Attaining Reasonable Certainty in Economic Damages Calculations (Part I of III)
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The AICPA has issued two practice aids, one on 2015 and most recently in November 2018,
focused on the calculation of economic profits and damages. The purpose of this article—
the first of three on this topic—is to provide the reader with an understanding of Chapter 1
(Revenue and Growth Rates) of the 2018 Practice Aid as well as certain other publications
containing a body of knowledge on the best practices for developing “but for” revenues and
revenue growth issues in lost profits models. Later articles will deal with Chapter 2 (Costs)
and Chapter 3 (What Constitutes Best Evidence) of the 2018 Practice Aid and related topics.
Resources:
Financial Litigation Specialty: Commercial Damages and Lost Profits
The Reasonable Certainty Requirement in Lost Profits Litigation—Best Practices for Proving
Your Damages Calculation
Explaining Damages to Judges and Juries
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Economic Damages Calculations
In 2015, the American Institute of CPAs (AICPA) Forensic and Valuation Services (FVS) issued
a practice aid entitled, “Attaining Reasonable Certainty in Economic Damages Calculations”.
That publication added to the body of knowledge available to experts calculating lost profits
and other forms of economic damages.
In November 2018, the AICPA FVS issued a second practice aid entitled, “Attaining
Reasonable Certainty in Economic Damages Calculations” (hereafter, the 2018 Practice Aid)
further adding to the body of knowledge. The 2018 Practice Aid was updated after the
AICPA decided that case law research may yield additional topics worth presenting. (The
AICPA also recently updated its “Calculating Lost Profits” practice aid and added a new
practice aid entitled, “Communicating in Litigation Dispute Services.”)
The purpose of this article—the first of three on this topic—is to provide the reader with an
understanding of Chapter 1 (Revenue and Growth Rates) of the 2018 Practice Aid as well as
certain other publications containing a body of knowledge on the best practices for
developing “but for” revenues and revenue growth issues in lost profits models. Later
articles will deal with Chapter 2 (Costs) and Chapter 3 (What Constitutes Best Evidence) of
the 2018 Practice Aid and related topics.
AICPA FVS practice aids are prepared by AICPA staff and volunteers and do not reflect AICPA
positions, nor establish standards or preferred practices. The AICPA’s position is the practice
aids provide illustrative information on the subject matter. The author is both an AICPA and
NACVA member and notes in certain of his expert reports, where applicable, that the work
performed was guided by the AICPA Standards and Practice Aids; the Litigation Services
Handbook, The Role of the Financial Expert, Sixth Edition, Roman L. Weil, Daniel G. Lentz, and
David P. Hoffman (the Weil Text); and the Comprehensive Guide to Lost Profits and Other
Commercial Damages, Fifth Edition, Nancy J. Fannon and Jonathan M. Dunitz (the Fannon
Text).
While the authors of the 2018 Practice Aid were members of the AICPA Forensic and
Litigation Services Damages Task Force, I submit the materials discussed in the 2018
Practice Aid—as well as in the Fannon Text and the Weil Text—would be useful guidance for
AICPA members, NACVA members and/or other experts performing lost profits and/or
other economic damages calculations.
The 2018 Practice Aid noted that lost profits claims include key elements: (1) the estimate of
“but for” revenues (“the estimate of revenues that would have been earned but for the
alleged bad act”)[1] and (2) revenue growth (“how the lost revenues … would have grown …
over the applicable damage period”).[2] The 2018 Practice Aid noted “there is a robust body
of case law” that examines the expert’s role in estimating “but for” revenues and revenue
growth.
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Courts concern themselves regarding the expert’s use of accepted methodologies and
whether revenue estimates and growth rates are grounded in solid analytical processes.
Courts examine both the application of reliable principles and methods as well as the
integrity and reliability of the underlying data used to estimate “but for” revenues and
revenue growth.
The court cases cited within the 2018 Practice Aid focused onhether defendants or third
parties had prepared marketing plans and/or sales projections; the expert’s understanding
and/or independent analyses, verification and/or testing of such plans and/or projections;
and the expert’s explanation of the analytical gap between the data and opinion offered
regarding the “but for” revenues and revenue growth within economic damages
calculations.
As a generalization, courts require experts both (1) to “conduct some sort of independent
investigation or verification to ensure that the data [used] is both accurate and helpful to
the Court”[3] and (2) to “[gain] a working familiarity with the borrowed data so that the
expert can demonstrate the data’s reliability”.[4]
The court cases cited within the 2018 Practice Aid concerned themselves with the experts’
improper dismissal of evidence that contradicted the underlying conclusions; the expert
witnesses’ failure to analyze competing products; the experts’ assumptions regarding static
competitive positions over time; and any contradicted market share estimates. As a
generalization, courts view unfavorably assumptions that are arbitrary and/or the “cherrypicking”
of evidence.[5]
The 2018 Practice Aid focuses on two separate hurdles that experts may need to cross: one
relating to the admissibility of testimony (under Daubert, in limine and/or other motions
seeking to bar the expert), the second being the weight given the testimony (likely after
cross-examination). In the latter instance, the factfinder generally decides how much weight
to give or not give expert’s opinions. In the latter instance, the issue is no longer about the
selection of a methodology, but the more granular decisions involving the elements of the
calculations of economic damages.
These granular decisions involve (for example) selecting the appropriate base period for
measuring “but for” revenues and revenue growth; analyses of trends (and rejection of
“outliers”); performance of comparable benchmarks; “the selection of data inputs to employ
in [the economic damages] model”; and “[that] there is an analytical basis for the data
used in the method employed”.
