New business: reasonable certainty test for lost profits

Demystifying Valuation, Economic Damages + Forensic Accounting

lost profits, new business, litigation, valuationSeveral years ago, I wrote about whether a new or unestablished business can recover a claim for lost profits. Older case law precluded the recovery of lost profits for new businesses due to the remote or speculative nature of the damages. This was known as the “New Business Rule.” A review of the older case law found that recovery of other types of damages were allowed in certain circumstances. These included net expenses incurred and lost profits due to intentional interference with a contract expectancy where the plaintiff had similar business experience in other states. However, claims for lost profits were generally not allowed for unestablished businesses under this rule.

Most states have rejected the “New Business Rule” and replaced it with what is known as the “Modern Rule,” which allows for a recovery of damages for lost profits when those profits can be proved with reasonable certainty. Arizona follows the “Modern Rule.”1

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So, what is reasonable certainty? The following elements are common:2

  • The court must be certain that some injury to the plaintiff occurred as a result of the alleged wrongdoing.
  • Courts generally resolve doubts in favor of the plaintiff and, thereby, not allowing the defendant to be unjustly rewarded for the wrongful action.
  • Intentional or willful action by the defendant can result in requiring a lesser degree of certainty from the plaintiff.
  • The plaintiff must be able to estimate the damages, but the court should be able to have confidence in the accuracy of the calculation.
  • Past performance can be reasonably predictive of future results (for established businesses).
  • Expert testimony, business records, economic and financial data and other verifiable data/information can be used to establish reasonable certainty of damages for a new or speculative business.
  • The plaintiff must use the best available evidence.

Therefore, the lost profits damage estimate is not required to be determined with absolute accuracy or precision but must be adequately proved with reasonable certainty. Other legal standards that must be met include the following:

  • Economic loss doctrine (for tort claims)
  • Proximate cause
  • Foreseeability
  • Duty to mitigate

These standards will be discussed in future blogs and articles, so subscribe to our Litigation + Valuation Perspectives blog to get the most up-to-date information on this topic.

Steve Koons, CPA, ABV, ASA, CFF

  1. See for example: Rancho Pescado, Inc. v. Northwestern Mutual Life Insurance Co., 140 Ariz. 174, 680 P.2d 1235 (1984); Short v. Riley, 150 Ariz. 583, 724 P.2d 1252 (Ariz. App. 1986); and, Earle M. Jorgensen Co. v. Tesmer Manufacturing Co., 10 Ariz. App. 445, 459 P.2d 533 (1969).
  2. Litigation Services Handbook, Fifth Edition, published by John Wiley & Sons, Inc. (2012), p. 4.3.