Quantification of damages in commercial disputes

June 2012 | 10QUESTIONS | LITIGATION & DISPUTE RESOLUTION

financierworldwide.com

FW speaks with Gregory K. Bell at Charles River Associates about the quantification of damages in commercial disputes.

FW: To what extent have the litigation or arbitration costs and complexities of commercial disputes risen in recent years? How do you prepare a case efficiently, both in terms of your time and your needs for management time of the company involved?

Bell: In today’s business world, there is a trend toward increasing complexity, which tends to result in higher costs. In particular, it is becoming more crucial to understand the often complex commercial behaviour related to legal disputes. For example, if a particular business decision led to a dispute, an expert often must consider what other business options could have been pursued. In this context, simple accounting-based analyses of lost profits are unlikely to be appropriate. A credible analysis will often draw on industry knowledge as well as expertise in economics, accounting and finance. In my experience, it is useful for experts to meet with business people to discuss the realities of the industry and company operations. These meetings can take place relatively early in the course of the expert’s involvement but should be conducted following some relevant background work on the industry and using a well-formulated set of questions to minimise the burden on company personnel.

FW: How important is it for a company considering filing a commercial dispute to thoroughly assess the potential damages involved?

Bell: Companies may enter into litigation or arbitration for a variety of reasons; damages can certainly be an important consideration. Because it is expensive to enter into litigation or arbitration, both in terms of legal fees as well as management resources, a claimant should be realistic about the damages claim that could be credibly supported. It is often not enough to rely on speculations by company personnel as to what might have been lost due to the conduct in question; the company needs to understand what a qualified damages expert is able to support and prove. There can be a significant divergence between these amounts.

FW: Given the time and cost associated with a commercial dispute, is it preferable to enlist the aid of experts before making a final decision on how to proceed?

Bell: Yes, experts can be highly valuable. Early involvement by the expert can help understand the strengths and weaknesses of the damages case, including how damages arguments may be presented in light of the facts and how the other side is likely to respond. Once a case is filed, the expert can also assist in assembling and producing the relevant information to support damages claims and in preparing for witness examination to ensure the necessary facts are in the record. Throughout the process, the expert can also help evaluate potential settlement opportunities. Although parties may be concerned that early involvement by experts will increase costs, it has been my experience that earlier engagement actually reduces costs by identifying significant efficiencies and argument issues that can arise, thus making the damages case run more smoothly.

FW: Could you outline some of the key approaches, methodologies and models used to quantify damages?

Bell: This is a big topic about which a great deal has been written. What is important is the choice of an appropriate methodology for the situation at-hand. ‘Lost profits’ remains a benchmark damages methodology, but it is crucial to understand that it means lost economic or incremental profits and not lost ‘accounting’ profits. So, the distinction between fixed and variable costs needs to be taken seriously, as does the possibility of costs associated with forgone opportunities. Mitigation alternatives should be taken into account. If the claim is that additional units of output could have been sold, it will be necessary to understand if and how the price would have changed. Also, the issue of pre-judgment interest can be significant as a proportion of the total damages award – statutory interest rates may not be appropriate.

FW: Do you expect to see changes in the way damages are assessed and quantified going forward? Are methods continually evolving?

Bell: Damages assessments and quantifications are going to become more sophisticated to address the increasing complexity of today’s business world. It is less about the methods evolving and more about how the methods are used appropriately to assess damages. Examples include market studies rather than rote extrapolation of demand trends, critical analysis of future prices rather than blind acceptance of business perspective, calculation of appropriate present value discount factors rather than simple use of a standard investment hurdle rate and consideration of the pre-judgement interest rate rather than application of a rate designed for other purposes. It is worth emphasising that the expert still needs to present his or her opinion to arbitrators, judges or juries, so clarity of analysis and explication will remain crucial. A complicated case may require a complex damages analysis but the credible expert will be one who can explain, in lay terms, the frequently simple rationale behind the analysis.

FW: What steps need to be taken to collect and analyse data relevant to the case, for the purposes of evaluating damages?

