Measuring Commercial Damages

First Chapter

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Chapter 1
INTRODUCTIONThis book is designed to provide a methodological framework for measuring commercial damages. Its goal is to discuss some of the more important issues within this framework. The discussion is presented with an emphasis on the interdisciplinary nature of commercial damages analysis. Depending on the type of case, the expert who values damages of a company in litigation may need to have a well-rounded knowledge of the research and practices in the related disciplines of macroeconomics, microeconomics, econometrics, and finance, including investment analysis, capital market theory, corporate finance, and, last but not least, accounting. Given the broad range of expertise that may ultimately be needed, combined with the fact that few individuals would be experts in all of these fields, a team of experts, such as economists working with accountants, is often the optimal solution.
This book is not meant to present an exhaustive review of all the issues relevant to commercial damages analysis. Rather, it is meant to discuss the most important and fundamental issues. However, each case brings with it its own set of unique factors and these need to be considered on an individual basis. No broad-based book, such as this one, can anticipate all of the unique circumstances that may be encountered. For this reason, this book focuses on the more commonly encountered circumstances and presents a general damages evaluation framework capable of handling all of them.

DEVELOPMENT OF LITIGATION ECONOMICS

Litigation economics, sometimes also referred to as forensic economics, has developed significantly over the past two decades, during which the National Association of Forensic Economics (NAFE) was formed (http:// nafe. net). A national body of economists who work in the field of litigation economics and who may provide expert testimony in court proceedings, the organization is composed of mainly Ph. D. economists, many of whom have academic affiliations, as well as other members with different backgrounds. In addition to the creation of NAFE, three well-received, refereed, academic journals devoted to the field of litigation economics—Journal of Forensic Economics, Journal of Legal Economics and Litigation Economics Digest —have begun publication. These journals have given litigation economics an academic stature similar to other subdisciplines in the field of economics. In addition to there being a forum for respected scholarly work in this area, most of the major meetings and the leading professional conferences of economists in the United States, including the American Economics Association and the Western Economics Association annual meetings, now have several sessions devoted exclusively to litigation economics. Such conferences have allowed the exchange of ideas that has further developed the methodologies in the field. There are also now two online exchange forums. The first, sponsored by the National Association of Forensic Economics and called NAFEL, features the exchange of ideas on a variety of litigation economics topics but is mostly geared to personal injury litigation. The second, called Business Damages Forum, features an exchange of ideas on various issues related to commercial damages and business valuations.
At present, the leading use of damages experts, often economists, tends to be in personal injury and wrongful death litigation. This is not surprising, because this type of litigation is clearly the most common. Although there are some similarities between commercial damages analysis and the estimation of damages in personal injury and wrongful death litigation, major differences cause them to be two separate fields, often including different groups of practitioners. In general, economists who do personal injury damages analysis tend to have a background in labor economics, but may not have a background in finance. Many of these experts are sole practitioners who often have a full-time academic position. Experts in commercial damages analysis, instead, tend to be a more diverse group. Many of them work for large firms, including some public companies. They come from a variety of backgrounds, with the most common being accounting, economics, and finance.

COMMERCIAL DAMAGES ANALYSIS COMPARED TO PERSONAL INJURY AND EMPLOYMENT LITIGATION

Economists are often called upon to provide testimony on damages in personal injury and wrongful death litigation. These cases utilize a more or less standard methodology that does not vary significantly among cases. This methodology has been well developed in the forensic economics literature. In addition, a concise statement of many of the generally accepted steps in the damages measurement process for personal injury cases has been set forth in Economic Expert Testimony: A Guide for Judges and Attorneys. The methodology usually involves projecting lost earnings and fringe benefits (net of mitigation in personal injury cases) over the work-life expectancy of the plaintiff, as well as a valuation of lost services over a time period that may approach the plaintiff/ decedent's healthy life expectancy. The work life is the generally accepted standard for the terminal date of lost earnings estimates while the life expectancy is often used as a guide to establish the length of the loss period to measure the value of lost services (the life expectancy may be reduced to reflect the diminished ability to provide services due to the aging process). Both the life expectancy and the work-life expectancy are based on statistical data that establish averages from demographic and labor market characteristics, as contrasted with commercial damages analysis where the loss period is usually determined by a different set of circumstances, such as what may be set forth in a contract.
In personal injury litigation, the monetary amount presented is usually derived from the historical earnings of the plaintiff or decedent. For those who have not yet had much of an earnings history, lost earnings may be derived from government statistics that set forth earnings as a function of age, sex, and education. Where appropriate, historical compensation data may allow the expert to measure the value of fringe benefits. Once the total compensation base has been established, the expert constructs a projection by selecting a proper growth rate. The projected values are then brought to present value terms by applying an appropriate discount rate.
In employment litigation, the expert may project damages using methods similar to those employed in personal injury cases. However, the role of the economist can be expanded when there are claims of bias or other discriminatory practices. Here, in addition to possibly measuring the damages of the plaintiff, the economist may be called upon to utilize his or her econometrics and statistical background to render an opinion on the liability part of the case.
Commercial damages cases tend to vary considerably. Although some of the evaluation techniques used may be similar, the circumstances tend to vary more widely from case to case. In addition, the industries involved can be very different and may each present unique issues. Given this wide variability and the necessary industry analysis, commercial damages cases present a greater degree of complexity and typically result in greater time demands being placed on the expert in order to conduct a thorough analysis. The time demands often tend to be significantly greater than those associated with a typical personal injury or wrongful death loss analysis, thereby making a commercial damages loss analysis a more expensive proposition.
Another important difference between commercial damages analysis versus personal injury and wrongful death loss analysis is the role of cost analysis. The losses of a worker are typically wages and benefits, with job-related expenses usually not as significant a factor. In commercial damages analysis, costs related to lost revenues are generally quite important. Here the skills of an accountant may be most useful in measuring the appropriate costs that would have been incurred in order to realize certain lost revenues. QUALIFICATIONS OF A DAMAGES EXPERT
It is important that the commercial damages expert possess a well-rounded background to measure the damages reliably and to withstand the criticisms that come from cross-examination. Although courts are generally somewhat lenient in what they accept as an expert, the "expert must possess requisite skill, training, education, knowledge, or experience from which it can be assumed that the opinion is reliable." Given that these attributes are generic, it is important to focus on the specific credentials relevant to measuring economic damages.
The desirable qualifications of an economic expert witness are set forth in various publications in the field of litigation economics. Examples can be found in Stuart Speiser's Recovery For Personal Injury and Wrongful Death, Michael Brookshire and Stan Smith's Economic/ Hedonic Damages, Gerald Martin's Determining Economic Damages, and Gary Baker and Michael Seck's Determining Economic Loss in Personal Injury and Death Cases. The qualifications set forth in these publications focus on applications in personal injury and wrongful death litigation. The requisite qualifications to competently estimate commercial damages and render an expert opinion are similar, however, the qualifications tend to be broader. These have also been set forth in the forensic economics literature.
Desirable qualifications of an economist who could provide expert witness testimony on commercial damages include:

• Doctorate in economics, finance, or accounting
• Background in finance or financial economics
• University teaching position— preferably at the graduate level
• Scholarly publications in economics, finance, or accounting
• Professional presentations in economics, finance, or accounting
• Experience in industry analysis and forecasting
• Experience in commercial damages analysis

The qualified witness may not possess all of the foregoing, but may have clear strengths in one area that may outweigh possible deficiencies in others.
In lost profits litigation, the courts have consistently ruled that economists and accountants are appropriate expert witnesses to testify on damages. Attorneys sometimes hire accountants to do lost profits analysis, but CPAs generally have a limited background in economics and finance and lack the expertise to conduct a thorough economic analysis. However, accountants may provide valuable expertise on certain issues such as cost analysis and preparation of pro forma financial statements. For some commercial damages cases an interdisciplinary approach combining the expertise of economics, finance, and accounting, perhaps through the use of more than one expert, may be useful. This may mean that just one expert testifies and that the testifying expert relies on the work of other experts.

