Critiquing an Expert Report: Step 9 - Mitigation

"The key to a successful defense is often proof that the plaintiff failed to mitigate damages.  The plaintiff is required to act reasonably to mitigate damages, but its failure to do so must be proved by the defendant."   [1]

You have now completed the following steps in your review of an expert report on damages:

1. Review author’s credentials and qualifications;
2. Identify scope limitations;
3. Assess underlying assumptions;
4. Consider conclusion as opinion versus calculation;
5. Identify and assess damages approach;
6. Identify and assess damages period;
7. Ensure future damages appropriately discounted; and
8. Consider the contract.

Step 9 to critiquing an expert report involves assessing the extent to which the damages calculations consider mitigation.  This is a critical step because mitigating income reduces a plaintiff’s damages claim and mitigation is often "assumed away" by experts when quantifying damages. 

 

In assessing mitigation, the following questions should be considered as you review the expert report:

1. What should the plaintiff have done to mitigate its losses?
2. What did the plaintiff do to mitigate its losses?
3. What alternate or substitute contracts did the plaintiff receive?
4. What mitigating activities did the expert consider in the report?
5. What mitigating income did the expert consider in the report?

In a breach of contract matter, for example, certain resources (e.g. financial, human, capital assets, etc.) would have been used by the plaintiff to fulfill the contract.  Given the alleged breach, the plaintiff no longer had to deploy those resources for that contract.  Those resources, however, may have been put to use (e.g. alternate contract, substitute project, replacement customer, etc.).  Any income (i.e. revenue net of costs) generated from that "alternate use" could be considered mitigation.

 

I also like to consider a higher level approach to assessing mitigation, which involves reviewing the plaintiff’s financial statements for a period of time before (e.g. three years), during and after the alleged damages period.  If the income statement does not show a drop in revenue during the damages period or if revenues actually increased over the damages period, this could be an indication that the plaintiff was able to successfully mitigate its losses. 

 

It can be extremely difficult to quantify the impact of mitigation and the resulting mitigating income, if any, actually earned by the plaintiff that would not have been earned but for the breach.  There are, however, many cases illustrating successful proof by the defendant that the plaintiff’s profits earned in mitigation are to be offset against the claimed damages. [2]

 

If you are acting for the defendant in a breach of contract or other legal dispute and have just been provided with the plaintiff’s expert report on damages, contact us at www.vspltd.ca.  We can help by providing some preliminary comments, a limited critique report or an independent expert report which would be suitable for use at trial, mediation, arbitration or settlement discussions.

 

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1.    Recovery of Damages for Lost Profits, 6th Edition, Robert L. Dunn, page 569.
2.    Recovery of Damages for Lost Profits, 6th Edition, Robert L. Dunn, page 574.

4 Traps to Avoid When an Acquirer Approaches

You may be eager to sell your business, but are you prepared for the numerous questions a potential purchaser will have before they start looking inside every corner of the business?

 

Many of these questions will be objective in nature, such as:

• When does your lease expire and what are the terms?
• Do you have signed, up-to-date contracts with your customers and employees?
• Are your products and processes protected by patent or trademark?
• What kind of technology do you use and are your software licenses up to date?
• What are the loan covenants on your credit agreements?
• Do you have any litigation pending?

There will also be more subjective areas a purchaser will be interested in, including figuring out just how integral you are to the success of your business.  After all, one of the biggest value drivers and areas of concern for potential purchasers is the extent to which the target business is dependent on the owner and the risk associated with the transferability of the business to new owners.

 

An experienced purchaser will be creative in assessing this issue before providing a letter of intent and conducting detailed due diligence.  Here are 4 possible traps for business owners to avoid when being courted by a potential purchaser.

 

Trap #1: Last-minute meeting changes

An acquirer may ask to make a last-minute change to your meeting time.  How you respond to this request may provide a clue as to how involved you are personally in serving customers.  If you can't accommodate the change request, the acquirer may probe to find out why and try to determine what part of the business is so dependent on you that you have to be there.

 

Trap #2: Checking for consistency in your business vision

An acquirer may ask you to explain your vision for the business, which is a question you should be well prepared to answer. However, they may ask the same question of your employees and key managers.  If your staff members offer inconsistent answers, the acquirer may take it as a sign that the future of the business is in your head.

