Moore v. Getahun – Five Ways You Should be Using Your Financial Expert (Other than getting a full damages or valuation report)

Moore v. Getahun 2015 ONCA 55 is a case that has already generated a lot of discussion and navel gazing in both the legal and expert communities, and I hesitated for quite a while before deciding that I had anything worthwhile to add. But I think now that I do.

The appeal in Moore centred on the question of what ought to be the proper degree of interaction between lawyers and their experts. The trial judge had definitively ruled that:

“The practice of discussing draft reports with counsel is improper and undermines both the purpose of Rule 53.03 as well as the expert’s credibility and neutrality.”

The Court of Appeal disagreed with this proposition. It noted that various rules and standards, applicable to both lawyers (in their roles as advocates) and various other professionals (in their roles as experts) expressly prohibit the alteration of expert opinions in order to suit the aims of a litigant.

It added that there were also strong positive reasons for communication to take place between counsel and their experts:

[64]         Counsel play a crucial mediating role by explaining the legal issues to the expert witness and then by presenting complex expert evidence to the court. It is difficult to see how counsel could perform this role without engaging in communication with the expert as the report is being prepared.
As to the question of whether any such discussions (or alterations to draft reports) need be disclosed to the other litigants, the Court had this to say:

[78]         Absent a factual foundation to support a reasonable suspicion that counsel improperly influenced the expert, a party should not be allowed to demand production of draft reports or notes of interactions between counsel and an expert witness…[t]he trial judge erred in law by stating that all changes in the reports of expert witnesses should be routinely documented and disclosed.

How to get the most out of an expert

The Moore decision thus has much to say about the importance of experts receiving proper input from counsel; without such input, the resulting reports can be poorly written, confusingly structured, and legally ill-founded.

What is not really explored in this decision is the fact that the interaction between counsel and their experts is not unidirectional. In the following paragraphs, I discuss the sort of input that experts (and particular financial experts) can have into the case prepared by counsel. Here are five ways, listed in the chronological order in which they would occur in a lawsuit:

1.     Understanding the Background of Your Case

Plaintiffs will typically come to counsel with a story. They will describe their business, what happened to it, and how they have been affected. Or how they think they have been affected. They may have various financial records which they believe support their story. They will be passionate. They will also be biased.

Financial documents are written in their own language. It is not quite like reading a foreign language like Mandarin or Hebrew, and more like trying to read Shakespeare without any critical or explanatory notes; the words are generally familiar, but the connotations are different.  Some business owners are financially savvy and can interpret their records; others…decidedly less so. But the financial records tell a story, and finding someone who can read that story is often worthwhile.

Plaintiffs know their operations; counsel knows the law; and the accountant can often pick out parts of the story that may have been distorted somewhat in the telling by the business owner. By taking an independent review of the plaintiff’s financial documents, the financial expert can ensure that both counsel and client have a full understanding of the nature of the plaintiff’s business and that there are no “surprises” later on.

Financial experts can also assist plaintiff’s counsel by taking a preliminary inventory of the accounting records to ensure they are complete. This is a simple step that can save much time and effort in the long run. For example, if financial losses are being claimed for a period of time during which the plaintiff’s payroll was paid in cash (and not recorded), it will be important to understand this as soon as possible, as it may be very difficult to recover any losses for a period in which a major category of expense is undocumented.

2.     Theorization of Damages

In some cases, identifying the relevant areas of financial impact stemming from a particular wrongdoing can be quite simple; but it is not always so.  Thinking through the logical steps in a chain of causation is something that financial experts are well positioned to do; with years of focused experience, they will often be able to relate the particular fact pattern in question to a prior file, and to identify issues that may not have occurred to counsel to explore. These may be additional areas of damage, or subtle holes in the internal logic of the claim. The earlier in the process this type of analysis gets done, the better.

In essence, this sort of conceptualization should be evident in pretty much every post on this blog, and I will therefore not belabour the point here. To list a few more examples at random:

·     The possibility that the infringement of your client’s patent may have impacted not only its sales, but also its gross margins (if selling prices were slashed to maintain market share) or its normally “fixed” costs (through increases in advertising or selling expenses).

