The value of a business asset is the present value of the cash flows it is expected to generate in the future.1 All valuation professionals will agree with this statement.
Almost as axiomatic for business valuers in a disputes context was the notion that for a historical valuation, no account should be taken of events occurring after the valuation date.
That is, if a loss arose as a result of a breach of contract on a date in the past, a valuer would assess the effects based on reasonable expectations for the future at the time of breach, ignoring what is known about subsequent events (whether such events would increase or decrease the amount of the assessment).
Recent decisions in the UK courts will cause valuers to reappraise this approach, at least when dealing with lost profits claims under English law.
The emerging approach, as applied in Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory) and recently reaffirmed in Bunge SA v Nidera BV, allows the use of hindsight to the extent that it is seen to give effect to what has been termed an ‘accurate’ assessment of the loss.
This article summarises the current state of play and highlights some of the considerations this raises for assessments of damages from a valuation perspective.
According to the compensatory principle, the injured party in a breach of contract case is ‘so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed’.2
An assessment of damages, therefore, requires valuations of the financial positions of the injured party in both a situation in which the contract is performed (the but-for position) and a situation in which it is not performed (the actual position), with the losses being the difference between the two.
Valuations are forward looking. In performing a valuation, a valuer must convert expectations (and assessments of the degree of uncertainty regarding those expectations) into a value at a point in time – the valuation date.
There is no single approach to capitalising future financial returns into a value at a discrete point in time. The two primary approaches for the valuation of income-generating assets are the income approach and the market approach, where such expectations are generally reflected explicitly through the former and implicitly through the latter.
Income bases of valuation rest on the premise that an asset’s value is equal to the value of the cash flows that it is expected to generate in future, discounted at a rate that reflects the risks inherent in those cash flows. The most frequently used income approach is discounted cash flow (DCF) analysis.
Market-based valuation approaches are essentially comparative in nature in that the value of the subject asset is inferred from a comparison with the characteristics of similar traded assets, selected based on their growth prospects and risks.
The appropriate approach in any given case may vary, for instance, with the purpose of the valuation, the nature of the asset, and the availability of information.
If a valuer seeks to assess the effect of conduct that has resulted or is expected to result in lower sales being made or higher costs being incurred, for example, as is often the case in breach of contract disputes, an income approach is usually preferred, given its emphasis on performance projections (including projections of sales and costs).
In performing an income-based valuation at a date in the past, the valuer ordinarily uses a projection of future performance, ideally informed by analysis conducted by or for the parties prior to that date (as may have been prepared in the ordinary course of business or for specific purposes such as raising financing). If available, the valuer may also consider contemporaneous third-party research and analysis.
To the extent future events are incorporated they would need to be known or knowable at the valuation date, where the asset’s value would reflect both (i) their expected effect if they occurred and (ii) their estimated probability of occurrence.
Why hindsight matters
If all awards of compensation were made immediately after the date of injury, hindsight would be irrelevant.
However, as there is always a delay (and sometimes a lengthy one) between the date of injury and the date at which compensation is assessed, new information becomes available which, if taken into account, can have considerable effects on the valuations and resulting assessments of damages.
The potential effect of performing a valuation that takes into account hindsight information as compared to one that reflects the uncertainty that existed at an earlier point in time is perhaps best seen by way of example.
Suppose Company A agrees to purchase, and Company B agrees to sell, the rights to drill for oil over a plot of land for $100,000.
Company B reneges on the deal, refusing to sell the rights, at a time when it is not known how much oil the plot of land contains (or, indeed, whether it contains any at all). Mineral rights over similar plots of land, all thought to have the same chance of containing oil, are available at the same price of $100,000.
If it subsequently turns out that this particular plot of land contained oil worth $10 million, how much should Company A be awarded as compensation for Company B’s breach of contract?
One option is to award it the market value of the rights at the date of breach, $100,000. That value reflects the range of outcomes anticipated at the time, including the possibility that the land contained oil worth $10 million and the risk that it contained none.