 

Trap #3: Asking your customers why they do business with you

A potential purchaser may ask your pre-selected customers "Why they do business with you and your company?"  If your customers answer by describing the benefits of your product, service or company in general, that can be a sign of a valuable and transferable business.  If they respond by explaining how much they like you personally, that can be indicative of a business that is too dependent on its owner.

 

Trap #4: Mystery shopping

 

Acquirers will conduct initial research before expressing an interest in buying your business.  They may pose as a customer, visit your website, or come into your company to understand what it feels like to be one of your customers.  If they see you personally as the key to wooing new customers, they will be concerned that business could dry up when you leave.  Make sure the experience your company offers a stranger is consistent and try to avoid being personally involved in finding or serving brand new customers. 

 

You may not be expecting an acquirer any time soon, but it is never too early to be prepared to deal with the traps a potential purchaser will set to assess owner dependence.  Contact us at www.vspltd.ca for assistance with your succession and continuation planning.

Ex-Ante or Ex-Post - Which Do You See More Often?

When quantifying damages where the damages period extends beyond the anticipated trial date, there are issues to address with respect to discounting the future damages.  An earlier post addressed the issue of applying an appropriate discount rate to present value future damages. [1]  The issue of which date the damages should be present valued to, however, was not discussed.  The Ex-Ante and Ex-Post approaches address this issue.

The Ex-Ante approach computes damages (e.g. lost income) as of the assumed alleged breach date (or beginning of damages period), relying only upon information known or knowable at that time.  Under this approach, projected future damages are discounted to the beginning of the damages period using a discount rate that reflects the risk of the asset.

The Ex-Post approach, however, computes damages (e.g. lost income) as of the anticipated trial date, relying upon all known information at that time.  Damages incurred between the beginning of the damages period and the trial date are not discounted back to the beginning of the damages period but are measured as incurred.  Future damages that extend beyond the trial date are discounted back to the trial date.

The fundamental differences between the Ex-Ante and Ex-Post approaches lie in which information subsequent to the alleged breach is used, the date of the damages measurement and how the future damages are discounted.  These are summarized below:

	Ex-Ante Approach	Ex-Post Approach
Information	Use information known or knowable on the date of the alleged breach; ignore subsequent events (hindsight)	Use all available information (including hindsight information)
Measurement Date	Date of alleged breach.	Date of analysis (or anticipated trial date)
Discounting	Discount all cash flows back to date of alleged breach using a rate that reflects the risk of the asset.	Discount only future cash flows (beyond date of analysis or trial) to date of analysis or trial.

 

Proponents of the Ex-Ante approach argue that since the plaintiff was deprived of both asset returns and uncertainty surrounding those returns, it is improper to use hindsight, which effectively removes the uncertainty component.  In other words, awarding the plaintiff with all the benefits of a successful project without the plaintiff having to assume the project risk would overcompensate the plaintiff.

 

Proponents of the Ex-Post approach, however, argue that the Ex-Ante approach effectively imposes a forced sale upon the plaintiff at the time of the violation, which denies the plaintiff of any compensation for the loss of continued ownership property rights.  Using hindsight, however, correctly returns both the intrinsic risks and rewards of asset ownership to the plaintiff.  In addition, by virtue of the alleged breach, the defendant precluded the plaintiff from taking the risk associated with earning the cash flows.  Since the plaintiff wanted to take those risks, the defendant should not benefit from preventing the plaintiff from taking those risks.

 

Damages experts will sometimes apply a hybrid approach, wherein lost profits are discounted back to the breach date, but subsequent information (i.e. hindsight) is relied upon for purposes of the calculations.

 

Which approach do you see more commonly applied in expert reports quantifying economic damages?

 

 

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1. http://jasonkwiatkowski.blogspot.ca/2013/01/critiquing-expert-report-step-7.html

 

 

10 Ways to Increase Your Odds of Getting an Offer

The Sellability Score is an extremely valuable pre-sale planning tool for business owners to help assess the current "sellability" of their business. 