·    That your client’s claim for lost profit from the wrongful destruction of his or her small business may actually be equal to an amount greater than the value of the entire business (I’ll explain how in a subsequent post).

·    That a claim for negligent misrepresentation will not be worth very much if the defendant is able to argue that very similar losses would have occurred even if not for the misrepresentation.

3.     Preliminary Assessment of Claims

If you have engaged a financial expert for these first two stages, that expert should be able to give a rough sense as to the value of a claim.

There is a common perception that financial experts are very expensive, and there is therefore a tendency to wish to defer this cost to the very last minute. Without debating the factual merits of that perception – other than to say that there are a broad range of hourly rates in this field in Canada - I will simply say at this point that this can sometimes lead to unfortunate results, in which one (or both) of the parties can spend years in litigation without a very good idea as to how much the case is worth. Is it worth $50,000? $500,000? $5,000,000? Sometimes it is easy to tell, but not always.

Most cases will not proceed to trial, but will instead settle at some point in the litigation process. If you (and the opposing party) don’t know how much a case is worth, it can become much more difficult to negotiate settle it expeditiously.  An initial review of the relevant documents by a trained professional can often prove very useful in setting realistic expectations.

4.     Discoveries

One of the greatest frustrations a financial expert can experience is to find that, after finally being engaged on a case, critical questions have not been asked, and basic documents have been requested, at discovery.

For defendants, in particular, to get full value from their financial experts, it is highly recommended that they engage them in enough time to ensure that all key information is provided to them (or at least requested) by the plaintiff. In some cases, experts will have standard lists of documents they will require in certain types of cases or for certain industries; they will then tailor these to suit the particular case in question.

5.     Limited Critique Reports

These types of reports have become much more common in the past number of years in my experience. These reports are typically commissioned by defendants; the report provides a critique of the plaintiff’s expert report, and may contain illustrative calculations that show the impact of various “adjustments” to the plaintiff report’s calculations, but it does not contain any conclusion as to value or financial loss.

Commissioning such a report offers several advantages. These reports are typically less expensive (it is generally easier to critique than to build an alternate model), and they can be very useful in pointing out major flaws in the plaintiff’s expert’s reasoning and providing a more realistic sense as to the potential value (or at least order of magnitude) of the dispute.

Conclusion

Aside from providing a full-blown expert report, financial experts can provide a variety of other services at various stages in litigation proceedings. Most cases do not proceed to trial, but the value added from interaction between counsel and their financial experts at various stages along the way can do much to expedite the resolution of disputes in a cost-effective and timely manner.

Top 10 Issues in Damage Quantification - #2: "Build It and He Will Come"

I have already written, in another context, about the interaction between physical assets and lost profits. I want to explore the issue from a couple of additional angles.

In the 1989 film Field of Dreams, Kevin Costner’s character hears a voice telling him “build it and he will come”. Costner acts on the voice – why not, wouldn’t you? – and builds a baseball diamond in his Iowa cornfield; sure enough, the ghosts of the 1918 Chicago White Sox, and eventually Costner’s father, appear on the diamond. And James Earl Jones sounded great.

In real life, this is not the way business works. Sales do not necessarily grow or contract in direct proportion to a firm’s capacity. You can build it, but they may not come. (Just ask Target Canada).***

***For anyone reading this in the year 2020, Target Canada was the Canadian subsidiary of a  US department store that made a grand entrance into Canada in 2013, and a rather less grand exit less than two years later.

Consider the following examples:

• A hotel suffers a fire on one of its 10 floors, which cannot be used for 1 year. The hotel had an average of 75% occupancy in the year prior to the fire.  If the hotel’s normal annual revenue is $1M (or $100,000 per floor per year), is the revenue loss equal to 75% of $100,000?
• A commercial helicopter operator planned to expand his fleet from 3 to 4 helicopters, but as a result of a bodily injury sustained in a car crash he was forced to cease operations. If he had historically generated annual revenue of $600,000 per year, is it reasonable to assume that his annual revenue would have been $800,000 per year with the addition of a fourth chopper (assuming he can prove that he would have gone ahead with the fleet expansion)?
• A manufacturing plant with 8 identical production lines suffers damage to 2 of its lines. Is it appropriate to assume that it will suffer a 25% decline in revenue?