An alternative is to award it the value of the rights after the discovery of oil (ie, $10 million less the costs of extracting the oil and adjusted for any other costs and benefits of ownership of the rights). That is the value of the oil over which, as it is now known, Company A would have eventually come to hold rights (assuming it did not intend to dispose of them prior to the discovery).
While, to some, the latter may seem a more just outcome in the circumstances, it would, in effect, reward Company A for risks it did not actually bear.3
Which of these approaches is correct is a matter of law and would depend upon the court’s willingness to allow hindsight evidence.
Recent rulings in the UK courts
To what extent hindsight may be taken into account in valuations performed for damages assessments, if at all, has long been a matter of legal debate.
Indeed, as Lord Macnaghten asked over 100 years ago of the decision maker’s ability to consider the available information in Bwllfa and Merthyr Dare Steam Collieries (1891) Ltd v Pontypridd Waterworks Co, a case in which the owner of a coal mine was prevented from mining during a period when, with hindsight, it was known that the price of coal rose:4
Why should he listen to conjecture on a matter which has become an accomplished fact? Why should he guess when he can calculate? With the light before him why should he shut his eyes and grope in the dark?
The UK courts have, in contrast to the approach ultimately taken by Lord Macnaghten in the matter above, generally applied a ‘breach date rule’,5 assessing damages as at the date of breach in cases of breach of contract only using information that was known or knowable as at that date.
In that regard, Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory) represented something of a departure.
In July 1998, the Golden Strait Corporation chartered a tanker (Golden Victory) to Nippon Yusen Kubishika Kaisha for a period of seven years. While the earliest date of redelivery of the vessel under the contract was December 2005, the agreement provided both parties a right to cancel if war broke out between any two or more of a number of countries including the US, the UK, and Iraq.
In December 2001, Nippon Yusen Kubishika Kaisha repudiated the contract, and Golden Strait Corporation claimed for damages over the remaining 48 months until the agreed termination date.
In the arbitration to which the matter was referred in the first instance, the arbitrator determined that, while it was not foreseeable at the time of repudiation, the outbreak of the Second Gulf War in March 2003 would have allowed Nippon Yusen Kubishika Kaisha to cancel the agreement, had it still been in force, and, therefore, that it was only liable for damages over a period of 15 months.
The award was appealed and ultimately brought before the House of Lords where it was determined, in a 3-2 decision, that damages should be assessed by considering the course of events as at the date of the assessment, consistent with the decision of the arbitrator.
In particular, the majority in The Golden Victory, while stating that the date of breach was the ordinary starting point for a damages assessment, held that as the agreement included a term that meant the duration of the charter was uncertain, the outbreak of the war must be considered to reach an ‘accurate’6 assessment of the loss.
As it was found that both the contract and the hypothetical replacement that could have been entered as a form of mitigation (assumed to be on the same terms but at the lower prevailing market price) would have been cancelled, the period over which damages were assessed was truncated to reflect that fact.
In other words, in the view of the House of Lords, a forward-looking estimate of the loss as at the date of breach would have resulted in overcompensation where it was known, with hindsight, that a subsequent event would have reduced the loss.
In this regard, Lord Scott stated:7
The lodestar is that the damages should represent the value of the contractual benefits of which the claimant had been deprived by the breach of contract, no less but also no more.
A dissenting opinion was given on the basis that damages ought to be assessed at the date of the breach without regard for future events unless they were ‘inevitable’ or ‘predestined’.8 A key concern over the approach of the majority, as was raised by Lord Bingham, was that it ‘undermines the quality of certainty which is a traditional strength and major selling point of English commercial law’.9
Indeed, this was also noted by the arbitrator in the first instance:10
In essence, it does not seem to me that it can be right that the value of that which the Owners have lost (and which is calculable on the date of breach in the then prevailing circumstances) should thereafter vary according to when a determination is made in proceedings to enforce their rights and in perhaps quite different circumstances.
