Best Practices in Assessing Lost Earnings Capacity
By Mark C. Musa, Forensic Economist, Managing Director
Forensic economists and accountants are regularly engaged to calculate and determine the pecuniary value of economic damages after a personal injury or wrongful death. The present value loss of earnings capacity and the loss of employer sponsored fringe benefits are often a key component of a personal injury or wrongful death claim. Determining the worklife (often referred to as the damage period) of an injured party is a critical component of calculating damages. However, certain expected worklife estimates can appear reasonable on the surface but are actually improper, and when relied upon, will often result in an incorrect damage amount.
Worklife estimates based on the following criteria, are not grounded in science and will often result in incorrect damage conclusions, if relied on:
- Social security retirement age
- A retirement age anticipated by the party bringing suit
- A retirement age assumed by the economic consultant
Each of these criteria appear simple and can potentially be well-articulated by an economist. However, each of these methods for estimating worklife improperly assumes that the injured party would have been immune from disruptions in people’s worklife, such as disability, voluntary separations from the workforce and mortality. While retiring at the social security retirement age seems like a reasonable assumption, an economist must factor into a damages calculation the reality that statistically, not everyone will work until full retirement age due to life’s many unexpected and unforeseeable events.
Utilizing a retirement age assumed by the injured party or consultant is fraught with the same fallacies. Measuring the loss of earnings capacity based on an assumed retirement age suggests that the claimant possesses a crystal ball and is able to predict, often decades into the future, when they will actually retire. These conclusions often incorrectly estimate the likely number of years the claimant would have worked, and correspondingly, lead to inaccurate opinions of the present value amount of damages pursued.
Alternatively, worklife expectancy tables provide a statistical, unbiased means of measuring the remaining years in the workforce. Worklife statistics, historically published by the Department of Labor and more recently updated and made available in various economic journals, are based on demographics that include age, gender, and the highest level of educational attainment.
Worklife expectancy statistics can reasonably be applied to the injured party without introducing biases into the damage assessment. Worklife expectancy statistics consider both involuntary and voluntary separations from the workforce, which often are not foreseen. For example, a portion of the population are subject to becoming disabled prior to attaining a hoped-for retirement age, while others in the population at large become deceased prior to reaching an anticipated retirement age.
Attorneys should be aware that the data, assumptions and methodology utilized by their economist often have a profound impact on the damage conclusions, and correspondingly, the economic damages sought in tort actions. The most appropriate measure of the remaining years in the workforce is worklife expectancy statistics, which by their very nature factor into the analysis real world risks that should be taken into consideration when calculating lost earnings capacity.
Common Problems in Buy/Sell Agreements
Scott E. Evans, CPA, ABV, CFE, Managing Director
In our role as litigation support professionals, we are often asked to prepare valuations or various calculations based on the language in Buy/Sell agreements, operating agreements, and purchase agreements.
We find that these agreements often do not provide clear language as to how valuations or other calculations are to be performed. Below are some of the common problems we encounter:
Improper or Vague Accounting Terms
We run across vague terms like “profits” or “income” in Buy/Sell agreements. Often, the so called “profits” or “income” are to be used as inputs into various formulas in the agreement. However, these terms are vague and may not lead to the desired outcome. For example, are “profits” to be calculated on a cash or accrual basis? Should “profits” include owner’s compensation? What if owner’s compensation is under market? Should a market rate for owner’s salary then be determined? Should income taxes be deducted? Should interest on owner loans to the company be deducted? Should earnings from investments be included?
Accounting terms need to be properly defined, otherwise an accountant who is asked to prepare calculations consistent with the agreement will not have sufficient direction, and you may end up with unintended outcomes.
Improper Use of the Term GAAP
Frequently, we see the term GAAP (Generally Accepted Accounting Principles) used in Buy/Sell and similar agreements. Many attorneys use the term GAAP as shorthand for accurate financial statements. However, GAAP has a specific meaning that may not be applicable to many companies.
One of the biggest problems with requiring GAAP financials in an agreement, is that many companies likely have never actually prepared GAAP financial statements. Many small and medium sized businesses use cash basis accounting. Cash basis accounting does not comply with GAAP. Even if the company uses accrual accounting rather than cash basis accounting, the company may still not prepare GAAP financials. For example, many companies don’t prepare accurate year-end accruals in accordance with GAAP. Additionally, technically, financial statements prepared under GAAP are required to have footnotes - few small businesses prepare footnotes.