The answer in all three cases is: maybe, but likely not.  If a hotel is normally at 75% capacity, that means that it normally has unused capacity of 25%, or 2.5 floors out of a 10 floor hotel; theoretically, the loss of only 10% of the hotel’s normal capacity (i.e. one floor) may not have any impact on revenue.

Similarly, the addition of a fourth helicopter may lead to a proportionate increase in revenue, but only if there is sufficient demand willing to pay for and make use of the additional capacity.

This is not to say that there is no impact from the loss of capacity. The hotel that averages 75% occupancy may have 100% occupancy for half the year and 50% occupancy for the other half; clearly, in that case the loss of an entire floor would be quite impactful during the half year in which the hotel is normally full.

Moreover, even if the historic demand had been consistently 75%, night after night, that does not mean that this would have continued indefinitely into the future. It is important to consider any changes to the demand for the claimant’s planned capacity. A review of pertinent industry statistics, where available, may prove helpful in this regard (e.g. published tourism statistics for the region in which the hotel was located).

Conclusion

There is a flip side to the assertion that an increase in capacity does not necessarily drive a corresponding increase in revenue, and that is that a large increase in revenue (premised on anticipated demand for a product or service) can rarely ever be accomplished without a corresponding capital investment.  An increase in capacity is necessary, but not sufficient, for an increase in revenue to occur. In a coming post, I will provide an illustration of this and show how it can have a significant impact on lost profit calculations.

Pre-Judgment Interest, Part III: Property Damage, Profit, and PJI

My practice involves a lot of work for property insurance companies. When damage to property occurs, the property owner may advance a claim against the third party tortfeasor for both the value of the damaged property as well as an ongoing loss of income or profit associated with the damage. While most first party business interruption insurance policies will typically limit any claim for lost profits to a 12-month period from the date of incident, third party claims for lost profits can often extend outside of this period.

In such cases, not only will there be damages claimed for both the physical damage and lost profits; there will also claims for pre-judgment interest. This post looks at how pre-judgment interest should be calculated in such situations.

In my experience, pre-judgment interest is often awarded on the property damage as well as on the lost profits. Is this correct from a financial point of view? Consider that lost profits represent a rate of return that would have been earned on the damaged property. If the plaintiff is already being awarded a rate of return on its lost property, it would seem unfair to also award it with pre-judgment interest on that same asset.

An Example

Consider the following example, which should illustrate this basic point:

• Assume that ABC Corp. (“ABC”) has a single machine, which will cost $1M to replace in Year 5 and would have cost $900,000 to replace in Year 1. 
• The machine allows ABC to generate profits of $100,000 per year (we will ignore taxes for the sake of this example).
• The machine is destroyed in a fire at the beginning of Year 1; the fire was caused by faulty electrical work performed by a subcontractor, and liability is admitted***. Due to lack of funds and other logistical issues, the plaintiff was unable to replace the machine until the end of Year 5; once the machine is replaced, it is not anticipated that ABC will suffer any ongoing adverse effects.

***It is great how financial experts always get to assume liability is a non-issue in their examples, isn’t it? Nothing to it...

It is now the end of Year 5, and the trial has just concluded. The trial judge has awarded the plaintiff the replacement cost of the machine, which is $1M, as well as lost profits of $500,000 representing five years of lost profits.

 

In addition, ABC will likely receive pre-judgment interest (for a five-year period) on the value of the machine, as well as interest on each year’s annual lost profits. Let us assume that the judge has decided to apply a simple interest rate of 5%, based on the rates specified in the Courts of Justice Act for the relevant date of loss.

The award may look something like this: the end result is a damages award of $1.5M and pre-judgment interest of $312,500.

 

But there are two problems with this calculation, both of which will tend to overstate the pre-judgment interest award.

