Stephen L. Ferraro and Charles S. Amodio
BridgeTower Media Newswires
As forensic CPAs, we are often asked to build (or rebut) financial models that estimate lost profits. In our work, it's very important that we don't lose sight of the legal principles governing lost profits, with the goal of assisting the trier of fact.
Recovering lost profits generally requires the plaintiff to successfully address the following legal rules:
The proximate cause rule: The recovery of damages for lost profits is subject to the general principle that damages must be proximately caused by an event, breach or wrongful act of the defendant. This requirement is expressed in numerous cases and governs the recovery of all compensatory damages.
The reasonable certainty rule: A second requirement for the recovery of damages for lost profits is that the damages be proven with reasonable certainty. It requires that the damages be capable of measurement based on reliable factors without undue speculation. Again, this legal principle is expressed in several cases and is unquestionable.
The foreseeability rule: There is also a key question presented by cases looking for recovery of damages for lost profits on contract claims. The question is whether those damages were reasonably foreseeable as the expected and likely result of a breach of the contract at the time the contract was made.
These governing legal principles, which have been established and reinforced by case law, should be woven into arguments and financial models in a manner that shows their applicability to the case at hand.
Further discussion and supporting case law for the proximate cause rule appears below; further discussion of the reasonable certainty and foreseeability rules will follow in tomorrow's column.
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The proximate cause rule
As stated, damages for lost profits are recoverable only if the event, breach or wrongful act was the proximate cause of the loss. Proximate cause is an act from which an injury or damage results as a natural, direct and uninterrupted consequence and without which the injury or damage would not have occurred.
In other words, there must be a close link between the event, breach or wrongful act and the resulting damages. Furthermore, to demonstrate proximate cause, the plaintiff must establish both "transaction causation" and "loss causation."
"Transaction causation" relies on the concept that "but for" the event, breach or wrongful act, no damages would have been incurred. "Loss causation" requires that the plaintiff prove that a loss is related to the event, breach or wrongful act. The fact that an event occurred or the defendant breached a contract or performed a wrongful act does not alone support damages.
For example, in Universal Commodities, Inc. v. Weed, 449 S.W. 2d 106 (Tex. Civ. App. 1969), a plaintiff leased a seafood processing plant from a defendant, who was obligated to supply the seafood to be processed. The defendant breached the contract, but the court denied lost profits damages because the plaintiff had been unable to secure financing for the business and would not have had sufficient capital to operate and make a profit even if the defendant had performed as required by the contract.
The "fact of damage" is required to be proven with reasonable certainty. The fact of damage relates to whether the plaintiff can prove that the event or the acts of the defendant caused damage to the plaintiff. Once the fact of damage has been established, the amount of damage can be calculated.
The event or the defendant's acts need not be the sole cause of the plaintiff's lost profits, but they must be a significant or material factor in the cause of that loss.
Although other factors may also be partially responsible for the plaintiff's lost profits, in some cases it may not be practicable, or possible, to eliminate the effect of all other possible causes of loss. However, it is necessary to show that those other factors have been considered, to the extent possible.
Sufficient evidence must be presented to the trier of fact to allow a determination to be made as to what portion of the plaintiff's damages may be properly assigned to the event or defendant.
As an example, nearly 20 years ago we handled a business interruption loss for a General Motors car dealership. The dealership suffered a devastating fire loss at the same time a union strike had stopped production at 30 GM assembly plants and 100 parts plants across North America.
Through national and regional research of other "non-interrupted" GM dealerships, we could assess the probable impact of the strike on the dealership's historical car sales and related departmental profits and adjust our "but for" projections accordingly.
The plaintiff should present calculations in a manner that shows how the various factors causing the plaintiff's losses contributed to that loss.
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Stephen L. Ferraro and Charles S. Amodio are partners at Ferraro, Amodio & Zarecki CPAs, based in Saratoga Springs, New York. Ferraro can be contacted at sferraro@fazcpas.com. Amodio can be contacted at camodio@fazcpas.com.
Published: Wed, Apr 10, 2019
