The Guide To Damages in International Arbitration PDF

Global Arbitration Review
The Guide to
Damages in
International
Arbitration
Editor
John A Trenor
The Guide to
Damages in
International
Arbitration
Editor
John A Trenor
gar
Publisher
David Samuels
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Contents
Introduction ........................................................................................................... 1
John A Trenor
Part I: Legal Principles Applicable to the Award of Damages

1 Compensatory Damages Principles in Civil and Common Law Jurisdictions –
Requirements, Underlying Principles and Limits .......................................... 7
Clare Connellan, Elizabeth Oger-Gross, Angélica André and Heather Clark
2 Non-Compensatory Damages in Civil and Common Law Jurisdictions –

Requirements and Underlying Principles ................................................... 22
Reza Mohtashami, Romilly Holland and Farouk El-Hosseny
3 Damages Principles under the Convention on Contracts for the International

Sale of Goods (CISG) ................................................................................. 38
Petra Butler
4 Contractual Limitations on Damages .......................................................... 68

Gabrielle Nater-Bass and Stefanie Pfisterer
5 Overview of Principles Reducing Damages ................................................ 78

Craig Miles and David Weiss
6 Damages Principles in Investment Arbitration ............................................. 90

Mark W Friedman and Floriane Lavaud
iii
Contents
Part II: Procedural Issues and the Use of Damages Experts

7 Procedural Issues .......................................................................................107
Sophie J Lamb, Samuel M Pape and Laila Hamzi
8 Strategic Issues in Employing and Deploying Damages Experts ..................123

John A Trenor
Part III: Approaches and Methods for the Assessment and

Quantification of Damages
9 Overview of Damages and Accounting Basics ............................................145
Gervase MacGregor, Andrew Maclay and David Mitchell
10 Assessing Damages for Breach of Contract .................................................155

Ermelinda Beqiraj and Tim Allen
11 Overview of Methodologies for Assessing Fair Market Value ......................164

Philip Haberman
12 Income Approach and the Discounted Cash Flow Methodology ................174

Alexander Demuth
13 Determining the Weighted Average Cost of Capital ...................................196

Charles Jonscher
14 Market Approach or Comparables .............................................................204

José Alberro and Paul Zurek
15 Asset-Based Approach and Other Valuation Methodologies ........................219

Mark Bezant and David Rogers
iv
Contents
16 Taxation and Currency Issues in Damages Awards ......................................229

James Nicholson and Sara Selvarajah
17 Interest ......................................................................................................241
James Dow
18 Costs .........................................................................................................253
Micha Bühler
19 The Use of Econometric and Statistical Analysis and Tools .........................271

Boaz Moselle and Ronnie Barnes
Part IV: Industry-Specific Damages Issues

20 Damages in Energy and Natural Resources Arbitrations .............................289
Manuel A Abdala
21 Damages in Construction Arbitrations .......................................................301

Wiley R Wright III and Mark Baker
22 Damages in Financial Services Arbitrations.................................................310

Chudozie Okongwu
23 Damages in Life Sciences Arbitrations ........................................................320

Gregory K Bell, Andrew Tepperman and Justin K Ho
24 M&A and Shareholder Arbitrations ............................................................331

Kai F Schumacher and Michael Wabnitz
v
Contents
25 Damages in Intellectual Property Arbitrations ............................................342

Trevor Cook
26 Damages in Competition/Antitrust Arbitrations.........................................352

Carlos Lapuerta and Richard Caldwell
About the Authors ...............................................................................................361
Contact Details ....................................................................................................379
vi
Introduction
John A Trenor1
There are three types of arbitrators: those who understand numbers and those who don’t.
This old joke, adapted to the international arbitration community and repeated at confer-
ences, typically receives nervous laughter from parties, counsel and experts who may have
experienced innumeracy firsthand on the part of a tribunal. Yet this innumeracy is by no
means limited to those who serve as arbitrators; the joke could equally be applied to those
who appear as counsel and to other participants in the international arbitration community.
This book is aimed at everyone who gets the joke, whether they profess to understand
numbers or not. The objective of The Guide to Damages in International Arbitration is to help
all participants in the international arbitration community – from the arbitrators to the
parties to counsel and experts – understand damages issues more clearly and communicate
those issues more effectively to tribunals to further the common objective of assisting arbi-
trators in rendering more accurate and well-reasoned awards on damages.
In the vast majority of international arbitrations, one or more parties seek damages.
As such, damages are a critical component of most cases. A tribunal that misunderstands
the relevant damages issues does not render justice to the parties. An award that effectively
resolves the scope of liability but misunderstands, misapplies, or miscalculates damages does
not put the aggrieved party back in the position it would have been absent the wrongful
act. An award that seemingly takes a Solomonic approach by ‘splitting the baby’ or misun-
derstands the damages issues does not typically satisfy either party and does not contribute
to a favourable reputation for the arbitrators that issued the award.
Parties, and their counsel and experts, express frustration with awards that offer little
reasoning on damages or, worse yet, faulty reasoning or errors in principle or calculation.
1 John A Trenor is a partner in the international arbitration group at Wilmer Cutler Pickering Hale and
Dorr LLP.
1
Introduction
Arbitrators express frustration with counsel and experts who struggle to communicate
often complex damages issues clearly and effectively. Counsel and experts express frus-
tration with each other on how best to present damages cases to tribunals that may lack
quantitative backgrounds.
The idea behind this book arose from discussions among members of the Global
Arbitration Review editorial board, who have heard these frustrations being voiced and
who identified a void in the market for such a guide to damages in international arbitration.
This book draws upon the insights of leading lawyers, experts and academics in the field
to produce a work that will hopefully be a valuable desk-top reference tool for arbitra-
tors, parties, and their advisers and counsel, when approaching damages issues in interna-
tional arbitration.
This book is not intended to provide a comprehensive answer to every question.
Frequently, the answer depends on the context – on the contract or treaty language, the
applicable law, the arbitration agreement or rules, the facts of the case, etc. Indeed, on some
issues addressed in this book, the authors (and the editor) no doubt disagree. Participation in
this book is not meant to convey endorsement of the views expressed by others. However,
the objective of this book, and indeed the objective of resolving disputes between the
parties regarding damages, is to understand better why they disagree. Is the disagreement
based on differing views on what the contract, treaty or applicable law requires? Is the
disagreement based on differing assumptions of the parties and their experts? Is it based on
differing views of the appropriate methodology to assess and quantify damages? Is it based
on different quantitative models?
This book aims to make the subject of damages in international arbitration more
understandable and less intimidating for arbitrators and other participants in the field and
to help participants present these issues more effectively to tribunals. The chapters address
key issues regarding various aspects of damages, identify areas of general agreement and
disagreement, provide checklists and tips, and describe effective approaches to presenting
and resolving damages issues. With a firm understanding of the underlying issues and the
reason why the parties disagree, the arbitrators can make informed judgements on how to
resolve those differences.
The book is divided into four parts.
Part I addresses various legal principles applicable to the award of damages. The chap-
ters in this part include overviews of the civil and common law approaches to both com-
pensatory and non-compensatory damages, damages principles under the Convention on
Contracts for the International Sale of Goods (CISG), contractual limitations on damages,
principles reducing damages such as mitigation, and damages principles in investment arbi-
tration. The authors of these chapters are counsel from leading international arbitration
firms and legal academics.
Part II addresses various procedural issues regarding damages and the use of damages
experts, including bifurcation, evidentiary issues such as document disclosure, and tech-
niques and approaches to maximise the effectiveness of expert assistance on damages. The
authors of these chapters are also counsel from leading international arbitration firms.
Part III addresses various approaches and methods for the assessment and quantifica-
tion of damages. The chapters in this part include an overview of damages and account-
ing basics, quantifying damages for breach of contract, an overview of methodologies for
2
assessing fair market value, the income approach (discounted cash flow methodology) and
determining the weighted average cost of capital (WACC), the market approach (compa-
rables), the asset-based approach, taxation and currency issues, interest, costs, and the use of
econometric and statistical analysis. The authors of these chapters are experts from leading
expert practices and economic and financial academics.
Part IV addresses industry-specific damages issues. The chapters in this part include
overviews of damages issues in energy and natural resources arbitrations, construction arbi-
trations, financial services arbitrations, life sciences and pharmaceutical arbitrations, M&A
and shareholder arbitrations, intellectual property arbitrations and competition/antitrust
arbitrations. The authors of these chapters are again experts from leading expert practices
and counsel from leading international arbitration firms.
In addition to the hard copy version of this book, the content of the guide will also fea-
ture on the Global Arbitration Review website, together with additional online materials
identified by the authors. Online access is available to subscribers at the following address:
www.globalarbitrationreview.com/insight/guides.
Many individuals have contributed to making this book a success and deserve thanks.
First and foremost, the authors of the chapters have shared in the vision of helping partici-
pants in the international arbitration community understand damages issues better. Their
valuable contributions help to achieve this goal.
The professional team at Global Arbitration Review and its publisher, Law Business
Research, have worked tirelessly at all stages of the process, from conception of the idea,
through the editorial process, to publication. Among the many individuals who contrib-
uted are David Samuels, editor-in-chief and publisher of Global Arbitration Review, who
transformed an idea into reality; George Ingledew, senior business development manager
at Law Business Research, who secured the participation of the contributing authors; and
Iain Wilson, editorial coordinator at Law Business Research, who led the editorial team
that polished the drafts into the chapters that appear in this book.
This book would also not have been possible without the ideas and support of numer-
ous colleagues at Wilmer Cutler Pickering Hale and Dorr LLP. In particular, I would like
to thank Michelle Bock, Helmut Ortner, Jonathan Lim and Sabrina Lee for their assistance
in developing the contents of the book and identifying authors to contribute.
Global Arbitration Review’s The Guide to Damages in International Arbitration will be
updated in future editions. Contributing authors will be encouraged to update their chap-
ters, and new authors are invited to contribute additional chapters. If readers wish to see
additional topics addressed or existing topics addressed in more detail, please bring them to
my attention or to the attention of Global Arbitration Review.We also welcome comments
from readers on how the next edition might be improved.
I share the hope of Global Arbitration Review that this book and future editions will
form a valuable contribution to the field of international arbitration and that, in the future,
the joke that there are three types of arbitrators (or counsel, or others) – those who under-
stand numbers and those who don’t – no longer resonates.
3
Part I
Legal Principles Applicable to the Award
of Damages
1
Compensatory Damages Principles in Civil and Common Law
Jurisdictions – Requirements, Underlying Principles and Limits
Clare Connellan, Elizabeth Oger-Gross, Angélica André and Heather Clark1
Introduction
Compensatory damages – as the name indicates – are intended to compensate a claim-
ant for losses suffered as a result of the other party’s (wrongful) conduct. Those losses can
be pecuniary (i.e., arising from a breach of contract, loss of profit, related expenses) or
non-pecuniary (i.e., for pain and suffering, loss of reputation).2 The basic rule, in its com-
mon law formulation, is that a claimant is entitled to ‘that sum of money which will put
the party who has been injured, or who has suffered, in the same position as he would have
been in if he had not sustained the wrong for which he is now getting his compensation or
reparation’.3 This rule is formulated in similar terms in civil law jurisdictions – for example,
French law recognises the principle of full compensation, the objective of which is to put
the injured party in the position in which it would have been if the act that gave rise to the
damage had not occurred.4
This chapter will provide a comparative overview of the legal principles and elements
of compensatory damages in civil law and common law jurisdictions, focusing on English
and French law for illustrative purposes. There are several reasons why such a comparative
analysis is important for international arbitration practitioners. It is common for the disputes
1 Clare Connellan and Elizabeth Oger-Gross are partners at White & Case LLP. Angélica André and Heather
Clark are associates at White & Case LLP.
2 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section 2-001. As discussed
below, there are restrictions on a party’s ability to recover non-pecuniary losses in common law jurisdictions.
See, e.g., Common Law Series: The Law of Damages/Part I General Principles/Chapter 4 Damages for
non-pecuniary loss/E Disappointment, distress, humiliation and loss of enjoyment/Contract.
3 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section 2-002, citing
Livingstone v. Rawyards Coal Co [1880] 5 App Cas. 25 at 39.
4 Full compensation is the authors’ translation of the French term ‘réparation intégrale’. See A. Bénabent, Droit des
obligations (16th ed. L.G.D.J. Précis Domat, 2016) 680. See also H. Wöss and others, Damages in International
Arbitration under Complex Long-Term Contracts (OUP, Oxford 2014) paragraph 2.03.
7
Compensatory Damages Principles in Civil and Common Law Jurisdictions –
Requirements, Underlying Principles and Limits
underlying international arbitrations to be governed by a range of applicable national laws,

so it is important to be familiar with the broad principles of their substantive content – or,
at least, of two of the main legal traditions,5 though the differences among national laws
within those traditions should not be underestimated.While there is certainly a lot of com-
mon ground in relation to the legal principles and elements of compensatory damages
claims in common and civil law jurisdictions, there are also differences, as described in more
detail in the sections below. As advocates, it can be useful to be attuned to these differences
when formulating written or oral pleadings, particularly where the arbitral tribunal is of
mixed legal backgrounds.
While certainly less prevalent than national laws in international arbitration, transna-
tional principles can also play a role in damages analyses in international arbitration, either
where parties have agreed to apply them or where tribunals have cited them as a means
of reinforcing or supplementing the applicable law.6 These principles include those codi-
fied in instruments such as the 2010 UNIDROIT Principles of International Commercial
Contracts (the UNIDROIT Principles), which ‘reflect concepts to be found in many, if not
all, legal systems’.7 Understanding the origin of these transnational principles is important
preparation for their application.
As a final note, arbitration clauses sometimes contain broadly worded consents to arbi-
tration that may be interpreted to include non-contractual (i.e., tortious) claims.8 However,
the focus of this chapter will be on compensatory damages arising out of contractual claims.
In addition, we do not consider non-compensatory damages, damages principles under the
Convention on Contracts for the International Sale of Goods (CISG), contractual limita-
tions on damages, damages in investment arbitration, interest and costs. These topics are
addressed in other chapters of this publication.
The law applicable to damages

The law applicable to damages can have a significant impact on the assessment of damages,
as the law determines the conditions to obtain damages, the categories of damages available
and provides guidance regarding the amount of damages to be awarded.
5 A discussion of compensatory damages principles under other legal traditions is beyond the scope of
this chapter.
6 See E.F. Agrò, ‘The Impact of UNIDROIT Principles on International Dispute Resolution in Figures’,
www.unidroit.org/english/publications/review/articles/2011-3-finazzi-e.pdf , 721. The UNIDROIT
provisions on damages were among those most frequently invoked by arbitral tribunals and domestic courts.
See also P. Gélinas, ‘General Characteristics of Recoverable Damages in International Arbitration’ in Y. Derains
and R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of World
Business Law,Volume 4 (Kluwer Law International; International Chamber of Commerce (ICC) 2006) 20-29.
7 UNIDROIT Principles of International Commercial Contracts (UNIDROIT 1994), Introduction, xxiii (PDF 22).
8 See, e.g., ICC Case 9517, Interim Award, November 1998: ‘The Arbitrators find that the scope of the wording
of the arbitration clause “any dispute arising in connection with this Agreement” is clear and does not
lend itself to construction. It is very wide and covers any claim which arises, directly or indirectly, with any
relationship to the Management Agreement, and whether the claim is contractual or delictual of nature. There
is also no basis for constructing the clause or the ICC Rules as applicable only to commercial disputes. The
claims raised are, therefore, within the scope of the arbitration clause.’
8
The parties’ agreement is paramount in international arbitration. This is of course also

true in relation to damages. In the absence of a statement to the contrary, the right to dam-
ages, the categories and the amount of damages recoverable, and the nature of the proof
required are first and foremost governed by the parties’ agreement.9 Parties often choose to
specify the conditions to the recovery of damages, as well as the categories and the amount
of damages recoverable (e.g., with liquidated damages, penalty clauses or limitation clauses),10
broadening or limiting the rights available under national laws. However, the parties do not
always agree on such arrangements, and, in any event, their agreement will unlikely be
exclusive of all provisions of the applicable rules of law. Further, some national law rules and
principles, such as public policy rules and principles, are of mandatory application.
In the absence of the parties’ agreement relating to damages or to supplement it, arbitral
tribunals have to determine the applicable rules of law. The tribunal first has to determine
whether damages-related issues are substantive or procedural issues. Most damages-related
aspects are usually analysed as issues of substance. However, certain aspects, such as standard
of proof, are sometimes analysed as procedural matters, so that different laws or rules of law
can apply to different aspects of damages.
The arbitral tribunal will again be guided by the parties’ agreement and, absent such
agreement, the relevant conflict of laws rules, in order to determine the applicable rules of
law. Some arbitration rules and laws favour a ‘direct’ approach to determining the applicable
rules of law (i.e., without considering conflict of laws rules), referring to the rules of law
that the arbitral tribunal considers appropriate11 or those that have the closest connection to
the dispute.12 Others rely on a conflict of laws approach.13
The applicable rules of law can be a national law or a convention, principles or sets of
rules – such as the CISG,14 the UNIDROIT Principles or the 2002 Principles of European
Contract Law (PECL) that have been developed to reflect internationally accepted rules or
principles or to achieve a compromise between various legal systems. These international
instruments, however, often have to be complemented by national rules of law to the extent
that they do not cover specific issues and therefore do not necessarily exclude the applica-
tion of national laws.
In addition to national laws, arbitral tribunals at times take a transnational approach,
referring to principles applicable to damages in international arbitration, such as a generally
9 C. T. Salomon and P D. Sharp, ‘Chap 10: Damages in International Arbitration’, in J. Fellas and J. H. Carter
(eds), International Commercial Arbitration in New York (OUP New York 2010) 295.
10 See the chapter ‘Contractual Limitations on Damages’ in this publication.
11 See, e.g., French Code of Civil Procedure Article 1511; Austrian Code of Civil Procedure s 603; Belgian Code
of Civil Procedure Article 1710; 2010 UNCITRAL Arbitration Rules Article 35.1; SCC Arbitration Rules
Article 22; DIAC Arbitration Rules Article 33.1.
12 See, e.g., German Code of Civil Procedure Article 1051; Swiss Private International Law Article 187;
2012 Swiss Rules of Arbitration Article 33; 1979 CRICA Arbitration Rules Article 35.1.
13 See, e.g., English Arbitration Act 1996 Section 46(3) (‘the law determined by the conflict of laws rules
which it considers applicable’); UNCITRAL Model Law Article 28(2); Danish Arbitration Act Article 28(2);
1961 European Convention on International Arbitration Article VII(1).
14 See the chapter ‘Damages Principles under the Convention on Contracts for the International Sale of Goods
(CISG)’ in this publication.
9
recognised duty to mitigate.15 Such principles, however, are not uniformly identified
or applied.
Assessing the proof relating to damages

The assessment of damages is driven by a factual determination and often involves complex
data and economic issues, such that parties and arbitral tribunals often rely on experts. The
parties first have to establish their right to damages, before justifying the type and amount
of damages requested. It is thus essential to determine who bears the burden of proof and
what standard should apply.
The burden of proof

In international arbitration, as under national laws, the burden of proof lies with the party
making an assertion.16 This general rule, expressed by the Roman law expression actori
incumbit probatio,17 is one that achieves a consensus in common and civil law jurisdictions.18
This rule should not, however, be understood to mean that the burden of proof nec-
essarily lies with the claimant. Rather, the burden lies with the party making a claim, a
counterclaim or any assertion. The burden of proof thus moves from one party to another
depending on who makes assertions on specific aspects of a claim.19
The standard of proof

While the burden of proof determines which party should prove the relevant facts and law
underlying an assertion, the standard of proof sets the level of proof required and thus goes
to the heart of the case.
There is no unanimously recognised standard of proof in international arbitration as
there is with the burden of proof – national laws vary. Yet, the standard of proof is often
considered to be a ‘balance of probability’, ‘preponderance of the evidence’ or ‘more likely
than not’ standard – that is, a standard that does not rise to the ‘beyond all reasonable doubt’
standard that applies, for instance, in criminal matters in the United States or England.20
15 See, e.g., ICC case No. 2478, Award, Clunet 1975, 925 (‘we should not lose sight of the fact that, by virtue
of the general principle of law which is reflected in Article 42(2) and 44(1) of the Swiss Federal Code of
Obligations, it belongs to the aggrieved party to take all necessary measures in order not to increase the
damage.’). See further, the chapter ‘Overview of Principles of Reducing Documents’ in this publication.
16 N. Blackaby, C. Partasides and others, Redfern and Hunter on International Arbitration (6th ed Oxford University
Press, 2015) paragraph 6.84; G. Born, International Commercial Arbitration (2nd ed. Wolters Kluwer, 2014) 2314.
17 H. Wöss and others, Damages in International Arbitration under Complex Long-Term Contracts (OUP, Oxford 2014)
paragraph 2.14; G. Born, International Commercial Arbitration (2nd ed. Wolters Kluwer, 2014) 2314.
18 See, e.g., Article 27(1) of the UNCITRAL Arbitration Rules; Article 1353 of the French Civil Code (formerly
Article 1315); Article 8 of the Swiss Civil Code; Article 1315 of the Belgian Civil Code.
paragraph 2.14; N. O’Malley, Rules of Evidence in International Arbitration: an Annotated Guide, 2012, paragraphs
7.15, 7.32.
20 N. Blackaby, C. Partasides, and others, Redfern and Hunter on International Arbitration (6th ed Oxford University
Press, 2015) paragraph 6.85; G. Born, International Commercial Arbitration (2nd ed. Wolters Kluwer, 2014) 2314;
G.M. von Mehren, C. Salomon, ‘Submitting Evidence in an International Arbitration: The Common Lawyer’s
Guide’, 20(3) J. Int’l Arb. 285 (2003), 291.
10
Arbitral tribunals usually refer, cumulatively or exclusively, to the applicable substantive

national law to determine the applicable standard of proof.21
Although the standard of proof varies from one legal system to another, the standard is
often similar or leads to a similar analysis. In common law jurisdictions, the party making
the claim for damages must meet the standard of proof for civil cases – that is, the ‘bal-
ance of probabilities’ test.22 Under Swiss law, for example, the regular standard of proof
(Regelbeweislast) refers to the judge’s or arbitrator’s inner conviction, whereby he or she
should be convinced of a fact and have no serious doubts about its existence, although
absolute certainty is not necessary.23
Some civil jurisdictions, however, have no defined standard of proof and instead grant
the judges extensive leeway to determine damages-related facts. Under French law, for
instance, the judge enjoys wide discretionary powers to assess the evidence before him or
her.24 Judges particularly make use of these discretionary powers in the allocation of damag-
es.25 Likewise, under German law, the German Code of Civil Procedure grants full discre-
tion to judges. It refers to the judge’s free conviction (freie Überzeugung) to decide allegations
of facts, in general, (Section 286 of the German Code of Civil Procedure) and with respect
to the existence and scope of damages in particular (Section 287 of the German Code of
Civil Procedure). The standard of proof that the aggrieved party must meet to demonstrate
its damages requires establishing the existence of loss and causation regarding the extent of
the loss. In this context, a finding of preponderant probability of the existence of damages
and their extent is sufficient.26
Entitlement to damages
This section presents the conditions that are to be fulfilled in order to obtain damages and
analyses – in particular, the foreseeability requirement and duty to mitigate.
Establishing entitlement to damages

Before assessing damages, the claimant first has to establish that it is entitled to damages.
Under English law, the requirements are as follows. First, one must prove the existence of
21 G. Born, International Commercial Arbitration (2nd ed. Wolters Kluwer, 2014) 2315; N. O’Malley, Rules of Evidence
in International Arbitration: an Annotated Guide, 2012, paragraph 7.27.
22 Defined in English law by Lord Denning as ‘more probable than not’ in Miller v. Minister of Pensions [1947]
2 All ER 372; and described in the US as the preponderance of the evidence (the standard is satisfied if there
is a greater than 50 per cent chance that the proposition is true).
23 Swiss Federal Tribunal, BGE/ATF 130 II 321 dated 29 January 2004; R. Groner, Beweisrecht, 2011, 180;
P Guyan, in K. Spühler, L. Tenchio, D. Infanger, Basler Kommentar Schweizerische Zivilprozessordnung, 2013,
paragraph 7; H.P Walter, in H. Hausheer, H.P. Walter (eds), Berner Kommentar, ZGB, Band I/1, Einleitung,
Articles 1-9, 2012, paragraph 134.
24 D. Guével, JurisCl. Civil Code, ‘Art. 1315 et 1315-1: Preuve, Charge de la preuve et règles générales’, 2016,
paragraph 63, and, e.g., French Court of Cassation (1st Civil Chamber), 14 January 2010, No. 08-13160;
French Court of Cassation (Commercial Chamber), 6 September 2011, No. 10-17963.
25 C. Boismain, ‘Etude sur l’évaluation des dommages-intérêts par les juges du gond’, Petites affiches, 2007,
No. 39, p 7.
paragraph 4.330.
11
a ‘wrong’27 – that is, a breach of contract. Second, one must establish that the damage is not
too remote and that the losses were reasonably foreseeable at the time the parties entered
into the contract.28 Third, any damages awarded are subject to deductions for any failure to
mitigate (or contributory negligence in the case of breaches of duty of care).29 Fourth, any
damages awarded are also subject to any breaks in the chain of causation.30 Irrespective of
factual causation, English law can treat some losses as not having been legally caused by the
breach, on the basis that it is not fair to hold the defendant responsible for them due to a
‘break in the chain’ or novus actus interveniens.31 If the breach of contract was the ‘effective’ or
‘dominant’ cause of the loss, damages may be recoverable even if the cause was not the sole
cause of the loss.32 Where there are competing causes, a balance of probabilities test applies.33
Civil law jurisdictions embrace similar conditions. The French Civil Code has
recently undergone a substantial revision and restructuring with respect to contract law,
with Ordonnance No. 2016-131 dated 10 February 2016, which entered into force on
1 October 2016.34 The reform has made changes to the damages regime and has reshuf-
fled the relevant articles of the Civil Code but has not significantly changed the applica-
ble principles.
In contrast to English law, where a party has not performed its contractual obligations,
French law favours specific performance over damages, unless specific performance is not
possible or if there is a manifest disproportion between the costs of the specific performance
for the debtor and the creditor’s interest in the specific performance (Articles 1221 et seq. of
the French Civil Code35).36 If the aggrieved party has requested specific performance from
its debtor and if the debtor does not comply, the debtor can be liable for damages, pursu-
ant to Article 1231 of the French Civil Code. A claimant then has to prove the fulfilment
of three conditions to recover compensatory damages for breach of contract, drawn from
Articles 1231 to 1231-2 of the French Civil Code.37 First, the claimant must establish that
there has been a breach of contract. Second, the claimant must have suffered a loss. Third,
there must be a causal link between the breach and the claimant’s loss.38 Article 1231-1 pro-
27 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section 1-001.
28 Wagon Mound (No. 1) [1961] AC 388; J. Chitty, H. Beale, Chitty on Contracts, 6th ed., 2008, Ch. 26, paragraph
111. The notion of foreseeability will be further analysed below.
29 The notion of mitigation will be further analysed below.
30 C. T. Salomon and P D. Sharp, ‘Chap 10: Damages in International Arbitration’, in J. Fellas and J. H. Carter
(eds), International Commercial Arbitration in New York (OUP New York 2010) 295.
31 See, e.g., Corr v. IBC Vehicles Ltd [2008] 1 AC 884, per Lord Bingham: ‘The rationale of the principle that a
novus actus interveniens breaks the chain of causation is fairness.’
32 Galoo v. Bright Grahame Murray [1994] 1 W.L.R. 1360, 1374-1375.
33 Nulty and others v. Milton Keynes Borough Council [2013] EWCA Civ 15 (‘[T]he court must be satisfied on
rational and objective grounds that the case for believing that the suggested means of causation occurred is
stronger than the case for not so believing’).
34 Where relevant, this chapter refers to both the new and the former versions of the provisions of the French
Civil Code.
35 Replacing Articles 1142-1144 and 1184 of the French Civil Code.
36 D. Mainguy (ed), Le nouveau droit français des contrats, du régime général et de la preuve des obligations (après
l’ordonnance du 10 février 2016) (UMR-CNRS 5815, 2016) paragraph 229.
37 Formerly Articles 1146-1147 of the French Civil Code.
38 P. Malaurie, L. Aynès, P. Stoffel-Munck, Droit des obligations (8th ed L.G.D.J., 2016) paragraph 39.
12
vides for one exception to the recovery of compensatory damages, in case of force majeure
(rather than an external cause, cause étrangère, as was previously required under the former
Article 1147). The revised version of the French Civil Code defines a force majeure event
in this context as an event that is outside of the debtor’s control, that could not have been
reasonably foreseen at the time of conclusion of the contract, the effects of which cannot
be avoided by appropriate measures, and that now prevents the debtor from performing its
obligation (Article 1218).39
As under French law, specific performance is the rule under German law (Section 241(1)
of the German Civil Code). However, a party cannot request specific performance if per-
formance is impossible for the debtor or anyone else (Section 275 of the German Civil
Code). Regarding the entitlement to damages, German law has adopted similar conditions
to French law. The claimant has to establish three objective conditions, as under French
law: first, a breach of an obligation; second, the existence of a loss; and third, a causal link
between the two. A subjective element is added under German law in the form of a fault
on the part of the debtor.40
Similar conditions to those found in these civil law jurisdictions are found in interna-
tional instruments or transnational principles. Article 74 of the CISG requires the proof of
a breach of contract by one party and a loss suffered by the other party as a consequence of
the breach. Article 7.4.2 of the UNIDROIT Principles entitles an aggrieved party to full
compensation for harm sustained as a result of non-performance.
Where some civil law jurisdictions do depart from common law jurisdictions is on the
requirement of notice. There is no notice requirement under English common law, unless
a notice requirement is imposed by the contract. Under French law, however, the claimant
must give notice to the respondent that it is in delay or in breach of the agreement and
request performance of its obligation, unless – and this was added by the 2016 reform – the
non-performance is permanent; if the respondent does not perform upon receiving the
notice, the claimant will be entitled to damages.41 This requirement is consistent with the
emphasis that French law puts on specific performance.
The foreseeability requirement

Foreseeability refers to the notion used in common law jurisdictions. Civil law jurisdic-
tions do not necessarily refer expressly to foreseeability in the texts relating to damages,
although courts and commentators often rely on this requirement. The notion of foresee-
ability acts as a limitation on the amount of damages that have to be paid in common and
civil law systems.
l’ordonnance du 10 février 2016) (UMR-CNRS 5815, 2016) paragraph 242.
40 H. Wöss and others, Damages in International Arbitration under Complex Long-Term Contracts (OUP, Oxford
2014) paragraph 4.263. The requirement for a fault arguably also exists under French law (H. Wöss and
others, Damages in International Arbitration under Complex Long-Term Contracts (OUP, Oxford 2014) paragraphs
4.198-4.201).
41 Article 1231 of the French Civil Code; formerly Article 1146). See D. Mainguy (ed), Le nouveau droit français
des contrats, du régime général et de la preuve des obligations (après l’ordonnance du 10 février 2016) (UMR-CNRS
5815, 2016) paragraph 242.
13
Under English law, as set out above, damages for breach of contract are recoverable only
to the extent the loss that has occurred was reasonably foreseeable by the parties at the time
they entered into the agreement. This test is closely connected to and sometimes identical
to one of ‘remoteness’. This rule was first expressed in the 1854 case of Hadley v. Baxendale
as follows:
Where two parties have made a contract, which one of them has broken, the damages which
the other party ought to receive in respect of such breach of contract should be such as may fairly
and reasonably be considered either arising naturally, i.e. according to the usual course of things,
from such breach of contract itself, or such as may reasonably be supposed to have been in the
contemplation of both parties at the time they made the contract, as the probable result of the
breach of it.42
Thus, loss is recoverable only if the type of loss43 that occurs is ‘in the contemplation of the
parties’ (i.e., foreseeable)44 and ‘not unlikely’45 at the date of contracting (rather than the
date of breach).46 What is in the contemplation of the parties is assessed objectively on the
basis of the ‘ordinary course of things’ and subjectively on the basis of special circumstances
or knowledge attributed to the parties.47 If the remoteness test is satisfied, the respondent is
seen as having assumed the responsibility for the loss.48
In civil law systems, damages are generally recoverable only if they were foreseen or
ought to have been foreseen at the time the contract was made. Under French law, the
defaulting party is liable only for damages that were foreseen or foreseeable at the time of
conclusion of the contract, pursuant to Article 1231-3 of the French Civil Code.49 The idea
is that the parties should be in a position to understand the extent of their potential liability
for breach of contract when entering the contract.50 Foreseeability is applied in abstracto –
meaning what is ‘normally’ foreseeable – but this notion is flexible.51 This condition does
not have to be examined if the parties have not put this argument forward.52
However, the defaulting party cannot reduce its liability for damages on an argument
that the loss was not foreseeable if it has been grossly negligent (faute lourde) or has commit-
ted an intentional breach (faute dolosive).53 Before the 2016 reform, the French Civil Code
referred only to an intentional breach. However, the French courts already analysed gross
negligence as an intentional breach; the reference to gross negligence in the 2016 reform,
42 Hadley v. Baxendale (1854) 9 Exch. 341.

43 H Parsons (Livestock) Ltd v. Uttley Ingham & Co Ltd [1977] EWCA Civ 13.
44 Hadley v. Baxendale (1854) 9 Exch. 341.
45 Koufos v. C Czarnikow Ltd (The Heron II) [1969] 1 AC 350.
46 Hadley v. Baxendale [1854] EWHC Exch J70.
47 Victoria Laundry (Windsor) Ltd v. Newman Industries Ltd [1949] 2 KB 528.
48 Transfield Shipping Inc v. Mercator Shipping Inc (The Achilleas) [2008] UKHL 48; Supershield Ltd v. Siemens Building
Technologies FE Ltd [2010] EWCA Civ 7; Rubenstein v. HSBC Bank plc [2012] EWCA Civ 1184.
49 Formerly Article 1150 of the French Civil Code.
50 B. Fages, Droit des obligations (6th ed L.G.D.J., 2016) paragraph 326.
51 P. Malaurie, L. Aynès, P. Stoffel-Munck, Droit des obligations (8th ed L.G.D.J., 2016) paragraph 965.
52 French Court of Cassation (1st Civil Chamber), 15 July 1999, No. 97-10268.
53 Before the 2016 reform, Article 1150 of the French Civil Code only referred to intentional breach (dol).
14
therefore, only codifies applicable case law. In case of gross negligence or an intentional
breach, the defaulting party is liable only for damages that are the immediate and direct
consequence of its breach, pursuant to Article 1231-4 of the French Civil Code.54 The
notions of foreseeability in Article 1231-3 and direct consequence of a breach in Article
1231-4 – which refers to causation as opposed to foreseeability – appear, at first sight, to be
different. However, they are not well distinguished in practice.55
Other jurisdictions do not refer to foreseeability per se. German law provides, how-
ever, for compensation of losses that are within the scope of protection of the contractual
obligation breached (Schutzzweck der Norm, Normzweck), to the exclusion of damages that
were not contemplated by the parties in their contract.56 Some specific provisions also
include an element of foreseeability, such as Section 252 of the German Civil Code on lost
profits, which refers to profits lost that ‘could probably have been expected’ in the ‘normal
course of events’ or in ‘special circumstances’, particularly due to the measures and precau-
tions taken.
Mitigation
In common law jurisdictions, it is accepted that the aggrieved party is under a duty to take
steps to minimise and not increase its loss. Briefly, damages may be reduced if that party has
not taken steps to mitigate its loss. While mitigation and other means of reducing damages
will be discussed in detail in the chapter ‘Overview of Principles Reducing Damages’ in
this publication, a brief discussion of the comparative law aspects will be presented here.
Under English law, the claimant must take all reasonable steps to minimise its loss as a
result of the respondent’s breach of its obligation. The claimant cannot recover losses that
it could have, through reasonable action or inaction, avoided. Second, as a consequence of
the first rule, the claimant can recover the costs that it has incurred in taking reasonable
steps to minimise its loss. This is true even if the steps taken have in fact increased the loss.
Reasonable attempts to mitigate will not reduce damages payable, if they are unsuccessful.57
Third, where the claimant has minimised its loss, the damages owed by the respondent are
reduced by the amount of the reduction achieved by the claimant.58 The burden of proof in
this context is on the defendant.59 This duty is present in other common law jurisdictions
as well.
54 Formerly Article 1151 of the French Civil Code.

55 P. Gélinas, ‘General Characteristics of Recoverable Damages in International Arbitration’ in Y. Derains and
R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of World
Business Law,Volume 4 (Kluwer Law International; International Chamber of Commerce (ICC) 2006), p 10,
sp 15.
paragraph 4.261.
57 Lagden v. O’Connor [2004] 1 AC 1067, Lord Scott, paragraph 78.
58 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section paragraphs 9-002 –
9-006.
59 Lombard North Central plc and Automobile World (UK) Ltd [2010] EWCA Civ 20. A claimant should nevertheless
consider whether to take steps to show how it has mitigated its loss, as failure to do so can be risky. Bulkhaul
Ltd v. Rhodia Organique Fine Ltd [2008] EWCA Civ 1452.
15
Contributory negligence – that is, contribution to the loss by the aggrieved party
through its action or inaction – is a separate doctrine in common law jurisdictions. In a
contractual context, contributory negligence can apply if there is a contractual duty of care
and the contractual duty of care is concurrent with a tortious duty of care.60 Contributory
negligence reduces the damages payable in accordance with the court’s assessment of the
parties’ respective responsibilities for the loss.
Civil law jurisdictions have not necessarily developed or embraced a doctrine of mitiga-
tion. As mentioned above, civil law jurisdictions favour, contrary to common law jurisdic-
tions, specific performance over the monetary compensation of damages, at least in theory.
Nonetheless, civil law jurisdictions have over time evolved to include mechanisms similar
to mitigation. Under German law, for instance, there is no duty to mitigate per se, but a
similar result is achieved through the regime on contributory negligence. Section 254 of
the German Civil Code makes the entitlement and scope of damages dependent on the cir-
cumstances, in particular when a fault or negligence of the aggrieved party has contributed
to the occurrence or the amount of damages. The Japanese Civil Code provides that courts
can take account of a claimant’s fault – but not its negligence – in determining the entitle-
ment and scope of damages.61 Other civil law countries, such as Italy, Austria, Portugal and
Finland, are said to have similar provisions.62
There are, however, exceptions where an approach similar to common law jurisdictions
has been adopted. For example, the Quebec Civil Code includes an express obligation to
mitigate under Article 1479, which provides that ‘[a] person who is bound to make repa-
ration for an injury is not liable for any aggravation of the injury that the victim could
have avoided.’ Similarly, Article 404 of the Russian Federation Civil Code allows a judge
to reduce the scope of damages if the aggrieved party, intentionally or not, increased the
amount of damages or failed to take reasonable measures to reduce it.63
French law is generally presented as a legal system that does not embrace the duty to
mitigate, and it is true that the French Civil Code does not include an obligation or duty to
mitigate.64 The French Court of Cassation has confirmed that there is no obligation to min-
60 Forsikringsaktieselskapet Vesta v. Butcher and others [1989] AC 852; Barclays Bank plc v. Fairclough Ltd [1995]
QB 214.
61 Japanese Civil Code, Article 418. See also Y. Taniguchi, ‘The obligation to mitigate damages’ (2006), in Y.
Derains, R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of
World Business Law,Vol. 4 (Kluwer Law International; International Chamber of Commerce ICC 2006) p 79,
sp pp 81-82.
62 Finnish Sales of Goods Act Section 70(1); Italian Civil Code Article 1227; Austrian Civil Code s1304;
Portuguese Civil Code Article 570;Y. Taniguchi, ‘The obligation to mitigate damages’ (2006), in Y. Derains,
R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of
World Business Law,Vol. 4 (Kluwer Law International; International Chamber of Commerce ICC 2006) p
79, sp p 81; C. Larroumet, ‘Obligation de modérer le dommage et arbitrage du point de vue du droit français’,
Gaz. Pal. 2008, No. 290, p 5, paragraph 1.
63 A. Komarov, ‘Mitigation of Damages’ (2006), in Y. Derains, R.H. Kreindler (eds), Evaluation of Damages in
International Arbitration, Dossiers of the ICC Institute of World Business Law,Vol. 4 ((Kluwer Law International;
International Chamber of Commerce ICC 2006), p 37, sp p 39.
64 B. Fages, Droit des obligations (6th ed L.G.D.J., 2016) paragraph 327; A. Komarov, ‘Mitigation of Damages’
(2006), in Y. Derains, R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC
Institute of World Business Law,Vol. 4 (Kluwer Law International; International Chamber of Commerce ICC
16
imise the damages the aggrieved party has suffered in the context of non-contractual lia-
bility.65 This solution is generally understood to apply to contractual liability too.66 Indeed,
the duty of mitigation has been viewed by some as being in contradiction with the French
principle of full compensation. If the aggrieved party is entitled to recovery of all of its dam-
ages, it should not have to minimise its loss.67
However, the duty of mitigation finds its way in through the backdoor in French law,
and several commentators have welcomed this idea.68 Various avenues have been considered
to integrate the idea of mitigation in French law. Some judges have taken the aggrieved
party’s behaviour, in particular his or her inertia, into account in assessing damages, relying
on the judge’s full discretion to do so.69 Commentators have also referred to the obligation
of good faith in this context.70 The better legal justification appears, however, to be the
requirement for a causal link to establish the damages: had the aggrieved party taken some
actions or, on the contrary, refrained from taking them, the amount of damages would have
been lower; the aggrieved party should therefore not be entitled to the full amount of dam-
ages that it requests. This reasoning can be easily applied in connection with the judge’s full
discretion to assess damages.71
Further, the absence of an obligation to mitigate under French law does not amount to
a French public policy principle – or to a principle of French international public policy
relevant in the context of international arbitration – and parties can include such a duty in
their contracts.72 Finally, it has been suggested that a duty of mitigation could be taken into
account in international arbitral awards applying French law, without fear of being chal-
lenged before the French courts. The reasoning is that the duty to mitigate amounts to a
2006), p 37, sp p 39;Y. Taniguchi, ‘The obligation to mitigate damages’ (2006), in Y. Derains, R.H. Kreindler
(eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of World Business Law,Vol. 4
(Kluwer Law International; International Chamber of Commerce ICC 2006), p 79, sp p 81.
65 French Court of Cassation (2nd Civil Chamber), 19 June 2003, No. 01-13289, JCP G 2003.II.10170, note
C. Castets-Renard; with respect to contract law, French Court of Cassation (1st Civil Chamber), 3 May 2006,
No. 05-10411, D. 2006, p 1403, obs. I. Gallmeister).
66 French Court of Cassation (3rd Civil Chamber), 10 July 2013, No. 12-13851; B. Fages, Droit des obligations (6th
ed L.G.D.J., 2016) paragraph 327; P. Malaurie, L. Aynès, P. Stoffel-Munck Droit des obligations (8th ed L.G.D.J.,
2016) paragraph 963.
67 C. Larroumet, ‘Obligation de modérer le dommage et arbitrage du point de vue du droit français’, Gaz. Pal.
2008, No. 290, p 5, sp paragraph 2.
68 P. Malaurie, L. Aynès, P. Stoffel-Munck Droit des obligations (8th ed L.G.D.J., 2016) paragraph 963; B. Fages,
Droit des obligations (6th ed L.G.D.J., 2016) paragraph 327; C. Larroumet, ‘Obligation de modérer le dommage
et arbitrage du point de vue du droit français’, Gaz. Pal. 2008, No. 290, p 5.
69 French Court of Cassation (1st Civil Chamber), 2 October 2013, No. 12-19887; P. Malaurie, L. Aynès,
P. Stoffel-Munck Droit des obligations (8th ed L.G.D.J., 2016) paragraph 963.
70 P. Malaurie, L. Aynès, P. Stoffel-Munck, Droit des obligations (8th ed L.G.D.J., 2016) paragraph 963. This
justification has, however, been criticised (see J. Ortscheidt, La réparation du dommage dans l’arbitrage commercial
international, 2001, paragraphs 233 et seq.; C. Larroumet, ‘Obligation de modérer le dommage et arbitrage du
point de vue du droit français’, Gaz. Pal. 2008, No. 290, p 5, paragraph 10).
2008, No. 290, p 5, paragraph 11.
2008, No. 290, p 5, paragraph 5.
17
transnational principle, a principle of the lex mercatoria, which arbitral tribunals can rely on
in international arbitrations applying French law.73
Indeed, the duty of mitigation is widely recognised as a transnational rule, so much so
that several international and transnational instruments refer to it (see Article 77 CISG and
Article 7.4.8 of the UNIDROIT Principles). This principle is generally considered to be
part of general principles of law, in particular in the context of international arbitration.74
Assessment of the amount of damages

