Be Fruitful and Multiply: Pursuing Diminution in Value Damages With Respect to RWI Policy Claims—Part III

When an insured is pursuing a representation and warranty insurance (“RWI”) claim, a critical consideration is whether diminution in value damages (“DIV Damages”) can be asserted as Loss covered by the RWI policy.^[1] This article, being published in four parts, discusses Delaware mergers and acquisitions (“M&A”) damages law regarding DIV Damages and describes how an insured can pursue them as part of an RWI claim.

This is Part III of this article; it discusses the requirements for a DIV Damages award as part of an RWI claim. Part I of this article addressed (i) the principal differences between DIV Damages calculated using a multiple of EBITDA methodology (“MOE Methodology”) and DIV Damages calculated using a discounted cash flow methodology (“DCF Methodology”), and (ii) the evolution of cases involving DIV Damages calculated using an MOE Methodology under Delaware M&A damages law.^[2] Part II of this article addressed the evolution of cases involving DIV Damages calculated using a DCF Methodology under Delaware M&A damages law. Part IV of this article will discuss the limitations on, and other matters regarding, a DIV Damages award as part of an RWI claim.

Each part of this article contains practice tips for attorneys for insureds seeking recovery of DIV Damages as part of an RWI claim.

Requirements for DIV Damages With Respect to an RWI Claim

There are three basic requirements for any RWI claim,^[3] and therefore for any claim for DIV Damages under an RWI policy. An insured must establish that:

1. R&W Breach: An R&W Breach has occurred;
2. Loss: The target business or the insured has suffered a Loss as defined in the RWI policy (in the case of DIV Damages, a diminution in value of the target business with recurring effect);
3. Proximate Cause: The R&W Breach was the proximate cause of the Loss.

A different way to say the foregoing is that after the Acquisition, (i) the insured becomes aware of revenue or expense information about the target business without required disclosure by the seller, and (ii) had the insured known about the problem prior to the Acquisition, the insured would have reduced the purchase price that it paid for the target business.

Effectively, the DIV Damages serve as a post-Acquisition purchase price adjustment in favor of the insured.

1. R&W Breach

Some types of R&W Breach are more likely to lead to a claim for DIV Damages, while others are more likely to lead to a claim for out-of-pocket damages (i.e., a “1x claim”).

The following types of R&W Breach are more likely to lead to a claim for DIV Damages:

• Historical Income Statements: R&W Breaches regarding the target’s historical income statements^[4]—provided in the case of DIV Damages calculated using an MOE Methodology that the income statement line items in question are not those added back in calculating EBITDA (interest on certain types of debt (I), income and similar types of taxes (T), depreciation (D), and amortization (A)) or in making adjustments to EBITDA as that term was used by the buyer—may lead to a claim for DIV Damages.
• Significant Customers: R&W Breaches regarding the target’s significant customers are also likely to lead to DIV Damages, particularly representations and warranties that deal with the continued existence or strength of significant customers’ relationships with the target business or the pricing of the products or services provided to those customers.^[5]
• Other Types: Any other type of R&W Breach that can be deemed to have an adverse effect on the target business’s (i) Measurement Period EBITDA, and an anticipated recurring adverse effect on the target business’s EBITDA going forward after the Acquisition, or (ii) projected cash flows going forward after the Acquisition, may lead to a claim for DIV Damages. Examples are representations and warranties regarding compliance with laws, disclosure of liabilities, operating taxes (e.g., sales and use taxes), and regulatory status.

One other note regarding R&W Breaches: Very rarely does an Acquisition Agreement contain a representation and warranty with respect to the Measurement Period EBITDA itself or with respect to projections provided for the target business.^[6] Even though Measurement Period EBITDA or projections may be a critical piece of information regarding the target business and the purchase price to be paid therefor, buyers typically do not request and sellers typically do not offer such a representation and warranty.^[7]

2. Loss

Two types of loss can result from an R&W Breach:

• Third-party loss, for which the amount is rarely in doubt after the amount owed to the third party has been liquidated or settled, even though there may be an issue of whether the amount thereof (as well as any defense costs with respect thereto) is covered by the RWI policy.
• First-party loss, for which both the amount and whether that amount is covered by the RWI policy are at issue.

DIV Damages are expectation damages that are a type of first-party loss. Although there may be other types of methodologies to calculate DIV Damages, they almost always are calculated using an MOE Methodology or a DCF Methodology.^[8]

a. Issues With Respect to DIV Damages Using Either an MOE Methodology or a DCF Methodology

Certain issues are similar regardless of the methodology used in calculating DIV Damages.

i. Determining the Validity of DIV Damages

The Loss must be in the form of an adverse effect on the target business.