In addition, Lord Bingham observed that the compensatory principle, while long recognised as the governing principle in contract law:11
[D]oes not… resolve the question whether the injured party’s loss is to be assessed as of the date when he suffers the loss, or shortly thereafter, in the light of what is then known, or at a later date when the assessment happens to be made, in the light of such later events as may then be known.
Nevertheless, the majority’s view as to what constituted an appropriate assessment of loss in the light of the available information at the date of assessment was incorporated into the compensatory principle. As Lord Scott stated:12
The arguments of the Owners offend the compensatory principle. They are seeking compensation exceeding the value of the contractual benefits of which they were deprived.
This version of the compensatory principle has since been applied in a number of cases in the UK, including Flame SA v Glory Wealth Shipping Pte Ltd (The Glory Wealth) and Bunge SA v Nidera BV.
In The Glory Wealth, a case involving a repudiated freight contract, the court found, by reference to the decision of the House of Lords in The Golden Victory, that it was necessary to consider whether the innocent party, having been affected by a sharp decline in the freight market following the collapse of Lehman Brothers, would have been able to perform its side of the contract had it not been repudiated.13
If the owner could not prove that it could finance the agreed voyages, the court held that it would not be entitled to damages that would place it in a better position, at the date of breach, than it would have found itself in had the contract been performed.
Despite the differing views expressed within (as well as external criticism of) the decision in The Golden Victory, the court’s approach in that matter was recently reaffirmed by unanimous decision of the UK Supreme Court in Bunge SA v Nidera BV, a case involving a repudiated contract for milling wheat, where (like in The Golden Victory) the party in breach would have subsequently been able to cancel the contract (in this case, as a result of an embargo introduced by Russia).
In addition, the decision in Bunge SA v Nidera BV expressly stated that The Golden Victory interpretation of the compensatory principle applied equally to one-off sale contracts as to instalment contracts (the type of contract at issue in The Golden Victory), and, where the issue of commercial certainty was raised, Lord Sumption stated:14
Commercial certainty is undoubtedly important, although its significance will inevitably vary from one contract to another. But it can rarely be thought to justify an award of substantial damages to someone who has not suffered any.’
The Golden Victory application of the compensatory principle, and the scope it allows for account to be taken of hindsight, raises a number of issues that both lawyers and valuers will want to consider for damages assessments under English law. These include:
(i) In which cases is hindsight allowable?
(ii) What hindsight information may be used?
(iii) How is hindsight to be incorporated?
In which cases is hindsight allowable?
Notwithstanding the willingness of the courts to take account of subsequent events in the cases discussed above, the ‘breach date rule’ has not been displaced entirely.
Consider, for example, Ageas v Kwik-Fit (GB) Ltd and AIG Europe Ltd, in which Ageas, as the purchaser of a business, brought a claim against Kwik-Fit (GB) Ltd, the seller, and AIG Europe Ltd, its insurer, on the basis that the business’s warranted accounts contained errors in relation to bad debt provisions that resulted in an overstatement of profits and assets15 and, thus, an overpayment on the part of Ageas.
While it was agreed that the loss was the difference between the value of the asset as warranted and its true value, Ageas calculated its loss to be around double the level of AIG. The primary difference was that Ageas corrected the provision for bad debts at the time of sale based on historical bad debts prior to the sale and AIG’s correction of the provision took account of the actual bad debts after the sale, which were lower than in previous years.
Mr Justice Popplewell, in considering whether the business’s actual performance after the sale could be taken into account, accepted the approach in The Golden Victory that:16
In an appropriate case, the valuation can be made with the benefit of hindsight, taking account of what is known of the outcome of the contingency at the time that the assessment falls to be made by the court.
