Measuring Business Interruption Losses and Other Commercial Damages, by Patrick A.Gaughan

MEASURING BUSINESS INTERRUPTION LOSSES AND OTHER COMMERCIAL
DAMAGES
by Patrick A. Gaughan

Navigate the complexities of this interdisciplinary field with confidence.

With MEASURING BUSINESS INTERRUPTION LOSSES you’ll find overviews of
research
and
practices in subfields of economics, giving you points of reference that you can
use in
working with a
team of professionals. The book also applies a much-needed, cohesive framework
to the
study of
forensic economics: the first half of the book reviews damages resulting from the
interruption
of a
business’s operations; subsequent chapters then discuss related types of
commercial
damages. With
this authoritative source you'll quickly be able to:
- Identify fraudulent claims and how to differentiate between the legitimate
part of a
lost profits
claim and the inflated component
- Provide expert opinion on the magnitude of damages and a detailed
presentation
that will
hold up under scrutiny in the settlement negotiation process and, if necessary, in
court.

MEASURING BUSINESS INTERRUPTION LOSSES AND OTHER COMMERCIAL
DAMAGES is your
blueprint for expertly analyzing business interruption losses—and, ultimately,
success in your
practice.

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The definitive guide to success in business interruption litigation

Whether they result from a business interruption or other corporate events,
commercial
damages are
often difficult to measure.

The process can be complicated, with millions of dollars at stake for claimants
and/or
plaintiffs, as well
as insurance companies and defendants–all of whom must rely on accurate
calculations of
losses that
will hold up in negotiation or litigation.

A must for accountants, insurance adjusters and other insurance professionals,
attorneys,
and
economists, MEASURING BUSINESS INTERRUPTION LOSSES AND OTHER
COMMERCIAL
DAMAGES helps you navigate the complexities of this interdisciplinary field. Here,
you’ll find
overviews
of research and practices in subfields of economics, giving you points of reference
that you
can use in
working with a team of professionals. The book also applies a much-needed,
cohesive
framework to the
study of forensic economics: the first half of the book reviews damages resulting
from the
interruption of
a business’s operations; subsequent chapters then discuss related types of
commercial
damages.

MEASURING BUSINESS INTERRUPTION LOSSES AND OTHER COMMERCIAL
DAMAGES is your
blueprint for expertly analyzing business interruption losses–and, ultimately,
success in your
practice.

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The past few decades have seen the dramatic growth of litigation economics. It is
now a
multidisciplinary
field practiced by accountants, insurance adjusters, other insurance professionals,
attorneys,
and
economists. Despite the field’s expansion, there has been no single reference that
offers
these
professionals a comprehensive, methodological framework for how to analyze
business
interruption
losses–until now.

Clearly written, nontechnical in tone, and broad in scope, MEASURING
BUSINESS
INTERRUPTION
LOSSES AND OTHER COMMERCIAL DAMAGES applies a standardized
framework to a
vast and
complex field. The book’s self-contained chapters provide a solid introduction to
specialized
topics that
will prove indispensable when there’s a need to partner with other practitioners.
This
approach enables
attorneys, for example, to work with economists and accountants, and, if
necessary,
challenge their
findings; attorneys will also learn how damages should be measured, helping them
form
nonspeculative
opinions. Similarly, the book’s presentation will also allow accountants to become
conversant enough in
economic topics to perform economic analyses on their own, or work efficiently as
a team
with
economists.

MEASURING BUSINESS INTERRUPTION LOSSES AND OTHER COMMERCIAL
DAMAGES begins
with an informative survey of the commercial damages analysis field, covering such
relevant
topics as
how to find an expert on economic damages as well as legal damage principles. It
then
delivers
up-to-date insights on macroeconomic analysis for measuring commercial
damages,
conducting an
industry analysis, projecting lost profits, discounting and the time value of money,
business
valuation,
intellectual property—related damages, securities damages, antitrust concerns,
punitive
damages, and
more.

