Quantifying Economic Damages: A Federal Case Study
Does a business need to be completely destroyed to recoup economic damages incurred in a business tort claim? A recent federal court ruling awarded a plaintiff damages based on the value of the business prior to the defendants’ alleged wrongdoing — even though the business continued to operate.
Here’s how a business valuation expert helped the plaintiff recover approximately $1.5 million in damages.
West Plains is an agricultural commodity trading business with several divisions, including a freight logistics brokerage (CT Freight). In February 2012, West Plains was sold and the seller declined the buyer’s offer to continuing working as the company’s CFO. Neither the seller nor any of the company’s employees had signed noncompete agreements at the time of sale. And CT Freight didn’t have any long-term exclusivity agreements with its customers.
Approximately eight months after the sale, the seller started a competing business (Retzlaff Grain, doing business as RFG Logistics), and he approached several employees of CT Freight to join the new company. For several months, those employees were paid by RFG Logistics to provide financial and operational information about CT Freight.
In February 2013, the employees submitted resignations from CT Freight via email and joined RFG Logistics. Immediately after the mass resignation, RFG Logistics began making sales to several of the CT Freight’s top customers.
West Plains subsequently filed a lawsuit against RFG Logistics, its founder and the former employees who were part of the mass resignation. The plaintiff’s claims included tortious interference with business relationships, breach of the duty of loyalty and civil conspiracy. The case was litigated in federal court under Nebraska state law.
The plaintiff hired a business valuation expert to estimate CT Freight’s economic damages. He compared revenue from RFG Logistics’ top customers in 2013 to revenue generated by CT Freight’s top 20 customers in 2012 and 2013 (which represented between 70% to 75% of the company’s overall revenue). The expert found that CT Freight’s revenue from these top 20 customers effectively disappears in March and April 2013. Then in April 2013, RFG Logistics, which previously hadn’t had much sales, suddenly reported sales from the same customers.
Moreover, CT Freight reported over $19 million in total annual revenue and $800,000 in profits for 2012. In comparison, the monthly sales revenue drastically dropped after February 2013. The company reported only $7.5 million total annual sales and a loss of over $100,000 for 2013.
Before the mass resignation, the expert concluded that the value of CT Freight was approximately $2.1 million, using the income approach. Moreover, between February and October 13, 2013, CT Freight suffered $330,000 in actual losses as it tried “to mitigate the damage and rebuild the business.” To formulate his opinion, the expert compared CT Freight’s financial results and customer mix from the years 2011, 2012, 2013 and 2014. He also considered:
· Salaries, overhead and other expenses,
· Discussions with management,
· Revenue by customer,
· Industry trends, and
· Expected growth rates.
Based on his review of that information, the expert concluded CT Freight was “unable to make a profit going forward from the date of this incident all the way through 2014.”
Decisions Upheld on Appeal
The defendants filed a motion to exclude evidence of total loss of value damages, which the U.S. District Court for Nebraska denied. It ruled that Nebraska law doesn’t require a plaintiff to show complete destruction as a prerequisite to recovery on a lost value theory. Citing prior case law, the district court determined that, as long as there’s “sufficient evidence” to show a loss of profits was suffered, a jury may estimate damages from the “best evidence the nature of the case allows.”
The district court ruled in favor of the plaintiff, finding that, due to the mass resignation, “CT Freight immediately lost its capacity to broker large quantities of freight.” It concluded that “while there was nothing unjust about the employee defendants’ choice to leave at-will employment with West Plains … the employee defendants knew and understood their group resignation would decimate CT Freight.”
Accordingly, the jury awarded the plaintiff roughly $1.5 million in compensatory damages and required the former employees to forfeit approximately $50,000 in compensation. The case was subsequently appealed to the Eighth Circuit Court of Appeals.
The appellate court upheld the district court decision. It found that, based on the valuation expert’s testimony and other financial evidence, the jury’s damages award wasn’t based on improper reasoning. The damages award “was considerably less” than the expert’s estimate of business value before that mass resignation, and “reflected an amount a reasonable jury could have believed would fairly compensate [CT Freight], since [the company] made only $7.5 million in sales that year, but made $19 million the year before.” (West Plains, L.L.C. v. Retzlaff Grain Co., 870 F.3d 774, August 30, 2017.)
Valuators Add Value
The analyses performed by the plaintiff’s expert proved essential in this case. His business valuation served as a benchmark for the jury’s damages award. And the expert’s month-by-month comparisons of revenue helped establish that the company was unable to make a profit after the employees’ mass resignation.
On the flipside, the defendants failed to hire their own expert to dispute the value of the business or the financial comparisons performed by the plaintiff’s expert. An opposing expert might have critiqued the valuation report, possibly finding flaws in the analyses performed by plaintiff’s expert, which ultimately could have reduced the damages award.
If you’re involved in a similar case, Lou can help quantify lost profits and business value. Or your expert can review the opposing side’s analyses to expose potential errors and weaknesses.
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.