Therefore, when an agreement demands that financial statements be prepared in accordance with GAAP, and the company has never prepared GAAP financial statements, it can create a significant problem. Many companies would not be able to switch to GAAP financial statements economically and timely. Even if it was possible to prepare GAAP financial statements, the newly created GAAP financials would not be consistent with previously prepared financials, which can cause other problems.
Due to the high likelihood of problems arising from the improper use of the term GAAP, it is prudent to determine how the company keeps their books and then craft the requirements, in any agreement, accordingly.
Improper Use of the Term Fair Market Value
The term Fair Market Value (“FMV”) is often used in Buy/Sell agreements as the standard of value used to determine an owner’s interest in the company. The use of FMV is sometimes used as a default term, when Fair Value may be the more appropriate standard of value.
A FMV calculation of value generally requires discounts for lack of marketability and lack of control for ownership interests less than 50% of the company. Therefore, a valuation prepared using FMV will most likely result in a value, for the minority owner, significantly less than a valuation prepared using Fair Value. A Fair Value standard generally does not apply discounts for lack of marketability or lack of control. An alternative to specifying the application of Fair Value could be to require a value determined using FMV, but specifying that no discounts are to be applied.
Other factors, such as owner’s compensation, often need to be taken into consideration in valuing an owner’s interest in a company. Therefore, given the possibility of ending up with an unanticipated outcome, it is a good idea to consult with a valuation expert when crafting the methodology for valuing a business or an owner’s interest in a Buy/Sell or similar agreement.
Buy/Sell Agreements utilize accounting and valuation terms that should be carefully considered to achieve the objective of any Buy/Sell or similar agreement. Therefore, it would be wise to have an accountant familiar with business valuations take a look at your agreements to see if there are any issues or imprecise terms.
Meet Robb Itkin
Managing Director at Simon Consulting
B.S., Business Administration, Boston University
Juris Doctorate, The American University
Managing Director Robb Itkin, has over 30 years of experience in corporate turnarounds and restructurings, receiverships, law, finance, real estate, executive management, arbitration/mediation and as an expert witness, CRO, COO and General Counsel.
Prior to joining Simon Consulting, Mr. Itkin was a Senior Managing Director at the turnaround and restructuring firm MCA Financial Group, Ltd. and a partner at a national law firm where he represented corporations, business owners, real estate developers and lenders. He also held executive positions at Fortune 1000 and entrepreneurial companies and managed the legal functions of multi-billion dollar divisions of lenders CIT and Finova.
Mr. Itkin has worked extensively in structuring and negotiating complex transactions in real estate, M&A, capital markets and restructures ranging in size from $1 million to over $1 billion. He managed significant receiverships involving operating companies, subdivisions, resorts, condominiums, HOAs, office, retail and industrial centers, luxury homes and apartments, and as Chief Restructuring Officer in a Chapter 11 bankruptcy proceeding related to a 3,000-acre master planned ski and golf community.
He has served as an expert witness in cases involving financing (loan/lease terms, credit underwriting, workouts, collateral enforcement), real estate, lender/borrower liability and professional standard of care (trustees, receivers, real estate and mortgage brokers, attorneys, promoters/syndicators).
Mr. Itkin was selected to join the American Arbitration Association’s (AAA) National Roster of Arbitrators and also serves as Board Member and Vice President of the Executive Council of the Alternative Dispute Resolution (ADR) Section of the State Bar of Arizona. He serves on the Board of Directors of several non-profit organizations, including the Association of Corporate Counsel—a nationwide industry group of more than 40,000 in-house corporate attorneys—where he served as President of the Arizona Chapter and on the National Board of Directors.
Mr. Itkin received his Bachelor of Science in Business Administration from Boston University and his Juris Doctorate from The American University. He is a Certified Real Estate Specialist (State Bar of Arizona) and AV rated by Martindale Hubbell.
Robb’s ‘night job’ is as a RYT certified yoga teacher. He is married to Pam, an HR manager and Mom extraordinaire. He also has two daughters, 28 and 24. His older daughter (Alexa), who lives in Minneapolis, is a Lululemon manager and just got married! His younger daughter (Haley) is a graphic designer and yoga/fitness/nutrition buff.
Simon Consulting Supports the Local Community
Simon Consulting is very proud to have sponsored the Bankruptcy Section Seminar at the State Bar of Arizona Convention in Tucson last June! Over the three event-filled days, nearly 1,200 attorneys took part in 49 seminars and 15 special events.
