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The Intricacies of Calculating Lost Profits Damages

By Tim McPoland, CPA/ABV, CVA, CFE on September, 25 2012
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Tim McPoland, CPA/ABV, CVA, CFE

How “Speculative” Lost Profits Damages Can Crumble in Court

Author: Tim McPoland

Lost profits damages can be tricky to assess, particularly when valuators must base their calculations on a new business’s projected profits. A recent California case, Beijing Tong Ren Tang (USA) Corp. v. TRT USA Corp., illustrates how such claims can easily crumble upon examination.

A falling out

Beijing Tong Ren Tang USA (BTRTUSA) entered into an agreement with Advantage United Corporation, predecessor of TRT USA Corporation (TRT), to cooperatively sell traditional Chinese medicine products in the United States. According to the agreement, TRT would be the general exclusive agent distributing the main BTRTUSA products.

When the parties’ business relationship soured, BTRTUSA sued TRT and three of its officers and directors, alleging violations of the Lanham Act. TRT and its three officers and directors filed a counterclaim against BTRTUSA and Chuanli Zhou, BTRTUSA’s vice president, for fraud and breach of fiduciary duty.

A jury ruled in favor of TRT on the fraud claim against BTR and Zhou. As compensatory damages, it awarded $1.3 million in lost profits. The jury also ruled in TRT’s favor on the breach of fiduciary duty claim against Zhou, awarding an additional $741,450 in lost profits.

Evidentiary support is lacking

BTRTUSA and Zhou responded to the ruling by asking the district court for a judgment as a matter of law on the basis that the jury lacked sufficient evidence for its decisions. The district court determined that the fraud award was based on projected profits according to TRT’s business plan. BTRTUSA argued that, because the business plan projected profits for a new venture in an area where TRT had no track record, the lost profits damages were too speculative.

The court conceded that damages generally aren’t awarded for anticipated profits of a new business. However, that presumption can be overcome by concrete evidence that allows a fact finder to establish the amount of damages with reasonable certainty. TRT, the court decided, failed to provide such evidence. What’s more, evidentiary support for a lost profits claim was totally lacking. The lost profits projection was made on the basis of a “speculative, grandiose business plan” and, according to the court, made assumptions that were “totally unrealistic and unreasonably optimistic.”

Some damages allowed

In some circumstances, projected profits in a business plan may provide enough certainty regarding damages to overcome the absence of a proven track record. But the district court considered the profits projected by TRT’s business plan too speculative to meet the legal standard of reasonable certainty necessary to support lost profits damages.

However, the court allowed some lost profits damages. TRT’s damages expert had testified on an alternative way of computing fraud damages based on monies that TRT paid but wouldn’t have paid but for the wrongdoing by BTRTUSA and Zhou. This calculation included money paid for a product that wasn’t delivered or couldn’t be used; consulting and label design fees paid to Zhou; and a deposit paid on a canceled order.

These damages, according to TRT’s expert, totaled $141,168. The court found sufficient evidence to support the conclusion that they were caused by Zhou’s fraudulent representations.

Fiduciary duty damages fall

Part of the lost profits the court awarded for the breach of fiduciary duty claim was based on Zhou’s failure to ensure regulatory compliance and to provide exclusivity. The court held that those damages were too speculative.

Also ruled speculative was the part of the award related to distribution of Gummy Bear vitamins in China. TRT’s expert’s testimony on those lost profits was based entirely on a business plan by New York corporation IHI to sell the vitamins. Because TRT owned 50% of IHI, the expert assumed TRT would have received 50% of IHI’s profits. And because the business plan involved the distribution of 50 products, profits from the sale of the vitamins would represent one-fiftieth of overall profits.

The court, however, pointed out that IHI was an unestablished business. What’s more, it had never executed its plan to sell the vitamins in China. Further, TRT’s expert didn’t explain how projected profits in the plan were calculated or why the figures could be considered reliable estimates of anticipated profits. The court therefore found he wasn’t a credible witness.

Consequences of weak evidence

business interruptionIn the end, TRT saw its damages award slashed by more than 90%. Don’t let weak supporting evidence harm your clients’ claims. Credible experts who can prove lost profits to a reasonable certainty are essential in these types of cases.

For any questions relating to damage calculation or any litigation support issues, contact us here or call us at 716.847.2651.

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