The value of your contractual dispute just changed – up or down and by how much?

Globally, many businesses are currently suffering negative financial impacts in the face of the COVID-19 pandemic.

As economies have been gradually wound down to slow the rate of infection, demand for certain goods and services has reduced, both due to forced lockdowns by Governments and due to a reduction in discretionary spending by consumers. Parties claiming damages in commercial disputes, particularly those disputes on foot prior to the onset of COVID-19, should carefully consider the impact these changes may have on the estimation of loss.

How is loss estimated in a breach of contract?

In a breach of contract claim, damages are often estimated as the net present value, as at the date of breach, of the difference between:

  • the plaintiff’s actual cash flows including the impact of the breach; and
  • the cash flows the plaintiff would have derived but for the defendant’s breach.

Relative to the date at which loss is being estimated by an expert or a court, losses may be described as ‘past losses’ occurring between the date of breach and the date of estimation, or ‘future’ losses to the extent the plaintiff will continue to incur losses after the date of estimation.

Actual cash flows

In cases where there are both past and future losses, the actual cash flows will include:

  • actual historical cash flows from the date of breach to the estimation date; and
  • estimated future cash flows from the estimation date to the end of the loss period.

For breaches occurring prior to the impacts of COVID-19, the actual cash flows may have been impacted by both:

  • the effect of the alleged breach; and
  • the onset of COVID-19.

While the impact of the alleged breach on the business will often be negative, the impact of COVID-19 may vary depending on the industry in which the business operates (e.g. aviation, tourism, consumer staples, hospitality).There may be a further negative impact on the business, a positive impact, or little or no further impact, depending on how supply and demand has been affected in that particular industry. In each case, it can be challenging to separate the financial impacts caused by the breach from impacts caused by COVID-19 and other factors.

“But for” cash flows

To estimate the “but for” cash flows, experts may have regard to, among other things:

  • the business’ financial performance before and after the alleged breach; and
  • budgets or forecasts prepared by the business prior to the alleged breach.

In some cases, the legal analysis may indicate that the estimate of “but for” cash flows has regard to information or events after the date of the breach. For example, if a breach of contract prior to the onset of COVID-19 caused a reduction in actual sales, and COVID‑19 caused a further reduction in actual sales, then the “but for” cash flows may incorporate a reduction in sales due to COVID-19.

Relevance of budgets and forecasts

Where a business has prepared budgets or forecasts prior to the date of breach and the onset of COVID-19, the assumptions used to prepare them may require adjustment from February/March 2020 onwards.
For example, these assumptions may relate to:

  • prices and volumes for goods or services sold;
  • variable costs of providing the goods or services; and/or
  • fixed costs and capital costs.

The extent to which these assumptions are impacted largely depends on the business’ exposure to markets that have been impacted by COVID-19.

The factors discussed here by no means represent an exhaustive list of issues which may arise when estimating loss in the current environment. Engaging an experienced forensic accountant can help courts, parties and their legal advisers understand the potential impact of these issues to assist them in making well-informed decisions.

AUTHORED BY

Matthew Gold

Matthew Gold
Senior Manager, Brisbane
T: 07 3333 9886
E: mgold