INTERDISCIPLINARY NATURE OF COMMERCIAL DAMAGES ANALYSIS

Most commercial damages analysis tends to be performed by experts from one discipline, such as economics, finance, or accounting, without the expert drawing on the expertise of those outside of his or her discipline. This situation is unfortunate because in many commercial damages cases the necessary skills and expertise tend to transcend traditional discipline boundaries. The skills of an economist may be invaluable to analyze the relevant economic environment, do an industry analysis, and construct reliable projections. A finance expert may be necessary to analyze relevant variables from financial markets, such as rates of return. An accountant may be useful to conduct a costs analysis or to perform other work, such as the reconstruction of financial statements, including cash flow statements. The needs just described are in general not part of the training that one acquires in any one of these disciplines. However, it is common to see experts from one field try to conduct the entire damages analysis for a given case. In such instances, they may do a competent job on the part of the analysis within their expertise, while failing to do a competent job in that portion of the analysis that is outside of their expertise. A preferable approach is to use a team of experts, with one leading expert providing the methodological structure and performing the part of the analysis within his or her expertise. Other experts then provide their own specific expertise upon which the leading expert relies to put forward the loss measure.
Although it is acceptable for one expert to rely on the opinions of other experts when putting forward an expert opinion, it may be useful to have more than one expert on the team testify. In this manner, each expert stays within his or her own expertise and is capable of handling the cross-examination on the various relevant issues that might arise.

Relative Strengths of Economists versus Accountants

Economists have training in various forms of macroeconomic and microeconomic analysis. Often they have extensive training and expertise in statistical techniques and econometrics, techniques that may be invaluable in forecasting. However, unless they have separately acquired a background in finance, many economists have limited familiarity with financial statements and are not involved in the preparation of such statements. This is the bailiwick of accountants who may have specialized training in areas such as cost accounting, which can be most useful when determining profit ratios to apply to forecasted revenue levels. Some accountants have a Masters in Business Administration (MBA) degree and others have an undergraduate degree in accounting and a CPA. It is important to note that even though an MBA is a graduate degree, most MBA programs provide only general business training. The economics and forecasting courses in MBA programs are usually fairly elementary and provide the student with limited training. These courses are not comparable to the training that a Ph. D. economist would normally receive. Some accountants have doctoral degrees and may possess such training. However, one of the strengths of accountants is their experience in the field, which can be quite useful particularly if it is in the industry that is being considered in the lawsuit.
An example of the court's reaction to opposing experts who possessed some of the strengths and shortcomings just discussed can be found in Digital & Analog Design Corporation v. North Supply Company. The plaintiff introduced an expert who had a doctorate and who held himself out to be an expert in economics and business finance. Although the court seemed a little confused about the forecasting methods employed by the economist, they were notably impressed.

In this regard DAD's economic expert is in the field of economic analysis, with a large number of publications and professional activities to his credit. The evidence would reasonably support his technique of cost-profit analysis, the so-called "time series analysis and projection."
NSC, by comparison did not produce a comparable expert. Instead, NSC relied upon the testimony of a certified public accountant, an employee controller of NSC, a Mr. Simon, neither of whom it appears had as extensive training or expertise in the time series analysis method as had Dr. Zinser, and neither of whom utilized a competing method of analysis to calculate a lesser amount of profits.

Although impressed by the economist's forecasting abilities, the court found his cost analysis wanting. The economist merely applied the gross margin to projected lost sales without more carefully measuring incremental costs as discussed in Chapter 6. A solution that neither side attempted would have been to have an economist do the lost revenue projection and an accountant conduct the analysis of the costs associated with the forecasted lost revenues. Such an approach, when appropriate, is advocated throughout this book.

DIFFERENCE BETWEEN ECONOMICS AND FINANCE

Attorneys are more aware of the relative skills and strengths of economists versus accountants than they are when comparing specialists in economics versus finance, partly because the fields are somewhat interrelated. Many economists consider finance to be a subfield of economics. Indeed, there is a field called financial economics that applies economic analysis to financial markets. However, there are several differences between a doctorate in economics and a doctorate in finance. For one, finance degrees are often conferred by a college of business within a university whereas economics degrees may be offered by the university outside of the college of business. This difference is not important. What may be more relevant is the different training of the individuals.
The training of Ph. D. s in economics and finance have several differences. One of them is that a Ph. D. in finance may have some training in accounting and may have taken certain courses taught in the business schools that economists are not required to take. Many economists lack any knowledge of finance and financial statements. It is possible, for example, to get a doctorate in economics without ever having seen a financial statement (as shocking as this sounds). Indeed, many economists do analysis on many complicated and esoteric areas and consider topics such as the analysis of financial statements simplistic. Nonetheless, it is important that the economists in commercial damages analysis have a more broad knowledge base that may involve going beyond the initial training received in graduate school. For example, those who write their dissertation on a financially related topic may get this background as part of their thesis research.

FINDING A DAMAGES EXPERT

There are many ways for an attorney to find a damages expert. One of the most often used is word-of-mouth and referrals, whereby an attorney consults with colleagues he or she respects and gets the names of experts who have successfully performed for them. If this process is not successful, other methods must be employed.
Certain types of media, including regional legal publications and legal reference diaries, advertise the services of experts. It is important that references be gathered and checked, particularly in cases where initially the attorney does not have any additional information on the expert other than what the advertisement supplies. This review process can be enhanced by a verdict search, which may reveal the names of cases in which the expert has testified. Both the attorneys who retained the expert in the past and the attorneys who cross-examined the expert in prior matters can be consulted for feedback. Keep in mind, however, that an adversarial attorney, particularly one who may not have done as well as he wanted to in the case in question, may fail to give an objective review.
Other sources for obtaining information on experts are the expert referral companies. These firms maintain names and curricula vitae (CVs) of experts in many different specialties which they refer to attorneys for a fee. A CV is a document that lists an expert's credentials. The fee that these companies charge may include an initial charge as well as a built-in hourly charge that is incorporated into the expert's fee. This may cause the expert's fee to be different than what it otherwise would be if she were contacted directly without a referral intermediary. However, referral agencies can greatly speed up the process of finding an expert—particularly if one is looking for unique expertise such as a specialist in a certain narrowly defined industry.
Another source of experts can be local universities. A professor in a nearby university may have a certain appeal to a jury from the same community. In addition, professors may possess the ability to explain complicated concepts clearly. However, attorneys have to be very careful if they are hiring an academic who lacks litigation and testimony expertise. It takes a certain personality to withstand the rigors of the adversarial litigation process in the United States. Furthermore, the way one voices arguments and positions in an academic environment is very different from how opinions may be expressed in an adversarial litigation environment. As obvious as this sounds, many would-be litigation experts who are pure academics may find this difficult to comprehend. Therefore, attorneys need to exercise caution in using untested experts whose testimony may be somewhat unpredictable. The role of experience is discussed later in this chapter.
Several economic consulting firms, ranging from small "boutiques" to large national firms, offer litigation-related services. Some specialize in commercial matters while others offer a variety of damages-related services. Many possess well-qualified individuals but attorneys still need to give the specific experts working on their case careful scrutiny.
Still another source of experts is the major consulting arms of accounting firms and other larger litigation companies. In recent years, accounting firms have aggressively expanded their consulting operations after they discovered the profit margins on traditional accounting work, such as auditing, shrank because of competitive pressure and corporate cost cutting. These firms can bring larger quantities of personnel to a project. However, although it may seem comforting that such a firm can apply many professionals to a given project, usually one specific expert ends up testifying. The fact that an army of accountants may be employed at a given firm may be of limited benefit when that expert testifies on his personal credentials and on the analysis that was performed and the opinions that were developed. Therefore, when it comes to actual testimony the specific credentials and track record of the expert are more important than the quantity of staff that a firm employs. This should not be construed to imply that larger firms are inferior to small ones. Rather, the expert selection process is individualistic and should be focused on the specific expert or team of experts that will ultimately testify.