First, the replacement cost of the machine has been calculated in Year 5 dollar terms; the replacement cost in Year 1 was only $900,000, but due to inflation the price of the same machine has increased by around 11%, to $1M. Pre-judgment interest rates include an inflation component; banks (including the Bank of Canada) lend money in the anticipation that inflation will occur, and they need to recover the erosion in the nominal value of the principal as part of their interest payments. If the property damage award already includes an adjustment for inflation, then compensating ABC for inflation a second time (through the pre-judgment interest mechanism) will result in a windfall to ABC.

But there is a second, somewhat less intuitive problem with the award.

Pre-judgment interest is meant to compensate the plaintiff for the loss of return on its assets during the interval between the date of the loss and the trial date. Yet that is precisely what the award for lost profits represents – the loss of the annual return on the machine that would have been earned by ABC. By awarding both pre-judgment interest and lost profits resulting from the destruction of the machine, we are essentially double-counting the plaintiff’s lost returns on its machine.

Both of these problems can be easily illustrated by modeling the plaintiff’s cash flows "but for" the destruction of the machine. The plaintiff would have earned $100,000 per year, which it would have (presumably) reinvested and used to earn additional returns. These additional returns can be modelled with pre-judgment interest (notwithstanding the issues I raised in previous posts, which argue that such rates tend to undercompensate plaintiffs). It is these cash flows that will need to be replaced.

In addition, but for the wrongdoing, the plaintiff would have still had the machine; but now it does not. It therefore needs to receive an amount that will allow it to buy a replacement machine in Year 5; it needs only $1M to replace the asset, not $1M plus interest.



As you can see, our damages award is still $1.5M, but we no longer accrue any additional amounts for pre-judgment interest for the damaged machine; PJI falls from over $312,500 to only $62,500. The combined award will put ABC back in the position it would have been in but for the destruction of its machine.

Conclusion

 

Property damage and lost profits are commonly viewed as two distinct heads of damage, and in some senses they are indeed separate: property damage occurs at a point in time, while lost profits are the consequential result of that physical event.

But failure to recognize the linkages between property damage and lost profits can result in damages assessments that are significantly distorted. There are many senses in which this is true, and I hope to delve into this area in a future post, but the area of pre-judgment interest is one example in which failure to account for these linkages can result in an inflated overall award.

Pre-judgment Interest, Part II – Interest and Taxes

In the previous post, I discussed the large pre-judgment interest award in Cefaclor. In that case, one of the issues raised by defendant’s counsel was that to award the plaintiff compound interest would result in overpayment; since the damages award is calculated on a pre-tax basis, and allowing this to accumulate on a pre-tax basis, it was argued, would result in overcompensation:

[119]      Apotex argues that an award of compound interest will over compensate Lilly because it permits pre-tax dollars to be compounded rather than after-tax dollars.  It says that “an award of simple interest obviates the need to take such tax considerations – which considerations may be quite complex – into account and permits a more facile calculation.” 

The trial judge did not accept this line of argument. In this post I explore one possible reason why he was right.

 

Interest and Taxes

 

Let us begin with a simple example. Assume Plaintiff Co. suffers lost profits of $1M in Year 1, and that its tax rate on its lost profits would have been 25%. The matter goes to trial, and damages are awarded precisely 10 years later. Assume that corporate tax rates have not changed and will be assessed at 25% of the damages award.

Let us for the moment accept the "Coerced Loan Theory" advanced by Michael S. Knoll and Jeffrey M. Colon, which holds that pre-judgment interest should be assessed at the borrowing cost of the defendant. Assume the defendant’s borrowing cost throughout the loss period was 5%.*

*Lots of assumptions so far; you can imagine that real life situations are much more complex, as Apotex argued in Cefaclor. Of course, given that the two expert accountants in that case charged well over $1M between them, one would think such a calculation would not be beyond their ken.

Had Plaintiff not been wronged by Defendant and earned the profit of $1M, it would have paid taxes in Year 1, invested the after-tax amount at a rate of 5% per year, on which it would have also paid taxes. At the end of Year 10, it would have been left with an after-tax amount of $1,083,783.

Instead, Plaintiff did not earn its profit, but is granted a damages award of $1M. If we apply a compound PJI rate of 5%, Plaintiff will be left with an award of $1,628,895. Even after Plaintiff pays taxes of 25% on the net amount, it will be left with a sum of $1,221,671.