• Examples in the case of an MOE Methodology:
  • An actual adverse effect in the form of an overstatement of the target business’s Measurement Period EBITDA by reason of revenues of the target business having been overstated or expenses of the target business having been understated due to a financial statements R&W Breach.
  • A deemed adverse effect in the form of the target business being forced to pay an expense after the Acquisition that should have been reflected in the target business’s Measurement Period EBITDA, such as a regulatory fine or an operating expense that relates back to the EBITDA Measurement Period.
  • A deemed adverse effect in the form of the target business’s Measurement Period EBITDA having included revenue from a customer that has been lost during or after the end of the EBITDA Measurement Period, with that customer loss being the subject of an R&W Breach regarding significant customers. (Note in this example that the historical Measurement Period EBITDA was still accurate, but that cash flows from that customer will not recur after the Acquisition and can therefore be treated as a deemed reduction of the target business’s Measurement Period EBITDA.)
• Examples and principles in the case of a DCF Methodology:
  • Any type of R&W Breach that has a recurring adverse effect on EBITDA of the target business should also have an adverse effect on the projected cash flows of the target business for the DCF Measurement Period.^[9]
  • The adverse effect on the target business’s projected cash flows may be the result of an overstatement of revenue, an understatement of expense, or a combination of the two. It may be an adverse effect that began before the consummation of the Acquisition of the target business, or after the consummation, but in either case it must result from the R&W Breach in question.
  • The focus of the Loss requirement for an RWI claim is on an anticipated adverse effect on the target business’s projected cash flows for the DCF Measurement Period. Unlike the adverse effect on the target business’s Measurement Period EBITDA in the case of DIV Damages calculated using an MOE Methodology, which can be either actual or deemed, the adverse effect on the target business’s projected cash flows will always be an actual adverse effect, even to the extent that it is still only anticipated.

A claim for DIV Damages can only readily be made if the buyer can prove that the purchase price for the target business was based on either an MOE Methodology or a DCF Methodology.

The simplest and most effective proof of that is if the indication of interest (“IOI”) or the letter of intent (“LOI”) for the Acquisition explicitly sets forth the metrics of the methodology that the buyer used in arriving at the proposed purchase price for the target business.^[10]

Short of such explicit proof, evidence that the buyer established the purchase price for the target business on such a basis and that the seller knew the buyer was doing so should be sufficient under Delaware M&A contract damages law.^[11]

Short of that would be proof that the buyer primarily used such a methodology and that it was the most appropriate way to have valued the target business or established the purchase price for the target business.^[12]

ii. Determining the Diminution in Value

The determination of the diminution in value resulting from an R&W Breach is more of a forensic science than a legal analysis, and even then with some art mixed in.

The first step is to identify the actual or deemed adverse effect of the R&W Breach on the Measurement Period EBITDA or on the projected cash flows and terminal value. It may seem obvious, but if, for example, a significant customer has been lost prior to the consummation of the Acquisition without required disclosure by the seller, then the adverse effect is not measured by the revenue received from that lost customer during the Measurement Period but instead by that amount of revenue net of the costs that would have been incurred to earn such revenue and that can be avoided by the target business, often referred to as “avoided costs.”^[13]

The second step is to determine whether or not such net revenue (i.e., EBITDA or cash flow) from that customer would have been recurring enough to justify the award of DIV Damages.^[14]

b. Issues With Respect to DIV Damages Calculated Using an MOE Methodology

An MOE Methodology is composed of two elements: (i) Measurement Period EBITDA and (ii) a multiple applied to the Measurement Period EBITDA.

i. Measurement Period EBITDA

In addition to add-backs for I, T, D, and A, EBITDA is often adjusted to add back certain other costs and expenses to arrive at an “Adjusted EBITDA” for the target business. The buyer’s accounting expert’s quality of earnings (“Q of E”) report is the best source for an explanation of such adjustments and for information about a target business’s EBITDA generally.