General approach to damages in common law and civil law traditions
In common law jurisdictions, damages are seen as the primary remedy for non-performance
of contract, with specific performance seen as an exception. For example, the Restatement
(Second) of the Law of Contracts, a treatise that seeks to restate common law principles that
is frequently cited in US courts, states that ‘[s]pecific performance… will not be ordered
if damages would be adequate to protect the expectation interest of the injured party’.75
This is one area in which civil and common law jurisdictions differ in a more significant
manner, as the primary remedy in most civil law jurisdictions has traditionally been to have
the contract performed as agreed, with damages in lieu of performance as only a secondary
remedy.76 This remains the case in Germany, which has a strong position on the principle of
pacta sunt servanda.77 However, the recent reform to the French Civil Code puts less empha-
sis on specific performance, listing it among the options that are available to the aggrieved
party in case of a breach of contract (Article 1217 of the Civil Code78 refers to exceptio non
adimpleti, specific performance, price reduction, termination of the contract, damages).Yet,
as these reforms have only recently been implemented at the time of publication, it remains
to be seen how this will be interpreted by French courts.79
2008, No. 290, p 5, paragraphs 6-9.
74 A. Komarov, ‘Mitigation of Damages’ (2006), in Y. Derains, R.H. Kreindler (eds), Evaluation of Damages in
International Arbitration, Dossiers of the ICC Institute of World Business Law,Vol. 4 (Kluwer Law International;
International Chamber of Commerce ICC 2006), p 37, sp pp 40-41; C. Larroumet, ‘Obligation de modérer
le dommage et arbitrage du point de vue du droit français’, Gaz. Pal. 2008, No. 290, p 5, paragraphs 5-9;
G. Born, International Commercial Arbitration (2nd ed. Wolters Kluwer, 2014) p 3825; E. Gaillard, J. Savage
(eds), Fouchard Gaillard Goldman on International Commercial Arbitration (Kluwer Law International, 1999),
paragraph 1491.
75 Restatement (2d) of the Law of Contracts, § 359.
76 See, e.g., in relation to French law, P. Malaurie, L. Aynès, P. Stoffel-Munck, Droit des obligations (8th ed. L.G.D.J.
2016), paragraph 975, explaining that there is little point in initiating an action for compensatory damages
where performance of the contract is possible or the failure to perform cannot be proved.
paragraphs 4.256-258.
78 This article was introduced with the 2016 reform of the French Civil Code and replaces various provisions
under Articles 1142 to 1184 of the previous version of the Civil Code.
79 See discussion in D. Mainguy (ed), Le nouveau droit français des contrats, du régime général et de la preuve des
obligations (après l’ordonnance du 10 février 2016) (UMR-CNRS 5815, 2016) paragraphs 178-179.
18
Categories of recoverable loss

In common law jurisdictions, there are three basic categories of recoverable damages.80 The
main category is expectation damages, according to which damages are awarded on the
basis of putting the claimant in the position it would have been in, but for the breach. A
claimant’s ability to recover lost profits will depend on the subject of the breach of contract
– for example, it is more likely that a claimant will be able to recover lost profits in a con-
tract for the sale of goods than in a contract for the carriage of goods, as lost profits in the
latter situation are generally held to be too remote.81 The second is performance damages
– i.e., the cost of curing the defective performance. The third is reliance or ‘wasted expen-
ditures’ damages – i.e., expenditures or other losses that have been incurred by the claimant
in reliance on the contract.82 The purpose of reliance damages is to put the claimant in as
good a position as it was in prior to the promise.
Within the category of expectation damages in common law jurisdictions, there are
two sub-categories – normal or direct damages (also known as general damages) and con-
sequential damages (also known as special damages). Normal damages are those damages
that are the natural and probable consequence of the breach.83 Consequential damages are
those that do not flow directly from the breach; they are recoverable only in limited circum-
stances, they are particular to the injured party, and they may be more difficult to calculate
in financial terms.84
In most civil law jurisdictions, there are also two categories of loss – damnum emergens
(actual losses or damage already suffered) and lucrum cessans (loss of profits or wasted costs),
which have their origins in Roman law. In France, these two principles are codified at
Article 1231-2 of the Civil Code,85 which states that ‘[d]amages due to a creditor are, as a
rule, for the loss that he has suffered and the profit of which he has been deprived.’86 These
categories of damages roughly correspond to the common law categories of expectation
and reliance damages.87 In practice, French courts tend to apply terminology such as préju-
dice commercial (damages and loss of profits), préjudice économique (commercial damage, which
80 There are various other categories of loss that may be recoverable, such as moral damages, punitive or
exemplary damages, non-monetary damages (i.e. specific performance), but these topics are addressed in other
chapters of this publication.
81 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Sections 4-0018-19.
82 Halsbury’s Laws of England, §503.
83 For the position under English law, see H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell,
London 2016), Section 4-002; for the position under New York law, see C. T. Salomon and P D. Sharp, ‘Chap
10: Damages in International Arbitration’, in J. Fellas and J. H. Carter (eds), International Commercial Arbitration
in New York (OUP New York 2010) 299.
84 For the position under English law, see Halsbury’s Laws of England, §317 and H. McGregor, McGregor on
Damages (19th ed. Sweet & Maxwell, London 2016), Section 3-008; for the position under New York Law,
see C. T. Salomon and P D. Sharp, ‘Chap 10: Damages in International Arbitration’, in J. Fellas and J. H. Carter
(eds), International Commercial Arbitration in New York (OUP New York 2010) 300-302.
85 Formerly French Civil Code, Article 1149.
l’ordonnance du 10 février 2016) (UMR-CNRS 5815, 2016) paragraph 199; B. Fages, Droit des obligations (6th ed
L.G.D.J., 2016) paragraph 327.
87 Practical Law Company UK, Damages in International Arbitration, online resource ID 0-519-4371. See
also J. Paulsson, ‘The Expectation Model’ in Y. Derains and R. H. Kreindler (eds), Evaluation of Damages
19
includes loss of profits and diminution in value of assets) and préjudice financier (loss of profits,
loss of exploitation, non-monetary damages and expenses incurred as a result of the breach),
although those terms are sometimes used interchangeably.88
Assessment of the amount of damages89

Under English law, the normal measure of damages is the difference in value between
the performance that should have occurred, had the contract been performed, and the
actual performance.90 This follows from the principle that the compensation should put the
injured party in the position it would have been in but for the wrong.91
Under French law, the assessment of the amount of damages is based on the principle
of full compensation, the objective of which is to put the injured party in the position they
would have been in if the act that gave rise to the damage had not occurred.92 Full com-
pensation may be achieved through calculation of the difference in value (i.e., the normal
measure of expectation damages under English law) or through the calculation of the cost
of cure (i.e., as for performance damages under English law).93 However, it is important to
understand that French courts have a significant amount of discretion on how damages are
calculated and do not provide details in their justification of the amount of damages award-
ed.94 Importantly, the assessment of damages is the responsibility of the first and second
instance courts and cannot be reviewed by the Court of Cassation unless there has been an
error of law.95 In addition, French courts are not required to set out detailed reasoning in
relation to their assessment of the amount of damages.96 In practice, French courts tend to
use this discretion to take account of the degree of fault of the breaching party; i.e., where
the degree of fault is serious, they will take a ‘heavy hand’ in relation to the assessment
of damages.97
in International Arbitration, Dossiers of the ICC Institute of World Business Law,Volume 4 (Kluwer Law
International; International Chamber of Commerce ICC 2006), 63.
paragraph 4.191.
89 In this chapter, we will not discuss contractual limitations, the metric of compensation or the treatment of
expert evidence as these topics are being addressed in other chapters of this publication.
90 See e.g. H. Wöss and others, Damages in International Arbitration under Complex Long-Term Contracts (OUP,
Oxford 2014) paragraph 4.38.
91 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section 2-002, citing
Livingstone v. Rawyards Coal Co [1880] 5 App Cas. 25 at 39.
92 A. Bénabent, Droit des obligations (16th edn L.G.D.J. Précis Domat, 2016), [680].
paragraph 4.207.
94 C. Boismain, ‘Etude sur l’évaluation des dommages-intérêts par les juges du gond’, Petites affiches, 2007,
No. 39, p 7; H. Wöss and others, Damages in International Arbitration under Complex Long-Term Contracts (OUP,
Oxford 2014) paragraph 4.206.
95 The French Court of Cassation, which is France’s highest court in civil matters, only reviews issues of law; it
does not revise the findings of fact. See H. Wöss and others, Damages in International Arbitration under Complex
Long-Term Contracts (OUP, Oxford 2014) paragraph 4.206; B. Fages, Droit des obligations (6th ed L.G.D.J., 2016)
paragraph 327.
paragraph 4.208.
97 A. Bénabent, Droit des obligations (16th edn L.G.D.J. Précis Domat 2016), paragraph 680.
20
Certainty of damages
Under English law, one has to be able to prove the fact of loss and the amount of the loss
on the basis of the balance of probability. Where it is difficult to prove the amount of loss
with certainty, the wrongdoer should not be relieved of his or her responsibility to pay.98
Damages can be recovered for loss of a chance, which is an inherently uncertain head of
loss and raises difficult issues of causation and quantification.99
In contrast, in civil law systems, there is no requirement of certainty per se, and it has
been observed that ‘French lawyers … tend to be relaxed about the legal requirement of
assessing damages with certainty’100 because, as noted above, French judges have a signifi-
cant amount of discretion when making an assessment of damages.101
In relation to international arbitration, it has been observed that even when faced with
uncertainty, ‘arbitral tribunals will find juridical ways and means to arrive at a figure which,
given all the circumstances of the case, will lead to an equitable finding.’102
Conclusion
While there are differences in the approach to compensatory damages in common and civil
law jurisdictions – or among those jurisdictions – they often lead to similar results, albeit
through different paths. So much so that arbitrators, but also national judges and commen-
tators, have identified and applied international principles applicable to damages, such as
the duty to mitigate, in particular in international arbitration.
However, the analysis of damages is first and foremost driven by the facts of a case.While
the – often subtle – differences from one legal system to another might not lead to different
results in most cases, they might have a significant impact in specific circumstances. It is,
therefore, as important to ensure a proper analysis of the facts and of the assessment of the
damages, often with the help of experts, as it is to determine the applicable rules of law that
the arbitrators will refer to.
At the end of the day, all jurisdictions give substantial leeway to judges and arbitrators in
the determination of damages. It is therefore also important to take into account the legal
background of the arbitrators, which might, more or less consciously, impact their decisions.
98 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), Section 10-001.
99 H. McGregor, McGregor on Damages (19th ed. Sweet & Maxwell, London 2016), chapter 10(4).
100 P. Gélinas, ‘General Characteristics of Recoverable Damages in International Arbitration’ in Y. Derains and
R.H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of
World Business Law,Volume 4 (Kluwer Law International; International Chamber of Commerce (ICC)
2006) 12
101 C. Boismain, ‘Etude sur l’évaluation des dommages-intérêts par les juges du gond’, Petites affiches, 2007, No.
39, p 7.
102 P. Gélinas, ‘General Characteristics of Recoverable Damages in International Arbitration’ in Y. Derains and R.
H. Kreindler (eds), Evaluation of Damages in International Arbitration, Dossiers of the ICC Institute of World
Business Law,Volume 4 (Kluwer Law International; International Chamber of Commerce ICC 2006), p 11.
21
2
Non-Compensatory Damages in Civil and Common Law
Jurisdictions – Requirements and Underlying Principles
Reza Mohtashami, Romilly Holland and Farouk El-Hosseny1
Introduction
Arbitral tribunals are routinely presented with requests for compensation for sums corre-
sponding to the economic loss that the claiming party has suffered as a result of its coun-
terpart’s wrongful acts. This compensation is typically referred to as ‘monetary damages’,
‘compensatory damages’ or simply ‘damages’. The purpose of such an award of damages is
to put the claiming party in the position it would have been in but for the wrongful acts.
‘Non-compensatory damages’ are an exception to the rule, in that they are not intended
to compensate for the claiming party’s loss. Instead, they may be intended to correspond
to the benefits gained by the wrongful party, for example, or even to punish the wrong-
ful party.
In this chapter, we first review the availability of different types of non-compensatory
damages under common law and civil law systems.2 We then look at the limitations on the
authority of arbitral tribunals to award such non-compensatory damages, before turning
to consider the position under international law, and exploring the extent to which moral
damages – traditionally considered to be compensatory – are assuming a non-compensatory
function. Finally, we provide some concluding reflections.
1 Reza Mohtashami is a partner, and Romilly Holland and Farouk El-Hosseny are associates at Freshfields
Bruckhaus Deringer LLP.
2 For the purposes of this chapter, we primarily examine French and English law as illustrative of civil law and
common law systems respectively.
22
Non-Compensatory Damages in Civil and Common Law Jurisdictions – Requirements and
Underlying Principles
The concept of non-compensatory damages under common law and civil

law systems
Damages inexorably serve the function of compensating an actual loss. However, as already
mentioned, there are exceptions to this rule. Non-compensatory damages in the common
law and civil law systems have interlacing characteristics that can be identified.
Damages as the main form of compensation

Monetary damages in both the common law and civil law traditions aim to compensate
the claimant but not to place the claimant in a better position than if the contract had not
been breached.3
In the House of Lords decision of Attorney General v. Blake, Lord Nicholls affirmed that
‘…damages are compensatory. That is axiomatic’.4 The overarching principle articulated
by Lord Blackburn in Livingston v. Rawyards Coal Co is that their measure ‘is to be, as far as
possible, that amount of money which will put the injured party in the same position he
would have been in had he not sustained the wrong’.5
Reflecting the same ethos, the French Civil Code provides that ‘[d]amages owed to
a creditor are, in general, for the loss he sustained and for the profit of which he was
deprived...’.6 The principle of full reparation (which is often referred to as ‘le principe com-
pensatoire’) lies at the heart of French law on damages.7 In following this principle, French
courts are bound to indemnify the breach, and nothing but the breach.8 The Court of
Cassation is wary of eliminating the risk of unjust enrichment and seeks to ensure that
compensation does not result in either loss or profit.9 Beyond France, compensation for an
actual loss is the main function of civil liability under most civil codes.10 The Introductory
3 Civil and common law intertwine in a myriad of international instruments, including most notably the Vienna
Convention on Contracts for the International Sale of Goods which simply defines damages as consisting of
‘a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach’,
nothing less, nothing more. See United Nations Convention on Contracts for the International Sale of Goods,
1489 UNTS 3, article 74. See also Fauvarque-Causson, B. et al., European Contract Law (Sellier – European
Law Publishers, 2006), 279, 311.
4 Attorney-General v. Blake, Jonathan Cape Ltd (Third Party) [2000] E.M.L.R. 949, 962.
5 That amount (or quantum) will of course be governed by factors of remoteness, causation and mitigation.
See Livingstone v. Rawyards Coal Co (1880) 5 App Cas 25, 39; see also Robinson v. Harman [1843-60] All ER
Rep 383.
6 See Article 1231-2 (article 1149 prior to the 1 October 2016 amendment of the Civil Code), French Civil
Code, English translation available at: www.legifrance.gouv.fr/.
7 Laithier,YM, ‘Les règles juridiques relatives à l’évaluation du préjudice contractuel (droit anglais, droit français,
droit suisse)’, Revue de l’Arbitrage, Comité Français de l’Arbitrage, 361 (2015), 362.
8 The Court of Cassation will, for instance, quash an order of a lump sum of damages on the basis of equity
and not the actual harm suffered. See French Court of Cassation, First Civil Chamber, 2 April 1996 –
No. 94-13.871. See also Ibid., 362.
9 French Court of Cassation, Second Civil Chamber, 23 January 2003 – No, 01-00200. The clause pénale
and court-ordered astreintes penalty payments are exceptions to the principe compensatoire. Astreintes are
court-ordered periodic penalties for delays in the execution of a court judgment. See French Senate, Laws
Commission, Report n°558 on Civil Liability, presented by Anziani, A., and Béteille, L., 15 July 2009, 80
(‘French Senat Report on Civil Liability’), 80; Barrière, F., ‘Non-compensatory Damages: France under the
Influence?’, Osservatorio del diritto civile e commerciale, 323 (2012), 328.
10 Ibid., 324.
23
Act to the German Civil Code, for example, excludes damages that ‘obviously serve pur-
poses other than an adequate compensation of the injured party’.11
Notwithstanding the above, both common law and civil law systems permit certain
exceptions to the general principle that monetary damages are designed to compensate an
aggrieved party, as we explore below.
Non-compensatory damages – an exception to the rule

While the House of Lords in Blake emphasised the compensatory nature of damages, it
also recognised that there are situations in which the strict application of this rule would
lead to an injustice.12 The House of Lords in that instance granted the state restitutionary
damages by requiring the defendant to account for the benefits he had received from his
wrongful act.13 Such an award goes beyond the notion of compensation, as will be discussed
further below.
The French Civil Code is silent on the question of non-compensatory damages.14
Unusually, the Civil Code of Quebec provides that in cases of breach of contract, a Quebec
court may award punitive damages if it finds that a statute15 allowing it to award such dam-
ages has been violated.16 A recent proposal to incorporate a provision for punitive damages
in the French Civil Code which, when awarded, would be paid to the state to sanction
lucrative faults, thus remaining faithful to the principle of full reparation and eliminating
the risk of unjust enrichment, was roundly rejected.17
Certain European legislation also permits the award of non-compensatory damages.
For example, Directive 2004/48/EC on the enforcement of intellectual property rights,
11 Article 40(3) of the Einführungsgesetzes zum Bürgerlichen Gesetzbuche (‘the Introductory Act to the Civil
Code’) provides that ‘[c]laims governed by the law of another country cannot be raised insofar as they (1) go
substantially beyond what is necessary for an adequate compensation of the injured party, (2) obviously serve
purposes other than an adequate compensation of the injured party.’
12 Attorney-General v. Blake, supra note 4, 957.
13 Ibid., 951.
14 Barrière, F., supra note 9, 326.
15 These include the Charter of Human Rights and Freedoms or the Consumer Protection Act. See Article
49 of the Charter, which provides that: ‘Any unlawful interference with any right or freedom recognized by
this Charter entitles the victim to obtain the cessation of such interference and compensation for the moral
or material prejudice resulting therefrom. In case of unlawful and intentional interference, the tribunal may, in
addition, condemn the person guilty of it to punitive damages’. See Quebec Charter of Human Rights and
Freedoms, L.R.Q., ch. C-12.
16 Article 1621 of the Quebec Civil Code provides that: ‘Where the awarding of punitive damages is provided
for by law, the amount of such damages may not exceed what is sufficient to fulfil their preventive purpose.
Punitive damages are assessed in the light of all the appropriate circumstances, in particular the gravity of
the debtor’s fault, his patrimonial situation, the extent of the reparation for which he is already liable to the
creditor and, where such is the case, the fact that the payment of the reparatory damages is wholly or partly
assumed by a third person.’ See also Fauvarque-Causson, B. et al., supra note 3, 309.
17 Proposed article 1371 of the Civil Code provides that: ‘A person who commits a manifestly deliberate fault,
and notably a fault with a view to gain, can, in addition to compensatory damages, be condemned to pay
punitive damages, part of which may be allocated to the Public Treasury, at the court’s discretion. A court’s
decision to order the payment of damages of this kind must be supported by specific reasons and their amount
distinguished from any other damages awarded to the victim. Punitive damages may not be the object of
insurance.’ See Barrière, F., supra note 9, 331.
24
which has been implemented in the UK18 as well as in France,19 provides that the amount
of damages for infringement should take into account ‘unfair profits made by the infringer
and, where appropriate, any moral prejudice caused to the rightholder’.20 However, the
Directive’s aim is compensatory rather than punitive.21 Indeed, as underscored by the Rome
II Regulation,22 punitive damages are widely considered to be contrary to public policy in
most EU jurisdictions.23
Types of non-compensatory damages available under civil law and common law
systems
In this section, we address those categories of damages, available in civil and common law
alike, which do not strictly follow the compensatory principle. These include nominal
damages, liquidated damages, restitutionary damages and punitive (or exemplary)24 damag-
es.25 We also examine moral damages, at times a Manichean form of damages that can be
viewed through the prism of both compensation and non-compensation, particularly in
investment treaty arbitration, as will be discussed further below.26
Nominal damages
Under English law, nominal damages are symbolic and thus non-compensatory. They are
awarded when a wrong has been committed by a defendant but no loss or damage has been
18 Intellectual Property (Enforcement, etc.) Regulations 2006, Section 3.

19 French Intellectual Property Code, articles L331-1-3, L-521-7, L-615-7, and L-716-14.
20 Further, it enables the assessment of damages on the basis of ‘the royalties or fees which would have been due
if the infringer had requested authorisation to use the intellectual property right in question’ in cases where it
would be difficult to precisely determine the amount of the loss suffered. See Directive 2004/48/EC of the
European Parliament and of the Council of 29 April 2004 on the enforcement of intellectual property rights,
L 195/18 and article 13.
21 This criterion takes into account the expenses incurred by the rightholder, such as the costs of identification
and research. See Ibid., L 195/19.
22 The Rome II Regulation cautions against the application of a legal norm covered by it in a manner that
would cause ‘non-compensatory exemplary or punitive damages of an excessive nature to be awarded’ which
‘may […] be regarded as being contrary to the public policy (ordre public) of the forum’. See Regulation
(EC) No 864/2007 of the European Parliament and of the Council of 11 July 2007 on the law applicable to
non-contractual obligations (Rome II), 32 [our emphasis].
23 However, it is worth mentioning that, as confirmed by the European Court of Justice, the award of punitive
damages founded on EU anti-trust law is not, as a matter of general principle, ruled out. See Manfredi and
others, European Court of Justice, Judgment of the Court of 13 July 2006, C- 295/04 and C-298/04, 99.
24 For the purposes of this chapter, we consider the terms ‘punitive’ and ‘exemplary’ to be interchangeable. For
ease of reference, we use the term punitive throughout.
25 McGregor considers vindicatory damages as a form of non-compensatory damages, which ‘are intended not
to compensate for loss, of which there may be little or none, but to show to the public by a substantial award
of damages that the reputation of a defamed, or falsely imprisoned, claimant is secure’. See McGregor, H.,
McGregor on Damages, 19th edition (Sweet & Maxwell, 2016), 1-008–1-010.
26 Reisman, M. et al., International Commercial Arbitration: Cases, Materials, and Notes on the Resolution of International
Business Disputes, 2nd edition (Foundation Press, 2015), 250.
25
inflicted upon the aggrieved party.27 Nominal damages are often described as a ‘mere peg
on which to hang costs’ as the award of costs routinely follows the event.28
Under French law, courts have long accepted actions for ‘un franc symbolique’ whereby
damages are awarded to the aggrieved party in addition to costs in claims related to group
or public interests.29 As establishing damage is a precondition to standing, aggrieved parties
may invoke nominal damages to have their claim heard.30
Liquidated damages or the clause pénale

Under both civil and common law systems, parties to a contract are free to determine the
damages payable in the event of a specific contractual breach before the breach has arisen.
Predetermined damages are known as liquidated damages. A liquidated damages clause is
referred to as a ‘clause pénale’ in French, which is somewhat confusing given there is no
punitive element to such a provision. Under English law, a liquidated damages clause should
represent a ‘genuine pre-estimate of loss’.31 The amounts stipulated should be commercially
justified and not intended as a deterrent; otherwise, the clause risks being qualified as an
unenforceable penalty.32 In a 2015 decision, the English Supreme Court emphasised that
liquidated damages have long been available under English law, and noted that they are
equally common to the French, Italian, German, Swiss and Belgian legal traditions.33
There is a real chance, however, that a liquidated damages clause will provide for a sum
in damages that does not correspond to the losses of the aggrieved party. Thus, although
they have a compensatory function, liquidated damages cannot be said to be purely com-
pensatory. It is for this reason that, under French law, a judge has discretion to increase or
reduce the amount stipulated under a liquidated damages clause if it is deemed manifestly
excessive or derisory.34
Restitutionary damages
Restitutionary damages arise ‘where the commission of a wrong results in a benefit to the
wrongdoer which exceeds and outstrips the loss to the person wronged, who suffers a lesser
27 This could be the result of a failure by the claimant to prove either (i) any loss resulting from the breach of
contract or (ii) the actual amount of his loss. See McGregor, H., supra note 25, 12-001; Chitty on Contracts,Vol.
I, 32nd edition (Sweet & Maxwell, 2015), 26-009.
28 Beaumont v. Greathead (1846) 2 C.B. 494, 499; see also Ibid., 26-009.
29 Perhaps one of the most infamous examples is the award of one euro to Michael Jackson fans who alleged
emotional damage in an action brought against his former doctor. See BBC, ‘Michael Jackson fans win one
euro for emotional damage’ (11 February 2014), available at: www.bbc.co.uk/news/world-europe-26141075.
30 Garrigues, B., ‘La contre-prestation du franc symbolique’, La revue de référence en droit civil (1991), 459.
31 Lordsvale Finance Plc. v. Bank of Zambia [1996] 3 W.L.R. 688, 763.
32 Ibid., 764.
33 Cavendish Square Holding BV v. Makdessi [2015] 3 W.L.R. 1373, 1394.
34 French judges have, for instance, reduced to one euro the amount set forth under a clause pénale deemed
excessive. See Court of Cassation, Commercial Chamber, 11 February 1997– No. 95-10851; See also Article
1231-5 of the French civil code. The possibility of a reduction of a liquidated damages clause is also set
forth under the UNIDROIT Principles. See Article 7.4.13(2) on ‘Agreed payment for non-performance’,
UNIDROIT Principles (2010), available at: www.unidroit.org/english/principles/contracts/principles2010/
integralversionprinciples2010-e.pdf.
26
loss or, frequently, no loss at all’.35 In Blake, the Crown was not awarded compensatory
damages because it had suffered no loss as a result of Blake’s breach of contract.36 However,
in exceptional circumstances, defendants may be ordered to restitute benefits that have
arisen from a breach of contract.37 Accordingly, an innocent party may recover an amount
of profit from the wrongdoer even in the absence of a measurable loss.38
The developments unravelled by Blake were well noted in civil law jurisdictions in gen-
eral, and in France in particular, precisely because there are no remedies in France address-
ing ‘lucrative faults’ which lead to illicit gains.39 French legal doctrine rejects restitutionary
damages because they could lead to unjust enrichment.40 The French Intellectual Property
Code, transposing Directive 2004/48/EC into French law, is an exception to this rule.41
Punitive damages
English law regards compensatory and punitive damages as being as ‘incompatible as oil
and vinegar’.42 Punitive damages are, as the term suggests, concerned with punishing the
wrongdoer rather than compensating the aggrieved party. By definition then, their assess-
ment is not commensurate to the latter’s loss.43 Under US law, punitive damages are widely
available and may be awarded in commercial and contractual cases.44
Under English law, a court may order the payment of punitive damages in circum-
scribed and exceptional situations.45 However, as a matter of general principle, they are not
an available remedy for breach of contract.46 They confuse ‘the civil and criminal functions
35 McGregor, H., supra note 25, 14-002.

36 Attorney-General v. Blake, supra note 4, 979.
37 The relevant circumstances to consider include the subject matter of the contract, the purpose of the
contractual provision which has been breached, the context in which the breach occurred, the consequences
of the breach and the circumstances in which relief is being sought, and whether the plaintiff had a legitimate
interest in preventing the defendant’s profit-making activity and, hence, in depriving him or her of his or her
profit. See Ibid., 967.
38 Against this backdrop, Lord Steyn in Blake disagreed with the majority by issuing ‘a further note of warning
that if some more extensive principle of awarding non-compensatory damages for breach of contract is to
be introduced into our commercial law the consequences will be very far reaching and disruptive’. See Ibid.,
957, 983.
39 Viney, G., ‘Quelques propositions de réforme du droit de la responsabilité civile’, Recueil Dalloz (2009), 2949.
40 Ibid., 2949.
41 See supra note 19.
42 Broome v. Cassell & Co [1972] A.C. 1027, 1077; see also McGregor, H., supra note 25, 1-009.
43 McGregor, H., supra note 25, 1-008; Chitty on Contracts, supra note 27, 26-044.
44 Under New York law for instance, punitive damages may be available in cases of breach of contract where
a plaintiff can show a bad faith breach that reaches a sufficient level of egregiousness. See Leventhal, J. and
Dickerson, T., ‘Punitive Damages: Public Wrong or Egregious Conduct? A Survey of New York Law’,
76:2 Albany Law Review, 961 (2013), 997; see also Born, G., International Commercial Arbitration, 2nd edition
(Kluwer Law International, 2014),Vol. III, 3077.
45 See Rookes v. Barnard and Others [1964] A.C. 1129, 1227.
46 In its 1997 report on ‘Aggravated, Exemplary and Restitutionary Damages’, the Law Commission
recommended that ‘punitive damages must not be awarded for breach of contract or under an undertaking in
damages’. See Law Commission, ‘Report on Aggravated, Exemplary and Restitutionary Damages’, No. 247
(1997), 185.
27
of the law’ and are, therefore, regarded with scepticism.47 English courts may rely on Blake
to award restitutionary damages but have expressed no interest in awarding punitive dam-
ages in a contractual context.48
In most civil law jurisdictions, punitive damages are not available for contractual breach
unless such breach is tainted by fraudulent or malicious conduct.49 The Swiss Federal
Tribunal has qualified punitive damages as ‘foreign to Swiss law’.50 As already noted, Rome
II recognises that punitive damages are contrary to the public policy of several Member
States.51 However, the French Court of Cassation has refrained from deeming punitive
damages to be a violation of international public policy.52 Of course, such a violation would
effectively bar the recognition and enforcement of foreign judgments and awards ordering
the payment of punitive damages – an issue that will be discussed in greater detail in the
section on ‘Non-compensatory damages in international commercial arbitration’ below.
Moral damages
The notion of ‘moral damages’ derives from the French concept of ‘le préjudice moral’,53
which refers to a wrong to an individual’s emotions, honour or reputation.54 Moral dam-
ages are thus, in the civil law tradition, compensatory – they are claimed pursuant to the
principle of full reparation in the French Civil Code.55 The right to recover moral damages
as compensation is explicitly set out under several civil codes in the Middle East, includ-
ing most notably the Egyptian, Libyan and Lebanese civil codes.56 The assessment of moral
damages, including the quantum of such damages, in France is subject to the court’s discre-
tion.57 As the conduct of the defaulting party will not, in principle, be relevant to the court’s
assessment,58 an award of moral damages cannot, therefore, be characterised as punitive.
English law imported this terminology from EU intellectual property law.59 Moral
damages equate to non-pecuniary loss, which English courts can compensate, including
47 McGregor, H., supra note 25, 13-001; Chitty on Contracts, supra note 27, 26-044.
48 Indeed, in Kuddus v. Chief Constable of Leicestershire Constabulary, Lord Scott of Foscote affirmed that
‘[r]estitutionary damages are available now in many tort actions as well as those for breach of contract.
The profit made by a wrongdoer can be extracted from him without the need to rely on the anomaly of
exemplary damages’. See Kuddus v. Chief Constable of Leicestershire Constabulary [2002] 2 A.C. 122, 157.
49 Laithier,Y.M., supra note 7, 367.
50 Swiss Federal Tribunal, TF 4A_157/2007, 16 October 2007, 3.4.
52 See infra notes 83 and 94.
53 Jagusch, S., and Sebastian, T., ‘Moral Damages in Investment Arbitration: Punitive Damages in Compensatory
Clothing?’, 29:1 Arbitration International, 45 (2013), 46.
54 Companies could also claim moral damages. See French Court of Cassation, Commercial Chamber,
15 May 2012 – No. 11-10278.
55 Articles 1231-2 and 1231-3, French Civil Code.
56 See Article 222(1) of the Egyptian Civil Code, Article 225(1) of the Libyan Civil Code, and 134(2) of the
Lebanese Civil Code.
57 French Court of Cassation, Second Civil Chamber, 8 May 1964; on the court’s discretion or ‘pouvoir
souverain’, see French Court of Cassation, Civil Chamber, 23 May 1911; see also French Senate Report on
Civil Liability, supra note 9, 81.
58 Ibid., 79.
59 This ‘civil law terminology’ was apparently introduced following the transposition of EU intellectual property
law into English tort law. See McGregor, H., supra note 25, 46-071, 37-019 (footnote 108).
28
in contractual and commercial matters. These particularly cover physical inconvenience or

discomfort, pain and suffering and loss of amenities, mental distress and social discredit.60
Notwithstanding that moral damages are considered as compensatory in both the civil
and common law systems (as well as in international law), they stand distinct to monetary
damages. Moreover, certain recent investment treaty awards demonstrate that moral dam-
ages are beginning to be understood as having a punitive (and therefore non-compensatory)
function.We explore this development in the section ‘Non-compensatory damages awarded
in investment treaty arbitration’ below.
Non-compensatory damages in international commercial arbitration

As discussed above, common and civil law systems consider various forms of
non-compensatory damages, such as nominal and liquidated damages, as readily available.
Excluding intellectual property protection, restitutionary damages are only accepted under
English common law, but not French civil law. Moral damages are meant to be compen-
satory and are awarded on that basis under both systems. Finally, an outright rejection of
punitive damages in the contractual realm also seems to be a common rule, which makes
them the most problematic form of non-compensatory damages when they arise in the
context of an international arbitration.
An arbitral tribunal’s authority to award non-compensatory damages is constrained
in two ways: the first substantive and the second procedural. With respect to the first, the
applicable law, the lex arbitri, the arbitration agreement, and the arbitration rules (where
applicable) will together determine a tribunal’s authority to award such damages. The pro-
cedural scrutiny of arbitral awards by courts in set-aside and recognition proceedings con-
stitutes the second limitation, particularly with respect to the award of punitive damages.
The authority of arbitral tribunals to award non-compensatory damages

The applicable law
The applicable law governs ‘the consequences of a total or partial breach of obligations,
including the assessment of damages’.61 As such, the applicable law will determine, for
instance, whether the arbitral tribunal has the authority to reduce an amount set forth
under a liquidated damages clause – as provided under French, Swiss and Libyan law, for
example.62 The same applies to moral damages. Relying on the Libyan Civil Code, which
explicitly states that ‘compensation covers moral injury’,63 the ad hoc tribunal in Al-Kharafi
& Sons Co v. the Government of Libya and others awarded the claimant US$30 million for
reputational damage.64
60 See Simmons v. Castle [2013] 1 W.L.R. 1239, 1252; see also McGregor, H., supra note 25, 5-016.
61 Regulation (EC) No. 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law
applicable to contractual obligations (Rome I), Article 12(l)(c).
62 See ICC Cases No. 4629/1989, 165 and No. 4462/1985/1987, 27, in Arnaldez, J-J, Derains,Y., and Hascher, D.
(eds.), Collection of ICC Arbitral Awards (1991-1995) (Kluwer Law International, 1997).
64 Mohamed Abdel Mohsen al-Kharafi and Sons v. Libya, Economy Ministry of Libya, Finance Ministry of Libya and
General Board of Investment Promotion and Privatization and the Libyan Investment Authority, Award of
22 March 2013, 333, available at: www.italaw.com/sites/default/files/case-documents/italaw1554.pdf.
29
Conversely, an ICC tribunal seated in Zurich, hearing a technology licensing dispute

to which Indian law applied, found that it was not empowered to award punitive dam-
ages as under Indian law ‘… an arbitral tribunal, will normally give “damages for breach of
contract only by way of compensation for loss suffered, and not by way of punishment”’.65
While the choice of New York law as the applicable law (instead of Indian law) may have
empowered the arbitrators to award punitive damages, the enforcement of the ensuing
award would depend on the applicable public policy of the enforcing state.
The lex arbitri

Opinions diverge as to whether the availability of a specific head of relief, and the authority
of an arbitral tribunal to grant it, is a substantive or a procedural matter.66 Thus looking at
whether the applicable law grants arbitral tribunals the authority to award non-compensatory
damages is not sufficient.67 The lex arbitri requires equal and careful consideration.
In an often-cited case, an ICC tribunal seated in Geneva refused to award punitive
damages sought by the respondent for the claimant’s termination of a wine distribution
agency agreement governed by New York law,68 on the grounds that to do so would be
contrary to Swiss law as the lex arbitri.69 In support of its decision, the tribunal relied on a
provision of the Swiss Federal Private International Law Act, which provides that, in the
context of product liability claims based on foreign law, ‘no damages can be awarded in
Switzerland beyond those that would be awarded under Swiss law for such damage’.70
The arbitration agreement

An arbitration agreement may explicitly authorise an arbitral tribunal to award
non-compensatory damages. For instance, such an agreement could preclude71 or provide
for the award of punitive damages, as is not uncommon in the US,72 and as validated by
65 Manufacturer v. Manufacturer, Final Award, ICC Case No. 8445, 1994 in van den Berg, A.J. (ed), Yearbook
Commercial Arbitration,Volume 26, 177.
66 Petsche, M., ‘Punitive Damages in International Commercial Arbitration: Much Ado about Nothing?’,
29 Arbitration International (2013), 93.
67 Blackaby, N., Partasides, C., Redfern, A., and Hunter, M., Redfern and Hunter on International Arbitration, 6th
edition (Oxford University Press, 2015), 9.50.
68 ICC Case No. 5946/1990, 62, in Arnaldez, J-J, Derains,Y., and Hascher, D., supra note 62. See also Born, G.,
supra note 44, 3080.
69 The tribunal found that ‘[d]amages that go beyond compensatory damages to constitute a punishment of
the wrongdoer (punitive or exemplary damages) are considered contrary to Swiss public policy, which must
be respected by an arbitral tribunal sitting in Switzerland even if the arbitral tribunal must decide a dispute
according to a law that may allow punitive or exemplary damages as such’. See ICC Case No. 5946/1990, 62,
in Arnaldez, J-J, Derains,Y., and Hascher, D., supra note 62. Also cited in Born, G., supra note 44, 3080.
70 See Article 135(2), Federal Private International Law Act of 18 December 1987.
71 In the arbitration clause of a Farm-In and LNG cooperation agreement entered into between Shell and
Centurion, the parties agreed that ‘[t]he arbitrators shall not award consequential, punitive or other similar
damages in connection with the decision of any dispute hereunder.’ See Shell Egypt West Manzala GmbH &
Shell Egypt West Qantara GmbH v. Dana Gas Egypt Ltd [2009] EWHC 2097, 2098.
72 Lew, J., Mistelis, L., and Kröll, S., Comparative International Commercial Arbitration (Kluwer Law International,
2003), 650.
30
the US Supreme Court in Mastrobuono v. Shearson Lehman Hutton Inc.73 The arbitration
agreement could also set a cap on the amount of damages. A good example of this is the
Tapie arbitration, where the parties’ agreement to arbitrate capped Bernard Tapie and his
spouse’s claim to moral damages at €50 million.74 The arbitral tribunal awarded the claim-
ants €45 million to account for the ‘humiliation’ and ‘destructive manoeuvres’ suffered.75 As
shown above, moral damages are available under French law; however, the sum awarded to
Tapie is widely considered to be unprecedented in the French legal system. The authority
given to the tribunal under the arbitration agreement thus shows the pivotal role that such
clauses can play.
Arbitration rules
Arbitration rules are generally silent on arbitrators’ authority with respect to damag-
es.76 One notable exception is the ICDR-AAA International Arbitration Rules, which
expressly exclude the award of ‘punitive, exemplary, or similar damages’ unless the par-
ties agree otherwise.77 It is interesting to note that the AAA Arbitration Rules (i.e., the
equivalent domestic arbitration rules) do not contain such a provision.78 Perhaps this can be
viewed as a recognition that such damages are not available in many (if not most) jurisdic-
tions. This is also evidenced by the exclusion of the award of arbitration costs on the basis
of a party’s misconduct from the scope of this provision, which could be viewed as a form
of non-compensatory damages.79
Excess of jurisdiction and public policy considerations – the scrutiny of awards

on non-compensatory damages
One of the primary duties of arbitrators is to ensure that their awards are enforcea-
ble.80 To this effect, tribunals have to be mindful of the provisions of the lex arbitri as
73 Mastrobuono v. Shearson Lehman Hutton Inc 514 U.S. 52 (1995). See also Born, G., supra note 44, 3078-3079.
74 Bernard Tapie et al v. (1) CDR Créances and (2) Consortium de réalisation, Award of 7 July 2008, 82-83.
75 The award was overturned by the Paris Court of Appeal in February 2015 after finding that the arbitration
had been fraudulently conducted. The Court of Cassation subsequently confirmed the Court of Appeal’s
judgment. See French Court of Cassation, First Civil Chamber, 30 June 2016, No. 932. For a summary, see
the various GAR articles on this saga, including most recently: ‘IMF chief to stand trial over Tapie Affair’
(22 July 2016), available at: http://globalarbitrationreview.com/article/1067246/imf-chief-to-stand-trial-ove
r-tapie-affair.
76 Petsche, M., supra note 66, 96.
77 Article 31(5) provides that: ‘Unless the parties agree otherwise, the parties expressly waive and forego any right
to punitive, exemplary, or similar damages unless any applicable law(s) requires that compensatory damages
be increased in a specified manner. This provision shall not apply to an award of arbitration costs to a party to
compensate for misconduct in the arbitration.’ See International Arbitration Rules of the International Centre
for Dispute Resolution (ICDR), amended and effective as of 1 June 2014.
78 See American Arbitration Association Commercial Arbitration Rules and Mediation Procedures, amended and
effective as of 1 October 2013.
79 Other arbitration rules explicitly authorise tribunals to take into account a party’s conduct when deciding on
the allocation of costs. See for instance Article 37(5), ICC Arbitration Rules 2012.
80 This is a requirement found in many arbitration rules. For instance, the ICC rules provide that the ICC Court
and the arbitral tribunal ‘shall make every effort to make sure that the award is enforceable at law’, see Article
41, ICC Arbitration Rules 2012. The LCIA Rules, on the other hand, refer to an obligation incumbent on
31
mentioned above, as well as of the New York Convention.81 For instance, an award of
non-compensatory damages could be set-aside or denied recognition on the grounds of
excess of jurisdiction where a tribunal grants moral damages when no party sought such
damages, or where a tribunal refuses to order punitive damages in breach of the terms of
the arbitration agreement.82
In addition, the award could be challenged on the basis of the public policy exception,83
a point of primary relevance in relation to punitive damages. Interest in this issue stems
from developments in the US, notably the Supreme Court decisions in the Mitsubushi and
Shearson/American Express cases, that confirmed the authority of arbitral tribunals to award
treble (i.e., punitive) damages.84 Nevertheless, punitive damages are not common in inter-
national commercial arbitration.85
Given their relative rarity, there is little jurisprudence concerning the set-aside or
enforcement of arbitral awards ordering punitive damages.86 The recognition and enforce-
ment of US judgments that allow for punitive damages in continental jurisdictions sheds
some valuable light, however. There are, for instance, examples of decisions from France,87
Spain88 and Italy89 refusing to recognise US judgments, or parts thereof, containing an
award for punitive damages, particularly on the basis of the public policy exception.
However, in a trademark infringement case, the Spanish Supreme Court granted exe-
quatur to a Texas judgment awarding punitive damages and found that, in the circumstances,
the LCIA Court, the arbitral tribunal as well as the parties to make ‘every reasonable effort’ to ensure the
enforceability of the award at the seat, see Article 32.2, LCIA Arbitration Rules 2014. That said, ‘[a]rbitrators
cannot be expected to be aware of all formal requirements to ensure the enforceability of the award in any
given country.’ See Turner, P., and Mohtashami, R., A Guide to the LCIA Arbitration Rules (Oxford University
Press, 2009), 9.51.
81 In particular, see Articles V(1)(c) and V(2)(b), Convention on the Recognition and Enforcement of Foreign
Arbitral Awards (‘New York Convention’), 330 UNTS 38; 21 UST 2517; 7 ILM 1046 (1968). Article V(1)
(c) provides that recognition and enforcement may be refused if ‘[t]he award deals with a difference not
contemplated by or not falling within the terms of the submission to arbitration, or it contains decisions on
matters beyond the scope of the submission to arbitration, provided that, if the decisions on matters submitted
to arbitration can be separated from those not so submitted, that part of the award which contains decisions on
matters submitted to arbitration may be recognized and enforced.’ Article V(2)(b) sets an additional ground for
refusal on the basis that ‘[t]he recognition or enforcement of the award would be contrary to the public policy
of that country.’
82 Born, G., supra note 44, 3070.
83 In addition to the New York Convention, the public policy exception typically forms part of the lex arbitri.
For instance, article 1514 of the French Code of Civil Procedure provides that: ‘An arbitral award shall be
recognised or enforced in France if the party relying on it can prove its existence and if such recognition or
enforcement is not manifestly contrary to international public policy.’ See also Article 1520(5) of the Code, as
well as Article 190(2)(e) of the Federal Private International Law Act, and Sections 68(2)(g) and 103(3) of the
Arbitration Act (1996).
84 Mitsubishi Motors Corp v. Soler Chrysler-Plymouth Inc, 473 U.S. 614 (1985); Shearson/American Express Inc v.
MacMahon, 482 US 420 (1987). See also Petsche, M., supra note 66, 90.
85 Born, G., supra note 44, 3076.
86 Petsche, M., supra note 66, 101.
87 See infra note 94.
88 Spanish Supreme Court, ATS 163/2001, 18 September 2001.
89 Italian Court of Cassation, Civil Section III, 19 January 2007, No. 1183.
32
such damages could not be considered as undermining public policy.90 In the same vein,
Kaufmann-Kohler and Rigozzi consider that an award of punitive damages does not con-
stitute per se a violation of Swiss public policy.91 The Swiss Federal Tribunal has found that
the principle whereby an award of damages and interest must not result in the enrichment
of the injured party ‘pertains to Swiss or domestic public policy, but commentators do not
consider it as a concept belonging to international public policy’.92 Rather than outright
rejecting punitive damages, it is argued that the relevant test should be whether the amount
of punitive damages is compatible with public policy.93
This position was echoed by the French Court of Cassation.94 Addressing a denial by
the Poitiers Court of Appeal to grant exequatur of a Supreme Court of California judg-
ment, the Court of Cassation affirmed that ‘a foreign judgment ordering the payment of
punitive damages is not, as a matter of principle, contrary to the ordre public international de
fond.’95 However, it stated that a foreign judgment will not be recognised in France if the
amount of damages ordered is ‘manifestly disproportionate in relation to the damage caused
as well as the breach of contractual obligations’.96
Against this backdrop, it appears that the concept of punitive damages does not sys-
tematically trigger alarm bells of the courts in jurisdictions where punitive damages are
not normally awarded. This is reflected in an attempt to set aside an ICC award before
the English High Court. In this case, the claiming party argued that the arbitral tribunal
awarded damages under an indemnity clause of a share purchase agreement in a man-
ner that would characterise them as ‘punitive damages’ and, therefore, contrary to Spanish
public policy.97 This failed to convince the High Court, which found that the arbitral tri-
bunal may have erred in the application of Spanish law (as the applicable law) rules on the
assessment of damages. However, according to the Court, such an error in the application
of Spanish law did not meet the threshold to constitute a valid ground of challenge to an
arbitral award.98
90 Spanish Supreme Court, ATS 1803/2001, 13 November 2001, 9. On the availability of non-compensatory
damages in the context of intellectual property protection, see supra note 20.
91 ‘Contrary to other opinions, it is submitted here that an award of punitive damages does not necessarily
contravene public policy’. See Kauffmann-Kohler, G. and Rigozzi, A., International Arbitration: Law and Practice
in Switzerland (Oxford University Press, 2015), 8.276.
92 Enterprise nationale des engrais et des produits phytosanitaires ASMIDAL v. Compagnie française d’étude et de
construction TECHNIP, Swiss Federal Tribunal, 17 July 1998, in ASA Bulletin (Association Suisse de l’Arbitrage;
Kluwer Law International 2002,Volume 20 Issue 4), 660-676. See also Werner, J., ‘Punitive and Exemplary
Damages in International Arbitration’, in Derains,Y., and Kreindler, R. (eds.), Evaluation of Damages in
International Arbitration, 102.
93 Berger, B., and Kellerhals, F., International and Domestic Arbitration in Switzerland, 3rd edition, (Hart Publishing,
2014), 1770, 2100 (footnote 157).
94 French Court of Cassation, Civil Chamber, 1 December 2010, No. 09-13303.
95 Ibid.
96 Ibid.
97 The dissenting Spanish arbitrator considered that the majority imposed ‘punitive and multiple damages in a
manner which was not permitted under Spanish law and thus ignored the remedies available within the limits
of the law of the contract’ and that ‘[t]he Award was in consequence […] illegal, as a matter of public order,
under Spanish law’. See B v. A [2010] 2 C.L.C. 1, 5-6, 18.
98 Ibid., 18.
33
In sum, although the award of punitive damages is not accepted in an overwhelming

majority of jurisdictions, such awards seem to be dealt with by the courts in such jurisdic-
tions in subtle and nuanced ways.
Non-compensatory damages awarded in investment treaty arbitration

