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Exhibit 2 — In re Bank of America California Unemployment Benefits Litigation (Dkt. 571-4, S.D. Cal. No. 3:21-md-02992)

Filed October 17, 2025 in In re Bank of America California Unemployment Benefits Litigation; one of 1415 filings from this case.

Record facts

Court	U.S. District Court for the Southern District of California
Filed	2025-10-17

U.S. District Court for the Southern District of California · No. 3:21-md-02992-GPC-MSB · Doc. 571-4 · 2025-10-17 · Docket on CourtListener

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EXHIBIT 2
Case 3:21-md-02992-GPC-MSB Document 571-4 Filed 10/17/25 PageID.34439
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Case 3:21-md-02992-GPC-MSB Document 571-4 Filed 10/17/25 PageID.34440
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LITIGATION SERVICES HANDBOOK
FIFTH EDITION

Copyright # 2012 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or
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Library of Congress Cataloging-in-Publication Data:
Litigation services handbook : the role of the ﬁnancial expert / [edited by]
Roman L. Weil, Daniel G. Lentz, David P. Hoffman.—5th ed.
p. cm.
Includes bibliographical references and index.
ISBN 978-1-118-11639-5 (hardback); ISBN 978-1-118-22441-0 (ebk.);
ISBN 978-1-118-23740-3 (ebk.); ISBN 978-1-118-26253-5 (ebk.)
1.
Forensic accounting—United States. 2.
Evidence, Expert—United States.
I. Weil, Roman L.
II. Lentz, Daniel G.
III. Hoffman, David P.
KF8968.15.L57 2012
347.73
0
67—dc23
2012008094
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1

CONTENTS
Preface
xi
About the Editors
xv
About the Contributors
xix
PART I: THE LITIGATION ENVIRONMENT
1. A Dispute Resolution Primer
1.1
David P. Hoffman
Daniel G. Lentz
Roman L. Weil
2. Serving as a Financial Expert in Litigation
2.1
Stephen L. Buffo
David P. Hoffman
Roman L. Weil
PART II: DEVELOPING A DAMAGES ANALYSIS
3. Causation Issues and Expert Testimony
3.1
Randy C. Joshi
Catherine F. Madrid
Lee-Anne V. Mulholland
4. Developing Damages Theories and Models
4.1
Elizabeth A. Evans
Joseph J. Galanti
Daniel G. Lentz
5. Ex Ante versus Ex Post Damages Calculations
5.1
Michael K. Dunbar
Elizabeth A. Evans
Roman L. Weil
6. Use of Statistical Sampling in Litigation
6.1
Mark A. Gustafson
Peter P. Simon
7. Statistical Estimation of Incremental Cost from Accounting Data
7.1
Michael W. Maher
M. Laurentius Marais
William E. Wecker
Roman L. Weil
v

8. Econometric Analysis
8.1
Mohan P. Rao
Christian D. Tregillis
Sophie N. Yang
9. Estimating the Cost of Capital
9.1
Joseph J. Galanti
10. Business Valuation
10.1
Joseph J. Galanti
11. Business Interruption Insurance Claims
11.1
Daniel G. Lentz
Robert M. Reeves
12. Lost Earnings of Persons
12.1
Daniel G. Lentz
Elizabeth B. Sandza
13. Expert Analysis of Class Certiﬁcation Issues
13.1
Christopher Chorba
Mark A. Gustafson
D. Lee Heavner
Peter P. Simon
PART III: LITIGATION TOOLS AND TECHNIQUES
14. Data Management
14.1
Joshua Kelly Andrews
Karen M. Cheek
Matthew P. Jennings
David W. Rogers
Vincent M. Walden
PART IV: ANCILLARY ISSUES IN DAMAGES MATTERS
15. Prejudgment Interest
15.1
Jeffrey M. Colon
Michael S. Knoll
16. Punitive Damages
16.1
Peter A. Bicks
Stephen L. Buffo
Rachel M. McKenzie
Stephen M. Seliskar
17. Tax Treatment of Damages Awards
17.1
Merle Erickson
James K. Smith
vi
CONTENTS

PART V: CIVIL LITIGATION
Intellectual Property
18. Economic Analysis of Nonpatent Intellectual Property Rights
and Damages Measures
18.1
Elizabeth A. Evans
Peter P. Simon
19. Patent Infringement Damages
19.1
Ronen Arad
Michael P. Arnold
Christopher C. Barry
Vincent E. O’Brien
20. Royalty Examinations
20.1
J. Shawn McGrath
Ownership and Business Failure
21. Merger and Acquisition Transaction Disputes
21.1
Jerry M. Hansen
Christen L. Morand
Gregory E. Wolski
22. The Troubled Business and Bankruptcy
22.1
Daniel G. Lentz
Grant W. Newton
Lynda H. Schwartz
23. Alter Ego
23.1
Daniel G. Lentz
Lynda H. Schwartz
Regulatory Litigation
24. Federal Securities Acts and Areas of Expert Analysis
24.1
Nicholas I. Crew
Kevin L. Gold
Marnie A. Moore
25. Economic Analysis in Securities Class Certiﬁcation
25.1
Cathy M. Niden
Mohan P. Rao
26. Antitrust
26.1
Don T. Hibner, Jr.
Nels A. Pearsall
Andrew E. Reisman
Roy Weinstein
CONTENTS
vii

27. Federal Contract Disputes
27.1
Robert A. Esernio, Jr.
Nancy J. Harrison
Construction and Real Property Disputes
28. Construction Claims
28.1
Bilge Astarlioglu
Stephen P. Lechner
29. Real Estate Litigation
29.1
Mariano S. Borges
Steven A. Klett
Mark R. Molepske
Michael E. Straneva
Other Civil Litigation
30. Accountant Liability
30.1
Mark A. Carlson
Thomas H. L. Selby
31. Executive Compensation in the Litigation Setting
31.1
Eli Bartov
Lynda H. Schwartz
32. Employment Litigation
32.1
Christopher Haan
Elaine Reardon
Ali Saad
33. Wage and Hour Litigation
33.1
Robert W. Crandall
34. Financial Accounting Experts in Directors’ and Ofﬁcers’ Litigation
34.1
Stephen D. Hibbard
Timothy T. O’Donnell
John D. Wilson
35. Bank Failures: Regulatory Actions and Litigation
35.1
Abe Chernin
Catherine J. Galley
Christopher M. James
Yesim C. Richardson
Joseph T. Schertler
PART VI: CRIMINAL MATTERS AND INVESTIGATIONS
36. Tax Fraud: Criminal Cases
36.1
Edward M. Robbins Jr.
viii
CONTENTS

37. Financial Statement Investigations
37.1
Dean C. Bunch
Karen M. Cheek
Amy M. Hawkes
Randy C. Joshi
38. International Investigations: Successful Planning and Execution
38.1
Sergio P. Negreira
PART VII: FAMILY LAW
39. Family Law Services
39.1
Donald A. Glenn
Index
CONTENTS
ix

CHAPTER2
SERVING AS A FINANCIAL EXPERT
IN LITIGATION
Stephen L. Buffo
David P. Hoffman
Roman L. Weil
CONTENTS
2.1
Introduction
2.1
(a) Financial Expert Services Provided by
CPAs and Others
2.1
(b) Deﬁning Financial Expert Services
2.2
2.2
Financial Expert Services
2.2
(a) Typical Roles of the Financial
Expert
2.2
(b) Financial Expert Services in the
Litigation Environment
2.4
(c) Opinion Testimony
2.6
2.3
Qualiﬁcations of Financial Experts
2.7
(a) Skills Commonly Required of
Financial Experts
2.7
2.4
Professional Guidance and
Standards
2.8
(a) Guidelines for a Financial
Expert
2.8
(b) Professional Standards and
Malpractice Concerns
2.12
2.5
Logistics
2.13
(a) Fee Arrangements and Engagement
Letters
2.13
(b) Work Papers
2.14
2.6
Conclusion
2.15
NOTES
2.15
2.1
INTRODUCTION
(a) Financial Expert Services Provided by CPAs and Others.
Disputing parties and
their legal counsel frequently engage experts to provide assistance in evaluating
the ﬁnancial and related business aspects of the issues in dispute. The ﬁnancial
expert has a responsibility to explore the facts and to reach an opinion on the
ﬁnancial and related business matters at hand, and to communicate that opinion
to the trier of fact. The manner in which ﬁnancial experts conduct their work and
the way this process plays out depends on a number of variables including, most
notably, the dispute resolution venue and its rules and procedures governing
expert witnesses. For many years, the most common venues for civil litigation in
The authors acknowledge Peter Frank, Michael Wagner, and Christian Hughes for their work in creating
earlier versions of this chapter that appeared in previous editions of the Litigation Services Handbook.
2 1

the United States have been the federal and state court systems. This chapter will
discuss ﬁnancial expert services in the context of civil courts; however, many of
the principles and frameworks outlined herein apply as well in other venues.
An expert opinion undergoes intense scrutiny and cross-examination by an
opposing party, its counsel and experts, and the trier of fact. The processes, prin-
ciples, and professional and legal standards discussed in this chapter and
throughout this handbook ensure that ﬁnancial experts deliver services in a pro-
fessional manner that gives all parties an opportunity to test, challenge, support,
or controvert the opinion(s) presented. Experts must have qualiﬁcations pertinent
to the situation at hand and they must present conclusions consistent with the
facts while employing defensible assumptions and appropriate methods.
(b) Deﬁning Financial Expert Services.
The American Institute of Certiﬁed Public
Accountants (AICPA) guidelines consider ﬁnancial expert services as consulting
services (see Section 2.4), providing a deﬁnition of forensic accounting services
(which one can apply to ﬁnancial expert services) as follows:
Forensic accounting services generally involve the application of specialized knowl-
edge and investigative skills possessed by CPAs to collect, analyze, and evaluate evi-
dential matter and to interpret and communicate ﬁndings in the courtroom,
boardroom, or other legal or administrative venue. More simply, in a litigation
context, the term forensic means to be suitable for use by a court of law.
Forensic accounting services include dispute resolution, litigation support, bank-
ruptcy support, and fraud and special investigations, among many other services.
Forensic accounting services utilize the practitioner’s specialized accounting, audit-
ing, economic, tax, and other skills to perform a number of consulting activities. The
provision of forensic accounting services often requires the practitioner to serve as
an expert or fact witness, depending on the assignment.
Dispute resolution services assist parties with the settlement or determination of a
dispute. Litigation services involve pending or potential legal or regulatory proceed-
ings before a trier of fact in connection with the resolution of a dispute between
parties. A trier of fact may be a judge, a jury, a tribunal, a regulatory body or govern-
ment authority and their agents, an arbitrator, a mediator, a special master, a referee,
or another party with authority to decide the outcome of a dispute. Bankruptcy
support services assist debtors, creditors, other interested parties, and the courts
with pending or potential formal legal bankruptcy proceedings. Fraud and special
investigations typically involve the investigation of known or suspected bad acts or
events using recognized forensic techniques.1
While ﬁnancial experts do not always deliver their services in a litigation
context, most services provided by ﬁnancial experts fall under the same forensic
classiﬁcation and are subject to the same rubric.
This chapter describes the skills, roles, and professional guidelines for a ﬁnan-
cial expert when providing such forensic services, most often in the form of an
expert opinion, and in communicating the opinion to the trier of fact. The chap-
ters in Part II of this handbook will discuss the various types of damages analyses
performed by ﬁnancial experts.
2.2
FINANCIAL EXPERT SERVICES
(a) Typical Roles of the Financial Expert
(i) Expert Witness.
An expert witness renders an expert opinion at trial. The ﬁnan-
cial expert’s opinion usually relates to business issues in which the expert has
2 2
SERVING AS A FINANCIAL EXPERT IN LITIGATION

special skill, knowledge, education, work experience, or training. The trier of fact
commonly lacks this knowledge or expertise, so the ﬁnancial expert’s opinion
will help it reach a decision. Federal courts and many state courts require that an
expert witness submit a written report setting forth the opinions and the bases for
those opinions that the expert will present at trial. Federal courts also require
under Rule 26 of the U.S. Federal Rules of Civil Procedure that the expert’s report
include the following:
A complete statement of all the expert’s opinions, and the basis and reasons
for them;
The data or other information the expert considered in reaching opinions;
The expert’s qualiﬁcations, including publications authored by the expert in
the prior ten years;
A listing of cases in which the expert testiﬁed in the prior four years; and
Compensation of the expert.
Changes to Rule 26 that took effect on December 1, 2010 no longer allow
the discovery of draft reports and limit discovery of attorney–expert commu-
nications. Some state courts follow the Federal Rules. In other venues, such as
an alternative dispute resolution (ADR) occurring in the United States or
internationally, or in certain regulatory proceedings, other rules will dictate
the disclosure of an expert’s opinions and related ﬁles; therefore, the expert
should obtain an understanding from counsel about the speciﬁc rules for dis-
closure in the venue for each case.
(ii) Consultant.
Sometimes an attorney hires a ﬁnancial expert as a consultant to
advise the disputing party and its legal team about the facts, issues, and strategy
of the case. The consultant does not testify at trial. The attorney work-product
doctrine protects the consultant’s opinion, discussions, work papers, and impres-
sions from discovery by the opposition. Consequently, the opposition often never
knows of the ﬁnancial expert serving as a consultant. However, if a ﬁnancial
expert progresses from conﬁdential consultant to expert witness, the expert’s
work product, writings, work papers, and even notes likely will become discover-
able. For large cases, attorneys often have one ﬁnancial expert as a consultant and
designate another to provide expert testimony. Coordinating their roles without
exposing to discovery the consultant’s work demands close communication with
counsel and, usually, separate retention agreements.
The work of a consultant usually includes analyzing and advising on how best
to discredit the opposing expert’s work. Sometimes the consultant also examines
the strengths and weaknesses of the client’s case and how best to represent these
facts at trial.
Attorneys retain consultants on occasion to evaluate the effects of particu-
larly troublesome facts not shared with the testifying expert. Philosophies
vary on the advisability of this practice. If the opposing side knows the trou-
blesome information, it could surprise the unprepared expert at deposition
or, worse, at trial.
(iii) Other.
Financial experts often perform roles other than that of expert or con-
sultant for one party in a dispute. For example, a court can appoint the ﬁnancial
expert as a special master who will decide certain facts in a dispute. The ﬁnancial
2.2
FINANCIAL EXPERT SERVICES
2 3

expert then acts in this function as the judge and jury. The special master be-
comes useful when a case has difﬁcult or highly technical accounting or ﬁnan-
cial issues that only a CPA or economist can understand. On rare occasions, the
judge retains the expert to advise the judge in deciding these issues.2 Some-
times the parties want to agree on an individual to make these decisions in an
effort to get an informed decision, or accelerate the process, or save expenses.
(Financial experts also serve as arbitrators or mediators in ADR settings, as
Chapter 1 discusses.)
(b) Financial Expert Services in the Litigation Environment
(i) Discovery Assistance.
Business litigation often depends on documents to prove
or disprove an issue at trial. As a result, the parties undertake voluminous
document discovery and production, which has become weighted toward elec-
tronic records and information, involving both structured data (such as
accounting or business systems information) and unstructured data (such as
text documents or other user ﬁles, and emails). Business records become
crucial to a number of issues in most cases. Financial experts can assist in ﬁnd-
ing, understanding, and explaining the information from these documents. To
assist with the magnitude and complexity of electronic information, forensic
technology specialists have become commonplace members of the ﬁnancial
expert’s team (see Chapter 14).
Lawyers need to know the types of documents that exist in managing a
business so they can formulate precise discovery requests. This knowledge
also helps the lawyer to assess the responsiveness of particular document pro-
ductions and to understand what other documents might exist, as discussed in
Chapter 14.
Depositions of ﬁnancial and management personnel often relate to technical
business issues. Attorneys need help in understanding the real issues and in
formulating effective questions. Because technical people will often answer
questions in jargon that has a special meaning in a particular industry or business
discipline, attorneys often need assistance in understanding the answers and
developing follow-up questions. Financial experts can assist in this area.
Lawyers need information regarding the opposing expert’s work to effectively
cross-examine and rebut the opposing expert’s opinion. When the expertise
involves business matters, ﬁnancial experts can assist lawyers in analyzing the
expert’s work and the strengths and weaknesses of its support.
(ii) Proof of Business Facts.
In commercial litigation, factual evidence—except that
derived from testimony—comes principally from the business records of the
parties or from industry and market sources. Financial experts can help lawyers
obtain, understand, authenticate, organize, and explain this information.
Experts can base opinion testimony on either facts or assumptions. They usu-
ally base assumptions on facts or presumptions from facts. In either case, the
expert must lay a proper foundation as to the source of the information. Financial
experts can help to develop these facts by collecting the relevant business or in-
dustry data to support their own or other experts’ opinions. Rule 702 of the U.S.
Federal Rules of Evidence requires that experts reliably apply their methods to
the facts of the case. Accordingly, even when testifying based on hypothetical
2 4
SERVING AS A FINANCIAL EXPERT IN LITIGATION

premises, the expert must have conﬁdence in the plausibility of those premises.
The expert who accepts implausible assumptions is ﬁshing with his reputation
for bait.
(iii) Computation of Damages.
Financial experts often calculate damages in commer-
cial litigation, and this topic dominates much of the remainder of this book. Nu-
merous types of damages occur—such as actual losses of cash or equivalents, or
other property, or expected proﬁts—and practitioners have developed methods
to compute them. The type of damages that the expert must compute can be a
question of fact or opinion, and may also be a function of what the law permits,
such as statutory rates of interest. The law may also limit recovery of certain types
of damages in certain causes of action.
The ﬁnancial expert should communicate with the attorney to agree on
the type of damages to calculate and an appropriate method of computation.
Otherwise, the court can rule a calculation inadmissible as inappropriate to the
circumstances.
Actual loss incurred deﬁnes one type of damages recovery. Experts compute
this form of restitution, which applies in many fraud cases, as the difference
between what the plaintiff paid for something and the actual value received or as
the value of something once but no longer possessed.
The expected proﬁts from a proposed contract or deal represent another com-
mon type of recovery. Practitioners often refer to this as the beneﬁt-of-the-bargain
approach of computing damages in contract disputes. Plaintiffs often claim lost
proﬁts in business litigation, measured as the amount by which the plaintiff’s
actual earnings fall short of the earnings that would have occurred but for the
defendant’s illegal actions. Practitioners most often state this formula as the
difference between but-for proﬁts (i.e., those that the plaintiff would have earned
but for the defendant’s improper act) and actual proﬁts. Disgorgement of a
wrongdoer’s ill-gotten gains or proﬁts is often an alternative to a plaintiff’s lost
proﬁts. More generally, most damages analyses require the use of assumptions
and projections about what would have happened if the defendant had behaved
differently.
Examples of other types of damages claims include reasonable royalty analy-
ses in patent infringement, actual cash value computations under business prop-
erty insurance policies, and monetary cost to restore the plaintiff back to the
starting point under equitable rescission theories in some contract cases. Chapter
4 describes many of these alternative types of damages in the context of a frame-
work for developing a damages claim; subsequent chapters discuss speciﬁc types
of damages in more detail.
(iv) Development of Strategy.
Financial experts who serve as litigation consultants
can suggest approaches to the business issues in a case. Even the best trial law-
yers sometimes lack the business experience and insights that such ﬁnancial
experts have learned from their business consulting, experience, training, and
education.
Lawyers need independent analysis of the positions they believe they must
prove to win the case. Financial experts can help lawyers identify errors, ﬂaws,
and weaknesses; they can also devise alternative approaches, perhaps using
different assumptions.
2.2
FINANCIAL EXPERT SERVICES
2 5

(v) Document Management.
Financial expert services ﬁrms frequently have expertise
in information technology (IT), computer systems, and other forms of business
records. Such experts can help attorneys collect, organize, and summarize the large
volume of hard-copy and electronic documents that often arises in a business case.
They usually use IT systems to manage the large databases of documents, images,
and other electronic information produced for the case. Chapter 14 discusses tech-
niques involved in such document management and data management issues.
(c) Opinion Testimony
(i) Expert Opinion.
Expert opinion is testimony by a person qualiﬁed to speak author-
itatively because of some combination of special training, skill, study, experience,
observation, practice, and familiarity with the subject matter. Expert knowledge is
knowledge not possessed by laymen or inexperienced persons. State or federal rules
of evidence deﬁne the scope and nature of admissible expert opinion testimony.
The courts consider CPAs and other practitioners with appropriate experience
and training as experts on accounting matters. Many ﬁnancial experts also have
expertise in the application of economic, ﬁnancial, statistical, and econometric
techniques (which could include CPAs, economists, or others with appropriate
education, training, and experience). Financial experts frequently possess indus-
try expertise as well. We encourage experts to objectively weigh their qualiﬁca-
tions for any opinion they are asked to give and to do so early in the case lest
they ﬁnd themselves and their clients harmed by a successful Daubert challenge
(see Section 1.1(b) of Chapter 1).
(ii) GAAP / GAAS Rules and Compliance.
Practitioners need to understand the distinc-
tion between accountants’ opinions and expert opinions. Generally accepted ac-
counting principles (GAAP) and generally accepted auditing standards (GAAS)
relate to the preparation and examination of a company’s ﬁnancial statements.
An accountant’s opinion as a result of an audit, review, or compilation engage-
ment addresses whether—in the opinion of the accountant—the ﬁnancial state-
ments fairly present the results of the company in all material respects. An expert
opinion expressed by a ﬁnancial expert, on the other hand, while invariably
rooted in the books and records of the disputing party or parties, is not an
accountant’s opinion on ﬁnancial statements and is therefore exempt from GAAP
and GAAS.
There are some speciﬁc situations, however, where GAAP and GAAS are the
subject matter of the litigation. Such issues arise when a party questions the accu-
racy of ﬁnancial statements or the care with which they have been audited. Some
CPAs have the qualiﬁcations to render expert opinions on GAAP and GAAS.
GAAP and GAAS issues arise when a plaintiff sues an accounting ﬁrm for
violating these standards, alleging harm because it relied on the accuracy of the
ﬁnancial statements. Chapter 30 discusses accountants’ liability.
GAAP issues also arise when a dispute relates to the purchase or sale of a busi-
ness and one party questions the accuracy of the prior ﬁnancial statements or
those on which a postclosing working capital adjustment is based. GAAP issues
can also arise in damages computations that rely on ﬁnancial statements.
(iii) Attest and Audit Opinions.
Experts develop their own ﬁndings, conclusions, and
opinions. In an attest engagement, which requires a CPA’s expertise, the CPA
2 6
SERVING AS A FINANCIAL EXPERT IN LITIGATION

expresses a conclusion about the reliability of a written assertion that another
party—the asserter—has produced. In a litigation context, CPAs should not
undertake an Agreed-Upon Procedures report—an attest function wherein a
CPA issues a conclusion about speciﬁc and narrowly deﬁned results based on
inputs and scope as provided by the client. Litigation services engagements
rarely require an attest opinion, and the ﬁnancial expert should consider the facts
and circumstances before deciding whether to issue an attest report in a litigation
matter. Although an audit opinion is a form of expert opinion, it differs from an
expert witness opinion given at trial.
Sometimes the opposing lawyer tries to confuse the trier of fact by muddling
audit opinions with expert opinions. The lawyer might ask whether the CPA per-
formed an audit and can render an audit opinion. When the CPA answers no, the
attorney might suggest incorrectly that the CPA with no audit opinion can have
no expert opinion.
2.3
QUALIFICATIONS OF FINANCIAL EXPERTS
(a) Skills Commonly Required of Financial Experts.
Rule 702 of the Federal Rules of
Evidence provides the basis for evaluating the merit and relevance of a ﬁnancial
expert’s testimony (see Section 1.1(b) of Chapter 1): "If scientiﬁc, technical, or other
specialized knowledge will assist the trier of fact to understand the evidence or to
determine a fact in issue, a witness qualiﬁed as an expert by knowledge, skill,
experience, training, or education may testify thereto in the form of an opinion or
otherwise." The services provided by a ﬁnancial expert should be governed by
these criteria for the expert’s qualiﬁcations.
As Section 2.2 of this chapter describes, ﬁnancial experts can provide many
services throughout the litigation process. The discussion that follows lists the
special skills such experts need to competently perform such work. Of course,
crossover can occur where an accountant has education, training, or experience
in other related ﬁnancial, economic, and business areas, or when an economist or
ﬁnance professional understands accounting principles.
(i) Accounting and Auditing.
Damages analyses in litigation use the books and
records of the disputing parties, making accounting skills fundamental to ﬁnan-
cial expert services. When assessing damages, experts often need to understand
ﬁnancial statements, ﬁnancial systems, journals, and ledgers; interpret the results
of business segments, product lines, and facilities; and follow the dynamics of
balance sheet, income statement, and cash ﬂow items. Litigation services engage-
ments frequently use the skeptical attitude, investigative skills, and accounting
knowledge required by the audit function. Examples include investigation of
fraudulent transactions and reconstruction of ﬁnancial statements.
(ii) Cost Accounting.
The calculation of damages often requires cost accounting
skills. For example, cases in which the plaintiff is a multiline product manufac-
turer or service provider require allocation of common costs to each product line
affected by the defendant’s actions.
(iii) Financial Analysis.
Development and analysis of ﬁnancial ratios and relations
often aid in understanding the causes and symptoms of a litigant’s business
2.3
QUALIFICATIONS OF FINANCIAL EXPERTS
2 7