ii. Multiple

If the purchase price for the target business was calculated using an MOE Methodology, then the multiple used in calculating DIV Damages should be the same multiple that was used in calculating the purchase price.^[15] If a multiple has more than one number right of the decimal point, it is most likely an implied multiple (i.e., a multiple derived simply by dividing the purchase price by the Measurement Period EBITDA).^[16]

c. Issues With Respect to DIV Damages Calculated Using a DCF Methodology

A DCF Methodology is composed of three elements: (i) cash flow projections, (ii) terminal value, and (iii) a discount rate applied to each of the projected cash flows and the terminal value.^[17]

i. Cash Flow Projections

Because such projections are of cash flows, not of financial accounting income, noncash charges such as depreciation and amortization typically are not treated as reductions to revenue, unlike cash charges such as cost of goods sold (“COGS”) and selling, general, and administrative expenses.^[18]

If the purchase price for the target business was calculated using a DCF Methodology, then the calculation of DIV Damages may not require an in-depth analysis of the cash flow projections that were so used, but instead may only require use of the same projections but with the effects of the R&W Breach in question (including any avoided costs) backed out to calculate the deemed actual value of the target business as of the date of the R&W Breach.^[19]

ii. Terminal Value

There essentially are two types of terminal value used in a DCF Methodology:

The first type (which is more of a “continuing value”) assumes that the target business will experience steady growth after the final period of the projections, and then applies a mathematical formula to the final period’s net cash flow amount to calculate a sum of the infinite, growing cash flows, with that result discounted to net present value by application of the chosen discount factor.

The second type (which is more of an actual “terminal value”) takes the final period’s net cash flow amount and multiplies it by a market multiple, with that product discounted to net present value by application of the chosen discount factor.^[20]

In either case, the terminal value will constitute a significant portion (often 70 percent or more, pre-discounting) of the aggregate cash expected to be received from the target business.

iii. Discount Rate

Except to the extent that the cash flow projections were themselves adjusted for risk, the discount rate used should account for risk,^[21] and not solely to account for the time value of money (often referred to as the “risk-free rate”), to arrive at the DIV Damages—that is, the appropriate post-Acquisition purchase price adjustment discounted to then-present dollars and to reflect the probability of future risk.

A typical factor to use to account for risk is the buyer’s weighted average cost of capital (“WACC”).^[22] However, if DIV Damages are being calculated on a “with/without” basis, then the same discount rate used by the buyer in calculating the purchase price for the target business (the “with” case) should be used to calculate the deemed actual value of the target business backing out the effects of the R&W Breach in question (the “without” case).

It is often the case that the buyer did not actually use a DCF Methodology to “set the purchase price” for the target business, but instead only to confirm that the purchase price was within a range in line with the buyer’s expectations for its return on the Acquisition. In that context, it may be necessary to resize the DIV Damages calculated from the “with/without” analysis to correspond to the purchase price.^[23]

3. Proximate Cause

For DIV Damages to be recoverable Loss under an RWI policy, it is not sufficient merely to identify an R&W Breach and a Loss in the form of a shortfall in Measurement Period EBITDA or with respect to projected cash flows of the target business. That R&W Breach must have been the proximate cause of that Loss.^[24]

The typical process for an insured to formulate an RWI claim is to identify an R&W Breach and then to determine what losses have been proximately caused by that R&W Breach and whether such losses are recoverable under the RWI policy.

However, sometimes the script is flipped, and the insured identifies a loss impacting the target’s post-Acquisition business and then tries to find an R&W Breach that might have “caused” that loss (a “loss in search of a breach”).

In the case of an R&W Breach or Breaches with respect to the target’s historical income statement(s), the R&W Breach(es) needs to cover the entire Measurement Period for DIV Damages calculated using an MOE Methodology to be recoverable. Since the Measurement Period will often be a last twelve months (“LTM”) or trailing twelve months (“TTM”) period that does not match up with a single historical income statement covered by the financial statements representation and warranty, the R&W Breaches will need to apply to more than one such financial statement.^[25]

Practice Tips for Attorneys for Insureds

In the RWI policy claim evaluation phase, consider doing the following:

• Have a qualified forensic accounting firm or valuation firm weigh in on the evaluation and calculation of potential DIV Damages.
• Interview any manager or other key employee who worked for both the target business or the seller prior to the Acquisition and the target business or the buyer after the Acquisition, with an eye toward getting their input on the information going into a potential DIV Damages claim (before the RWI carrier or its counsel does so).
• For DIV Damages calculated using an MOE Methodology, review in depth the Q of E report prepared for the buyer prior to consummation of the Acquisition to understand the target business’s EBITDA generally and any adjustments thereto specifically.
• Determine whether anything should be done or not done to attempt to mitigate Loss associated with the potential DIV Damages.
• Try to avoid any action or omission by the target business or the insured that could be asserted as calling into question any material element of the DIV Damages.