Critically Reviewing a Potential Expert's Curriculum Vitae

Many attorneys seem to take at face value the content of a potential or opposing expert's CV without applying careful scrutiny. Some attorneys merely give the CV a cursory scan and conclude from the length of the CV that the expert possesses impressive credentials. Sometimes a closer review of the listings included on the CV can expose the misleading nature of the items. For example, in lieu of quality publications, an expert may list presentations made before attorneys, which are nothing more than marketing appeals and sales pitches. Other publications may include very general articles in legal newspapers and magazines. These articles do not go through the scrutiny that a refereed journal article or book would. Sometimes what is listed as a publication is a paper or article that has not even been published.

Degrees

One of the most fundamental characteristics of a degree as it relates to litigation is the degree's relevance. It is very common for experts to want to testify in an area that is outside of their expertise. Courts have been supportive of objections to experts testifying outside of their expertise. In the area of commercial damages, many individuals put themselves forward as experts. Courts are often liberal in accepting such individuals and rely on the voir dire process and cross-examination to expose any deficiencies. However, at a minimum, attorneys should be aware that doctoral degrees in some fields such as engineering or operations research provide little or no training in the areas that would be relevant to most types of commercial damages analysis. Attorneys should be very wary of the mail-away Ph. D. These are doctoral degrees that one can earn at home. Several institutions offering such degrees have sprung up and some even advertise in major publications. If the degree-granting institution is unknown, the attorney should get its catalog and review the criteria it employs for issuing degrees. When encountering opposing experts with such degrees, this area of inquiry can be very fertile.

Published Books

Published books can be an impressive credential for an expert to have. These books are even more impressive if they are published by major publishers who tend to be selective. Books that have received acclaim or won awards for their quality are even better. Books that have been used as textbooks may also provide the author with certain credentials that other experts who have not published any books may lack. In addition, books in the area in which the expert is testifying can be invaluable. It is great to use as an expert the person "who wrote the book" in the area.
Beware of books published by vanity publishers. These are publishers who publish a book for an author for a fee. They are not unlike photocopy houses as opposed to the more traditional publisher. Having such a published book implies that none of the many publishing houses that exist considered the work worthy of publication. It also implies that the book in question has a very limited readership and may not be regarded as authoritative by anyone in the field.

Refereed Journal Articles
In addition to published books, another important standard used for evaluating scholarship in academia is refereed journal articles. A refereed journal is one that utilizes a group of experts in specific specialities to blindly review articles submitted to the journal in their speciality. A journal's editors allocate the articles to the relevant referees and ensure that the process is completed without revealing the names of the authors or the referees. These referees judge the quality of the article and decide if it is worthy of publication. This peer review process is very different from articles that are reviewed by an editor who simply decides whether a piece is of interest to the readers.
There are three refereed journals in the field of litigation economics: the Journal of Forensic Economics, Journal of Legal Economics, and Litigation Economics Digest. Although many of the articles in these journals focus on areas other than commercial damages, a certain quantity of articles on commercial damages have been published in each of these refereed journals. Other refereed journals that may feature articles in the area of commercial damages can be found in the closely related field of law and economics. This is a subfield of economics, in which someone getting a doctorate in economics can specialize. The three leading journals in that field are the Journal of Law and Economics, the Journal of Legal Studies, and the Journal of Law, Economics and Organization. In finance, there are many refereed journals, including Journal of Finance, Journal of Financial Economics, Journal of Applied Corporate Finance, Financial Management, Financial Analysts Journal, Journal of Accounting and Economics, and many others. In econometrics there are several quality journals such as Econometrica, Journal of Econometrics, and Journal of the American Statistical Association in addition to others. In the field of accounting, Accounting Review and Accounting Horizons are two leading refereed journals. Accounting Horizons is published by the American Accounting Association. While not a refereed journal, the Journal of Accountancy is published by the American Institute of CPAs and is widely distributed to all members of the Institute.

Presentations
An expert's CV often contains lists of presentations. In the academic world the publication process often begins with a refereed presentation to one's peers in the specific area of the article. Refereed presentations are those that are accepted after a Call for Papers has been announced and various submitted articles are reviewed by the organizers of paper sessions at various academic conferences. The standards for acceptance vary widely but are usually higher than nonrefereed presentations. Attorneys should be wary of presentation listings that are merely promotion sales presentations made before potential clients.

Testimony Lists
Some experts list their prior testimony experience on their CV. When this is done along with other valid credentials it may serve a purpose. However, if this is the bulk of the CV, questions about the individual's expertise need to be raised. Perhaps the true expertise of the expert is selling his services to attorneys.

Concluding Comments on Contents of CVs
The expert witness arena has become quite crowded as professionals from many fields have discovered that they can earn impressive fees by serving as experts in litigated matters. They have learned that they may be better able to get the assignment if they have a long CV filled with impressive sounding contents. Therefore, it is incumbent on the attorneys to carefully review the listed items and ascertain their quality. When reviewing the contents of an opposing expert's CV, one's own expert can be invaluable. For example, it has been observed on many occasions that experts who lack publications may try to compile a list of alternative credentials that may take up several pages. As previously noted, one tactic employed by such witnesses is to list testimonies. The retaining attorney must then decide if a list of court appearances as an expert witness is truly a credential, particularly if there is little else on the CV. Another example that is really a form of misrepresentation is what may be listed under the heading of publications. Experts who lack legitimate publications often list various items that range from papers that were never published to names of speaking appearances. A cross-examining attorney can have a field day with such misrepresentations. Therefore, it is the retaining attorney's responsibility to review the contents of an expert's CV carefully.

