The critical first step in the estimation of commercial damages requires identification of the asset that has suffered harm. That asset might be tangible, like a building or an aircraft, or it might be intangible, like the earnings stream from a contract, a patent or the goodwill of a business.

Because a damages analysis requires linkage to the facts of the case, the expert must perform a close review of those facts before developing an approach to damages. Damages analysis always includes assumptions as to how the damaged asset would have performed, but-for the complained of acts, and the expert must also determine that these assumptions are reasonable, based on the facts of the case.

Failure to both link the damages analysis to the underlying facts and to determine that the required assumptions underlying the analysis are reasonable in light of those facts will always result in an indefensible analysis.

Case Study – Dealers vs Manufacturers

A recently-decided case tried before Senior Judge Nancy Firestone in the U.S. Court of Federal Claims provides an illustration of the criticality of reasonableness-testing of assumptions.

In that case, a group of former Chrysler and General Motors (“Manufacturers”) car dealers (“Dealers”) filed suit against the U.S. government related to the 2009 bankruptcies of the Manufacturers. The Dealers alleged, among other things, that the government had engaged in a “taking” of the Dealers’ valuable franchise agreements when the Manufacturers rejected the agreements in bankruptcy. The Dealers alleged that the government’s provision of financial assistance to the Manufacturers was contingent on the rejection of the Dealers’ franchise agreements and; therefore, the government should be liable for any lost value suffered.

A key distinction in this case was the difference between the value of a “franchise agreement” with a new car manufacturer and the value of a “dealership,” which includes elements not dependent on a franchise agreement. New car dealerships generate revenues from a number of sources, the most obvious of which is new car sales, which may come from one or more manufacturers. A typical dealership also sells used cars and provides parts and services for new and used cars, as well as financing and insurance products. Without a franchise agreement, a dealership cannot sell new cars or provide warranty service, but it can continue to sell used cars, provide parts and services, and sell finance and insurance products.

From a damages perspective, the Dealers claimed that their franchise agreements had significant positive value at the date of the taking, and that the harm suffered consisted of the loss of that value. An expert’s analysis of the damaged asset should therefore focus on the value of the franchise agreement and the future expected earnings from that agreement at the date of the taking. To the extent such an analysis focused on the Dealership as a whole, including its used car and nonwarranty parts and service business, it would likely overstate damages. This point is obvious when one considers that, at the date of trial in this case, seven of the nine model plaintiff Dealerships continued to sell new cars and one continued to operate as a used car dealership that also sold campers and trailers. Only one of the model plaintiff Dealerships ceased to operate.

Expert’s Flawed Assumptions

One of the plaintiff’s valuation experts presented damages evidence related to seven of the nine model plaintiffs.  The expert attempted to measure the harm suffered by the seven model plaintiffs, (which she estimated at up to $19.4 million), through an analysis of each Dealership, with adjustments to remove the financial results from competitive brands sold through the Dealership. In its decision, the Court noted that the expert, “opined that the franchise agreement, although only enumerating specific rights of the franchisee, is always valued as both the rights guaranteed, such as new car sales, but also other income streams that are clearly derived from those rights.”

The expert received a number of critical assumptions from counsel. She assumed:

1. No government financial assistance to Manufacturer (required by the Court)
2. Manufacturer enters bankruptcy but production continues without interruption
3. Franchise agreements remain in full force and effect (i.e., all are assumed by a hypothetical purchaser of the Manufacturer)

In her valuation analysis, she “normalized” each model plaintiff’s earnings to a number higher than its historical financial results. She utilized an earnings growth rate that exceeded each model plaintiff’s historical experience and that also exceeded forecasts for future performance from the Manufacturer. She utilized a one or one and a half  percent company specific risk premium for each model plaintiff, thus failing to consider the risk related to holding a franchise agreement with a bankrupt manufacturer. Finally, she calculated a terminal value assuming that each model plaintiff would grow at her inflated growth rate in perpetuity, and therefore failed to account for any risk that the bankrupt Manufacturer (or a purchaser) would reject the franchise agreement in bankruptcy.

Example Defensible Assumptions not Employed

With respect to each of these elements of valuation, the use of defensible assumptions could have resulted in a well-supported damages conclusion. Consider the following possible assumptions:

1. Model plaintiff historical earnings are the basis for the valuation
2. Earnings growth based on expected future growth for the brands sold at the valuation date
3. Company-specific risk determined based on an individualized analysis
4. Terminal value that considers the fact that the Manufacturer is in bankruptcy

However, the Court ultimately concluded that the expert’s valuations were unsupported, in part because her assumptions that the Manufacturer would continue uninterrupted production and would not reject Dealer franchise agreements “were not supported and were indeed contrary to the facts known at the time in 2009,” and further that she did not analyze the value of the assets of the Dealerships separate from the franchise agreement. The Court also found that there were “numerous other problems” with the expert’s opinion. Among these were findings that the growth rate was “wholly unsupported” and that her discount rate “was not supported by the economic circumstances.” Ultimately, the Court determined that the Model Plaintiffs’ franchise agreements “would have zero fair market value.”

Conclusion

The decision in this case demonstrates clearly that damages experts must link the harm measured to the acts complained of, and that the measure of harm must be analyzed with a clear focus on the asset impacted by those complained of acts. Finally, the expert must carefully consider each assumption on which the analysis relies, and affirmatively conclude that the assumption is reasonable based on the facts of the case.

Note:

The case referenced is Colonial Chevrolet Co., Inc., et al.; Alley’s of Kingsport, Inc., et al.; Union Dodge Inc., el at. v. The United States. Nos. 10-647C, 11-100C, and 12-900C consolidated. The October 2, 2019, decision of the trial court is on appeal.