This article is the third in the RWI Practice Insights series by John T. Capetta.

1. This article focuses on buyer-side RWI policies and U.S. law (principally Delaware case law). For purposes of this article:

   • DIV Damages are a form of expectation damages in which the amount of the damages is the difference between (i) the value of the target business as represented to the buyer, almost always the purchase price paid for the target business by the buyer, and (ii) the value of the target business after giving effect to the diminution in the target business resulting from a breach of the Acquisition Agreement representations and warranties (“R&W Breach”) or from fraudulent misrepresentation or deceit regarding the target business.
   • Although there are other methods to calculate DIV Damages, this article focuses on those calculated by using either (i) in the case of a multiple of EBITDA methodology (“MOE Methodology”), (a) an actual or deemed shortfall in the EBITDA of the target business for a specified measurement period (“Measurement Period EBITDA”) caused by the R&W Breach or the fraudulent misrepresentation or deceit, times (b) the multiple applied by the insured to the Measurement Period EBITDA in determining the purchase price to pay for the target business; or (ii) in the case of a discounted cash flow methodology (“DCF Methodology”), the loss of future cash flows and of terminal value over a specified period caused by the R&W Breach or the fraudulent misrepresentation or deceit, discounted to present value by the application of a discount factor.
   • The period of time for which the historical EBITDA is measured in an MOE Methodology and the period of time for which the projections used in a DCF Methodology are included are each referred to in this article as the Measurement Period.
   • As used in this article:
     • the term Loss has the definition set forth in the RWI policy;
     • the term Acquisition Agreement includes stock purchase agreements, merger agreements, asset purchase agreements, and other types of business combination agreements by which a buyer acquires a target business from a seller;
     • the term Acquisition refers to the business combination contemplated by the Acquisition Agreement;
     • the term the buyer and the term the insured are often used interchangeably;
     • the term target and the term target business are used interchangeably;
     • the term R&W Breach also includes a claim under an RWI policy with respect to a tax indemnification provision in the Acquisition Agreement; and
     • the phrase without required disclosure by the seller refers to a failure by the seller to make a disclosure to the buyer even though required to do so by a representation and warranty in the Acquisition Agreement.
   • “Expectation damages” are also sometimes referred to by courts as expectancy damages.

   ↑

2. Although relevant M&A damages law regarding DIV Damages may apply with respect to fraudulent misrepresentation or deceit (each a tort) regarding the target business as well as an R&W Breach (a breach of contract), DIV Damages with respect to an RWI claim can only be asserted for an R&W Breach and therefore will always be subject to M&A contract damages law. However, note in this regard the argument described in infra note 3 with respect to an R&W Breach in the form of a claim under the tax indemnity provision in an Acquisition Agreement. ↑

3. An argument can be made that an indemnification provision in an Acquisition Agreement that is triggered by a specific event, rather than by a breach of representation and warranty, may not be subject to M&A contract damages requirements and limitations that would apply in the context of breach. See Glenn D. West & Sara G. Duran, Reassessing the “Consequences” of Consequential Damage Waivers in Acquisition Agreements, 63 Bus. Law. 777, 785 (May 2008) (section titled “The Impact of Indemnification Provisions on General Contract Damages Rules”). The foregoing brings into question whether an R&W Breach in the form of a claim under a tax indemnification provision triggered by the incurrence post-Acquisition of taxes with respect to the pre-Acquisition Measurement Period may be more effective than one in the form of a claim for breach of the taxes representation and warranty in an Acquisition Agreement with respect to the same incurrence.

   On a different side of the foregoing argument, the provision of indemnification as a remedy (and even the sole remedy) in an Acquisition Agreement for breaches of representation and warranty should not be interpreted to prohibit a claim for the contractual remedy of expectation damages, unless expectation damages have been expressly excluded. See Interim Healthcare, Inc. v. Spherion Corp., 884 A.2d 513, 549 (Del. Super. Ct. 2005); see also Hudson’s Bay Co. Luxembourg, S.A.R.L. v. JZ LLC, No. 10C-12-107, 2011 WL 3082339, at *2 (Del. Super. Ct. July 26, 2011) (“A claim for indemnification resulting from the breach of a representation and warranty is a claim for breach of contract.”), aff’d on other grounds, 80 A.3d 960 (Del. 2013) (unpublished table decision). ↑

4. However, if an R&W Breach with respect to the historical balance sheets of the target business leads to the need to create a new accrual or to increase an existing accrual, and the accrual or increase would have a recurring effect on EBITDA or on the projected cash flows of the target business post-Acquisition, then DIV Damages may be appropriate. ↑