Credentials versus Experience in Litigation Analysis
Attorneys need to be aware that litigation-related analysis is a specialized field and not all highly credentialed experts can perform well in it. One classic example of an expert who possessed extremely impressive credentials but who lacked a familiarity with litigation analysis occurred in a recent antitrust case where the class action plaintiffs hired the Nobel Prize winning economist Dr. Robert Lucas. With respect to his credentials, the court had the following comments:

We next come to Dr. Robert Lucas and the opinions he expressed, particularly as regards to the alleged collusion engaged in by all of the Defendants. First, it is proper to recognize Dr. Lucas' eminent and distinguished credentials. He is affiliated with the University of Chicago, indisputably one of the finest educational institutions in the world. He is also a past recipient of the Nobel Prize in Economics, an award without equal in recognition of scholarship and contributions in his chosen discipline. It was with high expectation that the Court anticipated his testimony and denied requests from the defendants to preclude his testimony or to conduct a separate Daubert hearing out of the presence of the jury.

However, with respect to his analysis the Court was not as complementary.

Sad to say, Dr. Lucas' testimony did not measure up to his unique qualifications. Among other things, his testimony showed the following:

(a) he abdicated entirely the concept of the independence of the expert witnesses and simply became the sponsor for the Class Plaintiff's theory of the case;
(b) he was ignorant of material testimony and other evidence;
(c) his essential opinions were not only based on the evidence, they were inconsistent with it;
(d) his opinions were offered without any scientific basis or having been subject of economic methodological testing.

Dr. Lucas reached his conclusions within 40 hours of his engagement and before he undertook any substantial or detailed study of the prescription drug industry. Most of the facts upon which he based his opinions and conclusions were supplied by Class Plaintiffs' counsel, although he admitted he did not expect Class Plaintiff's counsel to have a balanced presentation. His expert's report was redrafted by Class Plaintiff's counsel in its entirety and included what counsel wanted. In Dr. Lucas' own words: "I don't think there is a single sentence in this affidavit that's intact from the first draft that I proposed."

The lesson derived from the above case is that a variety of skills and abilities are needed in order to be a competent expert witness in the field of commercial damages. Impressive academic credentials can be a major plus in a courtroom. These lofty credentials may cause a judge or jury to attach greater weight to the testimony of the expert. However, the value of experience in the courtroom cannot be overestimated. Professors are used to lecturing with few challenges from the student audience who are dependent upon the professor for their grades. Students tend to be more in awe of highly regarded professors than cross-examining attorneys who may believe that the testimony of the professor stands between him and a high verdict. The expert must be familiar with the aggressive challenges that can occur during a cross-examination or a long deposition. With such challenges in mind the expert prepares his report. Without such experience it is difficult to anticipate the nature of the challenges. Simple factors that the expert may take for granted can be the source of persistent cross-examination. Experience allows the expert to prepare properly. It is difficult to substitute a reputation derived from writing journal articles and conducting research studies for such an experience. The optimal solution is to find an expert who has impressive credentials in the form of degrees, publications, and awards, but who also has substantial experience in a litigation environment. Unfortunately, such experts are hard to find.

Reviewing the Expert's Publications

Publishing books and articles in refereed, scholarly journals can be a major plus for an expert. Such qualifications can add weight to the expert's opinions, particularly when the publications are related to the subject of the testimony. Attorneys should be aware of the content of these publications, making sure that the content of the publications does not contradict the opinions being offered at trial. Even the expert himself must review his publications for any potential inconsistencies. Such inconsistencies can be used to impeach the expert. Such was done to Dean Schmalensee, the economic expert put forward by Microsoft in its recent antitrust trial. Dr. Schmalensee, who opined on the lack of monopoly power by Microsoft, was confronted with the following quote from a Harvard Law Review article he wrote which addressed the relationship between persistent excess profits and long-run market power.
By Mr. Boies:

Q. Let me ask you to look at page eight, if I could, Dean Schmalensee, and the protion I want to direct your attention to is the paragraph right above the heading "Patterns of Conduct." As you can tell from the fact that I have highlighted the next paragraph, I'm going to want to direct your attention to that, too.
But right now I want to direct your attention to the paragraph that says, "Even if all measurement problems are solved, therefore, profitability is an unreliable measure of short-run market power. Nevertheless, persistent excess profits provide a good indications of long-run power. They show clearly that there is some impediment to effective imitation of the firm in question. The deadweight loss caused by such a breakdown in competition, and the resulting market power available to individuals firms, can be roughly estimated from the observed excess profits."
When you have had a chance to look at this paragraph in context, I have a couple of questions about it.

After a pause, where the witness may have considered how to reconcile this quote from one of his own publications with Microsoft's impressive record of profitability, the witness responded with a classic quote:

A. I have had a chance to look at it. It, of course, appeared 16 years ago, and my immediate reaction is, "What could I have been thinking?"

GETTING THE DAMAGES EXPERT ON BOARD EARLY ENOUGH

One of the errors that attorneys sometimes make in commercial and other types of litigation, such as personal injury and employment litigation, is not retaining the damages expert early enough in the process. Attorneys often devote much of their time to the liability side of their case while paying relatively less attention to the damages aspect. Sometimes, when they focus on damages, such as when they gather necessary damages-related documents, they may attempt do so without the aid of a damages expert. This may result in important documents not being gathered or important questions not being asked in depositions.
This error may occur for a variety of reasons. One is that the attorney may think he knows enough to gather the necessary damages-related materials and to conduct a complete deposition. Another reason is that there may be cost constraints driving the litigation where the client is trying to control litigation expenses and the attorney does not want to add to the client's costs by hiring an expert until the very last moment when it cannot be put off any longer. This often comes when deadlines for naming experts are near and the client either must incur this cost or go without an expert. While the attorney may believe that he has gone to great lengths to keep his client's costs down, putting off retaining the damages expert may cause the damage side of the case to suffer. In this case, the apparent cost consciousness may in the long run be a disservice to the client.
In commenting on the failure to bring an economic damage expert on early enough, one expert noted:

A typical disaster scenario. The damage expert gets hired two days before the deadline for expert disclosure. A pile of documents and depositions arise at the expert's office a week later. When the expert calls the attorney to ask for key data that was not in the pile, the litigator says "It looks like we never asked for that in the document request or at depositions. Oh, by the way, they want to take your deposition next week." The expert must do a damages analysis that makes assumptions about key facts and then alter those assumptions depending on trial testimony. This often results in a poorer analysis and increases expert's costs by a factor of 2 or 3.

COURT'S POSITION ON EXPERTS

Courts have underscored the importance of expert testimony on economic damages. In fact, in Larsen v. Walton Plywood Company, the court stated:

Respondents point out that a reasonable method of estimation of damages is often made with the aid of opinion evidence. Experts in the area are competent to pass judgement. So long as their opinions afford a reasonable basis for inference, there is a departure from the realm of uncertainty and speculation. Expert testimony alone is a sufficient basis for an award for loss of profits.

The Federal Rules of Evidence are quite broad regarding what is considered acceptable expertise in an expert witness. Rule 702 states that "A witness may be qualified as an expert by knowledge, skill, experience, training or education." With such general criteria, a wide variety of individuals may serve as experts. However, an individual who possesses some of the necessary criteria set forth in Rule 702 may still be objectionable if opposing counsel can demonstrate to the court that the expertise is not specific enough to the areas in which the expert is testifying.
Not all states, however, have adopted standards similar to the federal rules. Some states, such as California, are quite liberal and allow many individuals to testify if their testimony will assist the jury in reaching its decision. Even in the face of such broad rules, opposing counsel may be able to exploit the weakness in an expert's credentials on voir dire, which may reduce the weight that a jury would place on the expert's testimony.