problems. The ﬁnancial expert can also modify ratio analysis to derive assump-
tions as to what would have happened but for the alleged unlawful action. The
ﬁnancial expert can apply ﬁnancial analysis skills such as forecasting and dis-
counting to perform present value or prejudgment interest analyses, capital mar-
ket theory applications, and business valuations.
(iv) Economic Analysis.
Economists and accountants perform both macro- and
microeconomic analyses in a litigation services engagement. Development of
elasticity functions, analyzing market structure and market or pricing behavior,
or assessing barriers to entry can prove important in claims for antitrust damages
or for price erosion claims in a patent infringement matter.
(v) Market Analysis.
Much market analysis focuses on the collection of quantitative
data about supply and demand, buyers and sellers, competitors and other partic-
ipants in a particular marketplace. Financial experts can help collect and assess
the required data. Examples include the number or concentration of competitors
in a particular market or computation of the market share of each participant, and
trends driving changes to such market data.
(vi) Statistics.
Economists and many accountants understand statistical techniques
such as sampling and regression analysis. An expert uses sampling when analy-
sis of an entire population is too time-consuming or expensive for the case (Chap-
ter 6 discusses sampling). Regression analysis can help to project sales or suggest
cost relations. (See Chapters 7 and 8 for discussion on regression analysis.)
(vii) Other Relevant Knowledge.
Disputes often center on particular business
practices or processes, many of which apply to a particular industry or sector. In
addition to the functional skills described above, ﬁnancial experts often have such
business or industry skills and knowledge to apply in their analyses.
2.4
PROFESSIONAL GUIDANCE AND STANDARDS
(a) Guidelines for a Financial Expert.
The AICPA, through its standards and Code
of Professional Conduct, has set criteria for its members to help maintain the
integrity of the profession and its members. We discuss many of these here as
prudent guidelines for all ﬁnancial experts providing litigation services.
(i) Competency.
Experts should “undertake only those professional services that
the member or the member’s ﬁrm can reasonably expect to complete with profes-
sional competence.”3 Experts embarking on their ﬁrst litigation engagement can
ﬁnd themselves ill-equipped, ill-prepared, and lacking foundation for some of
their opinions. The attorney retaining the expert frequently cannot evaluate the
expert’s abilities. An expert uncertain of competence for the engagement should
not accept it.
(ii) Conﬁdentiality.
Experts bring to the courtroom all their prior experience and
knowledge of clients and their practices, operations, and trade secrets. The expert
should not disclose information obtained during other professional engagements
except with the client’s consent or pursuant to an appropriate order of the court.
Experience in similar cases enables someone to render expert opinions but the
2 8
SERVING AS A FINANCIAL EXPERT IN LITIGATION

expert must protect conﬁdential information obtained in previous engagements.
Often the expert will not need to disclose any conﬁdential information but must
recognize the dual responsibility of truthfulness and honesty while preserving
past and present clients’ conﬁdential information.
If experts rely on speciﬁc information obtained in an unrelated client engage-
ment and use that information as a basis for their opinion, a judge can require
them to disclose the information’s source. If the expert refuses, the judge can pre-
clude use of the testimony because the opposing counsel could not take discovery
on the information providing the basis of the expert’s opinion.
(iii) Objectivity.
Financial experts should avoid taking any position that might
impair their objectivity. Although experts can resolve doubt in favor of their cli-
ent—as long as they can support the position—they must not become blind to
objectivity in an effort to please their client. Such a lack of objectivity can become
apparent, thus damaging the client’s case and the expert’s own reputation.
Any opinions and positions an expert has taken in previous cases can become
a matter of inquiry. For example, the expert should not testify in a matter involv-
ing an accounting or ﬁnancial principle from a position inconsistent with one
previously taken with similar facts unless the expert can reconcile the apparent
inconsistency. Opposing counsel can quickly cast doubt on the expert’s objectiv-
ity and credibility.
(iv) Conﬂicts of Interest.
Conﬂicts of interest arise from the expert’s ethical obliga-
tion to preserve client conﬁdences or from other relations that can affect the
expert’s ability to present a client’s position.
The ﬁnancial expert must investigate possible conﬂicts of interest before
accepting a litigation engagement and must check whether any adverse party in
the litigation, including counsel, is a current or past client of the expert or the
expert’s ﬁrm. This in itself does not create a conﬂict, but the expert should con-
sider the implications and discuss this with counsel. Although certain professions
and professional organizations often impose ethical guidance differing by the
expert’s discipline, the existence of a legal conﬂict of interest is rare.4
Even when no direct conﬂict of interest exists, the expert should consider
whether to accept an engagement that could prove contrary to the interests of
another existing client. For example, civil complaints often identify many persons
and entities as defendants. Experts should be wary when asked to work for one
defendant when another defendant in the same case is a client. A problem can
arise if the plaintiff proves joint damages, because then the defendants will lose
the unity forged when trying to defeat the plaintiff and will instead dispute the
portion that each owes. The defendants often ﬁle cross-complaints against each
other in an attempt to escape the ultimate payment of damages. At this point,
experts could ﬁnd themselves opposing a current client.
When a litigation engagement involves a former client as the opposing party,
the expert must resolve the question of a conﬂict on a case-by-case basis. Factors
to consider include the length of time since the party was a client, the conﬁdential
information the expert possesses that could become an issue in the litigation, and
the issues of the case.
The ﬁnancial expert should consider disclosing all current and former relation-
ships with all parties to the litigation to the inquiring lawyer, even though the
2.4
PROFESSIONAL GUIDANCE AND STANDARDS
2 9

expert has concluded that no conﬂict of interest exists. On occasion, duties of con-
ﬁdentiality to a present or former client will not permit that disclosure, and seek-
ing permission to disclose from that client might violate the conﬁdentiality owed
to the prospective attorney-client. There is no tidy exit from this box.
Avoiding conﬂicts of interest—disclosure of conﬁdential information.
When a prospective client approaches an expert regarding a litigation
engagement, the client or attorney often gives the expert sufﬁcient informa-
tion regarding the case to help identify the parties and opposing counsel as
well as the key issues in dispute. In describing the matter, the potential client
will sometimes communicate conﬁdential information to the expert. Assume
that this prospective client does not retain the expert, but the client’s opposi-
tion subsequently approaches the expert. Should the expert decline the sub-
sequent offer of an engagement to protect the conﬁdential information
received previously?
Although the implication of a conﬂict of interest seems readily apparent, a
California appellate court decision, Shadow Trafﬁc Network et al. v. The Supe-
rior Court of Los Angeles County,5 highlights the importance of full disclosure
and analysis of any potential conﬂict of interest in a litigation service envi-
ronment. In Shadow Trafﬁc Network, the plaintiff’s law ﬁrm interviewed a
prospective CPA expert and then decided not to retain the CPA for trial pur-
poses. Subsequently, opposing counsel retained the same CPA to assist in
the same litigation even though the CPA expert had informed the new coun-
sel of previous discussions with plaintiff’s counsel. When plaintiff’s counsel
learned that defendant’s counsel had retained the rejected CPA ﬁrm in
the matter, the law ﬁrm moved to disqualify the defendant’s law ﬁrm from
further representation of its client because the ﬁrm had retained the CPA
to whom it had disclosed conﬁdential information. The trial court disquali-
ﬁed the law ﬁrm. On review, the appellate court decision upheld the trial
court’s decision.
The Shadow Trafﬁc Network ruling provides aggressive lawyers with an
opportunity to foreclose the participation of potential experts by contacting
them and disclosing minor bits of conﬁdential information. Most jurisdic-
tions discourage this practice; in some jurisdictions, such behavior can
expose counsel to sanctions or other disciplinary action by the state bar asso-
ciation. To avoid the problem, experts should limit the information they
receive from lawyers before committing to an engagement and inform the
inquiring lawyers that they have adopted this approach. Practitioners
should be careful about all communications with attorneys on a matter and
assure that they are under retainer and have cleared conﬂicts before any
substantive conversation about a case occurs.
Simultaneous consultations. Particularly with multinational accounting
and consulting ﬁrms and national law ﬁrms, a law ﬁrm might engage differ-
ent experts from the same ﬁrm to work simultaneously for and against the
law ﬁrm’s clients in different cases.
This question of conﬂicts presents more of a problem for counsel than an
ethical question for the expert witness. The expert, however, should know
the potential for problems in such circumstances and should, given
2 10
SERVING AS A FINANCIAL EXPERT IN LITIGATION

conﬁdentiality constraints, fully disclose such relations to counsel before
accepting an engagement or, when this is not possible, alert counsel to the
possibility of such an eventuality.
(v) Considerations for CPAs.
CPAs offering litigation services must comply with the
Statement on Standards for Consulting Services No. 1 and general standards of
the profession contained in the AICPA Code of Professional Conduct. CPAs
should also meet the legal standards appropriate to the expert’s role, applicable
state board of accountancy rules, or other professional organizations to which the
CPA belongs.
The AICPA has stated that litigation services do not meet the deﬁnition of an
attestation engagement (and therefore the attestation standards do not apply),6
except for the rare occasions when a CPA must give an attest opinion during a
litigation or when others will receive the written work of the accountant and,
under the rules of the proceeding, do not have the opportunity to analyze and
challenge the accountant’s work. The AICPA recognizes that in a litigation
engagement, the opposition and trier of fact will scrutinize the information and
conclusions reached by a CPA. CPAs must understand that their opinions
will receive the close attention of counsel and, in most instances, an opposing
expert or consultant. CPAs must ensure that anyone using their reports or work
papers understands why the CPA prepared them or has the right to depose
or cross-examine with respect to them. A CPA should take reasonable steps to
prevent a third party who does not know of the litigation from relying on the
reports; such a person could not challenge or fully understand the underlying
assumptions.
While a CPA is generally exempt from following the AICPA’s attestation
standards, they must follow the general AICPA professional standards for the
accounting profession. The following standards7 pertain when a CPA provides
litigation services:
1. Rule 102, Integrity and Objectivity
2. Rule 201, General Standards
3. Rule 202, Compliance with Standards
4. Rule 301, Conﬁdential Client Information
5. Rule 302, Contingent Fees
6. Rule 501, Acts Discreditable
As stated previously, all ﬁnancial experts—particularly CPAs—should con-
sider the standards of Rule 201, listed below:
(A) Professional Competence. Undertake only those engagements the CPA can
reasonably expect to complete with professional competence.
(B) Due Professional Care. Exercise due professional care in any performance of
professional services.
(C) Planning and Supervision. Adequately plan and supervise the performance
of professional services.
(D) Sufﬁcient Relevant Data. Obtain sufﬁcient relevant data to afford a reasonable
basis for conclusion or recommendations in relation to any professional
services performed.8
2.4
PROFESSIONAL GUIDANCE AND STANDARDS
2 11

Rule 101 of the AICPA’s professional standards will have relevance if a
dispute involves a CPA’s attest client. Rule 101-3 states that providing expert ser-
vices to a non–Securities and Exchange Commission (SEC) client will impair a
CPA’s independence but permits consulting services for non-SEC registrants.
The Sarbanes-Oxley Act of 2002 transformed the litigation services arena for
CPAs whose ﬁrms audit companies subject to regulation by the SEC. Such audit
clients cannot employ partners or staff of their audit ﬁrms in this capacity.9
The AICPA’s Forensic and Valuation Services (FVS) Section provides guidance
to CPAs who provide litigation services. We urge all practitioners to remain cur-
rent on publications issued by this section of the AICPA, particularly the current
text and any updates or modiﬁcations to AICPA FVS Practice Aid 10-1, “Serving as
an Expert Witness or Consultant.” In addition to Practice Aid 10-1, the AICPA has
produced a number of other publications dealing with litigation services, includ-
ing the following:
AICPA Consulting Services Special Report 03-1, “Litigation Services and Appli-
cable Professional Standards”;
AICPA FVS Section Special Report 08-1, “Independence and Integrity and Ob-
jectivity in Performing Forensic and Valuation Services”;
AICPA FVS Section Special Report 09-1, “Introduction to Civil Litigation
Services”;
AICPA
Business
Valuation
and
Litigation
Services
Practice
Aid
04-1,
“Engagement Letters for Litigation Services”;
AICPA
FVS
Section
Practice
Aid
07-1,
“Forensic
Accounting–Fraud
Investigations”;
AICPA FVS Section Practice Aid 06-1, “Calculating Intellectual Property
Infringement Damages”;
AICPA FVS Section Practice Aid 96-3, “Communicating in Litigation Services:
Reports”; and
AICPA FVS Section Practice Aid 98-2, “Calculations of Damages from
Personal Injury, Wrongful Death, and Employment Discrimination.”
The AICPA’s website contains a comprehensive listing of resources that it pub-
lishes or makes available (including this book); the list above simply identiﬁes the
most immediately relevant.
(b) Professional Standards and Malpractice Concerns.
In a California case, Mattco
Forge, Inc. v. Arthur Young and Co., an appellate court ruled that experts cannot as-
sert a statutory litigation privilege against their own clients. (A statutory litigation
privilege denies a party the right to sue an opposing expert for anything the expert
witness says at deposition or trial. This privilege protects the work of persons assist-
ing in litigation who may otherwise fear that an aggressive adversary will sue them
later for their work.) Thus, the opposing litigant cannot sue the CPA; however, the
court can review the performance of the CPA on behalf of the CPA’s only client in
light of the applicable professional standards. The appellate court stated:
Applying the privilege in this circumstance does not encourage witnesses to testify
truthfully; indeed, by shielding a negligent witness from liability, it has the opposite
2 12
SERVING AS A FINANCIAL EXPERT IN LITIGATION

effect. Applying the privilege where the underlying suit never reached the trial stage
would also mean that the party hiring the expert witness would have to bear the
penalty for the expert witness’s negligence. That result would scarcely encourage
the future presentation of truthful testimony by the witness to the trier of fact.10
The above example, while uncommon, demonstrates that CPAs who provide
expert witness services could face some exposure to the parties employing them
as experts. The professional standards of the accounting profession will likely
help the expert decide the appropriate standard of care. Others ﬁnd similar stan-
dards of their professions invoked against them in similar circumstances. Follow-
ing the relevant applicable standards and professional guidelines is the best way
for a ﬁnancial expert to avoid such issues.
2.5
LOGISTICS
(a) Fee Arrangements and Engagement Letters.
Practitioners bill most litigation
services engagements as they do other consulting engagements, with fees based
on hours extended by hourly rates, plus expenses. The expert can also perform
work for a ﬁxed fee, although the unpredictable course of litigation can make this
a risky proposition for all but the most narrowly focused topics of testimony.
Some lawyers want the attorney work-product doctrine to apply and yet do not
want the responsibility of paying the experts’ fees. Such lawyers will ask the expert
to send bills directly to the party and often ask the expert to sign a retainer agree-
ment expressly disclaiming any recourse against the lawyer for payment of the
expert’s bills. The lawyer needs to contemplate and understand the risk to the
applicable attorney work-product protection arising from this type of arrangement.
The expert could consider both the lawyer and the litigant as clients. Most
experts recognize that the litigant ultimately pays their fees and that lawyers
engage the expert as an agent for their clients. Some experts insist on holding
the lawyer equally or solely responsible for fees, even at the risk of losing the
engagement.
(i) Who Is the Client?
The expert retained to perform a litigation services engage-
ment has two potential clients: the law ﬁrm and the party to the lawsuit. Most
attorneys believe that to protect a nontestifying expert consultant’s work from
discovery, the expert must work for the lawyer. If the disputant hires the expert,
the attorney work-product doctrine likely will not apply, nor will the attorney–
client privilege, which protects communications only between a client and its at-
torney. Commercial considerations can enter into the discussion when an attor-
ney has concerns over the client’s ability or willingness to pay and prefers to stay
out of the contracting loop.
(ii) Engagement Letter.
The ﬁnancial expert should consider whether to use an
engagement letter in a litigation engagement, and the authors strongly encourage
this practice. An engagement letter beneﬁts both the expert and the attorney, set-
ting forth an agreement on the engagement’s terms and each party’s responsibili-
ties. The expert’s insurance carrier or professional standards often require one.
Some experts believe that an engagement letter unnecessarily restricts and limits
the areas of testimony; however, this argument lacks merit. In fact, the contrary
2.5
LOGISTICS
2 13

holds true: most attorneys prefer that the engagement letter be inexplicit as to the
nature and content of the opinions they hope the expert will develop. We suggest
that an expert require both counsel and the litigant to acknowledge the terms of
the engagement letter.
Most engagement letters describe the engagement’s scope and limit the use of
data or reports that the ﬁnancial expert prepares to the litigation (e.g., the client
cannot use a valuation opinion developed for a litigation to subsequently market
the company for sale). The scope should identify the nature of the services and
state whether such services include an audit or review (for CPAs). The letter
should restrict use of the expert’s work product to the case and prohibit distribu-
tion to others. Most engagement letters specify hourly rates and fees and call for
reimbursement of expenses. Some letters provide for a retainer that will apply
against the ﬁnal billing. The letter can also specify that the client will reimburse
any costs that the expert’s ﬁrm incurs for related and necessary legal counsel dur-
ing or after the case. The engagement letter might also address the possibility that
the client could change attorneys, give the expert the option to withdraw, provide
for the return of original documents, and state that the expert implies no war-
ranty or prediction of results.
(iii) Retainers.
Financial experts require a retainer in some litigation services
engagements. A retainer will protect the expert’s billing only if the expert holds it
as security for payment of the ﬁnal bill. Experience shows that unfavorable out-
comes can lead to unpaid bills.
An expert should investigate the client’s ﬁnancial ability to pay if the litigation
proves unsuccessful. If the client cannot pay in this situation, the ﬁnancial expert
should consider obtaining a retainer against the full anticipated ﬁnal bill. We rec-
ommend this practice regardless of the client’s ability to pay. Otherwise, the
judge and jury could view the expert as working effectively on a contingent fee
basis.
The ﬁnal outcome of marital dissolution actions usually makes both parties
unhappy. Paying spouses feel that they have lost too much, and receiving
spouses feel that they have obtained too little. Many ﬁnancial experts who prac-
tice in the marital dissolution ﬁeld require a sizable retainer.
(iv) Contingent Fees.
The American Bar Association and many state bars make it an
ethical violation for a lawyer to proffer testimony from an expert witness who
receives contingent compensation.
The ﬁnancial expert should avoid contingent fee arrangements in any testify-
ing role. An expert witness working on a contingency basis loses independence
and objectivity. Opposing counsel likely will effectively impugn the testimony of
an expert whose compensation depends on the outcome. Experts working as con-
sultants rather than witnesses need to decide on the wisdom of accepting contin-
gent arrangements.
(b) Work Papers.
A ﬁnancial expert in a litigation engagement will generate work
papers or analyses that develop and document opinions. The work papers and
analyses do not follow a prescribed format. As Section 1.1(b) of Chapter 1
explains, the Federal Rules of Civil Procedure require the witness to identify the
bases and underlying data supporting the opinion (Rule 26(b)(2)), and the Federal
2 14
SERVING AS A FINANCIAL EXPERT IN LITIGATION

Rules of Evidence require the witness to disclose, if asked, the facts or data under-
lying the opinion (Rule 705).
Opposing counsel will likely gain access to materials that the testifying expert
prepared: notes, calculations, and materials to which an expert witness refers.
For an expert serving as a consultant, the attorney probably can assert a work-
product privilege, and opposing counsel likely will never discover and analyze
such work papers. Nonetheless, we suggest that consulting experts maintain
their ﬁles free of superseded drafts, completed to-do lists not otherwise needed,
and other such extraneous materials. Recent changes to Rule 26 preclude the
discovery of draft expert reports and communications between counsel and the
testifying expert. In state courts that do not follow Rule 26, once the lawyer and
expert agree on the expert’s role, the expert should understand that notes of
meetings can include preliminary opinions, draft schedules, and reports. Many
attorneys in these jurisdictions negotiate agreements with opposing counsel to
waive the right to discover these items. After preparing ﬁnal versions, the expert
will usually ﬁnd it unnecessary and even inadvisable to retain the preliminary
work product so long as the expert can trace the ﬁnal conclusions and opinions
back to source documents.
As a matter of professional principle, lawyers will generally not instruct an
expert to destroy notes, ﬁles, and outdated work, regardless of venue. More often,
they will inquire as to the expert’s normal practice and suggest that the expert
follow that practice. Most experienced experts keep lean ﬁles, retaining only cur-
rent versions. This procedure reduces the problems caused in comprehensive dis-
covery but can cause the witness extra work to become familiar again with items
once learned and since forgotten or to recreate discarded work later deemed use-
ful. Such extra work can generate extra costs for the client, but most lawyers pre-
fer that procedure. The expert who maintains lean ﬁles should notify the lawyer
of the practice to give the lawyer an opportunity to provide any differing guid-
ance, rather than wait for the lawyer to suggest such a policy.
2.6
CONCLUSION
This chapter provides an overview of the skills, roles, professional guidelines,
and context for a ﬁnancial expert when providing expert services in litigation.
Preparing a complex commercial litigation for trial requires ﬁnancial experts to
accomplish many tasks. They can bring training and expertise to an adversarial
proceeding that will challenge and scrutinize their conclusions. The balance of
this book discusses the speciﬁc types of cases and approaches that the ﬁnancial
expert will face and employ.
NOTES
1. AICPA Practice Aid 10-1, Sections 1.3 1.5, p. 6.
2. This practice is more common in foreign venues, where custom and practice more
commonly involve retention of experts by the trier of fact rather than by the parties.
3. AICPA Code of Professional Conduct, Rule 201.
4. One example of a situation in which a legal conﬂict can occur is when an expert is
appointed to a role working for the debtor in a bankruptcy proceeding. The
NOTES
2 15

Bankruptcy Code contains a quite restrictive concept of “disinterested person” with
which experts must comply lest they see their fees and reputation evaporate.
5. Shadow Trafﬁc Network et al. v. The Superior Court of Los Angeles County, 22 Cal. App. 4th
853 (1994).
6. The AICPA excludes consulting
and thus litigation services
from its three general
categories of AICPA technical standards: Statements on Auditing Standards (SASs),
Statements on Standards for Attestation Engagements (SSAEs), and Statements on
Standards for Accounting and Review Services (SSARSs)
7. AICPA Code of Professional Conduct.
8. AICPA Code of Professional Conduct, Rule 201.
9. Section 201(a) of the Sarbanes-Oxley Act amends the Securities Exchange Act of 1934
by listing at the latter’s Section 10A (g)(8) as a prohibited activity “legal services and
expert services unrelated to the audit.”
10. Mattco Forge, Inc. v. Arthur Young and Co., 5 Cal. App. 4th 392 (1994).
2 16
SERVING AS A FINANCIAL EXPERT IN LITIGATION

PART II
DEVELOPING A
DAMAGES ANALYSIS
CHAPTER 3
Causation Issues and Expert Testimony
CHAPTER 4
Developing Damages Theories and Models
CHAPTER 5
Ex Ante versus Ex Post Damages Calculations
CHAPTER 6
Use of Statistical Sampling in Litigation
CHAPTER 7
Statistical Estimation of Incremental Cost from
Accounting Data
CHAPTER 8
Econometric Analysis
CHAPTER 9
Estimating the Cost of Capital
CHAPTER 10
Business Valuation
CHAPTER 11
Business Interruption Insurance Claims
CHAPTER 12
Lost Earnings of Persons
CHAPTER 13
Expert Analysis of Class Certiﬁcation Issues

CHAPTER4
DEVELOPING DAMAGES THEORIES
AND MODELS
Elizabeth A. Evans
Joseph J. Galanti
Daniel G. Lentz
CONTENTS
4.1 Introduction
4.1
4.2 Legal Standards
4.3
(a) Reasonable Certainty
4.3
(b) Economic Loss Doctrine
4.3
(c) Proximate Cause
4.4
(d) Foreseeability
4.5
(e) Duty to Mitigate
4.5
4.3 Damages Theory
4.5
(a) Compensatory (Expectation and
Reliance) and Restitution
Damages
4.6
(b) Comparing Beneﬁt of the Bargain,
Reliance, and Restitution
Approaches
4.9
(c) Punitive Damages
4.12
(d) Rescission or Rectiﬁcation (or
Reformation)
4.12
(e) Other Considerations
4.13
4.4 Modeling Considerations
4.15
(a) Use of Averages and Indexes
4.15
(b) Use of Ranges
4.16
(c) Lost Proﬁts versus Lost Business
Value
4.16
(d) Time Considerations
4.17
(e) Causation
4.18
(f)
Regression Analysis with Conﬁdence
Interval
4.19
(g) Monte Carlo Simulation
4.19
(h) Discounting
4.20
(i)
Prejudgment Interest
4.20
(j)
Damages for Different Types of
Cases
4.21
4.5 Developing an Effective Damages
Claim
4.21
(a) Learn the Background
4.21
(b) Understand Causation and Its
Effect
4.22
(c) Identify the Damages Theory
4.22
(d) Select the Damages Model
4.23
(e) Build the Damages Model
Lost
Proﬁts Scenario
4.23
4.6 Conclusion
4.31
NOTES
4.31
LIST OF CASES
4.34
REFERENCES
4.34
4.1
INTRODUCTION
This book describes approaches, issues, and nuances associated with damages
claims of many types—intellectual property, antitrust, government contracts,
and accountant liability, to name a few—and provides guidance to practitioners
4 1

involved in those types of cases. To set the context for a deeper understanding of
these areas, this chapter provides a general framework for selecting a damages
theory and developing a model to calculate damages. This chapter contains an
overview of the various standards under which U.S. courts assess damages
claims, summarizes the most commonly accepted damages theories and models,
and describes accepted methods and damage elements that practitioners use in
measuring damages claims.
Accepted damages theories and elements can differ widely between state and
federal court systems, in different jurisdictions, and for various types of matters.
We cannot cover all potential differences in this chapter. Practitioners should dis-
cuss the appropriate standards and elements of damages with counsel before in-
vesting time and effort on a wrong approach. Accordingly, this chapter provides
a general framework to prepare an effective analysis and will help practitioners
identify the right questions when they begin to assess damages.
Historically, based on the English court system, two types of civil courts
existed in the United States: courts of law and courts of equity. Courts of law
made their judgments in accordance with federal or state law and awarded mon-
etary damages as their remedy. Courts of equity, on the other hand, used a set of
principles based on fairness, equality, moral rights, and natural law, rather than a
strict interpretation of the law. In a court of equity, relief came in the form of an
action, rather than the payment of money.1 The wide variety of equitable reme-
dies includes the following:2
Rescission: undoing (or reversing) the actions taken under a contract;
Reformation (or rectiﬁcation): restructuring the terms of a contract to pre-
vent an inequitable outcome;
Speciﬁc performance: requiring performance of the contract according to its
terms;
Injunction: requiring a party to refrain from certain acts;
Subrogation: providing that one party can assume the rights of another;
Account of proﬁts: determining proﬁts improperly gained by a ﬁduciary
that breached its duty; and
Declaratory relief: seeking a preemptive court ruling as a common
mechanism of relief in divorce and certain contract matters. For example, in
insurance coverage disputes, a party can preemptively seek the court’s
decision as to whether an insurance policy provides coverage for certain
types of losses.
In the United States, most states have merged their law and equity courts. As a
result, courts now administer both legal and equitable remedies and often con-
sider a combination of the two depending on the matter at hand. While this chap-
ter focuses on the legal remedy of damages, it will address several equitable
remedies because they commonly involve expert services and often relate to
damages claims.
Whether the remedy sought is legal, equitable, or contains elements of both,
legal standards exist that affect the veracity of a claim before one considers a rem-
edy. Section 4.2 addresses these standards.
4 2
DEVELOPING DAMAGES THEORIES AND MODELS