5. The length of the relationship with those customers is important for this purpose, but with the focus being on the anticipated prospective length, not on the historical retrospective length. ↑

6. Indeed, most Acquisition Agreements contain an explicit disclaimer of any representation or warranty regarding projections provided to the buyer for the target business. ↑

7. In Dura Medic, the target did make representations and warranties as to its last twelve months (“LTM”) ending on April 30, 2018, financial statements, but appears not to have explicitly made a representation and warranty as to the LTM April 30, 2018, EBITDA derivable therefrom. In re Dura Medic Holdings, Inc. Consol. Litig., 333 A.3d 227, 243 (Del. Ch. 2025). In Cobalt, the opinion refers to “Crystal’s representation that WRMF’s annual broadcast cash flow was $5 million,” Cobalt Operating, LLC v. James Crystal Enters., LLC, No. 714, 2007 WL 2142926, at *1 (Del. Ch. July 20, 2007) (footnote omitted), aff’d, 945 A.2d 594 (Del. 2008) (unpublished table decision); to “WRMF’s cash flow [being] in fact $5 million, as represented by Hilliard [Crystal’s sole owner],” id. at *7 (footnote omitted); and to “Hilliard’s representation that WRMF’s cash flow for the twelve months leading up to the closing would be $5 million,” id. at *8. However, the description of the Acquisition Agreement in Cobalt does not refer to such a representation, id., and thus the references in the opinion to such a “representation” by Crystal or Hilliard appear not to be references to a representation and warranty in the Acquisition Agreement about WRMF’s cash flow for the Measurement Period. For a finding that a buyer could have sought a specific representation and warranty regarding the value of the target business but failed to do so, see Interim, 884 A.2d at 551. However, the foregoing finding in Interim does not appear to have been followed in other Delaware M&A damages cases. ↑

8. See NetApp, Inc. v. Cinelli, No. 2020-1000, 2023 WL 4925910, at *18 (Del. Ch. Aug. 2, 2023) (“Precedent in the M&A context provides . . . illuminating guidance. In that setting, Delaware courts routinely use the purchase price as the starting point for benefit-of-the-bargain damages calculations. This makes sense. The purchase price for a company is often the result of arms’-length negotiations between sophisticated parties and reflects the potential risks and rewards of execution. The price might have been established with a market approach using a multiple, or an income approach using a discount rate. Damages, then, may be calculated using the corresponding method to account for any diminution in value attributable to the misrepresentation.” (footnotes omitted)).

   Interestingly, in NetApp, Vice Chancellor Will rejected the buyer’s claim for lost synergistic profits calculated using a DCF Methodology but granted the buyer DIV Damages calculated using a multiple of revenue methodology proposed by the seller.

   It should be noted that, in the case of either methodology, the purchase price calculated assumes a cash-free, debt-free target business, and the purchase price would be subject to adjustment to the extent that was not the case at the closing of the Acquisition. ↑

9. However, to the extent that the projected cash flows do not include add-backs for Interest or Taxes, or for adjustments to EBITDA, there may be an adverse effect on projected cash flows even though there would not be an adverse effect on EBITDA. ↑

10. Even where an IOI or an LOI sets forth an anticipated Measurement Period EBITDA and a multiple to be applied thereto, the seller (and therefore the RWI carrier) might still argue that the foregoing did not constitute agreement between the seller and the buyer to that as the methodology of setting the purchase price for the target business, and therefore for calculating DIV Damages, or that any such agreement was nonbinding; but any such assertions would likely have little weight with a court or arbitrator authorized to resolve such a dispute, particularly in light of then–Vice Chancellor Strine’s findings in Cobalt. See infra note 15. ↑

