the exclusion of a well known and established agricultural economist. While there was no attack on the economist qualifications, he was clearly very qualified, the Supreme Court agreed with the trial court that the lost profit calculations were unfounded.

One main issue, from the read of the court's opinion, was that unlike other cases where future lost pofit analyses were allowed, the individuals in this lawsuit had no track history of business success.

Specifically from the court's opinion:

'...In today's case, the testimony was proffered for one purpose, to show damages of lost profits as a result of unplanted crops. The Webbs brought this testimony forward without ever establishing that they were profitable.

Rather, the Webbs had been farming and operating at a loss in the years prior to the farming year which is the subject of this litigation. Therefore, the amount of damage allegedly resulting from the unplanted crops was not reasonably ascertainable based on the Webbs' past experience, as the rule requires. This being the case, any testimony to prove damage to the Webbs is tenuous at best and fails the reliability prong of the Daubert/McLemore test...."

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Sunday, September 10, 2006

Spam Stock Tips Work

Ever wonder if anyone buys stock based on the SPAM email? New academic study says yes, SPAM works! At least for the senders of the email.

The authors of the study, SPAM Works, Professors Frieder and Zittrain of Purdue and Oxford Universities, found that like it or not, smart or not, people buy the stocks listed in those unsolicited emails.

The authors show that the trading volume of the stock being touted in the email shot up on average by 1300% on the day that the SPAM messages were sent. Unfortunately, but probably not surprising, most who buy the stock in the email lose money. However, people who buy the stock before the email was sent, most likely the senders of the email, tend to turn a hefty profit.

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