The problem - and presumably what Apotex was alluding to - is that the interest rate that has been applied is a pre-tax interest rate. Suppose we deduct taxes from the PJI that accrues each year (effectively applying an interest rate of 3.75% instead of 5%); we then arrive at the same result as if Plaintiff had earned the profit back in Year 1 - our damages award puts Plaintiff in the exact position it would have been in but for the wrongdoing.

Changes in Tax Rates

The preceding example shows that the correct approach is to apply a PJI rate that replicates the after-tax rate that Plaintiff would have earned. Even though the damages award is a pre-tax figure, whereas the profit that would have been earned absent the wrongdoing would have been taxable in the year it was earned, the two approaches will yield identical results if tax rates stay the same.

 

But what if tax rates change over time?

Consider the same example as above; this time, however, we apply the actual combined tax rates in force in Ontario during the period, which have fallen steadily from Year 1 to Year 10. Here is the Plaintiff's profit had it not been wronged:

 

 

The Plaintiff pays taxes at 34.12% on its profit of $1M in Year 1, and earns a return of 5% each year, on which it pays taxes at the relevant rates. Its after-tax funds after ten years would have been $928,237.

 

On the other hand, if the damages award of $1M is "invested" retrospectively at 5%, and taxes are deducted on the interest each year, we find that even after paying taxes on the damages award in Year 10, the total after-tax value is higher, $1,035,600:

 

 

This is a result of changes in tax rates over time.

 

Now, there is no great difficulty in contriving an adjustment to the damages award that will reflect the impact of the lower tax rate in Year 10; and as I have argued previously, this is an adjustment that will need to be made regardless of pre-judgment interest considerations.

Conclusion

Income taxes provide another layer of detail to damage calculations. But the concepts are not difficult and the calculations can be easily performed.

Pre-Judgment Interest: Part I: Establishing a Rate – A Basic Framework

This first post on pre-judgment interest deals with the basic question: what is the best method by which to calculate a pre-judgment interest rate?

 The Law

Pre-judgment interest is interest that is added to a plaintiff’s monetary award in respect of past losses suffered prior to the date judgment is pronounced. 

Pre-judgment interest may be awarded by statute. In Ontario, for example, the relevant legislation is found in sections 127 to 130 of the Courts of Justice Act. The pre-judgment interest rates set out in those sections are noteworthy in two respects:

·         Rate - the prejudgment interest rate is based on “the bank rate established by the Bank of Canada as the minimum rate at which the Bank of Canada makes short-term advances to Canadian banks”. This is a very low interest rate that reflects very little in the way of a premium for default risk.

·         Method - the interest is calculated as simple, not compound, interest. In most commercial contexts, compound interest applies.

These peculiarities of the statutory rates were acknowledged by the Supreme Court of Canada in Bank of America Trust v. Mutual Trust Co. 2002 SCC 43. That case involved two lenders who were both party to a contract with a condominium builder. One of the two lenders (Mutual Trust) failed to fulfill its obligations under the contract, with the result that the builder was forced into receivership, resulting in the second lender (Bank of America) suffering losses of both principal and interest. Bank of America sought to recover its losses from Mutual Trust.

The Supreme Court ruled that Bank of America could recover compound interest at the rate specified in the contract, and was not bound to the interest provisions set out in the Courts of Justice Act. It noted that in general, interest is meant to compensate lenders for three things: (i) the time value of money (i.e. the idea that the ability to spend a dollar today is worth more than the opportunity to spend that same dollar at a later date) (ii) risk, and (iii) inflation. Historically, societal attitudes towards the charging of interest were generally negative, with the result that statutory pre-judgment interest rates have been set somewhat parsimoniously (or “miserly”, to quote another case from the Alberta Court of Appeal), and the commercial reality is that the rates set out in the Courts of Justice Act and various other statutes do not reflect any element of risk.

