Understanding economic damages in employment and personal injury cases
By Scott E. Miller
The use of economic damages experts in personal injury and employment cases can be a tremendous benefit to both plaintiff and defense attorneys. Unfortunately, it is not uncommon for attorneys to invest most, if not all, of their efforts into the case itself and leave it up to the trier of fact to determine what the amount of economic damages are. This is a very risky decision. Without putting a number before the trier of fact, you run the risk of getting a judgment far different than what you or your client believes appropriate. Judges and juries are not adequately skilled in determining damages and can frequently be unpredictable and determine awards which do not consider all of the relevant facts.
The purpose of this article is to provide a basic understanding of economic damages analysis in personal injury and employment disputes so they can more adequately educate the trier of fact. It is essential for both plaintiff and defense attorneys understand the importance of calculating and presenting the results to the trier of fact. Not only does such analysis provide the necessary data to determine an appropriate award, it can also be useful to reinforce the facts of the case.
GENERAL RULES WHEN WORKING WITH EXPERTS
Always hire your expert early on. If you unnecessarily delay introducing the expert into the case, it can result in wasted time and potentially settling the case too early, too late or for the wrong amount. A good expert may be able to provide additional insight into the facts of the case, uncover previously unknown facts or provide guidance as to the potential value of the case for settlement purposes.
When an expert is hired too late, there is frequently not enough time to properly develop the case or to identify all the issues. Attorneys may find hiring the expert they want can be difficult due to potential conflicts with other projects the expert may have. If the attorney engages the expert or consultant early on, he or she can be quite helpful in reviewing document requests and interrogatories. Experts are frequently more knowledgeable about where to look for different types of information that could substantially affect the presentation, value or success of a case.
Make sure your expert is experienced and qualified to calculate damages of this kind. Although most cases of this kind are handled in state court, it is not uncommon to find them in federal court. In these situations, it is the attorney’s responsibility to make sure the expert is qualified as an expert under Rule 702 and 703 of the Federal Rules of Evidence and under the standards set by the U.S. Supreme Court in Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579 (1993). (Also see Pabst Brewing Company v. Commissioner, No. 18466-92, 1996 WL 655710, General Electric Co. v. Jointer 522 U.S. 136 (1997), Target Market Publishing, Inc. v. Advo, Inc. 136 F.3d. 1139 (7th Circuit 1998), Kumho Tire Co. v. Carmichael 526 U.S. 137 (1999).)
An expert is not necessarily qualified to calculate economic damages in personal injury and employment cases just because he or she has testified in other types of cases before. Experts need to be properly trained and skilled in the particular types of analysis they are being engaged to perform. By engaging an unqualified expert, the attorney runs the risk of opposing counsel getting the expert disqualified and thereby significantly damaging the attorney’s case. In addition, unqualified experts may provide analyses which are not supported by the facts and leave the opposing expert’s analysis the only "reasonable" calculation left for the trier of fact to consider.
Is the expert able to effectively communicate with the judge and/or jury? Communication is not just the experts’ verbal or writing skills, but also their appearance, speed of their speech, the exhibits they prepare, their "body language" and their ability to "converse" with the court and engage the judge and/or jury during his or her testimony. Can the expert engage the trier of fact and eloquently and convincingly communicate the necessary facts and reasons to them? Your expert needs to be able to "draw in" the trier of fact and make his or her presentation interesting. This is not always easy with financial analysis, but it is necessary.
An expert must be believable. The attorney and the expert need to work together to present the expert as an independent neutral third party who, although engaged by and paid by the attorney, provides high quality unbiased testimony and credible analysis, which will assist the judge or jury to achieve the proper result in the case. If the expert is not objective and unbiased, the judge and/or the jury may disregard the expert’s testimony. An unobjective expert could damage other elements of the case. When interviewing experts, stay away from the "yes men," those who will say anything you want to hear just to get the case. If your case is bad, you need to know that so you can get it settled early on.
Make sure early on that the expert is well aware of the deadlines. This will allow the expert to plan his or her time out better to work around scheduling conflicts. The attorney needs to take responsibility for notifying the expert as soon as possible about scheduling changes and when and where the expert should appear at trial and depositions. The expert needs to have an appreciation for these deadlines and do his or her best to complete the work with sufficient time for the attorney to review their results prior to it being submitted to the court or opposing counsel.
