Assumptions – financial and operational capacity

Authored by David Duffus

In our video series on damage issues, we introduced a number of topics relevant to the analysis and quantification of damages.  One such topic was the use of assumptions.  In matters involving the analysis and quantification of damages, experts invariably need to make assumptions, including:

  • The length of the damage period;
  • The “but for” performance of the parties;
  • The volume of product that would have been sold;
  • The growth, if any, in sales volume and price;
  • The plaintiff’s operational and financial capacity to meet the sales volume; and
  • The incremental expenses applicable to the lost sales.

In this article, we evaluate the issue of assumptions surrounding the plaintiff’s financial and operational capacity to meet sales volume projections.  In doing so, it is illustrative to look at one area in particular, the analysis of lost profits in patent infringement matters, where there is well-established case law surrounding the evaluation of capacity in connection with the quantification of damages.

Currently, most courts evaluate entitlement to lost profits damages in patent infringement cases through the four-factor test that was set out in the Panduit[1] case.  Factor three of that test addresses whether the patent holder possessed the manufacturing and marketing capacity to meet demand for the patented product.  While not an exhaustive list, or for that matter a list that is applicable to every matter, the following may represent analytical tests that can be employed to evaluate capacity in accordance with Panduit factor three:

  • Quantification of the total volume of product sold by the patent holder and the infringer over the infringement period.  The volume can then be compared to the pre-infringement volume sold by the patent holder, as well as other measures such as overall manufacturing capacity, including manufacturing capacity that reasonably could have been obtained through expansion or contract arrangements, in order to evaluate whether the patent holder had the capacity to meet the demand for the patented product.
  • Evaluation of the financial capacity of the patent holder to support increased sales volume in order to meet demand.  This may entail evaluation of the availability of credit to support increased material purchases and other working capital needs, as well as the availability of credit or equity investments to support expansion to meet demand.
  • The evaluation of distribution capacity to meet the increased volume in order to meet demand.  This may entail the evaluation of patent holder’s existing distribution network, and its capacity to handle increased sales, as well as whether additional distributors/distribution channels could be obtained to meet the increased volume.

Note that the foregoing issues regarding the evaluation of capacity may also need to factor in  other effects on the damage analysis, beyond the impact on the revenue and volume assumptions. For example, if it is determined that capacity could be obtained through expansion or contract arrangements, the related costs of obtaining that additional capacity may need to be considered in the overall damage analysis.

The foregoing issues regarding the evaluation of capacity may also be applicable outside of intellectual property matters.  It is easy to see how the evaluation of issues such as the plaintiff’s financial capacity to meet the claimed lost volume, or the plaintiff’s ability to reach new customers or markets could be relevant considerations when evaluating lost sales in breach of contract or other economic loss matters.

For more information on this topic, or to learn how Baker Tilly forensic, litigation and valuation advisors can help, contact our team.