The Courts of Justice Act does provide for some flexibility in the granting of pre-judgment interest if can be shown to be “payable by a right other than under this section”. The Supreme Court ruled that in certain circumstances, such as breach of contract cases where an interest rate is clearly stipulated, it may be appropriate to depart from the statutory prejudgment interest rates, and to award pre-judgment interest as a head of damage. It noted, at paragraph 55, that “It may be awarded as consequential damages in other cases but there would be the usual requirement of proving that damage component” (emphasis added).

While the case before the Supreme Court at the time was for the breach of a loan contract (in which the interest rate was explicitly stated), this idea of awarding interest as an element of damages has been applied in other areas in which no contractual interest rate had been agreed to. In a recent patent infringement case, Eli Lilly v. Apotex, 2014 FC 1254 (“Cefaclor”), the trial judge awarded $31M in damages for the period 1997 to 2000, and approximately $75M in pre-judgment interest as part of the damages award under the Patent Act, rather than as a prescribed remedy under the Federal Courts Act.

The impact of this decision was profound. Although (for example) the pre-judgment interest prescribed under Ontario’s Courts of Justice Act for Q1 of 1997 (when the infringement action was brought) would have been simple interest at 3.3%, the trial judge awarded interest on Lilly’s lost profits using an average compound interest rate of approximately 8.5%.

The Theory

Once one recognises that the statutory rates do not properly reflect either the time value of money or risk, and that it may be possible in some situations to argue for compound interest on some other basis, the question becomes, what is the most appropriate way in which to quantify those factors? How should a pre-judgment interest rate that is economically “fair” be set?

There are two ways of conceptualizing pre-judgment interest.

The first is compensatory, and focuses on the plaintiff’s perspective. Under this view, pre-judgement interest compensates the plaintiff for not having the damage award between the time it was harmed until the time damages were determined.

The second is restitutionary, and looks at things from the point of view of the defendant. Pre-judgment interest can be viewed as the amount the defendant must disgorge to the plaintiff as a result of having, on an interest-free basis, wrongly held money to which the plaintiff was entitled. This focus on restitution will make most sense for financial remedies that are explicitly defendant-focused (e.g. the accounting of profits remedy),[1] but may also be applicable in other situations, as I discuss further below.

Note that these two rationales may not yield identical interest rates. For example, if the plaintiff’s borrowing cost is 6% but the defendant’s is 8%, the benefit to the defendant of holding the disputed funds in the period prior to trial is greater than the cost to the defendant in foregoing those funds. Similarly, if the plaintiff was forced to forego a highly profitable venture as a result of lack of funds, while the defendant earned a low rate of return while it held the award, its loss may be greater than the defendant’s gain.

The Options

1.     Plaintiff’s Return on Capital: The Alternative Investment Theory

This theory argues that as a result of the wrongdoing and the withholding of an award that rightfully belonged to the plaintiff, the plaintiff has had to forego potential investments on which it would have earned a return. It argues that the appropriate rate of interest should compensate the plaintiff for this lost opportunity. [2]

This appears to have been the approach adopted by the court in Cefaclor. The trial judge calculated the interest rate with reference to the plaintiff’s actual[3] “profit margins” during the damages period.

(Though it is not clear from the decision, it is possible that Zinn J. was referring to the plaintiff’s return on capital not its profit margin. Profit margins are calculated by taking a firm’s profits and dividing by its revenue; they say nothing about the profit a firm earns as a percentage of its invested capital.)

This choice of metric is noteworthy, insofar as it tacitly assumes that as a result of not having access to the damages award, the plaintiff may have been required to forego additional profit-making ventures. While this assumption may be valid for smaller businesses without ready access to capital, it may be less so for large publicly traded companies such as Eli Lilly, who have ready access to public debt and equity markets. It does not appear that Eli Lilly was required by the court to prove that it had in fact been forced to forego any specific investments as a result of not having access to its lost profits, let alone to adduce any evidence as to what the profitability of such hypothetical investments might have been.

There is another, more subtle, objection that can be raised to the above measure. The assumption that the plaintiff’s average return on capital is representative of the return the plaintiff would have generated on the award is also debatable. Plaintiffs invest in a variety of projects, some with higher rates of return than others. If the plaintiff can be assumed to be a knowledgeable economic agent, one might assume that in the absence of funds, the plaintiff would ration its funds and turn down the least profitable or most risky projects. The marginal loss of funds would then result in the loss of only these marginal, below average investment opportunities.