4.2
LEGAL STANDARDS
The judge or jury should award damages in cases where the harm
1. Will occur with reasonable certainty;
2. Can be measured by the appropriate contract or tort (referred to as economic
loss doctrine) standard;
3. Is the proximate cause of the damage and
4. Was foreseeable; in addition,
5. The harmed party has taken reasonable efforts to mitigate the damages.
This section explains these ﬁve legal concepts.
(a) Reasonable Certainty.
Section 352 of the Restatement (Second) of Contracts
(1981) states, “Damages are not recoverable for loss beyond an amount that the
evidence permits to be established with reasonable certainty.”3 Yet while all
courts require reasonable certainty for the award of damages, no single measure
of reasonable certainty exists. Individual states and federal courts have all issued
their own opinions as to the nature of reasonable certainty.4
Most cases concur on certain points:5
The court must be certain that some injury to the plaintiff occurred.
The defendant must not beneﬁt from its wrongful actions and courts gener-
ally resolve doubts in favor of the plaintiff.
Intentional or willful action by the defendant can result in a court requiring a
lesser degree of certainty from the plaintiff.
The plaintiff can estimate the amount of damages, but the court should have
conﬁdence in the accuracy of the estimate.
For a well-established business, past performance reasonably predicts the
future.
For a new or speculative business, parties can establish the measure of
damages with reasonable certainty by the use of expert testimony, business
records, economic and ﬁnancial data, and other veriﬁable data.
The plaintiff must use the best available evidence.
Most important, the court must balance its judgment: it cannot favor the de-
fendants to a contract by requiring too high level of proof that would encourage
unscrupulous actions on the their part, nor should the court favor the plaintiff by
requiring too little proof, which would encourage the parties to undertake costly
actions to avoid loss to plaintiffs who might ﬁle a lawsuit in the future.
(b) Economic Loss Doctrine.
The economic loss doctrine sets out the extent of loss
that the plaintiff can recover in a tort case. When the facts of a case could result in
either a damages award under a contract or under a tort, practitioners should
know the distinctions between the two. We will ﬁrst discuss the basic difference
between contract and tort law in order to set the place for a discussion of their
differing damages measures.
4.2
LEGAL STANDARDS
4 3

Under the common law of contracts, the seller and buyer decide between
themselves the nature of their respective rights and duties. If the buyer believes
that the seller has breached his duty or responsibilities under the contract, the
buyer can bring suit against the seller. Similarly, the seller can sue the buyer for
the breach of the buyer’s duties under the contract. In addition, one can ﬁnd an-
other source of contract law in the Uniform Commercial Code (UCC), which dis-
cusses the rights and responsibilities of parties to a contract among its nine
articles.6 This chapter refers to both of these sources as contract law.
A tort involves the breach of a civil duty (not a contractual duty). Some deﬁne
a tort as a personal injury. Torts include (but are not limited to) such wrongs as
assault, battery, false imprisonment, defamation of character, interference with
business, unfair competition, interference with contract, trespass, and negligence.
Under tort law, an injured party can bring a civil lawsuit to seek compensation
for a wrong done to the party or to the party’s property.7
In many cases, the line between a contract issue and a tort problem appears
nebulous. Judge Richard Posner, of the Seventh Circuit Court of Appeals, notes
that “almost any tort problem can be solved as a contract problem, by asking
what the people involved in an accident would have agreed on in advance with
regards to safety measures if transaction costs had not been prohibitive.”8 He
goes on to say, “Equally, almost any contract problem can be solved as a tort
problem by asking what sanction is necessary to prevent the performing or pay-
ing party from engaging in socially wasteful conduct, such as taking advantage of
the vulnerability of a party who performs his side of the bargain ﬁrst.”9
For a breach of contract that is also a tortious injury, what amount of damages
should the injured party claim? Suppose a buyer in a contract receives and uses a
defective machine, resulting in nonsalable goods, but none of the buyer’s other
machines or property receives harm due to the use of the defective machine.
Should the buyer bring a product liability suit (tort) or bring a lawsuit for breach
of contract? Most states and federal jurisdictions hold that a party cannot recover
in tort for economic loss damages when physical property damage did not occur.
Where the harm causes damage only to the product itself (the defective machine
in our example), the buyer should have protected itself under contract law. We
refer to this majority view as the economic loss doctrine.10 On the other hand,
a minority of states and federal jurisdictions hold that a party can recover
additional losses related to negligence without the presence of damage to other
physical property. See, for example, Sharon Steel Corp. v. Lakeshore, Inc.11 An
intermediate position has also evolved where courts permit a products liability
action under certain circumstances even when the product harms only itself. The
Supreme Court in East River v. Transamerican DeLaval Inc.12 summarizes the inter-
mediate position, as well as the majority and minority views.13
While the attorney will choose whether to bring suit under the contract or in
tort, the practitioner should understand the distinctions of each and ensure that
the damages analysis matches the type of lawsuit ﬁled.
(c) Proximate Cause.
Even though the plaintiff’s harm would not have occurred
but for the defendant’s actions, courts nonetheless limit the plaintiff’s ability to
recover under the concept of proximate cause. That is, recoverable harm from the
chain of events caused by the defendant’s actions does not continue indeﬁnitely.
4 4
DEVELOPING DAMAGES THEORIES AND MODELS

At the point in which the court ﬁnds that the actions of the defendant did not
proximately cause harm to the plaintiff, damages cease. Section 3.2 of Chapter 3
focuses on the two components of causation: actual (but-for) cause and proximate
(or legal) cause and discusses proximate cause in greater detail. Courts decide
proximate cause on a case-by-case basis.
(d) Foreseeability.
One can test for proximate causation in several ways, but the
most basic test involves foreseeability. If one cannot reasonably foresee the conse-
quences resulting from the defendant’s actions, the plaintiff cannot recover for
the harm related to those actions. For example, if the defendant throws a rock at
Person A, but hits Person B standing next to Person A, a court would ﬁnd that the
harm to Person B was reasonably foreseeable. Hence, the defendant by throwing
the rock proximately caused the harm to Person B, even if the defendant did not
intend to hit Person B.
As with proximate cause, courts decide whether one can reasonably foresee
the consequences of an action on a case-by-case basis. Section 3.2 of Chapter 3
further illuminates this concept.
(e) Duty to Mitigate.
A victim to a breach of contract has a duty to mitigate the
actions caused by the other party’s harm. That is, the plaintiff must take reason-
able actions to avoid or reduce the damages. For example, assume that the de-
fendant signed a contract for the purchase of 1,000 widgets from the plaintiff. The
defendant breaches the contract and informs the plaintiff of the contract’s termi-
nation before the plaintiff obtains a source for the material needed to manufac-
ture these 1,000 widgets. The plaintiff should sue for the loss of the proﬁts on the
breached contract, but should not sue for the cost of the material that it has not
yet obtained at the time the defendant terminated the contract. The cost of the
material is an avoidable cost. Alternatively, assume that the defendant breaches
the contract after the plaintiff manufactures the widgets. If reasonably possible,
the plaintiff must sell the widgets to another party; by selling the widgets to an-
other party, the plaintiff can reduce the damages to the difference between the
defendant’s price and the new party’s price plus the additional costs required to
ﬁnd the new purchaser.14
4.3
DAMAGES THEORY
Parties to a lawsuit employ various theories of damage and related models in the
legal remedy of damages, depending on the court and the nature of the case. This
section describes damages theories that underlie models used to calculate dam-
ages. Exhibit 4-1 deﬁnes some categories of damages.
These categorizations are often interrelated. For instance, courts often remedy
actual and consequential damages with compensatory or restitution payments
from the defendant to the plaintiff. Courts may award punitive damages in addi-
tion to compensatory or restitution damages. In addition, statutes and case law
often specify the type of damages attached to speciﬁc offenses or actions. We dis-
cuss these measures in more detail further on.
4.3
DAMAGES THEORY
4 5

(a) Compensatory (Expectation and Reliance) and Restitution Damages.
Compensa-
tory damages involve either expectation damages or reliance damages.
Expectation damages, as the term connotes, compensate an aggrieved party for
the loss of the bargain for which it negotiated.15 Courts sometimes refer to expect-
ation damages as “beneﬁt of the bargain” (BOB) damages. Expectation damages
seek to make a plaintiff whole as if the defendant had performed the contract
in full.16
Reliance damages seek to compensate the plaintiff for losses resulting from its
reliance on the contract.17 Under reliance damages (RD) the plaintiff would re-
ceive only the amount it invested plus any out-of-pocket expenses as a damages
award, less any beneﬁts received if there was partial performance. Thus, an RD
remedy would essentially unwind the transaction, rather than awarding what
the nonbreaching party expected to realize had the transaction been completed as
planned. As a result, RD are usually less than BOB damages because RD do not
include any lost proﬁts from the breached contract. Many courts award RD only
when the court cannot measure BOB (expectation) damages.18
In contrast, where the nonbreaching party has not only acted in reliance upon
the contract, but that action also conferred a beneﬁt on the breaching party, courts
sometimes award a remedy of restitution (RR).19 Accordingly, RR measures dam-
ages based on the defendant’s ill-gotten gains rather than the plaintiff’s loss and
seeks to return the beneﬁt conferred. For example, assume that the buyer made a
down payment on the purchase of widgets and the seller used that down pay-
ment to make a proﬁt by depositing the money in the bank and earning interest
on the down payment. If the seller then breached the contract, its proﬁts from
interest on the buyer’s down payment would be the RR. RR requires the offend-
ing party to give up the proﬁts it earned through its misdeeds and turn them over
1. Measures related to the extent of damages
Actual (but-for) damages: caused directly by the defendant’s improper
actions
Consequential damages: a natural and foreseeable, but indirect, conse-
quence of the improper actions
2. Damages measures focused on plaintiff
Compensatory
damages: either
expectation
damages
or
reliance
damages
Expectation damages: the difference between the amount which the
plaintiff reasonably expected to receive and the actual amount
received
Reliance damages: an amount the plaintiff lost because it relied on
false representations from the defendant
3. Damages measure focused on defendant
Restitution (or disgorgement) damages: the amount that the defendant
foreseeably gained at the plaintiff’s expense
4. Other damages measures
Punitive damages: intended to punish or dissuade the objectionable
behavior; not directly tied to the plaintiff’s loss or defendant’s gains
Exhibit 4-1.
Damages Categories
4 6
DEVELOPING DAMAGES THEORIES AND MODELS

to the aggrieved party. Many jurisdictions consider losses suffered as a result of
misrepresentations made by the defendant, or on the contract itself, a part of the
RR damages measure. Although RR sometimes equals BOB or RD, RR will often
be smaller because it does not include the plaintiff’s lost proﬁts (BOB) and it does
not include the plaintiff’s expenditures made in reliance on the contract (RD).20 On
the other hand, ill-gotten gains made by the defendant (RR) may exceed proﬁts
made by the plaintiff (BOB) if the defendant enjoyed certain manufacture or distri-
bution efﬁciencies that the plaintiff did not have. Some courts hold that RR dam-
ages are not limited by the extent of BOB damages, as are RD damages by many
courts.21 (See Section 3.2 of Chapter 3 for more discussion.)
Using an analysis suggested by Professor Eyal Zamir,22 we summarize these
concepts in the following table.
Damages Measured
by Effect on
Injured Party
Damages Measured
by Effect on
Party in Breach
Undoes
the Effect
of the
Backward Looking
Reliance
Restitution
Contract
Forward Looking
BOB (Expectation)
Disgorgement
Breach
We compare damages measurements from these concepts later in this chapter.
While damages can derive from a wide range of actions under statutory, tort, and
contract law, the remainder of this chapter will focus on damages related to con-
tract law.
We next describe some subsets of the compensatory and restitution damages
remedies.
(i) Out-of-Pocket Damages.
Expectation, reliance, and restitution damages can over-
lap with each other to the extent that the damaged party incurred costs in connec-
tion with a breached contract. For example, if the nonbreaching party contracts
with another to purchase a product and pays advance or tooling costs, or incurs
marketing and promotional costs, or undertakes other efforts requiring monetary
or nonmonetary outlay, the court can award the buyer compensatory or restitu-
tion damages for these various costs.
In addition, the remedy of rescission can also involve out-of-pocket damages
claims and recoveries. In all instances, the courts will see that the defendant makes
whole the plaintiff for costs incurred as a direct result of the breached contract.
(ii) Repair Costs.
To return a defective product or do without the product or ser-
vices due under the contract is not always feasible or practical, even where the
deliverable provided represented a breach. Accordingly, the buyer that elects to
repair or mitigate the deﬁciencies will incur costs associated with this effort.
Costs incurred to remedy the breach can be the subject of a compensatory dam-
ages claim. These claims can include legal, technical, and ﬁnancial cost elements.
Repair cost damages afﬁrm the underlying transaction but compensate the
aggrieved party for the cost of setting things right owing to the defendant’s (or
nonperforming party’s) failures.
(iii) Operating Losses and Expenses.
A breach of contract can have serious deleterious
effects on the nonbreaching party, including reduced operating performance,
4.3
DAMAGES THEORY
4 7

higher expenses, and loss of revenue. Even where a company has a history of
operating losses, the breach can cause relatively higher expenses or result in un-
absorbed ﬁxed expenses. The practitioner, however, must recognize that operat-
ing losses that would have been incurred regardless of the defendant’s actions
should be offset against potential lost proﬁt damages in other periods. For exam-
ple, if the plaintiff would have an operating proﬁt in year three, but operating
losses in years one and two, the plaintiff should add all three years together, as-
suming that the plaintiff would not have proﬁts in year three without operating
the business in years one and two also. Similarly, future expenses that the plain-
tiff avoids because of the breach represent cost savings that the analysis should
discount to present values as an offset to potential damages. Careful analysis of
expense patterns can identify inefﬁciencies that result from a breach, causing the
plaintiff to experience higher levels of expense than normal; a compensatory
damages claim should include these excess expenses.
(iv) Lost Proﬁts.
Deﬁnitions for the various types of damages measures run for
more than three full pages in Black’s Law Dictionary, eighth edition, and many of
them fall within the realm of compensatory damages (e.g., beneﬁt of the bargain,
continuing damages, discretionary damages, expectation damages, hedonic dam-
ages, and liquidated damages). In breach of contract cases, however, the most
commonly sought damages measure relates to lost proﬁts. Lost proﬁts represent
the difference between the proﬁts that the plaintiff would have realized but for
the defendant’s actions and the plaintiff’s actual proﬁts. A thorough discussion
of this type of damages follows in Section 4.4 of this chapter.
(v) Consequential Damages.
In addition to the direct damages owed to the plaintiff,
consequential (or special) damages can also occur. As connoted by the name,
courts award consequential damages to compensate a plaintiff in a civil action
for a harm that is not a direct result of an illegal act, but instead a consequence to
that act. In a breach of contract case, the parties can reasonably foresee or contem-
plate consequential damages at the time they entered into the contract.23
Example 1. Consider a builder of a hotel that completed construction on time
but turned over the property with plumbing issues that the owner had to
correct before opening. Direct damages equal repair costs to rectify the
plumbing issues, while consequential damages equal the lost revenue less
saved costs related to the delay in opening the hotel.
Example 2. Suppose a buyer breaches a contract to purchase Product A,
which is jointly produced with Product B, and the breach thereby causes the
plaintiff to alter its production of both products. In this case, the breach
could also cause consequential damages related to Product B.
Example 3. Consequential damages can also arise when a breach affecting
the sales of a complicated machine also affects the subsequent sales of re-
placement parts or maintenance service for the machine.
If damages awards purport to restore the plaintiff to the position it would have
been in but for the defendant’s actions, the damages claim must encompass every
phase of the plaintiff’s business affected by the defendant’s actions. To ascertain
whether consequential damages have occurred whenever the plaintiff has an
4 8
DEVELOPING DAMAGES THEORIES AND MODELS

integrated facility may require that the practitioner or other consultant conduct a
market deﬁnition and market structure analysis not only for any primary product
but also for the joint or co-products. The presence of joint or co-products in the anal-
ysis will also have implications for mitigation. Minimizing the losses for one product
and minimizing a division’s losses can result in two different sets of actions.
(vi) Liquidated Damages.
In certain types of contracts, particularly in the construc-
tion industry, the parties sometimes agree to liquidated damages as a term of the
contract. In these cases, the parties agree to the amount of compensatory damages
associated with particular types of breaches (such as delays in performance) and
make them a part of the contract itself.
(vii) Return of Price.
Sometimes restitution awards can include the return of the
price (consideration) paid by the buyer. Some contracts, particularly in special-
ized manufacturing or research and development, require signiﬁcant advance
payments by the buyer in order for the seller to begin work under the contract.
Assume that the seller fails to perform on the contract owing to the emergence of
a more immediate and proﬁtable opportunity with another customer. As a result,
the buyer procures the required goods or services through an alternative pro-
vider at a higher cost. This breach could result in a restitution damages award
that would cover the return of the advance payments made, as well as compensa-
tory claims for the additional cost of the alternative contract. The restitution dam-
ages relate to the payments made under the contract for which the buyer received
no value. The price could include costs of delivery, handling, freight, warehous-
ing costs, fees, taxes, insurances, and any other costs associated with the purchase
of the product.
(viii) Disgorgement.
Disgorgement requires the surrender of proﬁts earned by the
breaching party through illegal or unethical means. Courts can order wrongdoers
to turn over such proﬁts to the aggrieved party, with interest, to prevent unjust
enrichment. Disgorgement is analogous to the equitable remedies of speciﬁc per-
formance and injunctive relief.24 Courts can award disgorgement in addition to
compensatory and other damages, but only to the extent that the disgorgement
does not duplicate other damages measures. Disgorgement damages depend on
the facts of the case, as well as the jurisdiction. For example, disgorgement is a
frequent remedy in intellectual property cases because of the nature of the harm
caused. Courts have recently awarded disgorgement in areas such as antitrust,
where the defendant remitted disgorged proﬁts to the U.S. Treasury.25 Damages
in copyright, trademark, and trade secret cases permit disgorgement of the
infringer’s proﬁt to the extent that the lost proﬁts calculation does not include
this amount. (See Chapter 18.)
(b) Comparing Beneﬁt of the Bargain, Reliance, and Restitution Approaches.
This
section presents a hypothetical fact situation and the damages computations asso-
ciated with the beneﬁt of the bargain (BOB), reliance (RD), and restitution (RR)
damages measures.
Hypothetical facts:
Buyer purchased ePad Co. for $800 million and expected to earn a 12.5 per-
cent annual return.
4.3
DAMAGES THEORY
4 9

Buyer expected to sell ePad Co. after ﬁve years for $1.5 billion.
ePad’s weighted average cost of capital (WACC) is 20 percent. (As a result,
the ﬁrst year’s cash ﬂow will have a present value factor of 0.83 (¼ 1/1.20).26
Seller fraudulently induced buyer to enter into a deal by representing that no
one else had ePad technology even though the seller secretly helped a friend
introduce a competing product in year two.
Buyer achieved expected cash ﬂows of $100 million in its ﬁrst year of
ownership.
The new competing project came into the market in the beginning of year
two. Buyer closed ePad Co. at the end of year two to mitigate ongoing losses,
suffering $100 million of losses and costs of shutdown during year two; the
company was deemed worthless at that time.
Exhibit 4-2 represents the relevant cash ﬂows from the ePad example.
Calculations of damages:
Beneﬁt-of-the-bargain damages (BOB): Based on the assumptions and cash
ﬂows enumerated above, BOB damages would provide the plaintiff with the
return it expected from the deal had the seller’s representations been true.
Thus, the difference between but-for versus actual cash ﬂows from the time
of purchase (t ¼ 0) to the time of expected sale (t ¼ 5) provides the appropri-
ate measure of BOB damages. As calculated in Exhibit 4-2, discounting fu-
ture cash ﬂows to t ¼ 0 at the weighted average cost of capital of 20 percent
equals BOB damages of $884 million.
Reliance damages (RD): RD-based undiscounted damages would consist of
the $800 million initial investment, less the $100 million return in year one,
plus the $100 million loss in year two. Applying the appropriate present
value factors (PVFs) to adjust for the time value of the cash ﬂows, RD-based
damages would equal $786 million (¼ $800 $83 þ $69).
Remedy of restitution damages (RR): For restitution damages, the practi-
tioner must look at this situation from the viewpoint of the defendant and
calculate its ill-gotten gains. Assuming the seller joined the competing com-
pany that beneﬁted by this breach and they were codefendants, the damages
would include the proﬁts earned by the defendant using the competing tech-
nology. In calculating RR damages, due consideration of the buyer’s plans to
sell the company in year ﬁve may affect RR calculations. For example, if the
seller continued to operate the business beyond the ﬁfth year, the buyer may
have difﬁculty establishing harm beyond the year that he planned to sell the
business in any event and an appropriate terminal value would be required.
In this case, RR damages would normally be substantially less than either
RD or BOB damages, unless the defendant enjoyed various efﬁciencies in
manufacture or distribution that the plaintiff did not possess.
When courts allow more than one method of computing damages, practi-
tioners have many considerations that affect the choice among BOB, RD, and
RR. One can decide based on case-speciﬁc, jurisdictional, and governing law
factors. Other factors that lead to a particular choice relate to the difﬁculty of
measurement, including the following situations:
4 10
DEVELOPING DAMAGES THEORIES AND MODELS