Using Management as Experts

In some cases attorneys have tried to use management and the company's officers as experts at trial. Courts have accepted such testimony. In Aluminum Products Enterprises v. Fuhrmann Tooling, the court allowed the plaintiff's president to testify based on his personal knowledge of the business and the industry. The disadvantage of such testimony is that the witness is an interested party in the litigation. However, the witness brings firsthand knowledge from working in the industry every day. Depending on the facts of the case, if such knowledge is helpful, a combination of internal fact/ expert witnesses and outside experts may be very effective. This may be the case when internal financial witnesses, such as a company controller, are used to authenticate and describe the collection of data, such as cost data, upon which the outside damages expert is relying. It also is helpful when the expert lacks a significant background in the industry. The internal expert can be used to testify on trends and practices in the industry. Such an expert can also confirm numerical trends that the external expert may testify that he has found when analyzing industry data. The internal expert may be able to verify that those quantitative trends, such as reduced sales of distributors caused by manufacturers selling directly to retailers, were experienced by those who worked in the industry.

Using an Expert as a Consultant

A damages expert can be invaluable to an attorney even if the expert never testifies. An experienced expert can assist the attorney in understanding an opposing expert's report and opinions. Often an attorney may not have specialized training in the field in which the opposing expert is testifying. The fields of economics, finance, and accounting are very specialized and it is difficult for an attorney to be knowledgeable in the law and also have expertise in these other related areas. In addition, like many other scientific fields, disciplines such as economics, finance, and accounting have their own set of jargon and notations that may require some interpretation. Having a knowledgeable and experienced expert to rely on can be of great benefit. Such experts can be used in a variety of ways from interpreting the opposing expert's report to preparing detailed lines of cross-examination for deposition and trial. The expert-consultant may also be able to check for the presence of errors in the opposing expert's report. Without a quantitative background, the opposing attorney may not be able to do such a careful quantitative review of the opposing expert's analysis. Attorneys should be aware, however, that such work can sometimes be surprisingly time consuming, because an opposing expert's report may intentionally be cryptic and may not fully reveal how the expert arrived at the various numerical values. Sometimes the term "reverse engineering" is used to describe this process. The consulting expert may have to invest considerable time figuring out exactly how the numbers were computed. In addition, once the method used by the opposing expert is exposed, counsel may want to run different scenarios using more favorable factual and economic assumptions to see their impact on the loss estimates. This is a very thorough way of pursuing the damages part of the case. However, such work may be time intensive and may require the consulting experts to invest more time than even the opposing expert.

STANDARDS FOR ADMISSIBILITY OF EXPERT TESTIMONY

For approximately 70 years, between 1923 and 1993, the standard applied in Federal Court for admissibility of expert testimony was the Frye test. This standard was based on the 1923 criminal case Frye v. United States in which expert testimony on the results of a lie detector test was ruled inadmissible. The Frye test focused on whether the analysis and testimony was based on generally accepted methods and standards within the given field. Whether the Federal Rules of Evidence superceded the Frye test was decided by the U. S. Supreme Court in 1993 in the Daubert v. Merrill Dow case. In this case, having to do with damages claims resulting from a mother ingesting Bendectin, the Supreme Court ruled that Rule 702 of the Federal Rules of Evidence is inconsistent with and supercedes the Frye test. The court stated that it did not find anything in the Federal Rules that requires general acceptance. The Supreme Court indicated that one should look to the Federal Rules to determine whether testimony is admissible.
The court stopped short of putting forward a checklist of characteristics to which expert testimony must adhere. Nonetheless, the court enumerated a list of four factors that expert testimony should possess:

1. Testing. This factor is more applicable to the physical sciences. However, insofar as testimony on statistical issues involve various forms of statistical analysis, such as hypothesis testing, this factor could become relevant.
2. Peer Review and Publication. Another factor that the U. S. Supreme Court highlighted was peer review and publications. This is particularly relevant for unique methodologies. If they have been subject to peer review, such as through the publication process in refereed journals, there may be a greater degree of reliability.
3. Known Rate of Error. If the analysis has a known rate of error, then this may be an indicator of its reliability. This rate can be applied to the case of statistical analysis which, for example, provides confidence levels for the value of a coefficient generated by a regression analysis, which is used to project lost revenues.
4. General Acceptance. Although the Supreme Court did not explicitly rule that general acceptance is required, it did point to such acceptance within the relevant community as one factor that a trial judge could use when evaluating such proposed testimony. The various components of the loss measurement process set forth in this book are standard components of various related disciples and do not have a problem of general acceptance.

However, to reinforce this point, various commonly used textbooks are cited throughout so as to emphasize this issue.

The Daubert standard is new and its applicability to damages testimony will be developed over time. There have been some examples of Daubert being used to deny economic expert testimony in the areas of hedonic damages, which is the use of certain research studies in labor economics to value a human life or the loss of the enjoyment of life. However, in the commercial damages arena, many of the techniques that are used, such as certain forecasting methods or cost accounting methods, are quite standard and not controversial. Therefore, the fact that Daubert has replaced the Frye test may be less relevant to economic damage testimony than it is for other areas of expert testimony.

Daubert Standards Do Apply to Commercial Damage Experts

The Daubert decision was directed at scientific experts. While many believed that it should apply to all expert testimony, it was not until the Kuhmo Tire decision that the court made clear that Daubert standards apply to all expert testimony. Kuhmo was the third of three related decisions that clarified this process. Daubert was the first and it was followed by General Electric v. Joiner. In Joiner, the court held that a trial court's decision on a Daubert motion should be reviewed by an appellate court under a traditional abuse of discretion criteria. Joiner also said that motions to exclude expert testimony based on Daubert should be made, where possible, prior to the trial. In Kuhmo Tire, the Supreme Court reversed the 11th Circuit of the Court of Appeals and held that Daubert standards apply to all expert testimony. Both Daubert and Kuhmo were later applied to the calculation of damages in a price fixing case, Coastal Fuels of Puerto Rico v. Caribbean Petroleum Corp. In this case, the First Circuit reversed and remanded a $4.5 million verdict. In reaching its decision the First Circuit cited Daubert and Kuhmo in ordering a new trial and encouraging the trial court to exercise its gatekeeping role as set forth in Daubert.

EXPERT REPORTS

The Federal Rules of Civil Procedure, Rule 26 (a) (2) require that the expert provide a signed expert report. This report should set forth all of the opinions that the expert may put forward at trial, including relevant exhibits in support of the opinions. The qualifications of the expert should also be disclosed as part of the report or as an attachment provided separately. In addition, the expert must provide a list of all the cases he/ she has testified in, either at trial or in a deposition, within the past four years. In addition to exchanging an expert report, the Federal Rules also require the disclosure of the identity of all experts who may give expert testimony at trial. States vary in their report disclosure requirements. Some follow the Federal Rules and some do not.
Although the Federal Rules require more disclosure in reports, a fair amount of leeway can still be applied in determining how detailed reports can be. One school of thought put forward by attorneys is to provide a very detailed report to show the other side that the analysis is very thorough and well thought out and that the damage estimates are firm. Armed with such a report, attorneys may think that the case is more likely to settle. Another reasoning in support of more abundant disclosure is to provide extra details so that there is no opportunity for opposing counsel to object on the grounds that the proper pretrial disclosure was not made. The other school of thought is to provide only the minimum required under the Rules so as to avoid providing fodder for cross-examination. Both approaches have pros and cons.