ELEMENTS OF DAMAGES
The biggest mistake made by experts and attorneys is their failure to understand the elements of damages. Although each case is fact-specific, most cases will contain all or a portion of the following elements of damages.
Wage Loss. The first element of damages is wage loss and it can be determined in different ways. The first thing to consider is the difference between the wages previously received and the amount of wages currently received. The loss may include lost wages during the period of unemployment, lost raises, promotions, bonuses, "step increases," etc. Again, your expert should look closely at the facts of the case to determine what the plaintiff might have been entitled to and be sure to have support for any position taken.
Although the calculation methodology will be based on the individual facts and circumstances of each case, there is a basic method to calculating lost earnings. Your expert needs to look at what the employee or injured person was earning prior to the "event" (i.e., termination or accident) and determine what changes in earnings might have occurred in the future with this employer. Is there sufficient information to project increases? Should promotions be considered? What kinds of job classifications are relevant in their analysis? How should union contracts be used and their elements considered? A qualified expert should know how to answer these questions and appropriately include the answers in their analysis.
Employee Fringe Benefits. The second element of damage is employee benefits or fringe benefits. Employee benefits include Social Security, Medicare, unemployment insurance, workers’ compensation insurance, short term and long term disability, medical, dental, vision, prescription drugs, educational reimbursement, retiree medical, vacation, sick pay and a litany of others. In some cases, the value of lost benefits can be more than the value of the lost wages, so be sure your expert knows how to deal with them.
The value of these benefits can be determined in a number of ways. One such way is looking at the actual cost of the particular benefit(s) to the employer. This approach can be helpful for benefits such as Social Security, Medicare, medical, dental, life, short and long term disability, vision and prescription drug benefits. Another method is to look at established studies on the cost of various employee benefits. There are a number of published studies. Your expert should be aware of them and how to use the data appropriately.
Lost Pension or Deferred Compensation Plans. The third element of damages is the value of a lost pension or deferred compensation plan.The expert needs to look at what level of participation the employee had in the plan(s) and what the historical and projected future performance would have been and then make an assumption about how that would affect this particular employee in this particular situation. Plan contributions can be made by both the employer and the employee, so be sure the effect of both are included (if applicable) in your expert’s analysis.
Stock-Based Compensation Plans. The fourth element of damages is stock options or other stock-based compensation programs. The two most recognized methods of valuing stock options are the Black-Scholes and intrinsic methods. The Black-Scholes method is the most complicated but there are software packages to perform the calculations. It requires a great deal of information, but will usually yield a more accurate value.
The intrinsic method is much easier, but provides only a base value determined by taking the current stock price less the option price times the number of options. The intrinsic value is almost always below the fair market value so before you accept this method talk to your client and get his or her thoughts. The value of stock-based compensation can be quite large. In some cases, a terminated employee may get a job immediately at a higher wage with better benefits, but because of the lost value of the employee stock options, the damages, nonetheless, can be substantial.
Retraining. The fifth element of damages is the cost of retraining. What if an employee had a high security clearance and was wrongfully terminated for theft or disclosing confidential information when he had done neither? What if the person is injured and can no longer stand or walk as required by the position? In these situations, the person may need to be retrained for a whole new career. The costs could include occupational training and counseling, a four year degree or other type of education or training.
Worklife Estimates. In both employment and personal injury cases, it is important to consider the expected worklife of the plaintiff to determine the length of the projection period. The most commonly used worklife data is from the U.S. Department of Labor, Bureau of Labor Statistics, published in February 1986. Your expert should use this data cautiously. There are a number of studies which are more recent and show differing results. In addition, it is important to know when the plaintiff may have wanted to retire, which may be at either an earlier or longer period of time.
Future Medical and Long Term Care. In personal injury cases, there may be the need for long term care or future medical expenses. It is important to consider what they are and what they are anticipated to be. Medical and vocational rehabilitation experts typically provide this data.
Life Expectancy. In personal injury cases your expert may have to consider the life expectancy of the individual now and as if the accident had not occurred. The Vital Statistics Division of the National Center for Health Statistics can provide that data.
After the calculations are complete, the attorney may ask the expert to consider mitigation; or what the person can, did or should have done to replace the income and benefits they have lost. In simple terms, did they get a new job? Did they even look for one? How long should it have taken them to find employment? Were there any jobs available in this person’s chosen field? In most cases, your expert will need to do a similar analysis to what they have already done to calculate the losses, but in order to calculate what the plaintiff could or should have done to reduce his or her damages.
