Trial court fumbles economic damages assessment

BVWireIssue #159-3
December 16, 2015

It’s not uncommon for a trial court to decide a valuation issue by “splitting the baby”—that is, reaching a compromise somewhere in the middle of the opposing figures. Often the decision, however puzzling, stands because the appeals court is reluctant to find an abuse of discretion. A knotty economics damages case followed this trajectory—until it reached the state Supreme Court.

‘Just splitting hairs’? Two partners owned an equal share of a rock-trading business (buys and sells rock for construction purposes). After one partner died in 2006, the surviving partner (defendant) unilaterally formed a new company to complete the old company’s contracts and pay its debts. He also owned a construction company that was a major buyer of the rock. The decedent’s estate sued, alleging the defendant had breached his fiduciary duty to the old company by usurping a business opportunity, and asked for present and future lost profits. The trial court found the defendant liable. The parties’ damages experts disagreed over the proper way of calculating damages.

The estate’s expert essentially performed a lost profits analysis. He explained that the defendant’s construction company bought rock from the subject company but failed to make timely payments. Consequently, the subject company ran into financial problems and risked going out of business. He also found that within the span of eight years, 650,000 tons of rock remained unreported and were diverted from the subject company. After the decedent’s death, that rock went to the defendant’s new company. This diversion of assets resulted in nearly $1.1 million in lost profits to the subject. The total loss attributable to the defendant’s misconduct was over $1.5 million.

The defendant’s expert claimed the rock was not unreported. Rather, the defendant “moved the tons” from the old company to the new company because he “kept on running the thing just like he was doing before,” he reasoned. To calculate damages, he performed a valuation of the “net book value” of the subject company and found it was about $125,000.

The trial court said the defendant’s expert had accounted for the unreported rock. It called the experts’ arguments over valuation methodology “just splitting hairs.” “Whether you call it asset based or net book value or lost profits, the Court is merely concerned with how and when to value this business.” It then used part of the estate expert’s calculation to determine “historical lost profits” of nearly $105,000. To this amount, it added the defendant expert’s net book value of $125,000 and ordered the defendant to pay $230,000, or $115,000 if the parties agreed to dissolve the company.

‘Illogical’ approach? The Court of Appeals affirmed, but a number of judges dissented. Precedent required the use of a lost-profits analysis to calculate damages for a claim of breach of fiduciary duty or usurpation of corporate opportunity, the dissent said. “Net book value is simply an accounting term that is not directly related to the actual value of the corporation’s assets.” The dissent added it was “illogical” to include a calculation of “net book value” in calculating damages responding to the type of claims at issue.

The state Supreme Court called the trial court’s damages assessment arbitrary. Under the applicable principle, the party breaching a fiduciary duty “is responsible for the entire loss suffered by the corporation as a result of the breach.” The loss included the diverted rock. A business valuation analysis was appropriate in divorce and eminent domain cases as well as in dissenting shareholder disputes, but not in the instant case. The high court remanded for a new damages determination.

Takeaway: The high court rejected the trial court’s loose attitude toward valuation concepts such as “asset approach,” “net book value,” and “lost profits” and found the lower court used the wrong accounting methods to calculate damages.

Find an extended discussion of Lane v. Lampkin, 2015 Miss. LEXIS 503 (Oct. 8, 2015)(Lampkin II), in the January edition of Business Valuation Update; the court’s opinion is available soon at BVLaw. The appeals court decision, Lane v. Lampkin, 2014 Miss. App. LEXIS 497 (Miss Ct. App., Sept. 16, 2014), is also available at BVLaw.

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