11. See, e.g., Cobalt, 2007 WL 2142926, at *7; Swipe Acquisition Corp. v. Krauss, No. 2019-0509, 2020 WL 5015863, at *7 (Del. Ch. Aug. 25, 2020) (“At the pleadings stage, it is reasonably conceivable that an EBITDA multiple could support a damages calculation. Plaintiff alleges that the parties discussed using an EBITDA multiple to calculate the purchase price and that the Buyers, in fact, did so.” (footnote omitted)). In Cobalt, as often happens in such a dispute, the seller Crystal contended that it had “not rel[ied] on cash flow in reaching its decision to sell WRMF for $70 million”; that “it would not have sold for anything less than that price”; and that “regardless of what WRMF’s actual or legitimate cash flow was at the time, Crystal would never have done a deal at that [reduced] price.” Cobalt, 2007 WL 2142926, at *29. But then–Vice Chancellor Strine rejected that argument, stating among other things that “[t]his argument misses the point of awarding a remedy in a breach of contract case like this, which is to compensate the non-breaching party for the injury caused by the breach,” and that, “regardless of whether a deal would have been reached at a reduced price, Cobalt has demonstrated an injury equal to the value of the station in light of its legitimate earnings.” Id. Although the inquiry regarding the R&W Breach is focused on the reasonable expectations of the parties ex ante, the inquiry regarding DIV Damages is focused on the reasonable expectation of the nonbreaching party ex ante. See, e.g., Duncan v. Theratx, Inc., 775 A.2d 1019, 1022 (Del. 2001) (“Expectation damages . . . require the breaching promisor to compensate the promisee for the promisee’s reasonable expectation of the value of the breached contract and, hence, what the promisee lost.”); NetApp, 2023 WL 4925910, at *17 (“Damages are measured from the plaintiff’s perspective at the time of the breach.” (footnote omitted)). Notwithstanding the foregoing, Vice Chancellor Will did not accept the plaintiff’s claim of synergistic damages in NetApp but instead awarded the plaintiff DIV Damages calculated using a multiple of revenue, as proposed by the seller. ↑

12. See, e.g., WaveDivision Holdings, LLC v. Millennium Digit. Media Sys., L.L.C., No. 2993, 2010 WL 3706624, at *23 (Del. Ch. Sept. 17, 2010) (in addition to the buyer’s assertion that it had relied on a multiple of EBITDA methodology in calculating the value to it of the cable systems it had sought to acquire before being jilted, then–Vice Chancellor Strine also favorably noted that it was common in the cable industry to use a multiple of EBITDA valuation methodology, and that the seller, certain debtholders of the seller, and the buyer all used such a methodology to value cable systems in transactions); Taylor Precision Prods., Inc. v. Larimer Grp., Inc., No. 15-CV-04428, 2023 WL 6785802, at *2 (S.D.N.Y. Oct. 13, 2023). In the absence of proof that the seller either agreed to the determination of the purchase price based on a multiple of Measurement Period EBITDA methodology or was at least aware that the buyer was using such a methodology, the seller (and therefore the RWI carrier) may argue that the buyer’s assertion is merely self-serving or does not reflect the entirety of how the buyer determined the purchase price, putting more pressure on the buyer’s proof in that regard.

    It is, of course, possible that a buyer may have calculated the purchase price it offered or paid for the target business using neither an MOE Methodology or a DCF Methodology, or using one or both of those methodologies among others. In that situation, the buyer or its expert may introduce evidence regarding what it believes to be the best way to calculate the actual valuation of the diminished target business, but the buyer’s burden of proof will likely be greater in that situation since it cannot rely simply on its calculated expectation of what the target business was worth as the starting point to calculate that diminution in value. ↑

13. See, e.g., In re Dura Medic Holdings, Inc. Consol. Litig., 333 A.3d 227, 257 (Del. Ch. 2025) (noting that “the Buyers’ [damages] expert . . . calculated the lost earnings for those two customers for LTM April 2018, including offsets for costs and expenses the Company would not have incurred”). For a detailed description of how those avoided costs and expenses were calculated in that case, see id. at 258, n.48. See also Restatement (Second) of Contracts § 347 cl. (c) (A.L.I. 2024) (“Subject to the limitations stated in §350-53, the injured party has a right to damages based on his expectation interest as measured by (a) the loss in the value to him of the other party’s performance caused by its failure or deficiency, plus (b) any other loss, including incidental or consequential loss, caused by the breach, less (c) any cost or other loss that he has avoided by not having to perform.”). The issue of which costs and expenses would be avoided, in full or in part, and which would continue to be incurred is one of the most demanding issues in evaluating DIV Damages, and one in which the input of the insured’s forensic accountants or valuation expert is essential.

