September 2010

A plaintiff with a large verdict against accounting giant KPMG lost its award because the appellate court could not find evidence that would support the damages. The moral of the story is that one should not take short cuts on damages analysis in substantial commercial cases. While this moral may sound self-evident, we regularly see trial plans that focus inadequate attention and resources on the case’s damage presentation.

The same appellate court affirmed all other aspects of the trial result that was before them. The appellate court supported the plaintiff’s interpretation of the law in all regards, and further supported the theory under which damages were calculated. The only problem is that the plaintiff failed to present expert testimony that implemented the acceptable damage theory. The trial court was instructed to retry the damages portion of the case. The case is Cast Art Industries v. KPMG LLP, MID-L-3295-03, Superior Court of New Jersey, Middlesex County (August 26, 2010).

In 2000, Cast Art Industries of Corona, California, entered an agreement to purchase Papel Giftware Inc., a KPMG client. The companies were competitors, with both making collectible ceramic figurines. As a condition of the purchase closing, KPMG audited Papel’s 1998 and 1999 financial statements. KPMG knew that its audit was being used for this purpose, and issued unqualified opinions on such financial statements. After the closing, Cast Art learned Papel’s financial statements were fraudulently prepared. Cast Art claimed that Papel caused the financial failure of the entire enterprise, including the parent company. Cast Art contended that this occurred because Papel’s purchase was financed entirely with debt, which caused an unbearable debt service obligation for the parent company. Cast Art ceased all operations.

Cast Art’s damage theory, which the appellate court accepted, was that plaintiff should receive the value of Cast Art immediately before the Papel closing. The Court supported this approach, as follows:

“There is no single formula for determining the appropriate measure of an injured party’s damages. The injured party is only required to provide for the jury some evidentiary and logical basis for calculating or, at least, rationally estimating a compensatory award. The appropriate measure of damages depends on the nature of the harm established by the injured party. We conclude that the value of Cast Art on the day of the merger was an appropriate measure of plaintiffs’ damages because the harm plaintiffs suffered as a result of KPMG’s malpractice was the financial failure and consequent loss of all value of Cast Art. …

This conclusion is supported by decisions in other jurisdictions, which have recognized that even though lost profits may be the most common measure of damages in business tort cases, the value of a destroyed business enterprise is a more appropriate measure if the evidence supports a finding that defendant’s wrongful conduct was a substantial factor in that destruction.” (Citations omitted) 

Plaintiffs presented three pieces of evidence to support Cast Art’s loss of business value. The Court critiqued and rejected the evidence as follows:

  1. Deposition testimony of an investment banking consultant that was read to the jury – The investment banker advised Cast Art in connection with the merger. But, the investment banker’s work had several important shortcomings that prevented it from being relevant evidence. Specifically:
    1. The investment banker’s work was for the purpose of determining the respective percentages of the merged company to be allocated to the Cast Art and Papel shareholders, and not for the purpose of determining asset values or calculating a monetary damage amount.
    2. The investment banker’s work was as of a year earlier than the merger.
    3. The investment banker’s writings reflected the parties’ negotiations, and were not his own judgment of what the companies were worth. In the investment banker’s opinion, the actual value of the companies could have been substantially less than what the parties to the negotiations were discussing.
    4. The investment banker’s writings contained the parties’ desires to achieve tax and financing motivations, which are different from a sales price established by arms-length negotiation where one business buys another business for cash.
  2. Trial testimony of Cast Art’s president – This person was not identified as having valuation expertise. Even if this person was so qualified, he made no effort to independently value Cast Art, but instead testified regarding what the parties agreed. The Court concluded that the president’s testimony contained the same failings discussed above about the investment banker.
  3. A report of a KPMG valuation expert that was admitted into evidence, but who did not testify at trial – No doubt, plaintiffs thought it was quite clever to present what they perceived was a defendant admission regarding value. However, the KPMG report showed a value substantially less than the damages awarded at trial. Additionally, the KPMG report indicated that its purpose was different than what plaintiffs needed. KPMG’s transmittal stated, “We understand our study is to be used for corporate planning and tax reporting purposes, and no other use of our report or opinion is intended or should be inferred.”

For these reasons, the Court concluded that none of the three pieces of potential evidence of damages was sufficient to support the damages award. Accordingly, the $31.8 million damages award was stricken, and a new trial on damages ordered.

All of this could have been avoided by presenting competent expert testimony, instead of taking short-cuts. Cast Art may not have had the money or inclination to present damages correctly in the first trial, but they will need the money and inclination to present their damages presentation a second time.

Fulcrum Inquiry performs business valuations for damage analysis purposes, and for non-litigation purposes.