October 2003

A 2002 case, Energy Capital Corp. v. United States (302 F.3d 1314; 2002 U.S. App. LEXIS 16447), provides guidance on three issues that frequently arise in calculating damages. The case provides guidance on the following issues:

  • Can A New Venture be Awarded Lost Profits?
  • What is the Proper Date to Use When Performing Discounting Calculations?
  • Is it Appropriate to Use a Risk-free Rate in Performing Damage Calculations?

We continue to see damage calculations that do not comply with the case’s findings and the appropriate economic theory behind it.

Can A New Venture be Awarded Lost Profits?

The Energy Capital Court extensively discussed whether lost profits are a permissible remedy for a start-up venture. This issue arises frequently, with defendants contending that the prohibition against speculative damage calculations means that this remedy is unavailable to a new venture. The following quotes from the Court’s ruling clearly analyze this matter, as follows:

“Lost profits are a recognized measure of damages where their loss is the proximate result of the breach and the fact that there would have been a profit is definitely established, and there is some basis on which a reasonable estimate of the amount of the profit can be made’. (Quoting Neely v. United States, 152 Ct. Cl. 137, 285 F.2d 438, 443 (Ct. Cl. 1961).  In applying this rule, some defendants contend there is a per se rule that lost profits may never be recovered for a new business venture that was not performed… While the nature of a new venture may make it difficult to recover lost profits by establishing all of the elements of the general rule, such damages are not barred as a matter of law. This is consistent with the weight of modern authority…Most recent cases reject the once generally accepted rule that lost profits damages for a new business are not recoverable. The development of the law has been to find damages for lost profits of an unestablished business recoverable when they can be adequately proved with reasonable certainty. . . . What was once a rule of law has been converted into a rule of evidence.

The courts focus on whether the plaintiff has adduced evidence that provides a basis from which the jury could with “reasonable certainty” calculate the amount of lost profits. . . . The risk of uncertainty must fall on the defendant whose wrongful conduct caused the damages…

The cases cited by the defendant do not stand for the proposition that a per se bar exists for lost profits for new ventures. Rather, they simply represent instances in which the claimant failed, as an evidentiary matter, to establish entitlement to such profits.”

Well said.

What is the Proper Date to Use When Performing Discounting Calculations?

When compared to the date of a breach or tort, lost profits are practically always an amount of future money.  Since moneys held now are worth more than amounts in the future, the damages calculation must reduce the damages to their present value.  This raises the question as to what date this discount calculation should be performed.

Plaintiffs (and many defendants) discount damages to the trial date.  However, some defendants argue that because damages are to be determined as of the date of the breach or tort, the discount should go back to that time.  This longer discount period reduces damages.  A similar argument is that, by discounting to the date of judgment, the trial court effectively awards impermissible prejudgment interest.

The Energy Capital Court ruled that damages should be calculated by discounting damages to the date of judgment.  The Court specifically stated, “Discounting future lost profits to the date of judgment merely converts future dollars to an equivalent amount in present dollars at the date of judgment; it is not an award of prejudgment interest.”

Is it Appropriate to Use a Risk-free Rate in Performing Damage Calculations?

The larger or higher the discount rate that is used, the smaller the calculated damages.  Some experts, practically always working on behalf of plaintiffs, use a discount rate based on a risk-free rate of return, as measured by U.S. Treasury instruments. Although the Energy Capital Court did not prohibit the use of a risk-free rate in all circumstances, the trial court use of a risk-free rate was reversed. The Energy Capital Court noted:

“The fact that the trial court has determined that profits were reasonably certain does not mean that risk should play no role in valuing the stream of anticipated profits. In other words, by finding that Energy Capital’s lost profits were reasonably certain, the trial court determined that the probability that the venture would be successful was high enough that a determination of profits would not be unduly speculative. The determination of the amount of those profits, however, could still be affected by the level of riskiness inherent in the venture…When calculating the value of an anticipated cash flow stream pursuant to the DCF [discounted cash flow] method, the discount rate performs two functions: (i) it accounts for the time value of money; and (ii) it adjusts the value of the cash flow stream to account for risk”.

This case will not alter the damages calculations performed by most competent damages experts.

Fulcrum Financial Inquiry is skilled in performing damage calculations in complex commercial litigation.  We have experienced expert witnesses with excellent presentation skill.

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