When businesses are defrauded, courts can — and in some states must — order restitution. But calculating fraud damages isn’t that simple.  It isn’t always easy for judges to decide how much a company has lost. That’s where fraud experts can help.

Calculating fraud damages: Benefit of the bargain method

At first glance, calculating restitution may seem easy: Someone steals $25,000, so he or she should repay that amount, perhaps with interest. But what about the profits the business lost because of the fraud? The answer varies by state and even by case.

Experts typically use either the “benefit of the bargain” or “out of pocket” rule to determine damages. The appropriate method depends to some degree on the location and nature of the fraud. But in most cases, the benefit-of-the-bargain method results in greater restitution for victims.

Take, for example, a hypothetical feed company that decides to buy and race a thoroughbred horse for promotional purposes. A horse dealer locates a suitable animal valued at $1 million, but offered at $900,000 because the current owner is retiring. In truth, however, the owner is selling the horse because it hasn’t lived up to expectations and it’s worth only about $700,000 — information the dealer has known for several weeks. Putting aside the buyer’s failure to perform proper due diligence, how much might it be able to expect in restitution?

Under the out-of-pocket rule, the company would be awarded $200,000 in damages, or the difference between the horse’s real value and the amount paid for it. Using the benefit-of-the-bargain rule, however, damages would be calculated at $300,000 — the difference between the dealer’s misrepresented value and the animal’s true worth.

Other methods

It’s obvious why plaintiffs typically prefer the benefit-of-the-bargain method. But there are other methods experts may use to calculate lost profits, including:

Benchmark (or yardstick). This approach compares the fraud victim’s corporate profits to those of another, similar company that wasn’t defrauded. This method is particularly appropriate for new businesses or franchises.

Hypothetical (or model). Also typically appropriate for businesses with little history, this method requires accountants to gather marketing evidence that demonstrates potential lost sales. After calculating the total, the costs that would have been associated with the lost sales are subtracted to arrive at lost profits.

Before-and-after. For longer-established businesses, experts look at the company’s profits before and after the fraud compared to profits during the time the fraud was being committed. The difference is the lost profits.

Best approach

Each method may be appropriate in certain circumstances. If your company has been defrauded, consider your specific fact pattern to arrive at the best approach to calculating damages.

(This is Blog Post #586)