European Volcanic Ash Cloud Economic Damages Factors that Are Important in Damages Calculations and Litigation

I was in Iceland in September of 2008 during the run-up to their late 2008 banking meltdown that saw the failure of the three largest banks in the country: Glitnir, Kaupthing, and Landsbanki. It is incredible to comprehend, but the debts of those three banks were approximately six times the country of Iceland's gross domestic product! Unfortunately, they were beyond help of any Banking Consultant.

While I was in Iceland, I traveled out into the countryside including the area of the Eyjafjallajökull (Pronounced: AY-uh-fyat-luh-YOE-kuutl, if you believe the BBC) volcano and its neighbor, the Katla volcano.

To

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further compound the potential danger of the situation, the Katla volcano is located only about thirty miles to the west of Eyjafjallajökull: and if you managed to stay awake in Earth Science class years ago, you know that thirty miles is nothing in terms of a distance between active volcanoes.

In the previous eruption sequence for these two volcanoes in 1823, Katla erupted and steam was observed coming out of Eyjafjallajökull. This time around, Eyjafjallajökull erupted; and there has been no activity reported at Katla, but let’s stay tuned.

One theory is that the volcano was shaken to life by the pounding of feet as all of the Icelanders ran down to get their money out of the banks. A more likely cause is probably related to Tectonic Plate Dynamics and the fact that the Mid-Atlantic Ridge is the dividing line between the North American Tectonic Plate and the Eurasian Tectonic Plate, and this ridge runs right through the area where Eyjafjallajökull and Katla sit. It’s mind-boggling to ride back and forth across these two major tectonic plates, as I did while visiting there. Whenever these two tectonic plates decide its time to move, trouble results. The takeaway here is that plate tectonics, such as they are, guarantee that these two volcanoes will continue to cause trouble, and on an unpredictable timetable. This law-of-nature fact and the unpredictability of the physical and atmospheric factors that determine the volume of ash and the winds that carry the ash compound the complexity of the job of dealing with these eruptions when the occur.

While many people and companies in many countries suffer from these airborne ash clouds, no industry suffers more than does the airline industry, whose business comes to a complete halt – at the command of the government – until the government permits it to resume.

No airline wants to fly its planes through ash clouds since it is a safety hazard and can damage and destroy aircraft engines, but it appears that during the recent volcanic eruptions, the European governmental regulators shut down flights in many areas where the airlines were sure that they could safely fly. As a result, the airlines were out a lot of money due to the overzealousness of the governmental regulators.

When a disaster like this happens, not only do airlines cease to generate revenue, they “go backwards” financially by having to pay out all manner of funds for passenger hotel rooms, meals, re-routing, etc., none of which were caused by anything the airlines did or did not do.

It appears that the bottom line as to why the government required the airlines to pay and not the airlines’ passengers is the simple fact that the passengers vote and the airlines do not.

If the volcanic ash eruptions had continued for a year - which is certainly possible since this very same volcano erupted on and off for a two year or so period from 1821 to 1823 - would the government have required the airlines to keep absorbing losses until their meager net worths were completely exhausted? Airlines were not to blame for these ash clouds and should not have been required to pay for passenger maintenance due to this disaster.

As a result, there have been lawsuits filed, and others are planned. The lawsuits will have to deal with two issues: (1) Who should have paid? and (2) How much are the economic damages?

This article explains the process that is used to determine the amount of Economic Damages that will be a part of this litigation.

Overview of the Process for Establishing Economic Damages

Recognizing, establishing and effectively demonstrating Economic Damages in this litigation requires a holistic comparative view of the damaged airline’s financial situation prior to and after the government dictated shutdown, a realistic and reasonable multi-year projection of how the damages will affect the airline in the future, and a net present-value calculation to provide a current damages estimate that will also incorporate future damages.

Let’s break this process down into its comprehensible components:

Step 1. Establishing the Economic Situation Before the Shutdown.

Step 2. Demonstrating the Most Likely Future Economic Situation Without the Shutdown.

Step 3. Defining the Proximate Causal Event (the Shutdown) and Tying it to the Damages It Caused.

Step 4. Establishing the Most Likely Future Economic Situation After the Shutdown.

Step 5. Demonstrating the Difference Between the Most Likely Future Situation Without the Shutdown and the Most Likely Future Situation After the Shutdown.

Step 6. Calculating the Net Present-Value of the Difference in the Two Projections.

Now, let’s take them one at a time:

Step 1. Establishing the Economic Situation Before the Shutdown.

The best way to do this is to establish a financial “snapshot” of the airline’s financial situation as it was immediately prior to the shutdown. This should be easy enough to accomplish by using past financial statements and tax returns.

Trends need to be established so as to reflect how the financial condition has changed year over year to arrive at the present “snapshot,” and that can be accomplished by looking at historical financial statements and tax returns for the three to five previous years before the shutdown.

Step 2. Demonstrating the Most Likely Future Economic Situation Without the Shutdown.

Having established the past trend that brought the person or entity to the position that it was in immediately prior to the shutdown, you should then project that same trend into the future so as to establish a realistic and reliable estimate of future financial performance.

The projection should be carried out for as many years as it is felt the projection can be accurately made. That projection may be five years, and it may be twenty-five years depending on how reliable you feel a projection can be made.

In addition, if there was any known unusual factor, or factors, present that could positively or negatively impact future financial performance, then that factor, or factors, should be included in the analysis.

Note that the factors had to be known before the shutdown because the damages calculation will be as of the date of the proximate causal event. Otherwise, the factors should be thrown out.

Step 3. Defining the Proximate Causal Event (the Shutdown) and Tying it to the Damages It Caused.

It goes without saying that some Shutdown would be required due to the problems created by the ash clouds. The issue that the airlines dispute is the length of time that the Shutdown was in place, and the expansive geographical area the Shutdown covered. Accordingly, the proximate causal event will have to be precisely defined as to the time and areas covered. The Economic Damages are the profits lost by not being able to fly in certain areas during certain periods when the airlines were comfortable flying but the governmental regulators prohibited them from flying.

Also, prohibiting the airlines from flying in certain areas and in certain time periods extended the costs the airlines incurred due to increased passenger support expenses.

Step 4. Establishing the Most Likely Future Economic Situation After the Shutdown.

This is the same process as described above in Step 2 except that it includes the negative influence of the Shutdown. The number of years projected into the future should be the same as used in Step 2 above. In some cases, you will have financial statements that clearly reflect the impaired financial performance of the airline after the Shutdown. In other cases, the airline’s ability to generate income may go away completely, for example, if an airline is forced into bankruptcy or otherwise fails. In those cases, the loss is the present value of the entire income stream projected in Step 2 above.

Step 5. Demonstrating the Difference Between the Most Likely Future Situation Without the Shutdown and the Most Likely Future Situation After the Shutdown.

Once you have established the most likely future income projections before (Step 2) and after the proximate causal event (Step 4), the difference in these two projections is the gross amount of the loss for the projection period, not taking time into consideration. That is your base number that you carry forward into the next step.

Step 6. Calculating the Net Present-Value of the Difference in the Two Projections.

This is a mathematical exercise that involves net present-valuing the difference in the two projections (Steps 2 and 4) in order to arrive at an Economic Damages value as of the date of the proximate causal event.

Range of Values

It is acceptable to produce an Economic Damages value that is a range of values. Due to the level of judgment and speculation that is involved in estimating Economic Damages, it is sometimes necessary to recognize that a particular factor could just as easily be one figure as another figure. In a case like this, it is acceptable to calculate the future financial performance using both factors, and then state the Economic Damages estimate as a range.

Expert Strategy

If you are involved in litigation that involves Economic Damages, then hire a professional that is familiar with Economic Damages calculation techniques, and that is highly experienced in providing supporting testimony at deposition and at trial. You can be assured that the expert will be questioned thoroughly regarding every step and factor of their methodology.

This methodology of calculating an estimation of Economic Damages is Daubert compliant since it assists the trier of fact to understand the evidence or to determine a fact at issue, is widely published and peer reviewed, is generally accepted as an accurate procedure, and is capable of being replicated by another competent professional.

It is extremely valuable for both sides to engage an Economic Damages expert since usually the Plaintiff’s expert will provide an Economic Damages opinion and the Defendant’s expert will either provide an alternate Economic Damages estimate or a critical review of the estimate provided by the Plaintiff’s expert.

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ABOUT THE AUTHOR: Banking and Economic Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ.

Clients have included numerous individuals, 75 banks, and governmental clients such as the IRS, FDIC.

Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator. BA degree from the University of Alabama. Postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.

Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.