Loss of opportunity – does your evidence prove a 1% chance?

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We look at the key lessons from Lee v Kwak [2017] NSWDC 202

The District Court of New South Wales found that an expert report assessing the value of lost opportunity should be given little or no weight because:

  • The important assumptions on which it was founded were not established; and
  • The prospect of profits from the lost opportunity was entirely speculative (following the principles in Malec1 and Sellars2).

This article considers the nature of assumptions and inputs the expert is required to adopt, and the impact on the persuasiveness of the opinion given. 

Key takeaways

In relation to an expert’s reliance on financial and other information upon which to express an opinion:

  • Where a party instructs an expert to adopt assumptions, it should ensure it is able to prove those assumptions by other evidence; and
  • Where the expert is required to gather third party information to inform an assessment, the specific relevance of the information gathered to the subject matter is paramount to establishing its persuasiveness. 

In assessing the value of a lost opportunity, the expert should consider all risk factors that could impact the commercial success of the enterprise, including:

  • Any preconditions for the opportunity to crystallize into an agreement or transaction that are outside the control of the parties, such as:
    • Legislative approvals;
    • Regulatory compliance; 
    • Funding approval; and
    • Availability of individuals and expertise.
  • Environmental or other unknown factors that can impact the performance of the agreement.

In assessing the impact of the identified risk factors on the value of the opportunity, an explicit adjustment to individually affected inputs is of greater assistance to the court than a collective adjustment for a range of risks.

Overview of the case

This matter involved, inter alia, a cross-claim by a vegetable farming company against an Australian-Korean cross-defendant for losses arising from a terminated joint venture agreement with a state-owned entity in North Korea. 

The Australian vegetable farming company was to supply seeds, logistics and agricultural expertise to the North Korean state-owned entity, in consideration for which it would receive profits from the sale of produce. 

The cross-claimant alleged that the actions of the cross-defendant had caused the termination of the joint venture agreement. It relied on an expert report that responded to instructions to address and value the loss of chance suffered by the cross-claimant as a consequence of the termination. 

Cross Claimant's Evidence

The expert assessed the loss using the discounted cash flow methodology. The expected future cash flows used in the assessment were said to be based on:

  • Details of the expected financial investment of the parties in the joint venture; and
  • The expected financial performance of the joint venture. 

The expert adopted a discount rate of 45-50% to take into account the following risks associated with the investment by the cross-claimant:

  • The risk associated with the investment being in North Korea;
  • The specific business risks associated with the investment; and
  • The risk that the returns expected to be received by the cross-claimant from the joint venture may not eventuate. 

Judgment

The court identified that the facts of the case raise for consideration the approach which the court must adopt in circumstances where the success of the commercial agreement may, on a proper assessment, be less than 50%. 

The court noted that:

  • According to the High Court in Malec, unless the chance is so low as to be regarded as speculative, being less than 1%, the court will take that chance into account in assessing the damages; and
  • According to the High Court in Sellars, the question is the proper assessment of the loss of a commercial opportunity which had some value, not being a negligible value, with the value being ascertained by reference to the degree of probabilities or possibilities of the opportunity. 

In relation to the cross-claimant’s evidence, the court found that the following key assumptions made in the expert report were not established on the evidence:

  • All North Korean government approvals would be obtained as required under the joint venture agreement;
  • A profit and loss statement relied upon was a document referred to in the joint venture agreement as the basis for agreed values;
  • The joint venture agreement would be carried out commercially;
  • The required financial contribution to the joint venture by the cross-claimant was an amount other than specified in the joint venture agreement; and
  • The cross-claimant (company) was in possession of the agricultural expertise it was required to provide under the joint venture agreement. 

The court expressed the view that these important assumptions were significant to the report and therefore the report should be given little or no weight. 

The court then went on to indicate that the expert report was largely a theoretical exercise which had been conducted on the basis of certain assumptions without appropriate consideration, including:

  • A subjective discount rate of between 45% and 50% without any empirical evidence of:
    • Success by foreign western owned companies in agricultural investments in North Korea; and
    • Whether North Korean government-controlled entities have complied with their contractual obligations;
  • Failure to have regard to evidence of disease and climate risks for agricultural enterprises in North Korea;
  • No reference to North Korean income tax rates and charges that would be applicable;
  • The relevance of the performance of Australian vegetable growing companies in an assessment of the possible performance of a joint venture entity in North Korea; and

A proper basis for a risk-free rate for a joint venture in North Korea other than applying a premium to a risk-free rate in Australia. 

Dicker SC DCJ concluded that there were very serious risks that the joint venture would lead to heavy losses as opposed to profits, and that no amount should be allowed for a loss of chance. 

His Honour added that if he was wrong in this approach, and some weight is given to the expert report, he would allow for a 1% loss of chance, which was equated to 1/45 of the mid-point value assessed by the expert, plus interest.

Read the full judgment here

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Malec v J C Hutton Pty Ltd (1990) 169 CLR 638; [1990] HCA 20
Sellars v Adelaide Petroleum NL (1994) 179 CLR 332; [1994] HCA 4

 

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