List members with an interest in causation and the assessment of damages in
breach of contract cases may be interested in a Scottish judgment handed
down on 10th November. The case is called Tullis Russell Papermakers Ltd v
Inveresk Ltd, and is available here:
http://www.scotcourts.gov.uk/opinions/2010CSOH148.html

The judgment is a lengthy one (some 319 paragraphs), but of particular
interest is the judge's analysis of the appropriate method for assessing
damages for breach of contract in relation to lost profits. The pursuer was
arguing that the defender's breach had led to a dramatic drop in profits
over a specific period of time, as a result of reduced sales by customers.
The judge
noted that both of the principal expert witnesses had agreed that a
counterfactual approach to damages was appropriate (see para 179 of the
judgment). However, those witnesses disagreed on the precise method for
undertaking a counterfactual calculation: should one look at each individual
customer and attempt to perform a counterfactual analysis of the level of
sales it would have made in the absence of the breach, or was it permissible
to adopt a 'portfolio approach', which considered the customers as a whole
(on the basis that there were substantial linkages between individual
customers, and that a bad experience by one customer might lead to such
experience being passed on to similar customers with the result of a further
drop in sales). The judge explains the 'portfolio' method more fully at
paras 179-180, where he mentions what the witness (Dr Cuchra) promoting the
approach argued that:

"it is conceptually robust because it has the ability to capture commercial
and economic linkages between different customers, including the implicit
impact of brand and reputation. Actions that directly affect sales to one
customer can cause a direct or indirect effect on sales to another customer.
Secondly, the portfolio methodology is characterized by better statistical
properties that any "bottom-up" estimates of damage for each customer. Dr
Cuchra considered this to be an important conceptual advantage, which gave
greater certainty in the estimation of the counterfactual scenario. In
particular, the uncertainty around the counterfactual for a portfolio of
customers is lower than the uncertainty around the estimates for individual
customers. Idiosyncratic, company-specific factors that lead to uncertainty
around counterfactual estimates for individual customers are diversified
when customers are considered on a portfolio basis, so that such factors
tend to offset one another. Thirdly, the portfolio method requires the
estimation of one counterfactual scenario, which can be established with
some certainty and cross-checked against a number of known and available
benchmarks. Estimating separate counterfactuals for each customer is
speculative unless a robust assessment of the likely evolution of demand for
each individual customer can be performed. The ability to cross-check
against appropriate benchmarks arises because idiosyncratic factors can be
expected to offset each other at the portfolio level. Dr Cuchra accepted
that it was possible that idiosyncratic factors did not offset each other
for the whole portfolio of acquired customers. To control for this, a
specific adjustment was required ..."

The 'portfolio' suggested by the expert witness was wide: "In principle, Dr
Cuchra was of opinion that the analysis should be performed against the
whole portfolio of customers acquired by the pursuers, without exclusion."
(para 181)

The same witness criticised the approach of evaluating each customer's
counterfactual position separately for the following reasons:

"the method had severe conceptual and methodological flaws. First, this
method could not account for cross-customer effects in the portfolio. In a
number of cases the evidence showed that sales to one customer were linked
to sales to other customers ... Dr Cuchra described this factor as being at
the heart of the valuation of intangible assets, where sales to individual
customers are correlated. Consequently, if [the other witness's] methodology
were adopted all such costs and customer effects would have to be separately
identified and quantified, on a customer-by-customer bases. Dr Cuchra
thought that this would fundamentally contradict economic theory and would
be impossible to do robustly in practice. Secondly, from a practical point
of view, Dr Cuchra was of opinion that the consideration of individual
customers would not produce robust results. Under this methodology, the
impact of the wrongful act would be to be distinguished from a range of
idiosyncratic factors applicable to individual customers. Thirdly, such an
approach was open to speculation about the exact behaviour and
decision-making process of each individual customer. Even the customers
themselves might not be able to identify what would happen in the
counterfactual scenario. Without that knowledge, however, there was a danger
that arbitrary assumptions would be made about customer behaviour."

The judge (Lord Drummond Young) preferred the 'portfolio' approach: see
para. 217 f of his judgment.

I found the decision of interest as I have not hitherto seen such a detailed
analysis of the appropriate counterfactual methodology in a case involving
multiple linked factors affecting economic loss, and I wonder if other list
members are aware of any such discussion in other cases, and, if so, what
approach was taken by the court.

Regards,

Martin

Dr Martin A Hogg, LLB, LLM, PhD, FRSA
The School of Law
The Old College
University of Edinburgh
EH8 9YL
Scotland

Homepage: http://www.law.ed.ac.uk/staff/martinhogg_45.aspx

Tel: +44 131 650 2071
Fax: +44 131 650 6317

Reply email may be addressed to:
Martin.Hogg@ed.ac.uk


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