Lost profits vs lost value in the calculation of economic damages

Often, the economic damages are more properly measured by lost business value – the difference between the value of the plaintiff’s business immediately before and after the defendant’s actions. Damages experts need to consider all the facts in determining which measure of damages is most appropriate. They must also ensure that their calculations of damages do not overlap so as to avoid a duplicate recovery of the same loss.

Both lost profits and lost business value are generally measured by the discounted value of lost income – incremental pre-tax cash flow for lost profits, and net after-tax cash flow for lost business value. Both need to consider an appropriate discount rate, and both consider expenses – incremental expenses in lost profits and all applicable expenses in loss of business value. The threshold question is whether the lost cash flow is for a finite period (lost profits) or is permanent/indefinite (lost business value).

By way of example, assume a plaintiff entered into a 5-year contract to provide parts. After year two, the defendant terminated the contract, constituting a breach. Economic damages would be measured by the lost profits (lost revenue less the incremental expenses related to the revenue) for the remaining 3-year term of the contract. Alternatively, assume the defendant’s actions resulted in a permanent loss of all or a portion of the business (e.g. destruction by fire, elimination of a division); economic damages would more properly be measured by the loss in value of the business.

Where the breach resulting in lost profits results in consequential damages such as cessation of the business, analysis of damages may include both lost profits and lost business value. Damages would be calculated using lost profits for the initial term, and lost business value as of the date the damages become permanent. The damages expert needs to be careful, however, to not overlap the periods covered under each scenario of damages.

Another difference in these calculations is the application of subsequent events. In valuations, only information known or knowable as of the valuation date is considered; subsequent events, if not known or knowable, are ignored. In lost profits calculations, however, subsequent events are routinely considered in the determination of damages.

In summary, damages experts need to analyse whether economic damages are more appropriately measured by lost profits or by lost business value. This will be based on the facts of each specific case, and application of the most appropriate damages theory.

---

Photo: Andrew Bayda - stock.adobe.com