In this section, we look at the particular status of moral damages in international law. As we
have seen, moral damages are considered as compensatory in both the civil and common
law traditions, as well as in international law. However, recent investment treaty awards
show that tribunals are increasingly considering moral damages to serve a punitive function.
A brief overview of compensatory and non-compensatory damages under

international law
The International Law Commission’s Articles on Responsibility of States for Internationally
Wrongful Acts (ILC Articles) seek to codify international law concerning, inter alia, the
legal consequences for the responsible state of internationally wrongful acts.99
Article 31 provides that the responsible state is to make ‘full reparation’ for the injury
caused by its wrongful act, that is to ‘wipe out all the consequences of the illegal act and
re-establish the situation which would, in all probability, have existed if that act had not
been committed’.100
Reparable injury includes any material or moral damage.101 The latter includes ‘indi-
vidual pain and suffering, loss of loved ones or personal affront associated with an intrusion
on one’s home or private life’.The Lusitania case underlines the long-established availability
of moral damages under international law, specifying that an aggrieved party could be com-
pensated for ‘an injury inflicted resulting in mental suffering, injury to his feelings, humili-
ation, shame, degradation, loss of social position or injury to his credit or reputation’.102
Pursuant to Article 36(1) of the ILC Articles, a responsible state is obliged to compen-
sate for the damage it causes, to the extent such damage is not made good by restitution.
Compensation does not, however, have a punitive or exemplary character.103
Finally, the commentary to the ILC Articles states that intention to harm (‘fault’) is
not a constitutive part of a state’s internationally wrongful act.104 Accordingly, fault is not a
prerequisite to an award for damages.
In line with the above, investment treaty tribunals have confirmed the availability of
compensation by way of moral damages under international investment protection treaties.
However, a number of tribunals have recently imposed the additional requirement of fault
99 2001 Articles on Responsibility of States for Internationally Wrongful Acts, 53 UN GAOR Supp. (No. 10) at
43, UN Doc. A/56/83 (2001).
100 International Law Commission, Draft Articles on Responsibility of States for Internationally Wrongful
Acts, November 2001, Supplement No. 10 (A/56/10), chp.IV.E.1 (‘ILC Articles Commentary’), 91;
Chorzów Factory (Claim for Indemnity) (Merits), Germany v. Poland, 1928 P.C.I.J. Ser. A., No. 17, Judgment
(13 September 1928), 47.
101 Ibid. It should be noted that moral damage may also be referred to as ‘non-pecuniary’, ‘non-economic’,
‘non-material’ or ‘intangible’ damages.
102 Opinion in the Lusitania Cases (1923) 7 RIAA 32.
103 ILC Articles Commentary, 91.
104 Ibid., 36.
34
as a pre-requisite to awarding moral damages. If the loss of the aggrieved foreign investor is
no longer at the crux of an evaluation of moral damages, then awarding such damages risks
evolving from the compensatory mechanism described by the ILC Articles, to a punitive
tool to be wielded by tribunals, in contravention of the ILC Articles.
Moral damages: the shift to a non-compensatory approach

In Desert Line, the claimant claimed 40 million Omani rials105 for moral damages includ-
ing loss of reputation.106 The tribunal found that a party may request moral damages in
‘exceptional circumstances’.107 It determined that the state’s treatment of the claimant’s
executives in the case in hand was ‘malicious’ and ‘therefore constitutive of a fault-based
liability’, and that as a result, the state should be liable for the substantial prejudice the
claimant incurred.108 The tribunal awarded moral damages of US$1 million, a sum it con-
sidered ‘more than symbolic yet modest in proportion to the vastness of the [underlying]
project’.109 The tribunal’s focus on the state’s fault begs the question as to whether the
tribunal was seeking not only to compensate the claimant but also to reprimand the state.
The tribunal in Al-Warraq was more explicit in its conclusion that fault is a condition
precedent to moral damages, which are generally awarded ‘only if illegal action was moti-
vated or maliciously induced’.110
In Lemire, the tribunal concluded that fault is a constituent part of the ‘exceptional cir-
cumstances’ required to award moral damages (according to the tribunal in Desert Line) and
elaborated a three-tiered test to determine exceptionality as follows:
- the State’s actions imply physical threat, illegal detention or other analogous situations in
which the ill-treatment contravenes the norms according to which civilized nations are expected
to act;
- the State’s actions cause a deterioration of health, stress, anxiety, other mental suffering such
as humiliation, shame and degradation, or loss of reputation, credit and social position; and
- both cause and effect are grave or substantial.111
In the event, the tribunal decided that the test was not met. Interestingly, it underlined its
decision by pointing out that Mr Lemire’s conduct towards the Ukrainian authorities ‘may
have appeared rude and disrespectful’, which served to ‘reinforce the conclusion that a
105 Approximately US$100 million at the time.

106 Desert Line Projects LLC v.The Republic of Yemen (ICSID Case No. ARB/05/17).
107 Ibid., 289.
108 Ibid., 290.
109 Ibid., 290.
110 See Hesham Talaat M Al-Warraq v. the Republic of Indonesia, UNCITRAL, Final Award (15 December 2014),
653, a claim brought pursuant to the Agreement on Promotion, Protection and Guarantee of Investments
among Member States of the Organisation of the Islamic Conference, dated June 1981. The tribunal relied
upon the ICSID decisions Inmaris Perestroika Sailing Maritime Services GmbH and Others v. Ukraine (ICSID
Case No. ARB/08/8, and The Rompetrol Group NV v. Romania (ICSID Case No. ARB/06/3) in support of
this assertion.
111 Joseph Charles Lemire v. Ukraine (ICSID Case No. ARB/06/18), 333.
35
separate redress for moral damages is not appropriate’.112 The tribunal’s analysis compounds
the notion that the award of damages has moved away from a compensatory measure and
is instead being deployed as a means of dispensing equity, with moral damages available
subject to the attitudes, behaviour, intention, and motivation of the responsible state and
the investor alike.
In Arif, the tribunal referred to the ILC Articles to support its assertion that moral
damages may be awarded in international law, but noted that they are an ‘exceptional
remedy’.113 It stated that compensating a ‘sentiment of frustration and affront’ would ‘sys-
tematically create financial advantages for the victim which go beyond the traditional con-
cept of compensation’.114 It further remarked that both the conduct of the state and the
prejudice of the investor must be ‘grave and substantial’ to merit the award of moral dam-
ages (thereby elevating the non-cumulative ‘grave or substantial’ standard in Lemire).
As in Lemire, the Arif tribunal’s finding that exceptional circumstances did not exist
turned on considerations that did not relate to the loss actually suffered by the investor.
Thus, the tribunal found that the investor should have had a certain level of ‘mental forti-
tude’ to deal with the authorities in a ‘transition economy’ where the institutions are ‘weak’
and governance is ‘improving’.115 These facts, according to the tribunal, have a bearing on
whether the exceptional circumstances test is met. In the event, the tribunal concluded that
although the conduct of the state caused the investor ‘stress and anxiety’, the state’s actions
‘did not reach a level of gravity and intensity which would allow it to conclude that there
were exceptional circumstances which would entail the need for a pecuniary compensation
for moral damages’.116
Although the facts may not have warranted an award of moral damages, the tribunal’s
analysis once again turned away from the concept of compensation as a means of fully
repairing the harm suffered by the investor towards a concept that permits the tribunal to
assess the extent to which an investor deserves an award of moral damages in light of its
own conduct as well as that of the state.
Following Desert Line and Lemire, the tribunal in Bernard von Pezold and others awarded
moral damages, overtly stating that such remedy served the dual function of repairing
‘intangible harm’ to the investor and ‘condemning the actions of the offending State’.117
Thus the tribunal considered that moral damages could be deployed as a punitive measure.
The tribunal also referred to Desert Line when determining quantum, awarding precisely
the same sum of US$1 million, irrespective of the difference between the factual matrices
in the two cases. This further calls into question the extent to which moral damages, in
this instance, were awarded to compensate the injury suffered by the investor rather than
to reprimand the state.
The upshot of these cases is that an absence of malicious and egregious fault on the
part of the state would seem to bar an investor from successfully obtaining moral damages,
112 Ibid., 345.

113 Mr Franck Charles Arif v. Republic of Moldova (ICSID Case No. ARB/11/23), 584.
114 Ibid., 592.
115 Ibid., 605.
116 Ibid., 615.
117 Bernhard von Pezold and others v. Republic of Zimbabwe (ICSID Case No. ARB/10/15), 916.
36
notwithstanding that fault is not a condition precedent to ‘full reparation’ under interna-
tional law as codified in the ILC Articles.
Tribunals should be encouraged to reconsider an award of moral damages as a means
of compensating parties for losses suffered, possibly looking to the jurisprudence of human
rights tribunals for guidance on how intangible harms have been quantified.118 The authors
consider that while equitable considerations concerning the manner in which the state
breached its obligations should not determine the availability of moral damages, equity
could play a role in determining the quantum of any moral damages awarded.119 This
quantum assessment should of course be subject to the usual principles of remoteness and
causation and also broken down where possible so that the damages are understood to cor-
respond to the actual loss suffered.
An investment arbitration tribunal may in practice be an investor’s sole (effective)
recourse to justice for reparation of losses suffered arising out of its investment. It is there-
fore important that notions of equity, merit and fairness are not allowed to dominate deci-
sions on whether or not to award moral damages, at the expense of a proper assessment of
the full extent of damages suffered by the investor and how that can be repaired.
Conclusion
In this chapter, we have examined the different types of non-compensatory damages avail-
able in civil law and common law jurisdictions, and identified the limitations to which
arbitral tribunals are subject when considering a claim for non-compensatory damages,
most notably in the context of a request for punitive damages where tribunals should be
aware of a possible conflict between the applicable law and the lex arbitri.We have seen that
moral damages, viewed as compensatory in both legal systems, are evolving under inter-
national law from a compensatory tool to a non-compensatory one at the hands of invest-
ment treaty tribunals. Such an evolution is problematic if it leads to the award of punitive
damages via the back door.
Given the overlap between participants (among users, counsel and arbitrators) in invest-
ment treaty arbitration and commercial arbitration, it is possible that the non-compensatory
notion of moral damages in the former may begin to influence the award of moral damages
in the latter. Such a development would have profound consequences if tribunals decide
to award moral damages not on the basis of the applicable law but on the basis of equity.
118 See Champagne, A., ‘Moral Damages Left in Limbo’, McGill Journal of Dispute Resolution,Vol 1:2 (2015).
119 See, in this regard, Sabahi, B., ‘Moral Damages in International Investment Law: Some Preliminary Thoughts
in the Aftermath of Desert Line v.Yemen’, Transnational Dispute Management,Volume 9, Issue 1 (January 2012),
260, and Ripinsky S. and Williams K., Damages in International Investment Law (British Institute of International
and Comparative Law, 2008), 312.
37
3
Damages Principles under the Convention on Contracts for the
International Sale of Goods (CISG)
Petra Butler1
Introduction
The CISG provides a neutral set of rules for international sale of goods transactions.2 It
encapsulates the modern understanding of the key legal contract principles in regard to
international sales and is heralded as a successful amalgamation of common and civil law
contract principles.3 According to WTO trade statistics, nine of the 10 largest export and
import nations are CISG contracting states, with the United Kingdom being the excep-
tion. Those 10 countries account for more than 50 per cent of world trade.4 It follows that
international sale of goods contracts account for a large majority of international contracts
1 Petra Butler is associate professor at Victoria University of Wellington and co-director of the Centre for Small
States at Queen Mary University of London.
2 Article 7 CISG directs to an autonomous interpretation of the CISG void of any fall back on domestic
principles. CISG academic literature is almost unanimous in the conclusion that recourse to any national law,
which must be defined according to private international law rules, is an ultima ratio solution for gap filling
under the CISG and should be avoided as far as possible [I Schwenzer/P Hachem in Schlechtriem & Schwenzer
Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 7 para
42; J Honnold/H Flechtner, Uniform Law for International Sales under the 1980 United Nations Convention (4th
ed, Wolters Kluwer, Alphen aan den Rijn, 2009) para 102; U Magnus in Vol XIV Staudingers Kommentar
zum Bürgerlichen Gesetzbuch (14th ed, De Gruyter, Berlin, 2011) Article 7 para 58; P Schlechtriem/P Butler,
UN Law on International Sales (Springer, Heidelberg, 2009) paras 45, 47]. Deducing general principles from
the CISG is always the first priority (Article 7(2)). Since there is no highest court deciding on issues arising
from the application of the CISG note should be taken of academic literature, the opinions by the CISG
Advisory Council, an independent body of experts (www.cisgac.com/) and the jurisprudence from courts and
arbitral tribunals.
3 Compare P Schlechtriem ‘25 Years of the CISG: An international lingua franca for Drafting Uniform Laws,
Legal Principles, Domestic Legislation and Transnational Contracts’ in H Flechtner/R Brand/ M Walter (eds)
Drafting Contracts under the CISG (OUP, Oxford, 2008) 167, 168.
4 See www.wto.org/english/res_e/statis_e/its2014_e/its14_world_maps_merchandise_e.pdf (last accessed
12 July 2016).
38
Damages Principles under the Convention on Contracts for the International Sale of Goods (CISG)
related to trade. It is, therefore, essential to be aware of the application of the CISG, as the
most widely accepted uniform international sales law, and its damages regime.5 The major
advantage of the CISG is that it provides a uniform and neutral set of substantive rules spe-
cifically drafted for international sale of goods contracts. Importantly, unlike some national
contract laws that favour either the buyer or the seller, the CISG balances the rights and
obligations of both equally. The CISG provides for the substance of an international sale
of goods dispute what international arbitration provides in regard to procedure: a neutral,
independent from any domestic law, regulatory framework. Parties who want their inter-
national sale of goods disputes decided in a truly international manner should choose the
CISG as applicable law, and international arbitral tribunals should apply the CISG to an
international sale of goods dispute whenever they have a mandate.6
Application of the CISG (esp Article 1 CISG)

In regard to the application of the CISG to business-to-business international sale of goods
contracts by an arbitral tribunal, three scenarios have to be distinguished (Article 1 CISG).7
Firstly, and uncontroversially, an arbitral tribunal will generally respect the choice of the
CISG by commercial parties as the governing law of their sale of goods contract.8 Second,
it is also uncontroversial that Article 1(1)(b) CISG can be applied by an international arbitral
tribunal.9 Article 1(1)(b) dictates the application of the CISG when the rules of the private
international law of the forum lead to the application of the law of a CISG Member State.
Article 1(1)(b) is not a choice of law rule. It gives the CISG domestic law status and pre-
vents any possible renvoi.10 Third, it is controversial, however, whether an arbitral tribunal
can apply the CISG by virtue of Article 1(1)(a) CISG, which stipulates the application of
5 There are a number of free databases dedicated to providing near comprehensive resources in regard to case
law and academic writing on the CISG: cisg-online: www.globalsaleslaw.org/index.cfm?pageID=29; CISG
database: http://iicl.law.pace.edu/cisg/cisg; UNCITRAL Digest on the CISG: https://www.uncitral.org/pdf/
english/clout/CISG-digest-2012-e.pdf; case law on UNCITRAL texts (‘CLOUT’): www.uncitral.org/clout/
index.jspx.
6 See below in regard to the application of the CISG, in particular footnote 8.
7 See also for a more detailed discussion I Schwenzer/P Hachem in Schlechtriem & Schwenzer Commentary on the
UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Intro to Articles 1- 6 paras 12 et seq.
8 An arbitral tribunal will apply the CISG as the choice of the parties directly if the parties have chosen the
law of a member state without any specification since the CISG is part of its domestic law. However, the
requirements of Article 1(1) have to be met. In addition, a tribunal will respect the direct choice of the CISG
as applicable law if it is either acting as amiable compositeurs or if the lex arbitri permits or even requires the
application of rules of law instead of (or in addition to) a particular domestic law [see I Schwenzer/P Hachem
in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP,
Oxford, 2016) Intro to Articles 1- 6 para 12]. Note that issues of the application of mandatory rules or ordre
public in regard to the application of the CISG should only arise in exceptional circumstances (potentially in
regard to interest if the seat of the arbitration is in an Islamic state) since the CISG was drafted with the aim to
amalgamate the world’s legal regimes.
9 G Petrochilos ‘Arbitration Conflict of Laws Rules and the 1980 International Sales Convention’ (1999)
52 Revue Hellenique de Droit International 191; S Kröll ‘Arbitration and the CISG’ in I Schwenzer,Y Atamer, P
Butler (eds) Current Issues in CISG and Arbitration (Eleven International Publishing, Den Haag, 2013) 59.
10 See in regard to the application of Article 1(1)(b) A Janssen, M Spilker ‘CISG in the World of International
Commercial Arbitration’ 77 (2013) RabelsZ 131, 139 who also discusses whether Article 95 CISG binds the
arbitral tribunal.
39
the CISG if parties have not agreed on an applicable law to their contract but do have their
businesses in two CISG Member States. The prevailing view is that Article 1(1)(a) of the
CISG does not apply in the context of arbitration.11 This view is based on the understand-
ing that the CISG is an international treaty and as such binds the states and its organs but
only those. In other words, Article 1(1)(a) is a direction to the courts alone and not (inter-
national) arbitral tribunals.12
Entitlement to damages
The buyer’s entitlement to damages under Article 45(1)(b) and the seller’s entitlement to
damages under Article 61(1)(b) stem from the respective duties of the parties imposed by
the contract, in particular, the duties stated in Articles 3013 and 53.14 Any kind of breach,
even the most minor one, of a contractual duty can trigger the entitlement to damages. Also,
a breach of the obligation to make restitution when unwinding the contract upon avoid-
ance (Article 81(2)) leads to liability under Article 74.15
To ascertain the particular obligations that the parties have agreed upon, arbitral tri-
bunals are required to consider not only any written contract but also pre-contractual
and post-contractual behaviour of the parties (Article 8(3) CISG) as well as trade usages
between the parties and usages in the relevant industry (Article 9 CISG).16 The seller’s duty
to deliver goods in conformity with the contract (Article 35 CISG) has generated consid-
erable jurisprudence by courts and arbitral tribunals.17 ‘Lack of conformity’ includes not
only differences in quality, but also differences in quantity, delivery of an altogether different
good and defects in packaging.
11 See G Petrochilos ‘Arbitration Conflict of Laws Rules and the 1980 International Sales Convention’ (1999)
52 Revue Hellenique de Droit International 191; S Kröll ‘Arbitration and the CISG’ in I Schwenzer,Y Atamer, P
Butler (eds) Current Issues in CISG and Arbitration (Eleven International Publishing, Den Haag, 2013) 59.
12 S Kröll ‘Arbitration and the CISG’ in Schwenzer, Atamer, Butler (eds) Current Issues in CISG and Arbitration
(Eleven International Publishing, Den Haag, 2013) 59, 65; A Janssen, M Spilker ‘CISG in the World of
International Commercial Arbitration’ 77 (2013) RabelsZ 131, 137; see in regard to the view that arbitral
tribunals should have regard to Article 1(1)(a) P Butler ‘Choice of Law’ in L DiMatteo/A Janssen/U
Magnus/R Schulze (eds) International Sales Law (Beck, Hart, Nomos, Munich, 2016) Ch 30 paras 63-70.
13 CISG, Article 30 ‘The seller must deliver the goods, hand over any documents relating to them and transfer
the property in the goods, as required by the contract and this Convention.
14 CISG, Article 53: ‘The buyer must pay the price for the goods and take delivery of them as required by the
contract and this Convention.’
15 Roder Zelt- und Handelskonstruktionen GmbH v. Rosedown Park Pty Ltd and Reginald R Eustace (Fed Ct, Adelaide,
SA (28 April 1995) CISG-online 218.
16 That means the parol evidence rule is not applicable under the CISG unless the parties have specifically
agreed to the exclusivity of the written contract. It also should be noted that consideration is not required for
a valid contract under the CISG.
17 Overview in S Kröll in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the
International Sale of Goods (Beck, Hart, Munich, 2011) Article 35; I Schwenzer in Schlechtriem & Schwenzer
Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 35.
40
Damages
Under the CISG, the obligee can choose either specific performance,18 price reduction or
damages as the primary remedy for a breach of the sales contract. Articles 74 et seq. do not
provide a basis for an aggrieved party to claim damages.The requirements of Articles 45 and
61 have to be met for an obligee to be entitled to damages. The extent of the damages an
obligee is entitled to is set out by Articles 74 et seq. In the majority of cases the remedy
sought will be damages.19 The award of damages is dealt with in four provisions of the CISG
(Articles 74–77). These provisions provide the framework for the recovery of economic
loss. The CISG does not contain specific guidelines for the calculation of damages. Interest
is dealt with separately in Article 78. Article 79 sets out the requirements when a party is
excused of its performance as a result of force majeure or hardship.
General principle – Article 7420

The purpose of a damages award under the CISG is clearly stated by Article 74 to be
compensatory. The obligee is entitled to a sum equal to the loss caused by the breach
of contract. The obligee is entitled to be put in the economic position as if the contract
had been fully and correctly performed.21 The obligor is liable for all losses arising from
non-performance, irrespective of fault,22 unless the obligor is exempted in accordance with
Articles 79 and 80 CISG.23 Article 74 encompasses two principles: full compensation and
limitation of liability by the foreseeability rule, and thereby strives to marry the civil law
and common law traditions.
Compensation
That full compensation is the underlying damages principles is undisputed. However, the
precise meaning of full compensation has yet to be determined.24 Jurisprudence and aca-
demic commentary have established that compensation under the CISG comprises the obli-
gee’s expectation interest (i.e., gaining the benefits from the performance),25 their indem-
18 A claim for specific performance is subject to Article 28.

19 See the jurisprudence in I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the
International Sale of Goods (4th ed, OUP, Oxford, 2016) Articles 74 et seq.; J Gotanda in S Kröll/L Mistelis/P
Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale of Goods (Beck, Hart, Munich,
2011) Articles 74 et seq.
20 CISG, Article 74: ‘Damages for breach of contract by one party consist of a sum equal to the loss, including
loss of profit, suffered by the other party as a consequence of the breach. Such damages may not exceed
the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the
contract, in the light of the facts and matters of which he then knew or ought to have known, as a possible
consequence of the breach of contract.’
21 ‘Der Gläubiger ist wirtschaftlich so zu stellen, wie wenn der Vertrag vollumfänglich korrekt erfüllt worden
wäre’. Handelsgericht Zürich (17 September 2014) CISG-online 2656.
22 OGH (15 January 2013), CISG-online 2398; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN
Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 74 para 3.
23 See page 31, infra.
24 I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods
(4th ed, OUP, Oxford, 2016) Article 74 para 5.
25 M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International
Sales Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 23; I Schwenzer in Schlechtriem & Schwenzer
41
nity interest (i.e., not to suffer damage to other interests as a result of non-performance),26
but also their reliance interest (i.e., the expenditure made in reliance on the existence of the
contract).27 It is generally accepted that the CISG does not differentiate between pecuniary
and non-pecuniary loss and that the CISG does not per se prohibit overcompensation (i.e.,
that the damages claim exceeds the performance interest).28
Loss
Loss is not defined, except for Article 74 stating that loss includes loss of profits. It follows
that future losses are included in the concept of loss. Not included in the concept of loss
are punitive damages, since Article 74 is directed only towards the claimant’s loss. Article 74,
therefore, gives tribunals broad authority to award damages ‘in a manner best suited to the
circumstances’.29
It should be noted that the CISG does not adhere as such to the doctrine of efficient
breach of contract. Where the obligee has the right to avoid the contract, damages will be
awarded under Article 74, despite any assertion that certain future losses would not have
accrued but for the avoidance of the contract.30
Categories of loss
• Direct loss – Direct loss is measured by ‘the difference between the value to the injured
party of the performance that should have been received and the value to that party of
what, if anything, actually was received’.31 If the contract is avoided, direct damages are
calculated pursuant to Articles 75 and 76 (i.e., based on the costs of a cover purchase
or based on the market value of the goods). In cases where the obligee undertakes
measures to place itself in the same position that it would have been in had the contract
been properly performed, the obligee is entitled to recover the costs of those measures,
provided that they were reasonable.32
Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article
74 para 3.
26 OGH (14 January 2002) CISG-online 643; W Witz in W Witz/H-C Salger/M Lorenz, Internationales
Einheitliches Kaufrecht (Beck, Munich, 2016) Article 74 para 12.
27 OGH (14 January 2002) CISG-online 643, CISG-AC Op 6, J Gotanda, Comment 1.1.
29 Secretariat Commentary on the 1978 Draft, Article 70 (now Article 74) para 4.
30 This is implicit in Articles 75 & 76. M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U
Magnus/R Schulze (eds), International Sales Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 22.
31 Handelsgericht Zürich (17 September 2014) CISG-online 2656; Landgericht Trier (12 October 1995)
CISG-online 160; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for
the International Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 17; see also Secretariat Commentary
on 1978 Draft, Article 70 (now Article 74) para 7. Note that in regard to the seller’s calculation of damages
Article 74 et seq. are applicable within the European Union instead of the domestic provisions of the Late
Payment Directive (see I Schwenzer/P Hachem in Schlechtriem & Schwenzer Commentary on the UN Convention
on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 90 para 4 et seq.)
32 See Oberster Gerichtshof (14 January 2002) CISG-online 643; Nova Tool and Mold Inc v. London Industries Inc,
Ontario Court of Appeal (16 December 1998) CISG-online 572, [2000] O.J. No. 307. No. C31315; Delchi
42
Examples:
• If the delivery of the goods is unjustifiably delayed and the buyer carries out rea-
sonable measures to overcome the temporary loss and to avoid consequential dam-
ages, the buyer may be entitled to recover the expenses incurred.33 In particular,
rental costs for a replacement good can be claimed irrespective of whether or not a
replacement was actually obtained.34
• If the buyer is in possession of the defective goods but has not avoided the contract,
the buyer can recover damages pursuant to Article 74 for substitute transactions.The
value of the non-conforming goods has to be deducted.35
• If the non-conformity of the delivered goods can be remedied, the loss can be cal-
culated according to the necessary and reasonable expenses for the cure.36
• The seller is generally entitled to reimbursement of a bridging loan if the buyer
unjustifiably does not pay the purchase price in time.37
• The seller is entitled to damages if, as a result of the buyer’s late payment, the seller
suffers loss because of change of exchange rates or currency devaluation.38
• The loss of value of the purchase price due to inflation cannot generally be recovered.39
• Incidental loss – Expenses that were incurred by the obligee to avoid any additional
disadvantages are recoverable under Article 74 and are referred to as incidental loss.40
Generally, additional costs incurred by a party as a result of the other party’s unjustified
refusal to perform are recoverable.41 Article 77 (mitigation of damages) must be taken
into account for all incidental losses.42
Examples:
Carrier SpA v. Rotorex Corp, U.S. Circuit Court of Appeals (2nd Cir) (6 December 1996) CISG-online 140;
See Secretariat Commentary on 1978 Draft, Article 70 (now Article 74) para 6.
33 Oberlandesgericht Köln (24 April 2013) CISG-online 2480 para 46; Oberlandesgericht Köln (8 January 1997)
CISG-online 217; see Secretariat Commentary on 1978 Draft, Article 70 (now Article 74) para 7.
34 Compare Oberlandesgericht Köln (8 January 1997) CISG-online 217.
35 Handelsgericht Zürich (17 September 2014) CISG-online 2656; OLG Graz (29 July 2004) CISG-online
1627; Audiencia Provincial de Palencia (26 September 2005) CISG-online 1673; Chamber of National and
International Arbitration of Milan (28 September 2001) CISG-online 1582.
36 Bundesgerichtshof (25 June 1997) CISG-online 277; Delchi Carrier SpA v. Rotorex Corp US Circuit Court
of Appeals (2nd Cir) (6 December 1996) CISG-online 140; Oberlandesgericht Hamm (9 June 1995)
CISG-online 146. It has to be noted that the seller keeps the right to remedy the defects pursuant Article 48.
37 App Ct of Eastern Finland (27 March 1997) CISG-online 782.
38 Kantonsgericht Wallis (28 January 2009) CISG-online 2025; Oberlandesgericht München (18 October 1978)
but see OLG Düsseldorf (14 January 1994) CISG-online 119: recognition only in as far as seller can prove
that a timely payment would have yielded a higher monetary value than was possible as a result of the delay;
see overview J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the
International Sale of Goods (Beck, Hart, Munich, 2011) Article 74 paras 52 et seq.
39 OLG Düsseldorf (14 January 1994) CISG-online 119.
41 Bundesgerichtshof (10 December 1986) NJW 1987, 831.
42 See in regard to Article 77, page 27, infra.
43
• The buyer’s expenses for storing and preserving goods that have been delivered late
or that are defective and are returned to the seller.43
• The buyer’s expenses for the expedited shipment of alternative goods.44
• The buyer’s reasonable expenses incurred ascertaining whether the goods are in
conformity with the contract, but only if the non-conformity is actually established
and notice is given to the seller.45
• The seller’s expenses for storing and preserving goods that the buyer has unjustifi-
ably rejected or has not taken delivery of to avoid greater loss.46
• The seller’s expenses as a result of the buyer’s late payment.47
• The seller’s expenses as a result of the shipping space provided by the buyer being
unsuitable for the loading of the goods because it is dirty.48
• The seller’s expenses as a result of damage to the goods from the goods being stored
because the buyer had not paid in time.49
• Consequential loss – Consequential loss comprises losses other than those caused by
non-performance as such. Typically, consequential loss arises because of the obligee’s
liability to third parties as a result of the breach.
It is controversial whether damages resulting from the buyer’s liability to third parties
for death or personal injury caused by the seller’s defective products can be recovered
under the CISG. Some courts and academic literature deny the applicability of the
CISG to the recourse of the buyer in accordance with Article 5 CISG.50 Others, and the
CISG Advisory Council, allow the buyer’s claim for a consequential damage that is a
result of the seller’s defective product injuring a third party or his or her property.51 The
latter view is arguably preferable since it allows the buyer to be compensated under one
damages regime (i.e., that of the CISG). It avoids unnecessarily distinguishing between
separate heads of the buyer’s liability, namely contract, tort or property. Having to claim
43 OLG Köln (14 August 2006) CISG-online 1405; CIETAC (9 November 2005) CISG-online 1444;
Landgericht Landshut (5 April 1995) CISG-online 193; Arbitral Award Vienna Arbitral Tribunal
(15 June 1994) CISG-online 691; Arbitral Award, Arbitration Institution of the Stockholm Chamber of
Commerce 107/1997, CISG-online 1301.
44 Delchi Carrier SpA v. Rotorex Corp US Circuit Court of Appeals (2nd Cir) (6 December 1996)
CISG-online 140.
45 OLG Köln (14 August 2006) CISG-online 1405; Arbitral Award, Arbitration Institution of the Stockholm
Chamber of Commerce 107/1997, CISG-online 1301; Bundesgerichtshof (25 June 1997), CISG-online 277.
46 See Arbitral Award, ICC 7585/1992, CISG-online 105.
47 District Court Tukums (5 May 2010) CISG-online 2584; ICC Ct Arb 7197/1992 CLOUT No 104; Int Ct
Russian CCI (9 September 1994) 375/1993 http://cisgw3.law.pace.edu/cases/940909r1.html.
48 OLG Karlsruhe (8 February 2006) CISG-online 1328.
50 Cour d’appel de Paris (18 June 2002) www.cisg.fr/decision.html?lang=fr&date=02-06-18 (last accessed
27 July 2016); W Witz in W Witz/H-C Salger/ M Lorenz, Internationales Einheitliches Kaufrecht (Beck, Munich,
2016) Article 5 para 5; U Magnus in J v Staudingers Kommentar zum Bürgerlichen Recht Vol XIV (14th ed, De
Gruyter, Berlin, 2011) Article 5 para 8.
51 Supported by OLG Düsseldorf (2 July 1993) CISG-online 74; Handelsgericht Zürich (26 April 1995)
CISG-online 248 para 5.b.; CISG-AC Op 12 Rapporteur Sono, Comment 2.3.1; I Schwenzer/P Hachem
in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP,
Oxford, 2016) Article 5 para 10.
44
under different heads of damages would mean that a mixture of international law, the
CISG in regard to contractual claims, and applicable domestic law, in regard to tort or
property claims, would be applicable for a breach of the contract. The application of
those different damages regimes has the potential to either overcompensate or under-
compensate the buyer. In regard to compensating for the consequences of a breach of
an international sales contract, the CISG comprises a modern damages regime that
amalgamates common and civil law principle and is, therefore, preferable.
Academic literature and jurisprudence are not unanimous as to whether domestic
tort law may be applied concurrently with the CISG. Some support leaving this deci-
sion to the applicable domestic law.52 Others argue for the exclusion of domestic tort
law in these cases.53 A third view distinguishes between damage caused by the defective
performance of the good, in which case the CISG is exclusively applicable, and damages
caused because the goods did not adhere to general safety expectations and standards, in
which case the buyer has a course of action under the CISG and the applicable domestic
tort law concurrently available to them.
Examples:
• Time (e.g., visiting customers) and cost spent in trying to rectify defective goods are
only recoverable if extra staff had to be employed or additional workload was caused.54
• Legal costs (extrajudicial or procedural) incurred by the obligee in disputes with
third parties are recoverable.55
• Reputational loss and loss of goodwill as a result of breach of contract can be recov-
ered.56 The calculation of the loss of reputation should take into account, for exam-
ple, the size of the company, the market, the value of the trademark and the neces-
sary costs to re-establish the reputation.57
• Damage to the buyer’s own property as a result of the defective goods can
be recovered.58
52 See Miami Valley Paper LCC v. Lebbing Engineering and Consulting GmbH SD Ohio (10 October 2006)
CISG-online 1362, Supreme Court of Israel (17 March 2009) CISG-online 1980 para 73; U Magnus in J v
Staudingers Kommentar zum Bürgerlichen Recht Vol XIV (14th ed, De Gruyter, Berlin, 2011) Article 5 para 14; J
Lookofsky ‘Understanding the CISG’ (2003) Duke J Comp & Int’l L 263, 285.
53 OLG Tübingen (26 May 1998) CISG-online 513; J Honnold/H Flechtner, Uniform Law for International Sales
Under the 1980 United Nations Convention (Kluwer Law International, Alphen aan Den Rijn, 2009) Article
5 para 73.
54 See Castel Electronics Pty Ltd v.Toshiba Sinagpore Ptd Ltd Fed Ct Aust (28 September 2010) CISG-online 2158.
(4th ed, 2016) Article 74 para 35 but see in regard to the recovery of the obligee’s legal costs under Article
74 from the obligor stemming from their relationship, see page 15, infra.
56 CISG-AC Op 6, Calculation of Damages under CISG Article 74, Rapporteur J Gotanda, Comment 7.1; P
Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) para 299a; U Magnus in J
v Staudingers Kommentar zum Bürgerlichen Recht Vol XIV (14th ed, De Gruyter, Berlin, 2011) Article 74 para
27; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods
(4th ed, 2016) Article 74 para 36.
(4th ed, 2016) Article 74 para 36.
58 See examples in P Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) para 40.
45
• If the buyer has agreed to a contractual penalty in a subsequent contract, this penalty
can generally also be recovered from the seller.59
• The seller might incur consequential loss where the buyer refused to take delivery
of the goods (Article 53).60
Loss of profits
Article 74 explicitly provides that damages for breach of contract include lost profits.61
Lost profits are awarded to place the aggrieved party in the same pecuniary position it
would have been in but for the breach.62 It has to be emphasised that, in line with the view
advanced with regard to standard of proof,63 lost profits do not have to be calculated with
mathematical precision.64 Lost profits need to be established with reasonable certainty.65
The buyer cannot claim lost profits if the buyer failed to give notice pursuant to Article 44.
Whether or not the buyer has a reasonable excuse for not having given notice is irrelevant.66
The obligee is not only entitled to recovery for lost profits incurred prior to the judg-
ment or award, but also for future lost profits. Future lost profits are limited by the require-
ments that they have to be proved with reasonable certainty, that there has to be a causal
connection between the breach and the future profits, and that they be foreseeable.67
Examples:
• Lost profits include losses resulting from the inability to keep a business running caused
by the breach of contract.68
• Lost profits also include fixed costs (i.e., general expenses) on a pro rata basis69 that have
to be reduced by the expenses that would have been incurred when realising those
fixed costs.70
59 Aricle 74’s foreseeability requirement, however, might limit the recoverability – see page 13, infra.
60 See LG Aachen (14 May 1993) CISG-online 86.
61 Secretariat Commentary: the reference to loss profits was included since ‘in some legal systems the concept of
‘loss’ standing alone does not include loss of profit’ (Secretariat Commentary on 1978 Draft, Article 70 (now
Article 74) para 3.
62 See Audiencia Provincial de Murcia (15 July 2010) CISG-online 2130.
64 See CISG-AC Opinion No 6, Calculation of Damages under CISG Article 74, Rapporteur J Gotanda,
Comment 3.19.
65 J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale
of Goods (Beck, Hart, Munich, 2011) Article 74 para 27.
66 Compare ICC Court of Arbitration Arbitral Award No 9187/1999 CISG-online 705; W Witz in W
Witz/H-C Salger/M Lorenz (eds), Internationales Einheitliches Kaufrecht (Beck, Munich, 2016) Article 74 para
15; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods
of Goods (Beck, Hart, Munich, 2011) Article 74 para 28; D Saidov, The Law of Damages in International Sales:The
CISG and other International Instruments (Hart Publishing, Oxford, 2008) 76.
69 OLG Hamburg (26 November 1999) CISG-online 515; Delchi Carrier SpA v Rotorex Corp US Circuit Court
of Appeals (2nd Cir) (6 December 1996) CISG-online 140.
70 Compare Handelsgericht Zürich (22 November 2010) CISG-online 2160.
46
• The loss of chance of winning is recoverable.71

• Frustrated expenses are recoverable. They constitute the minimum loss incurred.72
• The seller is entitled to lost profits that are as a result of having missed out on an invest-
ment opportunity.73
Calculation of loss
• Concrete and abstract calculation – The principle of full compensation necessitates the
admissibility of the loss being calculated abstractly74 to achieve equal outcomes for all
obligees. As Schwenzer explains:
It cannot be justified that a truck seller is to compensate a commercial carrier for the costs of
vehicles the carrier rents in case of non-delivery, while the same breach of contract remains with-
out consequences when the buyer is an NGO which intends to use the trucks to deliver food
to conflict areas and cannot rent substitute vehicles. The loss due to the loss of use can be easily
calculated abstractly since rental markets exist for nearly for all types of goods.75
• Accounting for gain –The obligee has to offset the loss from the breach by any gains
resulting from the non-performance.76 It is important to note that only the gain that has
an adequate connection to the breach is to be subtracted.77
Time
Article 74 does not provide a specific time for the calculation of damages. A tribunal,
therefore, has broad discretion to determine the appropriate moment in time to calculate
the damages. The principle of full compensation, however, means that damages should be
71 CISG-AC Opinion No 6, Calculation of Damages under CISG Article 74, Rapporteur J Gotanda, Comment
3.15; I Schwenzer/P Hachem ‘The Scope of the CISG Provisions on Damages’ in D Saidov/R Cunnington
(eds), Contract Damages: Domestic and International Perspectives (Hart, Oxford, 2008) 91, 98; D Saidov, The Law of
Damages in International Sales:The CISG and other International Instruments (Hart, Oxford, 2008) 70 et seq. but
Delchi Carrier SpA v. Rotorex Corp US Circuit Court of Appeals (2nd Cir) (6 December 1996) CISG-online
140; Kantonsgericht Zug (14 December 2009) CISG-online 2026 not 13.5; but compare PICC (International
Institute for the Unification of Private Law, UNIDROIT Principles of International Commercial Contracts
2010, Official Comment 2) 7.4.3(2), which also stipulates the reimbursement of the loss of chance.
72 CIETAC (4 April 1997) CISG-online 1660; Serbian Chamber of Commerce (1 October 2007) CISG-online
1793; P Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) para 308.
73 Landgericht Stuttgart (31 August 1989) CISG-online 11; AG Oldenburg (24 April 1990) CISG-online 20.
74 Compare Semi-Materials Co Ltd v. MEMC Material Electronics, Ed Mo (10 January 2011) CISG-online 2168.
76 Compare Secretariat Commentary on 1978 Draft, Article 70 (now Article 74) para 5; J Gotanda in S Kröll/L
Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale of Goods (Beck, Hart,
Munich, 2011) Article 74 para 34.
77 J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International
Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 27; see also I Schwenzer in Schlechtriem & Schwenzer
74 para 44.
47
assessed at the latest possible time.78 That allows compensation for all possible consequences
that may arise.
Place
The CISG does not provide for where damages have to be paid. Schwenzer argues that
damages should be paid at the place where the breached obligation was to be performed.79
Others contend that damages should be paid at the obligee’s place of business.80 The latter
view is in line with the general principle of Articles 57 and 74 of full compensation.
Currency
General jurisprudence and academic opinion is that to fully compensate an obligee, dam-
ages should be calculated under the currency of the loss.81 However, the actual payment of
the damages may be in a different currency. In the case that a different currency in regard
to the damages is chosen, the tribunal will have to determine the appropriate exchange rate.
Causation
The obligee must establish that the loss was caused by the breach of the contract. It is
necessary, but generally also sufficient, for the breach to have been the conditio sine qua non
(i.e., the precondition for the occurrence of the detriment).82 It is immaterial whether the
breach caused the damage directly or indirectly.
Foreseeability
The loss has to be foreseeable at the time of contract conclusion.83 It is not the exact size
of the loss, but only the possibility of such loss that must be foreseeable.The foreseeable loss
Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 29; see also I Schwenzer in Schlechtriem & Schwenzer
74 para 46.
80 OLG Düsseldorf (2 July 1993) CISG-online 74; P Huber in P Huber/A Mullis, The CISG: A Textbook for
Students and Practitioners (sellier, Munich, 2007) 281; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds),
UN Convention on Contracts for the International Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 30.
81 Handelsgericht Aargau (10 July 2010) CISG-online 2176; OLG Hamburg (28 February 1997) CISG-online
261; D Saidov, The Law of Damages in International Sales:The CISG and other International Instruments (Hart,
Oxford, 2008) 265; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts
for the International Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 31; I Schwenzer in Schlechtriem
& Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016)
Article 74 para 65.
82 Kantonsgericht Zug (14 December 2009) CISG-online 2026, note 11.2.
83 Bundesgerichtshof (25 November 1998) CISG-online 353 (seller delivered surface-protective film to buyer
for use by the buyer’s business partner. The buyer did not test the film, which had to be self-adhesive and
removable. When the film was removed from polished high-grade steel products by the buyer’s business
partner, it left residues of glue on the surface. The buyer paid the expenses of removing the glue residue and
claimed for reimbursement of these expenses against the seller.); OLG Köln (21 May 1996) CISG-online
254. Cour de Cassation (17 February 2015) www.legifrance.gouv.fr/affichJuriJudi.do?oldAction=rechJuriJu
48
must be assessed in light of the facts that the party in breach knew (subjective assessment) or
ought to have known (objective assessment). What is relevant is what in that sector of trade
normally could have been foreseen, taking into account the information the contracting
party had at its disposal.84
Limitation on damages
Limited to monetary relief
It is well accepted that relief under Article 74 must be in the form of a monetary payment.85
Limited to material loss