He noted that hindsight was not merely permitted to determine reasonable expectations for the future at a historical date, as in Buckingham v Francis,17 but could be used to award a level of compensation different from that which would have been expected at the date of breach.18
However, Mr Justice Popplewell ultimately determined that it was not necessary to take account of hindsight in the case before him and that doing so would cut across the allocation of risk between the parties.
He reasoned that because the risk or reward of any loss or benefit as might arise from both the way the business was operated and external influences fell to Ageas under the contract (there was no provision for an adjustment of the price after closing), Ageas was entitled to compensation based on an extrapolation of historical bad debts (ie, to retain the benefit of the lower level of bad debts realised under its ownership).
While, on the surface, the approach here (rejecting hindsight to award a higher level of loss than would have been estimated at the time of breach) may appear to be at odds with that in The Golden Victory (in which hindsight was used to award a lower level of compensation than would otherwise have been estimated), this serves to illustrate that a one-size-fits-all approach is not appropriate in contract disputes.
In the case of a breach of warranty, at least insofar as the parties have not contracted to share the risks and rewards after the sale, it appears the purchaser will not be penalised for performance being better than would have been projected at the date of sale (whether due to factors within its control or external influences).
It is unclear how the court would have ruled in Ageas had there been a purchase price adjustment mechanism or if subsequent performance were worse than would have been expected at the date of sale.
In addition, it remains to be seen where the limits of The Golden Victory use of hindsight lie, more generally, in assessing damages in breach of contract cases.
What hindsight information may be used?
For a historical valuation in which hindsight is not allowed, it may be appropriate to refer to documents produced shortly after the valuation date in order to triangulate the position as at that time.
For cases in which hindsight is deemed permissible, a more comprehensive consideration of what information may be taken into account is required.
By the date of assessment of loss a wide range of information (including that relating to the overall economy, the industry and the company itself) may be available beyond what would have been known or knowable at the date of breach. This includes anticipated events for which the outcome was unknown in addition to events that were not even considered at the date of breach.
Certain of this information is independent of the parties (such as inflation and exchange rates), while other information may be influenced by the actions the parties took, including as a result of the dispute.
It is important to distinguish between the conditions that arose only as a result of the dispute as compared to those that would have arisen in any case in order to determine the relevance to the formulation of the but-for position or the actual position.
Where the court takes into account one type of information, it may not take into account all types of information. In the context of The Golden Victory, for example, the event that was taken into account (the outbreak of the Second Gulf War) was assumed, as discussed above, to affect both positions.
However, as Lord Brown noted, an account of hindsight could also be relevant to an assessment of the profits the owners would have earned given that the agreed rate of hire under the contract was a base rate plus a share of operating profit (as would affect the but-for position) and to the length of time it would take them to enter a replacement contract (as would affect the actual position only).19
In Louis Dreyfus Commodities Suisse SA v MT Maritime Management BV (The MTM HONG KONG), the court accepted, by reference to The Golden Victory, that account should be taken of the unexpected difficulties that ship owners experienced in re-letting the ship after repudiation by the charterer.20
On that basis, the court determined it was appropriate to lengthen the period over which damages were assessed (including beyond expiry of the original contract). It, therefore, in effect, compensated the injured party for ineffective (but what were held to be not unreasonable) efforts to mitigate the loss in the actual position.
Commentators have suggested this is a step too far, highlighting the problems with a ‘bare’ application of The Golden Victory compensatory principle that bypasses considerations of causation, mitigation and remoteness.21
Given the wide range between taking into account all available (relevant) information, on the one hand, and considering only a single event or type of information, on the other, this is an area where further guidance from the courts would be useful.
How is hindsight to be incorporated?
Assuming hindsight is allowed and the information that it is appropriate to incorporate is identified, there remains a question as to how the calculations are to be performed.
As discussed above, the ‘breach date rule’ prescribes a date of valuation. If a DCF analysis is performed, the value of lost cash flows would be expressed at the date of breach, with all loss amounts projected to arise after that date being discounted back to it.22
In contrast, in performing the valuation at a later date, the final valuation date and cut off for new information must be determined. It may be that the latest valuations are set out in each side’s respective expert reports or a joint report (if any), or the valuations may continue to be updated at the hearing or subsequently.
