Managing Claims and Losses I A Primer on Valuation and Loss Quantification for Corporate Counsel Michael Dobner – PricewaterhouseCoopers LLP Brett Harrison – McMillan LLP

McMillan LLP PricewaterhouseCoopers LLP2 August 18, 2008 Presentation Outline  Primer on loss quantification  Primer on valuation  Valuation or loss quantification?  Lawyer-Expert relationship  Expert reports  The role of corporate counsel

McMillan LLP PricewaterhouseCoopers LLP3 August 18, 2008 Economic Loss Quantification  Breach of contract  Business interruption due to third party actions  Vendor misrepresentations in an acquisition  Intellectual property infringement  Professional negligence  Anti competitive behavior  Class action suits  Construction delays

McMillan LLP PricewaterhouseCoopers LLP4 August 18, 2008 Loss of Income in Breach of Contract Loss quantification objective To put the plaintiff in the same position that it would have been in, but for the breach. Basic formula Loss of income = Income that would have been earned under the contract less actual income earned Loss of income includes past and future losses

McMillan LLP PricewaterhouseCoopers LLP5 August 18, 2008 Loss of Income in Tort  Loss quantification objective  To put the plaintiff in the same position that it would have been, but for the wrongful act.  Basic formula  Loss of income = Income that would have been earned had the wrongful act not occurred less actual income earned  Loss of income includes past and future losses

McMillan LLP PricewaterhouseCoopers LLP6 August 18, 2008 General Framework for Assessing Lost Profits  A backward looking projection of the lost profit from the date of the event to the date of the analysis The result of the backward projection is either left un- discounted or is future valued to the date of the analysis  A forward looking projection of the lost profit from the date of analysis onward The forward looking projection is present valued to the date of the analysis

McMillan LLP PricewaterhouseCoopers LLP7 August 18, 2008 General Steps of Past Loss Estimation 1. Estimate revenues that could have been earned but for the action 2. Determine actual revenues that were earned 3. Lost revenues = Revenues that could have been earned less actual revenues earned 4. Estimate gross profit as a percentage of sales applicable to lost sales 5. Loss of gross profit = gross profit percentage x lost revenue

McMillan LLP PricewaterhouseCoopers LLP8 August 18, 2008 General Steps of Past Loss Estimation (Continued) 6. Estimate incremental cost savings due to loss of sales 7. Estimate income produced from mitigation 8. Estimate additional costs, if any, incurred to mitigate loss 9. Loss of income = Loss of gross profit Less: Incremental cost savings Less: Income produced from mitigation Plus: Additional costs to mitigate the loss

McMillan LLP PricewaterhouseCoopers LLP9 August 18, 2008 Example of Past Loss Calculation

McMillan LLP PricewaterhouseCoopers LLP10 August 18, 2008 Future Loss Estimation 1. Project revenues that could have been earned but for the action (Revenue stream I). 2. Project revenues under current circumstances (Revenue stream II). 3. Lost revenue = Revenue stream I – Revenue stream II 4. Estimate gross profit as a percentage of sales applicable to projected lost sales 5. Loss of gross profit = Gross profit percentage x Lost revenue

McMillan LLP PricewaterhouseCoopers LLP11 August 18, 2008 Future Loss Estimation (continued) 6. Estimate incremental cost savings 7. Loss of income = Loss of gross profit Less: Incremental cost savings 8. Apply a discount rate to reflect the risks inherent in the projections as well as the time value of a dollar, and calculate the present value of future losses.

McMillan LLP PricewaterhouseCoopers LLP12 August 18, 2008 Example of Future Loss Calculation

McMillan LLP PricewaterhouseCoopers LLP13 August 18, 2008 Business Valuations: When are Valuations Used? Reorganizations Tax Income Tax & Estate Planning Tax Disputes Financial Reporting Mergers & Acquisitions/ Transaction Support/ Fairness Opinions Live Transactions Expropriation Securities Law Litigation Support Loss of Business?

McMillan LLP PricewaterhouseCoopers LLP14 August 18, 2008 Value Definitions  Value definition sets parameters of the valuation assignment  Fair market value (“FMV”) is defined as Highest price Expressed in terms of money or money’s worth Obtainable in an open and unrestricted market Between informed and prudent parties Acting at arm’s length Under no compulsion to transact  Judicial approval of definition in Re Mann Estate  Price ≠ FMV

McMillan LLP PricewaterhouseCoopers LLP15 August 18, 2008 Value Principles  Point in time  Hindsight  Case Law examples:  Ford Motor Co. of Canada v. Ontario Municipal Employees,  Woeller v. Woeller  Function of future expected earnings  Tangible asset backing  Minority and illiquidity

McMillan LLP PricewaterhouseCoopers LLP16 August 18, 2008 Value Terms  Intrinsic Value Notional market value, based on rates of return required by investors without consideration of possible synergies or economies of scale  Value to Owner Owner perceived economic / non-economic advantage that is not available to others.  Fair Value: Minority Oppression Matrimonial Cases Financial Reporting

