If a fraud event causes substantial financial losses for your organization, you may opt to initiate legal proceedings against the guilty party, potentially seeking compensation in the form of compensatory damages. You should be aware, assuming you prevail in court, that estimating fraud damages is difficult. It generally requires the assistance of a financial expert; he or she will evaluate the circumstances of the case and substantiate the damage incurred by your business. Let’s look at calculation methods.
Benefit-of-the-Bargain Vs. Out-of-Pocket
When calculating estimates, damages experts commonly employ either the benefit-of-the-bargain or out-of-pocket method. The method that is most suitable is contingent upon the specific location and nature of the fraudulent activity. However, the benefit-of-the-bargain method generally yields greater restitution for the victims.
Consider a real estate developer who purchases a parcel of land for $1.5 million when the seller estimates its value to be $2 million. In reality, the seller has falsified the valuation report and is lying about the parcel’s value. The land is worth approximately $800,000. Putting aside the developer’s lack of due diligence, how might fraud damages be calculated?
Under the out-of-pocket rule, the buyer would be awarded $700,000 in damages, or the difference between the land’s real value and the price paid for it. However, damages would be assessed at $1.2 million using the benefit-of-the-bargain rule—the difference between the seller’s misrepresented value and the parcel’s actual value.
Other Calculation Methods
For obvious reasons, plaintiffs generally prefer the benefit-of-the-bargain method. However, there are other methods that experts can use to estimate lost profits, such as the benchmark (or yardstick) method. When using this method, the expert compares the corporate profits of a fraud victim with a similar company that hasn’t experienced fraud. This approach is especially suitable for new businesses or franchises.
The hypothetical (or model) approach is also usually suitable for newer companies. The expert collects marketing evidence that illustrates possible lost sales. After calculating the total, the costs that would have been associated with the lost sales are subtracted to arrive at lost profits.
In the case of established businesses, the before-and-after approach is generally more favored. Experts compare the company’s profits before and after the fraud to its profits during the fraudulent activity. The difference represents the company’s lost profits.
Boost Your Odds
Early in the litigation process, you or your attorney should engage an experienced damages expert to increase the likelihood of obtaining adequate restitution in court. Contact us if you have any questions.
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