As more time elapses between the date of breach and the date of assessment, there is increased potential for subsequent events to affect the valuation. This means a valuation that uses hindsight can change considerably depending on when it is assessed.
Then, having used hindsight, one must consider what risks remain in the cash flows. On the basis that the use of hindsight removes the business risks, some valuers have taken the view that past losses need not be discounted and, rather, should be brought forward from the specific dates on which they arose in the past to the date of assessment of compensation at interest rates that reflect only the risk that the other party would not pay them.23
If, however, the past cash flows, as informed by hindsight, are merely taken to be the most likely amounts where there still remains risk that they could have been higher or lower, the cash flows may still be discounted back to the date of breach before being brought forward as a lump sum at a pre-award interest rate.
It remains to be seen what approach will be preferred under English law. Depending on the size of the discount rate and horizon over which the losses arise, the results may vary considerably depending on the approach taken.
Valuers have generally assessed losses in a disputes context based on reasonable expectations for the future at the time of breach, ignoring what is known about subsequent events.
The Golden Victory application of the compensatory principle, in allowing account to be taken of hindsight to the extent it is seen as necessary to give effect to an accurate assessment of the loss, while controversial, was recently reaffirmed in Bunge SA v Nidera BV.
This, therefore, removes some uncertainty as to where the UK courts stand on the permissibility of hindsight, at least for lost profits claims, but raises further uncertainties in the practical application of such an approach, as highlighted in this chapter.
Given the effect that hindsight information (and the particular way in which that information is implemented) may have on a valuation, these are areas that both lawyers and valuers will want to pay attention to in damages assessments under English law.
A one-size-fits-all approach to the use of hindsight may not be appropriate. In the absence of clear guidance from the courts, recent decisions suggest it is worth bearing in mind the allocation of risk between the parties and the effects of subsequent events in the context of overall considerations of causation, mitigation and remoteness.
- Leaving aside valuations in liquidations and other special cases.
- Robinson v Harman  1 Exch 850 at 855.
- Dunbar M, Evans E, and Weil R (2012), Litigation Services Handbook, fifth edition, chapter 5.
- Bwllfa & Merthyr Dare Steam Collieries (1891) Ltd v Pontypridd Waterworks Co  AC 426 at 431.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 71.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 63.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 36.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 40.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 1.
- Paragraph 56 of the award, as quoted at Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 7.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 9.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 38.
- Flame SA v Glory Wealth Shipping Pte Ltd (The Glory Wealth)  EWHC 3153 (Comm).
- Bunge SA v Nidera BV  UKSC 43, paragraph 23.
- A provision for bad debts is management’s estimate as to what amount of the outstanding receivables will not be collected. Because an increase in the provision goes through as a loss on the profit & loss statement and reduces accounts receivable on the balance sheet, a provision that is too low means that both the business’s historical profits and balance of receivables are too high.
- Ageas v Kwik-Fit (GB) Ltd and AIG Europe Ltd  EWHC 2178 (QB), paragraph 35.
- Buckingham v Francis  2 All ER 738.
- Ageas v Kwik-Fit (GB) Ltd and AIG Europe Ltd  EWHC 2178 (QB), paragraph 35.
- Golden Strait Corporation v Nippon Yusen Kubishika Kaisha (The Golden Victory)  2 AC 353, paragraph 81.
- Louis Dreyfus Commodities Suisse SA v MT Maritime Management BV (The MTM HONG KONG)  EWHC 2505 (Comm).
- Yihan G (2015), ‘Two Recent English Cases on the Compensatory Principle in Contract Law’.
- The value would then be brought forward as a lump sum to the date of assessment by application of pre-award interest.
- Losses projected to arise after the date of assessment of loss would need to be discounted to the date of assessment of loss.