McMillan LLP PricewaterhouseCoopers LLP17 August 18, 2008 Types of Valuation Reports Calculation Estimate Comprehensive (Opinion) Lowest Level of Assurance Highest Level of Assurance

McMillan LLP PricewaterhouseCoopers LLP18 August 18, 2008 Types of Valuation Reports (continued) Comprehensive Valuation Highest level of assurance Most comprehensive valuation report Extensive analysis, investigation and corroboration performed Higher level of due diligence on financial information, particularly with respect to client-prepared forecasts and asset/liability captions Written report with greater detail supporting conclusions Most expensive to complete Use of experts

McMillan LLP PricewaterhouseCoopers LLP19 August 18, 2008 Types of Valuation Reports (continued) Estimate of Value  Moderate assurance, but well-considered  Moderate review, analysis and market research  Some reliance on management representations  Summary written report with moderate discussion of all key issues and areas  Use of experts / management reliance

McMillan LLP PricewaterhouseCoopers LLP20 August 18, 2008 Types of Valuation Reports (continued) Calculation of Value  Lowest level of assurance  Limited analysis, investigation, and independent corroboration performed  Presented as a letter of PowerPoint presentation  Least cost to complete  Reliance on management

McMillan LLP PricewaterhouseCoopers LLP21 August 18, 2008 Overview of Valuation Approaches Is the Business Enterprise a viable, operating entity? NoYes Liquidation Approach Income Approach: Discounted cash flow Capitalized cash flow / earnings Market Approach EBITDA/EBIT Multiple Other multiples / rules of thumb Cost Approach: Reproduction Cost Replacement Cost Going Concern Approach Asset-Based Approach Valuation of each asset/liability Orderly vs. forced

McMillan LLP PricewaterhouseCoopers LLP22 August 18, 2008 Example of Valuation

McMillan LLP PricewaterhouseCoopers LLP23 August 18, 2008 Valuation vs. Loss Quantification: Main Differences 1. Valuation is conducted at a point in time and uses only information that was available at that point in time, where loss quantification may use hindsight  (i.e. information available on the date of the report or at the date of the trial). 2. Valuation usually provides an after tax result where loss quantification is usually calculated on a pre-tax basis. 3. Valuation may consider the impact of strategic purchasers who may be able to utilize the subject business in a more profitable manner than the current owners. This is usually not a consideration in loss quantification.

McMillan LLP PricewaterhouseCoopers LLP24 August 18, 2008 Valuation or Loss Quantification? Which One Should be Used  In some cases the law requires a valuation.  (e.g. expropriation, minority oppression, matrimonial cases)  Where the loss is of a finite nature (e.g. business interruption), loss quantification is the common method.  Where the loss is of a permanent nature (e.g. business destruction), the law does not provide clear guidance.

McMillan LLP PricewaterhouseCoopers LLP25 August 18, 2008 Valuation or Loss Quantification? Which One Should be Used (continued)  The intention of the plaintiff might provide guidance.  Generally where the plaintiff intended to benefit from the operation of the business, a loss quantification might be the preferred method and vice versa.  Practical issues might also play a role.  For example, where a business was destructed as a result of an action, a valuation might be a more practical method, given that the business was lost.  Expert should discuss with and be guided by Counsel.

McMillan LLP PricewaterhouseCoopers LLP26 August 18, 2008 Engaging an Expert Consider  whether an expert required  what type of expert is required  the need for additional expertise  the amount in dispute vs. cost of expert  the role expert will play in proceeding  the expert’s experience and testimonial history  if the opposing party has retained an expert

McMillan LLP PricewaterhouseCoopers LLP27 August 18, 2008 Tips in Hiring a Business Valuation/Loss Quantification Expert  Hire as early as possible  Ensure expert has relevant experience  External counsel should retain expert for privilege purposes  Align expert scope with the legal assumptions

McMillan LLP PricewaterhouseCoopers LLP28 August 18, 2008 What Can a Business Valuation/Loss Quantification Expert Do?  Input into the development of the statement of claim  Input into examinations for discovery  Prepare reports for submission  Retain other experts and coordinate their work  Provide critique on the other side’s expert reports  Testify  Assist in preparing counsel for cross examination

McMillan LLP PricewaterhouseCoopers LLP29 August 18, 2008 Expert Reports: What to Look For?  Transparent  Objective  User friendly  Addresses all the “difficult issues”  Fair and balanced  Sensitivity analysis

McMillan LLP PricewaterhouseCoopers LLP30 August 18, 2008 Expert Reports: Common Mistakes  Unreasonable assumptions  Taking extreme positions on issues that are debated among experts  Conclusions that do not pass the smell test  Inconsistency with other written materials  Assuming that estimated past losses are a certainty  Misuse of statistical analysis  Arithmetic mistakes  Double counting

McMillan LLP PricewaterhouseCoopers LLP31 August 18, 2008 The Role of Corporate Counsel Deciding when to retain expert Deciding who to retain Vetting scope of expert retainer Managing the information flow with the business Managing expectations of management and directors

QUESTIONS?