Negative NPV venture
Complex estimations:
New business with no operating history
Business in volatile industry
Few guideline companies
Complex business model
Potential changes in market conditions, such as Porter’s Five Forces:27
1. Increased bargaining power of buyers
2. Increased bargaining power of suppliers
3. Reduced barriers to entry
4. Increased competition
5. Increased threat of substitutes
As noted previously, practitioners should obtain from counsel the form(s) of
damages that the law prescribes. They should then evaluate and build their anal-
ysis with an eye to which available measure best ﬁts the facts of the case and cap-
tures all of the damages consistent with applicable law.
(c) Punitive Damages.
Punitive damages (also called exemplary, vindictive, presump-
tive, and added damages) are special damages awarded in addition to actual dam-
ages. They function to penalize the wrongdoer or deter others from engaging in
similar wrongful acts. Courts often award them when the defendant exhibited
malicious, deceitful, or particularly reckless or reprehensible conduct. Courts do
not award punitive damages in breach of contract matters.28
The court decides on the amount of punitive damages pursuant to Supreme
Court guidance. (Chapter 16 discusses the reasons for awarding punitive dam-
ages and the reasonableness of amounts awarded.) In some litigation, including
willful patent infringement or antitrust violations, the court can award treble
damages under statute as a particular type of punitive damages. Judge Posner
suggests that one should consider the difﬁculty of concealment when awarding
punitive damages. For example, if the probability of discovery of a tort equals
10 percent and the optimal damages award equals $60, the amount of punitive
damages should equal $600 (¼ $60/.10).29 Where liquidated damages provided
in a contract exceed the actual damages likely to be caused by a breach, the court
has discretion to treat some of the damages as punitive damages.
(d) Rescission or Rectiﬁcation (or Reformation).
Certain equitable remedies under
the law give rise to damages claims. Rescission of a contract means that the con-
tract should be undone, the agreement unwound, and the parties returned to
their pre-contract position.30 Rectiﬁcation (or reformation) of a contract involves
modifying its terms to reﬂect what the parties intended to say or “should have
said” or to avoid an egregious inequity in the outcome.31 Neither rescission nor
rectiﬁcation are themselves damages theories, but both commonly set the stage
for damages claims.
Reasons for undoing or reforming the terms of a contract include (1) poorly
drafted contracts and (2) fraud. First, sometimes the complexity of a transaction
results in a poorly or inadequately written contract. That is, the drafted contract
fails to reﬂect the bargain contemplated by the parties. Second, when one of the
4 12
DEVELOPING DAMAGES THEORIES AND MODELS

parties to a contract alleges fraud, that party often seeks rescission. For example,
suppose false information in an insurance policy application induces an insurer
to write a policy that it would not have issued under its underwriting standards
had the policyholder provided all of the accurate facts. Thus, the policyholder
induced the insurer to contract with the policyholder under false pretenses.
When the insurer establishes this fact situation, the court often awards rescission
of the insurance contract, relieving the insurer from any obligations under the
contract. Parties to the case retain forensic accountants to help establish the facts
or veracity of information in the contracting process, or to show ﬁnancial harm to
a party that relied on the fraudulent information used to induce agreement to the
contract. This in turn can form the basis for a damages claim in addition to the
equitable remedy of rescission.
(e) Other Considerations
(i) Anticipatory Breach.
Anticipatory breach occurs when either the buyer or seller
to a contract informs the other party that it will not perform its duties under the
contract. Either the breaching party informs the nonbreaching party or the non-
breaching party assumes that a breach has occurred because of the behavior of
the breaching party. The nonbreaching party can sue when the anticipatory
breach occurs; it does not need to wait until the time when the breaching party
would have performed its duties under the contract.32
An anticipatory breach can result in an efﬁcient result. Assume that Seller A
and Buyer B have contracted for 1,000 widgets at 10 cents per widget (or $100).
Seller A expects a proﬁt of 2 cents per widget (or $20). Buyer B ﬁnds Seller C who
will sell it the widgets for 6 cents (or $60). Buyer B is better off with an anticipa-
tory breach with Seller A and completing the contract with Seller B. Instead of
paying Seller A $100, Buyer B pays Seller A his lost proﬁts of $20 and pays Seller
C $60 for the performance of the contract, for a total of $80. Buyer B is $20 better
off because of its anticipatory breach. On the other hand, we knew in our example
Seller A’s lost proﬁts beforehand. Because Seller A’s lost proﬁts must meet the
reasonable certainty standard, complications can ensue where the contract in
question is long-term and the market for the product in question is thin.33
(ii) Effects of Competitive Markets.
The competitiveness of the market involved in the
litigation determines whether actual sales during the period of breach repre-
sented additional sales that would have occurred anyway or replaced the lost
sales attributable to the breach. For example, with a perfectly competitive market
for the plaintiff, the expert should assume that the plaintiff sells at the level justi-
ﬁed by cost considerations and capacity. (Even plaintiffs who could sell more
would not unless they were willing to use higher cost capacity or to invest in
extra capacity, a consideration we ignore for now.) In other words, the seller can
ﬁnd all the customers it wants. Now a customer breaches the contract. In a per-
fectly competitive market, the expert should assume that the seller could ﬁnd an-
other customer to take the breaching buyer’s amount. The only compensation
owed the plaintiff would equal the difference in the two buyers’ prices, if any
such difference existed.34
On the other hand, assume that the market has long-term contracts and few
buyers and the seller has extra capacity. Now one of the plaintiff’s buyers
4.3
DAMAGES THEORY
4 13

breaches, and subsequently the plaintiff makes sales to a new buyer (or addi-
tional sales to a present buyer). Here one can argue that the new sales do not
replace the breached amount and that the court should consider the full amount
of the breached contract as lost sales.35 Thus, experts who do not ﬁrst analyze
the plaintiff’s market and capacity can ﬁnd their conclusions vulnerable to
close scrutiny.
Suppose a buyer breaches the contract before, or shortly after, the seller has
begun performance. Should the seller receive its expected lost proﬁts (expectation
damages) or only the costs it incurred in reliance on the buyer’s performance (re-
liance damages)? The answer depends on the situation. A contract formed in a
competitive market with symmetrical information between the buyer and seller
can call for expectation damages. Otherwise one may ﬁnd that although expect-
ation damages present a solution to the problem of inefﬁcient breach (i.e., when
the costs related to the breach exceed its beneﬁts), reliance damages present a so-
lution to inefﬁcient purchase (i.e., when high-cost customers buy more than the
efﬁcient quantity and low-cost customers buy less than the efﬁcient quantity).36
(iii) Ex Ante versus Ex Post.
As noted above, a damages award should restore the
plaintiff to the position it would have been in but for the defendant’s actions. But
complications can occur when one considers the goal of deterrence and the pas-
sage of time. What if the plaintiff’s economic damages are less than the defend-
ant’s ill-gotten gains? For example, suppose the defendant steals a $1 lottery
ticket that has the possibility of paying out $20 million. One week later the holder
of that lottery ticket wins and receives $20 million. Are the damages of the theft $1
(the value of the lottery ticket at the time of the theft) or $20 million (the value of
the lottery ticket later in time)?
Ex ante damages describe the compensation that the plaintiff should receive to
place it in the position it would have been in before the defendant’s actions. Ex
ante damages use only information known or knowable before the date of the ac-
tion in question and ignore what happens afterwards. One computes damages as
of the date of the act in question. Ex ante damages would equal $1 in the case of
the lottery ticket. Ex post damages instead would use all available information
and would measure damages as of the time of the analysis. Ex post damages
would equal $20 million for the stolen lottery ticket. Chapter 5 discusses these
issues in greater detail.
(iv) Newly Established Business.
A difﬁcult proposition to establish for an expert will
be the lost sales or revenues for a newly established or never-established busi-
ness.37 Courts now hold that such businesses can recover damages, provided
they have been proved with “reasonable certainty.”38 As a result, the expert
needs to ascertain the plaintiff’s market structure. If the plaintiff’s market con-
tained many small ﬁrms or a few large ones, an expert should know where a ﬁrm
of the plaintiff’s expected size would ﬁt along this spectrum. If the plaintiff would
have been a small competitor in a market composed chieﬂy of large competitors,
the plaintiff’s expert has to prove that the plaintiff still could have competed in
such a market. Experts also need to consider ease of entry and the stability of
existing ﬁrms in the industry. If the plaintiff asserts that its ﬁrm would have had
an advantage over other competitors because of a patent or other new process but
for the defendant’s actions, the expert must make some reasonable assumption
4 14
DEVELOPING DAMAGES THEORIES AND MODELS

regarding how long the beneﬁts conferred by the patent or new process would
last.39 Regardless of the method used to estimate the plaintiff’s lost sales, the
expert should have some economic underpinning for the assumptions.
(v) Damages for Fraud.
The prevailing approaches for damages in fraud claims are
BOB and out-of-pocket damages. In these matters, the plaintiff can, but need not,
ask the court to proceed as though the plaintiff wishes to carry out the contract.
That is, the plaintiff can ask the court to remedy the damage done by the fraudu-
lent activities or, in the alternative, unwind the transaction and rescind the con-
tract. If the court calculates damages based on the assumption that the plaintiff
would carry out the contract, BOB damages provide the usual remedy; reliance
damages apply in the rescission scenario. A minority of jurisdictions recognize
other possible techniques for evaluating damages; practitioners should conﬁrm
the allowable techniques with counsel.
4.4
MODELING CONSIDERATIONS
This section identiﬁes various modeling techniques used for damages claims.
Many of the speciﬁc methods of calculating damages use these techniques. This
section will note those that have limited application to certain types of cases;
others have broadly accepted application across case types, jurisdictions, and
court systems.
(a) Use of Averages and Indexes.
The use of an average (or the mean) is a basic,
but sometimes necessary, technique used in damages claims. Practitioners
employ them when they cannot obtain sufﬁcient evidential matter that provides
a more accurate or reliable mechanism for estimating a value. For example, aver-
age revenue growth over an historical period could offer the only reasonable
means of estimating revenues during a but-for period where the resources
needed to provide insight into market trends and the likely impacts of the ad-
verse event are unavailable. Similarly, if useful data regarding cost trends are un-
available, practitioners can analyze averages across time, across an industry, or
across operating units.
In some instances, such as litigation of insurance claims, convention employs
the use of averages because developing and adjusting an insurance claim often
uses unsophisticated or expedient estimation techniques in developing the
underlying policy loss claim. Consequently, counsel and clients often do not
want to develop another, more sophisticated damages model for use in litigation,
absent other driving factors. This mindset reﬂects cost consciousness: the likely
difference that could result from more sophisticated techniques often does not
justify the added cost and complexity of using them. Practitioners also use aver-
ages when analyzing stable, mature businesses with predictable growth patterns
in revenue and cost.
On the other hand, the use of averages can mislead the analysis (as further
discussed in Section 4.4(g)),40 especially when used as a benchmark in but-for
comparisons. For example, suppose a practitioner draws a trendline average
based on a large number of disparate data points and then attributes damages to
a breach because sales fell below the trendline average. The opposing practitioner
4.4
MODELING CONSIDERATIONS
4 15

could easily refute this claim if most data points fell below the trendline but were
offset by a few skewed data points that fell well above the trendline (see the
Monte Carlo simulation discussion in Section 4.4(g)). In such instances, the use of
averages will present signiﬁcant risk to validity of the practitioner’s analysis.
Some analysts seek to mitigate this risk by using indexes and other broader-
based averaging techniques that can provide further corroboration for the use of
a company-speciﬁc average ﬁgure. For example, some practitioners compare a
company’s ﬁnancial performance and share price to a stock market index, such
as the S&P 500, to establish the relative effect of broader market variables for all
market participants versus the subject company’s results. But the practitioner
needs to justify the use of these indexes as an appropriate mechanism of compari-
son or they will be no more defensible than basic averages in proving damages.
(b) Use of Ranges.
Some courts allow or prefer the presentation of damages as a
range of results. Because damages claims often use but-for scenarios based on
analysis of events that might have occurred but for an alleged wrong, they are
inherently uncertain. Some courts ﬁnd the presentation of a single damages ﬁg-
ure objectionable when a certainty of knowledge of what would have occurred is
usually impossible. In these cases, practitioners often modify key assumptions to
generate a range of likely outcomes based on the probabilities of various assump-
tions coming to pass. This also allows practitioners some ﬂexibility in explaining
how they developed their damages conclusions. They should discuss with coun-
sel the court’s conventions and preferences when deciding whether to use ranges
versus speciﬁc damages ﬁgures.
(c) Lost Proﬁts versus Lost Business Value.
Commercial disputes involve claims of
lost income or lost business value41 or both. Sometimes the claims include loss of
future earnings or lost goodwill. How do practitioners differentiate among these
damages elements and when should each be used? The courts have not provided
consistency in distinguishing among these remedies. Some courts have ruled that
they are redundant or overlapping; others have allowed claims and awarded dam-
ages under more than one of these theories. Federal and state laws provide differ-
ent remedies depending on the substantive issues in the case and the types of
claims brought by plaintiffs. This section will clarify the proper theoretical applica-
tion of these measures, but practitioners should conﬁrm with counsel the local
court history and perspective on damages before concluding on the method to use.
As previously described, we deﬁne lost proﬁts as the difference in proﬁts be-
tween (a) what the plaintiff would have earned but for the defendant’s actions
and (b) the actual proﬁts made by the plaintiff. In this context, lost proﬁts usually
refer to lost cash ﬂows, but the practitioner must match the measure to the dam-
age suffered. Lost business value addresses the negative impact of the impaired
earnings (cash ﬂows) on the overall value of the business. The time period over
which the practitioner measures the lost proﬁts, as well as the portion of the
plaintiff’s business affected by the defendant’s actions, can result in different
computations for lost proﬁts and lost business value. If the defendant’s actions
caused the plaintiff to lose 100 percent of its cash ﬂows, however, the damages
from the lost proﬁts analysis, the lost cash ﬂow analysis, and the lost business
value should equal each other, ceteris paribus (all else being equal).
4 16
DEVELOPING DAMAGES THEORIES AND MODELS

Practitioners usually derive revenues for a lost proﬁts analysis using one of
four approaches:
1. Before-and-after approach. Comparing the performance of the company
before and after the alleged harmful acts.
2. Forecast approach. Using sales forecasts of expected performance for the
business or industry to evaluate the probable effect of the harmful acts.
3. Yardstick approach. Comparing the harmed business to comparable but
unharmed businesses or locations to assess but-for results.
4. Market share approach. Comparing the plaintiff’s market share during the
period prior to the harm to that of the ﬁrm afterward.
From these revenues, the practitioner subtracts the appropriate amount of costs.
Similarly, practitioners usually measure business value by comparing the
before-and-after values of the business using one of three approaches:
1. Discounted cash ﬂow approach: measures the present value of future earn-
ings that the owners of the business would receive.
2. Market approach: evaluates what informed capital market investors would
pay for shares in the company (generally, the market capitalization for pub-
licly traded companies).
3. Comparable company transaction approach: refers to recent transactions
involving the purchase or sale of comparable companies within a reason-
ably recent period of time.
The terms loss of future earnings and lost goodwill refer to the same measure of
damages as loss of business value because the various valuation approaches ac-
count for the effect of the defendant’s actions on the cash ﬂows and thus the value
of the business. A loss of goodwill will lead to reduced cash ﬂows, which factor
into the valuation.
Lost proﬁts and lost business value can be redundant terms because the business
value equals the discounted value of the stream of anticipated future earnings. How-
ever, the practitioner must ensure that a damages analysis does not inadvertently
make duplicate claims: the law does not allow for double recovery of damages. For
example, lost proﬁts and lost business value should not cover the same time periods.
Lost business value measures of damages are the appropriate measure when
the defendant’s injurious acts have destroyed a business. Lost proﬁts measures
are appropriate when the defendant’s actions have negatively affected, but not
destroyed, a business or when damages occur over a ﬁnite period. For example,
the breach of a ﬁve-year supply contract after the ﬁrst year would deﬁne the dam-
ages period for lost proﬁts analysis as the ensuing four years. Some cases involve
a period of impairment followed by a complete cessation of the business. Damages
analysis for these cases can include both lost proﬁts and lost business value ele-
ments, with the dividing line being the date of business demise. Note that claims
for so-called diminution of the value of a business are lost proﬁt claims—lost busi-
ness value claims only apply to the destruction of a business. The practitioner must
avoid overlap of these periods in the calculations to avoid duplicate claims.
(d) Time Considerations.
Time is a critical component of damages calculations:
inception and duration of the damages inﬂuence both underlying data and risk
4.4
MODELING CONSIDERATIONS
4 17

factors that affect cash ﬂows and discount rates. Damages have no universally
accepted valuation date. Accountants and economists often disagree whether to
measure damages at the date of violation, the date the violation ceased, the date
of trial, the date of recovery, or some other date.42 We show the effects of these
differences below.
Assume that the date of contract breach is January 2, 2010, the date of trial is
May 15, 2012, and the date of the ﬁnal judgment is April 20, 2013. Also assume
that the damages measurement involves ﬁve years of cash ﬂows (2010–2014).
Damages calculations as of the date of violation. The practitioner should
discount the ﬁve years of cash ﬂows (2010–2014) to January 2, 2010. Then the
practitioner should bring the damages amount forward using a prejudgment
interest rate to the time of trial (May 15, 2012).
Damages calculations as of the time of trial. Lost proﬁts calculations per-
formed as of the date of trial will not require prejudgment interest. The prac-
titioner should bring the cash ﬂows for periods prior to trial (January 2, 2010,
through May 15, 2012) forward to the time of trial and the cash ﬂows for
period post-trial (May 16, 2012, through 2014) backward to the time of trial.
Damages calculations as of the ﬁnal judgment or recovery. Where a great
deal of time passes between trial and the issuance of the ﬁnal verdict, some
courts permit the parties to recalculate the ﬁnal judgment as of the date that
the court rendered that judgment. That is, the amount calculated at trial in-
creased to reﬂect that the plaintiff did not have use of the recovery between
the time of trial and the time the court rendered its ﬁnal judgment.
The risk factors relevant to different measurement dates will also bear on the
valuation of both lost proﬁts and lost business value measures. The practitioner
can account for differing risk factors (such as market changes, operating differ-
ences, economic conditions, and new competition) either through adjustments to
the anticipated cash ﬂow streams or through adjustments to the discount rate, but
not both.43 The practitioner should avoid adjustments to both to prevent redun-
dant consideration (double counting) of a risk factor.
(e) Causation.
Courts too often ﬁnd that damages analyses do not adequately ad-
dress the issue of causation. Many times, counsel instructs the practitioner to rely
on the analysis and opinions of others. This instruction can put the practitioner,
and the case at large, on thin ice. A damages analysis that does not clarify the
proximate cause link between the defendant’s acts and the plaintiff’s damages
will fail court scrutiny. The court will often label the damages estimates as specu-
lative and would likely bar the damages measurement from evidence. The dam-
ages claim must consider all other material factors that could have affected the
plaintiff’s ﬁnancial results and develop sufﬁcient evidential support for the nexus
between the claimed damages and the defendant’s wrongdoings.
Practitioners can use several tools to establish and measure relations among
the variables that affect revenues and costs, and thus establish the causal link and
measure the negative impact on proﬁts. Sections 4.4 (f) through (j) discuss impor-
tant analyses used in properly developing damages claims that appropriately
consider these factors in the following sections.
4 18
DEVELOPING DAMAGES THEORIES AND MODELS

(f) Regression Analysis with Conﬁdence Interval.
Regression analysis applies a sta-
tistical technique to develop an equation depicting the relation among variables
and then uses that equation for prediction.44 For example, an expert who needs
to predict the sales that a ﬁrm would have made but for the defendant’s actions
could use a regression analysis that models the relation between the ﬁrm’s sales
and other relevant factors (e.g., total industry sales) over a control period preced-
ing the defendant’s actions to predict but-for sales in the absence of those actions.
Similarly, an expert who needs to estimate how a share would have performed
but for some event can predict this by performing a regression analysis. This re-
gression analysis might relate an investment in the ﬁrm’s share to an investment
of the same size in a portfolio of shares in the same industry or in the market.
The regression analysis also provides other relevant information such as the
statistical signiﬁcance of the relation among the variables, the degree of explana-
tion afforded by the equation, and the ability to construct conﬁdence intervals
around the estimate. Hence, the technique not only provides predictions but also
explicitly describes the strength or stability of the predictions.
Assume that an expert has constructed an equation that models the sales of
Firm A as a function of total industry sales. Now the expert would like to know
whether the sales of Firm A relate to the total industry sales, that is, whether this
variable helps explain the movement of the ﬁrm’s sales. The t-statistic generated
by the regression analysis will help the expert assess whether the variable has
signiﬁcant explanatory power. The expert can also check the coefﬁcient of deter-
mination (often called the R-squared) to measure the amount of the change in the
ﬁrm’s sales explained by the total industry sales.
Although regression analysis produces an unbiased estimate, certain data rela-
tions can occur that obscure or overemphasize the estimates. See Chapters 7 and 8
for more discussion on regression analysis.
(g) Monte Carlo Simulation.
Assume that the two parties in litigation need to
value a mine. Both sides agree that the mining operation can recover one million
tons of the mineral and that the incremental cost of mining the material equals
$10 per ton. Both sides also agree that the mineral has an uncertain future price,
ranging between $4 and $20 per ton, with an average of $12 (that is, the mean of
the two extremes). The defense argues that the court should base the value of the
mine on the average price of $12, leading to a valuation of $2 million [¼ 1,000,000
($12 $10)]. However, the average value of the property exceeds this because
if the mineral price drops below $10, the mine has the option to shut down, limit-
ing cost when the low price precludes extraction. In other words, if the price
drops to $8, the mine would not operate at a loss ($2 ¼ $8 $10), but would
cease operating until the price rose above $10. On the other hand, if the price
rises, no such limitation exists on the upside. At any price above $10, the mine
would operate. This example illustrates the principle that evaluating formulas
using average values of uncertain inputs does not result in the average value of
the formula. Mathematicians refer to this result as Jensen’s Inequality; Sam Sav-
age also pioneered much of the work in this ﬁeld.45
Monte Carlo simulation is a well-accepted valuation technique that avoids this
ﬂaw of averages (a term coined by Sam Savage). The mathematician Stanislaw
Ulam developed the Monte Carlo approach while working on the Manhattan
4.4
MODELING CONSIDERATIONS
4 19

Project. As the name implies, the approach resembles testing a gambling strategy
by repeating thousands of rolls of dice and recording the results. Suppose that a
damages calculation depends on several uncertain variables—an interest rate that
ranges between 2 percent and 28 percent; a price that ranges between $10 and
$40; and a cost that ranges between $1 and $12—but each uncertain variable has
its own pattern of probabilities. That is, certain interest rates will more likely oc-
cur than others and the pattern of probabilities for interest rates differs from the
patterns for prices and costs. A Monte Carlo simulation can easily calculate multi-
ple scenarios of a model by repeatedly sampling values from the probability dis-
tributions for each of the uncertain variables. The simulations can consist of as
many trials (or scenarios) as the expert wants—hundreds, or even millions. Dur-
ing a single trial, the model randomly selects a value from the deﬁned possibili-
ties (the range and shape of the distribution) for each uncertain variable and then
recalculates the value. The average of these outcomes would equal expected dam-
ages. The method offers, as a side beneﬁt, measures of dispersion of the average
estimate.
(h) Discounting.
Many empirical studies on discounting require consideration of
capital market risk.46 For example, in a present value analysis, the practitioner
discounts cash ﬂows to a speciﬁc date and the discount factor the practitioner
uses should reﬂect in some cases the market and industry effects of each period.
Experts can estimate the appropriate discount rate.
Practitioners often use the capital asset pricing model (CAPM) to estimate the
appropriate discount rate (see Chapter 9). CAPM deﬁnes the return of a ﬁrm as the
risk-free rate of return (usually measured by the return on short-term T-bills) plus
the difference between the return on the market and the risk-free rate of return
(otherwise known as the risk premium) times the ﬁrm’s beta (the measure of the
ﬁrm’s market risk).47 A practitioner using the CAPM could develop a discount fac-
tor for the present value analysis that would incorporate not only the effects of
cash ﬂows occurring in different time periods but also the return that the market
and the speciﬁc ﬁrm experienced. Hence, an expert could more precisely measure
what an expected cash ﬂow occurring in Period 6 would equal in Period 0.
Practitioners must also deal with the effect of leverage (or debt). The presence
of debt that a company must pay before the shareholders receive any return
makes the shareholders’ investment relatively riskier. The discount factor for a
ﬁrm’s assets will therefore differ from the discount factor for the ﬁrm’s equity by
the amount of risk represented by debt.48 If the practitioner measures lost cash
ﬂows after deducting interest, the practitioner should use the ﬁrm’s equity beta
in developing the correct discount rate. On the other hand, if the practitioner
measures lost cash ﬂows before deducting interest, the practitioner should use
the ﬁrm’s asset beta in developing the correct discount rate (or use the ﬁrm’s
weighted average cost of capital).
(i) Prejudgment Interest.
A practitioner who has used a discounted cash ﬂow
analysis to evaluate the plaintiff’s lost proﬁts will need an interest rate to bring those
cash ﬂows forward to the time of the trial from the base point of the analysis—
and if enough time passes between the trial and recovery, to the time of the ﬁnal
judgment. (This assumes that the jurisdiction or particular cause of action permits
4 20
DEVELOPING DAMAGES THEORIES AND MODELS

prejudgment interest—see Chapter 15.) At the very least, this interest rate should
reﬂect the value that the plaintiff’s funds have lost owing to inﬂation. This measure,
however, will not compensate the plaintiff for the opportunity costs of the use of
its funds.49
Some experts suggest using the defendant’s debt rate50 while others invoking a
similar theory prefer the risk-free rate51 to measure prejudgment interest. Others
suggest using the plaintiff’s cost of capital, that is, a measure of the opportunity
cost to the plaintiff (of course, at this point the defendant can argue that by doing
so, the plaintiff seeks consequential damages). The defendant’s borrowing rate
offers another measure because it regards the plaintiff’s claim as an investment
(albeit an involuntary one) in the defendant.52
Because confusion still abounds in the courts as to the meaning and proper
application of lost proﬁts, lost business value, appropriate valuation dates, dis-
count rates, and risk factors, practitioners should address these issues early in the
process through discussion with counsel to ensure proper consideration of juris-
dictional nuances and accepted approaches for the type of matter at issue.
(j) Damages for Different Types of Cases.
Certain types of cases have developed a
body of case law and have established precedents for methods of calculating
damages that nearly all practitioners use and nearly all courts recognize as the
most appropriate means of measuring damages. Examples include royalty rate
calculations in patent matters, market share analyses in antitrust matters, trend-
line analysis in business interruption insurance cases, and event studies in securi-
ties cases. The courts broadly (or even universally) apply some of these
precedents; other precedents are jurisdictional or even speciﬁc to a judge. We ad-
vise discussion with counsel to discern or conﬁrm these differences.
We also note that while some damages methods have academic support (for
example, see Chapters 24 and 25 for a discussion of the use of event studies in
securities cases), other damages measurement methods do not. Damages mea-
surement methods lacking an economic basis or support within the academic
community carry additional risk. Recently in Uniloc USA Inc. v. Microsoft,53 the
Federal Circuit unanimously struck down the use of the 25 percent rule in patent
damages cases. Although the court noted this measurement method had general
acceptance, the court also stated that this measure of damages was unrelated to
the facts in the case and was inadmissible under the Daubert guidelines.
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
Practitioners have no prescribed or universally accepted model for developing a
damages claim but experienced practitioners employ methods that will improve
the efﬁciency and effectiveness of the process and the results.
(a) Learn the Background.
Practitioners should ﬁrst understand the facts of the
case and the liability issues related to causation of the alleged damages. They
should review the relevant pleadings in the case that address damages (including
the complaint and answer) and discovery-related documents such as interrogato-
ries, depositions, and requests for admissions. Counsel often amends complaints
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
4 21

and answers, so the practitioner should review the most current pleadings. In ad-
dition, the practitioner should discuss the case background and liability assump-
tions with counsel to conﬁrm the basis giving rise to the claim. For some matters,
the practitioner will ﬁnd media coverage in either mainstream or industry-
speciﬁc sources. A search of the Internet can also yield useful background infor-
mation for some matters.
With the participation of counsel, the practitioner can obtain relevant back-
ground factual information from representatives of the company for whom the
practitioner performs the analysis. It is prudent, however, to recognize that infor-
mation obtained from a party to the litigation should be scrutinized with profes-
sional skepticism to avoid accepting potential bias in that information. Industry
research and company-speciﬁc research often yields a wealth of information that
provides insight into the substantive issues of the case; this can also prove useful
when the practitioner develops assumptions for the damages analysis. The bene-
ﬁts of learning the case background extend beyond the obvious need to under-
stand the ﬁrm’s operations and the effect thereon of the events in question; they
include helping the practitioner identify other potential factors that affected the
operations and incorporate them in the analysis.
(b) Understand Causation and Its Effect.
The harmful acts identiﬁed in the com-
plaint will likely provide a framework to begin understanding causation and
effects of the harm. However, most complaints and pleadings lack substantive
proofs of cause and effect; these are the requirements of trial and often the prov-
ince of the practitioner to prove. The practitioner should use the knowledge
gained in learning the background of the case to begin associating the defendant’s
injurious acts with the plaintiff’s damages. Other experts in the case (economists,
industry experts, engineering and other technical experts, and medical profession-
als) often establish causation. Nevertheless, the practitioner should not blindly
accept the conclusions of others without exercising due professional skepticism
in applying these conclusions to the facts of the case and observed effects on the
business. This becomes less complex when practitioners can establish causation
through their own work, but is nearly always a necessary step. Triers of fact will
look for a nexus between the actions of the defendant and the damages to the
plaintiff and will expect practitioners to establish that connection based on their
own work or through that of other experts. Practitioners can accomplish this
through a combination of applying logic to the facts, using targeted analytics,
and rebutting other possible explanations. Knowledge of company practices,
industry conventions, technical methods, competitive behavior, accounting re-
quirements, and economic principles are all important in analyzing potential
effects and building the foundation for causation arguments.
(c) Identify the Damages Theory.
As discussed throughout the chapter, many fac-
ets of damages analysis depend on the applicable law of speciﬁc jurisdictions or
the circumstances of each case. Accordingly, we iterate that the practitioners
should work with counsel to ensure that the damages categories in the model
comport with those pled and with the law from both a liability and quantum per-
spective. For example, the practitioner should discuss and understand whether
the plaintiff is seeking rescission of the contract, or afﬁrmation of the contract
4 22
DEVELOPING DAMAGES THEORIES AND MODELS