The expert should evaluate, where applicable, that the yardsticks are sufficiently
comparable to the target: that “the samples [are] fair congeners” (things of the same kind
or category as another); any averaging performed (because “an average of unknowns [is]
[6]
[7]
[8]
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also an unknown”);[9] and the sufficiency of a historical track record (both of the target and
the benchmarks).
The 2018 Practice Aid concluded that “courts will exclude expert opinions that contain
revenue and growth estimates not based upon accepted methodologies and approaches,
and which are generally untethered from any meaningful analyses.[10] Moreover, “the
courts are clear that experts need an analytical basis for relying upon data.”[11]
The Fannon Text also provides guidance on estimating the relevant lost revenues as part of
the chapter on “Performing Credible Lost Profits Analyses.”[12] The Fannon Text[13]
reinforces that the focus on estimating lost revenues in a lost profits analysis should be on
approaches and methodologies but goes somewhat further than the 2018 Practice Aid as
follows: “The approaches/methodologies that a financial expert uses to determine the
amount of estimated lost revenues should consider and address the reasonableness of his
or her analyses, including the documents relied upon and assumptions utilized on which the
calculations are based”.[14]
The Fannon Text provides additional guidance over the entire lost profits claim, not just the
baseline year, noting[15] analyses forecasting multiple years have the risk that, over time,
lost profits models may become more speculative and/or unknown unless supported by
sufficiently relevant data. As to growth rates, the Fannon Text notes that[16] the financial
expert may look at growth rates experienced prior to and after the analyzed damages
period and/or the subject company’s actual experience with other operating units of the
company.
By way of illustration, the author successfully used similarly-themed restaurants run by the
same owners, the same management company, with similar employee headcounts, but in
different cities, as an internally-available benchmark to evaluate the profitability (or lack
thereof) of the subject company being analyzed. Ultimately, the restaurant benchmark data
was used to develop projections of “but for” revenues and revenue growth in lost profits
models. However, this process, did not always produce clear trends of “but for” revenues
and revenue growth—requiring significant additional analyses and explanations.
The Weil Text[17] extends the above discussion when discussing measuring “but for”
revenues for a newly established business—an additional difficulty for a lost profits expert.
The Weil Text provides that Courts now hold that such businesses can recover damages,
provided they have been proved with “reasonable certainty”.[18] In the context of “but for”
revenues and revenue growth issues in lost profits models, The Weil Text provides
additional guidance regarding the use of averages and indexes[19]; the use of
ranges[20];lost profits vs. lost business value[21]; time considerations[22]; causation[23];
regression analysis with confidence interval[24]; and Monte Carlo simulations[25].
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While “it’s tough to make predictions, especially about the future,” (a thought generally
ascribed to Yogi Berra), experts preparing lost profits calculation now have ever-increasing
levels of guidance regarding best practices for developing “but for” revenues and revenue
growth issues in lost profits models—the 2018 Practice Aid now contributes further to that
body of knowledge.
Michael D. Pakter has more than 40 years of experience in accounting and forensic accounting,
business economics and investigations in numerous industries and diverse engagements,
including more than 20 years of experience in economic damages and business valuations. He
has submitted expert reports in several jurisdictions and testified in arbitrations, regulatory
proceedings and litigated disputes. State, Federal and Bankruptcy Courts, as well as arbitral
bodies, have recognized him as an expert in accounting, financial analysis, forensic accounting,
economic damages, business valuation and business economics.
Mr. Pakter is a Certified Public Accountant, registered in the State of Illinois. The AICPA has
recognized him as additionally Certified in Financial Forensics and Management Accounting. He
earned the NACVA Certified Valuation Analyst designation having completed its business
valuation specialty program and its Master Analyst in Financial Forensics designation having
completed its business and intellectual property damages specialty program.
The Association of Insolvency and Restructuring Advisors has awarded him its Certified Insolvency
and Restructuring Advisor and its Certification in Distressed Business Valuation. He is a Certified
Fraud Examiner and a Chartered Accountant with undergraduate academic education in
accounting, auditing, commerce and business economics.
Mr. Pakter can be contacted at (312) 229-1720 or by e-mail to mpakter@litcpa.com or
www.litcpa.com.
[1] AICPA FVS Practice Aid: Attaining Reasonable Certainty in Economic Damages
Calculations: Pg 11.
[2] Ibid,. Pg 11.
[3] Ibid., Pg 15.
[4] Ibid., Pg 15.
[5] Ibid., Pg 18.
[6] Ibid., Pg 21.
[7] Ibid., Pg 22.
[8] Ibid., Pg 23.
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[9] Ibid., Pg 24.
[10] Ibid., Pg 28.
[11] Ibid., Pg 28.
[12] The Fannon Text Ch 10.
[13] Ibid., Pg 236.
[14] Ibid., Pg 236 drawing on an appellate courts position in Wallace v. Kalnis (2013).
[15] Ibid., Pg 238.
[16] Ibid., Pg 238.
[17] The Weil Text, Sec 4.20.
[18] Ibid., Sec 4.21, citing Robert L. Dunn, Recovery of Damages for Lost Profits, 4th ed., vol. 1
(Westport, CT: Lawpress Corporation, 1992), pg 345.
[19] Ibid., Sec 4.5 (a).
[20] Ibid., Sec 4.5 (b).
[21] Ibid., Sec 4.5 (c).
[22] Ibid., Sec 4.5 (d).
[23] Ibid., Sec 4.5 (e).
[24] Ibid., Sec 4.5 (f).
[25] Ibid., Sec 4.5 (g).
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