Recovering Lost Profits for Start-Up Companies

At one time, the New Business Rule generally prevented an injured party from obtaining a damages award for lost profits due to the opposing party if the injured party was a newly established business (R. Dunn, Recovery of Damages for Lost Profits, 3d ed.,1987). Absent a history of past profits, future profits seemed too “uncertain and speculative,” particularly in the progress-oriented atmosphere of the late 1800s when rules defining damages first developed (Hickman v. Coshocton Real Estate Co., 58 Ohio App. 38 (Ohio ct. App. 1936)). In addition to their desire to limit excessive damages, courts often distrusted jurors with the discretion necessary to evaluate the reasonableness of future profit estimates (B. Bollas, New Business Rule and the Denial of Lost Profits, 48 Ohio State L.J. (1987)).
Changing attitudes towards jurors, a consensus focused on the inherent injustice to new businesses, and recognition of the economically nonoptimal allocation of resources that the New Business Rule encouraged may have all played a role in the shift in the interpretation of the rule away from a finding of law to a finding of fact, as pointed out by Bollas in the Ohio State Law Journal, and by Everett Gee Warner and Mark Adam Nelson in “Recovering Lost Profits,” 39 Mercer L. Rev. (1988). In most cases, says Michael L. Roberts in his article, “Recovery for the New or Unestablished Business” (The Alabama Law. (Mar. 1987)), the emphasis focuses on the fact that profits were lost, not on an absolute measure of those profits. As a result, calculation of lost profits need no longer conform to “absolute certainty” requirements; the “reasonable certainty” standard as applied to existing businesses with a history of profits has been applied to new enterprises as well (Michael G. Stewart, The Evolution of the New Business Rule, 17 Cumberland L. Rev. (1986)). However, as evidenced in Schonfel v. Hilliard, 62F. Supp. 2d 1062 (S.D.N.Y 1999) and Tipton v. Mill Creek Gravel, Inc., 373 F.3d 913 (2004) courts still give lost-profits claims heightened scrutiny when the party has no financial history. Clearly, when a business can show a history of profitability, both in the long-term and recent past, this profitability can often be reasonably projected into the future (with all other variables held constant). Additionally, if the contractual agreement between two parties makes mention of expected profits, quantification of those profits lost in the event of a breach proceeds without difficulty.
When faced with quantifying lost profits for new businesses with little or no history of earnings prior to the breach, quantification of lost profits becomes more of a challenge. Fortunately, the widespread application of the “reasonable certainty” standard allows several methods of quantifying damages without the requirement of complete and absolute certainty as to amount. The specific approach taken depends upon the operational effect the breach has upon the new business. An enterprise that fails because of the breach necessitates slightly different analysis than does one which continues operations at a reduced or at a level capacity. Regardless of the approach taken, however, an overriding concern focuses on the individuality of the case.
1. Business Enterprise Continues
If the business enterprise survives the breach, post-breach income figures, either for the injured party or for another who continues the enterprise at the same location, may be used to approximate profits lost due to the breach.
Post-Breach Profits, Injured Party
In some cases, the harmed business may be able to resume business along the same growth curve as existed prior to the breach. Although no permanent harm has occurred, the business has experienced a shortfall in income from the time of breach until production returns to normal. Profits will always lag as a result of the breach.
Notice that this method does not rely upon profitability at the time of breach. Rather, it focuses on the timing of profits. In limited circumstances, it may be possible to utilize post-breach income numbers as a proxy for expected income during the shortfall period. Additionally, use of this method depends heavily upon the continuation of existing market and production factors after the breach.
McDermott v. Middle East Carpet Co. Associated, 811 F.2d 1422, (11th cir.1987) (MECCA) applied this concept in determining a damage award for lost profits. Plaintiffs McDermott and his corporation Criterion Mills served as co-consultants to the royal family of Kuwait during construction of a carpet factory in the Middle East. As a result of McDermott’s inability to perform his contractual duties,