Damages Quantification

Before computing any number, the forensic accountant must establish which damages theory the claimant is pursuing, because the theory determines the methodology. A breach of contract claim in most common-law jurisdictions seeks to put the claimant in the position they would have been in if the contract had been performed: a lost-profits focus. An intellectual property infringement claim may seek the defendant's profits from the infringement, which is an unjust enrichment measure, or the claimant's lost licensing revenue. An asset damage claim looks at the reduction in value of the asset.

The but-for scenario is the most consequential judgment call in a lost-profits analysis. It represents the hypothetical financial performance the business would have achieved if the wrongful conduct had not occurred. Construct it too conservatively and the claimant recovers less than the actual harm. Construct it too aggressively and an opposing expert will demolish it by pointing to the gap between the projected growth and the business's actual pre-disruption performance.

• Use the pre-disruption trend. The most defensible starting point is the revenue and profit trend the business was actually achieving in the two to three years before the wrongful conduct. Management projections prepared before the conduct are also useful, but only if they are credible on their face and were actually used for operational planning.
• Benchmark against comparable businesses. If the claimant's industry was growing or declining during the damages period, the but-for scenario should reflect that. An expert who projects a strong upward trend for a claimant while the industry was declining will face a straightforward cross-examination point.
• Account for pre-existing problems. If the business was already struggling before the wrongful conduct, the but-for scenario must acknowledge that. An expert who ignores a pre-existing downward trend will be asked to explain it.
• State the key assumptions explicitly. Every assumption that materially affects the but-for revenue projection should be identified, explained, and supported by evidence. Assumptions not disclosed are assumptions the opposing expert will introduce to the court.

When lost profits extend into the future, or when historical losses are being brought to a common valuation date, the time value of money requires discounting. The present value of a future cash flow is calculated as the nominal amount divided by (1 + discount rate) raised to the power of the number of periods. Across a ten-year projection, a discount rate of 8 percent versus 12 percent can produce a difference of 30 to 40 percent in the present-value total, which in a large case is many millions of dollars.

The two main approaches to selecting a discount rate in damages cases are the risk-free rate and the risk-adjusted rate. The risk-free rate, often proxied by government bond yields of the relevant jurisdiction and maturity, is argued by claimants because it produces higher present values. The risk-adjusted rate, typically derived from the company's weighted average cost of capital (WACC) or from the claimant's industry beta-based cost of equity, is argued by defendants because it produces lower present values. Courts have accepted both in different contexts, and the choice must be justified by reference to the nature of the cash flows being projected and the applicable legal standard in the jurisdiction.

Intellectual property damages, particularly in patent infringement cases, have generated a large body of case law about what damages methodologies courts will accept. In the United States, the standard for patent damages under 35 USC 284 is at minimum a reasonable royalty. The 'Georgia-Pacific factors' (a 15-factor framework from the 1970 Georgia-Pacific Corp. v. United States Plywood Corp. case) guide reasonable royalty analysis and are widely used by forensic accounting experts and economic consultants in patent litigation globally.

• Reasonable royalty: based on a hypothetical negotiation between a willing licensor and willing licensee at the time the infringement began. Both parties are assumed to know all the facts about the patent and the market at that date.
• Lost profits in IP cases: the Panduit factors (US) require the claimant to show demand for the patented product, absence of non-infringing alternatives, capacity to meet the demand, and the amount of profit that would have been made.
• Entire market value rule: in cases where the infringing component is a small part of a larger product, courts have limited damages to the value of the smallest saleable patent-practising unit rather than applying a royalty to the entire product's revenue. Experts who apply royalty rates to total product revenue when only a component is patented face Daubert challenges.

In contract disputes, the primary measure is the expectation interest: putting the claimant in the position they would have been in if the contract had been performed. The reliance interest, recovering costs incurred in reliance on the contract, is an alternative when expectation damages are too speculative. Experts should be aware of the mitigation duty, which requires the claimant to take reasonable steps to reduce losses; failure to mitigate is an affirmative defence that an opposing expert may quantify to reduce the damages figure.

Damages opinions are contested more routinely than fact-finding opinions because the financial stakes are higher, the methodological choices more numerous, and the scope for legitimate professional disagreement correspondingly wider. The following are the most common attack vectors.

• Overstated but-for revenue: the projection assumes market share, growth rates, or contract wins that the business had no realistic basis to expect. The opposing expert shows actual industry performance and the claimant's own pre-litigation internal forecasts.
• Ignored avoided costs: the expert deducts fixed costs from but-for revenue as if they were variable, overstating the net loss. The correct treatment is to deduct only costs the claimant actually would have incurred to generate the but-for revenue.
• Inconsistent period selection: the expert uses a high-performance period as the benchmark for the but-for trend while ignoring an earlier lower-performance period that would anchor the projection lower.
• Royalty rate unsupported by comparable licenses: in IP cases, an expert who applies a royalty rate without reference to actual market transactions for comparable licenses will face the challenge that the rate is made up.
• Failure to segregate damages from non-actionable causes: if the claimant's losses were partly caused by market conditions, pre-existing problems, or the claimant's own decisions, the damages opinion must address what portion is attributable to the defendant's conduct. An opinion that attributes all losses to the defendant is easy to attack.