DEFENSE EXPERT AS A TESTIFYING EXPERT

One view within the defense bar is that the defendant should not put his own expert on the stand for damages. The idea is that if the defendant puts on alternative damages testimony, even though that testimony may put forward a lower damages value, such testimony might give credence to the idea that there really are measurable damages. There is also the concern that if a jury hears two damages amounts, a higher one from the plaintiff and a lower one from the defendant's expert, then they may simply average the two, particularly if they cannot decide which is more appropriate. On the other hand, the strategy of failing to call a defendant's damages expert can really backfire. One of the classic examples of that was the Texaco v. Pennzoil case where the defense decided not to put on his own damages expert and relied on attacking the plaintiff's damages analysis. When the jury found the defendant Texaco liable, there was no damages testimony for the jury to consider other than the plaintiff's presentation. The huge award that resulted underscored the drawbacks of this strategy.

Our problem in reviewing the validity of these Texaco claims is that Pennzoil necessarily used expert testimony to prove its losses by using three damages models. In the highly specialized field of oil and gas, expert testimony that is free of conjecture and speculation is proper and necessary to determine damages. (cite omitted) Texaco presented no expert testimony to refute the claims but relied on its cross-examination of Pennzoil's experts to attempt to show that the damages model used by the jury was flawed. Dr. Barrows testified that each of his three models would constitute an accepted method of proving Pennzoil's damages.

Another good example where the court highlighted the failure of the defendant to present alternative damages testimony occurred in Empire Gas Company v. American Bakeries Co.

A great weakness of American Bakeries' case was its failure to present its own estimate of damages, in the absence of which the jury could have no idea of what adjustments to make in order to take into account American Bakeries' arguments. American Bakeries may have feared that if it put in its own estimate of damages the jury would be irresistibly attracted to that figure as a compromise. But if so, American Bakeries gambled double or nothing, as it were; and we will not relieve it of the consequences of its risky strategy.

The success of the defense's use of an expert was underscored in Associated Indemnity Co. v. CAT Contracting Inc. where the court followed the analysis of the defense's expert in molding its damages award. 25 The Court of Appeals of Texas reversed a prior seven figure award and instead awarded an amount that was a fraction of the original award put forward by the defense's expert. In this case, a construction joint venture sued a surety. The court was more impressed by the defense's expert argument that the plaintiff's own financial history should be used to measure losses rather than just the industry averages used by the plaintiff's damages expert. The defense's expert testified as to what the lost incremental revenues were and what the profit margins associated with these revenues would be. The court then used these amounts, rather than the plaintiff's expert's computations, to arrive at a damages award.
In cases where the defendant believes that the plaintiff has mitigated his damages and, therefore, the plaintiff has not really incurred any net damages, it is best for the defense to put on his own damages expert to demonstrate the point. In these cases, if the analysis is sufficiently thorough and convincing the court may ignore the plaintiff's damages presentation and deny an award based on the defense's expert's testimony. The defendant may be able to reduce the effectiveness of the plaintiff's damages presentation if the defendant can show that while his actions may have resulted in some lost profits, the plaintiff was able to substitute other business that resulted in his profits being essentially unchanged from prior years. Such a result occurred in Alcan Aluminum v. Carlton Aluminum of New England.

QUANTITATIVE RESEARCH EVIDENCE ON THE BENEFITS OF CALLING A DEFENSE EXPERT

Robert Trout, of Economatrix Research Associates, Inc. and Lit-Econ, conducted a study that measured the impact of economic testimony on damages awards. His 1991 study found that when only the plaintiff called a damages expert, the average award was $418,355. However, when the defendant also presented his own damages expert to counter the plaintiff's damages expert, the average award was less than a quarter of the plaintiff's only expert alternative—$ 98,567. Trout summarized the results of his analysis as it relates to the benefits of the defendant calling his own damages expert as follows:

The findings concerning the use of economists suggest that a reasonable strategy for the defense counsel should be to use an economic expert whenever the plaintiff uses an economic expert, except in cases where the defense's economic expert testimony might increase the chance that liability would be found against the defendant or support the testimony of the plaintiff's economist. TYPES OF COMMERCIAL DAMAGES

There are several different reasons why a business may incur damages. For example, damages can arise from a breach of contract, tort, antitrust violation, fraud, or condemnation. The economic methods used to value these damages may be similar even though the law may be very different. However, depending on the particular cause of action, additional types of economic analysis may be employed. For example, in the case of an antitrust violation, a market analysis may be conducted using methods from the field of microeconomics known as industrial organization. These nondamages-related economic issues are briefly discussed in Chapter 11. Commercial damages may arise in the form of either lost profits or a loss of asset value. Chapter 6 defines what is meant by lost profits in a litigation context. Under certain circumstances, lost profits may not coincide with the more traditional accounting measure of profits. Lost asset value can occur when the value of an asset, such as a brand name or even a complete business, has declined due to reasons that are the subject of the litigation. Even when the lost asset value is the measure of loss, the method of measuring the diminution in value is often similar to the method that would be used in the lost profits approach. If the future cash flows to be derived from the asset are expected to be lower, the present valuation of this reduction can be used as the measure of loss.

TREATMENT OF THE RELEVANT CASE LAW

This book focuses on the methods of conducting a damages analysis. It does not focus on the relevant case law. This does not imply that this issue is not important. Clearly, the case law provides the framework within which losses can be presented in court. Readers, however, are directed to other fine works in this area for a discussion of the issue. One of the leading books in this field is Robert Dunn's Recovery of Damages for Lost Profits. 29 Another is William Cerillo's Proving Business Damages. 30 These works are relied on in this book to provide guidance on the court's position on the methods of measuring damages. They are regularly updated through supplements, which include recent cases on various damage-related issues.

LEGAL DAMAGE PRINCIPLES

In measuring damages, experts should be familiar with the basics of legal damage principles. This section touches on some of the relevant major principles. For a more in-depth discussion, readers are encouraged to pursue the abundant sources that are available in this area.

Proximate Causation and Reasonable Certainty

In order for damages to be recoverable, they must be proximately caused by the wrongful acts of the defendant. In addition, damages must be proved within a reasonable degree of certainty. A key word in the latter phrase is "reasonable." By applying the modifier reasonable, the courts have acknowledged that it may not be possible to compute damages with 100% certainty. Therefore, some degree of certainty less than 100% is acceptable. Here the opinion testimony of an expert can be used to establish the reasonable limits of acceptability. In allowing some level of certainty less than 100%, courts recognize that, even for historical damages, the actions of the defendant may have permanently changed events so that one may never know exactly what would have transpired in the absence of such actions. For future damages, the course of events clearly can never be known with certainty. If a 100% standard were adopted, damages might never be awarded. In addition, the defendant would be able to take advantage of the fact that, through the wrongful acts, it moved the plaintiff to a situation where it may never know the exact magnitude of its damages.

