Today's post features a guest entry by James T. Hunt, Jr., a business litigator and a partner at Slater, Tenaglia, Fritz & Hunt, P.A.
Business lawsuits involving the claim of “lost profits” as
damages can present unique challenges, especially if your business cannot
identify specific transactions or deals that were lost due to the defendant’s
wrongful conduct or breach of a contract. Some states have strict guidelines
governing the ability to recover lost profits, while others actually prohibit
lost profit recovery in certain circumstances.
A Tale Of Two States:
New York vs. New Jersey
Despite their proximity and the similarity in contract
caselaw, New York and New Jersey have somewhat different standards
regarding recovery of lost profits. In New
York , any business can recover its lost profits in a
lawsuit, regardless of how long the company has been operating. In fact, lost profits are somewhat treated the
same way as any other type of damages. New Jersey courts,
however, have steadfastly refused to permit recovery of lost profits in cases
involving a new business, which known as the “new business rule.” Only an established business with a history
of revenue and profits can recover lost profits.
In essence, there must be some rational basis on which to
support an award of lost profits. But a
request based on pure speculation will most certainly be rejected. Generally, three criteria need to be
satisfied to obtain an award of lost profits: (1) the damages were actually
caused by the breach, (2) the particular damages were fairly within the
contemplation of the parties to the contract at the time it was made, (in other
words, the damages were foreseeable), and (3) that the alleged loss is capable
of proof with reasonable certainty. New York falls in the
majority of states that permit recovery of lost profits even if it is a new
business with no track record of profitability. A new business endeavor is held to the same
standard – it must prove lost profits with reasonable certainty. At the same time, however, a New York court will not
allow an award to be based on pure conjecture or speculation. While the
standard is the same for an existing business or new business, in the case of a
new business a stricter standard is imposed because there is no experience from
which lost profits may be estimated with reasonable certainty and other methods
of evaluation may be too speculative. The more risky and speculative the
industry, the less likely a new business could prove lost profits with such
certainty.
What constitutes “reasonable certainty” can be nebulous and
difficult to pin down. For example, in a leading New York case, the court rejected a claim
for lost profits arising from a domed stadium that was never constructed. The
court concluded that the multitude of assumptions required to quantify the lost
profits award contained an impermissible level of “speculation and conjecture.”
Some of these questionable assumptions
included that the facility would be completed, available for use, and operating
profitably for over 20 years. In another federal New York case, the court rejected as
speculative a lost profit calculation that assumed the occurrence of numerous
successive hypothetical transactions. The court found this constituted
precisely the sort of conjecture that the reasonable certainty standard
prohibits.
In a Second Circuit Court of Appeals case, Trademark
Research Corp. v. Maxwell Online, Inc.,
a trademark search service brought suit against a software design firm
for alleged breach of a contract that required the defendant to create for the
plaintiff a trademark database and search system. The Second Circuit held that
plaintiff's claim for future profits from in-house trademark searches and sales
of disks providing direct access to plaintiff's database should not have been
presented to the jury because it was incapable of proof with reasonable
certainty as a matter of law. For
example, the plaintiff's accounting expert had assumed an abrupt expansion of the
market for trademark search services, assumed that plaintiff would reverse the
long decline in its market share, assumed that plaintiff's historically
aggressive competitors would take no measures to counter plaintiff's
ascendancy, and predicted which choices customers would make among a variety of
new and old search technologies. To cap it off, all of these assumptions were reduced
to speculative exact dollar amounts and spun out to the year 1998. Even though
there was a significant amount of evidence submitted, the court found that it
consisted of a “network of conjecture.”
By contrast, an established business often is in a good
position to offer evidence of past experience as a reasonable basis from which
a jury may determine lost profits with the requisite degree of certainty. For
example, in a case involving a sidewalk café seeking lost profits for breach of
contract, the New York Court of Appeals upheld a jury award for lost profits.
The Court of Appeals held that the evidence of the past experience and profits
of the established restaurant to which the cafe would be attached was
sufficient “to remove plaintiff's lost profit claim from the realm of
impermissible speculation.” In a federal
New York
case, a company in the business of selling costume jewelry through the mail
brought suit for breach of contract to distribute 8,000,000 advertising
supplements in newspapers. The company had been in business for over forty
years. The company offered statistical
evidence of its past performance in a remarkably similar advertising program. The
court found this evidence was sufficient to prove its lost profits with
reasonable certainty.