The CISG does not expressly exclude liability for non-pecuniary loss. However, given
the nature of the CISG regulating international sales of goods between businesses, the
CISG’s ambit does not extend to damages for pain and suffering, mental distress and loss of
amenities.86 Loss of reputation and loss of chance are classified under the CISG as pecuni-
ary loss.87 Schwenzer argues that non-pecuniary damages maybe recoverable under Article
74 if the intangible purpose of the performance became part of the contract and, there-
fore, making the incurred loss a typical consequence of the non-performance.88 Including
non-pecuniary damages under Article 74, if the parties have so agreed, conforms with the
CISG’s underlying principle of party autonomy.
Punitive damages
Article 74 does not permit the recovery of punitive damages. Article 74 expressly limits
damages to ‘a sum equal to the loss’.89 The prevailing view is that the application of the
CISG excludes the award of punitive damages under the applicable domestic law. However,
the parties are free to stipulate the provision of punitive damages in their contract.
di&idTexte=JURITEXT000030270329&fastReqId=1445360440&fastPos=1 (last accessed 28 July 2016) –

foreseeability not ascertainable, if damages cannot with certainty be established.
84 See ICC Court of Arbitration, Arbitration Case No. 9187 of June 1999 (Coke case) www.cisg.law.pace.edu/
cisg/wais/db/cases2/999187i1.html.
85 See Oberster Gerichtshof (12 January 2002) CISG-online 643.
Sale of Goods (Beck, Hart, Munich, 2011) Article 74 paras 38, 39 with further references; I Schwenzer in
Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP,
Oxford, 2016) Article 74 para 41 with further references.
87 See I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of Goods
(4th ed, OUP, Oxford, 2016) Article 74 para 4; see examples in UNCITRAL Digest on the CISG, Article
74 paras 21 et seq. www.uncitral.org/pdf/english/clout/CISG-digest-2012-e.pdf.
88 M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International
Sales Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 41. I Schwenzer in Schlechtriem & Schwenzer
Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 74 para
41; explicitly disagreeing P Huber in P Huber/A Mullis, The CISG: A Textbook for Students and Practitioners
(sellier, Munich, 2007) 279.
89 Oberlandesgericht Düsseldorf (2 July 1993) CISG-online 74.
49
Special cases
Disgorgement of profits
Given the considerable divergence of jurisprudence and academic literature in civil and
common law jurisdictions in regard to the question of whether disgorgement of profits is
a remedy, a head of damages or not recoverable at all,90 tribunals should arguably consider
granting damages based on disgorgement of profits only in narrow circumstances. In prac-
tice, international sale of goods cases where the obligee has suffered no loss at all, while
the obligor was able to make a profit, will be rare. Schwenzer has identified three scenarios
where the obligee should be entitled to disgorgement of profit under Article 74 (i.e., as a
head of damage):91
• the seller sells the goods a second time and realises a higher profit than agreed to under
the contract with the first buyer (i.e., efficient breach);
• the seller, who is contractually obliged to manufacture the goods in accordance with
ethical or human rights standards, lowers his or her production costs by resorting to
production mechanisms that are in breach of the agreement, and thereby increasing
their profits; or
• the buyer supplies a defined market, such as the European Union, NAFTA or Mercosur,
against an express stipulation in the contract with the purchased goods, and thus makes
a profit.
The commonality in all three cases is that common damages under Article 74 are difficult, if
not impossible, to prove.Therefore, tribunals may be open to calculate damages as disgorge-
ment of profits in cases where damages under Article 74 are otherwise impossible to prove
but the obligor would gain a clear windfall otherwise.
Legal costs
A uniform application of the CISG requires that the question of recoverability of legal costs
cannot depend on its classification as substantive or procedural by the relevant lex fori. That
would lead to a non-uniform interpretation and application of the CISG. Uncontroversially,
attorney fees and costs can be awarded when the contract provides for their payment. The
majority of academic literature is in agreement that extrajudicial costs may be recovered as
incidental damages under Article 74 (especially if extrajudicial activity mitigates damages).92
Extrajudicial costs include legal costs incurred in connection with preventing the breach or
90 See for a general overview of the treatment of disgorgement of profits: E Hondius/A Janssen (eds),
Disgorgement of Profits - Gain Based Remedies throughout the World (Springer, Heidelberg, 2015).
92 LG München (30 August 2001) CISG-online 668; Hermanos Successors SA v. Hearthside Baking Company,
Federal Appellate Court (7th Cir) (19 November 2002) CISG-online 684; J Gotanda in S Kröll/L Mistelis/P
2011) Article 74 para 73; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the
International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 74 para 31.
50
pursuing rights under the contract, such as a demand for performance.93 On the other hand,
the majority in the academic literature and jurisprudence by the courts does not support
that litigation costs are recoverable under Article 74.94 Arbitral tribunals do not present a
unified picture. Often it is hard to ascertain whether the tribunal has awarded costs under
the applicable rules or under Article 74.95
The majority opinion holds that the recovery of litigation costs is a matter of the
applicable domestic law or the applicable arbitration rules respectively. The main ration-
ale advanced is that allowing for litigation costs to fall under the ambit of loss under
Article 74 would violate the principle of equality between the parties which is embodied
in the CISG.96 If recovery of litigation costs was possible under Article 74, it would lead to
an unjustifiable preferential treatment of the successful plaintiff over the successful defend-
ant, since the defendant would not be able to claim litigation costs.97 However, this view
misinterprets the CISG equality principle. The CISG’s equality principle relates to seller
and buyer and not claimant and respondent. Buyer and seller will not be treated differently
in regard to the recovery of litigation costs under Article 74. The buyer as well as the seller
are able to claim litigation costs as part of their damages if they are the plaintiff. To achieve
global uniformity for parties to a contract to which the CISG applies, the better view to
take arguably is that litigation costs are incidental damages under Article 74. The recover-
ability of litigation costs will be limited by the foreseeability and causation requirements
inherent in Article 74.98
It seems less controversial that legal costs may indirectly be recovered as damages if they
accrue in regard to a sale to a third party.99
94 San Lucio et al v. Import & Storage Services et al D NJ (15 April 2009) CISG-online 1836; Norfolk Southern
Railway Company v. Power Source Suppy Inc WD Pa (25 July 2008) CISG-online 1776; M Bridge ‘Remedies
and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International Sales Law (Beck, Hart &
Nomos, Munich, 2016) Ch 19 paras 53, 54; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN
Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 74 para 30; CISG-AC Opinon
No. 6, Calculation of Damages under CISG Article 74, Rapporteur J Gotanda Comment 5.1.
95 See overview in UNCITRAL Digest on the CISG, Article 74 para 27 www.uncitral.org/pdf/english/clout/
CISG-digest-2012-e.pdf.
(4th ed, OUP, Oxford, 2016) Article 74 para 30; CISG-AC Opinon No. 6, Calculation of Damages under
CISG Article 74, Rapporteur J Gotanda Comment 5.1.
(4th ed, OUP, Oxford, 2016) Article 74 para 31 with further references.
98 See not excluding that Article 74 covers legal costs Stemcor v. Miracero (30 September 2014) US District Court,
SD of New York (14-cv-00921 (LAK)) CISG-online 2659; in regard to foreseeability, page 13, and in regard
to causation page 13.
99 See M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International
Sales Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 55: Goods are sold by A to B under a CISG
contract. The same goods are sold by B to C, whether under the CISG or domestic law. A breaches the
contract with B by delivering defective goods. B who on-sells those defective goods is in breach of its contract
with C. B ends up having to pay damages to C as well as its own legal costs and a contribution to C’s legal
costs. When B sues A for breach of contract under the CISG, B’s loss will include not just its damages liability
to C but also both sets of legal costs in the B-C proceedings.
51
Penalty clauses/liquidated damages

The CISG does not regulate if the contracting parties agree in advance the amount of
recoverable damages: be it as a penalty clause or a liquidated damages clause, be it that the
amount agreed falls below the foreseeable amount of loss, be it that the amount agreed is
in excess of any loss caused by the breach of contract.100 Whether or not an agreed damages
clause is valid in accordance with Article 4 is a matter of the applicable domestic law to the
contract ‘it has to be noted that tribunals have to fill the gap in the CISG finding an inter-
nal solution in accordance with Article 7 instead of resorting to domestic law’.101 Agreed
damages clauses, which are valid under the applicable domestic law, are compatible with
the CISG since an agreed damages clause may encourage performance of the contract and
deterring a breach, thereby fostering a basic value underlying the CISG as a whole. In the
event of a breach of contract, the agreed damages clause may encourage the parties to settle
their differences and avoid legal costs. In addition, a clause will provide clearer guidance for
recovery than often the foreseeability requirement can provide. An agreed damages clause
can, therefore, aid dispute resolution.102
Third-party claims
Only the contracting party can seek damages under Article 74. Third parties must pursue
their claims under applicable domestic law.103
Loss of volume
To allow for full compensation in the case of a lost volume seller,104 damages under Article
74 should encompass the recovery of lost profits that the seller would have made but for
100 See in contrast PICC, Article 7.1.6.: ‘A clause which limits or excludes one party’s liability for
non-performance or which permits one party to render performance substantially different from what the
other party reasonably expected may not be invoked if it would be grossly unfair to do so, having regard to the
purpose of the contract.’
101 Article 4 states;’ This Convention governs only the formation of the contract of sale and the rights and
obligations of the seller and the buyer arising from such a contract. In particular, except as otherwise expressly
provided in this Convention, it is not concerned with: (a) the validity of the contract or of any of its provisions
or of any usage;[…]’; see in regard to the application: OLG München (8 February 1995) cisgw3.law.pace.
edu/cases/950208g2.html; Hof Arnhem (22 August 1995) http://cisgw3.law.pace.edu/cases/950822n1.html;
ICC Court of Arbitration, Arbitral Award No 7197/1992 cisgw3.law.pace.edu/cases/927197i1.html; CISG
AC Opinion No 10, Agreed Sums Payable upon Breach of an Obligation in CISG Contracts, Rapporteur
P Hachem.
102 M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International Sales
Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 72.
103 See P Huber in P Huber/A Mullis The CISG: A Textbook for Students and Practitioners (sellier, Munich,
2007) 280.
104 A lost volume seller is a seller who can produce as much of certain goods as they can sell. That means that a
lost volume seller loses out on an opportunity to sell extra goods if the buyer breaches the contract.
52
the buyer’s breach, irrespective of any subsequent transactions by the aggrieved party.105 The
calculation of the lost profit may present, in some cases, a considerable forensic challenge.106
Child labour/human rights standards

It has been argued that human rights standards can be an inherent characteristic of goods.
In particular, there seems to be a general opinion that it is an inherent characteristic of any
good that a good be manufactured without child labour.107 If a good is manufactured with
child labour or contrary to a contractually agreed ethical/human rights standard, the buyer
can demand the difference between the price for the goods manufactured under ethical/
human rights compatible conditions and the price for goods manufactured in violation of
those conditions. In cases where the market value is difficult to assess, the manufacturing
costs that were saved as a result of the breach of contract can be used as minimum damages.108
Burden of proof and standard of proof

The CISG does not explicitly address either the burden of proof nor the level of proof
required. Jurisprudence and academic commentary generally agree that ‘a party who asserts
a claim has to prove all circumstance or facts advantageous to him’ (i.e., the party claiming
damages bears the burden to prove its damages).109
In regard to the level of proof required, jurisprudence and academic literature do not
present a unified picture. First, it has to be noted that tribunals have to fill the gap in
the CISG finding an internal solution in accordance with Article 7, instead of resorting
105 Oberster Gerichtshof (28 April 2000) CISG-online 581; see for an extensive analysis M Bridge ‘Remedies
and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International Sales Law (Beck, Hart &
Nomos, Munich, 2016) Ch 19 paras 48-50.
106 See example by M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds),
International Sales Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 50.
107 See for an in depth discussion of human rights standards as inherent characteristics of goods (Article 35): I
Schwenzer/B Leisinger ‘Ethical Values and International Sales Contracts’ in R Cranston/J Ramberg/J Ziegel
(eds) Commercial Law Challenges in the 21st Century; Jan Hellner in memorium (Stockholm Centre for
Commercial Law, Juridiska institutionen, 2007) 249; P Butler ‘The CISG - a secret weapon in the fight for a
Fairer World?’ in I Schwenzer (ed), CISG – 35 years and beyond (Eleven International Publishing, Den Haag,
2016) ch 18.
(4th ed, OUP, Oxford, 2016) Article 74 para 24; I Schwenzer/P Hachem ‘The Scope of the CISG Provisions
on Damages’ in D Saidov/R Cunnington (eds), Contract Damages: Domestic and International Perspectives (Hart,
Oxford, 2008) 91, 99, 100; N Schmidt-Ahrendts ‘Disgorgement of Profits under the CISG’ in I Schwenzer/S
Spagnolo (eds), State of Play: The 3rd Annual MAA Peter Schlechtriem Conference (Eleven International
Publishing, Den Haag, 2012) 89, 101.
109 Handelsgericht Zürich (17 September 2014) CISG-online 2656; Oberlandesgericht Zweibrücken
(31 March 1998), CISG-online 481; Tribunale die Vigevano (12 February 2000) CISG-online 493; CLOUT
case No. 476 (Tribunal of International Commercial Arbitration at the Russian Federation Chamber of
Commerce and Industry (6 June 2000) Arbitral Award 406/1998); CLOUT case No. 935 Handelsgericht
Zürich (25 June 2007); J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts
for the International Sale of Goods (Beck, Hart, Munich, 2011) Article 74 para 9; I Schwenzer in Schlechtriem &
Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016)
Article 74 para 66.
53
to domestic law.110 Some courts and tribunals have required a specific ascertainment of
damages.111 Others have required that the damages be reasonably proved,112 others that
have required sufficient proof of damages.113 Belgian courts, especially, have determined the
amount of damages often ex aequo et bono.114 The CISG-Advisory Council reasons that the
requisite standard should be one of ‘reasonable certainty’ without a need for ‘mathemati-
cal precision’.115 The reasonable certainty standard is supported by and consistent with the
CISG as a whole, which generally applies the reasonableness standard.116 It is also consistent
with the PICC.117
Limitation period
The CISG does not cover limitation periods. If the Convention on the Limitation Period
in the International Sale of Goods 1974 is applicable to the contract, damages fall under the
four-year limitation period under Article 8 of the Limitation Convention.118 In all other
cases, the choice of the parties’ dispute resolution mechanism will become highly relevant.
Civil law jurisdictions generally characterise statute of limitation issues as matters of sub-
stantive law and, therefore, as a matter of lex contractus.119 In many common law jurisdic-
tions, statute of limitation issues are considered a matter of procedural law and, therefore, a
110 M Bridge ‘Remedies and Damages’ in L Di Matteo/A Janssen/U Magnus/R Schulze (eds), International Sales
Law (Beck, Hart & Nomos, Munich, 2016) Ch 19 para 39; CISG-AC Opinion No 6, Calculation of Damages
under the CISG Article 74, Rapporteur J Gotanda Comment 2.1.
111 Oberlandesgericht Celle (2 September 1998), CISG-online 506; Oberlandesgericht Köln (21 May 1996)
CISG-online 254; Landgericht München (20 February 2002) CISG-online 712.
112 Käräjäoikeus of Kuopio (5 November 1996) CISG-online 869; CIETAC CISG/1990/01 http://cisgw3.law.
pace.edu/cases/910418c1.html (last accessed 28 July 2016).
113 CIETAC CISG/1995/01 CISG-online 971; Tribunal de Commerce Namur (15 January 2002)
CISG-online 759.
114 Steinbock-Bjonustan EHF v. NV Duma (4 June 2004) District Court Kortrijk http://cisgw3.law.pace.edu/
cases/040604b1.html (last accessed 27 July 2016); District Court Hasselt (18 October 1995) www.unilex.
info/case.cfm?pid=1&do=case&id=266&step=FullText (last accessed 28 July 2016); Vital Berry Marketing
v. Dira-Frost (2 May 1995) District Court Hasselt (last accessed 28 July 2016) http://cisgw3.law.pace.edu/
cases/950502b1.html.
115 CISG-AC Opinion No 6, Calculation of Damages under the CISG Article 74, Rapporteur J Gotanda
Comment 2.9; see Cour de Cassation (17 February 2015) www.legifrance.gouv.fr/affichJuriJudi.do?oldAct
ion=rechJuriJudi&idTexte=JURITEXT000030270329&fastReqId=1445360440&fastPos=1 (last accessed
28 July 2016) & Delchi Carrier SpA v. Rotorex Corp US Circuit Court of Appeals (2nd Cir) (6 December 1996)
CISG-online 140 which refer to ‘sufficient certainty’ albeit without discussion.
116 J Bonell in CM Bianca/J Bonell, Commentary on the International Sales Law (Giuffrè: Milan, 1987) Article 7 para
2.3.2.2.
117 PICC, Article 7.4.3. The UNIDROIT Principles of International Commercial Contract are soft law (devised
by UNIDROIT) and designed to be an elaboration of an international restatement of general principles
of contract law. They can be found at www.unidroit.org/english/principles/contracts/principles2010/
integralversionprinciples2010-e.pdf (last accessed 17 August 2016).
118 Convention on the Limitation Period in the International Sale of Goods 1974 can be found at:
www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1974Convention_limitation_period.html (last
accessed 5 October 2016).
119 Landgericht München I (6 April 2000) CISG-online 665; Oberlandesgericht Braunschweig
(28 October 1999) CISG-online 510; Landgericht Heidelberg (2 October 1996) 264.
54
matter of lex fori.120 Tribunals should consider whether to apply Articles 10.1 et seq. PICC,
which stipulate a relative limitation period of three years and an absolute limitation period
of 10 years.121
Damages in case of substitute transaction – Article 75122

Article 75 allows, in case of the avoidance of the contract, a concrete calculation of dam-
ages in the form of the difference between the contract price and the price of a cover
purchase (buyer) or the resale of the goods (seller). Further damage that is not already part
of the calculation under Article 75 can often be claimed under Article 74 (see Article 76).
Article 75 does not replace Article 74. It supplements and works in conjunction with it.
The application of Article 75 is not mandatory. Parties that have avoided the contract can
choose whether to seek damages pursuant to Article 75 or whether they only rely on the
abstract calculation of damages under Article 74.123
Avoidance
To claim damages in accordance with Article 75, the obligee has to avoid the contract (i.e.,
it must have dissolved its contractual obligation)124 before making a substitute purchase.125
Jurisprudence and academic commentary also concur that Article 75 is applicable if the
obligor unequivocally and finally refuses to perform.126
Substitute transaction
A sale or purchase by an aggrieved party qualifies as a substitute transaction under
Article 75 if two requirements are satisfied. First, the aggrieved party has to have undertaken
the purchase or sale as a substitute for the avoided transaction. Second, the cover purchase
or sale has to be commercially reasonable. It is generally accepted that the price of the cover
purchase or sale will minimise the loss of the breaching party to the extent reasonably
120 Lord Collins of Mapesbury et al, Dicey, Morris & Collins on the Conflict of Laws Vol I (15th ed, Sweet & Maxwell,
London 2012) paras 7-055, 7-056.
121 PICC, Article 10.2(1) and Article 10.2(2) respectively.
122 CISG, Article 75 states: ‘If the contract is avoided and if, in a reasonable manner and within a reasonable
time after avoidance, the buyer has bought goods in replacement or the seller has resold the goods, the party
claiming damages may recover the difference between the contract price and the price in the substitute
transaction as well as any further damages recoverable under article 74.’
124 See Articles 49, 64, 72, 73 in regard to the requirements of avoidance for buyer and seller respectively.
125 Oberlandesgericht Bamberg (13 January 1999) CISG-online 516; CISG-AC Opinion No 8, Calculation of
Damages under the CISG Articles 75 and 76, Rapporteur J Gotanda, Comment 2.3.3.
126 Handelsgericht des Kantons Zürich (17 September 2014) CISG-online 2656; OLG Brandenburg
(5 February 2013) CISG-online 2400; Supreme Court Poland (27 January 2006) CISG-online 1399;
Oberlandesgericht Hamburg (28 February 1997) CISG-online 261 (where the Court held that in the case
of the seller seriously and finally refusing to perform the principle of good faith mandated that the buyer did
not have to avoid the contract before making the cover purchase); I Schwenzer in Schlechtriem & Schwenzer
75 para 5.
55
possible.127 If the difference between the avoided contract and the substitute transaction
results in reduced costs, an adjustment to the damage amount may be warranted to account
for expenses saved by the obligee.128
The wording of Article 75 makes it clear that it is not applicable if the obligee does not
transact with a third party to fulfil the avoided contract.129 Article 75 is also not applicable
when the buyer uses goods in substitution for the non-conforming goods that have been
purchased before the avoidance of the contract.130
Reasonable time and manner

To avoid that the obligee, at the expense of the obligor, speculates on the development
of the market, Article 75 requires that the cover purchase has been made in a reasonable
manner and within reasonable time. Those requirements do not exclude, however, that the
obligee waits to avoid the contract to take account of market developments.131
Jurisprudence has determined that the threshold in regard to acting in a reasonable
manner is whether a party has acted as a ‘careful and prudent businessman’ who observes
the relevant trade practices.132 Being a ‘careful and prudent businessman’ can entail reselling
the goods substantially below the contract price.133
The substitute transaction also has to be done within a reasonable time.The time period
for a reasonable substitute transaction commences when the obligee declares the contract
avoided.134 What is reasonable depends on the circumstances and the good in question. For
goods that are subject to market price fluctuations, a reasonable time period will be rela-
tively short,135 whereas for goods that are seasonal or unique the period will be longer.136
If the obligee has not made an identified substitute transaction in a reasonable manner
or time frame, the obligee is free to claim damages in accordance with Articles 74 and 76,
which allow for an abstract calculation of damages.137 Conversely, if an obligee who pursues
127 See Secretariat Commentary on 1978 Draft, Article 71 para 4.

129 P Huber in P Huber/A Mullis, The CISG: A Textbook for Students and Practitioners (sellier, Munich, 2007) §13
(VII)(2)(a)(bb).
130 Delchi Carrier SpA v. Rotorex Corp, U.S. Circuit Court of Appeals (2nd Cir) (6 December 1996) CISG-online
140; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International
Sale of Goods (Beck, Hart, Munich, 2011) Article 75 para 14.
131 P Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) para 311.
132 ICC Court of Arbitration, Arbitral Award No 8128/1995, CISG-online 526; Oberlandesgericht Düsseldorf
(14 January 1994) CISG-online 119; compare Secretariat Commentary on 1978 Draft, Article 71 para 4
133 Oberlandesgericht Düsseldorf (14 January 1994) CISG-online 119.
134 Secretariat Commentary on 1978 Draft, Article 71 para 5.
135 Compare Oberlandesgericht Hamburg (28 February 1997) CISG-online 261 – period of two weeks
considered reasonable for cover purchase for iron-molybdenum.
136 Compare Oberlandesgericht Düsseldorf (14 January 1994) CISG-online 119 – period of three months
reasonable for seasonal goods.
137 The wording of Article 76 does not seem to support the view that an unreasonable substitute transaction
can be be claimed under Article 76 since Article 76 assumes that no substitute transaction has been made.
However, in practice a substitute transaction will be reasonable as to the market price (the market price is
generally reasonable under Article 77 mitigation of loss – see in regard to Article 77, page 27, infra) of the
goods which is what can be claimed as damages under Article 76. Therefore, in practice it will make little
56
a damages claim under Article 76 makes a substitute transaction after initiating litigation,
but before a reasonable time has elapsed since avoidance, then damages may be calculated
pursuant to Article 75.138
Calculating damages
Damages in accordance with Article 75 are measured by the difference between the price
of the substitute transaction and the contract price. The contract price is the price either
agreed expressly or implicitly between the parties in the contract, or the price as deter-
mined by Article 55 if the parties did not agree expressly or implicitly on a price.139 The
price of the substitute transaction is the price paid for the substitute goods plus extra
expenses incurred from having to make the substitute transaction, such as costs associated
with transport or changed market conditions, minus saved expenses.140
Further damages recoverable under Article 74

An aggrieved party may recover further damages under Article 74.This allows the recovery
of incidental and consequential damages in addition to the damages recovered under the
Article 75 calculation.
Examples:
• Costs associated with the substitute transaction under Article 75.141
• Loss caused by the delay in locating a substitute transaction.142
• Loss caused by a change in the interest rates or in the currency exchange rate between
the date that the transaction was supposed to have occurred under the contract and the
substitute transaction.143
• Costs of an unsuccessful tender of goods or their necessary storage by the seller.144
• Costs associated with the failed transaction.145
difference whether to base one’s claim on Article 75 or Article 76 in the case of an unreasonable substitute
transaction (see N Schmidt-Ahrendts, Das Verhältnis von Erfüllung, Schadensersatz und Vertragsaufhebung im CISG
(Mohr Siebeck, Tübingen, 2007) 84, 85; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN
Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 75 para 10).
138 Oberster Gerichtshof (28 April 2000) CISG-online 581.
139 Article 55 provides that when a contract has been validly concluded but does not expressly or implicitly fix
the price, the price will be the generally charged price for those goods at the time the contract was concluded,
unless the parties provide otherwise.
140 See Secretariat Commentary on 1978 Draft, Article 71 para 3; J Gotanda in S Kröll/L Mistelis/P
2011) Article 75 para 22.
141 Downs Investment v. Perwaja Steel, Supreme Court of Queensland (17 November 2000) CISG-online 587.
142 Delchi Carrier SpA v. Rotorex Corp, US Circuit Court of Appeals (2nd Cir) (6 December 1996)
CISG-online 140.
143 Landgericht Krefel (28 April 1993) CISG-online 101.
144 Handelsgericht Aargau (26 September 1997) CISG-online 329.
145 ICC Court of Arbitration, Arbitral Award 8128/1995, CISG-online 526; Delchi Carrier SpA v. Rotorex Corp, US
Circuit Court of Appeals (2nd Cir) (6 December 1996) CISG-online 140.
57
Foreseeability
‘Foreseeability’ is not a requirement of Article 75, according to its wording. This is not sur-
prising, since loss resulting from a substitute transaction is generally foreseeable.146
Burden of proof
It is on the obligee to prove that the avoidance of the contract was justified and that the
obligor was correctly notified of the avoidance. The obligee must also show that the sub-
stitute transaction was reasonable and within a reasonable time period after the avoidance
of the contract. If the obligor asserts that the substitute transaction could have been made
sooner, the obligor also implicitly invokes a breach of the duty to mitigate damages (Article
77) for which the obligor carries the burden of proof.147
Concrete calculation of damages without substitute transaction – Article 76148

Like Article 75, Article 76 is lex specialis to Article 74. Article 76 allows calculating damages
based on the current price of goods when the obligee has avoided the contract without
entering into a resale or cover purchase. The difference between Article 76 and Article
75 is that under Article 76 the damages are calculated abstractly without the need to show
a concrete measure of actual loss. Therefore, the advantage is that the obligee can recover
damages simply based on a straightforward calculation.
Article 76 allows when its requirements are met to abstractly calculate the performance
loss as the difference between the contract price and the market price. The advantage for
the obligee to claim under Article 76 is that concrete proof of the non-performance loss
is unnecessary.
Avoidance of the contract

The application of Article 76 requires that the obligee has avoided the contract. In addi-
tion, the prevailing view applies Article 76 to cases where the obligor unambiguously and
definitively refuses to perform.149
147 Compare Hof van Beroep Gent (20 October 2004) CISG-online 983.
148 CISG, Article 76 states: ‘(1) If the contract is avoided and there is a current price for the goods, the party
claiming damages may, if he has not made a purchase or resale under article 75, recover the difference between
the price fixed by the contract and the current price at the time of avoidance as well as any further damages
recoverable under article 74. If, however, the party claiming damages has avoided the contract after taking over
the goods, the current price at the time of such taking over shall be applied instead of the current price at the
time of avoidance.
(2) For the purposes of the preceding paragraph, the current price is the price prevailing at the place where
delivery of the goods should have been made or, if there is no current price at that place, the price at such
other place as serves as a reasonable substitute, making due allowance for differences in the cost of transporting
the goods.’
149 Oberlandesgericht München (15 September 2004) CISG-online 1003; I Schwenzer in Schlechtriem &
Schwenzer Commentary on the UN Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016)
Article 76 para 3 with further references; but formal avoidance needed to have certainty in regard to the time
for establishing the market price. Oberlandesgericht Graz (29 July 2004) CISG-online 1627; J Gotanda in S
58
Current price
Nature of current price
Article 76 requires a current price for the goods – ‘the price prevailing at the place where
delivery of the goods should have been made’ – but if no current price is available then
‘the price at such other place as serves a reasonable substitute’. The current price must be
for goods of the same kind as the avoided contract, under comparable terms. Article 35(2)
stipulates factors that can give guidance to determine what goods conform to the contract
and whether they can be used to set a comparable price.150 An adjustment should be made
for any differences in terms or circumstances between the contract terms and those associ-
ated with the market price.151
A current price can exist without being officially quoted.152 As one court has observed:
it is sufficient for the existence of a market price in the sense of Article 76(1) CISG if, owing to
regular business transactions for goods of the same type at a particular trade location, a current
price has been established.153
If there is no current price, then an abstract calculation cannot be performed and the obli-
gee may resort to Article 74.154 For subjectively valued goods or goods made on special
order, it might be impossible to ascertain a current price.155 The obligee thus has to resort
to Article 74.
Time of determination
The time at which to set the current price for the calculation is the time at which the
obligee made the statement of avoidance.156 Basing the relevant time on the statement of
Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale of Goods (Beck,
Hart, Munich, 2011) Article 76 para 7.
150 CISG, Article 35(2) states: ‘2) Except where the parties have agreed otherwise, the goods do not conform with
the contract unless they:
(a) are fit for the purposes for which goods of the same description would ordinarily be used;
(b) are fit for any particular purpose expressly or impliedly made known to the seller at the time of the conclusion
of the contract, except where the circumstances show that the buyer did not rely, or that it was unreasonable
for him to rely, on the seller’s skill and judgement;
(c) possess the qualities of goods which the seller has held out to the buyer as a sample or model;
(d) are contained or packaged in the manner usual for such goods or, where there is no such manner, in a manner
adequate to preserve and protect the goods.
(3) The seller is not liable under subparagraphs (a) to (d) of the preceding paragraph for any lack of conformity of
the goods if at the time of the conclusion of the contract the buyer knew or could not have been unaware of
such lack of conformity.’
151 CIETAC, Arbitral Award CISG/2000/01 (1 February 2000).
152 Novia Handelsgesellschaft mbH v. AS Maseko, Tallinna Ringkonnakohus (19 February 2004) CISG-online 826.
153 Oberlandesgericht München (15 September 2004) CISG-online 1627 (translation); see also official
commentary to Article 7.4.6 PICC.
154 See Oberlandesgericht Celle (2 September 1998) CISG-online 506.
155 See ICC, Court of Arbitration, Arbitral Award 8740/1996, CISG-online 1294; F Enderlein/D Maskow,
International Sales Law (Oceana, Dobbs Ferry NY, 1992) Article 76 para 2.
156 Oberster Gerichtshof (28 April 2000) CISG-online 581. Note that Article 31 determines the place of delivery.
59
avoidance leaves no room for tribunal discretion with regard to the timing, and avoids that
the obligee speculates at the obligor’s expense. If the obligee unreasonably delays making a
statement of avoidance, the obligor may seek relief under Article 77.157 Article 76 provides
an exception for the setting of the current price if the obligee avoids the contract after tak-
ing over of the goods. In that case, the current price is determined at the time when the
party took over the goods rather than at the time of avoidance.158
Location of goods
In determining the current price for the calculation of damages, first resort must be to the
place where the seller should have delivered the goods.159 If a determination at the place
of delivery is not possible, the tribunal can resort to a location that would be a reasonable
substitute.160 In accordance with the CISG’s underlying principles, ‘reasonable’ has to be
evaluated from the perspective of a typical merchant under similar circumstances, including
taking into account the cost of shipping to the substitute location.161
Price fixed by the contract

To calculate damages under Article 76, the ‘price fixed by the contract’ has to be determined.
It should be noted that Article 75 merely requires a ‘contract price’. The latter means that
to satisfy the requirement of Article 75, the price does not need to be fixed by the contract;
instead it can be determined by means of Article 55.162 Therefore, if the price is not fixed by
the contract and the obligee has not engaged in a substitute transaction, the obligee can only
pursue damages in accordance with Article 74. An application of Article 55 would result in
implying a contract price based on the market price at the time of the contract and then cal-
culating abstractly based on the market prices at the time of avoidance. Such a damages cal-
culation is undesirable since it would increase the uncertainty in the amount of damages.163
No substitute transaction
Abstract calculation of damages is only possible if the obligee has not engaged in a sub-
stitute transaction. It has to be noted that fixing damages concretely based on a substitute

159 See Oberlandesgericht Hamm (22 September 1992) CISG-online 75.
160 Secretariat Commentary on the 1978 Draft, Article 72 (now Article 76) para 11.
161 See Oberlandesgericht Hamburg (4 July 1997) CISG-online 1299; CISG AC-Opinion No 8, Calculation of
Damages under the CISG, Articles 75 and 76 Rapporteur J Gotanda, Comment 4.5.
162 CISG, Article 55 provides: ‘Where a contract has been validly concluded but does not expressly or implicitly
fix or make provision for determining the price, the parties are considered, in the absence of any indication to
the contrary, to have impliedly made reference to the price generally charged at the time of the conclusion of
the contract for such goods sold under comparable circumstances in the trade concerned.’ The drafting history
of Article 76 clarifies that Article 76 was drafted to exclude any price calculation on the basis of Article 55
(Summary of Records of Meetings of the First Committee, 37th Meeting, Consideration of Report of the
Drafting Committee to the Committee (7 April 1980) 1980 Vienna Diplomatic Conference, paras 59-69).
60
transaction takes precedence over an abstract calculation.164 The primacy of concrete calcu-
lation supposes that a substitute transaction will generally be the most cost-effective resolu-
tion after the avoidance of a contract.165
Whether the obligee has made a substitute transaction or not is assessed in accordance
with the requirements under Article 75. Thus, if the obligee made a ‘substitute’ transaction
that fails to meet the requirements stipulated under Article 75, the obligee is free to claim
abstractly calculated damages under Article 76.166 Abstract calculation might also be appro-
priate when the obligee has made a separate transaction similar to the avoided one and
where the obligee cannot show that a particular transaction replaced the avoided one.167
Foreseeability
The wording of Article 76 clarifies that foreseeability is not a requirement of Article 76.168
It would be contrary to the principle of full compensation if the obligor were able to argue
unforeseeable changes in the price, after the conclusion of the contract, that the obligor did
not take into account.169
Recovery of further loss

In addition to damages based on the difference between the current price at the time of
avoidance and the price fixed by the contract, the obligee may recover further damages
under Article 74. Article 76 allows a party to claim compensation for incidental and con-
sequential damages that occurred as a result of voiding the contract under Article 74. The
requirements of Article 74 have to be met, however, especially that further damages must
have been foreseeable.170 Care has to be taken that when the obligee claims additional dam-
ages under Article 74, the obligee is not placed in a better position than it would have been
in if the contract had not been avoided.
Anticipatory breach
If it is clear that one party will commit a fundamental breach, Articles 72 and 73 allow for
the avoidance of the contract before the date that performance was due. These provisions
may impact the determination of damages under Article 76 in a fluctuating market. In such
164 Oberlandesgericht Hamm (22 September 1992) CISG-online 75; Oberlandesgericht Graz (29 July 2004)
CISG-online 1627.
166 Secretariat Commentary on 1978 Draft, Article 72 (now Article 76) para 2.
167 See Oberlandesgericht Hamm (22 September 1992) CISG-online 75. Alternatively, in that scenario the
obligee may seek damages under Article 74. A claim under Article 74 may be particularly appropriate in the
case of a lost volume seller.
168 See for a different view: D Saidov, The Law of Damages in International Sales:The CISG and other International
Instruments (Hart Publishing, Oxford, 2008) 118, 119.
169 See I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International Sale of
Goods (4th ed, OUP, Oxford, 2016) Article 76 para 6; P Huber in P Huber/A Mullis, The CISG: A Textbook for
Students and Practitioners (sellier, Munich, 2007) 283, 288.
170 See page 13, supra.
61
a market, it is uncertain whether the market price at the time of performance would be the
same as or even similar to the market prices at the time of avoidance. As Gotanda observes:171
To address the risk that the market will change to the detriment of the obligee,Article 75 provides
the option to proceed with a substitute transaction and calculate damages concretely rather than
proceeding abstractly under Article 76. By choosing to proceed under Article 76, the aggrieved
party accepts the risk of inadequate compensation.
Burden of proof
The obligee has to prove the calculation of damages under Article 76 (i.e., the price fixed by
the contract as well as the current price).172 However, the obligor has to prove that the obli-
gee has or should have carried out a more favourable substitute transaction (Article 77).173
Mitigation of damages – Article 77

Article 77(1) obliges the party that wants to claim damages because of the breach of con-
tract of the other party to take reasonable measures to mitigate the damage caused by the
breach of contract. Under Article 77(2), a breach of this obligation will result in a decrease
in the amount of damages that can be claimed. The obligation to mitigate damages exists
only in regard to damages claims and not in regard to other remedies, such as claims in
regard to the performance of the contract.174
Obligation to mitigate
What the obligation to mitigate damages entails depends on the circumstances in the par-
ticular case. The threshold is a reasonable person in the shoes of the obligee.175 Trade usages
and practices, as well as special habits that exist between the parties, have to be taken into
account.176 In general, a cover transaction is reasonable if it is ‘made in such a manner as is
likely to cause a resale to have been made at the highest price reasonably possible in the
172 Oberlandesgericht Celle (2 September 1998) CISG-online 506; CIETAC, Arbitral Award (5 February 1996)
http://cisgw3.law.pace.edu/cases/960205c1.html.
173 Oberlandesgericht Hamm (22 September 1992) CISG-online 57.
174 UNCITRAL Digest on the CISG, Article 77 fn 7 www.uncitral.org/pdf/english/clout/CISG-digest-2012-e.
pdf.
175 Compare Article 8(2): ‘If the preceding paragraph is not applicable, statements made by and other conduct of
a party are to be interpreted according to the understanding that a reasonable person of the same kind as the
other party would have had in the same circumstances.’
176 P Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) para 315; see Article 9:
‘(1) The parties are bound by any usage to which they have agreed and by any practices which they have
established between themselves.
(2) The parties are considered, unless otherwise agreed, to have impliedly made applicable to their contract or
its formation a usage of which the parties knew or ought to have known and which in international trade
is widely known to, and regularly observed by, parties to contracts of the type involved in the particular
trade concerned.’
62
circumstances or a cover purchase the lowest price reasonably possible’.177 Cover transac-
tions that are identical to the terms of the original contract are more likely to be considered
reasonable.178 However, cover transactions that differ in terms such as quantity, credit or
time of delivery may still be considered reasonable, all circumstances taken into account.179
Examples of factors that have been taken into account are:180
• timeliness of a cover purchase181 or sale;182
• seasonal nature of goods;183
• potential consequences of a defect;184
• desirability to stop performance;185 and
• ability to preserve and store goods.186
Lost volume sales

