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Proving lost profits for an unestablished business

January 17, 2013

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Plaintiffs often seek to recover damages measured by the profits they would have earned but for the injury caused by the defendant. To compute lost profits for an established business, the company’s historical earnings and cash flow are analyzed to predict future performance.

But what about a startup or a business without a track record to work from? At one time, courts applied the “new business rule” to deny lost profits damages to unestablished businesses. But today, most courts allow such businesses to recover lost profits if they can be proven with “reasonable certainty.”

Factors considered

Damages experts look at a number of factors when predicting an unestablished business’s future performance, including:

•    Management quality,
•    Business plans and financial projections,
•    Profits earned by comparable companies,
•    Industry and market statistics, and
•    Liquidity.

They also examine risk factors that bear on a company’s chance for success, including the business’s age, the likelihood of failure based on the rate of failure of similar businesses, its stage of development and growth rate, and the amount of time it will take to become profitable.

Establishing reasonable certainty

The definition of “reasonable certainty” depends on state law. In some states, a plaintiff must prove lost profits by a “fair preponderance of the evidence.” In others, reasonable certainty means “probable” or “more likely than not.”

In the recent California case, Flying J v. Dept. of Transportation, an appellate court denied lost profits damages to a plaintiff whose calculation involved “too many conjectures.” The plaintiff, a truck stop operator, sued the defendant for breach of a contract to convey land. In support of its lost profits claim, the plaintiff offered expert testimony regarding the profits earned by five “comparable” truck stops.

The court found that the other truck stops were not sufficiently comparable — in terms of location, traffic patterns and other characteristics — to predict the profitability of the site in question. It also found that the plaintiff’s expert relied too heavily on conjecture in estimating future lost profits — for example, by relying in part on the assumption that building a truck stop on the site in question would divert traffic from other routes. To recover lost profits, the court said, damages must be “proven to be certain both as to their occurrence and their extent, albeit not with ‘mathematical precision.’”

Don’t speculate

Lost profits remain a viable measure of damages for unestablished businesses, but the burden of proving those damages with reasonable certainty is heavy. Regardless of the standard, it’s important to support lost profits with evidence that keeps speculation to a minimum.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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