with correction of the breach, or recovery of costs, or some other remedy. Ascer-
taining the objectives of the legal action will shed light on the available remedies
and in turn the damages theories that can underpin a damages claim. Sometimes
the plaintiff seeks a combination of equitable remedies and other legal remedies,
such as damages. The plaintiff could have suffered losses for which it seeks com-
pensation or could have lost opportunities for which it seeks restitution. In some
cases, there are claims for both, which may be recovered so long as there is no
duplication of the losses. Understanding the damages theory will allow the prac-
titioner to identify appropriate models for an informed discussion with counsel.
(d) Select the Damages Model.
Several factors affect the selection of an appropri-
ate damages model:
An understanding of the background of the case;
Knowledge of the causation of damages and the effect on the company of the
defendant’s injurious actions;
Veriﬁcation of acceptable damages theories for the jurisdiction and matter at
hand;
Practices accepted by professional peers and academics;
Consistency with the damages suffered; and
Avoidance of redundancy (if using multiple models).
For example, a royalty rate model is both commonly accepted and well suited
to assessing patent infringement damages because it applies an appropriate valu-
ation of the patented technology to the effect of lost sales usurped by the infring-
ing party. Once practitioners identify the appropriate model and conﬁrm its use
with counsel, they should begin to build the damages claim.
(e) Build the Damages Model—Lost Proﬁts Scenario.
A discussion of all the various
methods of preparing damages claims could ﬁll an entire book. Other chapters in
this book provide guidance on particular types of litigation and the claims that
naturally ensue in those matters. Thus, we limit this discussion to the develop-
ment of a lost proﬁts claim, although most of the steps identiﬁed (if not the spe-
ciﬁc procedures described) pertain to most damages analyses. Our scenario
presents the steps from the viewpoint of the plaintiff, but the same activities
occur regardless of which side of the litigation the practitioner represents. One
develops knowledge about important factors and considerations (e.g., back-
ground facts, contract terms, causation, damages theory (including recovery
objectives)) and ramiﬁcations of the breach before undertaking to build the dam-
ages model. Building the damages model concerns the quantum of loss claimed.
(i) Identify the Damage Period.
While the attorneys will likely have already identi-
ﬁed the key dates relevant to the damage period, the length of this period has
important implications for revenue and cost measurements; the attorney’s
assumptions should be critically reviewed by the damages expert. For example,
over a long enough period, almost all costs vary, and over a short enough period,
almost all costs remain ﬁxed. With a shorter period, practitioners will subtract
fewer indirect cost items from the lost sales revenues to estimate lost proﬁts. In
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
4 23

any event, practitioners who ignore this issue can arrive at the wrong answer
even though they have correctly made all the other assumptions in the analysis.
At a minimum, the practitioner must ascertain whether the lost proﬁts apply only
to the period of the contract term or have ramiﬁcations beyond the contract that
the practitioner will express as an ongoing detrimental impact to the business.
Identifying this period will deﬁne one of the most important parameters of the
damages claim.
(ii) Identify Assumptions and Estimates Needed for the Particular Case.
Practitioners who
calculate lost proﬁts damages must understand how to create a but-for world,
because such claims require assessing what would have happened to a business
had the defendant’s injurious acts not occurred. When practitioners need to make
conjectures, they develop and rely on supportable assumptions and estimates
that must hold up under the counterparty’s scrutiny. Thus, practitioners should
identify the elements of a damages analysis as
Undisputed facts, or
Estimates (and the estimation process), or
Assumptions (and the support for those assumptions).
An overabundance of estimates and assumptions can lead to a damages claim
that practitioners will ﬁnd difﬁcult to defend.
Practitioners frequently ground undisputed facts in lost proﬁts claims in either
the contract terms or certain veriﬁable key metrics (for example, actual sales vol-
umes, revenues, and ﬁxed-cost items). Practitioners obtain this information
through data that are readily available or subject to independent conﬁrmation.
Practitioners sometimes need to make estimates concerning many key ﬁnancial
components of the model (for example, levels of sales returns, bad debts, pur-
chase volumes and discounts available, and ramp-up rates on new product intro-
ductions). Practitioners base these on analyses of historical results achieved,
regression analysis of relevant variables, or other analytical procedures. Assump-
tions usually involve broader parameters of the but-for world (e.g., inﬂation rates,
price and demand elasticity, relevant market size and share, and interest rate
trends). Some practitioners do not recognize any practical distinction between
estimates and assumptions and use the term assumptions in referring to all subjec-
tive factors in the analysis.
(iii) Build the Foundation for the Damages Claim.
The process of building the foundation
for the damages claim is partly defensive and partly practical, but is always neces-
sary. Without sufﬁcient foundation, the practitioner cannot establish the defend-
ant’s injurious acts as the proximate cause of the claimed losses; this omission can
render the damages claim speculative and inadmissible. Even assuming another
expert established causation, an inadequately researched, documented, and sup-
ported claim can fail to meet professional standards, survive a Daubert challenge,
or prevail against the counterparty’s arguments. A proper foundation will include
supporting documentation, corroborative evidence, use of methods accepted by
professional peers, and conformance to the law and precedent in the jurisdiction.
Practitioners must address many considerations in a lost proﬁts analysis. Some
of them are conducive to analysis using sophisticated modeling, including regres-
sion analysis and game theory. However, adequate or reliable data are not always
4 24
DEVELOPING DAMAGES THEORIES AND MODELS

available for these models. Nevertheless, the practitioner would be remiss in not
adequately considering the factors described below, even if the practitioners can-
not employ preferred modeling techniques.
Company knowledge. The practitioner will have gathered signiﬁcant infor-
mation for the lost proﬁts model during earlier activities in the process of
evaluating the damages claim. The practitioner must now synthesize this di-
versity of knowledge and organize it to help develop and support the lost
proﬁts analysis. The practitioner should understand the company’s opera-
tions, markets, and management practices; these factors help explain the
negative impact on the company’s proﬁts. They also help the practitioner
account for other factors that could play a role in the company’s ﬁnancial
performance and explain the nature and duration of any negative effects
caused by factors other than the breach. Hence, the practitioner gathers this
body of knowledge for application to the damages claim model.
Pre-breach budgets and forecasts. Practitioners can review pre-breach bud-
gets and forecasts to help them understand the company’s expectations be-
fore the defendant’s injurious acts occurred. These documents can provide a
wealth of corroborative information about management’s expectations con-
cerning the operations of the business, its revenue plans, cost structure, and
investment plans. Most lost proﬁts models will employ more sophisticated
analyses to establish lost revenues and cost ramiﬁcations of a breach. (Sec-
tion 4.4(f) and Chapters 7 and 8 include discussions on regression analysis
that we will not repeat here.)
Certain matters involve loss models that derive from the underlying con-
tract, such as business interruption insurance claims. In these cases, practi-
tioners may use pre-breach budgets or forecasts as a basis for estimating
but-for revenues and costs. For example, to test and gain comfort on the fore-
casting accuracy previously achieved, an analyst could use a pre-loss budget
as the basis for cost estimates by performing regression analysis of historical
budgeted costs and actual results for the corresponding period. Aside from
these relatively limited applications, budgets and forecasts are largely bene-
ﬁcial only as corroborating evidence; the practitioner will need to explain
where they differ signiﬁcantly from modeled lost proﬁts.
Analysis of historical performance. Most practitioners consider the histori-
cal ﬁnancial performance of the subject company in validating estimates of
but-for performance, regardless of the method used to develop that but-for
estimate. Failure to do so will expose practitioners to criticism if their pro
forma estimates materially diverge from actual past performance unless, of
course, the parties intended the breached contract to have a material beneﬁ-
cial impact on that performance and the damages estimate reﬂects this gap.
For example, suppose that the plaintiff sold 26,000 widgets per year for the
two years preceding the damages period but the but-for analysis assumes
that the plaintiff sells 25 percent more. The plaintiff should explain why a
25 percent increase in sales was a reasonable assumption in the but-for
world. The analysis of historical performance should include a comparison
to other comparable market participants and to the industry at large. Trends
in historical performance can also be corroborative or identify other factors
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
4 25

that the practitioner must address in showing causal links. In short, a practi-
tioner will ﬁnd it perilous to prepare a damages claim in a vacuum, isolating
the claimed losses from what the company accomplished in the past.
Industry research/guideline company analysis. Another foundational ele-
ment used in developing a damages claim involves an analysis of the rela-
tive performance of guideline companies or industry averages. This
approach is particularly useful for new entities lacking historical track re-
cords, but practitioners broadly use this approach to establish corroborating
evidence, challenge assumptions and estimates, or to establish the reason-
ableness of loss estimates for the subject company. While no speciﬁc require-
ments exist for guideline company selection, valuation literature contains
widely accepted practices.54 Such guidance helps to ensure that the analysis
includes appropriate companies and excludes inappropriate companies. For
example, if the subject company’s labor costs as a percentage of revenue
were 10 percent higher than its competitors for each of the past ﬁve years
and the company reasonably expected this relation to continue, then the
practitioner could estimate costs for the subject company by using the guide-
line company actual results plus 10 percent. Such an approach could remove
the macroeconomic factors affecting performance (assuming these factors
would affect the guideline companies in a similar manner) by isolating rela-
tive performance of the subject company.
General economic conditions. Any approach used to estimate but-for prof-
its should account for the general market and economic conditions that
could affect future results in the absence of other intervening factors. Such
conditions are as diverse as changes in the core economic indicators (e.g.,
housing starts for a real estate company damages claim), ﬁnancial health of
suppliers and buyers, substitute or complementary product introductions,
pricing trends, inﬂation, legal and regulatory issues, and globalization of
markets. In addition, the practitioner should consider ongoing or anticipated
trends in these conditions or factors that will alter the prospects of the sub-
ject company or business.
Changes in competitive landscape. Other effects fall closer to home than
broad economic indicators. For example, in markets with high barriers to
entry for new competition, a breach of contract may eliminate a competitive
advantage and allow new entrants to enter an otherwise exclusive or re-
stricted market, permanently impairing the proﬁts of the victim of the
breach. Outside inﬂuences can also alter the competitive landscape. Con-
sider the effect of a hurricane on a broad geographic area. A breach of a sup-
ply contract suffered by a rooﬁng contractor, absent the hurricane, could
have a seriously detrimental effect on that contractor’s proﬁts. Assume the
intervening hurricane damaged the property of the contractor and all local
competitors, enabling out-of-state contractors to enter the market and win
market share. Given these circumstances, a lost proﬁts claim that relates all
of the detrimental impact on this contractor to the contract breach is likely
fatally ﬂawed.
Potential company-speciﬁc factors. Additional company-speciﬁc factors can
affect the performance of the company and the practitioner should consider
4 26
DEVELOPING DAMAGES THEORIES AND MODELS

them in developing the lost proﬁts analysis and, in some cases, establishing
proximate cause of the plaintiff’s damages. These factors are often speciﬁc to
the individual subject company and include the following:
Impairment of goodwill. Plaintiffs sometimes assert lost proﬁts claims
based on impairment of goodwill. These claims usually stem from actions
that damage the reputation of the business (for example, the effects of
counterfeit goods). This reputation damage can result in reduced revenues
and proﬁts. Establishing that the damage to the reputation (1) was caused
by the counterfeit goods, (2) resulted in lost sales and proﬁts, and (3) was
the only cause of the lost sales and proﬁts can present a number of chal-
lenges to the practitioner. The practitioner must avoid separate claims in
this regard—for example, claiming both lost proﬁts and lost value of the
intangible (goodwill) asset—as this reputational damage should manifest
in lost proﬁts and be recovered on that basis. In any event, supporting
these claims can be challenging and will require ample documentation
and a well-constructed analysis to prevail.
Management changes. Practitioners should also consider the possible
effects of normal changes in management as well as those that may have
resulted from the acts of others. The practitioner should have gathered
enough information about the company to establish critical management
positions, personnel, and responsibilities that affect operating perform-
ance. For example, if the chief scientist on a key new product in develop-
ment left the company, damages claims are appropriate if he was
improperly recruited away by a competitor developing a similar product,
but would not usually be expected if he went to teach in academia.
Other market issues. A number of other market factors will bear on the
performance of a speciﬁc company. These include the following:
Changes related to buyers and suppliers;
Changes in business lines and the market conditions that affect them;
The introduction of new products by the subject company and its com-
petitors; and
The legal and regulatory environment in which the company operates.
Accounting for all other factors that can reduce proﬁts for a company
would be overwhelming. Few cases require such rigor. Practitioners can
simplify the process by looking for the factors that materially affect business
performance and focusing on those material factors where changes occurred
or are anticipated. A practitioner who fails to explore key factors affecting
company performance will be ill-equipped to assure the court that the
defendant’s actions have caused the damages suffered, thus weakening the
causation argument and the damages case.
We next present a detailed analysis of constructing the revenues the plaintiff
should have received but for the actions of the defendant and the costs that an
expert should apply to those revenues.
(iv) Revenue Analysis.
In a lost proﬁts study, the practitioner must ﬁrst compute the
amount of lost revenues or sales units that the defendant’s actions have caused.
Practitioners use four common approaches to measure this amount:
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
4 27

1. Before and after. This approach compares the plaintiff’s sales level before
the defendant’s wrongdoing with the plaintiff’s sales level after the defend-
ant’s wrongdoing; the difference between the two levels represents the lost
sales. This approach assumes that only the defendant’s wrongdoing affected
the plaintiff’s business volume. It can underestimate lost sales for a plaintiff
whose sales were increasing prior to the defendant’s actions and overesti-
mate lost sales if a plaintiff’s business was in decline prior to the defendant’s
actions. To use such an approach effectively, practitioners often include a
market analysis in the lost proﬁts study. For example, if the target
company’s market is mature and stable during the period under question,
the plaintiff’s sales level probably would have remained unchanged but for
the defendant’s actions.
2. Statistical forecast. The expert forecasts but-for sales by using a variety of
tools such as regression (or other statistical) analysis and then subtracting
the actual sales to estimate the lost sales. With this approach, the expert’s
model (or equation) must adequately predict the sales and use a control pe-
riod (over which the equation is estimated) that does not contain events that
would bias the results; also, the regression equation must not contain biases
such as heteroscedasticity, autocorrelation, or other similar factors. The
model should also consider all important industry factors that affect the
sales of the plaintiff’s products. For example, the price of oil can affect
the sale of products used in constructing oil rigs. The omission of a signiﬁ-
cant factor can invalidate the practitioner’s results or make these results
seem less credible to a judge and jury. The practitioner should ensure that
the damages study considers all relevant factors and that the model in-
cludes the signiﬁcant ones.55
3. Yardstick. The practitioner identiﬁes an index of ﬁrms similar to the plaintiff’s
ﬁrm and compares the plaintiff’s performance with the index’s performance.
This approach assumes that, but for the defendant’s actions, the plaintiff
would have performed the same, relative to the index, as it had in the past.
Underlying biases in the data, however, can invalidate this index approach.
A plaintiff ﬁrm that is smaller or larger relative to the index ﬁrms can lead to
inaccurate results. For example, if a large plaintiff ﬁrm lost market share be-
cause of the defendant’s wrongful conduct, small ﬁrms that acquired those
shares could appear to be growing even if the market size remained constant.
4. Market share. Practitioners consider the plaintiff’s market share during the
period prior to the defendant’s wrongdoing. In addition to deﬁning the rele-
vant market, the practitioner must also ensure that the market remained
somewhat stable during the relevant time period. Numerous entrances or
exits of competitors could undermine the use of this measure. Also, the
analysis should examine the trend of the plaintiff’s market share because if
the plaintiff’s market share varies greatly over the period before the defend-
ant’s actions, this measure can yield unreliable results.
(v) Cost Analysis.
After estimating the amount of lost sales, the practitioner must
subtract the costs the ﬁrm would have incurred to achieve these revenues. Such
an analysis will consider many different cost measures depending on the nature
of the harm:56
4 28
DEVELOPING DAMAGES THEORIES AND MODELS

Marginal cost is the cost of producing one additional unit.
Incremental cost refers to the cost of an unspeciﬁed number of additional
units or of a new product line.
Average cost equals the total cost divided by the number of units produced.
Variable costs change as the activity (or production) level changes.
Direct costs are the costs of the direct material and direct labor incurred in
producing a product.
The practitioner must decide which cost measure pertains to the particular
case. For example, a variable cost estimate will apply only over a certain range of
production (called the relevant range). If the estimated lost sales units would in-
crease the production level outside the relevant range, then the use of the variable
cost estimate can be incorrect.
The relevant cost measure can vary, of course, depending on whether the busi-
ness is expanding or contracting. If the business is expanding and the amount of
lost sales units would take production beyond the plaintiff ﬁrm’s present capac-
ity, the practitioner should consider including the capital costs of investment in
new capacity or new equipment as a cost in the lost proﬁts analysis. The practi-
tioner using incremental costs should include such costs and should also make
reasonable assumptions concerning the timing of the investments.
A practitioner estimating costs for a ﬁrm that would have sold more units but
for the defendant’s actions should consider the possibility of economies (or dise-
conomies) of scale.57 If the model projects a large number of lost units, the plain-
tiff could achieve large cost savings at that production level. A study using only
current costs could underestimate the plaintiff’s damages. Similarly, learning
curve effects would lead to a higher cost structure in a start-up ﬁrm than in a ﬁrm
in business for some time. Finally, although average variable cost analysis can be
appropriate for a ﬁrm already in the market, it can be inappropriate for a new
entrant that will have to engage in promotional pricing to gain customer loyalty,
a capital asset that a longtime competitor already possesses.
Even when the practitioner has decided on the relevant cost measure, impor-
tant aspects of the analysis remain. For example, if claims relate to a single
division (or product) of a multidivision (multiproduct) ﬁrm, the practitioner
needs to consider joint costs.58 The time frame over which the practitioner ana-
lyzes the ﬁrm’s costs as ﬁxed or variable becomes important: the shorter the
period, the fewer the variable costs. The practitioner should consider whether to
analyze costs that vary as production rises and falls within some output range or
whether to measure costs that vary as production falls to zero (going-concern
versus shutdown analysis). For a ﬁrm that has large costs associated with pro-
ducing one unit that do not increase with the production level (zero-one costs),
the level over which one measures costs as variable could determine the outcome
of the case.59
(vi) Subtract Actual Results from the But-For Amount to Ascertain Lost Proﬁts Damages.
This
step is basic arithmetic and does not require much discussion. Exhibit 4-2 illus-
trates the basic format for calculating the amount of damages from the but-for
and actual balances. The practitioner only needs to match up but-for and actual
ﬂows so the practitioner can properly adjust for the time value of money.
4.5
DEVELOPING AN EFFECTIVE DAMAGES CLAIM
4 29

(vii) Adjustment for Time Value of Money.
As noted previously, courts differ on the
dates for evaluating a lost proﬁts analysis. Regardless of whether a court decides
that the appropriate date is the date of the breach, the date of the trial, or some
other date, the practitioner must value the lost proﬁts occurring in multiple peri-
ods to a single period. That is, the practitioner must adjust lost proﬁts for the time
value of money.
Practitioners use a variety of discount rates (as discussed previously), but they
use these discount rates to express the lost proﬁts occurring in multiple years as if
they occurred in a single year. For example, proper discounting allows the practi-
tioner to appropriately offset the negative cash ﬂows required in some years with
positive cash ﬂows that result in others because of those investments. Recall that
lost proﬁts are usually expressed as lost cash ﬂows in this analysis. Sometimes the
facts warrant a practitioner using proﬁt measures instead of cash ﬂows. Regard-
less of what measure the practitioner uses, the discount rate must correspond to
the ﬂow being discounted.
Although the cash ﬂows at issue can occur during the course of a year, most
practitioners do not conduct a monthly or daily discounted lost proﬁts analysis.
Instead they present an annual amount and discount that amount based on a mid-
year convention. With a midyear convention, the practitioner assumes that the an-
nual cash ﬂow occurs on June 30. Assume that the practitioner wants to discount
all cash ﬂows to December 31, 2008. Using the midyear convention, the January
15, 2009, cash ﬂow would be discounted too much while the December 15, 2009,
cash ﬂow would be discounted too little. On average, the cash ﬂows would be
discounted the proper amount. The practitioner, however, should check to ensure
that no factors exist that would cause the midyear convention to bias the results.
If practitioners discount the lost proﬁts to a date that is not the trial date, they
should adjust the net discounted lost proﬁts result to the date of the trial using
prejudgment interest. Many states have statutes governing the rate to use for pre-
judgment interest. Chapter 15 examines the principles and mechanics of prejudg-
ment interest.
(viii) Tax Considerations.
In many litigation analyses, the practitioner must consider
the effects of income taxes. This includes the average tax rate, the marginal tax
rate, the effective tax rate, or even the marginal effective tax rate.60 For example, a
ﬁrm’s weighted-average cost of capital calculation includes the marginal corpo-
rate tax rate, whereas a ﬁrm’s adjusted present value uses the effective tax rate.61
In addition, when practitioners complete their lost proﬁts calculations, they
should decide whether to calculate the damages on a pretax or after-tax basis.
Because the government taxes a lost proﬁts award, some practitioners prefer to
calculate the award on a pretax basis. This advice, however, can lead to an over-
or underestimation of damages by its failure to recognize changes in tax rates.
Alternatively, one could calculate the award on an after-tax basis and then gross
up the damages amount by the current tax rate (i.e., divide the after-tax damages
by one minus the current tax rate). For example, suppose the plaintiff would have
made $100 on a pretax basis during year one and, had it generated those funds in
year one, it would have paid $46 in federal income taxes. (This example ignores
present value and state tax issues.) Thus, the plaintiff would have had $54 more
but for the defendant’s wrongdoing. The plaintiff’s case goes to trial in year
4 30
DEVELOPING DAMAGES THEORIES AND MODELS

seven, after the marginal corporate federal income tax rate has dropped to 34 per-
cent. On the one hand, if the court awards the plaintiff the pretax $100 in year
seven, it will pay only $34 in federal taxes and on an after-tax basis will have $66,
$12 more than the amount needed to make it whole. On the other hand, had the
court awarded the grossed-up amount of the plaintiff’s lost proﬁts on an after-tax
basis, the plaintiff would have received $82 [¼ $54/(1 0.34)], paid $28 in taxes,
and have $54 left. In this example, the plaintiff would have beneﬁted had
the damages award been paid on a pretax basis. The results go in the opposite
direction if the tax rate increased. (Chapter 17 discusses the tax treatment of
damages awards.)
4.6
CONCLUSION
Damages claims present some of the most interesting challenges and complex
issues addressed by practitioners. A practitioner’s effectiveness requires an
understanding of the law, familiarity with the various damages models and their
appropriate usage, attention to detail and thoroughness in analysis, and close co-
ordination with legal counsel to assure the appropriateness of the models and
methods used. Courts vary widely in their level of sophistication in assessing
damages, and in many cases the practitioner will fulﬁll the traditional role of pro-
viding specialized knowledge to the triers of fact to help them understand these
complex issues.
Damages presentations are often the culminating events in a trial. They incor-
porate many of the key factual and expert presentations that establish the basis
for damages and claims and represent the means of righting the wrongs estab-
lished during trial. Consequently, practitioners often play a deﬁning role in the
success of litigation.
NOTES
1. Henry R. Cheeseman, Business Law, 5th ed. (Upper Saddle River, NJ: Pearson Educa-
tion, 2004), p. 200.
2. Ibid., pp. 311 13.
3. The American Law Institute ﬁrst compiled the Restatement of the Law of Contracts in
1932. Attorneys and courts often cite the Restatement (now in its second edition), but it
is not law. Cheeseman, Business Law, p. 193.
4. For a listing of cases by state, see Robert L. Dunn, Recovery of Damages for Lost Proﬁts,
4th ed. (Westport, CT: Lawpress Corporation, 1992), Section 1.2.
5. Restatement (Second) of Contracts, Section 352 (a) and (b) (1981); Robert M. Lloyd, “The
Reasonable Certainty Requirement in Lost Proﬁts Litigation: What It Really Means,”
Tennessee Journal of Business Law 12 (2010): 11, http://trace.tennessee.edu/transactions/
vol1 2/iss1 /2 .
6. Cheeseman, Business Law, pp. 192 93.
7. Ibid., pp. 74 81.
8. Richard Posner, Economic Analysis of Law, 5th ed. (New York: Aspen Law & Business,
1998), p. 272.
9. Ibid., p. 273.
10. See Seely v. White Motor Co., 63 Cal. 2d 9, 403 P.2d 145 (1965), and Jones & Laughlin Steel
Corp. v. Johns-Manville Sales Corp., 626 F.2d 280 (CA3 1980).
NOTES
4 31

