Lost Profits Represent Diminished Value

Harrison Mfg, LLC v. JMG Mfg., Inc., 2014 U.S. Dist. LEXIS 57782 (April 25, 2014)

After a business collapsed because of misrepresentations from the defendant, the court held a hearing on damages. What makes the case noteworthy is the court’s acceptance of the plaintiff expert’s methodology: “identifying” lost profits as part of the total financial loss he calculated.

The plaintiff’s predecessor manufactured baby and children’s furniture. It started as a family business in 1921 and at its pinnacle in the 1990s employed over 1,200 workers. But by 2008 its fortune had turned and it was sold. In August 2008, the acquiring company, the plaintiff, received $1.9 million in starting capital.

The defendant was the owner and president of a company that acted as a consultant for furniture manufacturers. The plaintiff sought a manufacturer for a new line of high-end furniture, the “Vogue Line” and used the defendant to obtain wood subassemblies for cribs and “case goods” (dressers and night stands) from a manufacturer in Indonesia. The defendant knew that the plaintiff worked under a tight deadline and depended on the manufacture of the cribs for the success of its new line.

The deal went sour. Despite repeated assurances from the defendant that the parts coming from Indonesia met the plaintiff’s specifications, no usable cribs was received and the plaintiff was unable to sell any products under the Vogue Line. By February 2009 the plaintiff had used up its available cash and required an additional $2 million to stay in business. By June 2009, it had depleted all of its operating capital and went out of business.

The plaintiff argued that had it known of the problems with the Indonesian manufacturer, it would have been able to switch to a different supplier in Vietnam. Instead, it relied on the defendant’s assurances and remained with the Indonesian manufacturer. In the first phase of the trial, the court found the defendant was liable.

The issue in the damages phase was how to quantify the losses stemming from the defendant’s wrongdoing. The plaintiff retained an expert whose report discussed causation: Because the plaintiff did not receive workable parts from the defendant, it was unable to fulfill its customer orders and suffered lost sales, which, in turn, resulted in the plaintiff’s complete loss of business. He projected what the business would have been worth had the defendant performed as promised, starting with the company’s actual financial position in November 2008. He determined that the present value of the future cash flows was about $5 million, which, he said, represented the plaintiff’s equity value as of December 2008 plus the profits that would have been realized had the Vogue Line sold as expected, which assumed that the plaintiff would sell two cribs to each of 100 stores for five years, as well as make sales for case goods, and applied a 20% discount rate (not explained in the opinion). He said his approach was conservative since the plaintiff’s own forecast assumed an increase in sales volume.

The defendant attacked the expert’s forecasting methodology, arguing that one of the plaintiff’s representatives had stated in his deposition that a product line typically only has strong sales for two years. Also, given the uncertain economic climate in 2008 and beyond, the expert’s use of a steady rate of sales for five years made his calculation unreliable.

The court found there was no evidence about the two-year strong sales statement on record, but it was receptive to the economic climate argument. It was more reasonable to assume sales would taper off and not remain constant, the court said. Consequently, it reduced the amount of the present value of the lost profits by $1 million and awarded a total of about $4 million.

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