Article 77 does not impose on a lost volume seller an obligation to find a substitute buyer
for the contracted goods following a breach. This is because, in the case of a lost volume
seller, the second sale would have been made even if there had been no breach of contract.
The second sale is thus not a substitute transaction.187
Burden of proof
The obligor has the burden of proof in regard to the facts that establish the obligee’s duty to
mitigate.188 In practice, the obligor may find it difficult to meet its burden because evidence
177 Secretariat Commentary on the 1978 Draft, Article 71 (now Article 75).
178 D Saidov, The Law of Damages in International Sales:The CISG and other International Instruments (Hart
Publishing, Oxford, 2008) 134; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on
Contracts for the International Sale of Goods (Beck, Hart, Munich, 2011) Article 77 para 20.
179 Secretariat Commentary on the 1978 Draft, Article 71 (now Article 75); CISG-AC Opinion No 8,
Calculation of Damages under the CISG Articles 75 and 76 Rapporteur J Gotanda, Comment 2.3.
180 See for additional examples UNCITRAL, Digest on the CISG, Article 77 paras 9 et seq. www.uncitral.org/
pdf/english/clout/CISG-digest-2012-e.pdf.
181 Tribunal of International Commercial Arbitration at the Ukraine Chamber of Commerce and Trade
(1 January 2005) CISG-online 1372; Oberlandesgericht Celle (2 September 1998) CISG-online 506;
Oberlandesgericht Hamburg (28 February 1997) CISG-online 261: cover purchase three times the contract
price reasonable given it was the market price in the available time period; P Schlechtriem/P Butler, UN Law
on International Sales (Springer, Heidelberg, 2009) para 315.
182 Treibacher Industrie AG v. Allegheny Technologies Inc, US Court of Appeals (11th Circuit) (12 September 2006)
CISG-online 1278; Lothringer Gunther Grosshandelsgesellschaft für Bauelemente und Holzwerkstoffe v. NV Fepco
International, Hof van Beroep Antwerpen (24 April 2006) CISG-online 1258: Six months not a reasonable
time period for resale.
183 Oberlandesgericht Düsseldorf (14 January 1994) CISG-online 119.
185 Tribunal of International Commercial Arbitration at the Russian Federation Chamber of Commerce and
Industry, Arbitral Award (27 July 1999) CISG-online 779.
186 ICC Court of Arbitration, Arbitral Award 7585/1992, CISG-online 105.
187 Oberster Gerichtshof (28 April 2000) CISG-online 581.
188 Handelsgericht Zürich (17 September 2014) CISG-online 2656.
63
concerning mitigations efforts is often within the knowledge and control of the obligee.189
Some tribunals have placed some obligation on both parties when a failure to mitigate
defence has been raised under Article 77.190
Interest – Article 78
Interest is due under Article 78 regardless of proof of loss.191 Interest can be claimed pursuant
to Article 78 independently from the damages under Articles 74 to 76.192 It applies to the
purchase price and to ‘any other sum in arrears’. Most courts and tribunals have held that
‘any other sum in arrears’ includes damages.193 The preponderant opinion also presumes that
the liability to pay interest arises under Article 78, even if the precise amount owed has to be
determined by a tribunal.194 Article 78 is silent on the most important questions in regard to
interest: the accrual period and the rate of interest. Both questions have to be answered rely-
ing on general CISG principles to achieve uniform and congruent application of the CISG.
Accrual period
Interest starts to accrue the moment the payment is in arrears, without any further require-
ment, such as a request or demand for payment or default, having to be met or any compli-
ance with formalities being necessary.195 Interest ceases to accrue when the obligation to
pay is extinguished.
Interest rate
The most controversial issue presented by Article 78 is at what rate interest on a sum in
arrears is to accrue, since Article 78, although providing an obligation to pay interest when-
ever a payment is in arrears, does not specify an interest rate or the means to determine
the interest rate. Therefore, interest rates are one of the most discussed issues by courts and
189 See Handelsgericht des Kantons St Gallen (3 December 2002) CISG-online 727: ‘The Court appreciates that
it might be extremely burdensome and difficult to prove [buyer’s] allegations to the satisfaction of the Court,
because [seller] only is in the position to give notice about its particular measures to mitigate.’
190 Tribunal of International Commercial Arbitration at the Russian Federation Chamber of Commerce and
Industry, Aribtral Award (23 December 2004) CISG-online 1188.
191 ICC Court of Arbitration, Arbitral Award 8962/1997, CISG-online 1300.
192 Oberlandesgericht Frankfurt (18 January 1994) CISG-online 123; Landgericht Hamburg
(26 September 1990) CISG-online 21; K Bacher in Schlechtriem & Schwenzer Commentary on the UN
Convention on the International Sale of Goods (4th ed, OUP, Oxford, 2016) Article 78 para 5.
193 See Kantonsgericht Zug (21 October 1999) CISG-online 491; Handelsgericht des Kantons Zürich
(5 February 1997) CISG-online 327; J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN
Convention on Contracts for the International Sale of Goods (Beck, Hart, Munich, 2011) Article 78 para 7;
CISG-AC Opinon No 14, Interest under Article 78, Rapporteur:Y Atamer Comment 3.b.
of Goods (Beck, Hart, Munich, 2011) Article 78 para 10; CISG-AC Opinion No 14, Interest under Article 78,
Rapporteur Y Atamer Comment 4 both with further references.
195 Handelsgericht des Kantons Aargau (5 November 2002) CISG-online 715; Landgericht Stendahl
(12 October 2000) CISG-online 592; Tribunale di Padova (31 March 2004) CISG-online 823;
P Schlechtriem/P Butler, UN Law on International Sales (Springer, Heidelberg, 2009) paras 318, 319. See
J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale
of Goods (Beck, Hart, Munich, 2011) Article 78 paras 17-20 for a discussion of the consequences of applying
domestic law to the issue.
64
tribunals in regard to the CISG.196 Various modi of determining the interest rate have been
used by courts and tribunals. The attempts can be roughly categorised into two broad clus-
ters: those preferring a uniform approach,197 and those giving domestic law primacy.198 The
former interprets the lacuna in Article 78 as inviting tribunals to define the applicable inter-
est rate by way of resorting to general principles deduced from the CISG (Article 7(2)).The
latter interprets Article 78 as excluding the question of the interest rate from the sphere of
application of the CISG, and therefore, as an express invitation to tribunals to resort to the
applicable domestic law. However, those who favour the uniform approach are not unified
in regard to the general principle that should be applied to determine the rate of interest.199
The following approaches can be found in the jurisprudence of courts and tribunals:
• the current interest rate at the creditor’s place of business;200
• the current interest rate at the debtor’s place of business;201
• the current rate of interest related to the particular currency of the claim;202
• an internationally or regionally applied interest rate like the Libor203 or the Euribor;204 and
• the application of Article 7.4.9 of the UNIDROIT Principles.205
196 See Chicago Prime Packers v. Northam Food Trading C 320 F Supp 2d 702, 715 (ND III 2004) (7th Circ 2005);
P Butler ‘CISG and Arbitration - A Fruitful Marriage’ (2014) XVII International Trade and Business Law 322;
J Gotanda in S Kröll/L Mistelis/P Perales-Viscasillas (eds), UN Convention on Contracts for the International Sale
197 See Zapata Hermanos Sucessors v. Hearthside Baking Co Inc US District Court, Northern District of Illinois
(28 August 2001) CISG-online 35; Internationales Schiedsgericht der Bundeskammer der gewerblichen
Wirtschaft in Österreich, Arbitral Award (15 June 1994) CISG-online 120; J Gotanda ‘Damages in Private
International Law’ (2007) 326 Recueil des Cours 73, 241 et seq.
198 ICC Court of Arbitration, Arbitral Award 7153/1992 CISG-online 35; Oberlandesgericht Koblenz
(31 January 1997) CISG-online 256; Tribunale di Pavoda (31 March 2004) CISG-online 823.
199 See CISG-AC Opinon No 14, Interest under Article 78, Rapporteur Y Atamer Appendix with an overview of
cases; UNCITRAL Digest on the CISG: www.uncitral.org/pdf/english/clout/CISG-digest-2012-e.pdf.
200 Internationales Schiedsgericht der Bundeskammer der gewerblichen Wirtschaft in Österreich, Arbitral Award
(15 June 1994) CISG-online 691; ICC Court of Arbitration, Arbitral Award No.7331 (1 January 1994)
CISG-online 106; Landgericht Frankfurt am Main (16 September 1991) CISG-online 26; Rechtbank van
Koophandel, Hasselt (20 September 2005) CISG-online 1496; Serbian Chamber of Commerce Arbitration
(19 October 2009) CISG-online 2265.
201 Oberlandesgericht Graz (13 June 2013) CISG-online 2458; Landgericht Berlin (21 March 2003) CISG-online
785; Tribunal Cantonal Vaud (11 April 2002) CISG-online 899;Yugoslav Chamber of Commerce Arbitration,
Arbitral Award (28 January 2009) CISG-online 1856; Rechtbank van Koophandel Oudenaarde (10 July 2001)
CISG-online 1785; LG Heidelberg (2 November 2006) CISG-online 1416.
202 Rechtbank van Koophandel Ieper (18 February 2002) CISG-online 764; Rechtbank van Koophandel
Oudenaarde (10 July 2001) CISG-online 1785.
203 ICC Court of Arbitration, Arbitral Award No 11849 (1 January 2003) CISG-online 1421; Tribunal of
International Commercial Arbitration at the Russian Federation Chamber of Commerce and Industry, Arbitral
Award (15 November 2006) CISG-online 2008.
204 Serbian Chamber of Commerce, Arbitral Award (4 June 2009) CISG-online 2266; Serbian Chamber of
Commerce, Arbitral Award (23 January 2008) CISG-online 1946; Rechtbank van Koophandel, Hasselt
(10 May 2006) CISG-online 1259.
205 China International Economic and Trade Arbitration Commission, Arbitral Award (2 September 2005)
CISG-online 1712; ICC Court of Arbitration, Arbitral Award No 8769 (1 December 1996) CISG-online 775;
ICC Court of Arbitration, Arbitral Award 8128/1995, CISG-online 526.
65
The CISG Advisory Council suggests that the interest rate applicable to any mature sum
should be determined according to the law of the state where the creditor has its place
of business.206 The major purpose of an interest claim is compensating the time value of
money for the creditor.Therefore, the interest claim in Article 78 is akin to a damages claim.
Thus, the full compensation principle underlying CISG damages should also be applied to
interest claims and the focus should be on compensating the creditor’s loss.
Simple versus compound interest

The CISG does not address whether interest should accrue on a simple or compound basis.
Most courts and tribunals have awarded simple interest.207 Parties are free to agree on the
payment of compound interest. If the parties have not addressed the issue of compound
interest in their contract, the CISG Advisory Council takes the view that the question of
whether compound interest should be awarded be resolved in accordance with the domes-
tic law of the creditor.208 Gotanda points out that awarding compound interest is in line
with modern economic and financial principles and practices, and the CISG’s underlying
principle of full compensation.209
More generally, it should be noted that a party may also be able to seek compound
interest as damages under Article 74. Article 78 provides for a claim to interest on a sum in
arrears without the proof of loss; such an interest claim is, therefore, independent from any
claim for damages (and, as noted above, only simple interest is awarded on such a claim by
most courts and tribunals). If, however, the obligee can prove under the standard required
for loss by Article 74 that a consequential loss resulting from the obligor’s breach of contract
was the loss of compound interest, compound interest should be recoverable in accordance
with Article 74.
Article 78 and Article 79

The obligation to pay interest under Article 78 remains, notwithstanding an exemption
from paying damages under Article 79 (discussed below). However, interest does not accrue
when and insofar as the failure to pay the monetary obligation was caused by the act or
omission of the obligee or when the obligor has exercised its right to suspend performance.
Exemptions under Articles 79 and 80

An obligor will be exempt from paying damages, but not from other remedies for
non-performance, in accordance with Article 79(1). Article 79(1) requires that because of
an unforeseeable impediment beyond the obligor’s control, the obligor is not able to per-
form the obligor’s obligation under the contract. Article 79 has not been of great practical
importance, since the threshold imposed by Article 79(1) to exempt the obligor is high and
206 CISG-AC Opinion No 14, Interest under Article 78, Rapporteur Y Atamer Comment 3.36.
207 ICC Court of Arbitration, Arbitral Award No 8502 (1 November 1996) CISG-online 1295; ICC Court of
Arbitration, Arbitral Award No 8908 (1 December 1998) CISG-online 1337; Hof van Beroep, Antwerpen
(24 Apr-2006) CISG-online 1258.
208 CISG-AC Opinon No 14, Interest under Article 78,Y Atamer (Beijing 2013) Comment 3.45.
66
parties have rarely succeeded in invoking Article 79.210 For example, financial constraints are
generally regarded as surmountable.211 Article 79(2) complements Article 79(1) by clarify-
ing that the obligor cannot avoid liability by relying upon third parties in order to fulfil the
obligor’s duties.212
Article 80 provides that an obligee may not rely on a breach by the other party to the
extent that the breach was caused by the obligee’s act or omission.
Other remedies
As stated earlier, it lies within the party’s choice which remedy the party wishes to pursue.
In addition to damages, the CISG provides for specific performance (Articles 46(1), 62, 28),
avoidance of the contract (Article 49(1), 64(1)), and price reduction (Article 50). A claim for
damages pursuant to Article 74 can be made concurrently with all three other remedies.213
The amount of the recoverable damages depends on whether and to which extent the
other remedy has been redressing the loss suffered.
Conclusion
Articles 74 et seq. provide for the obligor to put the obligee into the position the obligee
would have been in if the contract had been performed according to its terms. The CISG
offers the obligee a choice, if the breach was so fundamental that the obligee could avoid the
contract, to either calculate the obligee’s damages abstractly under Article 74, or concretely
under Article 75 if the requirements of Article 75 are met. The obligee may prefer recovery
under Article 75 (or recovery under Article 76 if no substitute transaction was done) if the
obligee cannot prove with a requisite degree of certainty that it suffered damages as a result
of the breach. In addition, the concrete calculation under Article 75 avoids the possibility
of having to open a company’s ‘books, i.e., ... disclose its internal calculations, its customers
and other business connections, etc.’214 to prove its loss.
(4th ed, OUP, Oxford, 2016) Article para 1.
211 See, for example: Tribunal of International Commercial Arbitration at the Russian Federation Chamber of
Commerce and Industry (17 October 1995) CISG-online 207: the lack of free convertible bank credit of the
Russian buyer/payment debtor does not relieve the buyer to pay the purchase price to the seller. Tribunale
Civile Monza (14 January 1993) CISG-online 540 the rise of the market price of steel by 30 per cent since
the conclusion of the contract is not unreasonable hardship.
212 For a full discussion, including the requirements of Article 79, see Y Atamer in S Kröll/L Mistelis/P
2011) Article 79; I Schwenzer in Schlechtriem & Schwenzer Commentary on the UN Convention on the International
Sale of Goods (4th ed, OUP, Oxford, 2016) Article 79; P Schlechtriem/P Butler, UN Law on International Sales
(Springer, Heidelberg, 2009) paras 288 et seq.
(4th ed, 2016) Article 74 para 10. The claim for specific performance is subject to Article 28.
of Goods (Beck, Hart, Munich, 2011) Article 75 para 3 citing P Schlechtriem, ‘Calculation of Damages in
the Event of Anticipatory breach under the CISG’ in Liber Amicorum Jan Hellner (2007) Sections I and III
available at www.cisg.law.pace.edu/cisg/biblio/schlechtriem20.html#*.
67
4
Contractual Limitations on Damages
Gabrielle Nater-Bass and Stefanie Pfisterer1
Contractual limitations on damages are of critical importance, allowing parties to better

assess and control business risks arising from a commercial transaction. It is thus no surprise
that some form of damage limitation is found in many commercial contracts today. Yet,
despite their prevalence, contractual limitations on damages give rise to difficult questions
that go to the heart of the legal system, such as how to balance the parties’ freedom to
contract against provisions of mandatory law, and the weight to be given to the respective
interests of creditors and debtors.
Contractual limitations on damages are agreements whereby the parties limit or exclude
the availability of damages that would otherwise be available under statutory law. They dif-
fer from more general ‘exemption clauses’2 or ‘liability limitations’ (Haftungsbegrenzungen)3
– clauses that absolve a party, whether in whole or in part, from liability under a contract or
for a related tort, or that qualify that liability – in that they relate specifically, and exclusively,
to damages. Clauses that go beyond a limitation of damages, for example, because they
exclude the coming into being of a contractual duty in the first place, are not the subject
of this chapter.
After first considering some general aspects relating to contractual limitations on dam-
ages (see ‘General Aspects of Contractual Limitations on Damages’, infra) we will address the
different forms that such limitations generally take (see ‘Forms of Contractual Limitations
on Damages’, infra). While the scope of the chapter does not allow for an in-depth analysis
of how contractual limitations on damages are dealt with under different legal systems,
key differences in the approaches to such limitations will nevertheless be highlighted and
1 Gabrielle Nater-Bass is a partner and Stefanie Pfisterer is an associate at Homburger.

2 1 Chitty on Contracts 14-001 (31st ed. 2012).
3 Lörtscher, Vertragliche Haftungsbeschränkung im schweizerischen Kaufrecht 6 (1977).
68
should be understood as red flags to keep in mind when confronted with such provisions
in practice.
General aspects of contractual limitations on damages

Agreements on contractual limitations on damages and their incorporation
A contractual limitation on damages needs to be agreed upon by the contracting parties. It
thus requires a contractual relationship between the creditor and the debtor.4
As long as there is consensus on the content, provisions containing contractual limita-
tions on damages can normally be included in a contract without further ado.5
In general, contract terms can also be implied, and be incorporated through the con-
duct of the parties. However, reading a limitation of damages into a contract on the basis
of party conduct will rarely be done in practice, and requires a previous course of dealings
between the parties on the same terms.6 In particular, mere personal relationships or the
existence of goodwill will generally not suffice to assume a limitation of liability.7
Limitations on damages are frequently contained in general terms and conditions
(GTCs). GTCs are contract terms that are pre-formulated by one party for a large number
of contracts.8 They are only effectively included in an agreement where the contract itself
refers to them.9 In civil law systems, the contracting party needs to have the possibility to
take note of the GTCs that were pre-formulated by the other party,10 whereas in other
systems it suffices for the written agreement referring to the GTCs to be signed for them to
be binding.11 In civil law systems, any GTC provisions that are considered so unusual that
they could not reasonably have been expected will not be considered to be a valid part of
the agreement and are thus invalid.12 On the other hand, common law systems frequently
require a showing of fraud or misrepresentation for a party to be able to escape the conse-
quences of its signature.13 Similarly, where a party claims to have misunderstood the GTCs,
it will have to satisfy the court that the document is radically different from that which the
party intended to sign and that the mistake was not due to carelessness.14 Some civil law
countries, and in particular German law, govern in detail the limitations of liability allowed
in standard terms (see ‘Limits of contractual limitations on damages’, infra).
4 Lörtscher, Vertragliche Haftungsbeschränkung im schweizerischen Kaufrecht 9 (1977).

5 Lörtscher, Vertragliche Haftungsbeschränkung im schweizerischen Kaufrecht 9 (1977). Common law may require
an exemption clause to be expressed clearly and without ambiguity, see 1 Chitty on Contracts 14-005 (31st
ed. 2012).
6 J Spurling Ltd v. Bradshaw [1956] [1956] 1 WLR 461.
7 For German law see Unberath, § 276 No. 50 in: Kommentar zum Bürgerlichen Gesetzbuch: BGB (3rd ed. 2012).
8 German Civil Code § 305(1).
9 For German law see Becker, § 305 No. 45 in: Kommentar zum Bürgerlichen Gesetzbuch: BGB (3rd ed. 2012).
10 For Swiss law see Kuoni, Haftungsbegrenzung im schweizerischen deutschen und englischen Recht para. 87 (2015).
11 Mellish LJ in Parker v. South Eastern Railway Co (1877) 2 C.P.D. 416.
12 German Civil Code § 305c(1).
13 Mellish LJ in Parker v. South Eastern Railway Co (1877) 2 C.P.D. 416.
14 Lawson, Exclusion Clauses and Unfair Contract Terms 1-046 (11th ed. 2014).
69
Interpretation/construction of contractual limitation on damages

Contractual limitations on damages are interpreted in the same manner as other contrac-
tual provisions, with the aim being to determine the parties’ actual intent.15 There exist a
number of methods that aim at arriving at the contractual intent.
The starting point is usually the wording used by the parties, but the purpose of the
agreement and the organisation of the various provisions of an agreement are also consid-
ered and may prevail over a strict interpretation of the wording.16 For example, an exemp-
tion clause may be so broad and general in scope that to apply it literally would create an
absurdity or defeat the main purpose of the contract into which the parties have entered.17
The courts will then need to ascertain the meaning to give effect to the agreement of
the parties.
In the Anglo-Saxon tradition, the contra proferentem rule and the rule that exclusion
clauses need to be interpreted strictly are also frequently applied.18 In Internet Broadcasting
Corp Ltd and (t/a NETTV) v. MAR/LLC,19 the High Court held that there is a presump-
tion, which appears to be a strong presumption, against exemption clauses being construed
so as to cover deliberate, repudiatory breaches. Similarly, in Bovis Construction (Scotland)
Ltd v. Whatlings Construction Ltd,20 the House of Lords ruled that a clause that limited
liability should state ‘clearly and unambiguously the scope of the limitation and would
be construed ‘with a degree of strictness’, albeit not to the same extent as an exclusion or
indemnity clause’.
Special consideration is required where an agreement provides for both a warranty and
limitation of liability. In such a case, interpretation of the agreement may lead to the con-
clusion that one of the clauses prevails, for example, where the warranty is contained in the
main text of the agreement and the limitation of liability in the annexed standard terms.
On the other hand, where a party gives a warranty without at the same time also assuming
liability for a breach of the warranty, the warranty may be considered to be consistent with
the limitation of liability.21
Burden of proof
It is for the party seeking to rely on the exemption clause to show that the clause, on its
true construction, covers the obligation or liability that it purports to restrict or exclude.22
15 See for Swiss law Swiss Code of Obligations Article 18(1); for English law Kudos Catering Ltd v. Manchester
Central Convention [2013] EWCA Civ 38.
16 For Swiss law see Kuoni, Haftungsbegrenzung im schweizerischen deutschen und englischen Recht paras. 389 et seqq.
(2015).
17 Suisse Atlantique Société d’Armement Maritime SA v. NV Rotterdamsche Kolen Centrale [1967] 1 A.C. 361, 398. See
also 1 Chitty on Contracts 14-007 (31st ed. 2012).
18 Lawson, Exclusion Clauses and Unfair Contract Terms 2-004 and 11 (11th ed. 2014).
19 [2009] EWHC 844 (Ch). See also Lawson, Exclusion Clauses and Unfair Contract Terms 2-011 (11th ed. 2014).
20 [1995] NPC 153. See also Lawson, Exclusion Clauses and Unfair Contract Terms 2-016 (11th ed. 2014).
21 See the decision of the Swiss Federal Supreme Court BGE 41 II 437.
22 1 Chitty on Contracts 14-018 (31st ed. 2012).
70
Limits of contractual limitations on damages

Party autonomy and contractual freedom are not unlimited. Limitations of liability and
of damages are a well suited example to illustrate the boundaries placed on contractual
freedom by mandatory law. Statutory limitations to contractual agreements limiting the
availability of damages are common in virtually all countries.
In Germany, parties cannot agree in advance to exclude liability for unlawful intent.23 If
contained in standard terms, an agreement to exclude liability for negligence will be con-
sidered invalid in the event of a violation of essential duties.24 Swiss law is more rigid, as it
provides that any agreement purporting to exclude or limit liability for unlawful intent or
gross negligence in advance is void.25 The court also has discretion to invalidate an advance
exclusion of liability for minor negligence in certain cases.26 Even narrower restrictions
exist for consumer contracts and GTCs.
In New York, the courts have a policy against limiting liability in contracts in cases of
grossly negligent conduct as well as purely intentional wrongdoing.27
In England, the Unfair Contract Terms Act 1977 (UCTA) restricts the operation and
legality of some contract terms. The UCTA contains a number of restrictions to limita-
tions of liability; these restrictions mainly concern the liability for death or personal injury
resulting from negligence. In addition, the UCTA applies a reasonableness test, requiring
that any term ‘shall have been a fair and reasonable one to be included having regard to the
circumstances which were, or ought reasonably to have been, known to or in the contem-
plation of the parties when the contract was made’.28
Contractual limitations on damages that exceed the statutory limits are not effective.
Depending on the applicable law and the type of contractual limitation involved, the limi-
tation on damages may be rendered absolutely ineffective or it may be partially effective, in
particular, only insofar as the term does not exceed the limits of mandatory law or satisfies
the requirement of reasonableness in the common law system.
Consequences of contractual limitation on damages

Contractual limitations on damages that are validly agreed upon and that do not go beyond
the limits described above are valid and serve to limit the availability of damages.29 In par-
ticular, a claim for damages does not exist to the extent it has been effectively excluded. On
the other hand, a primary duty to perform will not be affected by contractual limitations
on damages.30
23 German Civil Code § 276(3).

24 German Civil Code § 307(2)(2).
25 Swiss Code of Obligations Article 100(1).
26 Namely, if the party excluding liability was in the other party’s service at the time the waiver was made or the
liability arises in connection with commercial activities conducted under official licence. Cf. Swiss Code of
Obligations Article 100(2).
27 Novak & Co v. New York City Housing Authority, 480 N.Y.S.2d 403 (N.Y. App. Term. 1984).
28 UCTA Section 11.
29 Cf. for clauses limiting the liability in general under Swiss law, Buol, Beschränkung der Vertragshaftung durch
Vereinbarung para. 230 (1996).
30 Cf. for clauses limiting the liability in general under Swiss law, Buol, Beschränkung der Vertragshaftung durch
Vereinbarung para. 232 (1996).
71
Forms of contractual limitations on damages

Liquidated damages/penalty clauses
Common law jurisdictions distinguish clearly between liquidated damages and penalties.
Liquidated damages are an amount contractually stipulated as a reasonable estimation of the
actual damages to be recovered by one party if the other party breaches the agreement.31
Traditionally, courts have upheld liquidated damages clauses.32
On the other hand, penalty clauses are contractual provisions that assess against a
defaulting party an excessive monetary charge unrelated to actual harm.33 Penalty clauses
are generally considered unenforceable.34 In the words of Atiyah:
It not infrequently happens that contracts provide for what is to happen in the event of a breach
by the parties, or by one of them. Such provisions may be perfectly simple attempts to avoid
future disputes, and to quantify the probable amount of any loss. That is unobjectionable. But
sometimes clauses of this kind are not designed to quantify the amount of the probable loss, but
are designed to terrorize, or frighten, the party into performance. For example, a contract may
provide that the promisor is to pay £5 on a certain event, but if he fails to do so, he must then
pay £500. Now a clause of that kind is called a penalty clause by lawyers, and for several
hundred years it has been the law that such promises cannot be enforced.The standard justifica-
tion for the law here is that it is unfair and unconscionable to enforce clauses which are designed
to act in terrorem.35
Although the parties’ choice of ‘penalty’ or ‘liquidated damages’ in their contract will serve
as prima facie evidence of the term actually stipulated, the expression used by the parties will
not be conclusive. Rather, the court will have to determine whether the payment stipu-
lated in fact constitutes a penalty or liquidated damages.36 To assist this task of construction,
various tests have been suggested. For example, a payment obligation will be considered
to constitute a penalty where the sum stipulated is extravagant and unconscionable when
compared with the greatest loss that could conceivably have followed from the breach.37
There is no such general exclusion of penalty clauses in civil law countries. Quite to
the contrary, in Switzerland as well as in Germany and Austria, a penalty can be promised
for non-performance or defective performance of a contract, and unless otherwise agreed,
the creditor may then compel performance or claim the penalty.38 In fact, the Swiss Federal
Supreme Court has even confirmed that a contractual penalty may be agreed for the
31 Black’s Law Dictionary 473 (10th ed. 2014).

32 Clydebank Engineering and Shipbuilding Co v. Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6.
34 Cf. e.g., for New York law, Vernitron Corp v. CF 48 Associates, 478 N.Y.S.2d 933, 934 (N.Y. App. Div. 1984).
35 Atiyah, Promises, Morals, and Law 57-58 (1981).
36 Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motors Co Ltd [1915] A.C. 86.
37 Lord Halsbury in Clydebank Engineering and Shipbuilding Co v. Don Jose Ramos Yzquierdo y Castaneda [1905] AC
6; see also Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motors Co Ltd [1915] A.C. 87.
38 Swiss Code of Obligations Article 160(1). Where the penalty is promised for failure to comply with the
stipulated time or place of performance, the creditor may claim the penalty in addition to performance
provided he has not expressly waived such right or accepted performance without reservation (Swiss Code of
Obligations Article 160(2)).
72
purpose of punishing one of the parties.39 The penalty is payable even if the creditor has
not suffered any loss or damage.40 The parties are free to determine the amount of the con-
tractual penalty.41 However, under Swiss, German and Austrian law, the court may reduce
penalties that it considers excessive in its discretion.42
Liquidated damages and penalty clauses are thus treated differently in various legal
systems.This circumstance should be carefully considered when drafting an agreement, but
also later on if any such clause is in dispute.
Stipulation of a maximum amount of damages/limitation clauses

Clauses limiting the amount of damages, also called limitation clauses, are generally admis-
sible in common law. Pursuant to Ailsa Craig Fishing Co Ltd v. Malvem Fishing Co Ltd:
Clauses of limitation are not regarded by the courts with the same hostility as clauses of exclu-
sion: this is because they must be related to other contractual terms, in particular to the risks to
which the defending party may be exposed, the remuneration which he receives, and possibly
also the opportunity of the other party to insure.43
There is even case law holding that the principle of strict construction is not applica-
ble when considering the effect of clauses merely limiting damages.44 The modern view,
however, seems to be that the general approach to interpretation, which is to ascertain the
objective intention of the parties, also applies to limitation clauses.45 Under English law, a
clause providing for a maximum amount of damages will be valid if the limitation is con-
sidered to be reasonable.46 With regard to contract terms that restrict damages to a specified
sum of money, the UCTA provides that regard shall be had in particular to (a) the resources
that the person seeking to restrict damages could expect to be available to him or her for
the purpose of meeting the liability should it arise; and (b) how far it was open to him or
her to cover himself by insurance.The contract value and the turnover of the party seeking
to restrict damages are also taken into consideration.47
In civil law systems, caps on damages are generally valid, albeit only to the extent the
cap does not violate the statutory limits to limitations of damages.48 Moreover, in some
civil law jurisdictions, such restrictions will be examined to ensure that they do not unduly
restrict damages in such a manner as to exclude coverage of the actual damages incurred.49
39 Decision of the Federal Supreme Court BGE 109 II 462 at cons. 4a. See also Austrian Civil Code (ABGB)
§ 1336; German Civil Code §§ 340 et seqq.
42 Swiss Code of Obligations Article 163(1); Austrian Civil Code (ABGB) § 1336(2); German Civil Code § 343.
43 Ailsa Craig Fishing Co Ltd v. Malvern Fishing Co Ltd [1982] S.L.T. 377 at 380.
44 Ailsa Craig Fishing Co Ltd v. Malvern Fishing Co Ltd [1982] S.L.T. 377 at 382.
45 Whitecap Leisure Ltd v. John H Rundle Ltd [2008] EWCA Civ 429.
46 McKendrick, Contract Law:Text, Cases and Material 445 (2008).
47 McKendrick, Contract Law:Text, Cases and Material 445 (2008).
48 Decision of the Federal Supreme Court 4A_460/2013 at cons. 3.1 et seqq.
49 E.g., German law, decision of the German Bundesgerichtshof BGH VIII ZR 155/99, in: NJW 2001, 292, at
295 et seq.
73
Clauses stipulating a maximum amount of damages are thus generally admissible,

although they may nevertheless be subject to substantial restrictions, particularly in certain
civil law systems.
Exclusion of a particular damage type

Contractual limitations of damages may also limit the availability of certain types of damages.
Damages arising from death or personal injury can hardly ever be excluded. For exam-
ple, under English law, the UCTA provides that ‘[a] person cannot by reference to any
contract term or to a notice given to persons generally or to particular persons exclude
or restrict his liability for death or personal injury resulting from negligence’.50 Similarly,
under Swiss law, clauses excluding liability for personal injury are ineffective.51 If liability
for personal injury cannot be exluded, damages for personal injury cannot – following
the argument a maiore ad minus – be excluded either. It may thus be preferable to make a
reservation for damages arising out of personal injury when drafting clauses limiting the
availability of damages.
On the other hand, loss or damage that does not result directly or naturally from the
breach of contract can generally be excluded, unless the limitation exceeds the mandatory
limits.52 These damages are referred to as consequential damages or indirect damages.53
Under English law, case law provides guidance with regard to what is considered a
consequential loss or damage and to what extent a clause excluding consequential loss or
damage is effective. For example, in British Sugar Plc v. NEI Power Projects Ltd54 the relevant
clauses provided that ‘[t]he seller will be liable for any loss damage cost or expense incurred
by the purchaser arising from the supply of any such faulty goods or material or any goods
or materials not being suitable for the purpose for which they are required save that the
seller’s liability for consequential loss is limited to the value of the contract’. The value of
the contract was £106,000, while the damages claimed for the breach were £5 million.
The Court of Appeal stated that the clause simply limited the liability for loss and dam-
age not directly arising from the breach to an amount equal to the value of the contract.
Similarly, in Deepak Fertilisers & Petrochemical Group v. Davy McKee (London) Ltd55 the clause
explicitly excluded ‘indirect or consequential damages’ and ‘loss of profits’. The court con-
sidered the lost profits as damages that flow directly from the breach. However, since the
clause expressly excluded lost profits, these could not be recovered. English courts also
frequently give consideration to Hadley v. Baxendale56 to determine which damages directly
follow from a breach.57
50 UCTA Section 2(1).

51 There is no statutory prohibition, but scholars consider that such clauses are immoral and thus invalid pursuant
to Swiss Code of Obligations Article 20. Cf. Kessler, Article 41 N 2, in: Basler Kommentar (6th ed. 2015).
52 E.g., under New York law, consequential damages may be limited or excluded in commercial contracts,
unless such limitation or exclusion is unconscionable, Corinno Civetta Construction Corp v. City of New York,
502 N.Y.S.2d 681 (N.Y. 1986).
54 [1997] 87 BLR 42; [1997] CLC 622.
55 [1999] 1 Lloyds Rep 387.
56 [1854] 9 Ex. 341.
57 E.g., Jewson Ltd v. Kelly [2003] EWCA Civ 1030.
74
In civil law countries, the terminology is less clear. In Switzerland, the distinction
between direct and indirect damages is made on the basis of the length of the causal chain
involved.58 On the other hand, under German law, indirect damages are damages affecting
an asset other than the object of the contract that was breached.59 The boundaries placed
on limitations on damages by statutory law also apply to any types of damages that are
excluded. For example, under Swiss law, the governing principle is that damages for gross
negligence cannot be excluded. Accordingly, even if the contract excludes consequential
damages, any consequential damages arising from gross negligence will still be owed.60
Similarly, exclusions of indirect damages under German law will be invalid to the extent
that they are contained in GTCs and seek to exclude any damages arising out of a violation
of essential duties.61
In sum, it seems that exclusions of a particular type of damage are not an effective
means of managing risk contracts subject to civil law, as these systems tend to prescribe
a mandatory liability for damages arising from gross negligence or wilful misconduct. To
the extent that the damages arise from simple negligence or without fault, these may be
excluded as a whole, without there being a need to limit the exclusion to consequential
damages. On the other hand, common law systems tend to accept exclusions of different
types of damages, as long as such exclusions are reasonable, and in fact, it may be precisely
the exclusion of consequential damages but not direct damages that may render an exemp-
tion clause reasonable.
Modifications with regard to other aspects

Further clauses may also have the effect of limiting damages. For example, the parties may
agree to shorten the time limit for the notification of a breach of contract or shorten the
statutory limitation periods to the extent permissible under the applicable law.62 The parties
may also modify the statutory burden of proof or the standard of proof. For example, under
Swiss law, an obligor who fails to discharge an obligation must make amends for the result-
ing loss or damage unless he or she can prove that he or she was not at fault.63 The parties
can amend this principle by agreeing that the injured party needs to prove that the obligor
was at fault, which may – as the case may be – have the effect of a limitation on damages.
These examples show that the position of the creditor may be affected by clauses modi-
fying the modalities of liability. Such clauses, if admissible under the applicable law, may
have the same effect as contractual limitations of damages in the strict sense.
Limitation of damages owed by third parties

A different issue is whether contractual limitations can operate to protect a person who is
not a party to the contract.
58 Cf. the so-called ‘parrot case’ of the Swiss Federal Supreme Court BGE 133 III 257.
59 Oetker, § 249 N 99 in: MünchKomm BGB (7th ed. 2015).
60 Kuoni, Haftungsbegrenzung im schweizerischen deutschen und englischen Recht para. 305 (2015).
61 Decision of the German Bundesgerichtshof BGH X ZR 211/98 in: NJW-RR 2001, 324, at 343.
62 E.g., for English law, 1 Chitty on Contracts 14-003 (31st ed. 2012). Under Swiss law, the general statutory
time-limitation of 10 years cannot be shortened, cf. Swiss Code of Obligations Article 129.
75
Common law tradition generally considers that the principle of privity of contract pre-
vents a contractual agreement from granting benefits to third parties or imposing burdens
upon them.64 Based on this principle, courts have traditionally considered that third parties
cannot claim the benefit of an exemption clause between two contracting parties since they
are not a party to said contract.65 These decisions have been considered to be too rigid, in
particular, between businessmen. In Scruttons Ltd v. Midland Silicones Ltd,66 the argument was
made that the contracting party, in addition to contracting on his or her own behalf, is also
contracting as an agent for the third party to whom the provisions should apply. The situa-
tion has become clearer with the enactment of the Contracts (Rights of Third Parties) Act
1999. Section 1(6) of said act provides that ‘[w]here a term of a contract excludes or limits
liability in relation to any matter references in this Act to the third party enforcing the term
shall be construed as references to his availing himself of the exclusion or limitation.’
In civil law systems, the parties to an agreement are generally allowed to limit their
liability for any loss or damage caused by an associate to whom the performance of an
obligation or the exercise of a right arising from a contractual obligation is delegated.67
However, the majority view is that such clauses do not exclude the liability of the associate
himself (based on tort, etc.).68
In sum, it seems that clauses limiting damages owed by third parties tend to be more
effective under common law.
Conclusion
The above explanations demonstrate that the general concepts regarding how contractual
limitations of damages can be agreed, how they are interpreted, who bears the burden
of proving such limitations, and the consequences of such limitations are similar even in
diverse legal traditions.
On the other hand, the enforceability of contractual limitations on damages varies quite
heavily between the common law and the civil law traditions. While the common law sys-
tem tends to apply a reasonableness test, civil law countries generally focus on the degree
of fault and consider agreements purporting to exclude liability for unlawful intent and
gross negligence in advance to be ineffective.This difference is crucial for the availability of
several forms of contractual limitations on damages.
Differences in the approach towards contractual limitations on damages emerge in
almost all forms of such limitations on damages that have been assessed above.
Liquidated damages and penalty clauses are generally permissible in civil law systems,
with the caveat that excessive penalties may be reduced by courts. On the other hand,
64 Lawson, Exclusion Clauses and Unfair Contract Terms 2-054 (11th ed. 2014).
65 See e.g., Adler v. Dickson [1954] 3 All E.R. 397.
66 [1962] 1 All E.R. 1 at 10.
67 Swiss Code of Obligations Article 101(2). If the obligee is in the obligor’s service or if the liability arises
in connection with commercial activities conducted under official licence, any exclusion of liability by
agreement may apply at most to minor negligence (Swiss Code of Obligations Article 101(3)). See also
German Civil Code § 278.
68 Weber, Berner Kommentar Article 101 N 167 (2000); Wiegand, Article 101 N 16, in: Basler Kommentar,
Obligationenrecht I (6th ed. 2015).
76
penalty clauses, to the extent they provide for a monetary charge unrelated to the actual
harm, are considered ineffective in the common law tradition.
Stipulations of a maximum amount of damages are effective in the common law tradi-
tion if the limitation is reasonable. In civil law systems, caps on damages are only admissible
if they do not restrict the damages to an extent that is not admissible under statutory law;
in other words, in case of wilful intent or gross negligence, a cap may not be effective.
Clauses that exclude a particular type of damages generally face the same differences
in approach. One exception to this rule are damages arising from death or personal injury,
which can hardly ever by excluded. On the other hand, the common law tradition gener-
ally considers the exclusion of consequential damages to be valid, as long such exclusions
are reasonable. But in civil law, exclusions of a particular type of damage do not seem to be
very effective, since such limitations may not overcome the mandatory liability for damages
arising from gross negligence and wilful misconduct.
A further possibility that should be taken into consideration are clauses that modify the
liability with regard to other aspects, such as the statutory limitation periods, which may
have the same effect as contractual limitations on damages.
With regard to limitation of damages owed to third parties, it seems that the common
law tradition allows third parties to avail themselves of the contractual limitation of liability,
while this does not seem to be the case in civil law systems.
In sum, no general statement can be made about which law system is more favourable
towards contractual limitations on damages. Rather, the individual contractual limitation
sought or in dispute must be assessed under the applicable law. And depending on the
importance of contractual limitation on damages, the law applicable should be chosen with
a view to maximising the enforceability of such limitations.
77
Overview of Principles Reducing Damages
5
Craig Miles and David Weiss1
International arbitral tribunals operating under international law and municipal laws rou-
tinely apply well-recognised principles of law to limit compensation awarded to a claimant
for a respondent’s breach of law.The most common of these principles are (i) causation, (ii)
speculation, (iii) contributory fault, (iv) foreseeability, (v) mitigation and (vi) the bar against
double recovery. When reviewing authorities analysing or applying these principles, one
often finds a conceptual overlap among these principles, which can be explained, at least
in part, by the observation that these six principles are arguably all iterations of factual or
proximate causation.
In addition, one of the most commonly used tools to measure the value (as well as
loss of value) of a business is discounted cash flow (DCF) – i.e., the present value of the
expected cash flows that the business will generate in the future. Because DCF necessarily
relies on assumptions about future performance, including the risk that the expected cash
flows will materialise, tribunals using DCF to measure damages have broad discretion to
apply conservative assumptions to such models to lower the damages awarded.2
This chapter will address these principles and concepts in turn.
Causation
It is uncontroversial that, absent highly unusual circumstances, a respondent’s liability is
limited to damages that its conduct caused and, in general, a claimant bears the burden of
proving that the respondent caused the claimant’s injuries. Causation has long been widely
1 Craig Miles is a partner and David Weiss is a senior associate at King & Spalding LLP. The authors would like
to express their gratitude to Shayna Goldblatt for her research assistance.
2 Needless to say, tribunals also have discretion to use more aggressive assumptions, which would tend to
increase damages. This chapter, however, is focused on damages reduction principles.
78
recognised as a general principle of law.3 As stated by the tribunal in Biwater v. Tanzania,

‘it is well settled that one key requirement of any claim for compensation (whether for
unlawful expropriation or any other breach of Treaty) is the element of causation.’4 Article
31 of the ILC’s Articles on State Responsibility and its official commentary reflect the
principle as it exists under customary international law.5 The concept requires establishing
a cause-and-effect relationship between the act and the harm done.6
Many legal systems, including international law, draw a distinction between factual
causation and proximate causation. Factual and legal factors inform that distinction. Factual
causation concerns proving that an act caused the damage in question. As stated by Sabahi,
‘The factual aspect of proximity mainly turns on proving, with evidence, that the particular
unlawful act actually caused the damage in dispute.’7
Legal causation concerns underlying policies that limit liability even if factual causation
can be established. In US law, one of the classic cases that all first-year law students study is
Palsgraf v. Long Island Railroad.8 In this famous case, two railroad guards attempted to help
a man board a train. In doing so, they caused the man to drop a package. That package,
which was wrapped in newspaper and looked innocuous, contained fireworks and caused
an explosion that, in turn, knocked down scales at the other end of the train platform,
injuring the plaintiff. The court dismissed a claim against the railroad on grounds that the
injury was not foreseeable.9
The ILC Articles on State Responsibility reflect certain policies behind rules of proxi-
mate cause in international law. For instance, the commentary to Article 31 of the ILC
Articles, which provides that a responsible state must make full reparations for the injury
caused by the internationally wrongful act, explains that in international law, a state is
responsible for all of the harm its wrongful conduct caused, even if other factors contrib-
uted to the injury (unless it was as a result of contributory fault):
Often two separate factors combine to cause damage. In the Diplomatic and Consular Staff
case, the initial seizure of the hostages by militant students (not at that time acting as organs
or agents of the State) was attributable to the combination of the students’ own independent
action and the failure of the Iranian authorities to take necessary steps to protect the embassy.
In the Corfu Channel case, the damage to the British ships was caused both by the action of
a third State in laying the mines and the action of Albania in failing to warn of their presence.
Although, in such cases, the injury in question was effectively caused by a combination of fac-
tors, only one of which is to be ascribed to the responsible State, international practice and the
3 Bin Cheng, General Principles of Law as Applied by International Courts and Tribunals 241-253 (Cambridge
University Press 2006) (1953) (Bin Cheng).
4 Biwater Gauf (Tanzania) Ltd. v.Tanzania, ICSID Case No. ARB/05/22, Award, 24 July 2008 at paragraph 778
(Biwater v.Tanzania).
5 James Crawford, The International Law Commission’s Articles on State Responsibility, Introduction, Text, and
Commentaries 201-206 (Cambridge University Press 2005) (2002) (ILC Articles).
6 Borzu Sabahi, Compensation and Restitution in Investor-State Arbitration Principles and Practice 170 (2011) (Sabahi).
7 Id. at 171.
8 Palsgraf v. Long Island Railroad Co, 248 N.Y. 339, 162 N.E. 99 (N.Y. 1928).
9 Id. at 340-341, 347.
79
decisions of international tribunals do not support the reduction or attenuation of reparation for
concurrent causes, except in cases of contributory fault.10
Causation analysis could lead to no compensation even when there has been a breach of
a legal obligation. In Biwater v. Tanzania, the tribunal held that Tanzania violated the treaty
but that the violation caused no harm because the investment was already worthless; it thus
awarded zero compensation.11
The interaction between factual and proximate causation can often be decisive to the
outcome of a case. As many commentators have observed and analysed, CME and Lauder
concerned the same facts.12 The CME Tribunal held that the Czech Republic contributed
to the investor’s injury and, as provided for under international law, the other contributing
causes did not relieve the state of its obligation to provide full compensation.13 In contrast,
the Lauder Tribunal held that one of the other, non-state contributing causes (the acts of a
private party) were the main cause for the injury and that the Czech Republic’s conduct in
breach of the treaty did not cause the investor’s damages.14 As a result, the former tribunal
awarded US$270 million and the latter tribunal awarded nothing.15
Bar against speculative damages

Most, if not all, legal systems, including international law, reject damages that are too specu-
lative.16 The bar against damages that are too speculative is a form of factual causation. A
tribunal declines to award damages because there is insufficient evidence to prove that the
illegal act caused the damages the claimant seeks. A claimant always needs to prove facts in
support of its case. An inherent difficulty with damages is that one is often, if not always,
trying to prove a counter-factual. This is not proving what happened: it is proving what
would have happened if the respondent had not breached a legal obligation.
The principle against speculative damages does not require a claimant to prove its dam-
ages to a certainty.17 The standard most often utilised in municipal and international law is
one of ‘reasonable certainty’ or a ‘reasonable degree of certainty’. For instance, under US
law, a claimant must prove its damages with ‘reasonable certainty’, and the UNIDROIT
Principles of International Commercial Contracts uses the term ‘reasonable degree of
certainty’.18
In many legal systems, several nuances limit the extent to which the allegedly specula-
tive nature of the damages will prevent them from being awarded. For instance, doubts
10 The ILC Articles at 205-206.

