In a recent breach of contract case, a New York district court addressed the financial expert’s determination of lost profits damages. The court awarded more than $4 million in damages based on the expert’s calculation of lost earnings before interest, taxes, depreciation and amortization. But it rejected the expert’s calculation of damages based on decreased growth prospects, finding this component to be speculative.

Taylor Precision Products, Inc. v. The Larimer Group, Inc., No. 15-cv-04428 (S.D.N.Y. October 13, 2023).

Plaintiff paid inflated price

The plaintiff alleged that the defendants breached the purchase agreement by failing to disclose deteriorating relationships with their two key customers (big-box retailers Target and Walmart). At the time the parties were negotiating the sale, these customers had issued retail awards indicating they’d reduce the amounts of products to be purchased from the company going forward.

Previously, the court had found the defendants liable, so this proceeding was limited to quantifying damages. Under New York law, the injured party in a breach of contract case is entitled to the “benefit of the bargain.” That is, the injured party should be compensated or placed in the position it would have been in if the breach hadn’t happened. In this case, the plaintiff would be entitled to the difference between the company’s value as warranted and its true value at the time of sale.

The court noted that these damages are general, rather than consequential. So, a plaintiff must prove with reasonable certainty the fact of damages, but not their amount. With respect to the amount, a plaintiff need only provide the court with “a reasonable means of and basis for calculating damages.”

In Taylor Precision Products, the plaintiff proved that the defendants’ failure to disclose material changes in their relationships with key customers caused the plaintiff to pay an inflated price. Although the fact of damages had been established, a key question remained: How much was the price inflated?

Expert calculates two-part damages

The plaintiff’s expert calculated damages in two parts. The first component was based on a permanent loss of sales resulting from the reduction in product orders. In valuing the target, the plaintiff relied on its trailing twelve month (TTM) adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) and a purchase price multiple. Based on the $69.5 million purchase price and TTM-adjusted EBITDA of $9.2 million, the implied pricing multiple was approximately 7.55 times EBITDA.

To calculate the diminution in value attributable to lost sales, the expert isolated the cash flows in the prior year associated with the products that Target and Walmart would no longer buy. He determined that their TTM-adjusted EBITDA was $593,670. Multiplying that amount by 7.55, the expert arrived at a diminution in value of nearly $4.5 million.

The second component of damages was based on the company’s decreased growth prospects from the lost sales. The expert calculated this component by adjusting the purchase price multiple downward for the remaining purchase price (that is, $69.5 million minus the TTM-adjusted EBITDA associated with the lost sales). Because key customers were responsible for more than half of the company’s expected 2% growth rate, the expert estimated a loss of 1% expected annual growth. This translated to an additional $6.8 million in damages.

The plaintiff claimed it would have lowered its growth expectations if the deteriorating customer relationships had been disclosed. So, the plaintiff suggested that the court “pick a number between 0.5% and 2% to ‘represent the higher risk’ [the plaintiff] knowingly took on and plug it into a formula provided by [the plaintiff’s] expert.”

Lesson learned

The federal district court found that the plaintiff provided a reasonable means of and basis for calculating the first damages component. But it rejected the second component because it was speculative. Although it was reasonably certain that the plaintiff would have lowered its growth expectations if it had known about the lost sales, the plaintiff failed to provide a reasonable basis for estimating the amount.

The takeaway from this case is that financial experts must base lost profits and diminution-in-value calculations on solid, market-based evidence. Speculative estimates won’t pass muster in court.

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