    For an excellent introductory explanation of the concept of avoided costs, see Elizabeth A. Eccher, Jeffrey H. Kinrich & James H. Rosberg, Analysis of Cost Behavior When Calculating Damages Part 1: Understanding Costs, Bus. L. Today (Nov. 15, 2018); and Eccher, Kinrich & Rosberg, Analysis of Cost Behavior When Calculating Damages Part 2: Analyzing Avoided Costs, Bus. L. Today (Nov. 15, 2018). ↑

14. See the discussion of Zayo and Dura Medic in Part I of this article regarding the need for a recurring effect. Zayo Grp., LLC v. Latisys Holdings, LLC, No. 12874, 2018 WL 6177174 (Del. Ch. Nov. 26, 2018); Dura Medic, 333 A.3d 227; see also NetApp, 2023 WL 4925910, at *20 (“This did not amount to a one-time loss for NetApp, but would continue to affect future cash flows. In these circumstances, dollar-for-dollar damages would not make NetApp whole.” (footnote omitted)). ↑

15. There appears to have been only one case under Delaware or New York M&A damages law in which a buyer attempted to use a different, reduced multiple to calculate DIV Damages than the one used to calculate the purchase price for the target business, albeit unsuccessfully. See Taylor, 2023 WL 6785802, at *5. ↑

16. For an example of the derivation of an implied multiple, see, e.g., Taylor, 2023 WL 6785802, at *5. Of course, a “multiple” can be derived by dividing the purchase price for a target business by any metric, not just Measurement Period EBITDA. ↑

17. An attorney familiar with the use of a discounted cash flow methodology to calculate lost profits damages will be familiar with much of the terminology used in this subsection. However, it cannot be emphasized enough that there is a fundamental difference between the calculation of DIV Damages using a DCF Methodology and the calculation of lost profits damages using a discounted cash flow methodology. The former is largely an exercise in doing a “with/without” comparison, and the latter is largely an exercise in searching for an unknown number based on cash flow projections likely to be somewhat unreliable and with a discount factor chosen solely for purposes of that exercise. ↑

18. Cf. S.C. Johnson & Son, Inc. v. DowBrands, Inc., 294 F. Supp. 2d 568, 582 (D. Del. 2003) (“As to depreciation, . . . SCJ contends that Mr. Dunbar, DowBrands’ expert, agreed that SCJ would have appropriately subtracted that number if the depreciation was included in the cost of goods sold and . . . depreciation was included in the cost of goods sold.”), rev’d on other grounds, 111 F. App’x 100 (3d Cir. 2004). ↑

19. To the extent that the cash flow projections used in the DCF Methodology were prepared by the buyer, then the RWI carrier may have more opportunity to challenge their reliability. The basis and nature of a challenge to the cash flow projections can get into particularly thorny issues such as, or akin to, proximate cause, contributory fault, no windfall, unjust enrichment, seller disclaimer, discount rate suitability, and RWI carrier substitution for the seller, which are beyond the scope of this article. ↑

20. This second type of terminal value resembles a sale valuation of the target business as of the end of the final period of the cash flow projections calculated in accordance with an MOE Methodology, substituting the projected net cash flow of the target business for the final period for the Measurement Period EBITDA and then subjecting that future deemed sale valuation to the discount factor to account for the time value of money and the “de-risking” of that sale valuation. ↑

21. Technically, the term risk as used in this context should take into account both the probability that a lesser amount of future cash flows or terminal value will be achieved and the probability that a greater amount of future cash flows or terminal value will be achieved, but it is often understood to mean only the former.

    Although a seller (or an RWI carrier, standing in the liability shoes of a seller) could attempt to argue that a disclaimer in the Acquisition Agreement regarding representations and warranties with respect to target business projections precludes their use in DIV Damages calculated using a DCF Methodology, such an argument should fail on the basis that the use of such projections in a DCF Methodology is only for purposes of comparing the ”with” and the “without” cases in such a calculation. ↑

22. See, e.g., Surf’s Up Legacy Partners, LLC v. Virgin Fest, LLC, No. N19C-11-092, 2024 WL 1596021, at *23 (Del. Super. Ct. Apr. 12, 2024) (“A 26.47% discount rate was used and traditional WACC.” (footnote omitted)).

    The use of the buyer’s WACC in determining the appropriate risk-adjusted discount rate is justifiable on the basis that the purchase price represents the amount invested by the buyer to acquire the target business, and the WACC represents the rate of return that the buyer would expect to receive on that investment, taking into account the risks associated with achieving the future cash flows reflected in the projections used. The cost of capital is a weighted average between the expected rate of return on the buyer’s indebtedness and the expected rate of return on the buyer’s equity. The calculation of the former should be relatively straightforward based on the interest rates charged by the buyer’s financing sources, while the calculation of the latter is fairly complex, involving an attempt to approximate the rate of return expected by the buyer’s stockholders on the equity invested in the buyer.