11 Biwater v.Tanzania at paragraphs 798-807, 814.
12 See, e.g., Sabahi at 173-74; Mark Kantor, Valuation For Arbitration Compensation Standards Valuation Methods and
Expert Evidence 108 (2008) (Kantor).
13 CME Czech Republic BV v. Czech Republic, UNCITRAL, Partial Award, 13 September 2001 at paragraphs
584-585 (CME v. Czech Republic).
14 Lauder v. Czech Republic, UNCITRAL, Award, 3 September 2001 at paragraphs 222, 234-235 (Lauder v.
Czech Republic).
15 CME v. Czech Republic, paragraph 319.
16 Kantor at 70.
17 Id. at 71.
18 Restatement (Second) of Contracts § 352; Article 7.4.3 UNIDROIT Principles 2010.
80
should be resolved against the breaching party.19 The rationale is that a party that caused
a significant loss should not be allowed to profit from that breach. That rationale is espe-
cially applicable in instances where the respondent’s illegal conduct was wilful or destroyed
evidence that, if available, would have allowed the claimant to prove its damages with
more certainty.
A second important nuance is the distinction between proof of the fact of damages
and proof regarding the amount of damages. Though some authorities have held that the
‘reasonable certainty’ requirement applies to both the fact of damage and the amount of the
loss, the better view, at least when permissible under the applicable law, is that the ‘reason-
able certainty’ requirement should apply to the fact of damages, but that once the fact of
damages is established with reasonable certainty, proof as to the amount of damages may
be an estimate, uncertain and inexact because requiring a high degree of certainty unfairly
burdens the injured party and benefits the breaching party.20 For instance, Article 7.4.3(1)
of the UNIDROIT Principles provides that compensation ‘is due only for harm, includ-
ing future harm, that is established with a reasonable degree of certainty’, though Article
7.4.3(3) provides that ‘where the amount of damages cannot be established with a sufficient
degree of certainty, the assessment is at the discretion of the court.’ 21
At the same time, international tribunals often reject the use of a DCF model on
grounds that it is too speculative, especially if the project was not a going concern. For
instance, the US-Iran Claims Tribunal and several ICSID tribunals have rejected damages
based on a DCF model when the project at issue was not built or completed.22 Companies
that have yet to build a project face numerous risks: construction, force majeure, business
climate, currency risks and creditworthiness of a long-term purchaser, to name a few. On
the other hand, such companies are routinely traded on stock exchanges, which illustrates
both that they have value and that this value can be calculated to a reasonable degree of cer-
tainty. There have also been instances where a claimant was able to obtain significant com-
pensation based on DCF models for projects that were injured early in their life cycle and
thus not completed. In Gold Reserve v.Venezuela, the tribunal considered damages for breach
of the fair and equitable treatment standard with respect to a mine that never exploited the
minerals.23 Even though the mine never generated any cashflow, the tribunal concluded
that compensation based on a DCF model was appropriate because the damages concerned
19 See, e.g., Restatement (Second) of Contracts § 352.

20 J.Y. Gotanda, ‘Assessing Damages in International Commercial Arbitration: A Comparison with Investment
Treaty Disputes,’ TDM 6 (2007), www.transnational-dispute-management.com at 5-6 (citing Paulsson, ‘The
Expectation Model,’ at 60, in Derains & Kriendler (eds.), Evaluation of Damages in International Arbitration (ICC
Institute of World Business Law 2006); see also Kantor at 73.
21 Article 7.4.3 UNIDROIT Principles 2010 Edition.
22 See, e.g., William J. Levitt v. Iran, 14 Iran-US CTR (1987) 191, paragraphs 56-58; Dadras Int’l and Per-Am
Construction v. Iran, 31 Iran-US CTR (1995) 127, paragraphs 275-76; Impregilo SpA v. Argentina, ICSID Case
No. ARB/07/17, Award, 21 June 2011 at paragraphs 375-81 (Impregilo v. Argentina); Railroad Development Corp
v. Guatemala, ICSID Case No. ARB/07/23, 29 June 2012 at paragraph 269.
23 Gold Reserve Inc v. Bolivarian Republic of Venezuela, ICSID Case No. ARB(AF)/09/1, Award,
22 September 2014 at paragraph 863.
81
a commodity product for which data, such as reserves and price, were easily calculated, and
detailed mining cashflow analysis had been performed previously.24
Although declining to award damages based on a DCF model may be appropriate if
there is clearly no reasonable evidence that a project would have been profitable, it is argu-
ably inappropriate if proof of the fact of damage is very certain. In such instances, it may be
more appropriate to account for elevated levels of uncertainty by adjusting variables within
the DCF model. For instance, increasing the discount rate to account for the uncertainty
of the future revenue stream will decrease the net present value of that revenue stream and
thus the compensation awarded. In many fact patterns, this approach is more consistent
with financial valuations in the commercial world, where DCF models are routinely used
to value projects that are not yet established going concerns. We will discuss DCF and the
role of sensitivities in more detail below.
An alternative, which is common in investment jurisprudence, is to award a claim-
ant the monies it invested instead of using a DCF model when the tribunal concludes
that the model is too speculative because the project was not a going concern.25 In many
instances, this approach benefits the breaching party by undercompensating the claimant,
even though evidence of the fact of damage is well established. Further, in many fact pat-
terns, this approach, which is compensating the claimant for its reliance interest, is incon-
sistent with the Chorzów Factory principle. That principle, which is now considered the
primary rule for compensation under international law, provides that a claimant should
be placed in as near a position as it would have been ‘but for’ the breach.26 Yet it is often
difficult to conceive of a but-for fact pattern in which the claimant would have received
only the money it invested, and nothing more, if the respondent state had not violated the
international legal obligation at issue.
Yet another approach to redress damages that might otherwise be considered overly
speculative is to compensate a claimant for a lost opportunity. For instance, if a claimant is
improperly barred from participating in the bidding process for a potentially lucrative oil
and gas concession, it may be hard to prove that the claimant would have won the bidding
process had it been allowed to participate. The claimant might be able to provide compel-
ling evidence that it would have offered more than the winning bid, but how can it prove
that the party who actually won the concession was not willing to bid even more had it
been necessary? In such a circumstance, awarding compensation based on the assumption
that the claimant would have won the bid might be deemed too speculative. An alternative
approach would be to assess the odds that the claimant would have won the bid and award
the claimant compensation in accordance with those odds.Thus, for instance, if the tribunal
deemed that there was a 65 per cent chance that the claimant would have won the bid, the
tribunal might determine the amount of damages that would be due, assuming that the
claimant had won the bid, and then award the claimant only 65 per cent of that amount.
24 Id. paragraph 832-832.

25 See, e.g., Impregilo v. Argentina at paragraphs 375-81.
26 Factory at Chorzów, Merits, 1928, P.C.I.J., Series A, No. 17, p. 47; see also the ILC Articles at 201.
82
The UNIDROIT Principles expressly contemplate this form of compensation as one

in which the tribunal awards damages in proportion.27 In the Shappire Petroleum arbitration,
the tribunal awarded the claimant a portion of its anticipated lost profits as compensation
for a lost opportunity, but the tribunal did not expressly articulate the amount awarded
as being based on an assessed probability of the lost opportunity’s occurrence.28 In Bosca
v. Lithuania, the tribunal interpreted compensation for a ‘lost opportunity’ as the right to
recover direct damages (i.e., monies spent on the investment) as opposed to compensation
in proportion to the probability that the investment would have succeeded.29 Nevertheless,
there is nothing, in principle, under international law that would preclude a tribunal from
awarding compensation for the loss of a chance in proportion to the probability of its
occurrence – especially when a more conservative approach might unduly benefit the
breaching party that created the situation of uncertainty.
Foreseeability
In general, a claimant can only recover damages that the respondent could have foreseen.
Different countries apply this principle differently, but most, if not all, recognise this prin-
ciple as one that limits recoverable damages.30 At the same time, nuances of this principle
vary among legal systems. Some domestic laws do not apply this principle if the breach
resulted from wilful misconduct or gross negligence.31 Like the principle against specula-
tive damages, some authorities hold that a rough estimate of the amount of harm must be
foreseeable, whereas most only require that the type of harm was foreseeable.32 French and
English law assess foreseeability from the moment when a contract is executed, whereas
German law assesses foreseeability from the moment of breach.33
While this principle is widely recognised, it rarely arises in practice. International arbi-
trations typically concern large investment disputes or complex international commercial
disputes between sophisticated parties, and the object of damages will concern lost profits
and costs incurred as a result of a state’s breach of widely recognised standards under inter-
national law for the protection of foreign investments, or private parties for breach of a
contractual obligation. In these sorts of disputes, it is rare that a respondent would have a
credible argument that the claimed damages were not foreseeable.
Contributory fault
The contributory fault principle allows a tribunal to apportion liability between a claimant
and respondent when the claimant’s conduct materially contributed to its loss. This princi-
ple is recognised in international law, and it is generally recognised that the conduct must
27 Article 7.4.3(2) UNIDROIT Principles 2010 (‘Compensation may be due for the loss of a chance in
proportion to the probability of its occurrence.’).
28 Sapphire International Petroleums Ltd v. National Iranian Oil Co, Arbitral Award, 35 I.L.R. 146 (1963).
29 Luigiterzo Bosca v. Lituania, PCA Case No. 2011-05, Award, 17 May 2013 at paragraphs 296-301.
30 Herfried Wöss, Adriana San Román Rivera, Pablo T. Spiller, Santiago Dellepiane, Damages in International
Arbitration Under Complex Long-Term Contracts 212-214 (2014) (Wöss et al).
31 Kantor at 103.
32 Id.
33 Wöss et.al., 212-13.
83
be wilful or negligent.34 Thus, this principle is a mix of factual and proximate causation. A
tribunal may take into account the extent to which a claimant’s own conduct contributed
to its loss if that conduct was unreasonable, imprudent or unlawful. International invest-
ment tribunals have tended to apply this principle restrictively, though one example of its
application is MTD v. Chile.35 In this case, the tribunal determined that Chile breached the
treaty, but also held that the claimant contributed to its own loss by purchasing the property
at issue before obtaining the required permits for the project.36
One should also bear in mind that, unlike some other principles commonly used to
limit damages, contribution can operate as a defence to liability, as well as a condition
limiting a claimant’s damages. For instance, most legal systems recognise that one party to
a contract cannot assert a claim for breach of contract against another if that party’s own
conduct prevented the other from performing.37 Thus, depending on the facts, the degree
to which one party’s conduct caused another to fail to perform a contractual obligation
may operate as a defence to liability or as a limit on the amount of compensation the claim-
ant can recover.
Mitigation
The duty to mitigate damages has been widely applied in international arbitration.38 It is
recognised in common law systems and has been recognised by several investment tribu-
nals.39 The principle also exists in some civil law jurisdictions, but it does not exist in all
34 ILC Articles at 240-41.

35 MTD Equity Sdn Bhd and MTD Chile SA v. Chile, ICSID Case No. ARB/01/7, Award, 25 May 2004 at
paragraphs 242-246 (MTD v. Chile); see also Irmgard Marboe, Calculation of Compensation and Damages in
International Investment Law 121 (2009) (Marboe); Sabahi at 176.
36 MTD v. Chile at paragraphs 242-246.
37 See, e.g., United Nations Convention on Contracts For the International Sale of Goods Article 80,
11 April 1980, U.N. Doc. A/CONF.97/18, Annex I, reprinted in 19 I.L.M. 668 (‘A party may not rely
on a failure of the other party to perform, to the extent that such failure was caused by the first party’s act
or omission.’) (hereinafter the ‘CISG’); see, also, Bin Cheng at 149-158 (discussing the principle Nullus
Commodum Caprere De Sua Injuria Propria (‘No one can be allowed to take advantage of his own wrong’)
under international law).
38 See, e.g., The ILC Articles at 205; EDF International SA SAUR International SA and León Participaciones
Argentinas SA v. Argentina, ICSID Case No. ARB/03/23, Award, 11 June 2012 at paragraph 1302 (‘The
duty to mitigate damages is a well-established principle in investment arbitration. This idea is reflected in
Middle East Cement v. Egypt, where that tribunal clearly recognized it as a general principle of law.’ (citations
omitted)) (EDF v. Argentina); Marboe at 122 (citing E Gaillard and J Savage (eds), Goldman on International
Commercial Arbitration (The Hague: Kluwer, 1999) 832; M Mustill, ‘The New Lex Mercatoria: The First
Twenty-five Years’ (1998) 4 Arbitration International, 86, 113; ICC No 2478, Clunet (1975) 925; ICC no 2103,
Cluent (1974) 902; ICC No 3344, Clunet (1982) 978; ICC No 2412, Clunet (1974) 892).
39 See, e.g., Restatement (Second) of Contracts § 350; AIG Capital Partners, Inc and CJSC Tema Real Estate
Company v. Kazakhstan, ICSID Case No. ARB/01/6, Award, 7 October 2003 at 10.6.4 (‘Mitigation of
damages, as a principle, is applicable in a wide range of situtations. It has been adopted in common law
and in civil law countries, as well as in International Conventions and other international instruments – as
for instance in Article 77 of the Vienna Convention and Article 7.4.8 of the UNIDROIT Principles for
International Commercial Contracts. It is frequently applied by international arbitral tribunals when dealing
with issues of international law.’); Middle East Cement Shipping and Handling Co SA v. Egypt, ICSID Case No.
ARB/99/6, Award, 12 April 2002 at paragraph 167; EDF v. Argentina at paragraph 1302.
84
– most notably, it does not exist in French law and some countries whose laws are based on
French law.40 Thus, in an international commercial arbitration, one should always research
the applicable law and not assume that a duty to mitigate applies.
The duty to mitigate is a form of proximate causation. It arises after a respondent has
breached a duty and caused injury and obligates a claimant to take reasonable steps to limit
the extent of that injury.41
Although the precise contours of the duty may differ under different laws, in the con-
text of complex commercial and international investment disputes, reasonableness should
operate as a limitation on the duty to mitigate.42 The proper test for mitigation is whether
it was unreasonable for the claimant to forgo a particular opportunity; it is not whether
the forgone opportunity was better than the steps the claimant actually took. Further, the
‘reasonableness’ quality of this duty means that the claimant’s conduct should be judged
based on the information that was available to the claimant at the relevant time, not with
the benefit of hindsight.
Thus, for instance, if one party breaches a long-term sales contract that the purchaser
was knowingly relying upon for downstream sales, a duty to mitigate by purchasing
replacement volumes will, absent special circumstances, arise. At the same time, in pursu-
ing replacements, the mitigating party may to have agree to higher prices on replacement
volumes than might be available on a daily spot market if there is uncertainty regarding
the degree and length that the breaching party will remain in breach. The breaching party
should not be allowed to argue, with the benefit of hindsight, that damages should be
reduced because the mitigating party could have obtained less expensive replacements by
relying on a daily spot market that moves unpredictably.
Indeed, many authorities recognise that failed mitigation efforts may not be to the
detriment of the claimant. ‘If the claimant has taken reasonable measures to mitigate the
consequences of the breach, the result of the but-for vs. the actual comparison damages cal-
culation must incorporate the benefits and costs of mitigation’.43 In addition, the respond-
ent bears the burden of proving that the claimant did not mitigate its losses.44
Double recovery
The principle against double recovery – or allowing a party to obtain compensation in
excess of what is required to make that party whole – is widely recognised. A risk of double
recovery usually arises in the context of parallel, or multiple, related proceedings. Though
40 Wöss et al. at 215.

41 See, e.g., The ILC Articles at 205 (‘Although often expressed as a ‘duty to mitigate’, this is not a legal
obligation which itself gives rise to responsibility. It is rather that a failure to mitigate by the injured party may
preclude recovery to that extent’ (citing Gabcíkovo-Nagymaros Project (Hungary/Slovakia), I.C.J. Reports
1997, p. 7, at p. 55, para. 80)); Wöss et.al., 215-16.
42 See, e.g., The ILC Articles at 205 (‘Even the wholly innocent victim of wrongful conduct is expected to act
reasonably when confronted by the injury’); Restatement (Second) of Contracts § 350; Marboe supra n. 35, at
122-23; Wöss et al, 215-16.
43 Wöss et al, supra n. 30, 215 (citing Tractebel Energy Marketing Inc v. AEP Power Marketing Inc, 487 F.3d 89,
109-110 (2nd Circuit 2007); Djakhongir Saidov, The Law of Damages in International Sales:The CISG and Other
International Legal Instruments (Hart Publishing 2008) 102-3).
44 Id. at paragraph 404.
85
tribunals should strive to prevent double recovery, respondents should not be allowed to
rely on the mere risk of double recovery as a defence to paying the first recovery.The most
common solution is for the first tribunal deciding the claims before it to proceed and for
any other subsequent tribunals to take account of that prior decision. As stated by the tri-
bunal in Lauder v. Czech Republic, ‘the amount of damages granted by the second deciding
court or arbitral tribunal could take [the prior award of damages] into consideration when
assessing the final damage.’45 In Exxon v.Venezuela, one of the claimants had already received
compensation for one of the measures at issue in a related commercial arbitration against
the state-owned company, PDVSA.46 As required under the relevant agreement, the claim-
ant represented to the ICSID Tribunal that it would reimburse PDVSA in the event of a
favourable award. The ICSID Tribunal noted this representation in the operative part of its
award and held there was, therefore, no risk of double recovery.47
While this solution will resolve concerns regarding a double recovery in most instances,
tribunals should still be wary of potential unfairness. For instance, consider the follow-
ing hypothetical: two companies of different nationalities that are joint venture partners
under a single petroleum concession bring separate claims for expropriation under differ-
ent investment treaties against the same sovereign. The sovereign asserts the same environ-
mental counterclaim as an offset in both arbitrations. In this hypothetical, there is both a
risk of double recovery, and a risk that the respondent obtains an improper second ‘bite of
the apple’ (or cherry, depending on which continent you reside). If the first tribunal deter-
mines that the amount of environmental damage is US$100 and the second determines
that it is US$75, the first tribunal would offset its award for expropriation by US$100 and
the second tribunal, taking into account the offset in the first proceeding, would offset its
award by zero. But if the first tribunal determines that the amount of environmental dam-
age is US$75 and the second determines that it is US$100, then the second tribunal might
offset its award by US$25 (after taking into account the offset in the first award). In both
scenarios, the sovereign state obtains the benefit of the larger assessment of environmen-
tal damage.
Sensitivities in DCF as a damages-reduction strategy

We have briefly mentioned the DCF method above. Respondents routinely use variables
in a DCF model to reduce damages. In sum, the DCF method measures the value of a
business by adding the free cash flows that the company expects to generate in the future,
discounted at a rate that reflects the company’s cost of raising capital.48 The term ‘free’ cash
flows means the flow of cash that is generated by the company, and that is available to be
distributed to its shareholders and lenders. The free cash flows for any given year are equal
45 Lauder v. Czech Republic, paragraph 172; see also, British Caribbean Bank Limited (Turks & Caicos) v. Belize,
PCA Case No. 2010-18, Award, 19 December 2014 at paragraph 190 (citing with approval Lauder for
this proposition).
46 Venezuela Holdings BV, Mobil Cerro Negro Holding Ltd, Mobil Venezolana de Petróleos Holdings Inc, Mobil
Cerro Negro Ltd and Mobil Venezolana de Petróleos Inc v.Venezuela, ICSID Case No. ARB/07/27, Award,
9 October 2014 at paragraphs 378-381.
47 Id.
48 See R. Doak Bishop & Craig S. Miles, Lost Profits and the Discounted Cash Flow Method of Valuation, World
Arbitration & Mediation Review Vol. 1, No. 1, 33 (2007).
86
to the cash left over to the company after meeting all of its operating expenses and taxes,
but prior to making its debt and other financial payments.
Importantly, however, the stream of annual expected free cash flows must take into
account the time-value of money to reflect the basic economic principle that a dollar in
hand today is worth more than a dollar tomorrow. Thus, cash flows must be discounted at
a rate that reflects the facts that: (1) people generally prefer present cash to future cash; (2)
when there is inflation, the value of future cash flows decreases faster; and (3) the higher
the risk of realising the future cash flows, the more inclined a stakeholder will be to receive
a quicker (albeit discounted) return on his or her risk capital.
It is widely accepted that the most appropriate discount factor is the weighted average
cost of capital (WACC).49 The WACC represents the average cost of raising funds from
shareholders and lenders operating in the same industry as the damaged company. The cost
of raising funds from lenders is measured by the interest rate at which they are willing to
offer loans to the company, called the cost of debt, while the cost of raising funds from
shareholders is measured by the cost of equity, which represents the expected rate of return
(in the form of dividends) on the shareholder’s equity contributions to the company. Thus,
the WACC estimates the implicit risk existing on future cash flows, considering the rate of
return required by each of the two finance providers (i.e., lenders and shareholders), each
weighted by the optimal proportion of debt and equity observed in the company’s industry.
The effects of the discount rate cannot be overstated. For example, assume the same
DCF model for a 20-year concession expected to generate US$1 million in profits per year
for the 20-year term. If discounted at 10 per cent, the US$20 million in cash flows would
be presently valued at US$8,513,564, whereas at a 20 per cent discount rate, the same cash
flows would have a present value of only US$4,869,580.
One key factor in the discount rate is the country risk premium. In essence, the country
risk premium is a way to quantify how investing equity in a particular country is more risky
than investing equity in a ‘safe’ country. The most common way to measure it is by look-
ing at the difference between the interest rate of a local bond denominated in US dollars
versus a US bond of similar maturity. The higher the spread in interest rates, the higher the
country risk premium, therefore, the higher the discount rate and the lower the damages.
Of equal importance to a DCF calculation is the damages period, which in many
instances will be equal to the length of the future life of the company (unless the chal-
lenged measures have a shorter lifespan). In other words, for how many years can the
company expect to generate these cash flows? At times, the company may be operat-
ing under a concession or other principal contract containing a defined term. In other
instances, however, it is left to the discretion of experts (and, ultimately, the arbitrators)
to establish the asset’s remaining useful life. Moreover, a DCF analysis necessarily implies
49 See McKinsey & Company, Inc. (Tim Koller, et al.), Valuation: measuring and Managing the Value of Companies
(4th ed. 2005) (‘The weighted average cost of capital is the discount rate, or the time value of money, used to
convert expected future cash flow into present value for all investors. … It must comprise a weighted average
of the marginal costs of all sources of capital – debt, equity, and so on – since the free cash flow represents cash
available to all providers of capital.’).
87
some in-depth knowledge of the company and its products, markets and competition.50 It
involves understanding the industry in which the company operates and the factors that
drive that industry and have an impact on the company’s performance during the damages
period.51 Finally, it involves understanding the economic forces that affect the business and
financial outlook for the company.52
Although the underlying assumptions will be numerous and different in each case, in
very general terms, they can be summarised as follows:
• assumptions related to the business in which the firm operates (e.g., revenues, prices,
market shares, new products, operating expenses, capital expenses, inventory policy,
working capital, tax requirements, etc.);
• assumptions regarding external macroeconomic factors (e.g., GDP growth, inflation
rates, exchange rates, monetary and fiscal policy that may affect the firm directly or
indirectly, labour market conditions, wages and salaries, etc.);
• assumptions on how the relevant regulatory framework will evolve, including taxation
matters as well as forms of direct regulation, if applicable; and
• assumptions of financial viability, if binding.
All of these variables can lead to significant variations in different DCF valuations of what
is ostensibly the same damaged company.This ultimately gives arbitrators significant discre-
tion to accept or reject key assumptions in the DCF methodology advanced by one party
or the other, which can have a profound impact on the damages awarded. This points to
the importance of the underlying assumptions used and the ability of good advocates to
influence the damages outcome by arguing for conservative assumptions.
For example, in the Phillips53 case, the claimant was a participant in a 1965 Joint
Structure Agreement (JSA) with Iran, which provided for the exploration and exploitation
of petroleum resources in an offshore area in the Persian Gulf. In 1979, Iran terminated
the agreement. Phillips sought compensation and based its claim on a DCF valuation of
its interest in the JSA, which it calculated to be US$159,199,000.54 The tribunal agreed
that ‘the DCF method by the Claimant [is] a relevant contribution to the evidence of the
value of the Claimant’s contract rights which have been taken by the Respondents,’ but
‘that it is not an exclusive method of analysis and that all relevant considerations must be
taken into account’.55 The tribunal decided not to ‘make its own DCF analysis with revised
components, but rather to determine and identify the extent to which it agrees or disagrees
with the estimates of both Parties and their experts concerning all of these elements of
valuation’.56 Ultimately, the tribunal disagreed with several of the claimant’s assumptions
and awarded substantially less damages than the amount sought.
50 Nancy J. Fannon, Lost Profits Damages: A Natural Extension of Business Valuation Skills, The CPA Expert
(Spring 2001).
51 Id.
52 Id.
53 Phillips Petroleum Co Iran v. Iran, Iran-U.S. Claims Tribunal, Award No. 425-9-2, 29 June 1989.
88
First, the tribunal lowered Phillips’s assumption about the number of barrels of oil that
could be produced from the field. Phillips’s DCF valuation assumed about 375 million bar-
rels; the tribunal, however, reduced that amount to a range between 280 and 290 million
barrels.57 Next, the tribunal thought that Phillips’s assumptions about the price of oil were
too high and its assumptions regarding costs were too low.58
Third, and most significantly, the tribunal thought that Phillips’s discount rate of 4.5 per
cent was far too low. Phillips’s discount rate assumed that the WACC for large oil compa-
nies in general was 4.5 per cent, and that this project was no riskier than those associated
with interests in oil reserves elsewhere.59 The tribunal disagreed and held that the following
risks needed to be taken into account:
first, the risk that not all recoverable oil might, as a practical matter and for various reasons, be
produced during the remaining years of the JSA; second, the risk that world oil prices during
the remaining term of the JSA might prove lower than during the range foreseen; and third,
the risk of coerced revisions of the JSA in the future that would reduce its economic benefits.60
Although the tribunal did not select its own discount rate, it held that the real risk was
‘substantially’ higher, and it awarded only US$55 million in damages, which was about
one-third of the damages that Phillips sought.61
The principles discussed in this chapter operate individually and in an interactive man-
ner to limit damages awarded to claimants. At the same time, these principles are sufficiently
nuanced to ensure that full and proper compensation is awarded when these principles are
applied properly.
57 Id. at paragraphs 119-124.

58 Id. at paragraphs 125-134.
89
6
Damages Principles in Investment Arbitration
Mark W Friedman and Floriane Lavaud1
Introduction
Damages in investment arbitration are generally intended to make a party whole by giving
full reparation. The goal of full reparation is not to provide a windfall or a penalty to either
party, but rather to wipe out all the consequences of the illegal act. While the seminal case
on point, Factory at Chorzów,2 dates back to the 1920s, recent developments continue to
affect the calculation of damages.
In achieving full reparation, international law distinguishes between damages at large
and compensation for lawful expropriation. Compensation standards are typically codified
in investment treaties, whereas damages awards derive from customary international law as
defined by international courts and tribunals.
The distinction between compensation and damages is important. The party whose
assets have been the subject of wrongful conduct may be entitled to remedies such as resti-
tution in kind and enhanced damages, which may not be available in permitted expropria-
tion. Moreover, absent such distinction, states would face the same consequences regardless
of the illegality of their conduct. Such a result would provide no incentive for states to act
in accordance with the law.
This chapter is structured in four sections that follow this introduction. The first sec-
tion sets out the basic principles of customary international law derived from Chorzów.The
second section discusses treaty-based compensation as a remedy for lawful expropriation.
The third section analyses issues that can have a significant impact on valuation, such as
1 Mark W Friedman is a partner and Floriane Lavaud is a senior associate at Debevoise & Plimpton LLP. The
views expressed in this chapter are solely those of the authors. The authors are grateful to Nathan D Yaffe and
Joshua B Pickar for their contribution to this chapter.
2 Factory at Chorzów (Germany v. Poland), Merits, 1928 PCIJ (Ser. A) No. 17 (13 September).
90
the choice of valuation methodology or valuation date, and the inclusion of country risk
as an element of the discount rate. The fourth and final section offers concluding remarks.
International law principles

Full reparation: the Chorzów standard
International law requires states to provide ‘full reparation’ to investors for harm caused by
internationally wrongful acts. In Chorzów, the Permanent Court of International Justice
(PCIJ) articulated the full reparation standard as follows:
The essential principle contained in the actual notion of an illegal act – a principle which seems
to be established by international practice and in particular by the decisions of arbitral tribunals
– is that reparation must, as far as possible, wipe out all the consequences of the illegal act and
re-establish the situation which would, in all probability, have existed if that act had not been
committed. Restitution in kind, or, if this is not possible, payment of a sum corresponding to the
value which a restitution in kind would bear; the award, if need be, of damages for loss sustained
which would not be covered by restitution in kind or payment in place of it.3
Some tribunals have found that the customary international law standard articulated in
Chorzów applies not only to expropriations, but also to other breaches of investment trea-
ties (unless otherwise provided under the applicable treaty). For example, in BG Group
v. Argentina, the tribunal applied Chorzów where the breach at issue was of the fair and
equitable treatment provision.4 Numerous other tribunals have applied the full reparation
standard where the state engaged in unlawful conduct other than expropriation.5
Restitution of assets as paradigmatic approach to full reparation

The Chorzów case itself illustrates how restitution in kind is the preferred means for
full reparation.
3 Id. at paragraph 125 (emphasis added); Borzu Sabahi, Compensation and Restitution in Investor-State
Arbitration: Principles and Practice 47 (2011) (finding that the principle of full reparation is the ‘authoritative
principle governing determination of reparation due for committing wrongful acts in international law’).
See also Pierre Bienvenu & Martin J.Valasek, Compensation for Unlawful Expropriation, and Other Recent
Manifestations of the Principle of Full Reparation in International Investment Law, in 50 Years of the New York
Convention 231, at 234 (Albert Jan van den Berg, eds., 2009) (identifying this as the ‘most often cited passage’
of the Chorzów opinion) (Bienvenu & Valasek).
4 BG Group Plc. v. Republic of Argentina, UNCITRAL, Final Award, paragraphs 421–429 (24 December 2007)
(finding that, although Chorzów’s focus was expropriation, its holding subsequently crystallised into a rule
of customary international law, later codified in the Articles on State Responsibility and, therefore, it was
appropriate to ‘be guided by’ Chorzów’s principles even in the event of a breach of the fair and equitable
treatment provision).
5 See, e.g., Murphy Exploration & Production Co. International v. Republic of Ecuador, UNCITRAL, PCA Case No.
AA434, Award (6 May 2016) (breaching the requirement of fair and equitable treatment); Swisslion DOO
Skopje v. Former Yugoslav Republic of Macedonia, ICSID Case No. ARB/09/16, Award (6 July 2012) (same);
Railroad Development Corp v. Republic of Guatemala, ICSID Case No. ARB/07/23, Award (29 June 2012)
(same); Lemire v. Ukraine, ICSID Case No. ARB/06/18, Award (28 March 2011) (same); Schneider v. Kingdom of
Thailand, UNCITRAL, Award (1 July 2009) (same). See also White Industries Australia Ltd v. Republic of India,
UNCITRAL, Final Award (30 November 2011) (arising under the most favoured nation clause).
91
Chorzów involved the unlawful seizure of a nitrate factory, which had been built in
1915 in a swathe of German territory that was transferred to Poland when the latter
regained independence after World War I.6 Despite the transfer of the territory – called
Upper Silesia – the factory remained under German ownership.
As part of the transition of power, Germany and Poland concluded the Convention
Concerning Upper Silesia (the Geneva Convention) in 1922, which constrained Poland’s
sovereign power to expropriate German assets in Upper Silesia.7 Despite this prohibition,
Poland later transferred possession and management of the factory to a Polish national.8
The nature of Poland’s deprivation entitled the investor (whose claims were espoused
by Germany) to restitution in kind.The PCIJ differentiated between prohibited takings and
otherwise lawful expropriations (where only payment of compensation is lacking):
The action of Poland which the Court has judged to be contrary to the Geneva Convention
is not an expropriation – to render which lawful only the payment of fair compensation would
have been wanting; it is a seizure of property, rights and interests which could not be expropri-
ated even against compensation.9
In other words, where a State is not permitted to expropriate alien property, the party
whose assets have been expropriated is entitled to restitution in kind. By contrast, other-
wise lawful expropriation arguably limits recovery to the value of those assets at the time
of the taking. As the PCIJ points out, providing any less would fail to ‘wipe out all the
consequences of the illegal act and re-establish the situation which would ... have existed’.10
Monetary damages equivalent to restitution

Restitution is not appropriate in every case. As the PCIJ recognised, investment tribunals
may award damages equivalent to restitution where restitution has become impossible from
the standpoint of the injured party:
The dispossession of an industrial undertaking – the expropriation of which is prohibited by

the Geneva Convention – then involves the obligation to restore the undertaking and, if this be
not possible, to pay its value at the time of the indemnification, which value is designed to take
the place of restitution which has become impossible.11
As this passage illustrates, the PCIJ explicitly linked the amount of the ‘indemnification’ and
the concept of restitution.Thus, where restitution has become ‘impossible’, the principle of
full reparation requires the payment of damages equivalent to restitution in kind. In light of
6 Factory at Chorzów (Germany v. Poland), Jurisdiction, 1927 PCIJ (Ser. A) No. 9, paragraph 42 (26 July).
7 Id. Thus, unlike in modern investment treaties, the expropriation by Poland could not be rendered lawful
simply by virtue of Poland observing certain procedural requirements and providing compensation.
8 Factory at Chorzów, supra note 2, at paragraphs 48–49.
9 Id. at paragraph 123 (emphasis added).
92
the practical realities surrounding cases of prohibited takings, awarding monetary damages
is ‘the most usual form of reparation’.12
The PCIJ also stated that monetary damages are ‘not necessarily limited to the value of
the undertaking at the moment of dispossession, plus interest to the day of payment’.13 In
light of Poland’s obligation not to expropriate, limiting damages in such a fashion would ‘be
tantamount to rendering lawful liquidation and unlawful dispossession indistinguishable in
so far as their financial results are concerned’.14
Supplemental damages
To the extent restitution or its monetary equivalent alone do not make the injured party
whole, the full reparation standard requires that the investor also receive damages for conse-
quential losses stemming from the unlawful conduct.15 Consequential damages may entail
recovery for such diverse harms as loss of goodwill, reputational harm, or administrative
costs.16 While recognising that only consequential damages, in conjunction with restitution
or its financial equivalent, ‘will guarantee just compensation’, some tribunals have dismissed
this type of damages on the basis that it would result in double recovery.17
Another head of damages sometimes pleaded in investment disputes is moral damages.
Moral damages are appropriate for ‘individual pain and suffering, loss of loved ones or per-
sonal affront associated with an intrusion on one’s home or private life’.18 Although some
tribunals have recognised moral damages as a theoretically valid basis for recovery under
international law, tribunals are typically wary of moral damages claims – both construing
the grounds for granting them strictly and capping the amount awarded for moral damages
(often at US$1 million).19

14 Id.
15 Bienvenu & Valasek, supra note 3, at 235 (‘The injured party is also entitled to additional monetary damages
for the consequential losses suffered as a result of the unlawful taking’). But see Total SA v. Argentine Republic,
ICSID Case No. ARB/04/1, Award, paragraph 216 No. 258 (27 November 2013) (‘[T]he [t]ribunal
considers that the losses incurred by [claimant] in respect of sales to others than the distributors ... might be
labelled as indirect or consequential. As such they would not be covered by the international obligation of
compensation.’).
16 See, e.g., Tidewater Inc. v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/10/5, Award, paragraph 145
(13 March 2015) (noting that ‘goodwill and know-how’ constitute part of the investment and thus
are protected by the treaty); Siemens AG v. Argentine Republic, ICSID Case No. ARB/02/8, Award,
paragraph 386 (6 February 2007) (awarding damages for costs of administration associated with skeleton
operation post-expropriation); Azurix Corp v. Argentine Republic, ICSID Case No. ARB/01/12, Award,
paragraph 432 (14 July 2006) (finding that negotiation costs could in principle be included in recovery as
consequential damages).
17 Amoco International Finance Corp v. Islamic Republic of Iran, 15 Iran-U.S. Cl. Trib. Rep. 189, paragraph 18 (1987)
(Brower, J., concurring in part and dissenting in part).
18 James Crawford, The International Law Commission’s Articles on State Responsibility – Introduction, Text,
and Commentaries, Commentary 5 to Article 31 (2002) (Commentaries).
19 See, e.g., OI European Group BV v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/11/25, Award,
paragraphs 910–917 (10 March 2015) (noting respondent’s behaviour was not ‘worthy of an additional
compensation for moral damages’ because it did not ‘amount ... to physical threats, illegal detention or
ill-treatment’); Lemire v. Ukraine, ICSID Case No. ARB/06/18, Decision on Jurisdiction and Liability,
93
Codification of the Chorzów standard

By and large, the customary international law standard articulated in Chorzów has been
codified in the Draft Articles on the Responsibility of States for Internationally Wrongful
Acts (Articles on State Responsibility).20
Article 31, for example, requires states to ‘make full reparation for the injury caused by
the internationally wrongful act’.21 The accompanying commentaries elaborate that Article
31 envisions ‘full reparation in the Factory at Chorzów sense’, meaning the state must ‘wipe
out all the consequences of the illegal act and re-establish the situation which would, in all
probability, have existed if that act had not been committed’.22
Article 36, in turn, requires states responsible for an internationally wrongful act ‘to
compensate for the damage caused thereby, insofar as such damage is not made good by
restitution’.23 Indeed, restitution ‘comes first among the forms of reparation’ because it
‘most closely conforms to the general principle that the responsible State is bound to wipe
out the legal and material consequences of its wrongful act’.24 Restitution only gives way
to compensation where it is ‘unavailable or inadequate’, including when ‘the property in
question has been destroyed or fundamentally changed in character or the situation cannot
be restored to the status quo ante for some reason.’25
The party whose assets have been the subject of a wrongful state act nonetheless retains
the right ‘to elect as between the available forms of reparation’.26 Claimants often seek
damages rather than restitution in light of the fact that the relationship with the host state
has likely deteriorated to such an extent that it would impede operation of the assets in the
future.Yet where claimants have sought non-pecuniary relief, tribunals have been willing to
entertain such claims.27 Even in Arif v. Moldova,28 which presented the unusual scenario of
a state advocating for restitution over monetary damages, the tribunal allowed the claimant
to recover monetary damages.29
paragraph 333 (14 January 2010) (same); Desert Line Projects LLC v. Republic of Yemen, ICSID Case No.
ARB/05/17, Award, paragraph 291 (6 February 2008) (awarding moral damages but limiting recovery to
US$1 million).
20 Draft Articles on Responsibility of States for Internationally Wrongful Acts, Article 31(1), in Report of the
International Law Commission on the Work of Its Fifty-third Session, U.N. GAOR, 53th Sess., Supp. No. 10,
U.N. Doc. A/56/10 (2001) [hereinafter Articles on State Responsibility].
21 Id.
22 Commentaries, supra note 18, Commentary 3 to Article 31 (quotations omitted).
23 Articles on State Responsibility, supra note 20, Articles 34–36.
24 Commentaries, supra note 18, Commentary 3 to Article 35.
25 Id. at Commentary 4 to Article 35.
26 Id. at Commentary 6 to Article 43.
27 See, e.g., von Pezold v. Republic of Zimbabwe, ICSID Case No. ARB/10/15, Award, paragraphs 743–744
(28 July 2015) (finding restitution is available); Micula v. Romania, ICSID Case No. ARB/05/20, Award,
paragraphs 1309–1311 (11 December 2013) (same); Goetz v. Republic of Burundi, Award, ICSID Case No.
ARB/95/3, Award, paragraphs 134–137 (10 February 1999) (accepting that the tribunal has power to order
Burundi to create new ‘free zone’ conferring tax and customs exemptions, consistent with parties’ settlement).
28 See Arif v. Republic of Moldova, ICSID Case No. ARB/11/23, Award, paragraphs 567–571 (8 April 2013).
29 Specifically, the tribunal noted that restitution was ‘preferable’ and provided for the parties to negotiate
the terms of a restitutionary remedy, but ordered that damages would be awarded if restitution had not
94
Treaty-based compensation
Treaty-based reparation standards
Nearly all bilateral and multilateral investment treaties provide for compensation in cases
of lawful expropriation.30 The four traditional elements of legal expropriation are that the
expropriation must be undertaken (1) for a public purpose, (2) in accordance with due
process, (3) in a non-discriminatory fashion, and (4) upon payment of compensation.31
The US Model Bilateral Investment Treaty (BIT), for instance, limits states’ prerogative to
expropriate as follows:
Neither Party may expropriate or nationalize a covered investment either directly or indirectly
through measures equivalent to expropriation or nationalization (‘expropriation’), except:
(a) for a public purpose;
(b) in a non-discriminatory manner;
(c) on payment of prompt, adequate, and effective compensation; and
(d) in accordance with due process of law.32
Although the formulation may vary, investment treaties typically articulate the compen-
sation requirement as an obligation to pay ‘just compensation’ or ‘prompt, adequate, and
effective compensation’, and many specifically require ‘fair market value’ as the measure of
that compensation.33 For example, the US–Argentina BIT provides:
[Prompt, adequate, and effective] [c]ompensation shall be equivalent to the fair market value of
the expropriated investment immediately before the expropriatory action was taken or became
known, whichever is earlier; be paid without delay; include interest at a commercially reasonable
rate from the date of expropriation; be fully realizable; and be freely transferable at the prevailing
market rate of exchange on the date of expropriation.34
As the text above illustrates, investment treaties answer some of the potential questions
related to quantum. However, beyond the general principle that compensation is ‘equated
been arranged after 90 days, and in any event gave the claimant the ability to opt for financial recovery if
negotiations over restitution did not proceed satisfactorily. See id., at paragraphs 567–571.
30 See David Rivkin & Floriane Lavaud, Determining Compensation for Expropriation in Treaty-Based Oil and
Gas Arbitrations, in Leading Practitioners’ Guide to International Oil & Gas Arbitration 217, 220–226 (2015).
31 Rudolf Dolzer & Christoph Schreuer, Principles of International Investment Law 99–100 (2012) (‘It is today
generally accepted that the legality of a measure of expropriation is conditioned on [these] requirements’).
32 United States Model Bilateral Investment Treaty, Article 6(1) (2012), available at www.state.gov/documents/
organization/188371.pdf. See also 2004 Canadian Model BIT, Article 13.1 (setting forth the same
requirements, but not in list form).
33 Rudolf Dolzer & Magrete Stevens, Bilateral Investment Treaties 108, 115 (1995).
34 Treaty between the United States of American and the Argentina Republic Concerning the Reciprocal
Encouragement and Protection of Investment, US–Argentina, Article IV(1) (1994). See also Agreement
between the Government of the United Kingdom of Great Britain and Northern Ireland and the
Government of the Republic of Panama for the Promotion and Protection of Investments, Article 5(1) (1985)
(‘Such compensation shall amount to the fair value which the investment expropriated had immediately
before the expropriation became known, shall include interest until the date of payment, shall be made
without delay, be effectively realisable and be freely transferrable.’).
95
with the fair market value of the business’,35 treaties often provide limited guidance.36
Thus, the key issue – discussed below in Section IV – is often the choice of the valuation
methodology to arrive at the ‘fair market value’, rather than the language of the compensa-
tion provision.37
Lawful v. unlawful expropriations

Determining whether an expropriation is lawful or unlawful can have a significant impact
on recovery. While an investor with lawfully expropriated assets is typically entitled to
recover only the value of the assets at the time of the taking, an investor whose assets are
unlawfully expropriated may receive remedies such as restitution and supplemental dam-
ages, as well as valuation based on the date of the award.38
Investment tribunals have adopted somewhat divergent positions over the criteria for
identifying an unlawful expropriation. Although there is general acceptance that violations
of the ‘procedural requirements’ for lawful expropriations (public purpose, due process and
non-discrimination) render an expropriation unlawful, there is disagreement over whether
an expropriation that violates only the compensation requirement is unlawful.
Some tribunals have found that expropriations conducted in compliance with all treaty
requirements but lacking only compensation remain lawful. For example, the tribunal in
Tidewater v. Venezuela found that ‘an expropriation wanting only a determination of com-
pensation by an international tribunal is not to be treated as an illegal expropriation.’39
Rather, it deemed expropriations that fell into this category ‘provisionally lawful’, by which
it meant that any potential unlawfulness would be cured upon the (presumably forthcom-
ing) payment of adequate compensation.40 Venezuela Holdings v.Venezuela reached the same
result, noting that ‘the mere fact that an investor has not received compensation does not in
itself render an expropriation unlawful.’41
In both cases, the tribunal clearly stated that, as a result, recovery was limited to fair
market value of the asset at the moment of dispossession.42 Arguably, the Factory at Chorzów
case is consistent with this result when it stated, albeit in dicta, that such limitation ‘would
only be admissible if the Polish Government had had the right to expropriate, and if its
wrongful act consisted merely in not having paid to the two Companies the just price
35 Mark A. Chinen, The Standard of Compensation for Takings, 25 Minn. J. Int’l L. 335, 352 (2016).
36 Cf. Joshua B. Simmons,Valuation in Investor-State Arbitration: Toward a More Exact Science, 30 Berkeley J.
Int’l L. 196, 205 (2012) (discussing lack of instruction on calculation issues in the compensation provisions of
many treaty provisions).
37 Cf. Tidewater, supra note 16, at paragraph 145 (‘[T]he Treaty standard of ‘market value’ does not denote a
particular method of valuation.’).
38 See supra Section II.
39 Tidewater, supra note 16, at paragraph 140.
41 Venezuela Holdings v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/27, Award, paragraphs 301, 306
(9 October 2014).
42 Tidewater, supra note 16, at paragraph 142 (‘[C]ompensation for a lawful expropriation is fair compensation
represented by the value of the undertaking at the moment of dispossession.’); Venezuela Holdings, supra note
41, at paragraph 306 (holding that ‘compensation must be calculated in conformity with the ... BIT’ which
provided for fair market value at the time of the taking).
96
of what was expropriated’.43 As Tidewater noted, scholars – drawing on this dicta – ‘have
insisted on the necessity to distinguish expropriation illegal per se and expropriation only
wanting compensation to be considered legal’.44
Other tribunals have taken the opposite view, finding that payment of compensation
was a condition for the lawfulness of the expropriation. In von Pezold v. Zimbabwe, for
example, the tribunal found that ‘no compensation ha[d] been paid for the properties and
therefore ... the expropriation did not fulfil the “lawful” criteria.’45 Given that no compen-
sation had been paid, there was no need for the tribunal ‘to decide whether the acquisition
was for a public purpose, whether there was access to due process or ... whether the acquisi-
tion was non-discriminatory’.46 Likewise, the tribunal in Unglaube v. Costa Rica found that
the state’s mere failure to compensate rendered the expropriation unlawful.47
The gap between these two approaches may be more apparent than real. In both
Tidewater and Venezuela Holdings, the state was willing to pay compensation, or at least to
negotiate toward that end. Tidewater explicitly linked its decision to reject illegality to the
fact that there was no ‘refusal on the part of the state to pay compensation’.48 Instead, the
dispute arose because ‘the [p]arties were unable to agree on the basis or the process by
which such compensation would be calculated and paid.’49 Venezuela Holdings went even
further, specifically noting that claimants bore the burden of showing that Venezuela’s par-
ticipation in compensation negotiations, and subsequent offers, were ‘incompatible with
the requirement of “just” compensation ... of the BIT’.50
A good faith requirement, therefore, may help reconcile these apparently contradictory
positions. If the state willfully and wantonly disregards the compensation requirement, the
tribunal may be inclined to find the expropriation to be unlawful. By contrast, where the
state makes a good faith effort to comply with the compensation requirement, eventual
failure to pay compensation alone does not render the expropriation unlawful. Both von
Pezold and Unglaube are consistent with this result in the sense that Zimbabwe and Costa
Rica failed to take any real action to begin arranging for compensation, suggesting out-
right disregard of the treaty standards – arguably a distinguishing feature from Tidewater and
Venezuela Holdings.51
43 Factory at Chorzów, supra note 2, at paragraph 124.