Occurrence of versus the Amount of Damages

It is important to distinguish between establishing the fact of damages within a reasonable certainty and the actual measurement of those damages. 31 The reasonable certainty is applied to the fact that the damages actually occurred. However, a lesser standard is applied to the actual measurement of the magnitude of the damages themselves. Here the courts have recognized the particularly difficult problem that arises in the measurement of damages that may have or will occur after the actions of the defendant may have permanently changed the course of events. The courts do not allow the defendant to benefit from the fact that its causation of the plaintiff's damages may render such damages incapable of being proved within a 100% degree of certainty. However, if the occurrence of the damages themselves is uncertain, then the plaintiff may not be able to recover such damages. This reasoning is clearly articulated in Story Parchment Co. v. Paterson Parchment Paper Co. 32 In this case, in which the plaintiff sought damages for antitrust violations of the defendant, the Supreme Court stated the following:

Where the tort itself is of such a nature as to preclude the ascertainment of the amount of damages with certainty, it would be a perversion of fundamental principles of justice to deny any relief to the injured person, and thereby relieve the wrongdoer from making any amend for his acts. In such case, while the damages may not be determined by mere speculation or guess, it will be enough if the evidence shows the extent of the damages as a matter of just and reasonable inference, although the result is only approximate. The wrongdoer is not entitled to complain that they cannot be measured with exactness and precision that would be possible if the case, which he alone is responsible for making, were otherwise.

Reasonable Basis for the Damages Calculation

There must be a reasonable basis for the damages put forward. This basis is sometimes referred to by other terms such as a rational standard. 33 The courts may try to serve as a filter through which speculative presentations are prevented from being used by the jury to arrive at a damages award. The range of acceptability is still quite broad and the expert is allowed to adopt the damages methodology to fit the unique requirements of each case. As the Supreme Court of Kansas stated in Vickers v. Wichita State University:

As to evidentiary matters a court should approach each case in an individual and pragmatic manner, and require the claimant furnish the best available proof as to the amount of loss that the particular situation admits.

Foreseeability

Another important legal principle in the field of commercial damages is the foreseeability rule. In order to be recoverable, the damages must be foreseeable by the defendant at the time the defendant acted in a way that resulted in the damages. For example, in a breach of contract, the defendant must be able to foresee that when it breached the contract with the plaintiff, the defendant was going to cause the plaintiff to incur damages. This legal principle arises out of the very famous Hadley v. Baxendale English case. This case is similar to many business interruption claims that occur today. It involves a mill owner who sued a shipper for lost profits due to the late shipment of an iron shaft necessary to run the mill. The court concluded that the lost profits were not recoverable, as they were not within the contemplation of the parties.
Foreseeability can become clear when the plaintiff explicitly communicates its anticipation of damages to the defendant at the time of the defendant's actions. In the absence of such direct communications, the courts are put in the position of determining what was within the contemplation of the parties. This can be interpreted to mean that if the defendant is capable of understanding how its actions might have an adverse effect on the plaintiff, then they are within the contemplation of the defendant. For example, if the defendant has contracted with the plaintiff to provide certain services or products, the defendant may know of the use to which the plaintiff may be putting such services or goods. The defendant may be further able to anticipate the impact on the plaintiff if he would have to do without such services or goods. In such cases, the actual contract between the parties may provide some useful information for determining what is within the contemplation of the parties. Other evidence can come from testimony or knowledge of communications between the parties, where the use to which the plaintiff was putting the goods and services provided by the defendant was communicated to the defendant. The plaintiff would ease its burdens of proof if, at the time he entered into the contract, he explicitly advised the defendant of the anticipated damages if the defendant failed to complete his contractual obligations.
A clue to the reasonable foreseeability should be the fact that a given transaction was commercial in its nature. Continuing with the contract example, the court may conclude that the defendant knew in advance that the plaintiff was using the goods or services for some commercial purpose in the hopes of generating profits. Accepting this, a court may conclude that it would be reasonable that there may be a loss of profits if the contract was breached. It may be even clearer if both parties were unambiguously aware of the purpose to which the goods or services provided by the defendant were put by the plaintiff.

Collateral Transactions

A party may claim damages from a collateral transaction, a transaction that is contingent upon another transaction. A party may claim that the failure of the defendant to perform the first transaction resulted in losses in another transaction that was itself contingent on the performance of the first transaction. Damages resulting from such transactions may not be recoverable unless it can be demonstrated that they were foreseen and within the contemplation of the parties at the time of the agreement. The plaintiff may have a clearer case if she can demonstrate that the second transaction flows directly from the first, as opposed to a more indirect route where the plaintiff might argue that if she had been able to enjoy the proceeds from the first contract, then she would have pursued another venture which, in turn, would have generated additional profits which she claims as damages. The plaintiff's argument is stronger if she can show that she gave the defendant notice of the dependence of the second transaction on the first. Such notice, however, may not be necessary in the case of a reseller where the seller knows the nature of the buyer's (reseller) business. Here foreseeability is presumed given by the nature of the buyer's business.

CONTRACT-RELATED DAMAGES

Parties to a contract can incur damages in a number of ways. A buyer may lose profits due to the failure of a seller to deliver. Such a failure may cause the buyer to incur incidental and/ or consequential damages. Incidental damages are those expenses that the buyer may incur from having to secure replacement goods. Consequential damages are those which the plaintiff may have incurred as a consequence of the defendant's failure to perform. Once again, the defendant must have been able to foresee these damages and the plaintiff must not have been able to avoid such damages by securing performance from other parties. This alternative performance is sometimes referred to as cover. The plaintiff, however, may be able to cover the transaction by securing the goods or services elsewhere but still incur damages. This would be the case if the cover price were higher than the contract price. Here the damages would be the price difference as well as any incidental damages.
The law carries with it a requirement that the plaintiff make efforts to mitigate its damages from securing alternative sources or cover. The situation becomes more problematic when the goods or services in questions are unique and not readily available in the marketplace. Mitigation of damages is discussed in Chapter 6.

Contractually Related Liability Limitations

The seller may include provisions in the contract to limit its liability to the buyer. In a sale of goods, such as machinery, these provisions may limit the seller's obligations to repair the goods without any allowance for the recovery of consequential damages, including any lost profits. Courts have concluded that if the limitations are very extreme, they may be found unconscionable.

Warranty-Related Damages

A breach of warranty is a contract-related claim. Under the Uniform Commercial Code, there are two types of warranties: express and implied. In an express warranty, the seller clearly delineates which characteristics of the goods that he sells are guaranteed. In an implied warranty, the promise is less clearly stated and a more general guarantee is given, such as general merchantability. The normal standard of warranty-related damages is the difference between the value of the goods as warranted and the value of the goods that were accepted. Although this area of commercial damages is important, it is not the focus of this book, which is more directed to the measurement of lost profits, such as those that might arise in contract-related consequential damages.

Other Types of Damages Cases

A complete listing of all of the different types of cases in which there is a claim for commercial damages is well beyond the scope of this section. However, it may be useful to highlight a few of the more common types that may give rise to a lost profits claim.

