October 2024

A common question in litigation matters is "What is the case worth?" In some areas of litigation, an attorney often is able to come up with an initial estimate without much help from an expert. However, breach of contract matters typically require a deeper level of analysis and therefore require the expertise of someone, such as a CPA, with an understanding of how to quantify the damages. The calculation of damages from the breach of a contract involves … the analysis of historical financial data, analysis of the current status of the parties involved, and projections of future economic activity. In most breach cases there is a basic formula used to calculate damages. In simple terms, the difference between what would have happened without the breach of contract and what did happen as a result of the breach of contract is the economic damage. Quantifying that difference is based on a combination of actual verifiable data, assumptions, and projections.

There are three phases of most damage calculations. First is the period from the commencement of the contract to the date of the "event" (breach). Generally, this is the period where data is most available, relevant, and reliable. The second phase is the period from the date of the breach to the date of trial. The information in this period is also reliable and relevant but, depending on the circumstances surrounding the breach, may not be readily available. The third phase is the period of time from date of trial into the future. This is the period where economic activity is projected and is, by definition, the least reliable or available. It is also the phase where assumptions play a significant role in the calculations. It must be prepared and presented in a form, though, that is relevant and persuasive.

Selecting the Right Expert

The role of the expert in a breach of contract matter is to assist the parties in quantifying the damages. This may involve assistance in discovery, developing reasonable assumptions, reading and interpreting contracts, compiling financial data, and presenting the data. Discovery will be based on the theory of damages being pursued and an experienced forensic accountant can drive a more efficient process of collecting and using relevant data.

Presentation of the conclusions and the basis for the conclusions is often critical to the success of the engagement. There are a lot of experts who can do an adequate or even superior job in the analysis stage but cannot present the data in a form that is understandable and reasonable for a trier of fact to adopt. Conversely, there are experts who tell a good story but do not have the analytical skills required. They either have others do the analysis and step in personally only to provide the testimony or they do scant analytical work and rely on their testifying skills to carry the day. Finding both skills in one expert brings efficiency to the damages phase of the case. Regardless of the venue (jury trial, bench trial, or arbitration) the ability to present the conclusions in an easily understood presentation that is backed up with substantial data not only can win the case, it can also assist in settling the case before incurring the expense of a trial.

Avoid These Traps

The following are some traps to avoid when retaining an expert to provide consultation and/or expert witness work in the damages phase of a breach of contract matter:

• Retaining the damages expert right before trial (at the last minute) is common but dangerous. Depending on the circumstances, clients are sensitive to litigation costs and there is a working theory that the damage phase will be addressed if/when there is a decision that the damage actually took place. By doing so, any advantage of having a financial expert assisting with discovery and development of damages theories is lost. Additionally, experienced and busy financial experts will either be unavailable or have a policy of not taking on "last minute" cases.

• Telling the expert what you want the damages to be is ultimately self-defeating. Reputable experts will not allow themselves to be used in that manner. Often, it comes out in trial either directly or by implication and has a negative impact on results.

• Retaining an expert that is weak either analytically or in presentation skills is an unnecessary compromise. The expert should be allowed to prepare the necessary analysis as well as design exhibits with the client and lawyers that are clear, expressive, and persuasive. This is often an interactive process that results in a smooth presentation.

Exceptional Expertise

Arxis Financial offers litigators exceptional forensic accounting support. Our "Litigation Support" practice provides objective and independent evaluation of the economic and financial issues involved in commercial and civil litigation. Clients are pleased with our professionals' abilities to clearly, persuasively, and accurately present economic and financial arguments.

Trade secrets are defined under the law in varying ways depending on the legal jurisdiction. There are three factors that tend to cut across all definitions: it is information that is generally not known that confers economic benefit on its holder, and is the subject of reasonable efforts to maintain its secrecy. The value of the secret derives specifically from the fact that it is not known, not just from the value of the information itself. If a company takes no steps to protect the information there is a weakened ability to claim trade secret status.

Businesses generally protect secrets through the use of non-compete and non-disclosure contracts with vendors, customers, employees, and others who have access to the information. This places the theft of secrets into a framework of violating a written agreement in addition to the actual misappropriation and misuse of the information. Once a company suspects that its secrets have been stolen there must be an effort to identify not only who took the secrets, but how they are being used. This generally requires an extraordinary effort to obtain (often, secret) communications, data download histories, relationship clues, and interviews/cooperation from individuals (recipients of the secrets) who are not motivated to assist in the investigation.

The most common case of trade secret theft is when an employee resigns or is terminated. It is common in trade secret cases to discover that the departing employee was recruited by a competitor business and offered employment and compensation for changing employment and bringing secrets with them. Resolving these cases is often dependent on sophisticated data tracking systems that retain emails and date/time stamped records of data dumps from servers and hard drives.

Once the case has been made that secrets were stolen the decision is made whether to pursue criminal prosecution, civil remedies, or both. The criminal penalties are severe and can include jail time for the persons involved. Under federal law, companies involved in theft of trade secrets can be fined the greater of $10,000,000 or three times the value of the stolen trade secret.

Civil litigation can result in a range of penalties including injunctions, a reallocation of profit earned from the secret by the party who benefitted from the theft, reimbursement of actual damages, and punitive damages. In some jurisdictions, the award can include a multiple of actual damages. Actual damages can be calculated as lost profits or by placing a value on the information that was stolen. To the extent the information was stolen and destroyed (published widely, for example) the extent of damage was the value of the information right before it was destroyed.

Valuation of intellectual property, including trade secrets, is ultimately based on the projected income stream generated by the information discounted to present value at an appropriate risk rate. The valuation of trade secrets is difficult because of the need to isolate the historical income stream associated uniquely with the information that was protected as secret. The valuation expert must be able to identify income, direct expenses, and allocated indirect expenses associated with the information. That data is then used to project future net cash flows. In some cases where the information is stolen, used by a competitor, and cannot be recovered the value of damages is calculated based on the marginal benefit derived by the competitor from the stolen information.

As noted above, accurate and relevant estimates of damages are based on reliable historical accounting information. Additionally, the use of an experienced account and valuation expert is required to properly use the historical information as a basis to opine as to the value of the trade secret and/or the damages caused by the theft of the trade secrets.

The Forensic Accounting practice is headed by partner Chris L. Hamilton, CPA, CFE, CVA. Mr. Hamilton is a Certified Public Accountant, Certified Fraud Examiner, and Certified Valuation Analyst. He is a licensed life and disability insurance agent and a General Securities Representative. Mr. Hamilton has published articles in several publications, and has made presentations at national conferences, training institutes and seminars on topics including forensic accounting, fraud and business appraisal.