Whether you want to build your own practice in the analysis of economic damages
or simply
learn how to
optimize your partnership with its various litigation support practitioners, you can
turn to
Measuring
Business Interruption Losses and Other Commercial Damages, a major
contribution to the
literature of
this emerging, multifaceted field.

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CONTENTS

PREFACE

1 INTRODUCTION
Development of the Field of Litigation Economics
Lost Profits Business Interruption Analysis Compared to Personal Injury
and
Employment
Litigation
Qualifications of an Economic Expert
Qualifications of an Accounting Expert on Damages
Interdisciplinary Nature of Commercial Damages Analysis
Difference Between Disciplines of Economics and Finance
Finding a Damages Expert
Critically Reviewing a Potential Expert’s Curriculum Vitae
Getting the Damages Expert on Board Early Enough
Court’s Position on Experts on Economic Damages
Standards for Admissibility of Expert Testimony
Expert Reports
Defense Expert as a Testifying Expert, Not Just a Consultant
Quantitative Research Evidence on the Benefits of Calling a Defense
Expert
Treatment of the Relevant Case Law
Legal Damage Principles
Other Types of Damages Cases
Summary
References

2 ECONOMIC FRAMEWORK FOR THE LOST PROFITS ESTIMATION
PROCESS
Foundation for Damages Testimony
Role of Assumptions in Damages Analysis
Hearsay
Approaches to Proving Damages
Causality and Damages
Using Demonstrative Evidence to Help the Client Understand Its Losses or
Lack
of Losses
Causality and Loss of Customers
Graphical Sales Analysis and Causality
Causality and the Special Case of Damages Resulting from Adverse
Publicity
Length of Loss Period: Business Interruption Case
Length of Loss Period: Plaintiff Goes out of Business
Length of Loss Period: Breach of Contract
Methodological Framework
Summary
References

3 ECONOMIC ANALYSIS IN BUSINESS INTERRUPTION LOSS
ANALYSIS.
Macroeconomic Analysis
Definition of a Recession
Measuring Economic Growth and Performance
Business Cycles and Economic Damages
Using More Narrowly Defined Economic Aggregates
Overstatement of Inflation Statistics
Regional Economic Trends
International Economic Analysis
Marcroeconomic and Regional Economic Analysis and the Before and
After
Method
Summary
References

4 INDUSTRY ANALYSIS
Introduction
Sources of Industry Data
Standard Industrial Classification Codes
New North American Industry Classification System
Retaining an Industry Expert
Conducting an Industry Analysis
Relating Industry Growth to the Plaintiff’s Growth
Other Industry Factors
Yardstick Approach and Industry Analysis
Summary
References

5 PROJECTING LOST REVENUES
Projections versus Forecasts: Economic versus Accounting Terminology
Using Graphical Analysis as an Aide in the Forecasting Process
Methods of Projecting Lost Revenues
Curve-Fitting Methods and Econometric Models
Understanding Regression Output and Diagnostics
Common Problems Affecting Regression Models
Using Break Point or Chow Tests to Determine Break Points
Case Study: How the Chow Test Can Be Misapplied
Confidence in Forecasted Values
Frequency of the Use of Econometrics Techniques in Commercial
Litigation
Seasonality and the Forecasting Process
Capacity Constraints and Forecasts
Sensibility Check for the Forecasted Values
Projecting Lost Sales for a New Business
Projecting Losses for an Unestablished Business
Case Study: Lightning Lube, Inc. v. Witco
Summary
Appendix
References