Distributor, Manufacturer's Representative, and Franchisee Relationships
A variety of contract cases arise involving the various representations by a manufacturer or another goods or service provider. A distributor is similar to a manufacturer's representative. Both represent the manufacturer, but a distributor often takes possession of the goods and maintains an inventory of the products whereas a manufacturer's representative augments the seller's sales force without physically storing an inventory. Each may or may not have exclusive territories. A franchisee may be given the right to market a company's products within an exclusive territory. Disputes often arise from the termination of these agreements with the terminated party claiming damages for lost profits under the agreement. These disputes may be caused by the franchisee or distributor failing to perform or the franchisor failing to live up to its obligations such as by failing to provide agreed upon marketing support for the product. The franchisor may contend that it terminated the franchisee because it did not properly market the product.
Despite the wide variety of these lawsuits, the methodology used to measure damages can be found within the framework set forth later in this book. The method usually involves constructing revenue projections and applying costs ratios to derive profits from projected revenues. In other instances, such as in the case of terminated franchisees, the damages analysis may involve employing business valuation techniques to place a value on a terminated franchisee that no longer exists.

Contracts to Provide Services
Other types of contract-related damages can arise from a failure to provide the contractually agreed upon services. When these cases involve major figures in high-profile businesses, they tend to attract much media attention. For example, movie stars who walk out on film agreements or authors who fail to provide manuscripts are forms of these types of disputes. In the case of publishers, they may involve demands for a return of an advance. In the film industry, however, the analysis may be substantially more complicated, involving loss of invested capital or lost projected profits.

Construction-Related Contract Cases
Another common type of contract cases are construction cases. These often involve lawsuits for failure to complete construction on time or according to the specifications of the contract. Other construction cases have to do with who pays for certain costs and whether cost overruns can be passed on to the builder. Still another type of construction case is one that involves damages related to the loss of bonding capacity. The loss of such capacity may limit the volume of work that a contractor can bid for, which may give rise to a claim for lost profits on the additional work that the plaintiff claims he would have been awarded, had he had a certain bonding capacity.

Noncompete Agreement Cases
Still another common form of contract-related damages cases are those that involve covenants not to compete. This can come from provisions in a business sales agreement where an owner of a business agreed not to compete with the buyer for a period of time. Other cases involve professional service firms where individuals agreed not to compete for a period of time with an employer in exchange for certain consideration. The damages analysis can sometimes be complicated as it may involve measuring the damages that result exclusively from the illegal competition. An important part of this analysis is isolating these specific damages. Cases may be more straightforward where a personal service provider, such as an attorney or a broker, competed by stealing specific clients or customers than in a situation where a firm improperly competes and is one competitor among several in the market. In such cases, the industry analysis may be quite important in assessing the change in the level of competition and the resulting damages.

COMMERCIAL DAMAGES IN PERSONAL INJURY

Economists play a prominent role in measuring damages in personal injury. These damages often involve projections of lost earnings over a work-life expectancy or a valuation of the services that an injured party or a decedent would have provided. In a personal injury lawsuit, a business generally cannot claim damages due to the injuries of an employee. However, in cases where the employees were largely responsible for the profits of the business, such as in a small business with few employees and where the plaintiff was the prime force behind the generation of the business' profits, the profits of the business may become an important part of the damage measurement process. An example could be a president of a small business who was involved in an accident that caused him not to be further involved in the business which, in turn, resulted in the closure of the business. Here the projected profits, along with other forms of compensation that the individual derived from the business, such as officer's compensation or other perks, might be relevant.
The courts have usually drawn a distinction between cases where the profits of a business are a function of an individual's personal efforts and returns that are the product of the invested capital. In the latter case, where returns are more passive, the law of torts is less relevant.

Personal Injury and Corporate Damages Due to Loss of Key Man

It is not unusual that a company's rise to success can be largely caused by the efforts of one unique individual. This is sometimes referred to as the role of the key man in corporate finance. Corporate America is filled with examples of companies whose growth and success can be largely attributed to the efforts of one individual making a far greater contribution than any other member of the company. It is logical, then, that a company can be significantly damaged if that individual dies or is impaired as a result of injury so that he can not participate in the activities of the business. The courts have come to recognize this. Although the company itself may not be able to recover its lost profits, the injured party, who may be a controlling shareholder, may be able to individually recover such lost profits.

Damages Resulting from Other Business Torts

A variety of tortious behaviors can cause recoverable damages in the form of lost profits. These can include tortious interference with business, fraud, and unfair competition. The varieties of each of these categories of business torts can be virtually limitless. While the case law is correspondingly voluminous, the methodology to measure damages, such as lost profits, can be found in the following chapters. Basically, however, courts have found that "lost profits in a tort action are limited to those damages proximately caused by the defendant's wrongful conduct." Such profits usually can be measured through a projection of but for profits and a comparison of such projected profits with the actual and "projected actual" profits. This comparison is described in detail in the chapters that follow.

Punitive Damages

Punitive damages have increased dramatically over the past three decades. Punitive damage awards can be far higher than and bear little discernable relationship to the actual damages incurred by the plaintiff. For example, in TXO Production Corp. v. Alliance Resources Corp. (TXO), the court allowed a $10 million award of punitive damages even when the compensatory damages were only $19,000. A very different set of factors are employed in arriving at an amount of punitive damages. For example, in TXO, the court considered the amount of harm caused by the defendant, the defendant's intent, and the amount of an award that would be necessary to prevent the defendant from engaging in this behavior in the future. The U. S. Supreme Court found that such factors can support an award of punitive damages that far exceeds the compensatory damages so that it bears no relationship to it as reflected by the multiple of 526: 1.
Prior to TXO, the courts had been more intent on keeping some relationship between compensatory and punitive damages. In Pacific Mutual Life Insurance Co. v. Haslip, the court asserted that it would be difficult to derive a clear mathematical relationship between compensatory and punitive damages. However, this court did caution against arriving at punitive damages amounts that were far out of proportion with the actual damages the plaintiff incurred.
This book does not focus on punitive damages but concentrates on compensatory damages in commercial litigation. Readers are referred to the abundant literature on this topic which sets forth some methods for arriving at such damages.

SUMMARY

This chapter introduces the use of an expert to measure damages in commercial litigation. One of the first steps in this process is selecting the right expert. Given the diversified nature of the field of commercial damages, this expert needs to have a well-rounded background in fields such as economics, econometrics, finance, and accounting. Given the fact that a wide range of expertise may be needed, it may be necessary to have a team of experts where one expert testifies but relies on the work of other experts. A common combination is an economist and an accountant. In some cases, more than one expert may testify.
There are many sources of experts. The most often relied upon seems to be referrals from colleagues. If that is not a fertile source of experts, then other sources such as local universities or referral agencies may be needed. Particularly in cases where the expert is not referred by a colleague, attorneys need to carefully review the expert's credentials. These credentials should include a terminal degree in his field, a doctoral degree, and publication of books and refereed journal articles in the field. Care must be applied when reviewing experts' CVs to ensure that they are accurate and truly what they are purported to be. For example, what is listed as a publication should be verified as a published work. There are several ways to use damages experts. One is to have the expert author a report and serve as a witness. Another is to use the expert purely as a consultant but not as a testifying witness. This latter strategy is often used by defendants who do not want to give credence to the plaintiff's damages claims. Instead, they may want to use the expert to help cross-examine the plaintiff's expert. Research results, as well as the experience of several notable cases, raises serious questions about this strategy. In some cases it works well and in others it can backfire. The strategy for each case varies and should be determined based on close consultation with the expert.