In May, Simon Consulting sponsored the Drive for Justice, an event of the Arizona Foundation for Legal Services and Education. The Foundation is a non-profit organization with the mission of promoting access to justice for all Arizonans.
Simon Consulting is also involved in voluntarily educating professionals in their areas of expertise. If you are interested in having one of Simon Consulting’s forensic accounting experts speak to your firm or group, please click on the button below to request information.
Who We Are
As the premier provider of complex financial and litigation consulting services in the Southwest, Simon Consulting, LLC (“Simon”) is the authority for forensic accounting, fraud investigation, damage calculations, receivership and restructuring, business valuations, family and criminal law matters, forensic economics, and expert witness services. Simon personnel has provided expert testimony regarding fraudulent transfers, damages, solvency, forensic accounting, alter ego, lost earnings, business valuations, and other matters hundreds of times in both State and Federal courts. Simon’s team provides the required depth of knowledge, education, experience, and skills necessary to meet and exceed client expectations.
What We Do
Simon provides coordinated professional services in three primary areas:
- Forensic Accounting: Fraud and forensic investigations, commercial damages, and business valuations, bankruptcy, family law, regulatory, criminal, or other matters.
- Receivership and Restructuring: Management, restructuring, turnaround, or sale of businesses or real estate in transition or distress, and related expert services.
- Forensic Economics: Economic analyses and determination of lost profits and lost earnings, including those related to tort and contract matters.
Sample List of Receiverships
Certain of our open receivership cases and some past (closed) cases are listed below:
- Arizona Corporation Commission v DenSco Investment Corporation; Maricopa County
Superior Court; Receiver, 2016
Simon was appointed Receiver for DenSco Investment Corporation in a matter brought by the Arizona Corporation Commission in August 2016. DenSco was engaged primarily in funding hard money loans for the purchase of real estate secured by deeds of trust using money raised from investors. In the short time since the inception of the receivership, Simon has identified the underlying fraud schemes that resulted in DenSco’s collapse and has collected over $7.5 million for the benefit of investor victims. Simon continues to administer DenSco’s remaining loan portfolio and pursue numerous additional avenues of recovery. Additional information regarding this ongoing receivership is available on the Receiver’s website at http://denscoreceiver1.godaddysites.com/.
- Titan Capital Holdings LLC, et al; Maricopa County Superior Court; Receiver, 2016
Simon was appointed Receiver for Titan Capital Holdings, LLC, et al. in February 2016 after the companies’ founder determined that the companies were insolvent. The insolvency was caused in whole or in part by non-performing loans, including loans to Titan principals and related entities, and by the failure of the companies to effectively collect funds due. The Receiver was appointed to conduct an orderly liquidation of Titan’s assets. During the investigation, Simon determined that Titan was insolvent only six short months after the company began operating, and only two months after it began accepting investor funds. Simon continues to administer Titan’s remaining loan portfolio and pursue claims against Titan principals and third parties for the benefit of its creditors. Additional information regarding this ongoing receivership is available on the Receiver’s website at http://www.titanreceivership.com/.
- KeyBank NA v Power Marine Sales Inc., et al.; Maricopa County Superior Court; Receiver, 2009
Simon was appointed Receiver for Power Marine Sales, Inc., et al. as a result of litigation brought forth by a secured lender. As Receiver, Simon liquidated 200 high end marine craft, parts, supplies, equipment and a manufacturing plant. Simon recovered various deposits, accounts receivable, vehicles, equipment, transfers and other collateral. Simon’s work in this case exceeded recovery expectations.
- Colorado City Unified School District; Arizona State Board of Education; Receiver, 2005
In December 2015, CCUSD became the first Arizona school district to be placed in receivership following the enactment of the new state law in the spring of the same year. Appointed as Receiver by the Arizona State Board of Education (“SBE”), Simon encountered and overcame numerous obstacles as the first School Receiver over a district serving a remote northern Arizona community long dominated by a polygamist sect. As Receiver for CCUSD, Simon investigated various allegations of fraud and determined that former staff and governing board members had embezzled over $600,000. Simon replaced the leadership team and the key accounting personnel, liquidated unnecessary assets, resolved various outstanding claims and oversaw the passage of legislation enabling a longer payback period of debt repayments. Simon successfully addressed and resolved the district’s gross financial mismanagement, corrected deficiencies in CCUSD’s compliance with the Uniform System of Financial Records (“USFR”), assisted CCUSD’s staff in maintaining and improving the quality of education, and achieved financial solvency by the fiscal year ending June 30, 2008.