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COVID-19 and the assessment of economic damages: Part one

Wednesday, August 26, 2020 @ 1:29 PM | By Rachel Ryman and Larry Andrade


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Rachel Ryman
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Larry Andrade
COVID-19 has catalyzed a recession likely worse than the Great Depression. Since this economic event has no historical precedent, the magnitude of the recession and the nature of the recovery is shrouded in uncertainty. This poses a challenge to many financial professionals who rely on the historical performance of businesses to forecast future performance. Here, we explore how COVID-19 has and will continue to impact one such type of financial professional: independent financial experts.

In our role as independent financial experts, we are retained to calculate economic losses incurred by parties to a lawsuit and to provide opinion evidence in court. We serve the courts and help businesses access justice by quantifying losses in a fair, objective and non-partisan manner. Often, the assessment of economic losses requires predicting what would have happened in the future if an alleged wrong had not occurred. Broadly, this exercise requires projecting the “but for” profit of the impacted party and deducting their actual or anticipated profit in order to determine their economic losses over the relevant loss period.

Projecting a party’s profit but for an alleged wrong requires some fortune telling on the part of the expert. Fortune tellers rely on precognition to see the future. Precognition (stemming from the Latin “prae”: before, and “cognitio”: acquiring knowledge) is quite literally what we use too. A number of tools are deployed to acquire knowledge about the impacted party before the cause of action, and this information is used to predict how the party would have performed but for the cause of action. This involves looking at company-specific factors, industry factors and economic factors, both historical and forward-looking.

What happens when the past performance and forecasts of a business, its industry and the economy have no ostensible bearing on future performance? The COVID-19 pandemic has caused us to contemplate this question.

Despite elevated uncertainty caused by COVID-19, we must continue to uphold our duty to the courts when calculating economic damages. In the paragraphs below, and in part two of this article, we explore various considerations when calculating economic damages during these uncertain times. In part one, we discuss the benefits of consulting an economist and how to account for risk through scenario analysis. In part two, we discuss how to account for risk through higher discount rates and various considerations when issuing expert reports.

Consult an economist

We are required to provide opinion evidence that is related only to matters within our area of expertise. When historical results are deemed to be indicative of future results, projecting but for and actual profit of businesses is within our purview. Given the complexity of forecasting how the economy will respond to this pandemic, we may require guidance when assessing the macroeconomic impacts of COVID-19.

We submit that economists are best positioned to predict the impacts of COVID-19 and that independent financial experts are best positioned to turn these predictions into loss calculations.

Economists can provide input on scenario analysis (i.e., selecting relevant recovery curves), the likelihood of each scenario and growth rates for projections. While we acknowledge that consulting with an economist may seem to increase costs, employing the right expertise can improve the credibility of evidence and actually save time and money throughout the legal process.

Account for risk through scenario analysis and higher discount rates

Uncertainty creates risk. While there is always some degree of uncertainty involved when calculating economic losses, the pandemic has created additional uncertainty and risk. To account for this elevated risk, we suggest providing scenario analysis and higher discount rates when calculating economic losses.

Scenario analysis

As previously discussed, we need to project the but for profit of the impacted party and to deduct their actual or anticipated profit, to determine their economic losses over the relevant loss period. In instances where the loss period extends into the future, both the but for and the “actual” profit need to be projected.

The economic impacts of COVID-19 create greater uncertainty in our projections of but for and actual profit. Economists have presented us with an alphabet of recovery curves (V, U, W and L) upon which to make these projections, although the period over which recovery will occur is not clear. Beata Caranci, chief economist at Toronto-Dominion Bank, estimates that a full economic rebound is at least two years away. The nature and magnitude of recovery will also be dependent on the industry and business model. For example, an online clothing retailer will be less impacted than a bricks-and-mortar restaurant.

Under normal circumstances, the longer the loss period, the more uncertainty in projecting but for and actual profit. This is because historical profit becomes a less reliable predictor of profit the further we move away from a given point in time. Under our current circumstances, the short term may be even less certain than the long term. This is because the economy is anticipated to recover in the medium to long term; however, little is known about the short term. (We note that consequential effects of COVID-19, such as increased debt, deskilling and permanent changes to consumer demand, may permanently impair certain industries.)

Given it is not known or knowable how businesses will recover from the impacts of COVID-19, we can present a number of scenarios based on the various recovery curves or other relevant factors. Courts can then select which scenario to rely upon. We can also probability-adjust each scenario to assess the expected value of the business losses, integrating all scenarios. In addition, independent financial experts acting for all parties can collaborate and agree on which scenarios and probabilities are most reasonable.

This is the first of a two-part series. In part two, we discuss how to account for risk through higher discount rates and various considerations when issuing expert reports.

Rachel Ryman, is a senior manager in Deloitte’s disputes practice, quantifying economic losses and writing expert reports for lawsuits. Larry Andrade is a partner and national leader in Deloitte’s disputes practice, quantifying economic losses and writing expert reports for lawsuits.

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