11. Sharon Steel Corp. v. Lakeshore, Inc., 753 F.3d 851 (10th Cir. 1985).
12. East River v. Transamerican DeLaval Inc., 476 U.S. 858, 868 75 (1986).
13. For a listing of cases under the majority and minority positions, see Dunn, Recovery
of Damages for Lost Proﬁts, Section 3.16.
14. See Restatement (Second) of Contracts, Section 347 and comments to that section; Posner,
Economic Analysis of Law, p. 131.
15. Restatement (Second) of Contracts, Section 344 (a).
16. Under expectation damages in some jurisdictions, the analyst may be able to calculate
damages associated with related product sales or other ﬁnancial beneﬁts stemming
from the project (like service contracts stemming from product sales), so long as
these damages were not speculative.
17. Restatement (Second) of Contracts, Section 344 (b).
18. Jeffrey T. Ferrie ll , Und erst and ing Cont r acts, 2nd ed. (LexisNexis, 2009), http://www
. l e x i s ne x is . c o m / l aw s c h o o l / s t u d y / o u t l in e s / h tm l/ c o n t r ac t s / c o n t r a c t s 16 . h t m, § 16 . 0 1
Types of Remedies [2].
19. Restatement (Second) of Contracts, Section 344 (c).
20. Ibid., Section 344 (c) and comments to that section; Cheeseman, Business Law, pp. 305,
310.
21. F e r r i e l l , Unde rsta nd ing Co ntracts , ht t p://www.lexisnexis.co m/ lawsc ho ol/stu dy /
outlines/html/contracts/contracts16.htm, §16.01 Types of Remedies [2].
22. Eyal Zamir, “The Missing Interest: Restoration of the Contractual Equivalence,”
Virginia Law Review 93 (2007): 59.
23. Cheeseman, Business Law, p. 306.
24. Caprice L. Roberts, “Restitutionary Disgorgement for Opportunistic Breach of Contract
and Mitigation of Damages,” Loyola of Los Angeles Law Review 42 (2008): 131 44.
25. See U.S. v. KeySpan Corp., No. 10-cv-1415 (S.D.N.Y. ﬁled Feb. 22, 2010).
26. An investor should value a project using the project’s weighted average cost of capital.
Using a company cost of capital is incorrect unless the new venture has the same risk
as the company. Richard A. Brealey, Steward C. Myers, and Franklin Allen, Principles
of Corporate Finance, 8th ed. (New York: McGraw-Hill Irwin, 2006), p. 216.
27. See M. E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review,
March/April 1979. In 1979, Professor Michael Porter of Harvard Business School de-
veloped a framework to analyze a company’s industry in order to develop its business
strategy. A worsening of industry conditions could result in values less than originally
expected at the onset of the transaction that could cause RD damages to exceed BOB
damages.
28. Cheeseman, Business Law, pp. 94 95.
29. Posner, Economic Analysis of Law, pp. 240 41.
30. Cheeseman, Business Law, p. 310.
31. Ibid., p. 312.
32. Uniform Commercial Code, Section 2-610; Restatement (Second) of Contracts, Section
253.
33. See Matthew Milikowsky, “A Not Intractable Problem: Reasonable Certainty, Tractebel,
and the Problem of Damages for Anticipatory Breach of a Long-Term Contract in a
Thin Market,” Columbia Law Review 108 (2008): 452.
34. Charles H. Goetz and Robert E. Scott, “Measuring Sellers’ Damages: The Lost-Proﬁts
Puzzle,” Stanford Law Review 31 (1979): 323.
35. Goetz and Scott, 1979.
36. Friedman, 1989.
37. See Chapter 11 of the fourth edition of the Litigation Services Handbook.
38. Dunn, Robert L., Recovery of Damages for Lost Proﬁts, 4th ed., vol. 1 (Westport, CT:
Lawpress Corporation, 1992), p. 345.
4 32
DEVELOPING DAMAGES THEORIES AND MODELS

39. Most patents have a legal life of 17 years. Their effective life, however, may be less
if the market has frequent technological changes or one can easily design around
the patent.
40. See also Chapter 10 of the fourth edition of the Litigation Services Handbook.
41. The term business value is inadequately descriptive, as there are many potential mea-
sures, including fair value, fair market value, enterprise value, and value in use,
to name a few. All are different measures and will yield different values. Chapter 10
provides further information on this topic. For this discussion, business value will be
construed to mean fair market value of the business, which is representative of what a
willing buyer and seller, neither under compulsion to transact, would be willing to
exchange for the business.
42. Our time consideration discussion differs from ex ante/ex post considerations. The
former relates to the time of the damages measurement, while the latter relates to
the information considered available to make the damages measurement.
43. We discuss discounting in Section 4-4(h) of this chapter as well as in Chapter 9 of this
book. Beta is one of the discount formula variables that addresses risk; selection of and
adjustment to beta risk is an important element in correctly discounting damages
more fully addressed in Chapter 9.
44. We forgo a detailed explanation and direct the readers to Chapters 7 and 8 in this book
for more discussion regarding regression analysis in litigation.
45. See Sam L. Savage, The Flaw of Averages: Why We Underestimate Risk in the Face of Uncer-
tainty (Hoboken, NJ: John Wiley & Sons, 2009). See also Chapter 10 in the fourth edition
of the Litigation Services Handbook.
46. Capital market risk results from economy-wide factors that generally beneﬁt or
threaten all businesses.
47. Richard A. Brealey and Stuart C. Myers, Principles of Corporate Finance, 6th ed.
(New York: McGraw-Hill, 2000), p. 195.
48. Ibid., pp. 231 32.
49. Opportunity cost refers to the fact that had the plaintiff not been denied the use of
the damages amount, it would have invested it in some enterprise (perhaps in shares,
perhaps in the performance of the plaintiff ﬁrm) and would have received a return on
this amount.
50. James M. Patell, Roman L. Weil, and Mark A. Wolfson. “Accumulating Damages in
Litigation: The Roles of Uncertainty and Interest Rates.” Journal of Legal Studies, 11
(1982): 341 64.
51. Fisher and Romaine 1990.
52. See Patell et al. 1982. Note that the defendant’s interest rates used to bring the damages
to present value should be the effective after-tax rate to reﬂect the realities of the
plaintiff’s alternative uses of cash. To do otherwise would have investments in dam-
ages claims grow more rapidly than real investments of similar risk. The ﬁnal amount,
of course, should be grossed up by the plaintiff’s tax rate, as discussed previously.
53. No. 2010-1035, 2010-1055 (Fed. Cir. January 4, 2011).
54. See Shannon P. Pratt and Alina V. Niculita. Valuing a Business, 5th ed. (New York:
McGraw-Hill, 2007).
55. In certain situations, practitioners use the plaintiff’s budgets and forecasts as a basis
for developing but-for sales, making adjustments as appropriate for factors such as
industry trends and historical budgeting prowess.
56. These deﬁnitions are taken from the glossary of ﬁnancial terms found in the fourth
edition of the Litigation Services Handbook.
57. With economies of scale (i.e., increasing returns to scale), a ﬁrm can increase produc-
tivity or lower average costs of production by increasing production. For example, if a
ﬁrm increases inputs by 10 percent and total output increases by more than 10 percent,
the ﬁrm is better off with the higher production (assuming that price does not fall).
NOTES
4 33

With economies of scope, a ﬁrm can achieve lower costs by producing multiple goods
together. For example, a ﬁrm that produced both clocks and watches might be more
efﬁcient than two ﬁrms, one of which made clocks and the other of which made
watches, because the ﬁrst ﬁrm could share industry-speciﬁc knowledge and machin-
ery across both product lines (P. Samuelson and W. D. Nordhaus, Economics, 14th ed.
[New York: McGraw-Hill, 1991], p. 735).
58. In Marsann Co. v. Brammal, Inc., 788 F.2d 611 (9th Cir. 1986), the Ninth Circuit held that
the relevant average variable cost is that of the items sold at the challenged price,
rather than that associated with the production of the total output.
59. Remarks about cost estimation made previously in this chapter also apply here.
60. The average tax rate is the rate found by dividing income tax expense by net income
before taxes. The marginal tax rate is the tax rate imposed on the next dollar of taxable
income generated. The effective tax rate is the rate that includes the effects of tax
shields. The effective marginal tax rate is the marginal tax rate that includes the effects
of tax shields.
61. Richard A. Brealey and Stuart C. Myers, Principles of Corporate Finance, 6th ed.
(New York: McGraw-Hill, 2000), pp. 544, 558.
LIST OF CASES
East River v. Transamerican DeLaval Inc., 476 U.S. 858, 868 75 (1986)
Jones & Laughlin Steel Corp. v. Johns-Manville Sales Corp., 626 F.2d 280 (CA3 1980)
Marsann Co. v. Brammal, Inc., 788 F.2d 611 (9th Cir. 1986)
Seely v. White Motor Co., 63 Cal. 2d 9, 403 P.2d 145 (1965)
Sharon Steel Corp. v. Lakeshore, Inc., 753 F.3d 851 (10th Cir. 1985)
Uniloc USA Inc. v. Microsoft, No. 2010-1035, 2010-1055 (Fed. Cir. January 4, 2011)
United States v. KeySpan Corp., No. 10-cv-1415 (S.D.N.Y. ﬁled Feb. 22, 2010)
REFERENCES
Brealey, Richard A., and Stuart C. Myers. Principles of Corporate Finance, 6th ed. New York:
McGraw-Hill, 2000.
Brealey, Richard A., Suart C. Myers, and Franklin Allen. Principles of Corporate Finance, 8th
ed. New York: McGraw-Hill, 2006, p. 216.
Cheeseman, Henry R. Business Law, 5th ed. Upper Saddle River, NJ: Pearson Education,
2004.
Dunn, Robert L. Recovery of Damages for Lost Proﬁts, 4th ed. Westport, CT: Lawpress Corpo-
ration, 1992.
. Recovery of Damages for Lost Proﬁts, 5th ed. Westport, CT: Lawpress Corporation,
1998, vol. 1, p. 345.
Ferriell, Jeff rey T . Understanding Contracts, 2nd ed. (LexisNexis, 2009). http://www
. l e x i s ne x is . c o m/ l a w s c h o o l / s t u dy / o u tl in e s / ht ml / c o nt r a c t s / c o n t r ac ts 1 6. h t m, §1 6. 0 1
Types of Remedies [2].
Fisher, Franklin M. “Multiple Regression in Legal Proceedings.” Columbia Law Review 80
(1980): 702.
Fisher, Franklin M., and R. Craig Romaine. “Janis Joplin’s Yearbook and the Theory
of Damages.” Journal of Accounting, Auditing and Finance 145 (New Series 1990): 145 157.
Friedman, D. D. “An Economic Analysis of Alternative Damage Rules for Breach of
Contract.” Journal of Law and Economics 32 (1989): 281.
Goetz, Charles H., and Robert E. Scott. “Measuring Sellers’ Damages: The Lost-Proﬁts
Puzzle.” Stanford Law Review 31 (1979): 323.
4 34
DEVELOPING DAMAGES THEORIES AND MODELS

Lloyd, Robert M. “The Reasonable Certainty Requirement in Lost Proﬁts Litigation: What
It Really Means.” Tennessee Journal of Business Law 12 (2010): 11.
Milikowsky, Matthew. “A Not Intractable Problem: Reasonable Certainty, Tractebel, and
the Problem of Damages for Anticipatory Breach of a Long-Term Contract in a Thin
Market.” Columbia Law Review 108 (2008): 452.
Patell, James M., Roman L. Weil, and Mark A. Wolfson. “Accumulating Damages in Litiga-
tion: The Roles of Uncertainty and Interest Rates.” Journal of Legal Studies 11 (June
1982).
Porter, M. E. “How Competitive Forces Shape Strategy.” Harvard Business Review, March/
April 1979.
Posner, Richard. Economic Analysis of Law, 5th ed. New York: Aspen Law & Business, 1998.
Pratt, Shannon P., and Alina V. Niculita. Valuing a Business, 5th ed. New York: McGraw-
Hill, 2007.
Roberts, Caprice L. “Restitutionary Disgorgement for Opportunistic Breach of Contract
and Mitigation of Damages.” Loyola of Los Angeles Law Review 42 (2008): 131 44.
Samuelson, P., and W. D. Nordhaus. Economics, 14th ed. New York: McGraw-Hill, 1991,
p. 735.
Savage, Sam L. The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty.
Hoboken, NJ: John Wiley & Sons, 2009.
Zamir, Eyal. “The Missing Interest: Restoration of the Contractual Equivalence.” Virginia
Law Review 93 (2007): 59.
REFERENCES
4 35

CHAPTER5
EX ANTE VERSUS EX POST DAMAGES
CALCULATIONS
Michael K. Dunbar
Elizabeth A. Evans
Roman L. Weil
CONTENTS
5.1
Introduction
5.1
5.2
Expectancy versus Outcome Damages
5.2
5.3
Application of the Ex Ante Approach in
Litigation
5.3
(a) The Mechanics of Ex Ante
Analyses
5.3
(b) The Debate
5.6
5.4
Application of the Ex Post Approach in
Litigation
5.7
(a) The Mechanics of Ex Post
Analyses
5.7
(b) The Debate
5.9
5.5
Hybrid Approach
5.10
5.6
The Book of Wisdom
5.11
5.7
The Wrongdoer’s Rule
5.13
5.8
Conclusion
5.14
APPENDIX: CASE LAW SUPPORTING EX
ANTE AND EX POST ANALYSES
5.15
NOTES
5.21
LIST OF CASES
5.22
REFERENCES
5.23
5.1
INTRODUCTION
Economic damages awards in litigation serve a double purpose: they compensate
entities that suffered harm from unlawful acts, and they deter future unlawful
acts. The optimal compensation award should put an injured entity in the same
economic position it would have been but for the act. The optimal deterrent
award, putting aside punitive issues, should be equal to the ill-gotten gain de-
rived from the unlawful act adjusted for the probability that someone will detect
the act. In many cases these two amounts are the same. Consider an example
whereby I steal $100 from you. If I were immediately apprehended and forced
to return your money, then your economic loss would be eliminated and my
The coauthors acknowledge their former coauthor, Michael Wagner; this chapter has retained much
of his work from previous editions of the Litigation Services Handbook.
5 1

ill-gotten $100 would have been disgorged. Under that circumstance, the com-
pensation amount equals the deterrent amount. I would have no incentive to steal
from you, and you would have no incentive to make it easy to be robbed.
In this example of immediate restitution, one can easily ﬁnd an optimal award
that satisﬁes both the compensation and deterrent purposes. Ideally, plaintiffs
would receive instantaneous compensation for the damages they suffered with-
out delay between the date of injury and the award of damages. If a delay occurs
between the time of the unlawful act and the date of restitution, however, the
victim’s harm and the wrongdoer’s ill-gotten gain often diverge.
In the real world, a delay always occurs between the date of injury and the
date the plaintiffs receive compensation. During the time lag, in addition to the
divergence between the damages and ill-gotten gain, information about the pay-
offs to the unlawful act becomes available, which can change the parties’ percep-
tion of the damages.
For example, suppose that you buy a lottery ticket for $1. Then suppose I steal
it from you before the lottery winner becomes publicly known. Assume that on
the date of the injury all lottery tickets had an equal chance of winning and there
was no shortage of tickets available for $1. Time passes and it turns out that the
ticket I stole from you is the lottery winner and is now worth $32 million. How
much should I pay you to make you whole? Do I owe you the expected value of
the return from the ticket, about 12 cents, called the ex ante value—its value before
the event?1 Or, do I owe you the fair market value of the ticket I stole, $1? Or, do I
owe you the amount that you would have made had you owned the winning
ticket, $32 million, the ex post value—its value after the event?
Surely one could argue that if you bought a ticket with an expected value of
12 cents, you were not planning to try to resell it before the winner was announced.
If you weren’t keeping the ticket through the lottery, you would have been better
off not buying it at all. Therefore, after the fact—ex post—it is a virtual certainty that
you would have won the lottery. One could also argue that the $1 price of the ticket
is the replacement cost of that ticket and reﬂects the value of the low probability of
a particular ticket winning plus the transaction costs of participating in the lottery.
Given these circumstances, and considering that at the time of the theft you
could have bought another ticket with equal probability of winning for $1, few
would disagree that on the date of the theft, damages did not exceed $1. How-
ever, after the lottery ends and your ticket becomes worth $32 million, few juries
would consider a remuneration of $1 for $32 million in winnings a just resolution,
even with the understanding that I had borne the risk of the ticket’s not winning.
After all, the case would likely not have gone to trial if the ticket did not win, and
therefore, I had borne only a small risk of having to pay at all.
5.2
EXPECTANCY VERSUS OUTCOME DAMAGES
Ex ante is Latin for “from before.” A pure ex ante analysis would use information
only if it were available at the time of the unlawful act to calculate the damages
incurred at the time of the act. Practitioners base the analysis, therefore, as though
they were to analyze the damage caused by the act contemporaneously with the
occurrence of the act. Most business activities resemble lotteries: the ﬁrm invests
time and money up front in an activity with an uncertain outcome. Thus, the
5 2
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

damages expert faces the question of whether to compute damages at the time of
the investment (or unlawful act) or after the outcome is known.
Ex post is Latin for “from after.” A pure ex post analysis uses all the information
available up to the date of the analysis. Such an outcome-based analysis accounts
for facts that become known after the unlawful act, such as a product’s success in
the marketplace, the increased value of a tangible asset, or, indeed, the outcome
of a lottery.
One could also perform an analysis that is a hybrid between ex post and ex ante.
For example, when analysts use information available from the date of the un-
lawful act forward, they often discount cash ﬂows that occurred at a risk-adjusted
discount rate during this same period.
The differences between ex post and ex ante analyses lie in which information
subsequent to the unlawful act the analyst uses, the date of the damages measure-
ment, and how the analyst discounts future damages. Exhibit 5-1 highlights the
differences between the two approaches as practitioners have applied them.
5.3
APPLICATION OF THE EX ANTE APPROACH IN LITIGATION
(a) The Mechanics of Ex Ante Analyses.
To illustrate the mechanics of ex ante
analyses, we use the following example. Suppose that on New Year’s Day 2000,
the defendant stole the victim’s 1972 AMC Pacer. At that time, the defendant and
others could have bought an identical replacement Pacer for $300. Also, suppose
that in early 2005 BMW came out with a remake of the original Pacer and subse-
quently the fair value of a classic AMC Pacer increased to $10,000.
The car’s owner ﬁles a lawsuit, and trial begins on December 31, 2006. An
expert using a pure ex ante approach would calculate damages of $300 and then
Ex Ante
Ex Post
Information
Use information known or
knowable on the date of the
unlawful act; ignore subse-
quent events.
Use all available information.
Measurement
Date
Date of unlawful act.
Date of analysis.
Discounting
Discount all cash ﬂows back to
the date of unlawful act using
a rate that reﬂects the risk of
the asset. Calculate prejudg-
ment interest on this amount
from the date of the unlawful
act to the date of judgment
using a rate reﬂecting either
the plaintiff’s cost of capital, or
the defendant’s debt rate.
Bring past cash ﬂows (i.e.,
damages)
to
present
value
using an interest rate reﬂect-
ing either the plaintiff’s cost of
capital or the defendant’s debt
rate.
Discount
future
cash
ﬂows (i.e., damages) to the
date of judgment.
Exhibit 5-1.
Differences between Ex Ante and Ex Post Calculations
5.3
APPLICATION OF THE EX ANTE APPROACH IN LITIGATION
5 3

might calculate interest on the $300 from January 1, 2000, to December 31, 2006.
Three hundred dollars is the expected value of the car as dictated by the then-cur-
rent market price. If the plaintiff had a different expectation for the car’s future
value, he could have mitigated any damages by buying another car for $300 after
the theft. In fact, if he had thought the car was worth more than its market value
of $300, he should have bought additional cars.
Advocates of ex ante analyses point out that using ex ante information properly
allocates risk.2 In the example of the Pacer, the car’s market price on the date of the
theft already incorporates the probability that the model will become a collector car.
The market price also incorporates the then-higher probability that the car will
ultimately be worth only the salvage value of the metal used in its manufacture.
When the victim’s $300 car was stolen, he was relieved of the risk that it would
ultimately become nearly valueless and deprived of the low probability outcome
that it would become a collector car. The market value of the car on the theft date
reﬂects the present value of these two possible outcomes and all future costs and
beneﬁts associated with ownership of the car. In this way, an ex ante approach helps
analysts avoid two signiﬁcant potential pitfalls associated with an ex post approach:
incorrectly accounting for avoided risk, and neglecting avoided costs and beneﬁts.
Proponents of the ex ante approach argue that awarding $10,000 improperly
rewards the plaintiff for the full current value of the car without taking into ac-
count that the plaintiff avoided the costs and risks of ownership. Implicitly, the
costs and risks of ownership equal $9,700 (¼ $10,000 – $300). An ex ante approach
properly measures the value of an asset at the time it was taken, whereas an ex post
approach converts a risky investment into a certain outcome.
Even though the ex ante approach solves some particularly sticky problems as-
sociated with ex post, it has problems of its own. For example, some ﬁrms have
private information on which they value particular assets more or less highly
than the market does. In that case, do the ﬁrms’ expectations set the amount of
damages? Likewise, the plaintiff may have had a once-in-a-lifetime chance to suc-
ceed (i.e., there may have been no additional lottery tickets or Pacers available to
replace the stolen one). Additionally, the assets can have unique value to a partic-
ular ﬁrm. Is this unique value the relevant measure of ex ante damages if the ﬁrm
falls victim to an unlawful act? Proving that an asset has a value that differs from
market value can be difﬁcult.
The damages expert can rarely value the act’s consequences with accuracy as
of the time of the act because of the difﬁculty of reconstructing the information
known when the act occurred. Sometimes contemporaneous forecasts exist, but
these can be imprecise information sources. Forecasts produced for different pur-
poses or by different business units in the same organization can vary. Sometimes
individuals associated with a project prepare more aggressive forecasts than
those prepared by management, whose bonuses rely on performance compared
against those forecasts. Banks and venture capitalists prefer conservative fore-
casts. Firms and industries often make multiple forecasts showing different
expected outcomes. These problems sometimes drive experts to inappropriately
rely on forecasts made at the time of the unlawful act that were not reliable.
(i) Usable Information.
An ex ante analysis relies on information known or know-
able at the time of the unlawful act. However, one cannot easily identify all
5 4
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

knowable information. Anything in the public domain is arguably knowable. Pri-
vate information held by the opposing parties or third parties is also arguably
knowable. Indeed, patent law accepts that the patent holder’s private information
is knowable. Patent law regards all subsequent information as knowable at the
time of the hypothetical negotiation that the courts assume to occur contempora-
neously with the act. Section 5.6 of this chapter discusses this concept, also known
as the book of wisdom.
One way to identify relevant information hypothesizes an analysis that the
plaintiff could have performed at the time of injury. The current analysis could
include any information that the injured party would have used in performing
that contemporaneous analysis. As a practical matter, the expert uses other infor-
mation from documents dated slightly after the date of the unlawful act on the
basis that the information was known or knowable prior to the date that the doc-
ument memorialized it.
Questions often arise regarding the treatment of subsequent mitigation and in-
vestment. If one uses an ex ante analysis, one should not consider the outcome of
subsequent actual mitigation. Doing so converts the analysis into an ex post mea-
sure of damages. Similarly, in theft of trade secrets or patent infringement cases,
the injured party often makes signiﬁcant investments after the date of the theft
that it might not have made had it been aware of the theft. To ensure consistency,
a pure ex ante analysis should not consider subsequent information about these
actual investments.
(ii) Measurement Date.
The measurement date is the date as of which the expert
calculates damages. In the case of an unlawful act that occurs on a single date—
the breach of a contract, for instance—the measurement date would be the date of
the breach. Some cases have multiple unlawful acts occurring on different dates.
For example, one could argue that every time a patent infringer makes, or uses,
or offers to sell, or sells an infringing product, the infringer commits a new un-
lawful act. In this example, an expert applying an ex ante analysis should measure
the damages associated with each separate unlawful act on the date that each
occurred.3
(iii) Probability of Outcome.
If no contemporaneous market price exists, or if, for
whatever reason, the market price does not reﬂect the idiosyncratic value to the
victim, then the expert can forecast future cash ﬂows with contemporaneous
information. Such forecasts lend themselves to the assignment of relative proba-
bilities to different possible outcomes. Similarly, if contemporaneous analyses
do exist, one may ﬁnd multiple analyses, such as best-case, worst-case, and
expected-case analyses. A proper analysis should assign probabilities to the
various scenarios and weight the resultant net present values of damages
proportionately.
(iv) Ex Ante Discounting.
In ex ante discounting, an expert applies a risk-adjusted
rate of return appropriate for the company or project at issue when discounting
the lost cash ﬂows back to the date of damage (or breach). This calculation yields
a lump sum equal to the present value of the damages on the date of the injury.
The analysis can weight this lump according to the probability of outcome as de-
scribed in Section 5.3(a)(iii) of this chapter. The expert subsequently applies
5.3
APPLICATION OF THE EX ANTE APPROACH IN LITIGATION
5 5

prejudgment interest to the damages amount starting from the date of the act and
continuing through the restitution date.
As with identifying measurement dates, discounting becomes complicated
when the unlawful act is not a one-time event. For example, suppose that two
unlawful acts occur on different dates. An analyst could ascertain separate dis-
count rates for each unlawful act and discount the lost cash ﬂows back to the
corresponding unlawful act dates. Or, as in the case of the patent infringement
discussed in Section 5.3(a)(ii) of this chapter, one should not discount all the cash
ﬂows back to the date of ﬁrst infringement; instead, an expert should discount the
separate cash ﬂows (at different discount rates, if necessary) to the date of each
lost sale. In summation, if the unlawful act does not occur on a single date, then
the expert should calculate damages associated with each unlawful act and dis-
count the damages for each act back to the appropriate date at the appropriate
discount rate, which depends on the date of each unlawful act.4
(v) Prejudgment Interest.
Some courts allow the computation of prejudgment inter-
est and grant that amount to plaintiffs. One should calculate prejudgment interest
from the date of damages to the date of recovery. Because of uncertain recovery
dates, the courts often use the date of trial as a proxy for the recovery date. Courts
have used a variety of interest rates for prejudgment interest. State law and fed-
eral statutes often specify a statutory rate. If no statutory rate exists, it is common
and logical to use the defendant’s unsecured borrowing rate.5 This practice
makes sense because the defendant owes the damages to the plaintiff; thus, the
analysis can regard the damages as funds that the plaintiff has, albeit in-
voluntarily, lent to the defendant. The appropriate risk-adjusted rate for this loan
reﬂects the defendant’s default risk, captured by the defendant’s unsecured bor-
rowing rate for loans of similar duration initiated in the same time period. Even
though courts sometimes use the plaintiff’s opportunity cost as a measure of pre-
judgment interest rates, this rate is inappropriate because it is calculated under
the false assumption that the plaintiff would have assumed risk in order to earn
its opportunity cost.
(b) The Debate
(i) Advantages.
The ex ante approach properly accounts for risk. The contempora-
neous market price or contemporaneously conducted analyses capture the proba-
bility of the entire spectrum of outcomes. Awarding a plaintiff with all the
beneﬁts of a successful project without the plaintiff’s having to assume the project
risk would overcompensate the plaintiff. In fact, it would give the plaintiff an in-
centive to seek harm. Better that I should induce you to deprive me of the right to
drill for oil on a site that is likely a dry hole than that I should spend the, say,
$1 million to drill for myself. If I can induce you to deprive me of the right to drill,
then I can save the $1 million of drilling costs but still collect the value of the oil if,
contrary to expectation, the well turns out to be a gusher. Additionally, the results
of an ex ante analysis are independent of when the trial occurs. Therefore, there is
no incentive for a plaintiff to attempt to game the court system by timing a poten-
tial lawsuit to maximize damages awards. Ex ante analyses also provide foresee-
ability of consequences to potential wrongdoers. Another advantage: it does not
penalize the plaintiff for a decision to either pursue or not pursue mitigation.
5 6
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