PRE AND POST TRIAL ANALYSIS
When it comes time to review your expert’s analysis, be sure your expert has broken it down into pre-trial and post-trial damages, commonly referred to as back pay and front pay in employment cases. Pre-trial damages start at the date of the event and extend to the date of trial, mediation or arbitration. As the attorney, it is your responsibility to tell your expert which to use. The post-trial damages extend from the date of trial, mediation or arbitration through the date the person achieves parity with their original situation or until the time she would have retired or in limited cases, the date of death. (See the discussion above regarding worklife and life expectancy tables.)
Pre-Trial Interest. Be sure to tell your expert if they should include pre-trial interest and if so, what rate they should use. Is there a statutory rate? Is there a contractual rate? Should they use a safe rate?
Discount Rate. When selecting an interest/risk/discount rate your expert must be able to articulate why he or she chose a particular rate. How far out are the projected damages? If there is no evidence to the contrary, your expert should use a "safe rate," or one that is reasonable and utilizes assumptions that make sense in this particular situation. A safe rate is a rate with no or little risk of loss. The Supreme Court stated in Jones & Laughlin Steel v. Pfeifer, 462 US 523 (1983), that the discount rate used should be based upon the interest rate on the best and safest investments. The best and safest investment is usually considered to be a U.S. Treasury security.
Calculating the Present Value. Once the discount rate has been selected, the next step is to calculate the present value of the person’s damages. The amount of damages is not the total of each year added together. The concept of present value is quite simple. There is an element of risk associated with obtaining a payment in the future. That is why banks and other lenders pay or receive interest on money loaned to or by them. By present valuing the string of payments, you recognize the risk associated with it and also the time value of money (or a dollar today is worth more than a dollar received tomorrow.)
Inflation Considerations. Has your expert determined what to do about inflation? Does he know how to estimate it? Does she know where to get her inflation data? This is important because he or she needs to determine what the anticipated real growth will be of the damages. The real growth is the growth less inflation. Your expert should be well versed enough to understand the rates being used and if he or she has included or excluded inflation from all of their calculations. If not, he or she will most likely end up "double dipping" the inflation component or creating an "apples and oranges" scenario.
INCOME TAX CONSIDERATIONS
Once the base calculation of damages is made, there needs to be a consideration of the taxability of the award. Damages received for personal injury or wrongful death are not taxable under IRC 104(a)(2). Damages under state law for an occupational injury covered by workers’ compensation are also not taxable under Reg. §1.104-1(b). The exclusion does not apply to a retirement pension or annuity to the extent it is determined by reference to the employee’s age or length of service even if the employee’s retirement is caused by an occupational injury. Also, the exclusion is limited to the amount provided in the applicable workers’ compensation statute. Damages for claims relating to employment and discrimination are taxable as are emotional distress claims.
Tax Effects on the Award. When preparing an analysis of employment or emotional distress claims, your expert will need to consider the tax effects on the award. Because the total award should be equal to the amount the plaintiff would have received net of tax, a complex calculation of the effect of income taxes on the award must be prepared. The taxes would then be added to the award to arrive at the total award. The total award would be an amount which will result in the plaintiff receiving, after paying taxes, the amount of the damages award.
To properly present an employment or personal injury case to a trier of fact, the attorney should engage an expert to calculate the plaintiff’s economic damages. A qualified expert should be engaged early on, be able to communicate effectively, be believable and understand clear deadlines from the outset.
Your expert should be familiar with how to calculate all the elements of damages such as wage losses, benefit losses, stock-based compensation losses, deferred compensation plan losses, pension plan losses, etc. Their damages analysis should consider issues of work life expectancy, life expectancy, inflation and present value. The most difficult element of damages, which is also the least understood, are the tax effects of a damages award. Be sure any potential expert is well versed in tax consequences before engaging his or her services.
And lastly, the attorney may call upon the expert to calculate mitigation, which is an analysis of what the plaintiff did or, in some cases, should have done to reduce or eliminate economic losses. The mitigation figure is then deducted from the damages calculation to arrive at net damages.
ABOUT THE AUTHOR
Scott E. Miller, CPA, CVA, heads Forensic Analytics, a firm specializing in forensic accounting, economic damages analysis, business appraisal and litigation support. He has testified numerous times in state and federal court, has been engaged as a special master in federal court, and has authored articles published in state and national publications as well as textbooks. He can be reached at (503) 221-5056 or scott@ forensicanalytics.com.