45 See, e.g., von Pezold, supra note 27, at paragraph 497.
47 Unglaube v. Republic of Costa Rica, ICSID Case No. ARB/08/1, Award, paragraph 305 (16 May 2012)
(‘[A]dequate compensation ... was not, in fact, paid to [claimant] within a reasonable period of time after the
State declared its intention to expropriate. In these circumstances, the [t]ribunal cannot accept ... that the
provisions of Article 4(2) alone must govern.’) (emphasis in original).
49 Id.
50 Venezuela Holdings, supra note 41, at paragraph 305.
51 Von Pezold, supra note 45, at paragraphs 491–497; Unglaube, supra note 47, at paragraph 209 (noting failure
to even ‘make timely arrangements to determine’ potential compensation). See also ConocoPhillips Petrozuata
BV v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/30, Decision on Jurisdiction and Merits,
paragraphs 361–401 (3 September 2013) (chronicling the history of negotiations between the parties and
‘conclud[ing] that the [r]espondent breached its obligation to negotiate in good faith for compensation for its
taking of the ConocoPhillips assets’).
97
Issues with potential significant impact on valuation

Valuation methodology
Neither customary international law nor treaty-based standards require the application of
a particular valuation methodology, leaving that choice to the tribunal. In light of the sig-
nificant impact that the choice of valuation methodology can have on recovery, the subject
warrants serious consideration but will only be treated briefly in this chapter given that
Part III of this volume broadly covers valuation (including basic methods).
Income-based approaches
Income-based approaches can refer to any of the following three methods: discounted cash
flow (DCF), adjusted present value and capitalised cash flow.52 The DCF analysis, which
is the most common valuation method,53 aims to calculate the present value of future
expected cash flows.54 As discussed in ‘Country risk as an element of discount rate’, infra,
the determination of the appropriate rate at which to discount future cash flows to current
value in investment arbitration raises the additional issue of whether to add country risks
concerning potentially illegal state conduct.
Tribunals’ willingness to apply the DCF analysis typically depends on whether there
is a sufficient basis to estimate future cash flows, and numerous tribunals have rejected
application of the DCF analysis where projections are deemed too speculative.55 Where an
investment is a start-up with no track record, history of performance or other solid basis on
which to make projections of profits, a tribunal may decide not to apply the DCF analysis.56
52 For a comprehensive overview, see Mark Kantor, Valuation for Arbitration: Compensation Standards,Valuation
Methods, and Expert Evidence (2008).
53 World Bank, Guidelines on the Treatment of Foreign Direct Investment IV.6(i) (2002) (embracing DCF as the
basis for valuing ‘a going concern with a proven record of profitability’) [hereinafter World Bank Guidelines].
See also Quiborax SA v. Plurinational State of Bolivia, ICSID Case No. ARB/06/2, Award, paragraph 344
(16 September 2015) (‘[T]he DCF method is widely accepted as the appropriate method to assess the [fair
market value] of going concerns.’).
54 William H. Knull, III, et al., Accounting for Uncertainty in Discounted Cash Flow Valuation of Upstream Oil
and Gas Investments, 25 J. Energy & Nat. Res. L. 3, 5 (2007).
55 See, e.g., Awdi v. Romania, ICSID Case No. ARB/10/13, Award, paragraph 514 (2 March 2015) (‘The
application of the DCF method relied upon by [c]laimants ... is not justified in the circumstances ... There are
... uncertainties regarding future income and costs of an investment in this industry in the Romanian market.’);
Compañía de Aguas del Aconquija SA v. Argentine Republic, ICSID Case No. ARB/97/3, Award, paragraph 8.3.3
(20 August 2007) (‘[C]ompensation for lost profits is generally awarded only where future profitability can be
established (the fact of profitability as opposed to the amount) with some level of certainty.’); LG&E Energy
Corp v. Argentine Republic, ICSID Case No. ARB/02/1, Award, paragraph 51 (25 July 2007) (rejecting DCF
and holding that ‘lost future profits ... have only been awarded when an anticipated income stream has attained
sufficient attributes to be considered legally protected interests of sufficient certainty to be compensable’ and
noting ‘[t]he question is one of certainty’) (internal quotations omitted); World Bank Guidelines, supra note 53,
at IV.6(i).
56 See, e.g., Gold Reserve Inc v. Bolivarian Republic of Venezuela, ICSID Case No. ARB(AF)/09/1, Award,
paragraph 830 (22 September 2014) (‘[A] DCF method can be reliably used in the instant case because of the
commodity nature of [gold] and detailed mining cashflow analysis previously performed.’); Compañía de Aguas
del Aconquija SA, supra note 55, paragraph 8.3.3 (‘[T]he net present value provided by a DCF analysis is not
always appropriate and becomes less so as the assumptions and projections become increasingly speculative.’).
98
Market-based approaches
The market-based approach entails a comparison to ‘similar businesses, business ownership
interests, securities or intangible assets that have been sold’.57 Specifically, the comparative
analysis draws on either ‘comparable items’ or ‘comparable transactions’.58 In Yukos v. Russia,
for example, the tribunal found it had ‘a measure of confidence’ on the basis of existing
stock market indexes, whereas it rejected the DCF analysis as less reliable on the facts of
the case.59 Some tribunals have considered other transactions involving the very same assets
at issue in the arbitration to be particularly compelling evidence of the fair market value
of these assets.60
Asset-based approaches
The third dominant valuation approach is the asset-based approach, which uses either the
‘book value’ or the ‘replacement value’ of the expropriated assets. The book value looks
to the difference between total assets and total liabilities, as indicated by the company’s
books. The replacement value takes a similar approach without deducting depreciation.
Although these approaches were featured prominently in the jurisprudence of the Iran–US
Claims Tribunal,61 they have fallen out of favour with contemporary investment tribunals,62
reflecting the reality that investments are often worth more than the salvage value of assets.
Cf. Amoco, supra note 17, at paragraph 239 (rejecting the use of the DCF method as ‘speculative’, especially
when ‘it relates to such a volatile factor as oil prices’).
57 Kantor, supra note 52, at 4.
58 Charles N. Brower & Michael Ottolenghi, Damages in Investor-State Arbitration, 4 Transnat’l Disp. Mgmt. 6,
20–21 (2007).
59 Hulley Enterprises Ltd (Cyprus) v. Russian Federation, PCA Case No. AA 226, Final Award, paragraphs 1785–1787
(18 July 2014); Veteran Petroleum Ltd (Cyprus) v. Russian Federation, PCA Case No. AA 228, Final Award,
paragraphs 1785–1787 (18 July 2014); Yukos Universal Ltd (Isle of Man) v. Russian Federation, PCA Case No.
AA 227, Final Award, paragraphs 1785–1787 (18 July 2014). See also Stati v. Republic of Kazakhstan, SCC Case
No. 116/2010, Award, paragraphs 1617–1625 (19 December 2013) (finding the DCF analysis presented by
claimants was not ‘convincing’ and consequently looking to comparable transactions); CME Czech Republic
BV v. Czech Republic, UNCITRAL, Final Award, paragraph 533 (14 March 2003) (referring to prior purchase
offers to arrive at valuation for CME).
60 See, e.g., Kardassopoulos v. Republic of Georgia, ICSID Case No. ARB/05/18 and ARB/07/15, Award, paragraph
599 (3 March 2010) (‘It is difficult to conceive of clearer evidence of the likely value of an expropriated
asset (and related rights) than a sale transaction involving the same asset (and rights) 16 days after the
expropriation.’).
61 See, e.g., Oil Field of Texas, Inc v. Islamic Republic of Iran, 12 Iran-U.S. Cl. Trib. Rep. 308 (1982); Phillips Petroleum
Co Iran v. Islamic Republic of Iran, 21 Iran-U.S. Cl. Trib. Rep. 79 (1989).
62 See, e.g., Tidewater, supra note 16, at paragraph 165 (‘[I]n the [t]ribunal’s view, it is not appropriate to
determine the fair market value by reference to either the liquidation value of the assets of the [expropriated
enterprise], or the book value of those assets.’); Enron Corp v. Argentine Republic, ICSID Case No. ARB/01/3,
Award, paragraph 382 (22 May 2007) (disregarding the book value method on the ground that it ‘fail[ed] to
incorporate the expected performance of the firm in the future’); ConocoPhillips, supra note 51, at paragraph
400 (discussing Venezuela’s ‘insistence on book value’ to compensate expropriated investor as evidence of
Venezuela’s lack of good faith).
99
Other approaches
In some cases, investment tribunals simply apply the amount of recovery based on prior
court decisions or arbitration awards. For example, in Saipem v. Bangladesh, the tribunal
determined the amount of damages due based on a prior arbitration award.63 In other
cases, tribunals calculated the amount of loss sustained by the injured party based on a
wrongfully charged tax, or some other discrete financial imposition placed on the investor
by the state.64
Valuation date
The choice of the valuation date can also have a significant impact on the amount of
compensation awarded to a party whose assets have been the subject of wrongful state con-
duct.65 Whether the tribunal can rely only on information available at the time of the tak-
ing or use hindsight as of a later date can have enormous consequences. In Yukos v. Russia,
the valuation date was a US$44 billion issue.66
Ex ante and ex post approaches to valuation

In theory, expropriation and adequate compensation should occur simultaneously. In that
case, no issues related to valuation date would arise. In practice, however, legal and practi-
cal obstacles often delay compensation. When that occurs, tribunals face the question of
whether to use hindsight or to rely solely on information available as of the date of the tak-
ing. These two approaches reflect, respectively, ex ante and ex post approaches to valuation.
Under the ex ante approach, the injured party will receive the value of the investment
at the time of the taking, adjusted at the time of the award by an appropriate pre-judgment
interest rate (with post-judgment interest typically to accrue thereafter until payment). By
contrast, under the ex post approach, the claimant will receive the value of the investment at
a later date, which generally coincides with the date of the award (as well as post-judgment
63 Saipem SpA v. People’s Republic of Bangladesh, ICSID Case No. ARB/05/07, Award, paragraph 202
(30 June 2009) (‘[T]he [t]ribunal considers that in the present case the amount awarded by the ICC
Award constitutes the best evaluation of the compensation due under the Chorzów Factory principle.’).
See also Chevron Corp (USA) v. Republic of Ecuador, PCA Case No. 34877, Partial Award, paragraph 546
(30 March 2010) (‘When conceiving of the wrong as the failure of the Ecuadorian courts to adjudge TexPet’s
claims as presented to them, the starting point for the [t]ribunal’s analysis must be TexPet’s damages claims as
they were presented before these courts.’).
64 See, e.g., British Caribbean Bank Ltd v. Government of Belize, PCA Case No. 2010-18, Award
(19 December 2014) (valuing damages using the face value of loans not repaid); Occidental Exploration and
Production Co v. Republic of Ecuador, LCIA Case No. UN3467, Final Award, paragraphs 205–207 (1 July 2004)
(valuing compensation on the basis of tax refunds not paid to claimant).
65 See generally Floriane Lavaud & Guilherme Recena Costa,Valuation Date in Investment Arbitration: A
Fundamental Examination of Chorzów’s Principles, 3 J. Damages in Int’l Arb. 33 (2016).
66 Hulley, supra note 59, at paragraph 1826 (‘The total amount of [c]laimants’ damages based on a valuation date
of [the expropriation] is USD 21.988 billion, whereas the total amount of their damages based on a valuation
date of [the award] is USD 66.694 billion. Since the [t]ribunal has concluded earlier that [c]laimants are
entitled to the higher of these two amounts, the total amount of damages to be awarded before taking into
account any deductions necessary ... is USD 66.694 billion.’); Veteran Petroleum, supra note 59, at paragraph
1826 (same); Yukos, supra note 59, at paragraph 1826 (same).
100
interest). By then, the value of the investment will have increased or decreased compared
to its value at the time of the taking.
Evolution of the law

Historical practice and first signs of change
Scholars have long recognised that Chorzów’s articulation of ‘full reparation’ could logically
imply that the valuation date should coincide with the date of the award.67 However, tri-
bunals historically valued the investment at or about the date of the expropriation.68 That
is, even in cases of unlawful conduct, tribunals applied an ex ante approach to valuation.
While a variety of potential reasons may explain this result,69 suffice it to say that the use of
the award date in connection with unlawful expropriations remained largely dormant for
much of the twentieth century.
The first signs of change emerged from the jurisprudence of the Iran–US Claims
Tribunal. Recalling Chorzów’s statement that full reparation means damages are not neces-
sarily limited to the value of the undertaking at the moment of dispossession, plus interest
to the day of payment, Judge Brower’s concurring opinion in Amoco v. Iran explained that
unlawful takings entitle the injured party to:
[D]amages equal to the greater of (i) the value of the undertaking at the date of loss (... includ-
ing lost profits), judged on the basis of information available as of that date, and (ii) its value
(likewise including lost profits) as shown by its probable performance subsequent to the date of
loss and prior to the date of the award, based on actual post-taking experience, plus (in either
alternative) any consequential damages.70
The approach outlined by Judge Brower in Amoco was later vindicated implicitly by Starrett
Housing Corporation v. Iran, and explicitly by Phillips Petroleum v. Iran.71 The latter announced
a principle that closely resembles the current state of the law: that the distinction between
lawful and unlawful expropriations set forth in Chorzów could be ‘relevant only to two
possible issues: whether restitution of the property can be awarded and whether compen-
sation can be awarded for any increase in the value of the property between the date of
the taking and the date of the judicial or arbitral decision awarding compensation’.72 In
67 See, e.g., Max Sorenson, Manual of Public International Law 567, paragraph 9.18 (1968) (‘Since monetary
compensation [under the Chorzów standard] must, as far as possible, resemble restitution, the value at the date
when the indemnity is paid must be the criterion.’); Georg Schwarzenberger, International Law as Applied by
International Courts and Tribunals: I 660 (1957) (‘[T]he value of the property at the time of the indemnification,
rather than that of the seizure, may constitute a more appropriate substitute for restitution.’).
68 Manuel A. Abdala & Pablo T. Spiller, Chorzów’s Standard Rejuvenated – Assessing Damages in Investment
Treaty Arbitrations, 25 J. Int’l Arb. 103, 108 (2008).
69 See Lavaud & Recena Costa, supra note 65, at 50–52 (identifying sources of uncertainty and more pressing
issues dominating the jurisprudence in the mid-twentieth century).
70 Amoco, supra note 17, at paragraph 18 (Brower, J., concurring in part and dissenting in part) (emphasis added).
71 Charles N. Brower & Jason D. Brueschke, The Iran-United States Claims Tribunal 512 (1998) (discussing Amoco’s
influence on other tribunals in the IUSCT).
72 Starrett Housing Corp v. Islamic Republic of Iran, 16 Iran-U.S. Cl. Trib. Rep. 112, 195 (1987); Phillips Petroleum Co
v. Iran, supra note 61, at paragraph 110.
101
retrospect, these cases laid the groundwork for the evolution that took hold years later in
ADC v. Hungary.
The turning point: ADC v. Hungary

The full implications of the Chorzów damages framework were not embraced by invest-
ment tribunals until the ADC v. Hungary award.73 Since then, the Chorzów standard – spe-
cifically, the distinction it established between lawful and unlawful state conduct and the
choice of valuation date – has enjoyed a ‘renaissance’.74 Now, several international tribunals
largely have used the award valuation date where appropriate.75
In ADC v. Hungary, the claimants argued that Hungary expropriated their investment
by issuing a decree that took over claimants’ airport enterprise.76 Not only did Hungary
fail to pay compensation, but the tribunal also found the expropriation violated the BIT
for failing to comply with due process or serve the public interest.77 The tribunal agreed
with the claimants that the BIT did not apply where a state expropriates unlawfully;78
instead, the illegality of the expropriation triggered the customary international law stand-
ard reflected in Chorzów.79 In language evocative of the PCIJ’s, the tribunal stated:
The BIT only stipulates the standard of compensation that is payable in the case of a lawful
expropriation, and [such a standard] cannot be used to determine the issue of damages payable
in the case of an unlawful expropriation since this would be to conflate compensation for a law-
ful expropriation with damages for an unlawful expropriation.80
In light of the fact that the investment had risen in value since the date of the expropriation
(which the tribunal held to be 1 January 2002), the claimants sought to obtain the value of
their expropriated investment as of the award date.81 Despite the fact that such an approach
was ‘almost unique’, the tribunal found that the ‘application of the Chorzów Factory standard
73 See Lavaud & Recena Costa, supra note 65, at 54–64 (analysing the practice of tribunals after ADC). See also
Bienvenu & Valasek, supra note 3, at 231 (‘[U]ntil recently, the implication of Chorzów Factory for establishing
a different standard of compensation for unlawful as opposed to lawful expropriation seems not to have been
fully appreciated by arbitral tribunals in investment cases.’).
74 Bienvenu & Valasek, supra note 3, at 255.
75 But see Lavaud & Recena Costa, supra note 65, at 56–58 (reviewing factual or evidentiary factors that
lead tribunals to nonetheless apply the date of the taking, as well as outlier awards that do not follow the
now-standard approach).
76 ADC Affiliate Ltd v. Republic of Hungary, ICSID Case No. ARB/03/16, Award, paragraphs 218–219
(2 October 2006).
77 Id. at paragraph 476(d) (‘[T]he expropriation ... was unlawful as: (a) the taking was not in the public interest;
(b) it did not comply with due process.’).
78 As in Chorzów, ‘unlawfully’ here meant for more than mere failure to pay compensation.
79 ADC, supra note 77, at paragraphs 480–481 (‘The principal issue is whether the BIT standard is to be applied
or the standard of customary international law ... [T]he BIT does not stipulate any rules relating to damages
payable in the case of an unlawful expropriation.’).
102
requires that the date of valuation should be the date of the [a]ward and not the date of
expropriation’.82
In other words, the ADC tribunal found first that violation of BIT provisions (other
than the compensation requirement) triggered the application of customary international
law, and second that customary international law required valuation based on the award
date where the value of the investment had increased. Following ADC, other tribunals
used the award date as the valuation date,83 or at least embraced the reasoning in ADC
even where the claimant could not make out a factual case for higher damages based on
the award date.84
Country risk as an element of discount rate

A critical element of the DCF analysis is the application of a discount rate, which is neces-
sary to obtain the present value of future cash flows.85 In investment disputes, one of the
key issues pertaining to discount rate is whether to incorporate ‘country risk’ reflecting
potential illegal state conduct. This determination can have a significant impact on the
calculation of damages.
Conceptual tension contributes to lack of consensus on this issue. On the one hand, the
purpose of investment treaties is to reduce the risk of investing abroad. Of course, country
risks related to domestic business conditions, currency fluctuations and structural economic

83 See, e.g., von Pezold, supra note 27, at paragraph 813 (‘The sum of compensation that the [t]ribunal arrives
at should reflect the value of the [e]state that would have been received if restitution had been successful;
that is, the value at the date of the [a]ward.’); Yukos, supra note 59, at paragraph 1826 (‘The total amount of
[c]laimants’ damages based on a valuation date of [the expropriation] is USD 21.988 billion, whereas the total
amount of their damages based on a valuation date of [the award] is USD 66.694 billion. Since the [t]ribunal
has concluded earlier that [c]laimants are entitled to the higher of these two amounts, the total amount of
damages to be awarded before taking into account any deductions necessary ... is USD 66.694 billion.’);
Quiborax, supra note 53, at paragraph 370 (‘The [t]ribunal has already held that the standard of compensation
in this case is not the one set forth in Article VI(2) of the BIT, but the full reparation principle under
customary international law ... because it is faced with an expropriation that is unlawful not merely because
compensation is lacking ... [T]he majority of the [t]ribunal considers that this requires an ex post valuation.’);
El Paso Energy International Co v. Argentine Republic, ICSID Case No. ARB/03/15, Award, paragraphs 704–705
(31 October 2011) (finding that because the expropriation was unlawful, ‘the property ... is to be evaluated by
reference not to the time of the dispossession, as in the case of a lawful expropriation, but to the time when
compensation is paid,’ i.e., the date of the award).
84 See, e.g., Siemens AG, supra note 16, paragraphs 352–353 (‘The key difference between compensation under
the Draft Articles and the Factory at Chorzów case formula, and Article 4(2) of the Treaty is that under the
former, compensation must ... ‘wipe out all the consequences of the illegal act’ as opposed to compensation
‘equivalent to the value of the expropriated investment’ under the Treaty ... It is only logical that, if all
the consequences of the illegal act need to be wiped out, the value of the investment at the time of this
[a]ward be compensated in full.’); Compañía de Aguas del Aconquija SA, supra note 55, at paragraph 8.2.3–8.2.5
(20 August 2007) (‘[T]he Treaty thus mandates that compensation for lawful expropriation be based on
the actual value of the investment ... However, it does not purport to establish a lex specialis governing the
standards of compensation for wrongful expropriations ... There can be no doubt about the vitality of [Chorzów
Factory’s] statement of the damages standard under customary international law ... It is also clear that such a
standard permits, if the facts so require, a higher rate of recovery than that prescribed in Article 5(2) for lawful
expropriations.’) (emphasis in original).
85 Kantor, supra note 53, at 44.
103
factors must be borne by the investor as they are part of the typical risks associated with
investment activities. However, when it comes to risks associated with wrongful state con-
duct, discounting the value of the investment in light of the prospect of such conduct seems
in tension with the raison d’être of the investment treaty itself.Thus, at least one tribunal has
excluded the effect of unlawful state conduct from the calculation of the discount rate with
the goal to avoid a potential windfall to the state.86
On the other hand, a hypothetical willing buyer may have factored in the risk of illegal
state conduct. On this view, excluding any aspect of country risk would constitute a wind-
fall to the investor. A string of recent cases involving Venezuela have adopted this approach,
incorporating different amounts of ‘confiscation risk’ into their country risk figures.87
In part as a result of these competing considerations, investment tribunals have applied
widely varying country risk premiums, ranging from 6 per cent (OI Group) to 14.75 per
cent (Tidewater) for the same country and for effectively the same period.88
Conclusion
As the range of cases and economic stakes in investment arbitration has grown, so too has
the significance of compensation and damages issues. While some of the basic principles
were established decades ago, detailed rules and precedents on how to apply those princi-
ples in individual cases are not always available. International tribunals will therefore con-
tinue to define and refine remedies in investment arbitration.
86 Gold Reserve, supra note 56, at paragraph 841 (‘The [t]ribunal agrees ... that it is not appropriate to increase the
country risk premium to reflect the market’s perception that a State might have a propensity to expropriate
investments in breach of BIT obligations.’). See also Florin A. Dorobantu et al., Country Risk and Damages in
Investment Arbitration, 2015 ICSID Rev. 1, 13 (arguing that tribunals should distinguish ‘actionable country
risk’ from which the investor is protected by the BIT and which should not impact the discount rate, from
other ‘non-actionable country risks’, which the investor should bear).
87 See, e.g., Venezuela Holdings, supra note 41, at paragraph 365 (‘[I]t is precisely at the time before an
expropriation (or the public knowledge of an impending expropriation) that the risk of a potential
expropriation would exist, and this hypothetical buyer would take it into account when determining the
amount he would be willing to pay in that moment. The [t]ribunal considers that the confiscation risk
remains part of the country risk and must be taken into account in the determination of the discount rate.’);
Flughafen Zürich AG v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/10/19, Award, paragraph 907
(18 November 2014) (finding claimants were aware of political and legal uncertainties in Venezuela when
they made the investment); OI European Group BV, supra note 19, at paragraph 708 (finding the country
risk captures the ‘disadvantage’ emerging market countries face in light of investors’ preference to invest in a
developed country); Tidewater, supra note 16, at paragraphs 184, 186 (holding that the country risk premium
quantifies the ‘general risks, including political risks, of doing business in a particular country’ and that the
bilateral investment treaty was not insurance against such risks).
88 See generally Jennifer Lim & Laura Sinisterra, A New Kind of Risk? Recent Approaches to Country Risk in
the Valuation of Damages, Arbitration News (February 2016) (analysing recent jurisprudence on country risk in
the Venezuelan cases).
104
Part II
Procedural Issues and the Use of Damages
Experts
7
Procedural Issues
Sophie J Lamb, Samuel M Pape and Laila Hamzi1
Introduction
Selecting the most suitable procedures for the efficient development of damages evidence
and the ultimate assessment of damages in international arbitration is of considerable
importance to parties and arbitrators alike. These issues benefit from early consideration
by the parties and the tribunal. In this chapter, we examine five key issues that parties and
tribunals may wish to consider when determining the optimal procedure for the determi-
nation of quantum in any given case. First, we explore the issue of bifurcation. Second, we
discuss those aspects of documentary disclosure that are particularly relevant to damages.
Third, we consider certain procedures for the use of witness evidence in relation to dam-
ages, including expert evidence. Fourth, we examine the ways in which proactive case man-
agement can assist in resolving damages issues. Finally, we consider two less conventional
procedures for the determination of damages.
Bifurcation
The parties and tribunal are often required to consider whether damages should be assessed
in the same phase as the merits, or whether the proceedings should be ‘bifurcated’ such
that damages should fall to be assessed separately, only after the tribunal has determined
the merits of the dispute (as well as admissibility and jurisdiction, if these issues are in dis-
pute). In this section, we consider the circumstances in which it might be appropriate for
proceedings to be bifurcated, and if so, how the issues of merits and quantum might be
divided between phases.
1 Sophie J Lamb is a partner, and Samuel M Pape and Laila Hamzi are associates in the international arbitration
practice group at Latham & Watkins. The views expressed in this chapter are those of the authors alone.
107
Procedural Issues
The practice of bifurcation

All major institutional rules allow for proceedings to be bifurcated, either under the general
powers conferred upon the arbitral tribunal2 or, more infrequently, under specific provi-
sions regarding the bifurcation or phasing of proceedings.3
Institutions have shown particular interest in this issue in recent years, viewing bifurca-
tion as a possible procedural tool that can allow for a more efficient and cost-effective dis-
pute resolution process. The revised IBA Rules on the Taking of Evidence in International
Arbitration were adopted by the IBA Council on 29 May 2010 (the ‘IBA Rules of
Evidence’). They advocated a more prescriptive approach to arbitration, inviting the tribu-
nal to promptly identify issues for which a preliminary determination may be appropriate
and encouraging the systematic organisation of arbitral proceedings by issues or phases.
In 2012, the ICC Commission on Arbitration in its report, ‘Controlling Time and Costs
in Arbitration’ suggested that ‘arbitral tribunals should consider, or the parties could agree
on, bifurcating the proceedings when doing so may genuinely be expected to result in a
more efficient resolution of the case.’4
Is bifurcation effective in reducing the time and costs of dispute resolution?

The limited studies available on the subject of the effectiveness of bifurcation for these
purposes are inconclusive. The major institutions do not tend to release specific data on
bifurcation. As one author has observed, the only real way to assess the effect of bifurcation
is to examine published awards and to compare cases – bearing in mind the myriad varia-
tions in complexity.5
Based on this sort of case-by-case analysis in the investor-state context, the author of a
study in 2011 found that the time for concluding the (then known) 45 bifurcated ICSID
cases was 3.62 years, compared to 3.04 years for non-bifurcated cases.6 Moreover, out of the
19 concluded ICSID Additional Facility cases, for which information was publicly avail-
able at the time, 10 bifurcated cases took an average of 3.39 years to reach final award, as
compared with 2.96 years for the nine non-bifurcated cases.
Given the limited data available, the difficulty in isolating bifurcation as a variable in
proceedings in light of all the other parameters in international arbitration, and the fact that
studies tend to focus on investment treaty arbitration awards rather than commercial awards
2 E.g., Article 44 of the ICSID Convention enables a tribunal to determine questions of procedure, including
whether or not to bifurcate proceedings. See Suez, Sociedad General de Aguas de Barcelona SA, and Vivendi
Universal SA v.The Argentine Republic, ICSID Case No. ARB/03/19, Decision on Liability dated 30 July 2010,
page 106 paragraph 273. See also, Article 17(1) of the UNCITRAL Arbitration Rules 2010; Article 22(1)
and (2) and Article 24(3) of the ICC Rules of Arbitration 2012; Article 13(1) of the HKIAC Administered
Arbitration Rules 2013; Article 14(1) of the LCIA Arbitration Rules 2014; Article 19(1) of the SCC
Arbitration Rules 2010.
3 See, for example, Rule 19.4 of the SIAC Rules 2016; Article 30(3) of the ICDR Arbitration Rules 2014. See
also Gary Born, International Arbitration: Law and Practice (Kluwer Law International 2015), 345.
4 International Chamber of Commerce Commission on Arbitration and ADR, ICC Arbitration Commission
Report on Techniques for Controlling Time and Costs in Arbitration (ICC Com No 861-1 ENG 2015) 11.
5 Lucy Greenwood, ‘Does Bifurcation Really Promote Efficiency?’ (2011) Journal of International Arbitration 28(2)
105, 106-107.
6 Greenwood (n 5), 107.
108
Procedural Issues
(of which there are many more, but most of which are confidential), it is difficult to draw
any general conclusions.
In particular cases, tribunals have initially bifurcated the proceedings in the interest of
procedural efficiency, or following agreement by the parties, only to later realise that it
would have been faster and more cost-effective to proceed to a single award.7 Bifurcation
can, in such cases, prolong disputes and delay the issuing of the award. For instance, in
the NAFTA case of Mobil Investment and Murphy Oil v. Canada,8 the tribunal decided to
bifurcate the liability and damages phases. The majority delivered its award on liability and
the principles of quantum in May 2012. It left the assessment of damages, subject to the
claimants providing evidence of damages actually incurred, to a subsequent phase of the
proceedings. The parties proceeded to file their submissions on damages after receiving
extensions of time, and the hearing on damages was ultimately delayed to April 2013. The
parties then responded to queries put by the tribunal and subsequently filed their respective
statements of costs and responses. In January 2014, the parties agreed to a standstill of the
proceedings, pursuant to settlement discussions. In February 2015, the standstill was termi-
nated and the tribunal was requested to issue its award. The tribunal issued its final award
on 20 February 2015, almost three years after its decision on liability.
When might bifurcation be appropriate?

The appropriateness of bifurcating the liability and damages phases of a dispute will depend
on the circumstances of the dispute. Significant time and cost efficiencies will result where
the quantification of claims is likely to be a time-consuming and complex undertaking,
and a finding on liability could ultimately be dispositive of the dispute.9 For instance, in
Methanex v. USA, Methanex sought damages of approximately US$970 million plus inter-
est and costs. The tribunal decided to hear jurisdiction and the merits in a first phase, and
to bifurcate quantum. Ultimately, the claims failed in the first phase, averting the need to
undertake a complex quantification phase.
Bifurcation might also promote the prospects of an early settlement. A finding on liabil-
ity might encourage the parties to settle,10 for example, where the scope of the dispute on
damages is narrow, or if bifurcation shores up weaknesses in certain aspects of the parties’
arguments as previously articulated.
In addition, bifurcation can sometimes reduce the complexity and scope of the dispute
for the purposes of determining quantum, again saving costs and time. For instance, in Suez
v. Argentina, the tribunal decided to bifurcate the merits for reasons of judicial economy.
7 Electrabel SA v. Republic of Hungary, ICSID Case No. ARB/07/19, Award dated 25 November 2015.
8 Mobil Investments Canada Inc and Murphy Oil Corporation v. Canada, ICSID Case No. ARB(AF)/07/4, Award
(20 February 2015), paras. 3-26.
9 Examples of cases where the damages phase was never reached, following bifurcation include: Mondev
International Ltd v. United States of America, ICSID Case No. ARB(AF)/99/2, Award dated 11 October 2002;
ADF Group Inc v. United States of America, ICSID Case No. ARB(AF)/00/1, Award dated 9 January 2003;
Methanex Corporation v. United States of America, UNCITRAL, Preliminary Award of Jurisdiction and
Admissibility, pages 86, 90.
10 This was suggested, for example, in Meg Kinnear et al, ‘An Annotated Guide to NAFTA Chapter 11’ in
Meg Kinnear, Andrea Bjorklund and John Hannaford (eds), Investment Disputes under NAFTA (Kluwer Law
International 2006), 1135-9.
109
Procedural Issues
The case comprised three consolidated claims arising out of a concession to operate water
and waste-water services in Buenos Aires. The tribunal found that Argentina had breached
its obligations under three bilateral investment treaties by denying the claimants’ invest-
ments fair and equitable treatment. After finding on liability, the tribunal observed that the
case was very complex and that the record was extraordinarily voluminous. In addition,
each party had engaged financial specialists who had reached vastly different conclusions
on damages. In these circumstances the tribunal held that it was appropriate to dedicate a
separate phase of the proceedings to damages.11 In this regard, it was stated that:
the Tribunal by rendering a decision on liability … and thereby defining the scope of its inves-
tigation with respect to a determination of damages will be able more efficiently to define the
mission of the independent expert that will assist the Tribunal in this determination.12
In certain cases, a tribunal’s decision, in the liability phase, on the correct valuation date for
assessing damages can result in an important narrowing of issues to be determined during
the damages phase. Similarly, cases involving complex questions of causation, or difficult
valuation exercises tend to be particularly propitious for bifurcation, though few reported
decisions provide reasons for the bifurcation of the damages phase.13 In Pope & Talbot and
SD Myers v. Canada, the investors claimed that the challenged measures affected their abil-
ity to export products from Canada. Damages were left to be determined in a standalone
phase, presumably on the basis of the complex issues of causation involved.
By contrast, in other disputes, questions of liability and quantum might be so inter-
twined that bifurcation would result in significant duplication of work, to the extent the
issues can be cogently divided at all. Separating issues of causation, mitigation and remote-
ness into questions of pure ‘liability’ or ‘damages’ may be somewhat artificial and difficult. In
certain cases, the fact that damage has been suffered might even affect a finding on liability
such that it is impossible for damages to be considered in isolation.14 In Electrabel v. Hungary,
bifurcation of liability and quantum was found to have been ‘at least unfortunate’.15 The
tribunal, upon the parties’ initiative, had determined to bifurcate the liability and dam-
ages phases. In turn, the claim relating to the Energy Charter Treaty’s Fair and Equitable
Treatment standard arguably combined issues of both liability and quantum. Because of
the bifurcation of the merits, the tribunal decided to defer its decision on both liability
and quantum in relation to the FET claim to a later phase of the proceedings.16 In their
submissions in the second phase of the proceedings, the parties agreed that loss was not in
fact relevant to the issue of liability under the FET claim. By this stage, however, the claim
had already been bifurcated to the second phase, and had given rise to a significant volume
of submissions and exchanges by the parties.
11 Suez v. Argentina (n 2), page 106 paragraph 273.

12 Ibid., page 106 paragraph 272.
13 Pope & Talbot Inc v.The Government of Canada, UNCITRAL, Statement of Claim, paragraphs 96-104. SD Myers
Inc v. Government of Canada, UNCITRAL, Statement of Claim, paragraph 33; Second Partial Award, pages
28-29, paragraphs, 117-122.
14 Electrabel SA v. Republic of Hungary (n 7) pages 61-62, paragraphs 203-210.
15 Ibid., page 69, paragraph 235.
16 Ibid., page 1, paragraph 1(3).
110
Procedural Issues
Nonetheless, it may in appropriate circumstances be possible to establish ‘a broad divi-

sion between liability and quantum [and] … to determine the principles on which damages
should be awarded, while leaving the pure arithmetical calculations to a second stage’.17
The tribunal in CME v. Czech Republic18 took this approach. It bifurcated the quantum
phase upon the parties’ agreement and left only the amount of monetary damages for
determination in the quantum phase.19
An unconventional but emerging method for case management in civil trials in the
United States is known as ‘reverse bifurcation’, whereby the issue of damages is heard and
determined before liability. This can be a useful tool and one on which those involved
in international arbitration may wish to draw, 20 particularly for cases in which there is a
serious argument that the claimant has suffered little or no damages. An early determina-
tion to this effect may lead to early disposal or settlement of the case. Reverse bifurcation
might also alert the parties to weak elements of their respective arguments on liability, again
encouraging settlement. Where reverse bifurcation is used in arbitration, care will need to
be taken to protect the due process rights of the parties and to ensure that neither party’s
case on the merits is pre-judged or otherwise unduly prejudiced.
The procedure in a bifurcated damages phase

Careful consideration needs to be given as to what the procedure within a bifurcated
damages phase should look like. The damages phase of proceedings can sometimes be just
as long and costly as the merits phase, sometimes unjustifiably. In such instances, bifurca-
tion can serve to complicate and prolong the dispute, rather than assist in its swift and
cost-effective resolution. For example, in Suez v. Argentina, the tribunal decided proprio motu,
at the conclusion of the liability phase, and after the parties had already made detailed sub-
missions on damages (which were later revised), that it would bifurcate the damages phase
because of the complexity of ascertaining damages.21
One potential pitfall of bifurcation consists in the quantum phase mirroring the liability
phase, where this would be disproportionate or otherwise inappropriate. In practice, dam-
ages phases will almost invariably involve one22 or two,23 rounds of written submissions by
the parties as well as the submission of written witness statements and expert opinions on
quantum (which will often play a central role in the phase). These submissions are often
followed by (or take place concurrently with) document production, and an oral hearing.
17 Nigel Blackaby et al. ‘Chapter 6. Conduct of the Proceedings’ in Nigel Blackaby et al., Redfern and Hunter on
International Arbitration (Kluwer Law International 2015), pages 353–414 paragraph 59.
18 CME Czech Republic BV v.The Czech Republic, UNCITRAL, Final Award dated 14 March 2003.
19 CMS Gas Transmission Company v.The Republic of Argentina, ICSID Case No. ARB/01/8, Award dated
12 May 2005, page 129 paragraph 444.
20 This was explored by the authors in Thomas Tallerico and J Behrendt, ‘The Use of Bifurcation and Direct
Testimony Witness Statements in International Commercial Arbitration Proceedings’ (2003) Journal of
International Arbitration 295, 297.
21 Suez v. Argentina (n. 2), Decision on Liability dated 30 July 2010, page 4 paragraph 7.
22 See SD Myers v. Canada (n. 13).
23 See, for instance, ConocoPhillips Petrozuata BV, ConocoPhillips Hamaca BV and ConocoPhillips Gulf of Paria BV
v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/30 and CME Czech Republic BV v.The Czech
Republic, UNCITRAL, Final Award dated 14 March 2003.
111
Procedural Issues
In some cases, such as in CME v. Czech Republic there may be both an ‘evidentiary hearing’
and a ‘final hearing’.24 An evidentiary hearing gives the parties the opportunity to provide
both factual and expert evidence to the tribunal and for counsel to make legal submissions.
A final hearing allows the parties to submit their final pleadings prior to the close of the
arbitration.The parties are sometimes then called upon to submit post-hearing submissions
on damages.
All of these steps are not necessarily required in a damages phase, and parties and
tribunals would be well served to build the procedure for the quantum phase using a
‘bottom-up’ approach, starting with the bare minimum and considering carefully which
features are really necessary and proportionate.25 Nonetheless, there may well also be cases
in which the quantum phase ought rightly, by reason of its significance or complexity, to
be lengthier and include more procedural steps than the merits phase.
Documentary evidence, disclosure and confidentiality

In this section, we focus on documentary evidence and particular aspects of disclosure in
international arbitration that may be relevant to the assessment of damages. In particular, we
draw attention to the treatment of confidential information that may be especially relevant
to damages issues.
In international arbitration proceedings, the parties will almost invariably seek to sub-
mit the documents on which they wish to rely, either through the submission of standalone
indexed bundles, or as exhibits to witness statements or pleadings. In relation to damages,
parties will often submit various documents accompanying their expert reports (discussed
below). For example, where a discounted cash flow method is used, internal evidence of the
business such as documents pertaining to operating cash flow and capital expenditures may
accompany an expert report. Similarly, the parties may submit market reports and other
data as a comparator for determining growth forecasts and for applying the discount rate.26
Where one party may have access to documents relevant to the issue of damages that
are not in the possession of the other party, it may be appropriate for the proceedings to
include a procedure for documentary disclosure. The IBA Rules of Evidence provide a
potential defence to disclosure on ‘grounds of commercial or technical confidentiality that
the Arbitral Tribunal determines to be compelling’.27 This potential defence is often of
particular relevance to documents relating to damages. Commercial disputes often arise
between competitors (such as between joint venture partners in the extractive sectors), or
between parties whose businesses legitimately depend upon securing the confidentiality of
certain information (for example, gas price review disputes often involve questions of pric-
ing strategy and internal rates of return that can be of utmost sensitivity in the industry).
24 CME Czech Republic BV v.The Czech Republic (n. 18).