Just across the river, New Jersey courts allow recovery of lost
profits but not if the business is new and has no history of generating
revenue. This rule is called the “new
business rule,” and is the law in a minority of states. Generally, profits lost
by reason of breach of contract may be recovered if there are any criteria by
which probable profits can be estimated with reasonable certainty. Indeed, New Jersey courts do permit
considerable speculation by the trier of fact as to damages. As one court has
stated, “[t]he rule relating to the uncertainty of damages applies to the
uncertainty as to the fact of damage and not as to its amount, and where it is
certain that damage has resulted, mere uncertainty as to the amount will not
preclude the right of recovery.” Courts
have pointed out that the mere fact a plaintiff cannot pinpoint its damages
with laser preciseness should not get a breaching party off the hook, since the
breaching party caused the problem in the first place. Accordingly,
the fact that a plaintiff may not be able to fix
its damages with precision will not preclude recovery of damages. But a request
for damages that is based on pure speculation and on mere opinion evidence
without factual support will not succeed. Again, “reasonable certainty” is the
touchstone.
A lack of past performance is why New Jersey continues to apply the New
Business Rule, which prohibits a new business from recovering lost profits. The
reasoning behind the new business rule is that lost profits cannot be
determined with a reasonable degree of certainty because there is not an
established history of revenue and profits. Under the New Business Rule, prospective profits of a new business are
considered per se too remote and speculative to meet the legal standard of
reasonable certainty. The short existence
of the entity makes a determination of lost profits too speculative. A New Jersey appellate
court acknowledged it is in the minority of states that preclude lost profits
in new business cases, and conceded that it was without any power to award such
damages unless the New Jersey Supreme Court changed the law.
So what constitutes a “new business”? The answer is decided upon a case-by-case
analysis of the individual factual circumstances involved and the type of
industry in which the business operates. For example, in one case an appellate
court deemed a 2 ½ year old business to be “new.” The business offered
educational, recreational and entertainment services for children, teens, and
adults in one modern community center.
In so doing, the court deemed the business “new and unproved.” Under
other circumstances, courts have permitted an award of lost profits where the
business had operated only two years (from 1996 to 1998). In fact, the Third
Circuit Court of Appeals has permitted lost profits for a business operating
for only 1 ½ years. Obviously, the more risky and speculative the industry, the
less likely a newer business could prove lost profits.
Past Is Prologue
So how important is it to
demonstrate past performance? In fact it is the key to recovering lost profits.
Past experience of an ongoing, successful business can provide a reasonable
basis for the computation of lost profits with a satisfactory degree of
definiteness. Past profit experience on
other projects is widely accepted as relevant to a determination of damages
based on lost profits. Courts have held
that evidence of such a past performance may form the basis for a reasonable
prediction as to the future. In
addition, courts have accepted other evidence of the profitability of a
business, such as industry-wide information and projections and even revenue
data of a competitor. While a newer business with no track record may
ultimately be able to recover lost profits, it will be a much more difficult
task than a business with a solid, several-years record of profitable
performance.
Proving Your Damages:
The Battle
Proving a company’s lost profits to a reasonable degree of
certainty will most likely require expert testimony. In most cases, if the
stakes are high, a battle of the experts will ensue, where both parties retain
experts who submit differing and contradictory expert opinions. Victory will then hinge on which side
retained the most convincing expert. While
it is possible to use the owner of the business as a sort of “expert” given his
or her deep knowledge of the business and the industry, it is far too risky to
go it alone without a qualified expert. Experts will have to analyze the
company’s operating and revenue history, its costs and expenses, and forecast a
lost profit figure that can pass muster. Retaining a highly competent, qualified,
and trial-experienced accountant as your expert is a necessity.
Jurisdiction is
Important
If you have the option to file a lawsuit in several
different jurisdictions, it is always important to confer with an experienced
business law attorney to determine which jurisdiction will be most beneficial
to you. This is especially true if you have a new business that intends to
claim lost profits as part of the damages suffered. Certain factors may dictate
where you can sue and what state law applies to the case. For example, if the
matter involves an inter-state transaction across jurisdictional lines,
determining “where” the transactions occurred as a legal matter will impact
your case. Further, your contract may contain a choice of law provision that requires
application of the law of a particular state.
You need an experienced business lawyer to assess the ramifications of
such a provision and the hurdles the applicable state’s law would raise in your
case.
About the author: James Hunt is
a business litigator and a partner at Slater, Tenaglia, Fritz & Hunt, P.A., a
commercial and business litigation firm with offices in NY and NJ. To learn more about
claiming lost profits, contact Slater, Tenaglia, Fritz & Hunt, P.A., to schedule a free initial
consultation
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