To Prove Economic Damages, Track What Would Have Happened During Mitigation

To Prove Economic Damages, Track What Would Have Happened During Mitigation
February 10, 2016
Rather than discussing a new court decision or a pending regulatory issue, this alert addresses the practical implementation of legal concepts that underlie recovery of damages for an ongoing business enterprise.

To demonstrate real world application of these concepts, I consider how a complex manufacturing facility, a petroleum refinery, would prove economic damages. My hope is that readers, in seeing how these concepts might apply to a refinery, would also see how they could apply in other situations.  Also, I acknowledge that I find refining a particularly interesting enterprise.  I worked in a refinery before law school; I have been fortunate enough to have represented several refineries throughout the country; and my trial experience includes “first chair” in refinery litigation.

Suppose a refinery operating unit is partially or wholly disabled, due to the negligence or breach of contract of another entity. Repairing the equipment will be one element of damages, and is usually fairly straightforward.

Lost profits are often the larger potential recovery. In pursing lost profits, the refinery management must remember two key principles.

First, they need to mitigate damages. That is, they need to operate the refinery in a manner that keeps the lost profits to a minimum, regardless of who caused it.  They need to remember that they may be second guessed regarding key decisions, in hindsight, by the opposition.

Second, they need to gather data to show what the profits of the refinery would have been, had the damage not occurred.   This is necessary, because lost profits are based on the difference between what actually occurred after the damage and what would have occurred had the damage not happened.

In my experience, refinery managements are very good at mitigating damages. They constantly deal with equipment outages, changes in crude supply, regulatory changes, and other factors. It seems to come natural to them to respond to developments, regardless of who caused them, and make the refinery as profitable as possible during the time it takes to repair the damage, which I call the “mitigation period.”

However, it can be a challenge to develop and maintain the information necessary to show what would have happened, had the damage never occurred. Managements do not always think to devote resources to the theoretical exercise of how they would be operating had the damage never occurred, although proving what the profits would have been is important to recovering lost profits.

Refining provides examples of the challenge this presents. Some of the key data for a refinery may include:

·         Many refineries purchase some of their crude on relatively short term contracts, especially in these times of declining crude prices. If the refinery purchases crude during the mitigation period, it needs to also identify the crude purchases it would have made, absent the damage.

·         If the refinery changed key settings on its cracking units due to the damage, it must identify the settings it would have made, and the resulting mix of outgoing streams, but for the damage.

·         The refinery must develop and keep data on the mix of final products that it would have made, including the selling prices of those products.

·         It must have data to allow it to estimate the theoretical production costs that it would have incurred, had the damage never happened.

Given that these decisions in a modern refinery can change rapidly, even daily, identifying and maintaining data on what would have occurred, to contrast with what did occur for the purpose of calculating lost profits, can be a significant challenge for busy refinery management.

For best results, management should develop and preserve key data from the moment that the mitigation period begins, and continue to do so during the entire mitigation period. This will allow the facility to paint a convincing picture of what would have happened had the damage never occurred.

But what if the facility fails to develop and maintain all of the data from the beginning, or has gaps in the data during the mitigation period? Does this preclude the facility from recovering lost profits?  No.  Proof must be reasonably certain, but need not be perfect.  Perhaps a future alert will discuss more details about proving lost profits with reasonable certainty.

Managements should appreciate that the better they gather and maintain data on what would have happened but for the damage, the greater the potential for recovery of all of the lost profits.

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