2.     Plaintiff’s Cost of Borrowing: The Alternative Investment Theory, Light

This theory is similar to the previous one, but instead of arguing that the plaintiff would have used the award to invest in another project, it assumes that, at the very least, the plaintiff would have paid down some of its debt and relieved itself of interest obligations on that debt.

The advantage of this approach over the first is largely evidentiary. While it may be very difficult for the plaintiff to point to investments that it rejected due to insufficient funds – and not only that, but to also prove the level of profit it would have made from those investments – it should be easy for the plaintiff to point to specific bank loans it could have paid off had it had access to capital.

This may be what the plaintiff could have done, but is it what the plaintiff would have done? Perhaps, but this is not easy to prove. There are numerous other ways in which corporations expend their money – reinvestment, dividends, and increased executive compensation. Many companies have a target debt level, and will not use every spare dollar to pay down debt the way a conservative middle-aged investor preparing for retirement would. In short, it is not always easy to determine what the plaintiff would have done with the money, and insofar as that is the correct measure of the plaintiff’s damages, using the plaintiff’s cost of borrowing may also not be appropriate.

3.     Defendant’s Return on Capital: Disgorging the Profit

This is similar to option #1 above, but from the perspective of the defendant; it looks to disgorge the defendant’s profit earned from holding the award that rightfully belonged to the plaintiff.

The evidentiary problems with reconstructing what the plaintiff would have done with the money do not exist under this option – the defendant’s use of the money, and its profit from that use, is known. It might be attractive to look at the arrangement in existence between the damage date and the date of trial as some sort of partnership or constructive trust, in which the silent and unwilling partner is entitled to the profit earned on its capital.

Of course, in reality there is no real equity investment here. If the defendant incurs negative investment returns during the period between the date of damage and the trial, it is surely no argument for it to say that the plaintiff should be stuck with those losses on its share of the capital. It may be unfair to reward the plaintiff with any profits, while at the same time not exposing it to any of the losses.

4.     Defendant’s Cost of Borrowing: The Coerced Loan Theory

 This is the approach endorsed in an excellent article by two US scholars, Michael S. Knoll and Jeffrey M. Colon. Knoll and Colon argue that in wrongfully holding the plaintiff’s money, the defendant has effectively coerced the plaintiff into loaning it money. They argue that the interest rate to be charged, retroactively, on such a loan should be equal to the defendant’s floating cost of unsecured debt.

This was a measure that was advocated by the plaintiff in Merck & Co., Inc. v. Apotex Inc., 2013 FC 751 (“lovastatin”), and received favourable comment by Snider J. as being restitutionary; it is  a sound measure of the defendant’s benefit to be disgorged, in that it measures what the defendant would otherwise have had to pay in order to borrow an amount equal to the award.

Less intuitively, it can also be viewed as a measure of the plaintiff’s loss, if one considers that the plaintiff has been deprived of the difference between a market rate of return on lending funds to the defendant (or a firm with a similar default risk profile). To consider how this is so, consider the following example:

·        Suppose that Defendant caused the Plaintiff to lose $1M in profits in the year 2000. Damages will be awarded 10 years later.

·        Knoll and Colon argue that the unpaid judgment in the hands of the defendant is effectively an unsecured loan from the plaintiff to the defendant. Immediately following the date of damage, one can think of a notional “asset” (i.e. a loan receivable) accruing to the Plaintiff in the amount of $1M, and a corresponding “liability” (a loan payable) accruing to the Defendant’s balance sheet.

·        Knoll and Colon argue that the pre-judgment interest rate should be the rate that compensates the Plaintiff for a) inflation, b) the time value of money, and c) the risk that the Defendant will not repay the Plaintiff the $1M.[4] It is this risk that was actually borne by the plaintiff, and it is this risk – not the risk of, theoretically, investing in a new factory or technology – for which the plaintiff should be compensated.

