Lost Profits – Part 1: Understanding and Analysis of Causation

This is the initial post in a three part series discussing the calculation of lost profits in a hypothetical scenario seeking economic damages for the alleged violation of a non-competition covenant.  The three part series will utilize the following fact pattern.

• The Best Animal Hospital, Inc. is a veterinary clinic located in Atlanta, Georgia.  The company was established on January 1, 2000 by Bob and Jill
• Bob and Jill each own 100 shares of The Best Animal Hospital, Inc.’s stock representing 100% of the outstanding shares of the company
• Bob and Jill signed a Shareholder Agreement on January 1, 2000, which contained a five mile non-competition covenant for a period of one (1) year subsequent to termination
• On December 31, 2013, Bob and Jill parted ways, and Jill purchased Bob’s 100 shares
• On January 1, 2014, Bob opened Bob’s Animal Hospital, Inc. which is located within five miles of The Best Animal Hospital, Inc.
• Jill filed a lawsuit on January 1, 2015 for the alleged violation of the Shareholder Agreement, specifically the non-competition covenant
• John, a seasoned forensic accountant, was engaged by legal counsel for The Best Animal Hospital, Inc. as a financial expert regarding lost profits

In general, lost profits as a remedy for economic damages are recoverable only if the plaintiff can show that the breach or wrongful act by the defendant was the proximate cause of the loss.  According to the AICPA practice aid for calculating lost profits, “proximate cause is an act from which an injury results as a natural, direct, uninterrupted consequence and without which the injury would not have occurred.”  As a result, causation is one of the initial considerations a financial expert needs to discuss with legal counsel and the client.  Further, the financial expert is often instructed to assume liability.  However, the financial expert generally attempts to understand causation and assess the reasonableness of it, without arguing or attempting to prove causation. What follows is a hypothetical forensic accounting analysis performed by John at the request of The Best Animal Hospital, Inc.’s legal counsel regarding the factual circumstances of the patients serviced by each of the clinics.

1. Understanding and Analysis of Causation

The Best Animal Hospital, Inc. alleged that Bob caused losses to the business as a result of setting up his business nearby.  In order to evaluate this claim, counsel requested that John evaluate whether Bob’s Animal Hospital, Inc. took patients of The Best Animal Hospital, Inc.  To perform this analysis, John obtained a listing of the patients served by The Best Animal Hospital, Inc. during the period from January through December of 2013 and a separate list for January through December of 2014.  Additionally, John obtained a listing of the patients served by Bob’s Animal Hospital, Inc. from January through December 2014.  The patient lists for both clinics contained the following information:

• Name of patient
  • First Name
  • Last Name
• Name of owner
  • First Name
  • Last Name
• Address of owner
  • Street number
  • Street name
  • Zip code
  • State
• Patient number

The patient numbers contained in The Best Animal Hospital, Inc. data were assigned in numerical order by the clinic’s practice management software, and each patient number is a unique identifier of that specific animal. Utilizing the patient numbers contained in the clinic’s patient data John compared the list of pets served by The Best Animal Hospital in 2013 to those seen in 2014.  Based on this comparison, John identified 863 patients that were seen by a doctor at The Best Animal Hospital, Inc. in 2013 that were not served in 2014.

Unfortunately for John, animals do not have a unique identifier across multiple disparate veterinary practice management systems (e.g. social security number).  As a result, the patient numbers in the patient data for Bob’s Animal Hospital, Inc. did not match to the patient numbers in The Best Animal Hospital, Inc. data.  Since the lists of pets obtained from two clinics did not have a matching unique identifier, John utilized the following information to create a unique identifier for each patient:

• First digit from the owner last name (e.g. “Wright” = “W”)
• First three digits from the street number (e.g. “12345” = “123”) and
• First five digits from the zip code (e.g. “30328” = “30328”)

John combined the extracted data to create a unique identifier for each patient (e.g. “W12330328”) in the data from The Best Animal Hospital, Inc. data for the 863 identified patients and the 2014 patient data from Bob’s Animal Hospital. The list of 863 pets that were served by The Best Animal Hospital, Inc. in 2013 and not contained in the 2014 patient listing, were compared to the 2014 patient listing for Bob’s Animal Hospital, utilizing the unique identifier created by John.  Of the 863 patients from The Best Animal Hospital, Inc. list, 734 or 85% were located by John in the patient data from Bob’s Animal Hospital, Inc.  The 734 identified patients were manually reviewed for accuracy based on the full set of patient data.  The manual review resulted in the identification of one (1) patient with a different patient first name in the two systems.  However, subsequent to additional follow-up with the patient’s owner, it was identified that the patient in question was in fact the same pet.  John determined that it was reasonable to assume causation and there was a link between the lost patients of The Best Animal Hospital, Inc. and Bob’s competing business.

In conclusion, forensic accountants can perform analyses, such as comparing data from disparate systems and identifying fact patterns that can often be very useful in litigation. In future posts, we will explore calculating lost revenues and identifying saved costs. In the meantime, if you have any questions or need assistance in a complex damages matter, please contact Tyler Wright at 770-635-1701 or Karen Fortune at 770-635-1699.  Initial consultations are offered free of charge.

Written By: Tyler Wright