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The Courts Deal With Economic

2008-02-08 - Breach of Contract

The Reasonable Certainty Standard on Lost Profits of New Businesses

In 1996 we published an article 1, with Dr. Roger I. Abrams, in the Ohio State Law Journal discussing the issues relating to the nature of expert testimony in cases involving lost profits of new businesses. At that time many courts, particularly in New Jersey, still had a rule on the books known as the "new business" rule. A recent ruling by the NJ Appellate Court has addressed the issue again.2

The basis for the rule was some old case law including the NJ Supreme Court case known as "Weiss"3. Although New Jersey, as well as other states, no longer precludes testimony from experts on lost profits suffered by new businesses, there is still considerable controversy as to what sort of testimony is acceptable under the reasonable certainty standard.

The recent trend in the courts, beginning in the early 1990's, has been to award lost profits to new enterprises under the reasonable certainty standard. Although there are still no specific guidelines for this standard, a number of guidelines, some of which were discussed in Abrams, Welsch and Jonas, are generally considered relevant in these cases. They include:

1. Projection of sales, costs and profits based on actual or prospective company performance,
2. Relevant experience and skills of the company management,
3. Performance of similar companies in the same geographic area and industry segment.
In Bell Atlantic v. P.M. Video, the Court found that even without consideration of the "new business rule", the testimony provided was too speculative in nature to warrant overturning the lower court's finding. In doing so, the Court noted that the types of testimony that would have met the reasonable certainty standard were not provided. They stated that the key judicial finding relates to the market viability of the new enterprise. This finding must be based on sound economic, financial and accounting aspects of the loss estimation. We are flattered that the Court cited Abrams, Welsch and Jonas as the basis for the market viability standard.

Expert Testimony on the "Bottom Line"

In April, 1999, the New Jersey Supreme Court overturned a twenty-plus year ruling that restricted economic experts from offering testimony regarding the total losses suffered by individuals in wrongful death cases4. Until this rule went into effect, attorneys were forced to summarize total loss estimates in their jury summations. Based on a 1975 case5, experts were only permitted to testify as to the components of economic and financial losses but not present the "bottom line" impact of the individual components.

In the opinion, Judge O'Hern found that experts should be permitted to testify to the total losses suffered by a plaintiff if the judge instructs the jury regarding the nature of the testimony and the need to consider the reasonableness of the expert's underlying assumptions.

As practicing economists and accountants, we find the requirement to consider the reasonableness of the assumptions the most interesting aspect of the opinion. In fact, it is the determination of the assumptions, stated or implied, that is the heart of the forensic economist and accountant's expertise.

We wish that the courts had provided some guidelines as to how to determine a reasonable assumption. Hopefully, they would have considered the following issues:

1. The foundation of the assumption - We would hope that each assumption was rooted in accepted economic and financial theories and principals. This grounding in accepted theory permits the assumption to be evaluated using the accumulated body of knowledge relating to the assumption.

2. The type of data used in formulating the assumption - We would hope that the estimation of the assumption would employ the best available data for the task. The modern statistical accumulation and distribution system offers the analyst easy access to the specific data needed to focus the assumption on the proper level of detail. When specific cohort information is available, the use of aggregate data needs to be examined.

3. The historical data used in the assumption - We would hope that the assumption would be based on the most comprehensive data set available. Although the most recent data should be included in the assumption estimation, sufficient historical data should be used to insure the proper perspective on the assumptions.

1- Abrams, Welsch and Jonas, "Stillborn Enterprises: Calculating Expectation Damages Using Forensic Economics", Ohio State Law Journal Vol: 57:809-1996, pages 809-834.
2- Bell Atlantic Network Services v. P.M. Video Corp et al, 6440-96T2
3- Weiss v. Revenue Building and Loan Assn, 116 NJL 208 (1936)
4- Mary Beth DeHanes v. Michael Rothman MD (A-167-97)
5- Tenore v. Nu Car Carriers Inc 67 NJ 466 (1997)