 

In the fall of 2012, the Sellability Score researchers analyzed data from users over the past 12 months.  The research team compared the data provided by users that had received an offer to buy to data provided by users that had not received an offer to buy.  The sample included 2,300 companies from around the world, with the majority of users being from Canada, US, UK, Australia and Ireland. [1]
 

The results reveal an interesting picture of the qualities and attributes acquirers look for in a business.  Focusing on the factors that are more closely linked to getting an offer will help increase the odds of attracting numerous suitors for your business.  The 10 factors that will increase your odds of receiving an offer for your business include:

The business can survive without you – you are twice as likely to get an offer if your business can operate and thrive without you
Your top sales person is replaceable – you are twice as likely to get an offer if you could easily replace your most important sales or marketing person
You are personally responsible for less than 75% of your sales – you are half as likely to get an offer if you are responsible for more than 75% of sales
Your top product/service design and delivery person is replaceable – you are almost twice as likely to get an offer if you could replace your most important product/service design and delivery person
Your annual revenues are over $3 million – companies with annual revenues over $3 million are twice as likely to get an offer compared to businesses with annual revenues below $500,000
Your key suppliers are replaceable – you are almost twice as likely to get an offer if you could replace a key supplier
Your business has a formal management team – you are almost twice as likely to get an offer if you have a management team as opposed to being a sole owner operator
More than 25% of your revenues are recurring in nature – you are more likely to get an offer if you have created a recurring revenue stream
Your business has over 10,000 followers – you are almost twice as likely to get an offer if you have more than 10,000 followers (i.e. aggregate of e-mail subscribers, Twitter followers, Facebook fans, Google + connections or LinkedIn connections)
You are younger than 33 years of age – although beyond your control, younger owners were twice as likely to get an offer than mature owners (it is speculated that this occurs in instances where the purchaser is interested in acquiring a company for the people or ‘talent’ building the product)

You may not be looking to sell your business today.  However, more than 310,000 businesses in Canada are poised to change hands over the coming five years.  The increasing supply of businesses for sale will create a buyer’s market putting downward pressure on sale prices over this time period.  The Sellability Score can provide you with vital information needed to command a premium price when it comes time to sell your business, especially in a competitive buyer’s market. 

 

Visit us at www.vspltd.ca or http://www.sellabilityscore.com/vsp/jason-kwiatkowski to find out your company’s Sellability Score.

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1.  Sellability Tracker Q4, 2012 – Increasing Your Odds of Getting an Offer.

Critiquing an Expert Report: Step 8 – Consider the Contract

You have nearly completed your review of an expert’s report by conducting the following steps:

1. Review author’s credentials and qualifications;
2. Identify scope limitations;
3. Assess underlying assumptions;
4. Consider conclusion as opinion versus calculation;
5. Identify damages approach;
6. Identify damages period; and
7. Ensure future damages appropriately discounted.

Step 8 to critiquing an expert report is relevant to legal disputes involving a breach of contract.  Such breach could include a breach of buyer/seller agreement, warranty agreement, franchise/distributorship agreement, construction contract, service agreement, lease agreement, non-compete agreement, insurance contract, etc. 

 

Step 8 involves asking the question "Did the expert consider and refer to the terms of the original contract in quantifying the damages?"  Ultimately this question is meant to help ascertain whether the assumptions underlying the damages conclusion are reasonable and consistent with the terms in the contract.  If the expert report relied upon assumptions that are inconsistent with the terms in the original contract, the conclusions could be inaccurate and unreliable.  Such key terms, which may be relevant for purposes of quantifying damages, could include: volumes, prices, costs, time period/duration, renewal period, termination clauses, etc.

 

It may seem obvious to suggest that an expert should refer to the actual contract in a breach of contract matter.  However, I was once retained by the defendant in a legal dispute (involving the alleged mismanagement of client funds by an investment advisor) to review the plaintiff’s expert report with respect to a claim for damages.  The plaintiff’s expert report did not consider or refer to the original client agreement with the investment advisor.  The expert report relied upon an assumption with respect to a suitable portfolio mix (e.g. risk-free, income, equity, etc.) based on instruction from counsel which was inconsistent with what the client stated and agreed to in the original contract.

 

Our responding report highlighted this as one of our concerns with the conclusions contained in the plaintiff’s expert report.  The case never did proceed to trial as the parties ended up settling the matter out of court for an amount less than the plaintiff expert’s assessment.

 

Taking the time to find out whether or not the assumptions underlying the expert’s conclusions are consistent with the original contract is a step that should not be avoided in order to conduct an effective review of that expert’s report.