A Case Study of Damages Involving Noncompetes (Litigation)
Consider this scenario: Two executives leave XYZ Company. Both executives have two-year noncompete agreements, but they take two key customers of XYZ with them to their new company. XYZ sues the two executives for breach of their noncompetes and for damages related to pirating the two customers. The expert witness for the plaintiff is asked to determine the damages related to the loss of the two customers. When the expert starts the analysis, he or she has to decide the proper method of determining the lost profits. There are two options:
- Calculate damages for the two-year period of the noncompete or
- Quantify the loss of value of the business.
The right choice depends on the facts of the case. If the evidence shows that the loss of profit from the customers will only last during the two-year period of the noncompete agreement, in theory the damages would only be calculated for that period of time. However, it is unlikely that the damages would suddenly stop at the end of the two-year noncompete period. Instead, the damages are likely to continue for some time afterwards.
Comparing Apples to Apples
One alternative method of determining the damages, would be to determine the “life” of the customer and to assume that the damages would occur during the entire period of the customer life. The best way to determine the life of a customer is to analyze actual data from the historical records of XYZ Company. Many companies have sufficient records to make such a determination. Absent this, the expert could use databases and other available information to determine the average customer life span for a business similar to XYZ and its customers. You must compare apples to apples—not apples to oranges.
A good source for locating information about customer life spans is the marketing departments of universities. Their professors may have that information or may be able to determine where to find it.
Once the customer life is determined, the expert can make the case that the damages would have lasted throughout the estimated life of the customer. Of course, this calculation must take into account the length of time that the pirated customers had already been customers of XYZ, prior to leaving with the departing executives. If the customers have already stayed beyond the normal life, an assumption might reasonably be made that they would have stayed longer (remember, we are dealing with averages), or at least through the two-year period of the noncompete.
Looking at Business Value
Can it be argued that there was permanent damage to XYZ as a result of the taking of the two customers? The answer is “sometimes.” The expert would have to show that these customers would likely have remained indefinitely with XYZ and that the company’s business was permanently damaged by their loss.
One situation where this might be logical is if the two customers made up a large percentage of the XYZ’s business as a whole. For example, if the two customers taken by the breaching executives amounted to 75 percent of XYZ’s entire business, it could be argued that the value of the business had been permanently impaired by the loss of these customers. In this case, the amount of damages could be determined by the loss of value of XYZ resulting from the loss of these two customers. Accordingly, a valuation of XYZ with and without the business of these two customers would need to be performed to determine the damages.
Getting Everyone on the Same Page
This case study emphasizes the importance of coordination and communication between the attorney and the financial expert witness. An attorney can help the expert determine the methodology that is appropriate to a particular case. This is not to say the hiring attorney should tell the expert how to determine damages—that is the domain of the expert—but the attorney should be fully aware of the approach being used by the expert and be “on board” with the methodology.
LOUIS J. CERCONE, JR., CPA, CFE, CFF, ABV, ASA, CVA
Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters.