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A Framework for the Valuation of Loss of a Commercial Opportunity

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A Framework for the Valuation of Loss of a Commercial Opportunity A FRAMEWORK FOR THE VALUATION OF LOSS OF A COMMERCIAL OPPORTUNITY BEN CURTIN A thesis submitted in partial fulfilment of the requirements for the degree of Doctor of Philosophy The University of Sydney Business School University of Sydney July 2016 Statement of originality This is to certify that to the best of my knowledge, the content of this thesis is my own work. This thesis has not been submitted for any other degree or purpose. This further certifies that the intellectual content of this thesis is my own work, and that any assistance and sources used have been acknowledged. Parts of chapter seven of this thesis have been published in the following refereed journal article: Johnstone, David and Ben Curtin, ‘Damages for negligent valuation of mortgage securities: A finance theory perspective’, (2012) 30 Company & Securities Law Journal 476–92. Ben Curtin July 2016 2 Dedication To Gerald, Clare, Kristen, Joseph and William In memory of Geoffrey Edward Hart 31.7.1947–21.7.2016 a friend and colleague 3 Acknowledgments I would like to thank my supervisor, Professor David Johnstone, for his support, guidance, and comments. Accommodating an inter-disciplinary thesis is a major exercise, and Professor Johnstone discharged that task with patience and grace. His contribution to this thesis has been substantial. I would also like to thank my wife, Kristen, for her comments on the legal issues and structure of the thesis. She allowed me to devote a significant amount of time to writing the thesis, and for that I am grateful. 4 Abstract This thesis examines the valuation of loss of a commercial opportunity in a damages context. The object of the thesis is to consider the legal doctrine of loss of a commercial opportunity and to develop a general legal framework for the valuation of this type of loss, that is based on, and consistent with, the financial theory of valuation. This framework rests on the argument that, in principle, the loss of a commercial opportunity should be valued by reference to its market value, where market value is either observable or estimated theoretically. The thesis comprises three main Parts. Part one examines two things by way of introduction. First, it examines the role of financial valuation theory in the assessment of damages for economic loss in a commercial context. Secondly, it examines the legal doctrine of loss of a commercial opportunity. The object of this Part is to provide the foundation for the analysis contained in Parts two and three. Part two examines the legal principles relevant to the fact, character and valuation of loss of a commercial opportunity. The object of this Part is to analyse the legal principles and to develop a general legal framework for the valuation of this type of loss. Part three contains a case study. The case study applies the valuation framework developed in Parts one and two to the valuation of the loss of a lending opportunity, being a particular type of loss of commercial opportunity. The object of the case study is to demonstrate the utility of the valuation framework and, more generally, to demonstrate the importance of finance theory in providing a coherent and rigourous theoretical framework with which to value the loss of a commercial opportunity. 5 Table of contents Statement of originality 2 Dedication 3 Acknowledgments 4 Abstract 5 Table of contents 6 Abbreviations 11 Part 1: Introduction Chapter 1: Introduction Introduction 13 Purpose and structure 13 The topic 13 Scope of topic 13 Justification 18 Contribution 20 State of knowledge 21 The thesis 22 Overview 22 Structure 24 Approach 25 Limitations 27 Chapter 2: Principles of financial valuation theory in a damages context Introduction 29 Purpose and object 29 Structure 30 Value in a damages context 30 Introduction 30 General legal concept of value 31 6 Value in a damages context 33 Financial valuation theory 36 Introduction 36 DCF analysis 37 DCF methodology 47 Other valuation methodologies 48 Present value in a damages context 51 Introduction 51 General 51 Assessment at date of wrong 53 Assessment at date of trial 57 Conclusion 60 Chapter 3: Loss of a commercial opportunity Introduction 61 Purpose and object 61 Structure 61 Loss of a commercial opportunity 62 Introduction 62 Basis of liability 66 Compensation for loss 80 Introduction 80 Compensatory principle 80 Compensation for loss of a commercial opportunity 82 Conclusion 92 Part 2: A framework for the valuation of loss of a commercial opportunity Chapter 4: Fact of loss Introduction 95 Purpose and object 95 Structure 95 7 Proof of loss 96 Introduction 96 Identification of loss 97 Burden of proof 97 Standard of proof 99 Existence of loss 110 Introduction 110 Subjective or personalistic probability 111 Evidentiary foundation 112 Non-negligible value 113 Conclusion 129 Chapter 5: Character of loss Introduction 131 Purpose and object 131 Structure 131 Character of loss 132 Commercial opportunity as an asset 132 Indivisibility of loss 135 Capital and income distinction 136 Introduction 136 General 136 Origins of distinction 139 Distinction in law 142 Problems with distinction 149 A principled approach 161 Conclusion 162 Chapter 6: Valuation of loss Introduction 164 Purpose and object 164 Structure 164 Proof of value 165 Burden and standard of proof 165 8 Evidentiary foundation 166 Value of loss 173 Market value 173 Valuation approach 175 Simple probability approach 175 Single outcome or weighted average method? 177 Valuation of loss 183 Introduction 183 Value of the object of the opportunity 184 Probability of the opportunity 192 Accounting for benefits received 202 Additional opportunities 205 Conclusion 208 Part 3: Case study Chapter 7: Valuation of loss of a lending opportunity Introduction 211 Purpose and object 211 Structure 212 Limitations 212 Negligent valuation 213 Introduction 213 Basis of liability 213 Taxonomy of claims 214 Loss of a lending opportunity 218 Introduction 218 General approach to valuation 218 Application of valuation framework 227 Introduction 227 Fact of loss 227 Character of loss 229 Valuation of loss 230 9 An alternative model 235 Introduction 235 Elementary model 236 Conclusion 242 Part 4: Conclusion Chapter 8: Conclusion Introduction 244 Purpose and object 244 The thesis 244 Validation of thesis argument 244 Limitations of thesis argument 248 Bibliography Reference material 251 Articles 251 Books 258 Reports 262 Loose-leaf services 262 Cases 262 Statutes 279 10 Abbreviations Abbreviations The following abbreviations are used in this thesis. ACL = CCA, Schedule 2, Australian Consumer Law CCA = Competition and Consumer Act (2010) (Cth) CAPM = capital asset pricing model DCF = discounted cash flow TPA = Trade Practices Act (1974) (Cth) WACC = weighted average cost of capital References to ACL On 1 January 2011, the TPA was renamed the CCA, and the ACL was inserted as Schedule 2 of the CCA. Sections 52(1) and 82(1) of the TPA were repealed and replaced by ss 18(1) and 236(1) of the ACL, in similar but not identical terms. For consistency and ease of reference, references in case law to ss 52(1) and 82(1) of the TPA have been replaced with references to ss 18(1) and 236(1) of the ACL, where appropriate. 11 Part 1 Introduction 12 Chapter 1 Introduction ‘For the rational study of the law the black-letter man may be the man of the present, but the man of the future is the man of statistics and the master of economics’ (Oliver Wendell Holmes)1 Introduction Purpose and structure This chapter introduces the thesis topic and outlines the subject matter. The chapter is divided into two main sections. The first section outlines the topic and the justifications for conducting this research. The second section contains an overview of the thesis and the approach to and limitations of the thesis. The topic Scope of topic Introduction This thesis examines the valuation of loss of a commercial opportunity in a damages context. The object of the thesis is to consider the legal doctrine of loss of a commercial opportunity and to develop a general legal framework for the valuation of this type of loss, that is based on, and consistent with, the modern financial theory of valuation. This framework rests on the argument that, in principle, the loss of a commercial opportunity should be valued by reference to its market value or to theoretical proxies for market value (where observed or traded market value do not exist). The topic is bounded in several respects. 1 Oliver Wendell Holmes, ‘The Path of the Law’ (1897) 10(8) Harvard Law Review 457, 469. 13 Economics, and in particular finance theory, offers a highly developed theory for the measurement of economic values and losses, and the intention of this thesis is to give finance theory an explicit role in the valuation of loss in a legal context. The thesis will introduce the fundamentals of finance theory into the valuation of loss in this context, including, discounted cash flow, opportunity cost, the cost of capital, and risk-adjusted discounting. The thesis contains a case study on the valuation of loss of a lending opportunity, being a particular type of loss of commercial opportunity. The case study is used to demonstrate the utility of the valuation framework developed in Parts one and two of the thesis, and to exhibit the use of financial concepts and logic and in a legally practical and important context. Damages In general terms, damages may be defined as ‘an award in money for a civil wrong.’2 The thesis is concerned with compensatory damages at common law and under s 236 of the ACL. An award of compensatory damages is given as compensation for loss or damage caused by a civil wrong.
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