(ii) Disadvantages.
Ex ante approaches often require a complex reconstruction of the
world at the time of the unlawful act, likely impaired by a shortage of contempora-
neous information. The expert will often need to construct both an actual and a but-
for world, neither of which in fact existed. The constructed actual world reﬂects the
cash ﬂow from the next best alternative given the unlawful act. The but-for world is
composed of future cash ﬂows that would have followed but for the act.
Another potential disadvantage of the ex ante approach lies in its use of con-
temporaneous markets for valuation at the time of the unlawful act. The notion
that the market value at any given time reﬂects the present value of future cash
ﬂows assumes efﬁcient markets and perfect information. However, some markets
are not efﬁcient, and perfect information rarely exists. In fact, proponents of the
ex ante approach agree that since private information related to the value at
the date of the act provides the best information, the market is not the ultimate
arbiter of value.6 Also, even with complete information, market forecasts can
be wrong. Even if one had a broad portfolio of stolen cars, the forecast future
value of the cars at the time of the theft will not likely closely match the actual
future value if the restitution were many years away.
5.4
APPLICATION OF THE EX POST APPROACH IN LITIGATION
(a) The Mechanics of Ex Post Analyses.
Ex post computations rely on actual out-
comes. The expert looks backward from the time of trial and uses actual informa-
tion. In an ex post analysis, experts believe that events that happened after the
date of the unlawful act provide information useful in understanding the eco-
nomic effect of the act and, thus, affect the cost imposed by the act. Consider our
example of the stolen AMC Pacer introduced in Section 5.3(a) of this chapter. The
market value on the date of theft was $300 even though the current market value
is $10,000. Using ex post information, damages would be $10,000 less the avoided
costs of ownership between the theft date and today (e.g., costs of maintenance,
insurance, and fuel), plus any lost beneﬁts of ownership of the car between the
theft date and today (e.g., monetary award in a car show and the cost of replace-
ment transportation services).
The application of ex post information raises several questions:
If subsequent information is available, how should the expert use it?
If the analysis uses subsequent information, how does this affect the risk
proﬁle of the cash ﬂows and, consequently, how does this affect the appro-
priate discount rate for discounting those cash ﬂows?
Does the use of subsequent information affect the selection of the present
value date used for the calculation of damages?
How should the analysis treat subsequent mitigation and investment?
(i) Usable Information.
In a pure ex post analysis, all available information has rele-
vance. Because the analysis aims to value the unlawful act as of the date of resti-
tution, more recent information about the value becomes particularly important
in assessing the current value. If only forecasts are available at the time of compu-
tation, the analysis uses recent forecasts, not earlier ones, and adjusts those fore-
casts for known differences in assumptions.
5.4
APPLICATION OF THE EX POST APPROACH IN LITIGATION
5 7

Additionally, both the outcomes of mitigation efforts and the actual invest-
ments made by the victim provide relevant and important information in
ex post analyses. If, for example, the defendant wrongfully precluded the plain-
tiff from making a particular investment, an expert should consider what the
plaintiff subsequently did or should have done with the funds it could not
invest.
(ii) Measurement Date.
Experts measure ex post damages as of the date of restitu-
tion. Such analyses use the trial date or the analysis date as proxies for the date
of restitution. One could also use the expected date of ﬁnal payment or even the
expected date of the resolution of subsequent appeal, depending on the facts of
the case and the available information.
(iii) Ex Post Discounting of Cash Flows.
The ex post approach discounts future lost
cash ﬂows at the risk-adjusted rate of return appropriate for the company or
project at issue. Ex post discounting uses past lost cash ﬂows and brings them
forward to the restitution date at a rate sufﬁcient to compensate for the defend-
ant’s default risk, but with no other risk considerations. As Section 5.4(a)(ii) of
this chapter discussed, the analysis can use various dates as a proxy for the res-
titution date.
Proponents of the ex post approach argue that their method of discounting has
merit because it gives the plaintiff the exact recovery that, if invested at the same
risk-adjusted rate of return as that of the ﬁrm, would reproduce the future stream
of lost cash ﬂows. Proponents also argue that the ex post approach offers the only
means of putting plaintiffs in the same position they would have been in but for
the unlawful act. In fact, one could argue that this approach is conservative, be-
cause it regards the plaintiff’s restitution date as the date of trial when, in fact,
restitution often does not occur until much later after appeals. In that situation,
even though the plaintiff does not receive restitution until years after the initial
trial date, the method discounts the amount generated from future cash ﬂows
further back than necessary, to the initial trial date.
Critics of the ex post approach argue that by discounting only future dam-
ages that occur after the restitution date, experts accept pretrial damages as
though they were certain and neglect the risk associated with earning those
cash ﬂows. The counterarguments have a legal, rather than economic, basis.
In fact, the defendant precluded the plaintiff from taking the risks associated
with earning those particular cash ﬂows. If the plaintiff wanted to and could
take those risks, the defendant should not beneﬁt from preventing the plaintiff
from taking those risks. One could also argue that once the plaintiff proves
liability, the beneﬁt of any uncertainty should go to the plaintiff. Section 5.7 of
this chapter discusses the case law supporting this concept, known as the
wrongdoer’s rule. Moreover, critics argue ex post damages reduce the incentive
for mitigation—after all, victims could have bought another lottery ticket or an-
other Pacer and restored their economic position as of the time of the unlawful
act. If one knows they will collect ex post damages, then they have no incentive
to mitigate.
(iv) Prejudgment Interest.
Even though ex post analyses do not discount past lost
cash ﬂows, the cash ﬂows should accrue prejudgment interest from the date the
5 8
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

plaintiff lost them to the date of recovery (or a proxy for such a date). As with
ex ante analyses, courts have used various interest rates for prejudgment interest.
State law or federal statutes often specify a statutory rate. If no statutory rate
exists, one can use the defendant’s unsecured borrowing rate because the plaintiff
is effectively lending the damages amount to the defendant.
(b) The Debate
(i) Advantages.
The ex post approach appeals to an individual’s sense of justice. If
someone steals your lottery ticket that becomes worth $32 million, even an un-
skilled lawyer can persuade jurors to award you $32 million in damages, not
$1. While proponents of the ex ante approach argue that an ex ante analysis makes
the victim whole as of the date of the unlawful act, proponents of the ex post
approach argue that the ex post approach makes the victim whole at any time.
The ex post approach also provides a social deterrent to violating the legal
rights of others. Only cases with signiﬁcant damages will go to trial. For example,
no one will bring a case to trial for a stolen lottery ticket that became worthless.
Ex ante damages, therefore, will fail to deter when the plaintiff has little incentive
to bring the wrongdoer to justice either because the outcome was small (or nega-
tive) or because even when the outcome was large, its expected value was small
and the defendants need pay only the expected value. In the real world of poten-
tial judicial error and high transaction costs to litigating, this implication suggests
that ex ante damages analysis without compensation for both the chance of court
error and transaction costs does not properly deter.
Additionally, the ex post approach ensures that those who commit unlawful
acts do not receive windfalls from doing so. Even though the thief of a losing
lottery ticket is not brought to justice, his beneﬁt was small—the small probability
of winning and keeping the beneﬁts of winning. This observation poses a power-
ful argument for using ex post information to calculate unjust enrichment.
(ii) Disadvantages.
The ex post approach to measuring damages has disadvantages,
one being that the damages amount changes over time as new data become avail-
able. Because the changing environment inﬂuences ex post damages, this ap-
proach provides incentive for gaming the courts to maximize or minimize
damages. For instance, a party can intentionally delay proceedings until the stock
market improves, or, as in our example, until classic AMC Pacers are valued at
$10,000. Second, as Section 5.4(a)(iii) of this chapter discusses, the ex post ap-
proach unquestionably gives plaintiffs the beneﬁt of the proceeds from a risk that
they did not bear. Also, this approach risks overcompensation of the plaintiff. In
particular, if the plaintiff can choose between an ex post and an ex ante remedy, the
plaintiff is overcompensated when the ex post damages exceed ex ante damages. A
defendant will argue whichever approach gives the lower damages ﬁgure as the
correct approach to use.
Frank Fisher puts forth an alternative argument that the ex post method can
overly deter wrongdoers because the infringer runs the risk of the downside loss.
For example, assume that an infringer has a 50 percent chance of a $200 gain and
a 50 percent chance of a $100 loss; his expected gain then equals $50 [¼ (50%
$200) þ (50% $100)]. The plaintiff will not choose to sue if the infringer incurs
a loss but will sue if the infringer makes a gain. The plaintiff’s expected recovery
5.4
APPLICATION OF THE EX POST APPROACH IN LITIGATION
5 9

equals $100 [¼ (50% $200) þ (50% $0)], and the defendant’s expected net loss
after disgorgement is $50 [¼ (50% ($200 – $200)) þ (50% ($100 þ $0))].7
Thus, the plaintiffs could be compensated for risks they did not bear while the
infringers could be overpenalized by both bearing the downside risk and poten-
tially being forced to disgorge the entire upside.
5.5
HYBRID APPROACH
Experts frequently blend different aspects of both ex ante and ex post analyses in a
hybrid approach. A common hybrid between a pure ex ante and a pure ex post
analysis uses ex post information but an ex ante measurement date. Experts dis-
count the lost cash ﬂows back to the date of the unlawful act, using a risk-
adjusted discount rate based on the actual volatility of the returns in the ex post
period.
The hybrid approach reasons that if all parties know what the lost cash ﬂows
would have been, no rationale exists for ignoring this information. What actually
happened was, after all, one of the plausible outcomes at the time of the breach.
This hybrid approach also appeals to some individuals’ sense of justice because
it uses the real world as a basis for the calculation of damages as opposed to a hypo-
thetical expectation of what was known and knowable at the time of the unlawful
act. It eliminates some speculation as to what the cash ﬂows would have been.
Advocates argue that we must discount the actual cash ﬂows to reﬂect the
business risk of earning those cash ﬂows. If the analyses do not discount actual
cash ﬂows at a risk-adjusted rate—as occurs in a pure ex ante approach—plaintiffs
enjoy a superior economic position relative to where they would have been but
for the unlawful act because the analyses ignore business risk.
Consider the situation in which a person has a choice between earning cash
ﬂows associated with some uncertainty and holding a free call option on his or
her future cash ﬂows. This individual would invariably choose the call option in
order to avoid downside risk. Likewise, pursuing a pure ex post result in court is
like giving the plaintiff a free call on his or her future lost cash ﬂows, because to
obtain those cash ﬂows, but for the unlawful act, the plaintiff would have had to
suffer through some level of uncertainty, whereas he avoided such uncertainty
when the act occurred.8
Discounting the ex post cash ﬂows back to the date of the unlawful act at the
appropriate risk-adjusted discount rate moves the pure ex post result closer to a
position that is at risk parity with what would have happened but for the un-
lawful act. The appropriate discount rate for the hybrid approach should incorpo-
rate information from proxy companies in the market. The risk premium would
be the market risk premium multiplied by the beta of the proxy companies for a
period that parallels the damages period as closely as feasible. This hybrid analy-
sis should calculate prejudgment interest as in the ex ante analyses—from the date
of the unlawful act to the date of restitution. Therefore, an expert would ﬁrst dis-
count future lost cash ﬂows to the date of the unlawful act and then apply pre-
judgment interest to both future and past lost cash ﬂows from the date of the
illegal act. When statute does not specify a prejudgment interest rate, a reason-
able rate would be the defendant’s borrowing rate.
5 10
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

5.6
THE BOOK OF WISDOM
Some hybrid analyses use the concept of the book of wisdom. This concept allows
damages experts to apply facts established after the date of damage to their calcu-
lations. The Supreme Court ﬁrst set forth the concept of the book of wisdom in
1933 in the landmark case Sinclair Ref. Co. v. Jenkins Petroleum Co.9 In its decision,
the Court stated that
at times the only evidence available may be that supplied by testimony of experts as
to the state of the art, the character of the improvement, and the probable increase of
efﬁciency or savings of expense . . . . This will generally be the case if the trial fol-
lows quickly after the issue of the patent. But a different situation is presented if
years have gone by before the evidence is offered. Experience is then available to
correct uncertain prophecy. Here is a book of wisdom that courts may not neglect.
We ﬁnd no rule of law that sets a clasp upon its pages, and forbids us to look within.
Further, the Court opined that facts established after the date of damage do not
necessarily change past facts; rather, they “bring out and expose to light the ele-
ments of value that were there from the beginning.”
Use of the book of wisdom often persuades courts because one could perceive
it as a call for less speculation. In Transit RR. Comm’rs.,10 the courts ruled that
“certainty is better than conjecture, and injuries actually inﬂicted a better guide
than opinion of experts as to the market values just before and after.” Likewise,
in Fishman et al. v. Estate of Arthur M. Wirtz et al.,11 the Seventh Circuit allowed a
damages calculation that applied the book of wisdom, stating that “we know of
no case that suggests that a value based on expectation of gain is more relevant
and reliable than one derived from actual gain.”
In cases involving a measurement of value, the courts have used the book of
wisdom to allow an analysis or grant an award based on a lost outcome (i.e., ex
post) approach, as opposed to a lost expectancy (i.e., ex ante) approach. For exam-
ple, the Seventh Circuit sided with a book of wisdom approach in Fishman. The
Fifth Circuit also supported a valuation analysis based on the book of wisdom in
Park v. El Paso Board of Realtors,12 even where it opined that, though a hypothetical
sale at the date of the unlawful act can present a useful analogy for purposes of
valuation, a lost going-concern value offers a more appropriate measure of loss
when the plaintiff has been driven out of business. The court based its support of
a lost going-concern calculation because nothing in principle prevents a plaintiff
with a destroyed business from recovering future proﬁts.
In addition to cases of valuation, courts often apply the book of wisdom in pat-
ent infringement cases when deciding the details of the hypothetical negotiation
that would have occurred between two parties. In Fromson v. Western Litho Plate &
Supply Co.,13 the Federal Circuit, citing Sinclair, indicated that one could look at
postinfringement events in calculating reasonable royalty damages. In this case,
the plaintiff wanted to use the infringer’s actual proﬁts as evidence of the value
of the patent. The court found that excluding the evidence was erroneous and
explained that
the methodology [of simulating a hypothetical negotiation] encompasses fantasy
and ﬂexibility; fantasy because it requires a court to imagine what warring parties
5.6
THE BOOK OF WISDOM
5 11

would have agreed to as willing negotiators; ﬂexibility because it speaks of negotia-
tions as of the time infringement began, yet permits and often requires a court to
look to events and facts that occurred thereafter and that could not have been known
to or predicted by the hypothesized negotiators.
Likewise, in Jamesbury Corporation v. United States,14 the opining judge found
that because he was “aided by the beneﬁt of hindsight, it [seemed] unnecessary
to create such a ﬁctional [analysis]” as a hypothetical negotiation would have
used.
On occasion, however, courts have limited the applicability of the book of wis-
dom. In TWM Manufacturing Co., Inc. v. Dura Corp.,15 the defendant argued that
the plaintiff erred in its damages calculation because it based damages on a gross
proﬁt value that the defendant’s management had projected in an internal memo-
randum prior to the defendant’s infringement of the patent. The defendant be-
lieved that the plaintiff should have considered actual gross proﬁt values, not
projected values. The Federal Circuit rejected the defendant’s argument and con-
sidered its preinfringement memorandum as probative on the reasonable royalty
issue. Thus, the court focused on the time the infringement began—speciﬁcally, it
ruled that the book of wisdom did not apply in this case. Evidence of what hap-
pened after that time did not mitigate damages. Additionally, in Odetics, Inc. v.
Storage Technology Corp.16 (CAFC), the U.S. Court of Appeals for the Federal Cir-
cuit found that the federal district court had not abused its discretion by disallow-
ing a book of wisdom approach and thus excluding evidence of two licenses
granted by a patent infringement plaintiff from consideration in calculating a rea-
sonable royalty rate for award of damages. The Federal Circuit reasoned that, be-
cause the hypothetical negotiation required in reasonable royalty analysis obliges
courts to envision the terms of a licensing agreement reached between patentee
and infringer when the infringement began, the court could not in this case con-
sider the license agreements in question, which were negotiated four and ﬁve
years after the date of infringement.
Robert Goldscheider reconciles the contrary positions of the courts by stating
that “one may employ the book of wisdom only by looking prospectively from
the date of the hypothetical negotiation, not retrospectively.” He illustrates this
concept with the example of an invention that had no noninfringing alternative
at the date of the hypothetical negotiation but had one—a design-around—ﬁve
years later. In this case, the expert cannot use the book of wisdom to say that this
alternative technology was potentially available at the time of the hypothetical
negotiation just because it was achieved ﬁve years later. However, this example
shows that it took ﬁve years to design around the infringed patent. The expert
should use this information in calculating damages. Goldscheider adds that
“reference should be made by expert witnesses to the book of wisdom whether
or not such actual subsequent events were non-foreseeable aberrations. Anything
that can contribute to the realism of the exercise should be given serious
consideration.”17
In sum, case law indicates that experts can, and indeed should, incorporate all
information, even information relating to events that occurred after the date of
damage or after the date of hypothetical negotiation in the damages analysis. If
the goal is to ascertain the amount of damages that would return the plaintiff to
5 12
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

the same position it would have been in but for the unlawful act, the expert
should use all available information in reconstructing the but-for world so that
the resulting award reﬂects all the events that have contributed to or limited the
damages suffered by the plaintiff.
5.7
THE WRONGDOER’S RULE
Because precedent has accepted both ex post and ex ante analyses, how do the
courts decide which approach to use? Both experts and courts often overlook the
concept of the wrongdoer’s rule.
When the court has found liability, the wrongdoer’s rule gives the beneﬁt of
the doubt to plaintiffs, leaving defendants with the burden of dispelling
any uncertainty. In Story Parchment Co. v. Paterson Parchment Paper Co. et al.,18 the
Supreme Court ruled that “whatever . . . uncertainty there may be in [a] mode of
estimating damages, it is an uncertainty caused by the defendant’s own wrong
act; and justice and sound public policy alike require that he should bear the risk
of the uncertainty thus produced.” The courts can apply this ruling to ﬁnd in
favor of a plaintiff’s damages calculation.
Although its application is certainly not limited to ex post and ex ante cases, the
wrongdoer’s rule can provide a guideline for courts dealing with these two alter-
native analyses when deciding which damages calculation to award. Unless
proved otherwise by the wrongdoer, courts will not withhold a reasonable dam-
ages estimate from the plaintiff. In Fishman et al. v. Estate of Arthur M. Wirtz et al.,19
the Seventh Circuit granted a damages award based on an ex post analysis, opin-
ing that the defendants’ objections of speculation were not sufﬁcient as the
“defendants . . . should not beneﬁt because their wrongdoing made it difﬁcult to
establish the exact amount of injury.” Additionally, the court held that an ex post
analysis was a reasonable estimate of damages as “we know of no case that sug-
gests that a value based on expectation of gain is more relevant and reliable than
one derived from actual gain.” It also cited Sinclair in saying that “to correct un-
certain prophecies . . . is not to charge the offender with elements of value non-
existent at the time of his offense. It is to bring out and expose to light the ele-
ments of value that were there from the beginning.” As applied by the Court of
Appeals of Maryland in M & R Contractors & Builders, Inc. v. Michael et al.,20 the
court can use the wrongdoer’s rule in awarding an ex ante damages calculation.
In this case, the court found nothing wrong in a damages calculation based on a
proﬁt expectation that was measured as of the signing of the subsequently broken
contract. The court advised the district court, “Where a defendant’s wrong has
caused the difﬁculty of proving damage, he cannot complain of the resulting
uncertainty.” Citing from Corbin on Contracts (1951), the court further expressed
“doubts [as to whether the amount of lost proﬁts] will generally be resolved in
favor of the party who has certainly been injured and against the party commit-
ting the breach.”
Courts have not frequently applied the wrongdoer’s rule to cases in which ex
ante and ex post have been points of contention, but courts have tested and upheld
its applicability on many occasions. In each of these occasions, the defendants
complained that the plaintiffs’ measures of damages were speculative, yet the
5.7
THE WRONGDOER’S RULE
5 13

courts allowed these calculations because, as stated in Story Parchment, the uncer-
tainty involved was “caused by the defendant’s own wrong act.” Following Story
Parchment, the Supreme Court again applied the wrongdoer’s rule in granting
damages based on historical performance to the plaintiff in Bigelow et al. v. RKO
Radio Pictures, Inc., et al.21 The wrongdoer’s rule as established by Story Parchment
allowed for the granting of damages “which are deﬁnitely attributable to the
wrong and only uncertain in respect of their amount.” However, in Bigelow, the
Supreme Court went one step further than it had in Story Parchment, concluding
that even though a jury cannot “render a verdict based on speculation or guess-
work . . . the wrongdoer may not object to the plaintiff’s reasonable estimate of
the cause of injury and of its amount, supported by the evidence, because [it is]
not based on more accurate data which the wrongdoer’s misconduct has ren-
dered unavailable.” Few courts, however, have applied the wrongdoer’s rule as
recognized in Bigelow to establish a causal relation between the harmful act and
economic damages.
The Second Circuit has also used the wrongdoer’s rule to award plaintiff dam-
ages when damage has resulted from the defendant’s harmful act. See Contempo-
rary Mission, Inc. v. Famous Music Corp.22 and Indu Craft, Inc. v. Bank of Baroda.23 As
the Second Circuit stated in its Contemporary Mission decision, “Under the long-
standing New York rule, when the existence of damage is certain, and the only
uncertainty is as to its amount, the plaintiff will not be denied a recovery of sub-
stantial damages.” State courts have also supported the wrongdoer’s rule. The
Supreme Court of Michigan has ruled that the risk of uncertainty should be
thrown upon the wrongdoer instead of upon the injured party (Allison v. Chan-
dler).24 Similarly, in Tull v. Gundersons, Inc.,25 the Supreme Court of Colorado
granted damages to the plaintiff “although the amounts were not mathematically
certain, [because] had we disallowed recovery . . . for injuries that had been
proven in fact, we would have rewarded the injurious party.”
In cases of ex ante and ex post, the courts can use the wrongdoer’s rule in siding
with the plaintiff’s measure of damages. Because both approaches yield arguably
reasonable results, defendants carry the burden of showing why the plaintiff’s
analysis is not appropriate for a speciﬁc case. This approach is especially relevant
when the defendant’s own acts have precluded an accurate understanding of the
but-for world (e.g., cases of antitrust and breach of contract).
5.8
CONCLUSION
The time lag between the date of the unlawful act and the date of restitution will
always cause debate as to the merits of using ex ante and ex post analyses in calcu-
lating damages. No single approach will be appropriate for all situations; the de-
cision to apply any particular approach will depend on case speciﬁcs. For any
method described in this chapter, one can concoct a situation in which the result
of applying that method would not satisfy a common perception of fairness.
5 14
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