Bell: Accounting data, including data on product sales and costs, are obviously critical. It will often be important to understand the manufacturing cost system and to probe into the rationale behind standard costs and variances. Coming to terms with this information often involves discussions with company personnel most familiar with accounting systems. Business records are also important, and it is useful to be precise about the types of business records that really matter. The damages expert should have access to the strategic plans, brand plans, forecasts, competitive intelligence reports and market research studies for the products or services that may be affected by the conduct at issue. These types of information will help the damages expert understand how the products or services were positioned in the market and what their prospects were for success.

FW: Does historical information on past awards have a role in the determination of damages in the context of a particular dispute? Do these historical trends serve as good indicators when a new dispute surfaces, or are there frequently too many variables involved?

Bell: Actual amounts awarded in past cases are likely irrelevant. Assets, business situations and disputes tend to be specific and an appropriate award of damages is based on those factors. Moreover, there is invariably insufficient disclosure of the specifics related to past awards to be useful. On the other hand, information on damages methodologies applied in past disputes can be instructive. The damages expert should understand the relevant legal framework to the extent that it impacts damages and the challenges that may have been asserted against different damages methodologies.

FW: How might the role of the damages expert differ in litigation vs. arbitration? How might the damages expert assist counsel in preparing the case for trial or arbitration?

Bell: In litigation, the damages expert is limited to responding to specific questions in direct and cross-examination. In arbitration, the expert is not so confined. In my experience, many of the most effective questions come from the arbitrators who often ask questions that highlight whether there might be some misunderstanding of the opinion. In addition, some of the most enlightening testimony can come from witness conferencing among the experts, a tactic that I have seen used only in arbitrations. Witness conferencing can be used very effectively to sharply delineate areas of agreement, areas of disagreement and many of the reasons for disagreements. In this respect, the best experts are likely to be those with a solid understanding of the business, economic, accounting and financial issues of the dispute. In terms of preparing the case, for either litigation or arbitration, the damages expert can be used most effectively to highlight the expected attack points of the opinion and provide a foil for counsel preparing cross-examination of the opposing expert.

FW: What are the advantages of using an expert from the industry (a retired executive, for example) versus using a damages expert?

Bell: There could be advantages to using an industry expert with a damages expert. I think it is problematic to use an industry expert to the exclusion of a damages expert. Industry experts’ experience is often their Achilles’ heel. They may not be able to articulate the economic structure of the industry or to untangle accounting profits to address profit at an incremental level. This is not because they are unskilled but because that type of work is not what tended to make them successful in their career. Industry experts are likely to fare particularly poorly in a witness conference setting against an expert with some business background as well as significant training in economics, accounting and finance.

FW: When it comes to quantifying damages, what general advice would you give to companies on the brink of a commercial dispute?

Bell: Select an expert early and work with that person to identify the arguments that can be supported and proven from those that are more speculative. Make sure that the expert has the requisite grounding in the business, economic, accounting and finance issues likely to be addressed in the dispute. Ensure that the expert has an opportunity to review relevant issues with company personnel. Lastly, get the expert’s perspective on the arguments likely to be put forth by the other side, particularly those that would be raised if he or she were acting as the expert for the other side.

Gregory K. Bell, PhD, is a Group Vice President at Charles River Associates, a global economics and management consulting firm headquartered in Boston, Massachusetts. For more than 15 years, Dr Bell has been testifying as an expert witness on damages issues in a variety of contexts and venues. He has appeared in antitrust, intellectual property, transfer pricing, financial markets, valuation, and general commercial damages matters in courts and arbitration proceedings in North America, Europe, and Australia. He brings a broad base of experience and expertise to the issues: he is a Chartered Accountant in Canada; he has a MBA and a PhD from Harvard University, with concentrations in business strategy, economics, finance, and trade; and he leads a global strategy and policy consulting practice at CRA. Dr Bell can be contacted on +1 (617) 425 3357 or by email: gbell@crai.com.

THE RESPONDENT

Gregory K. Bell

Charles River Associates