Damages Resulting from a Lost Opportunity:the Proper Damage Date in Utah Contractand Tort Cases
| Publication year | 2010 |
| Pages | 30 |
Vol. 23, No. 4, 30. Damages Resulting From a Lost Opportunity:The Proper Damage Date in Utah Contractand Tort Cases
Volume 23 No. 4
July/August 2010
The issue of how to calculate the damages from a lost opportunity often arises in contract and tort cases. For example, suppose aplaintiff is involved in a business venture that is impacted by a tort.The plaintiff contends that had the tort not occurred, plaintiff would have received substantial profits at some future date. Or, suppose a business enters into a contract to receive a crucial spare partused to operate its production facility. The part is not delivered on time and the business loses an opportunity to work with alarge and important customer. In these types of cases, the plaintiff will normally contend that if the contract had not been breached,plaintiff would have made a wind fall at some future time. In both of these situations, a damage expert will be asked to calculatethe value of the predicted lost profits at the time of trial.
Experts that we have seen address this issue are profoundly inconsistent.Some experts will simply estimate the future profits number and then discount this number back to the date of trial. Other experts will take the future profits number, discount back to the date of the injury, and then bring that number forward using a rate of interest to the date of trial. While both approaches seem sensible, they resultin significantly different damage calculations, thus proving that they cannot both be accurate at the same time. In fact, some experts provide both calculations and present them as alternatives.
To illustrate this problem, suppose a plaintiff claims it lost anopportunity as a result of a breach of contract occurring on January 1, 2009, that would have resulted in net profits of $500,000 on January 1, 2020. The trial date is set for January 1, 2013. Both experts agree that the appropriate discount rate is 25%. Utah's statutory prejudgment interest rate for contract claims is a simple 10%.Under these facts let's compare the two calculation methodologies.
As is evident, the different damage dates makes a significant difference for the final damage number. Before explaining why we believe only the second calculation is correct, we first explain why the two calculations come to different conclusions.
REASONS FOR DIFFERENT DAMAGE NUMBERS
Two factors account for the difference between these two calculations.The first factor is the treatment of risk. The second factor involves the treatment of prejudgment interest. We consider each in turn.
How Risk Factors Into a Damage Calculation
It is a fundamental tenet of economic theory that safer dollars are worth more than riskier dollars. Indeed, most of us will pay substantial amounts of money in the form of insurance to convertrisky, uncertain dollars into safer dollars. It is an often-observed aspect of human behavior that people generally prefer a sure bet toa gamble even if the sure bet and the gamble have the same expected value. For example, consider the following two situations:
Both Situation A and Situation B have the same expected value,yet most people will prefer Situation B to Situation A. This is because people are generally risk averse and do not like gambles.(fn1)It follows that if a plaintiff alleges that a lost opportunity was there sult of a risky venture (such as an investment in lottery tickets,or a new business) the plaintiff would be over compensated at trialif awarded certain dollars in place of the risky dollars actually lost. Ignoring risk is tant amount to permitting the trier of fact to pretend that the plaintiff was going to garner profits from a riskless savings account rather than from investing in a risky venture.
How do experts account for risk? The general approach is to identify public data concerning projects that have a risk similar to the plaintiff's opportunity. Once such projects are identified,the expert must determine what the market requires to pay investors to induce them to add such investments to a diversified portfolio.The additional compensation required by investors above the risk-free rate of return is the risk premium.(fn2) Expert testimony is necessary to determine the appropriate risk premium becauseit requires knowledge of financial economics and an empirical study concerning how the market values risk that is similar to the risk at issue. An unaided jury is...
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