Appendix:
Case Law Supporting
Ex Ante and Ex Post
Analyses
CASE LAW SUPPORTING EX ANTE ANALYSES
This section discusses cases that reﬂect court decisions supporting ex ante analy-
ses. We list these cases in chronological order. Note that the following cases
reﬂect that breach of contract damage measures usually employ ex ante
approaches.
M&R Contractors & Builders v. Michael, 215 Md. 340, 351; 138 A.2d 350, 356 (1958).
Defendants hired a contractor (plaintiff) to build a home for them. Several
months later the defendants informed the plaintiff that they did not want to have
a home built at that time and asked the plaintiff to release them from the contract.
Plaintiff ﬁled suit against the defendants for the contract price of $23,420, of
which $20,020 represented costs and $3,400 the expected proﬁt. The plaintiff
admitted that the only work done prior to the breach consisted of contract prepa-
ration, studying plans, and obtaining estimates from subcontractors. The plaintiff
did not begin digging, paying for building materials, or signing contracts with
subcontractors. At trial, the plaintiff abandoned his claim for the cost of the home
and asked only for his anticipated proﬁt, which he calculated by subtracting
the estimates of the subcontractors from the contract price. The trial court found
the plaintiff’s proof of loss proﬁts speculative and granted the defendants a mo-
tion for dismissal. The plaintiff appealed that decision and the appellate court
reversed and remanded for a new trial. The appellate court held that one should
measure unrealized proﬁts as the difference between the contract price and the
actual or estimated costs of full performance and that in this case the plaintiff
appeared to make a reasonable estimate of his lost proﬁts. The defendants
5 15

also raised the issue of whether the plaintiff had minimized his damages. The ap-
pellate court held that the court should not deduct from the damages measure the
gains made by the plaintiff on another transaction unless the plaintiff could not
have worked on another job without the defendants’ having breached the origi-
nal contract. Hence, while the lost proﬁts damages measure relied on an ex ante
analysis, whether the court should reduce the plaintiff’s lost proﬁts by the
amount of proﬁt made on a substituted contract depended on an ex post analysis.
Sharma v. Skaarup Ship Management Corporation, 916 F.2d 820, 825–26 (1990).
The
plaintiffs alleged that the defendants (Chemical Bank and other individuals)
breached a reﬁnancing agreement, causing the plaintiffs to lose ownership of
four tankers that became the property of the defendants. The plaintiffs sought as
damages not only the market value of the vessels ($15 million) but also lost proﬁts
from future years ($80 million). The plaintiffs argued that Chemical Bank be-
lieved the shipping industry would experience sharply increased demand shortly
and wished to acquire these tankers prior to the economic boom and that, but for
Chemical Bank’s wrongful actions, the plaintiffs would have received substantial
proﬁts when demand for the tankers increased. The trial court disagreed with
this reasoning, stating that the plaintiffs could recover only the market value of
the tankers and that lost prospective proﬁts was not a proper damages measure.
The plaintiffs appealed that decision. The appellate court also disagreed with the
plaintiffs. The appellate court stated that “it is a fundamental proposition of con-
tract law, including that of New York, that the losses caused by a breach are de-
termined as of the time of the breach.” The appellate court cited the following
examples:
In measuring damages, courts cannot take into account changes in currency
exchange rates subsequent to a breach.
Damages for the breach of an agreement to purchase securities equal the dif-
ference between the contract price and the market value of the asset at the
time of the breach.
Damages for a breach of contract to buy real estate equal the difference be-
tween the contract price and the market value at the time of the breach.
The appellate court concluded this discussion by noting that measuring dam-
ages by using the value of the items at the time of breach takes expected lost fu-
ture proﬁts into account. “The value of assets for which there is a market is the
discounted value of the stream of future income that the assets are expected to
produce. This stream of income, of course, includes expected future proﬁts and/
or capital appreciation.”
Indu Craft, Inc. v. Bank of Baroda, 47 F.3d 490 (1995).
The jury found that the Bank
of Baroda (the defendant) had curtailed the credit of Indu Craft (the plaintiff) and
had caused Indu Craft difﬁculties in obtaining letters of credit because Indu
Craft’s president failed to invest in the computer business of the son of one of the
bank’s ofﬁcers. The jury further found that these actions caused Indu Craft to go
out of business in November 1987. The plaintiff presented two claims: (1) lost
proﬁts, and (2) the loss of the value of the business. The appellate court rejected
the calculation of lost proﬁts because the plaintiff did not include ﬁxed costs in its
5 16
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

analysis. The appellate court, however, accepted the plaintiff’s calculation of the
lost business value. The plaintiff calculated the lost business value by estimating
the earnings as of November 1987 (adjusted for a nonrecurring event—the
embargo of a country from which Indu Craft imported goods) and applying an
earnings multiplier based on the earnings of publicly traded comparable compa-
nies to that number. The appellate court cited the Sharma case, which stated that
“where the breach involves the deprivation of an item with a determinable mar-
ket value, the market value at the time of the breach is the measure of damages”
(emphasis added).
Brushton-Moira Central School District v. Fred H. Thomas Associates, 91 N.Y.2d 256,
261–62; 692 N.E.2d 551, 553–54; 669 N.Y.S.2d 520, 522–23 (1998).
The plaintiff
school district employed the defendant to renovate its high school building.
Three months after the defendant completed the renovations, insulated panels
that replaced glass windows began to deteriorate, permitting water to penetrate
the building. The plaintiff sued for breach of contract. On appeal, the Appellate
Division of the Supreme Court of New York held, among other issues, that the
plaintiff should receive the replacement cost of the defective panels measured as
of the trial date, and sent the case back to the trial court. In turn, the plaintiff and
defendant appealed that decision. The Court of Appeals of New York rejected the
prior measurement date (i.e., the trial date) for damages. “Damages are intended
to return the parties to the point at which the breach arose and to place the non-
breaching party in as good a position as it would have been had the contract been
performed. . . . A cause of action for defective design or contruction accrues
upon the actual completion of the work.” The Court of Appeals also held that the
trial court should award prejudgment interest from that same date.
Kelly v. Marx, 428 Mass. 877, 878; 705 N.E.2d 1114, 1115 (1999).
The plaintiffs paid
the defendants a $17,500 deposit for the $355,000 purchase of the defendants’
property. Five months later, the plaintiffs informed the defendants that they
could not purchase the property and asked the defendants to put it back on the
market. Several weeks after that, the defendants sold the property for $360,000,
but refused to return the plaintiffs’ deposit. The plaintiffs sued to recover their
deposit. The trial court held that the liquidated damages clause in the contract
was enforceable and allowed the defendants to retain the deposit. The Appeals
Court of Massachusetts ruled that the defendants should not keep the deposit in
that they suffered no damage and as a result liquidated damages served as a
penalty, not as compensation for a loss. The Supreme Court of Massachusetts
sided with the trial court. It rejected examining the amount the defendants ﬁ-
nally received (i.e., the retrospective or “second look” approach) and instead
focused on the circumstances at the time of contract formation or the time of the
plaintiffs’ breach (i.e., the “ﬁrst look” approach). The Supreme Court noted that
“a liquidated damages clause in a purchase and sale agreement will be enforced
where, at the time the agreement was made, potential damages were difﬁcult to
determine and the clause was a reasonable forecast of damages expected to oc-
cur in the event of a breach.” The court found that, under the circumstances, the
deposit was a reasonable forecast of the defendants’ losses should the plaintiffs
breach the contract.
APPENDIX: CASE LAW SUPPORTING EX ANTE AND EX POST ANALYSES
5 17

CASE LAW SUPPORTING EX POST ANALYSES
This section cites cases containing ex post analyses by courts. For example, deci-
sions related to antitrust, patent infringment, damage to property by government,
and legal malpractice cases have used ex post analyses. We list these cases by sub-
ject matter in chronological order.
1. Antitrust
A.C. Becken Co. v. Gemex Corporation, 314 F.2d 839, 840 (1963).
Civil Antitrust.
The plaintiff claimed injury because the defendant refused to sell
the plaintiff watch bands after 1956. At the original trial, the district court
had found as fact and concluded as law that the plaintiff was not damaged. The
Seventh Circuit Court of Appeals reversed and remanded in 1959, stating that, in
ﬁxing the proper amount of damages, the district court should consider the evi-
dence already in the record on the subject of the plaintiff’s damages, any proper
evidence offered by the defendant, and rebuttal evidence of plaintiff. On the
remandment, the district court considered additional evidence that occurred
while the case was on appeal. According to the Seventh Circuit, these actions by
the district court placed it in a position “where it had the beneﬁt, not only of such
projections as might have been reasonable based on the facts appearing at the ﬁrst
trial . . . but it also had the superior advantage of evidence of conditions which
had in fact occurred while the case had been on appeal.” The Seventh Circuit
noted that while the evidence at the ﬁrst trial was a reliable basis for damages,
“no one can deny that to the extent future events modiﬁed its correctness, the
entire evidence must be considered together.”
Park v. El Paso Board of Realtors, 764 F.2D 1053, 1068 (1985).
Sherman Act.
The plaintiff ﬁled suit in 1978, claiming that the defendants had
conspired to boycott his real estate ﬁrm in retaliation for the plaintiff’s attempts
to reduce real estate commissions. In 1982, the jury found that six of the ten
remaining defendants had conspired to boycott the plaintiff’s ﬁrm and entered
a $927,559 judgment against them for past and future proﬁts for the period
from 1978 to 1991. To calculate damages, the plaintiff relied solely on the testi-
mony of its expert, Dr. George. Among other factors, Dr. George estimated that
by 1983 the plaintiff’s ﬁrm would have captured 20 percent of the El Paso real
estate market, but presented no basis for the support of that assumption. The
Fifth Circuit Court of Appeals reversed and remanded for a new trial on sev-
eral issues. Because the court believed that the issue of adequate support for
the damages amount might arise on remand, it noted that several aspects of
Dr. George’s model lacked a rational basis. For example, had the plaintiff’s
ﬁrm captured 20 percent of the El Paso real estate market, it would have
equaled the size of the four largest real estate ﬁrms in El Paso combined. “On
remand, the plaintiff must present a revised damages model, with a rational
basis for each of the model’s principal assumptions.” The Fifth Circuit further
stated that “since the exact number of residential resales can now be deter-
mined for much of the damages period, the plaintiff should incorporate these
ﬁgures into his model rather than rely on projections as he did previously. The
plaintiff should also use actual ﬁgures rather than projections for the home
5 18
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

resale inﬂation rate, when calculating the commission he would have received
for his lost sales.”
Fishman v. Estate of Wirtz and Illinois Basketball, Inc. v. Estate of Wirtz, 807 F.2d 520,
552 (1986).
Sherman Act and Illinois Law.
In 1972, Illinois Basketball Inc. (IBI) and Marvin Fish-
man sought to purchase the Chicago Bulls (the Bulls). Instead the Chicago Profes-
sional Sports Corporation (CPSC) purchased the Bulls. IBI and Fishman ﬁled a
lawsuit claiming that CPSC had acquired the Bulls through violations of the Sher-
man Act and Illinois common law. The district court found that the defendants
had engaged in anticompetitive acts in destroying the contract the plaintiffs had
executed with the former owners of the Bulls. The Seventh Circuit Court of Ap-
peals agreed that the defendant had violated Sections 1 and 2 of the Sherman Act,
but disagreed with the district court’s judgment that the defendant’s actions
amounted to a boycott or tortious interference with the contract. The Seventh Cir-
cuit also found that the district court erred in its computation of damages and
remanded the case back to the district court for a new trial on this issue. The dis-
trict court calculated IBI’s damages using the yardstick of CPSC’s actual ﬁnancial
experience from 1972 until 1982 (the time of the original trial). While the Seventh
Circuit agreed with the general use of this yardstick, it found that the district
court’s damages method required revision. The Seventh Circuit, nevertheless,
speciﬁcally disagreed with the defendant’s assertion on appeal that damages
must be computed as of the date of the injury (i.e., July 1972). “We know of no
requirement that damages must always be computed as of the time of the injury
or, if not, reduced by some appropriate discount rate to produce a value as of that
date. . . . If a victim is deprived of what may turn out to be an unusually success-
ful investment, his damages should reﬂect that fact.” Further, the majority opin-
ion disagreed with the dissent, which adopted 1972 as the time at which the court
should measure damages. The dissent argued that while IBI lost one business
opportunity, it could go out and invest in the next best business opportunity in
1972 and that the district court should have awarded the plaintiffs only the bar-
gain element of its contract (i.e., the amount at which the plaintiffs would have
been able to buy the Bulls below their “market price”). The dissent concluded
that the plaintiffs lost no bargain element, no unique opportunity (in 1972), and
they had no damages. The majority opinion noted that “we ﬁnd the dissent’s
analysis unpersuasive insofar as it may suggest that IBI should have invested
promptly in another basketball team. The dissent appears to treat basketball
teams as fungible commodities. But the record does not disclose that there is any-
thing like an auction market in basketball teams. As far as we know, the law im-
poses no duty on a buyer who has been unlawfully done out of a purchase of the
Bulls to cover immediately with the Bucks, Celtics, or the Lakers. The record does
not disclose that these teams were either fungible or available.”
2. Patent Infringement
Trans-World Manufacturing Corp. v. Al Nyman & Sons, Inc., 750 F.2d 1552, 1568
(1984).
Design Patent Infringement.
In 1978, the defendant (Nyman) asked the plaintiff
(Trans-World) to design display racks for the eyeglasses that the defendant
APPENDIX: CASE LAW SUPPORTING EX ANTE AND EX POST ANALYSES
5 19

sold. The plaintiff delivered to the defendant models of the display racks.
Later, the plaintiff obtained design patents for these racks. Meanwhile, the
defendant arranged for another ﬁrm to manufacture display racks based on
the plaintiff’s designs. The plaintiff claimed that the defendant’s design pat-
ents were invalid. The plaintiff ﬁled for two design patents for the racks in
1979 and the Patent Ofﬁce issued the patents in 1980 and 1981. The plaintiff
ﬁled this suit in 1981. The trial judge refused to admit evidence of the
defendant’s proﬁts on the sale of eyeglasses sold from the infringing display
racks. Ultimately, that decision was irrelevant because the jury concluded
that both patents were invalid. The appellate court, however, reversed the
jury’s decision on the patents’ validity. Hence, the appellate court decided to
issue an advisory opinion on the admissibility of the defendant’s proﬁts be-
cause the plaintiff would likely seek to introduce that evidence at the new
trial. The appellate court noted that among the Georgia-Paciﬁc factors, the jury
should consider the infringer’s “anticipated” proﬁt from use of the patented
invention and that “evidence of the infringer’s actual proﬁts generally is ad-
missible as probative of his anticipated proﬁts.” Hence, the trial judge should
admit this previously excluded evidence at the new trial, if offered.
Fromson v. Western Litho Plate and Supply Co., 853 F.2d 1568, 1575 (1988).
Patent Infringement.
The plaintiff accused the defendant of violating its patent.
Both parties appealed from the district court’s decision. In discussing the proper
damages measure, the appellate court stated that without evidence of an estab-
lished royalty rate, the district court must create one based on “hypothetical ne-
gotiations between a willing licensor and a willing licensee.” The court went on
to state that this hypothetical negotiation “encompasses fantasy and ﬂexibility;
fantasy because it requires a court to imagine what warring parties would have
agreed to as willing negotiators; ﬂexibility because it speaks of negotiations as of
the time infringement began, yet permits and often requires a court to look to
events and facts that occurred thereafter and that could not have been known to
or predicted by the hypothesized negotiators.”
3. Damage to Property by Government
The Board of Rapid Transit Railroad Commissioners of the City of New York, 197 N.Y.
81, 90 N.E. 456 (1909).
The building of a subway caused damages to homes in
Brooklyn, making them unﬁt for habitation for approximately 18 months. The
court found that a railroad constructed beneath the street was a new burden, not
contemplated by the original owner of the land when he agreed to devote the
land to use as a street. As a result, the claimants were entitled to the full value of
their property that was taken without deduction for beneﬁts and also to just com-
pensation for the injury done to the remainder. The commissioners must adapt
the measure of damages to the actual injury. “It is the duty of the commissioners
of appraisal to receive evidence relating to the condition of the properties down
to the time of trial.”
Michigan State Highway Commission v. Davis, 38 Mich. App. 674; 197 N.W.2d 71 (1972).
For the purposes of highway construction, in 1968 the Highway Commission pro-
posed to take portions of a parcel that would have severely limited the owners’
5 20
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

use of the remaining property. Two preliminary appraisals valued the damages
at $62,200 and $78,000. The Highway Commission, however, did not complete
the contracting process until May 1969. Moreover, in June 1969 the commission
made changes to the plans, giving the owners access to their remaining property.
A third appraisal made at this time valued the damages at $25,650. In the
condemnation hearing, the trial court ruled that it would calculate damages as of
the time of possession in 1968. The appellate court overruled the trial court’s
exclusion of the third appraisal, stating that “since we are dealing here not with
the value of the property taken, but rather with the damage done to the residue as
a result of the taking, we ﬁnd no bar to the introduction of evidence bearing on
those damages despite the fact that the evidence concerns facts occurring after
the date of the taking.”
4. Legal Malpractice
Kilpatrick v. Wiley, Rein & Fielding, 37 P.3d 1130, 1145 (2001).
The plaintiffs, who
had formed MWT, Ltd., alleged that the defendants represented them from 1981
to 1991 in connection with their efforts to acquire a television station and that the
defendants breached their ﬁduciary duties. The plaintiffs’ expert presented two
valuations of the television station, one as of 1987 and the other as of 1997, but for
the alleged breaches of ﬁdicuary duty. The defendants appealed the trial court’s
decision to allow the jury to measure the plaintiffs’ damages “either from the date
of defendants’ alleged breaches of ﬁduciary duty or from the date almost a dec-
ade later when the case was ready for trial” (emphasis added). The appellate
court disagreed and stated that, while measuring damages at the time of the
breach is appropriate in some cases, “the general objective of tort law [is] to place
an injured person in a position as nearly as possible to the position he would have
occupied but for the defendant’s tort” and that “the trial court is in the best posi-
tion to determine what award of damages will make a plaintiff whole.” As
a result, the appellate court ruled that the trial court could use its discretion in
deciding the date from which the jury would measure damages. The appellate
court concluded that allowing the jury to hear evidence related to both dates
“allowed the jury to come to a reasonable approximation of the damages the
MWT, Ltd., limited partners actually incurred as a result of defendants’ alleged
breaches of ﬁduciary duty. Accordingly, the trial court’s decision was within its
permitted discretion.”
NOTES
1. Here we ignore the state’s vigorish in selling tickets. Because of the state’s take from
the proceeds before disbursing to the winners, the expected value of all legal lotteries
of which we are aware is negative.
2. The statement of this approach appears in J. M. Patell, R. L. Weil, and M. A. Wolfson,
“Accumulating Damages in Litigation: The Role of Uncertainty and Interest Rates,”
Journal of Legal Studies 11 (June 1982): 341 64.
3. In the case of continuing breach, such as patent infringement, the limiting case occurs
when each period approaches zero length. (Recall the limit theorems and analysis of
ﬁrst-year calculus.) In that case, under suitable assumptions of continuity of damages
APPENDIX: CASE LAW SUPPORTING EX ANTE AND EX POST ANALYSES
5 21

paths, the ex ante analysis and the ex post analysis will give the same result. The peri-
ods are so short that the before-the-fact analysis of each period becomes identical with
the after-the-fact analysis of the preceding period.
4. Obviously, this approach merits a measure of common sense. At some point, this exer-
cise becomes so complex that it becomes unfeasible.
5. The ﬁrst showing of this result appears to be in Patell et al. (see n. 2). See also Chapter
15 in this book.
6. Franklin M. Fisher and Craig R. Romaine, “Janice Joplin’s Yearbook and the Theory of
Damages,” Journal of Accounting, Auditing and Finance 5 (Winter 1990): 156 57.
7. Edward F. Sherry and David J. Teece, Some Economic Aspects of Intellectual Property
Damages, Practicing Law Institute; Patents, Copyrights, Trademarks and Literary
Property Course Handbook Series, PLI Order No. G0 007N, New York City, October
7 8, 1999, Section XI.
8. As stated earlier in the chapter, we assume that courts do not err. If the courts will
assume that there is some chance of error, then they should divide the result by the
probability of being found guilty.
9. Sinclair Ref. Co. v. Jenkins Petroleum Co., 289 U.S. 689, 698 99, 53 S. Ct. 736, 77 L. Ed.
1449 (1933).
10. Transit RR. Comm’rs., 197 N.Y. 81, 108, 90 N.E. 456, 465 (1909).
11. Fishman et al. v. Estate of Arthur M. Wirtz et al., 807 F.2d 520 (7th Cir. 1986).
12. Park v. El Paso Board of Realtors, 764 F.2d 1053 (1985).
13. Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1586, 1575 76 (Fed. Cir. 1988).
14. Jamesbury Corporation v. United States, 207 USPQ 131 (US ClCt 1980).
15. TWM Manufacturing Co., Inc. v. Dura Corp., 789 F.2d 895, 899 900 (Fed. Cir. 1986).
16. Odetics, Inc. v. Storage Technology Corp. (CAFC), 51 USPQ2d 1225 (1999).
17. Robert Goldscheider, “The Employment of Licensing Expertise in the Arena of Intel-
lectual Property Litigation,” IDEA: Journal of Law and Technology (1996).
18. Story Parchment Co. v. Paterson Parchment Paper Co. et al., 282 U.S. 555, 51 S. Ct. 248 (1931).
19. Fishman et al. v. Estate of Arthur M. Wirtz et al., 807 F.2d 520 (7th Cir. 1986).
20. M & R Contractors & Builders, Inc. v. Michael et al., 215 Md. 340, 138 A.2d 350 (1958).
21. Bigelow et al. v. RKO Radio Pictures, Inc., et al., 327 U.S. 251; 66 S. Ct. 574 (1946).
22. Contemporary Mission, Inc. v. Famous Music Corp, 557 F.2d 918 (1977).
23. Indu Craft, Inc. v. Bank of Baroda, 47 F.3d 490 (1995).
24. Allison v. Chandler, 11 Mich. 542, 550 56 (1863).
25. Tull v. Gundersons, Inc., 709 P.2d 940, 945 (1985).
LIST OF CASES
A.C. Becken Co. v. Gemex Corporation, 314 F.2d 839, 840 (1963)
Allison v. Chandler, 11 Mich. 542, 550 56 (1863)
Bigelow et al. v. RKO Radio Pictures, Inc., et al., 327 U.S. 251; 66 S. Ct. 574 (1946)
Brushton-Moira Central School District v. Fred H. Thomas Associates, 91 N.Y.2d 256, 261 62;
692 N.E.2d 551, 553 54; 669 N.Y.S.2d 520, 522 23 (1998)
Contemporary Mission, Inc. v. Famous Music Corp., 557 F.2d 918 (1977)
Contractors & Builders, Inc. v. Michael et al., 215 Md. 340, 138 A.2d 350 (1958)
Fishman et al. v. Estate of Arthur M. Wirtz et al., 807 F.2d 520 (7th Cir. 1986)
Fromson v. Western Litho Plate and Supply Co., 853 F.2d 1568, 1575 (1988)
Indu Craft, Inc. v. Bank of Baroda, 47 F.3d 490 (1995)
Jamesbury Corporation v. United States, 207 USPQ 131 (US ClCt 1980)
Kelly v. Marx, 428 Mass. 877, 878; 705 N.E.2d 1114, 1115 (1999)
5 22
EX ANTE VERSUS EX POST DAMAGES CALCULATIONS

Kilpatrick v. Wiley, Rein & Fielding, 37 P.3d 1130, 1145 (2001)
Michigan State Highway Commission v. Davis, 38 Mich. App. 674; 197 N.W.2d 71 (1972)
M&R Contractors & Builders v. Michael, 215 MD. 340, 351; 138 A.2D 350, 356 (1958)
Odetics, Inc. v. Storage Technology Corp. (CAFC), 51 USPQ2d 1225 (1999)
Park v. El Paso Board of Realtors, 764 F.2d 1053, 1068 (1985)
Sharma v. Skaarup Ship Management Corporation, 916 F.2d 820, 825 26 (1990)
Sinclair Ref. Co. v. Jenkins Petroleum Co., 289 U.S. 689, 698 99, 53 S. Ct. 736, 77 L. Ed. 1449
(1933)
Story Parchment Co. v. Paterson Parchment Paper Co. et al., 282 U.S. 555, 51 S. Ct. 248 (1931)
The Board of Rapid Transit Railroad Commissioners of the City of New York, 197 NY 81, 90 NE
456 (1909)
Transit RR. Comm’rs., 197 N.Y. 81, 108, 90 N.E. 456, 465 (1909)
Trans-World Manufacturing Corp. v. Al Nyman & Sons, Inc., 750 F.2d 1552, 1568 (1984)
Tull v. Gundersons, Inc., 709 P.2d 940, 945 (1985)
TWM Manufacturing Co., Inc. v. Dura Corp., 789 F.2d 895, 899 900 (Fed. Cir. 1986)
REFERENCES
Adams, Edward S., and David E. Runkle. “Solving a Profound Flaw in Fraud-on-the-
Market Theory: Utilizing a Derivative of Arbitrage Pricing Theory to Measure Rule
10B-5 Damages.” University of Pennsylvania Law Review (May 1997): 1097 145.
Ben-Shahar, Omri, and Lisa Bernstein. “The Secrecy Interest in Contract Law.” Yale Law
Journal (June 2000): 1885 925.
Bonsack, Konrad. “Damages Assessment, Janis Joplin’s Yearbook, and the Pie-Powder
Court.” George Mason University Law Review 13 (Fall 1990): 1 26.
Fisher, Franklin M., and R. Craig Romaine. “Janis Joplin’s Yearbook and the Theory of
Damages.” Journal of Accounting, Auditing and Finance 5 (Winter 1990): 145 57.
Kabe, Elo R., and Brian L Blonder. 1999. “Discounting Concepts and Damages (New).” In
Litigation Services Handbook, 1999 Supplement to the 2nd Edition. Hoboken, NJ: John
Wiley & Sons, pp. 325 54.
Kolaski, Kenneth M., and Mark Kuga. “Measuring Commercial Damages Via Lost Proﬁts
or Loss of Business Value: Are These Measures Redundant or Distinguishable?” Jour-
nal of Law and Commerce (Fall 1998): 1 354.
Lanzillotti, R. F., and A. K Esquibel. “Measuring Damages in Commercial Litigation: Pres-
ent Value of Lost Opportunities.” Journal of Accounting, Auditing and Finance 5 (Winter
1990): 125 44.
MacIntosh, Jeffrey G., and David C. Frydenlund. “An Investment Approach to a Theory of
Contract Mitigation.” University of Toronto Law Journal Spring (May 1987): 113 82.
Patell, James M., Roman L. Weil, and Mark A. Wolfson. “Accumulating Damages in Litiga-
tion: The Roles of Uncertainty and Interest Rates.” Journal of Legal Studies 11 (June
1982): 341 64.
Phillips, John R. “The Rite Way to Discount Damages.” Putnam, Hayes & Bartlett, Inc.
Scott, Robert E. “The Case for Market Damages: Revisiting the Lost Proﬁts Puzzle.” Univer-
sity of Chicago Law Review 57 (Fall 1990): 1155 202.
Taurman, John D., and Jeffrey C. Bodington. “Measuring Damage to a Firm’s Proﬁtability:
Ex Ante or “Ex Post”?” Antitrust Bulletin 37 (Spring 1992): 57 106.
Tye, William B., and Stephen H. Kalos. “Antitrust Damages From Lost Opportunities.”
Antitrust Bulletin (Fall 1996).
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