Tuesday, November 20, 2012

Critiquing an Expert Report: Step 3 - Assumptions

The third and, in my view, most important step to critiquing an expert report involves identifying and assessing the reasonableness of the assumptions relied upon by the expert.  The extent to which the underlying assumptions are not reasonable and/or not supported can significantly impact the reliability of the findings.
 
An expert report should identify the underlying assumptions.  In Canada, Chartered Business Valuators (CBVs) must follow CICBV Practice Standard 310 for Expert Reports which states,
"At a minimum, all Expert Reports that will (or likely will) be disclosed publicly (e.g. in open court, in a prospectus, etc.) shall include the assumptions used and the procedures followed to determine the reasonableness and appropriateness of key assumptions." [1]
 
While reviewing an expert report, key questions to consider regarding assumptions include:
  • Are they reasonable?
  • Are they supported by the facts of the case, independent research or third party evidence?
  • Are they within the expert’s area of expertise?
These questions apply to many expert reports, including those that quantify economic damages in a civil or commercial dispute as well as those that include a business valuation in a shareholder or matrimonial dispute.
 
Reviewing a complex technical expert report on damages or business valuation can be a daunting task.  There will likely be many minor assumptions and a few key major assumptions.  Major assumptions are those that, when altered, will alter the conclusions significantly.  Conversely, minor assumptions will have less of an impact on the conclusions when changed.  A list of the major and minor assumptions relied upon by the expert should be prepared while reviewing the expert report.
 
In my experience, it is common to find fewer than 5 major assumptions underlying a damages calculation or business valuation.  The goal is to identify the key major assumptions and assess their reasonableness in light of the facts of the case and the independent research conducted by the expert to support those assumptions.  Where assumptions are found to be unreasonable or unsupportable, a sensitivity analysis should be performed to identify the impact on the conclusions of using more reasonable or supportable assumptions.
 
Examples of major assumptions in a commercial dispute involving a lost profit claim include:
  • Volume and/or pricing assumptions with respect to the revenue projections;
  • Incremental direct cost assumptions and the resulting profit margin assumptions;
  • Time period assumption over which the lost profits have been calculated; and
  • Discount rate assumption which has been applied to present value the future lost profits.
I was asked to review an expert report on damages in a breach of tender matter involving a school board and one of its suppliers.  The supplier was not selected as the winning bidder and sued for lost profits.  The plaintiff’s expert quantified lost profits based on the estimated volumes in the original tender bid and did not consider the fact that: a) the actual volumes awarded to the successful bidder were much lower; and b) the school board was not obliged to order the quantities indicated in the original tender. 
 
Our responding report identified this, among other things, as a major concern.  This case never proceeded to trial as the parties ended up settling for much less than the plaintiff’s expert’s assessment.
 
In another matter, I was retained to review and critique the plaintiff’s expert report in an estate litigation involving a business valuation and damages quantification.  Ultimately, I presented expert evidence in Court on, among other things, the opposing expert’s underlying assumptions.  This is noteworthy because the plaintiff’s claim was dismissed with the Judge indicating in the Reasons for Judgment that:
"There are a considerable number of assumptions made by the plaintiff’s expert that I do not accept as being reasonable." [2]
 
Both of these cases illustrate the importance of reasonable and supportable assumptions underlying the conclusions contained in an expert report.  In my view, being able to identify and assess the major assumptions in an expert report is the most important factor in effectively critiquing an expert report.
 
The fourth step, to be discussed next week, involves assessing the extent to which the actual conclusion contained in the expert report represents an expert opinion or simply calculations based upon management representations.
 
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1.  CICBV Practice Standard No. 310 – Report Disclosure Standards and Recommendations (Section 9.2)  (https://cicbv.ca/practice-standards/)
2.   http://www.canlii.org/en/on/onsc/doc/2011/2011onsc5259/2011onsc5259.html

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