    A further explanation of the discount rate is beyond the scope of this article, and likely beyond the scope of what an attorney for an insured needs to know compared to the buyer’s forensic accountants or valuation expert. For anyone interested in a further explanation, albeit one targeted to a lawyer involved in lost profits litigation, see Robert M. Lloyd, Discounting Lost Profits in Business Litigation: What Every Lawyer and Judge Needs to Know, 9 Transactions: Tenn. J. Bus. L. 9 (2007). ↑

23. See, e.g., S.C. Johnson, 294 F. Supp. 2d at 595–96 (“The Court concludes that SCJ’s damages calculation must be reduced to reflect the ratio of the purchase price to the valuation. Given that SCJ paid $1.125 billion for DowBrands, which was 93% of the valuation, SCJ’s agreement that DowBrands is responsible to reimburse them for the ‘amount of the purchase price’ attributable to Latin America and the instructive case law on the benefit of the bargain rule, the Court concludes that SCJ is entitled to damages in the amount of $21,948,000.00, which is 93% of its valuation of the Latin American business as derived from the valuation of the business as a whole.”). ↑

24. See, e.g., In re Dura Medic Holdings, Inc. Consol. Litig., 333 A.3d 227, 255–56 (Del. Ch. 2025) (“In addition to showing the existence of damages, the plaintiff must show that the damages flowed from the defendant’s violation of the contract. The court evaluates but-for causation by considering how the positions of the parties would differ in the ‘but-for’ world—i.e., the hypothetical world that would exist if the [a]greement had been fully performed. The court evaluates proximate causation by considering how close the relationship is between the causal factor and the resulting damages. If the causal factor is too attenuated, then a court can decline to award damages because of a lack of proximate cause.” (footnotes and internal quotation marks omitted)); NetApp, Inc. v. Cinelli, No. 2020-1000, 2023 WL 4925910, at *26 (Del. Ch. Aug. 2, 2023) (loss of synergistic profits not the proximate result of the misstatements regarding the target business).

    The importance of proximate cause between the R&W Breach, on the one hand, and the Loss, on the other hand, is exemplified by Vice Chancellor Glasscock’s holding in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, No. 7906, 2020 WL 948513 (Del. Ch. Feb. 27, 2020):

    • In Great Hill, Vice Chancellor Glasscock rejected most of the plaintiffs’ claims of breach of contractual representations and warranties in the Acquisition Agreement and of fraud in connection with the purchase of the target company, Plimus (an intermediary between payment processors and vendors), but did find in favor of the plaintiffs with respect to certain breaches of contractual representations and warranties and fraud, in the latter case committed by the target company’s CEO.
    • The most significant of such R&W Breaches and fraud involved nondisclosure to the buyer of pre-Acquisition termination threats by PayPal, which at the time of the closing of the Acquisition was the target company’s largest payment processor by volume and its only United States–based payment processor.
    • In addition, Vice Chancellor Glasscock found that the plaintiffs “suffered harm from the non-disclosure of PayPal’s termination threats.” Id. at *23 (footnote omitted), Moreover, the plaintiffs asserted an enormous amount of losses suffered by them after the Acquisition, in total exceeding the purchase price that the buyer paid for the target company.
    • Nevertheless, Vice Chancellor Glasscock “award[ed] no fraud or contract damages to the Plaintiffs in connection with the misrepresentations regarding PayPal’s termination threats.” Id. at *23 (emphasis added).
    • Although the opinion referenced a number of flaws in the plaintiffs’ damages assertions, particularly speculativeness (i.e., a lack of certainty, to be addressed in Part IV of this article), the court’s decision to award the plaintiffs no damages for the R&W Breaches and the fraud regarding the undisclosed PayPal termination threats came down to the lack of proximate cause between those breaches and fraud and the losses that the plaintiffs had asserted.
    • Those losses assumed that the plaintiffs would prevail on all of their R&W Breach and fraud claims, and the plaintiffs chose not to pare back their losses assertions to those that were the proximate result of the R&W Breaches and fraud that they did prevail on.
    • Vice Chancellor Glasscock found that the plaintiffs’ choice prevented him from awarding damages to them with respect to the undisclosed PayPal termination threats.
    • To use a baseball analogy, the plaintiffs in Great Hill tried to hit a grand slam and instead struck out looking with the bases loaded.

    ↑

25. For example, if the Measurement Period EBITDA is for a TTM or an LTM Measurement Period ending on April 30, it may be necessary to piece together that twelve-month period from two or more income statements covered by the financial statements representations and warranties in the Acquisition Agreement, such as an annual income statement and one or more interim income statements. ↑