6 COST ANALYSIS AND PROFITABILITY
Presentation of Costs on the Company’s Financial Statement
Measures of Costs
Profit Margins and Profitability
Appropriate Measure of Profitability for a Lost Profits Analysis
Case Study: Cost Analysis in Business Interruption
Burden of Proof for Demonstrating Costs
Fixed versus Variable Costs
Using Regression Analysis to Estimate Costs as Opposed to More Basic
Methods
Pitfalls of Using Regression Analysis to Measure Incremental Costs
Possible Nonlinear Nature of Total Costs
Limitations of Using Unadjusted Accounting Data for Measuring
Incremental
Costs
Treatment of Overhead Costs
Capacity Constraints and Fixed versus Variable Costs
Must a Plaintiff Be a Profitable Business to Recover Damages?
Mitigation of Damages
Cash Flows versus Net Income: Effects on the Discounting Process
Recasted Profits
Case Study: Profits That Are Not Really Profits
Firm-Specific Financial Analysis
Cross-Sectional versus Time Series Analysis
Summary
References

7 TIME VALUE OF MONEY CONSIDERATIONS
Determination of Interest Rates
Types of Interest Rates
Financial Markets: Money Market versus Capital Market
Money Market Securities and Interest Rates
Capital Market
Real versus Nominal Interest Rates
Determinants of Interest Rates
Prejudgment Losses
Components of the Cost of Capital
Discounting Projected Future Profits
Common Errors Made in Discounting by Damages “Experts”
Summary
References

8 BUSINESS VALUATIONS
Legal Standards for Business Valuations in Business Interruption Cases
Lost Profits versus Lost Business Value
Business Valuation Framework
Theoretical Value of a Business
Public versus Private Companies
Business Valuation Parameters
Revenue Ruling 59-60 and Factors to Consider in Valuation
Valuation Concepts
Most Commonly Used Valuation Methods
Case Study: Applying the Discounted Cash Flow Method of Business
Valuation
Capitalization of Earnings
Comparable Multiples
Case Study: Use of Multiples to Determine Enterprise Value
Adjustments and Discounts
References

9 INTELLECTUAL PROPERTY
Patents
Computation of Damages for Patent Infringement
Legal Requirements Necessary to Prove Lost Profits
Lost Profits Due to Price Effects
Lost Profits Due to Changing Cost Conditions
Royalty Arrangements
Copyrights
Measurement of Damages for Copyright Infringement
Trademarks
Trade Secrets
Summary
References

10 SECURITIES-RELATED DAMAGES
Key Securities Laws
Damages in Securities Litigation
Fraud-on-the-Market
Comparable Index Approach
Event Study Approach
Mergers-Related Damages
History of Mergers in the United States
Churning
Appendix A: Case Study: In Re Computer Associates, International, Inc.
Appendix B: Cases Setting Holding Periods
References

11 ANTITRUST
Antitrust Laws
Antitrust Enforcement
Economics of Monopoly
Changing Pattern of Antitrust Enforcement
Antitrust and the New Economy
Monopolization and Attempts at Monopolization
Market Power
Measures of Market Concentration
Common Types of Antitrust Cases
Summary
References

12. THE ECONOMICS OF PUNITIVE DAMAGES
Evolving Position of the U.S. Supreme Court on Punitive Damages
Frequency of Punitive Damages
Frequency of Punitive Damages and the Shadow Effect of Punitive
Damages
Purposes of Punitive Damages
Punishment of Corporations and Corporate Governance
Spillover Effects and Punishment of Corporations
Deterrence Theory and the Changing Litigation Environment
Deterrence and Regulatory Processes
Typical Financial Measures Used in the Determination of Punitive
Damages
Net Worth
Market Capitalization
The Uncertain Litigation Environment
Summary
References

INDEX

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EXCERPT FROM THE INTRODUCTION

“This book is designed to provide a methodological framework for how lost profits
should be
measured
in business interruption litigation. Such a framework is provided so that a standard
approach
can be
followed in the measurement of such damages.

“In following the discussion, readers will notice the interdisciplinary nature of
commercial
damages
analysis. Depending on the type of case, the expert who seeks to measure a
plaintiff’s lost
profits needs
to possess a well-rounded knowledge of the research and practices in certain
major
subfields of
economics (macroeconomics, microeconomics, econometrics, and forensic
economics),
several
subfields of finance (investment analysis, capital market theory, and corporate
finance), and
accounting.
Given the broad range of expertise that may ultimately be needed and 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 those issues which are the most
important
and
fundamental. It is necessary to bear in mind, however, that each case brings with it
a unique
set of factors
which 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 those circumstances that are most commonly encountered and attempts to
present a
general
damages evaluation framework capable of handling most of them.

