March 2010

CALCULATING PROFITS FOR A NEWLY ESTABLISHED BUSINESS

James M. Hoey, Clausen Miller P.C.

Courts across the country are split on the application of the "new business rule." Essentially, "the new business rule" prevents an unestablished, newly formed business from recovering lost profits when injured by another's breach of contract or tort. The theory behind the rule is that in order to recover lost profits, the profits must be calculated to a reasonable degree of certainty, and new businesses often lack the operating history from which lost profits can be calculated with reasonable certainty. See, Tas Distributing Co., Inc. v. Cummins Engine Co., 491 F.3d 625, 634 (7th Cir. 2007) Over time, the "new business rule" has been eroded because many courts reason that it would be unfair to allow a defendant to avoid liability for lost profits simply because plaintiff's business was recently established. There are, however, several jurisdictions that still apply the rule, and it often operates as a complete barrier to the recovery of lost profits for a recently formed business. ¹

One issue that often arises in cases discussing the application of the "new business rule" is the use of expert testimony to support the alleged lost profits. This issue was recently addressed by the United States District Court District of Kansas in Blair-Naughton, L.L.C. v. Diner Concepts, Inc., 568 F.Supp.2d 1261 (D. Kan. 2008) (applying Georgia law).

In Blair-Naughton, plaintiff, a restaurant operator, filed suit alleging that defendants provided a different, inferior modular diner structure than what was agreed to in the sales contract. The plaintiff attempted to show lost profits as a result of the different structure. The lost profit estimates were based on projections involving traffic counts and the number of people who ate at similar restaurants. Plaintiff also took into consideration projected costs of land, building and improvements. Id. at 1262. Gary Poore, a Certified Public Accountant, reviewed plaintiff's profit calculations, as well as projections of estimated profits prepared by third-party lenders. Mr. Poore reached conclusions regarding amounts the diner should have earned and how much the diner would lose annually. Id. at 1263 Defendant moved to exclude the testimony of plaintiff and Poore.

The court held that the calculations of plaintiff were unreliable, and that the unsupported nature of plaintiff's assertions rendered it impossible to accept Poore's calculations, since Poore's calculations were tied to plaintiff's. Id. at 1263-64. "The expert evidence presented by [plaintiff] and Poore on the issue of lost profits is not sufficiently reliable to be presented to the jury." Id. at 1265 The court reasoned that its conclusion was consistent with the Georgia courts' adherence to the "new business rule." "The Georgia rule is a general reflection of the inherent difficulties of calculating accurately the profits which a new business might generate. Even courts which permit the recovery of lost profits for new businesses still require that such losses be proved with 'reasonable certainty.' The proposed expert testimony offered by plaintiff falls far short of this mark." Id. at 1265; see also, Parlour Enterprises, Inc. v. Kirin Group, Inc., 61 Cal. Rptr. 3d 243 (Cal. Ct. App. 2007).

Learning Points

It is evident from the recent decision in Blair-Naughton that the methods used by a forensic accountant to calculate the lost profits of a new business will be highly scrutinized. The losses must be proved to a "reasonable certainty."

In cases such as this, the plaintiff should consider utilizing the services of an expert who has experience in opening restaurants. The expert should be able to demonstrate experience, skill or training in analyzing new opportunities for restaurants or for quantifying the likely profits for such endeavors. The underlying data on which calculations are based should be made available to the court and the opposing party. Further, the plaintiff should demonstrate that the type of economic data relied upon are data of the sort which are generally relied upon in the restaurant business as factors which will yield reliable estimates of what a new restaurant can expect to make in profit. This type of additional evidence may render it more likely that a court will allow the testimony of the plaintiff and the plaintiff's forensic accountant.

About the Author

James M. Hoey is a partner in the Chicago law firm of Clausen Miller P.C. He is a member of the American Bar Association and is active in the Property Insurance Law Committee. He has lectured extensively in matters relating to property insurance and has authored and coauthored articles concerning such topics as boiler and machinery insurance, builder's risk insurance, business interruption and appraisal. Mr. Hoey is active in the Property Loss Research Bureau and is a frequent lecturer and workshop panelist.

Mr. Hoey has tried cases involving claims under all-risk policies, and named-peril policies involving damage to objects such as turbines, generators, motors and furnaces. He has also tried cases involving other property insurance issues, such as the amount of a business interruption loss, fraud and arson.

Mr. Hoey's experience includes cases and projects involving a myriad of industries, such as power plants, chemical and petroleum refineries, manufacturing facilities, food processing plants, cold and dry storage warehouses, mining including coal and minerals, and aluminum and bauxite facilities.

To reach Mr. Hoey, please contact him at 312-606-7493 or jhoey@clausen.com.

1 See, Livingston, Margit, "Recovering Lost Profits: The New Business Rule." LexisNexis® Expert Commentary (2009)