This is arguably the least speculative measure that can be used to calculate pre-judgment interest. It looks not at what the plaintiff would have done with its money, nor at what it could have done, but at what it did. The plaintiff has lent the defendant money, and the defendant should pay it an appropriate rate.

Discretion

Section 130(2) of the Ontario Courts of Justice Act states that in some situations, the court may decide to vary the award of pre-judgment interest for any number of reasons, including:

 (f) the conduct of any party that tended to shorten or to lengthen unnecessarily the duration of the proceeding;

This paragraph is often used by defendants – and often used successfully – to argue that the award of pre-judgment interest should be reduced on account of the plaintiff’s role in delaying resolution of the dispute.[5]

From the discussion above, I would hope that it is clear that this section of the Act is likely based on a view of pre-judgment interest as somehow punitive in nature, as opposed to merely compensatory. The economic reality is that the plaintiff is rarely better off by having its award sit in the hands of the defendant and accrue simple interest at the low rates set by the Courts of Justice Act.[6] The very fact that the default pre-judgment interest award will be at a low, simple rate should be enough to encourage plaintiffs to expedite proceedings to the extent possible, and further reducing the pre-judgment interest award on these grounds may be redundant.

Conclusion

The Bank of America decision is more than ten years old; yet (based on an admittedly non-exhaustive inquiry) there do not seem to be a large number of cases in which pre-judgment interest has been awarded based on common law or equitable principles of damages. In many cases, no doubt, it may not be worth the hassle, although the Cefaclor case certainly presents an extreme situation in which pursuing the argument was highly profitable to the plaintiff. I hope the above discussion may prove useful in setting straight some of the conceptual and evidentiary issues associated with each potential measure.

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[1] In Reading & Bates Construction Co. v. Baker Energy Resources Corp. ( C.A. ), [1995] 1 F.C. 483, the Federal Court of Appeal noted that in an accounting of profits case, “The awarding of pre-judgment interest should be characterized as deemed secondary benefits, i.e. deemed earnings on the profits... The awarding of interest on the contract profits is part of the assessment of the profits that the plaintiff is entitled to and would have made if they had been paid to him rather than to the infringer.

 

Bearing in mind the modern reality that interest paid or earned on deposits or loans is compound interest and the need to achieve equity in the accounting of profits, the awarding of compound pre-judgment interest as deemed earnings on the profits is the rule, subject to a Court's discretion to mitigate it or to award only simple interest in appropriate circumstances.”

[2]Interestingly, this is also the rationale used by the trial judge in Bank of America, namely that (as summarized by the Supreme Court):

In deciding the appropriate measure of pre-judgment and post-judgment interest, the trial judge agreed with the appellant that it should be awarded the interest rate provided for in the Loan Agreement because, although it only intended to be an interim lender, the breach by the respondent resulted in the appellant becoming a long term lender which resulted in the appellant missing other investment opportunities as the money due to it was not paid and not available for other loans [para 12]. 

The case was somewhat unique in that Bank of America’s “investments” were in fact bank loans.

[3] Justice Zinn rejected the proposal that the plaintiff’s weighted average cost of capital – which measures the rate of return required by rational investors, given the risks inherent in the company – be used to calculate the discount rate, noting that it was a merely theoretical measure and that it was not reflective of what the plaintfif had actually done (and, presumably, would have done)

[4] I should hasten to point out that we are not speaking here of what is known as “litigation risk”, i.e. the risk the plaintiff might be unsuccessful in winning its case. Rather, we are referring to the risk that the defendant might go bankrupt between the date of wrongdoing and the judgment.

[5] I am not aware of any case in which a plaintiff has argued that the defendant has unnecessarily shortened the duration of the litigation.

[6] This reality has been recognized by some courts. For example, the Federal Court of Appeal noted in Reading & Bates Construction Co. v. Baker Energy Resources Corp. that:

A judgment in an infringement action is not complete, where the plaintiff elects an accounting of profits, until the profits have been accounted for and the judgment rendered on the report of the person designated to take accounts. The complaint that the referee took more than two years to file his report while pre-judgment interest was accruing overlooked the fact that the respondents had been deprived of that money during that period of time while the appellant had it. Furthermore, compound interest is not a penalty, but a recognition of reality.