Lost-Profits Claim After a Supplier's Wrongful Termination
TechForge Inc. manufactures specialty brackets. In 2023 its exclusive distributor terminated the agreement without the required 180-day notice. TechForge's 2023 revenue was $5.0 million, and its revenue had grown at 5% annually in the three years before termination. Its incremental contribution margin, after variable materials, labor, and selling costs, is 35%. Fixed manufacturing overhead is $900,000 per year and would not have been avoided. TechForge's damages report projects 2024-2026 revenue using the distributor's forecast of 18% annual growth, applies a 42% gross margin, deducts only 6% variable selling costs, and discounts the result at 8%, producing a claim of $2.4 million. Defense discovery shows that TechForge replaced 60% of the lost volume within four months through a backup distributor, but at a 5-percentage-point lower contribution margin because of price concessions. Incremental working capital of $200,000 would have been required. TechForge's marginal tax rate is 25%. The contract contains no liquidated damages clause.
1. Critique the plaintiff's lost-profits methodology, focusing on the growth rate, margin, fixed costs, and mitigation.
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The plaintiff's methodology has several vulnerabilities.
Growth rate. The 18% forecast comes from the terminated distributor, an interested party, and is not supported by TechForge's own history. TechForge grew at 5% annually before termination. A lost-profits claim must be based on reasonable certainty, not on an optimistic projection. Using the distributor's forecast shifts the risk of unrealized growth to the defendant.
Margin. The plaintiff applies a 42% gross margin, which includes fixed manufacturing overhead. But fixed overhead of $900,000 would not have been avoided, so it is not an incremental cost. Deducting fixed overhead from lost revenue understates the contribution lost on each sale. The correct measure is incremental contribution margin of 35%, which already reflects variable materials, labor, and selling costs. The plaintiff's separate 6% selling-cost deduction is also inconsistent: if the 42% gross margin already includes some selling costs, the plaintiff may be double counting; if it does not, the plaintiff has mixed margin concepts.
Mitigation. The plaintiff ignores that 60% of the lost volume was replaced within four months. The replacement sales generated contribution, although at a 5-point lower margin. Damages should be reduced by the contribution actually earned on replacement sales, and the remaining loss should reflect only the 40% of volume not replaced plus the margin shortfall on the replaced volume.
Discount rate. An 8% rate may be too low for a small, concentrated manufacturer. The rate should reflect the risk of the projected cash flows. The report should also reconcile the claim to the underlying revenue, margin, and discounting assumptions; the $2.4 million figure is not transparent.
2. Recalculate a defensible pre-tax and after-tax damages estimate using a 5% growth rate and the incremental contribution margin.
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Use the but-for revenue at TechForge's historical 5% growth rate, not the distributor's 18% forecast.
| Year | But-for revenue | Lost contribution at 17% |
|---|---|---|
| 2024 | $5.000M x 1.05 = $5.250M | $892,500 |
| 2025 | $5.250M x 1.05 = $5.5125M | $937,125 |
| 2026 | $5.5125M x 1.05 = $5.7881M | $983,977 |
The 17% lost contribution rate combines two effects: 40% of volume is lost entirely, so 40% x 35% = 14%; and 60% of volume is replaced at a 5-point lower margin, so 60% x 5% = 3%. Total = 17% of but-for revenue.
Present value at 8%:
- 2024: $892,500 / 1.08 = $826,389
- 2025: $937,125 / 1.08^2 = $803,434
- 2026: $983,977 / 1.08^3 = $781,013
- Total PV = $2,410,836
Subtract the $200,000 incremental working capital that would have been required but was not invested. This is an avoided cash outflow, so it reduces the damages claim. Pre-tax damages = $2,210,836.
After-tax damages at a 25% marginal rate = $2,210,836 x 0.75 = $1,658,127.
A defensible range is therefore approximately $2.2 million pre-tax and $1.66 million after-tax, subject to refinement for the four-month replacement delay, which would slightly increase the Year 1 loss because full volume was lost for part of the year.
3. Discuss whether the backup distributor's lower margin is an offset and how mitigation and tax should be presented to the court.
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The backup distributor's lower margin is an offset, but not a dollar-for-dollar reduction of the plaintiff's claim. The correct measure is the contribution actually earned on the replacement sales compared with the contribution that would have been earned on the same sales under the but-for scenario. If the replacement sales earned a 30% contribution margin instead of 35%, the difference of 5 percentage points on the replaced volume is a recoverable loss. The plaintiff is not made whole by replacing volume at a lower margin, but it also cannot recover the full margin on sales it never lost.
Mitigation should be presented as a factual adjustment. The defendant bears the burden of proving that the plaintiff failed to mitigate or that replacement sales reduced the loss. The plaintiff should disclose the replacement volumes, prices, and costs. If the replacement was not comparable in volume or timing, the court should adjust.
Tax should be presented consistently with the jurisdiction's practice. If the award is taxable to TechForge, the damages should be computed after tax so the plaintiff does not receive a tax windfall. If the award is not taxable, the pre-tax figure is appropriate. The report should state the assumption and show both figures. The discount rate should be applied to after-tax cash flows if the tax effect is modeled, and the working capital investment should be treated as a cash outflow avoided, not as an accounting expense. The court should also consider whether the 180-day notice would have allowed TechForge to find a replacement sooner, which affects the four-month delay.