DEVELOPMENT OF THE FIELD OF LITIGATION ECONOMICS

“The field of litigation economics, which is sometimes referred to as forensic
economics, has
developed
significantly over the past two decades. During this time period, the National
Association of
Forensic
Economics (NAFE) was formed. It is 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
primarily of Ph.D. economists, many of whom have academic affiliations.

“In addition to the advent of NAFE, three well-received, refereed, academic journals
devoted
to the field
of litigation economics have been created. They are the Journal of Forensic
Economics,
Journal of Legal
Economics, and Litigation Economics Review. These journals have given litigation
economics an
academic stature similar to other subdisciplines in the field of economics. In
addition to this
forum for
respected scholarly work in the area, most of the major meetings and the leading
professional
conferences of economists in the United States, including the annual meetings of
the
American
Economics Association and the Western Economics Association, now have
several
sessions,
sponsored by NAFE, devoted exclusively to litigation economics. Such
conferences have
allowed an
exchange of ideas that has further developed the methodologies in the field.

“At present, the leading use of damages experts, often economists, is in personal
injury and
wrongful
death litigation. This is not surprising, since this type of litigation is the most
common. While
there are
some similarities between lost profits analysis and the estimation of damages in
personal
injury and
wrongful death litigation, there are major differences which cause them to be two
separate
fields, often
including different groups of practitioners. Most economists who do personal injury
damages
analysis
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
business
interruption
matters, however, tend to be a more diverse group. Some of them work for large
firms,
including some
public companies. They come from a variety of backgrounds, the most common of
which are
accounting,
economics, and finance.

LOST PROFITS BUSINESS INTERRUPTION ANALYSIS COMPARED TO
PERSONAL
INJURY AND
EMPLOYMENT LITIGATION

“As noted above, economists are often called upon to provide testimony on
damages in
personal injury
and wrongful death litigation. These cases utilize a methodology which 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
valuating lost
services
over a time period that may approach the life expectancy of the plaintiff/decedent.
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 for the valuation 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 upon
statistical
data that
establish averages from demographic and labor market characteristics. This
contrasts with
lost profits
analysis in which the loss period is usually determined by a different set of
circumstances,
such as a time
period set forth in a contract. Naturally, there may be differing interpretations of this
contract
and what it
means about the length of the loss period.

“In personal injury litigation, the monetary amount that is 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 which list 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-day value
terms through the application of an appropriate discount rate.

“In employment litigation, the expert may project damages using similar methods
as 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
background to
render an
opinion on the liability part of the case.

“Business interruption lawsuits, on the other hand, tend to vary considerably.
Although some
of the
evaluation techniques used may be similar, the circumstances often 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, business interruption cases present a greater degree of complexity
than the
two types of
litigation mentioned previously. They typically involve significant time demands for
the expert
who must
conduct a thorough analysis. These time demands often are greater than those
associated
with a typical
personal injury or wrongful death loss analysis, thereby making an expert business
interruption analysis a
more expensive proposition.

“Another important difference between business interruption analysis and personal
injury or
wrongful
death loss analysis is the role of cost analysis. The losses of a worker are
typically wages
and benefits;
job-related expenses usually are not a significant factor. In business interruption
analysis,
however, costs
related to lost revenues are generally quite important. It is here that 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. This is why we have devoted an entire chapter to cost analysis.”

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ABOUT THE AUTHOR

PATRICK A. GAUGHAN, Ph.D., is President of Economatrix Research
Associates, Inc., and
Professor
of Economics and Finance at Fairleigh Dickinson University.
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2004, 478 pages. Order #DR781.
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