25 See the general approach to procedure in international arbitration advocated by David W Rivkin: ‘Towards a
New Paradigm in International Arbitration: The Town Elder Model Revisited’ (2008) Arbitration International
(24), 375, 378.
26 See Noel Matthews and Andrew Wynn, ‘Valuation in International Arbitration’ (Global Arbitration
Review 2016) http://globalarbitrationreview.com/insight/the-middle-eastern-and-african-arbitration
-review-2016/1036970/valuation-in-international-arbitration accessed 12 October 2016.
27 IBA Rules, article 9(2)(e).
112
Procedural Issues
The parties invoking confidentiality as a defence to production are required to give

reasons for each objection and, in some cases, to indicate the documents, if any, that they
would be prepared to produce instead of the documents requested.28 Generally, tribunals
require convincing arguments before they grant confidentiality protection. Such argu-
ments may include that the information has industrial significance and may provide the
disclosing party with a competitive advantage, that the information contains data and
know-how for the development of the project subject to the dispute, or that the informa-
tion is protected by a specific confidentiality agreement because it involves third-party
proprietary technology.29
In exceptional circumstances, where the production of a document is objected to, but
the tribunal determines that it should not see the document – because of confidentiality
concerns – the IBA Rules of Evidence provide that the tribunal may appoint an independ-
ent and impartial expert, bound by confidentiality, to decide on the objection.30 Ultimately,
however, determination of the validity of the objection rests with the tribunal.
Treatment of Confidential Information

In practice, where documents are confidential, tribunals have taken a variety of case-specific
measures to protect one party’s information, while taking into account the need to secure
the other party’s rights of due process. Redaction of documents is a commonly used
method, although this will only be helpful where the information to be redacted is not
material to the dispute.31 Where redaction is not appropriate, a tribunal may make protec-
tive orders prescribing that access to the document be restricted to certain individuals only.
Frequently, these individuals will include members of the tribunal and legal counsel, on
the condition that they do not disclose the document to any other person, including the
counsel’s client.32 In these circumstances, however, it may be difficult for legal counsel to
assess or test the information if the information is particularly technical and legal counsel
are unable to take instructions from their clients in relation to it. The reverse is true when
only the tribunal and experts are given access to the document. Accordingly, sometimes
access to the document is given to the tribunal, the parties’ counsel and experts, but not the
parties.33 Further, in other cases, the dispute may require that counsel and experts be given
additional instructions by the parties themselves, in which case, access may also be given to
specified party representatives.34
28 See, for example, South American Silver Limited v. Bolivia, UNCITRAL, PCA Case No. 2013-15, Procedural
Order No. 1 (27 May 2014), para. 5.2.1.
29 See, for example, South American Silver Limited v. Bolivia, UNCITRAL, PCA Case No. 2013-15, Procedural
Order No. 2 (1 December 2014), para. 23 and Procedural Order No. 8 (26 August 2015), para. 29.
30 IBA Rules, article 3.7; Commentary on the New IBA Rules of Evidence in International Commercial
Arbitration, p. 23.
31 On this subject, see, Domitille Baizeau and Juliette Richard, ‘Addressing the Issue of Confidentiality in
Arbitration Proceedings: How is this done in Practice?’ in Elliott Geisinger (ed) Confidential and Restricted
Access Information in International Arbitration (ASA Special Series No. 43, 2016) 53, p. 55.
32 See Jeff Waincymer, Procedure and Evidence in International Arbitration (Kluwer Law International, 2012) p. 876.
33 See Baizeau and Richard (n 31), p. 58.
34 Ibid., p. 59.
113
Procedural Issues
Additional measures used to protect confidentiality include requiring the return or

destruction of the documents in addition to restricted access, or restricting access to the
visual inspection of the documents rather than circulating them.35
Witness evidence
Although the building blocks for a party’s case on damages will often be found in hard
data and, therefore, documents, the tribunal will often benefit from witness testimony that
explains that hard data.
Witnesses of fact
The lion’s share of the evidence on damages is often given by (or at least presented through)
the evidence of expert witnesses.36 However, witnesses of fact can also play an important
role in supporting the appropriateness of any valuation or calculation. For example, mem-
bers of the parties’ finance departments or those who otherwise have first-hand knowledge
of the figures and projections on which the claim for damages is based can be of assistance
to tribunals, particularly where the source and meaning of the data is in dispute, or at least
not self-evident.37
Expert witnesses
Expert witnesses provide the tribunal with their opinion on the parties’ cases on dam-
ages. They do so on the basis of their particular expertise, rather than their knowledge of
particular facts. There are two principal types of experts used for assessing damages: foren-
sic/advising experts and testifying experts. Forensic or advising experts are often retained
where they have had previous involvement in the issues in dispute, and have already gener-
ated work product that can form the starting point for the testifying expert’s evidence. The
forensic or advising experts may not have a sufficient degree of independence from the
party, or may not be experienced in adopting the relevant methodology for the calcula-
tion of damages in international arbitration. In contrast, testifying experts will most often
be retained by the party’s counsel rather than by the party itself, and will have a greater
degree of independence and potentially greater specialist experience to address the subject
of their testimony.
Experts from a variety of disciplines are often instructed to give evidence on damages,
for instance, accountants, engineers, economists, financial and valuation analysts, business
valuation experts and oil market experts. In some cases, a combination of industry experts
35 Ibid., pp. 62-63.

36 In gas price review arbitrations, experts usually provide the majority of the evidence and legal submissions will
largely follow the expert evidence. See Mark Levy and Rishab Gupta ‘Gas Price Review Arbitrations: Certain
Distinctive Characteristics’ in J William Rowley QC (eds), The Guide To Energy Arbitrations (1st edn Global
Arbitration Review 2015) 177.
37 For an example of an award in which factual evidence in support of damages was relied upon, see SD Myers
Inc v. Government of Canada, UNCITRAL, Second Partial Award dated 21 October 2002, paragraphs. 180,
197-205 where the CEO of SD Myers testified as to how profits were generated. Another industry participant
gave evidence about his observations on the relevant market while the contested events unfolded.
114
Procedural Issues
and valuation or economic experts may be helpful. For example, in Occidental v. Ecuador,38
12 experts were appointed including oil and gas consultants and quantum experts. Similarly,
in Exxon Mobil v. Venezuela,39 the claimants appointed eight experts including an oil price
forecasting expert and oil reserves evaluation experts. Separate quantum experts were also
engaged by the claimants to advise on the extent of damages resulting from production and
export curtailments.40
Experts are sometimes called upon to report separately to the tribunal, and in other
cases to provide an agreed joint statement.41 For instance, in Occidental v. Ecuador, the experts
produced a joint report estimating the fair market value of the investment according to cer-
tain agreed parameters. The experts were able to agree to employ a common model and to
reach agreement on ‘the most reasonable approaches and methodology for calculating fair
market value, consistent with the Tribunal’s instructions’.42 In turn, the tribunal appeared to
accept the experts’ conclusions.43
Independence of experts
Experts are most often selected, instructed and remunerated by one party. This gives rise
to the question of their independence, and a perception that their testimony may be of
limited probative value, despite the fact that their role is not to advocate on behalf of the
party instructing them. Expert witnesses must be independent but arbitral rules do not
explicitly recognise the existence of a duty as between an expert and the arbitral tribunal.44
Accordingly, experts must be transparent about the reasons for their conclusions or calcula-
tions and should be willing to change their assessment of damages if the underlying facts
or assumptions change.45 Tribunals are often heavily reliant on experts when quantifying
damages, and therefore, experts’ credibility is of utmost importance.
Both the IBA Rules of Evidence and the CIArb Protocol require that a party-appointed
expert disclose any past or present relationships that may create a conflict of interest with
another participant in the arbitration.46 These types of disclosure regimes are generally
38 Occidental Petroleum Corporation and Occidental Exploration and Production Company v.The Republic of Ecuador,
ICSID Case No. ARB/06/11.
39 Venezuela Holdings BV, et al (case formerly known as Mobil Corporation,Venezuela Holdings BV, Mobil Cerro Negro
Holding Ltd, Mobil Venezolana de Petróleos Holdings Inc, Mobil Cerro Negro Ltd and Mobil Venezolana de Petróleos Inc)
v. Bolivarian Republic of Venezuela, ICSID Case No. ARB/07/27, Award of the Tribunal dated 9 October 2014.
40 Ibid., paragraph 265.
41 Howard Rosen and Matthias Cazier-Darmois, ‘Expert Evidence’, in J William Rowley QC (eds), The Guide To
Energy Arbitrations (1st edn Global Arbitration Review 2015).
42 Occidental Exploration and Production Company v.The Republic of Ecuador (n 38) paras. 694-702.
43 Ibid., para. 778.
44 Rules will usually specify that experts are to remain independent, without referring to a duty. See Article 4(3)
ICC Rules for the Appointment of Experts and Neutrals. By contrast, see Article 4(3) of the CIArb Protocol
which explicitly imposes a duty on experts, consistent with the rules under English Civil Procedure. See
English Civil Procedure Rules Part 35 and its Practice Direction.
45 Vidja Rajaro, ‘Perspectives And Best Practices In Quantifying Damages, Business Valuations And Expert
Witnesses’ (2016) Indian Journal of Arbitration Law.
46 Article 5(2)(a) of the IBA Rules; Article 4(4)(b) of the CIArb Protocol. See also Mark Kantor, ‘A Code of
Conduct for Party-Appointed Experts in International Arbitration – Can One be Found?’, (2010) Arbitration
International 26(3) 323.
115
Procedural Issues
accepted in international arbitration as sufficient to address issues of independence and

impartiality. Further, the tribunal may sometimes take into account any concerns in this
regard in assessing the credibility of, and thereby the weight to be placed on, the evidence
of experts.
In contrast, in certain civil law jurisdictions, and under certain institutional rules that
are influenced by those civil law jurisdictions, the independence of experts is of such a
concern that the default rule is for the tribunal, rather than the parties, to appoint experts.
For example, the default position under the Deutsche Institution für Schiedsgerichtsbarkeit
(DIS) Rules is that the tribunal appoints the experts unless the parties agree otherwise. In
turn, in DIS proceedings, where evidence is given by party-appointed experts, arbitra-
tors sometimes accord less weight to the evidence because of concerns about the experts’
impartiality.47 We address the issue of tribunal-appointed experts further below.
Witness conferencing
Witness conferencing (colloquially known as ‘hot tubbing’) is an emerging case manage-
ment tool in international arbitration whereby multiple witnesses are required to give
evidence simultaneously, rather than sequentially. The practice involves a simultaneous
joint hearing of all witnesses with the aim of addressing divergences in their evidence
on the spot.48 Hearing practices can vary from asking directed questions and asking
counter-witnesses to respond, to the use of witness statements as a guide.49 Such practices
give the opposing experts the opportunity to immediately respond to each other’s views in
a way that traditional sequential testimony does not allow.
The IBA Rules of Evidence and the ICC ‘Arbitration Commission Report on
Techniques for Controlling Time and Costs in Arbitration’ (the ‘ICC Report’) both
encourage the use of witness conferencing in appropriate cases. Witness conferencing can
potentially enhance efficiency, clarify disputed issues and eliminate weak or irrelevant argu-
ments.50 Conferencing can also, in principle, draw the tribunal’s attention to the quality and
objectivity of an expert’s opinion by offering an immediate contrast between the experts.51
However, the practice is not without its controversies as detractors have argued that con-
ferencing is too interventionist to be used in arbitration and does little to remedy the gap
between the opinions of expert witnesses appointed by the parties.52
47 See Professor Dr Richard Kreindler, Dr Thomas Kopp and Nicole Rothe, ‘International Bar Association
Arbitration Guide’ (IBA Arbtration Committee 2013), page 12.
48 See Trevor M Cook and Alejandro I Garcia, International Intellectual Property Arbitration (Kluwer Law
International 2010); See also Wolfgang Peter, ‘Witness ‘Conferencing’’ (2002) Arbitration International (18)
47, 49.
49 Wolfgang Peter (n 48), 47, 52.
50 Ibid, 55.
51 Gregory Bell et al, ‘Expert Witnesses In Arbitration’ (Corporate Disputes Magazine 2012).
52 Kantor (n 46); For examples of cases in which witness conferencing was used see Ioannis Kardassopoulos
and Ron Fuchs v. Republic of Georgia, ICSID Case Nos. ARB/05/18 and ARB/07/15, Award dated
3 March 2010 and Rompetrol Group NV v. Romania, ICSID Case No. ARB/06/3, Award dated 6 May 2013.
116
Procedural Issues
Pre-hearing meeting of experts

A pre-hearing meeting of expert witnesses to identify areas of agreement and areas in
dispute is a method of case management, available under the IBA Rules of Evidence53 and
endorsed in the ICC Report. The aim of these meetings is for expert witnesses to meet
(in the absence of counsel) to identify issues in common and refine the issues in dispute,
which a tribunal needs to deal with. The CIArb Protocol sets out detailed guidance on
pre-hearing meetings between experts, stipulating that they ought to hold a conference
to: identify issues on which their opinions will be sought; identify tests or analyses to be
conducted; and if possible, to agree upon those issues, and tests, and the manner in which
such tests shall be conducted.54
Where experts are able to identify common findings, the parties and tribunal are likely
to accept those findings, enabling them to focus on the issues in dispute.55 In this way,
pre-hearing meetings of experts can directly reduce costs and delays. However, the practice
may prove less fruitful in circumstances where one, or both, of the experts take adversarial
positions in an attempt to advocate on behalf of their appointing party. The outcome may
be an increase in costs, without the associated benefit of clarifying the issues in agreement.
In this respect, where a pre-hearing meeting is being considered, it may be worth requiring
that the meeting take place before the experts have submitted their opinions.56
Tribunal proactivity
Tribunal proactivity in relation to damages can take several forms, from active case manage-
ment and the suggestion that the parties be required to articulate their theory of damages
early on, to departing from party-proposed approaches to assessing quantum. The latter
practice is not without controversy as it may give rise to concerns in relation to the parties’
due process rights. In this section we consider some of these proactive procedures available
to tribunals and, where relevant, associated due process considerations.
Proactive case management

In the majority of cases, issues relating to damages are left to be addressed towards the end
of the proceedings. Problematically, where damages have not been considered early on
in the proceedings, critical points of law or fact may arise which could have been more
efficiently dealt with earlier in the proceedings. Issues such as causation, remoteness of loss,
mitigation and valuation dates are particularly susceptible to overlap between questions of
liability and damages. Additionally, there is increased risk that evidence pertaining to dam-
ages presented near the end of the case may be based on previously unarticulated theories
53 Article 5(4) of the IBA Rules of Evidence enables a tribunal to order the party-appointed experts to meet and
to discuss the issues considered or to be considered in their expert reports.
54 Chartered Institute of Arbitrators, Protocol for the Use of Party-Appointed Expert Witnesses in International
Arbitration Article 6(1)(a).
55 IBA Commentary on the revised text of the 2010 IBA Rules on the Taking of Evidence in International
Arbitration, page 20.
56 As suggested by Jeff Waincymer (n 32) page 963.
117
Procedural Issues
of compensation.57 By contrast, a late examination of the damages phase may eclipse valu-
able opportunities to narrow the scope of damages issues, or to exclude improbable dam-
ages claims, and therefore, to bring about a timely and more cost-effective resolution of
the dispute.
Accordingly, tribunals may be well-served by giving at least some consideration to dam-
ages issues early on. The International Institute for Conflict Prevention & Resolution has
provided detailed guidance in its Damages Protocol on how to raise damages issues with
the parties early on. In particular, the Damages Protocol proposes that arbitrators address
damages in or around the initial conference with the parties, and that the arbitrators require
the parties to articulate their theories of compensation and their defences.58
Taking such measures can assist in reducing the scope of the dispute and in pre-empting
complex or problematic issues that are likely to result in delay and increased cost later in
the proceedings.
Independent tribunal initiatives

There is some disagreement on the extent to which a tribunal may utilise a procedure
in international arbitration that is different from the procedures proposed by the parties.
In relation to the issue of damages, each party may have a set idea of the procedure that
would best allow it to present its case.The tribunal may have a very different view from the
parties as to the most appropriate procedure. In this section, we examine the question of
tribunal-appointed experts and tribunal-led assessments of quantum.
Tribunal-appointed experts
In a minority of cases in international arbitration,59 tribunals appoint their own experts,
either because they deem any experts already appointed by the parties to be insufficient
to allow the tribunal to fulfil its mandate, or because the parties themselves have requested
the tribunal to do so.60
To a common law lawyer, this approach may seem at odds with the principle of party
autonomy and the adversarial litigation process. However, arbitrators from a civil law back-
ground may expect that the expert will be selected by, and responsive to, the tribunal rather
than the parties, in the interest of the expert’s independence, as explained above.
57 CPR International Committee on Arbitration, ‘Protocol On Determination of Damages in

Arbitration’, Introduction, available at www.cpradr.org/RulesCaseServices/CPRRules/
ProtocolonDeterminationofDamagesinArbitration.aspx.
58 Ibid.
59 The Queen Mary University of London School of Arbitration indicates that expert witnesses are appointed by
the parties 90 per cent of the time and only 10 per cent of time by the tribunal (n 58), 24.
60 For example, in Siemens AG v.The Argentine Republic, ICSID Case No. ARB/02/8, Award Dated
17 January 2007, page 115, paragraph 360, the parties took different approaches to what constituted adequate
evidence of Siemens’ investment. The claimant considered audited financial statements to be sufficient
evidence of the amounts invested. The respondent considered it necessary to demonstrate how each unit of
currency was spent. Accordingly the respondent insisted that the tribunal use an expert to analyse the relevant
accounts and to ensure that the amounts spent were spent for purposes of carrying out the investment. The
tribunal saw no merit in prolonging the proceedings and appointing an expert.
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Procedural Issues
A number of institutional rules (including the UNCITRAL Arbitration Rules and the
LCIA Rules), and some BITs, even make express and specific reference to the possible use
of tribunal-appointed experts, after consultation with the parties, though none of the rules
require the use of tribunal-appointed experts. The expert, if appointed, is to report to the
tribunal on specific issues, determined by the tribunal.61 Under the US Model Bilateral
Investment the tribunal’s discretion is more limited. It can appoint an expert upon the
request of a disputing party, or on its own initiative, unless the parties disagree, to address
‘any factual issue concerning environmental, health, safety, or other scientific matters raised
by a disputing party in a proceeding’.62
In certain cases, concerns may be raised that the tribunal-appointed experts may
become the de facto arbitrator. Accordingly, arbitrators must be careful not to delegate their
decision-making responsibilities to the experts they appoint, unless the parties agree to
this. While the English courts have not found that tribunal-appointed experts constitute
an improper delegation of the tribunal’s powers,63 the IBA Rules of Evidence have sought
to address these concerns by recommending that parties examine the correspondence
between the tribunal and the expert, and that the parties should be able to question the
expert at the evidential hearing.64 In a similar concern for transparency (and perhaps a rec-
ognition that the expert will ultimately be paid for by the parties), English law, for example,
prevents arbitrators from meeting privately with the tribunal-appointed experts regardless
of the content of the discussions.65
Where an expert is to be appointed by the tribunal, it would normally be appropriate
for the parties to be called upon to provide input on the identity of the expert. For exam-
ple, the parties may each be asked to draw up a list of proposed experts and then for the tri-
bunal to select any overlapping candidates to act as tribunal-appointed experts.66 Similarly,
it would normally be appropriate for a tribunal to provide the parties with an opportunity
to comment on the tribunal-appointed expert’s report.67
Tribunal-appointed experts can also be useful where the tribunal does not have the
benefit of evidence from both parties. This was the case in National Grid v. Argentina, where
the tribunal did not have a damages valuation from Argentina. The tribunal-appointed
expert did not use its own valuation model but did observe that the claimant’s expert report
contained ‘manifest errors’.68 The tribunal ultimately accepted a number of its own expert’s
recommendations on discounted cash flow valuation inputs.69
61 See, for example, Article 21.1 of the LCIA Rules; Article 29(1) of the UNCITRAL Rules.
62 2012 US Model Bilateral Investment Treaty, Article 32.
63 Brandeis (Brokers) Ltd v. Herbert Black and others [2001] All ER (D) 342.
64 IBA Rules, Article 6.
65 Kantor (n 46) 279 – 314. See also, Suez v. Argentina (n 2).
66 See Klaus Sach quoted in Cook and Garcia (n 46), 208.
67 See e.g., Suez v. Argentina (n 2), page 13 paragraph 16.
68 National Grid plc v.The Argentine Republic, UNCITRAL, Award dated 3 November 2008, pages
12-13 paragraphs 47-49.
69 See also Joshua Simmons, ‘Valuations in Investor-State Arbitrations’ in John Moore (ed), International Arbitration
Contemporary Issues and Innovations (Martinus Nijhoff 2013) 104; citing National Grid plc v.The Argentine
Republic, UNCITRAL, Award dated 3 November 2008, paragraphs 289-290.
119
Procedural Issues
Tribunal-led assessments of damages

In a number of cases, the tribunal may wish to depart from the parties’ assessment of dam-
ages and adopt what then becomes, to varying degrees, its own methodology.
In some cases, tribunals may be entirely dissatisfied with the models used by the parties
to quantify their damages. For instance, both experts may have failed to consider relevant
factors or may have departed from a well-accepted principle of valuation without any jus-
tification.70 In these circumstances, tribunals sometimes choose to adopt their own meth-
odologies and depart from what has been put forward by the parties.
In other cases, tribunals opt to change the calculation methodology and then request
that the experts provide recalculated forecasts. In cases where income-based forecasts are
presented on the basis of a discounted cash flow valuation, tribunals sometimes request to
be provided with the party-appointed experts’ financial model.The tribunal can then input
any permutation of figures or assumption drawn from the party-appointed experts’ respec-
tive forecasts to arrive at a recalculated forecast of its own.71 This is a controversial approach
and one which the relevant experts may resist because of risks associated with disclosing
proprietary information contained in their models.72
Alternatively, a tribunal might simply want to test the effect of disputed assumptions
by adjusting model inputs and ‘testing the sensitivity of the important components of the
calculations.’73
In all such types of cases, the tribunal might ultimately find that its mandate is best
served through adopting a more interventionist approach. For example, in CMS v. Argentina,
the tribunal built its own model with the assistance of its experts. It then ‘tested a number of
scenarios by changing different variables … [focusing] on the most important determinants
of value (as well as the main sources of uncertainty)’.74 Ultimately, the tribunal was able to
modify the assumptions underpinning the claimant’s expert’s calculation of loss.75 Similarly,
in Enron v. Argentina, the tribunal-appointed expert assisted the tribunal in addressing the
parties’ competing positions.76 Notably, the tribunal found its expert’s approach to be ‘more
balanced and realistic’ than that of the party-appointed experts.77 Accordingly, the tribunal
accepted its own expert’s recommendations on several inputs into the discounted cash flow
valuation that was used.78
Due process
Where tribunals use these sorts of proactive measures, they ought to be particularly mindful
of their obligation to ensure that the parties are given the opportunity to be heard. Where
70 Rajaro (n 45), 160.

71 Kantor (n 46), 301.
72 Ibid.
73 Ibid., 302.
74 CMS Gas Transmission Company v.The Republic of Argentina (n 19) paragraph 436.
75 Ibid., paragraph 439.
76 Joshua Simmons, (n 69), 104.
77 Enron Corporation and Ponderosa Assets, LP v. Argentine Republic, ICSID Case No. ARB/01/3, Award dated
22 May 2007, paragraph 435.
78 Joshua Simmons, (n 69) 104.
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Procedural Issues
due process rights are violated, the relevant award may be liable to annulment. Due process
requires that parties have a reasonable opportunity to be informed about, and comment
on, the bases for a tribunal’s decision on damages. Accordingly, if after hearing the parties as
to the appropriate methodology for calculating damages, a tribunal decides to take a third
approach, or to appoint its own expert, the tribunal may at that point find it appropriate
to communicate its proposed course of action to the parties and invite their comments or
further submissions.79
Unconventional procedures
In this final section, we consider two unconventional procedures for determining damages,
which certain parties may find of interest, and which tribunals might wish to propose to
the parties in appropriate cases.
The first of these procedures is known as ‘baseball arbitration’, a term that originates in
the resolution of salary disputes in Major League Baseball in the US.80 In baseball arbitra-
tion, rather than award the actual quantum of damages, the tribunal is mandated to decide
between two fixed offers made by the opposing parties. There are two variants of baseball
arbitration.‘Day baseball’ arbitration occurs when the tribunal is aware of the offers submit-
ted by the parties and then chooses between them. By contrast, in ‘night baseball’ arbitra-
tion, the submitted offers are kept confidential as between the parties until the tribunal has
rendered the award on liability and damages. At this point, the offers are disclosed to the
tribunal and the offer closest to the damages awarded is awarded.81
A key advantage of baseball arbitration is that it may encourage the parties to make
more realistic offers as compared with what their positions on quantum might otherwise
be. The method can therefore help parties to settle. Finally, baseball arbitration can acceler-
ate the deliberation process and reduce costs because the tribunal may, for day baseball at
least, not be required to include as much detail in the award on damages.82
The procedure, of course, has its limits and is likely not to be suitable to most cases.
Some commentators have questioned whether baseball arbitration constitutes ‘arbitration’
at all given that the procedure significantly curtails the tribunal’s discretionary powers – a
concern that reflects the tension between party autonomy and the tribunal’s adjudica-
tive role.83 Finally, critics of baseball arbitration argue that limiting the tribunal’s remedial
powers can result in ‘arbitrary and unintended’ outcomes and ‘raises enforceability issues in
some jurisdictions’.84
79 Examples of where tribunals have done this include, Suez v. Argentina (n 2); Occidental v. Ecuador (n 38); National
Grid v. Argentina (n 66); and LG & E Capital Corp and LG & E International Inc v. Argentine Republic, ICSID
Case No. ARB/02/1, Award (25 July 2007), paragraphs. 8-9.
80 Josh Chetwynd, ‘Play Ball? An Analysis of Final-Offer Arbitration, Its Use in Major League Baseball and Its
Potential Applicability to European Football Wage and Transfer Disputes’ (2009) Marquette Sports Law Review
(20) 109, 110.
81 See Irene Welser and Alexandra Stoffl ‘The Arbitrator and the Arbitration Procedure, Calderbank Letters and
Baseball Arbitration – Effective Settlement Techniques?’ in Christian Klausegger and Peter Klein et al. (eds),
Austrian Yearbook on International Arbitration (Manz’sche Verlags- und Universitätsbuchhandlung 2016), 94.
82 Ibid., 96.
83 Gary Born, International Commercial Arbitration (Kluwer Law International 2009), 282.
84 Ibid, 281.
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Procedural Issues
The second procedure that parties and tribunals may wish to consider is known as
‘high-low arbitration’. Parties can include a high-low clause in their arbitration agreement,
or agree to such a clause on an ad hoc basis when a dispute arises, in order to set a floor and
ceiling for an award of damages. The tribunal is not necessarily informed of the high-low
agreement between the parties. In these circumstances, if quantum assessed by the tribunal
exceeds the maximum amount specified by the parties, then the award is fixed at that maxi-
mum amount, and, conversely, upon a finding of liability, the quantum cannot be below the
minimum.85 Like baseball arbitration, high-low arbitration has attracted some criticism and
may not be suitable for most cases. In particular, it has been suggested that high-low arbitra-
tion favours risk-takers and invites parties to gamble, as a ‘“moderately-extreme” position
seems to offer the best risk-benefit ratio’.86
Conclusion
In this chapter we have outlined some of the procedural issues relevant to the determina-
tion of damages in international arbitration.This is certainly an area in which users of arbi-
tration can benefit from counsel and arbitrators striving to devise the optimal procedure in
each case, thinking creatively and drawing on past experience where necessary. Early tribu-
nal proactivity in this area may be particularly helpful in cases where the parties themselves
(or their counsel) are insufficiently focused on damages issues at the outset of the dispute,
and can, at least in some cases, lead to significant savings of time and costs.
85 Born (n 3), 115.

86 Christian Buhring-Uhle, Lars Kirchhoff, Gabriele Scherer, Arbitration and Mediation in International Business
(2nd edn, Kluwer Law International, 2008), 201.
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8
Strategic Issues in Employing and Deploying Damages Experts
John A Trenor1
Parties frequently engage experts to assist in developing, calculating and presenting their
cases on damages to tribunals in international arbitration. Such experts may specialise in
economics, finance, or accounting or possess specialised business acumen in a particular
industry, country or subject matter. Some damages experts offer scientific, technological or
other technical skills. In many cases, damages experts are engaged to provide quantitative
‘number-crunching’ capabilities or modelling experience, such as company valuation or
cash flow analyses.
Given the flexibility inherent in international arbitration and the focus on party auton-
omy, parties often have significant ability to craft the procedures regarding the resolu-
tion of damages issues. Of course, tribunals are typically granted considerable discretion to
determine the applicable procedures under most arbitration laws and rules, including as it
pertains to the resolution of damages and expert evidence.
This chapter addresses a number of techniques and approaches that parties and their
counsel, as well as tribunals, can consider to maximise the effectiveness of expert assistance
on damages issues. It bears emphasis that the usefulness or appropriateness of a particular
technique or approach depends significantly on the circumstances of the case at issue.What
may work or be appropriate in one case may not work in another. One size does not fit
all. Parties should work with tribunals to determine the most appropriate procedures in
each case.
Determining whether a damages expert is appropriate

One of the first strategic choices parties have to make regarding damages is whether to
retain a damages expert and, if so, which expert.
1 John A Trenor is a partner in the international arbitration group at Wilmer Cutler Pickering Hale and
Dorr LLP.
123
It is important for parties to begin considering damages issues, together with liability
issues, as early as possible, especially after a dispute has arisen but often before, to guide
appropriate decision-making. Counsel experienced in damages issues can work closely
with clients, especially the commercial and financial teams within companies, to provide
preliminary assessments and to determine what issues may arise and what type of damages
expert may be appropriate.
Parties and their counsel often think first and foremost about whether a damages expert
would help to present their case before the tribunal, but damages experts can be effective
in helping to develop the damages case in the first place. Moreover, in many cases damages
issues are intertwined with merits issues, and thus the right experts can help parties and
their counsel to develop the entire case. Knowing how strong a damages case may be or
how to accurately quantify the likely damages that may be recovered can help influence
a party’s strategy from the outset, including whether to initiate an arbitration or assert
a counterclaim.
Although damages experts can be extremely useful, such experts are obviously not nec-
essary in every arbitration. In some cases, parties and their counsel can effectively quantify
damages and present the damages case. Sophisticated counsel, with experience in damages
issues, can often work with the in-house teams of the client – whether commercial, finan-
cial, or other – to build and present the damages case.
Whether to engage a damages expert depends on a variety of factors, including the
amount in dispute and the complexity of the damages issues. In cases involving small
amounts in dispute, it may not be economical to engage damages experts. In cases with
seemingly straightforward damages issues, it may not be necessary to engage damages
experts. However, what may seem simple at the outset can be misleading, and an under-
standing of the complexity may develop over time.
Whether the opposing party has or is likely to engage a damages expert is another
important consideration. It is not always necessary to engage a damages expert just because
the other side has. There may even be strategic considerations about sending a message to
the tribunal regarding the simplicity (or complexity) of the damages issues. However, it is
important to fully consider the expectations of the tribunal and the assistance that damages
expertise may provide, depending on the circumstances of the particular dispute.
The sophistication of the arbitrators on damages issues, if known, can also be an impor-
tant factor in whether to engage a damages expert.
Of course, a party’s financial resources and ability to pay for a damages expert influence
the decision as well. In some instances, third-party funding may be an option.
Engaging the right damages expert

Engaging the right damages expert for the dispute is one of the most important decisions
a party makes, together with its choice of counsel.
Given that damages issues are governed by the applicable law and often linked with
liability issues, the lawyers engaged by the parties typically work closely with the client to
identify the right experts for the case.
A wide variety of factors influence the selection of the right damages experts, including:
• the scope and depth of relevant experience, expertise and education;
• quantitative skills;
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• reputation;
• demeanour, persuasiveness and credibility;
• ability to communicate complex issues clearly and persuasively in writing and orally at
the hearing in terms a tribunal can understand;
• experience testifying at an arbitration hearing and, in particular, facing cross-examination;
• experience with expert conferencing (also known as ‘hot tubbing’);
• cost; and
• availability.
Of course, it is critical to establish that the expert is independent of the parties and impar-
tial. Therefore, counsel must enquire about the extent to which the potential expert has
previously worked for or has any other relationship with any of the parties or counsel
(including opposing counsel, if known). The potential expert must be conflict-free. It is
important to review any available publications by the candidate to determine if there are
issue conflicts (i.e., positions taken by the candidate that might conflict with or undermine
positions in the arbitration). These questions can be relevant not only for the individual
candidate under consideration, but also for the organisation for which the expert works.
It is also worth inquiring whether the potential expert has any experience with experts
retained by the other party or parties, if known yet. Experts often have experience working
with or against other experts or have heard stories from others who have such experience.
Often experts have useful insights on the strengths and weaknesses of their colleagues.
Of course, it is important to establish whether the potential expert is on board substan-
tively with the party’s case. If not, the party and its counsel must find another expert or
revise the position the party intends to take.
Often, strategic questions arise whether to engage a damages expert with the neces-
sary experience in the industry or country involved, or whether it would be preferable to
hire separate experts. Sometimes, it is difficult to find all of the necessary expertise in one
person. In such cases, it may be necessary to engage multiple experts who work together to
quantify damages.That, in turn, raises questions about whether the multiple experts should
work together or separately, submitting a joint report or separate reports.
Counsel for a party typically research a number of potential experts (sometimes dozens)
to best match the needs of the case with the expert’s skill set. Counsel often interview a
short list of candidates, occasionally with client participation, to make a final decision.
There are a number of issues that arise with the formal terms of the engagement itself.
Although these are beyond the scope of this chapter, two are worth brief mention. First,
in some jurisdictions, it is important for the lawyers to engage the experts on behalf of the
client (rather than have the client engage the experts directly) to maximise the protection
of legal privilege. Second, when considering the terms of compensation for the expert, care
should be taken to preserve the impartiality of the expert. This is often addressed through
payment based on hourly fees or a fixed fee for the matter (or fixed fees for various stages).
Working with damages experts

Advance planning by counsel working in conjunction with damages experts, once engaged,
and by tribunals and the parties to establish the procedures for addressing how evidence
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from damages experts will be presented is critical to maximising the beneficial role that
such experts can play.
For parties and their counsel, this advance planning typically starts with a detailed pro-
duction schedule for ensuring that the experts are effectively integrated into the develop-
ment of the damages case and that expert reports are prepared in a timely fashion in close
coordination with the preparation of the parties’ memorials.
In many cases, it takes time to develop the appropriate methodology for assessing and
quantifying damages. This frequently entails a collaborative process involving the expert,
counsel and the client that may take weeks or even months to develop, taking on board
the parallel development of the factual and legal case, which influences the damages case.
Counsel typically works with the expert to obtain relevant documents, data and other
information from the client.
An early issue that often arises is whether to seek (or oppose) bifurcation of liability and
damages, an issue discussed in the chapter on ‘Procedural Issues’ in this publication.
The tribunal can play an important role by placing issues regarding damages and experts
on the agenda for the first procedural conference so the parties are prepared to discuss ten-
tative procedures for addressing expert evidence on damages. Of course, in most instances,
the parties cannot be expected to have fully developed their damages cases at that early
stage and may not be ready to take positions on the relevant procedural issues regarding
the presentation of expert evidence. Indeed, in many instances the parties will not yet have
engaged damages experts at that stage.That can frequently be the case for the claimant, and
it is even more often the case for the respondent.
However, if the tribunal begins the discussion early, it can encourage the parties to
begin planning and considering options. In some cases, tribunals recognise the difficulties
in committing to procedures regarding the presentation of expert evidence on damages at
the outset and schedule procedural conferences at various stages in the timetable to revisit
these issues as the parties develop their damages’ cases further.
One issue that may arise when the parties and tribunal discuss the procedural timetable
is whether the expert reports should be submitted together with the parties’ legal and fac-
tual submissions, as is often the case in international arbitration, or whether expert reports
should be submitted at a later stage, either simultaneously or consecutively, whether in
one round or two. Although there are pros and cons to different approaches, which may
be influenced in part by differing views as to the role of the expert, it is often true that
the parties and their counsel work closely with the experts they appoint to develop their
cases, including on damages, and in many arbitrations it would not be possible or effective
for parties to present their memorials without the support of accompanying expert dam-
ages reports.
Some tribunals propose – and occasionally even impose – off-the-shelf rules regarding
the presentation of expert evidence. This can raise significant concerns among parties if
such rules are not sufficiently flexible for proper application to the nuances of the case at
issue. Although these rules may have worked in other cases, they may not be appropriate
in others.
In considering which procedures are most appropriate for the particular case, it is obvi-
ously important to consider the costs, delays and potential distractions they may impose
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on the parties, through additional work to be performed not only by the experts, but by
counsel and in-house personnel.
Effective presentation of damages issues in memorials and expert reports

Counsel play a critical role in presenting damages issues to the tribunal. Although the
damages experts present their work in separate expert reports, it is the parties’ memori-
als that the tribunal will read first, and it is counsel’s presentation of the damages case that
makes the first impression. The expert reports are often viewed, together with witness
statements, as supporting materials, and it is counsel’s role to integrate the expert’s work
into the memorials.
Counsel must work closely with the damages expert to develop and present a cohesive
and comprehensible damages case, building on the relevant law, facts and expert analysis
contained in the expert report.
To effectively present the damages case and the analysis of the damages experts, it is
critical for the lawyers to fully understand the expert’s methodology and analysis. This is
important both for preparing written submissions and for the hearing, where it is essen-
tial in particular for effective cross-examination. Although this can at times be difficult,
it is often apparent from the party’s memorial when counsel do not fully understand the
expert’s analysis. This leads to less persuasive submissions and can even result in incorrect
descriptions of the expert’s work that undermine the client’s case. Counsel who truly
understand the expert’s methodology and analysis are also better positioned to identify
inconsistencies, weaknesses or other concerns in a draft report and can work with the
expert to resolve them.
Counsel cannot effectively summarise and describe the expert’s analysis without truly
understanding the methodology that the damages experts use. Indeed, it is often important
for counsel to work closely with the damages expert in developing the appropriate meth-
odology. The theories of liability and damages must be mutually consistent. Therefore, the
experts must have appropriate instructions on any legal parameters governing the calcula-
tion of damages.
Many damages issues relate to application of the central principle that the claimant
should be restored to the position it would have been in ‘but for’ or absent the wrongful
actions. This general principle that the wrongdoer must make full reparation for the injury
caused by the wrongful act – whether that is a breach of contract or a treaty violation –
often lies at the heart of many aspects of the damages case. However, as always, the devil is
in the detail and the precise legal standard that governs the dispute.
Moreover, damages calculations must anticipate the legal determinations that the tribu-
nal must make on issues of liability and damages to ensure that the damages model is useful
in light of the decisions ultimately reached by the tribunal. That may require alternative
scenarios by the experts if damages calculations are conducted before a finding of the scope
of any liability. This emphasises the need for clear communication by counsel to experts
(and by the tribunal to the parties and their experts) and the need for clear understanding
by the experts as to what this means for purposes of quantifying damages.
It is important for counsel and experts to consider how best to present the damages
assessment in a manner that enables the tribunal to understand the quantification associated
with particular claims or theories and to avoid double counting or inconsistent decisions
127
on liability and damages. For example, if a claimant alleges two separate grounds for breach
of contract, the experts must assess what damages if any arise from either or both, avoid
double counting and consider any interaction between the two. Sometimes separating the
bases for damages is straightforward. In other cases, it can be extremely complicated.
In most cases, it is counsel that instructs the experts in relation to the scope of their
expert reports. Counsel can also assist the damages experts in helping to ensure that the
expert reports are as easy to understand as possible. Counsel can provide useful input
on drafts to identify passages that may not be readily understood by tribunal members
who themselves are typically lawyers without technical backgrounds. Counsel also assist in
ensuring that the experts have access to the relevant facts, including documents and data,
on which to assess damages. This is often a collaborative process in which counsel provide
the expert with the information they have obtained and the experts identify additional
information that is necessary or useful in their assessments.
Experts, working with counsel, must communicate very complicated issues and seek to
do so in clear, simple terms. It is not an easy task. Given that expert reports often address
very complex topics, it can be helpful to move technical details to annexes, so that the
body of the reports focus on the key issues in dispute. In some cases, it may be appropri-
ate to consider the body of the expert report as being targeted at the tribunal, while the
annexes are targeted at the other side’s experts who are more interested in the details and
backup calculations.
Visuals, such as charts, figures and tables, are extremely helpful presentation tools for
damages issues both in the memorials and in the expert reports. Effective use of visuals
demonstrate the adage that a picture is worth a thousand words. Not only do they break up
dense text, but they can help lay readers understand technical issues. However, ineffective
visuals, such as charts or tables that are not explained well, can confuse the tribunal. And,
obviously, misleading visuals can readily undermine the parties’ case.Typically, counsel work
with the experts to propose various visuals that counsel believe would be useful to include
in the expert reports, which can then be duplicated in the memorials to explain and sup-
port the damages case.
Another effective tool for experts to use in their reports is to walk the tribunal through
the damages case in a table that sets forth the key steps in the quantification.
It is fairly standard practice that an expert must provide copies of all documents and
data on which he or she has relied. Experts should ordinarily identify the source of all data
used in a particular analysis, including citations to the record. Charts, figures and tables
should include precise identification of the source material, including where appropriate
annexes with the actual data, methodology and calculations used.
Damages models
One of the core functions of the damages expert is to develop an appropriate model to
calculate the damages.
Considerable thought must be given as to how simple or how complex the model
should be. There is no clear answer that applies to every case. A simple model can be easier
for a tribunal to understand, and it can be less costly and time-consuming for the expert to
develop and for the other side and the tribunal to assess. However, an overly simple model
may not be sufficiently realistic or accurate. A complex model may be more applicable to
128
the facts at issue and arrive at a more precise estimate of damages. However, an overly com-
plex model may be more likely to contain errors, create more grounds for disagreement on
less critical issues, be more costly to create and for the other side and the tribunal to assess,
and be less understandable to the tribunal. Often, the ideal model is a compromise between
simplicity and relevant detail that captures the key factors driving damages, without unnec-
essary complication that does not materially impact the results.
In some cases, issues regarding transparency arise when a damages expert seeks to use a
proprietary model to quantify damages. Some experts have created their own confidential
models that contain valuable work product. For example, the experts might rely on previ-
ously created models that they have refined over years of extensive (and expensive) market
research, for use in consulting engagements with companies in the relevant industry. Such
models could have significant value for other companies in the industry or other experts
who work in that industry.
In such cases, there may be tension between the willingness (or ability) of the expert
engaged by one party to disclose its model and the ability of the other party to defend
itself without access to the model. Ordinarily, experts are expected or required to disclose
the information on which they rely. That typically extends to the damages model used by
the expert. In cases where an expert seeks to rely on a model that it is not willing or able
to disclose, the tribunal ultimately may be called upon to decide how to address this ten-
sion. In some cases, limited disclosure to attorneys only may provide a viable alternative; in
other cases, even that may not be appropriate or possible, or such limited disclosure may
not be sufficient.
In a number of cases, one or both parties may seek to submit confidential documents,
data, or other information in support of their submissions. In such cases, the parties may
agree on confidentiality undertakings to protect the confidential nature of the information.
These undertakings can range from simple statements to detailed multi-page agreements.
In some cases, the permitted recipients of the confidential information can be restricted,
for example, to counsel and experts only, but there typically must be good reason for such
restrictions to be imposed. If a party seeks such restrictions, compromises may be possible
in which disclosure to certain designated individuals at the client is permissible, or perhaps
to non-commercial employees, such as in-house counsel. In rare instances, one of the par-
ties may seek to prevent disclosure to the damages expert engaged by the other side. This
can raise serious issues regarding equality of arms. Where the parties are unable to reach
agreement on the terms of the confidentiality undertakings and restrictions on disclosure,
the tribunal must resolve the differences. Negotiation of such undertakings can be time
consuming and costly, so it is important for the party seeking to impose such restrictions to
raise the issue as early as possible.
In some cases, damages models are so simple that they can be presented in the expert
report itself, either in the form of a table or annex. In many other cases, damages experts
create their models as spreadsheets in Microsoft Excel or similar software. This software
offers remarkable functionality to address the simplest to the most complicated models.
However, the sophistication of the software can result in spreadsheets that are virtually
indecipherable to non-experts. For example, numerous ‘commands’ available in the soft-
ware are not remotely self-explanatory and may conceal elaborate mathematical, logical,
statistical or financial functions. Other functions, called ‘look up’ or reference functions, can
129
be used to draw from data or calculations elsewhere in the spreadsheet or even from other
spreadsheets or databases. Experts are even able to create their own functions as ‘add-ins’,
which gives the software even greater functionality.
There are numerous ‘best practices’ that some advocate using in the creation of spread-
sheets, although these may not be necessary or appropriate in all circumstances.
Obviously, each tab, each column and each row should contain clear headings identify-
ing with appropriate precision the information contained therein. Moreover, the applicable
unit of the data must be clearly stated; for example, the relevant currency, whether the fig-
ures are set forth in ones, thousands or millions, or the relevant unit of measurement (e.g.,
kg, cubic metre, kWh).
One of the most common recommendations is that the spreadsheet should clearly dif-
ferentiate between the three key parts of the model: (1) the variable inputs, (2) the calcula-
tions and (3) the outputs. If the spreadsheet is designed with this structure, the hope is that
the model will be easier to understand. Some models even include tabs labelled as ‘Inputs’,
‘Calculations’ and ‘Outputs’ to help the reader navigate through the model.
Another recommendation is that the spreadsheet should start with an instruction or
cover page that provides an overview of how the model is structured and how the spread-
sheet flows from tab to tab.
In some instances, the inclusion of a ‘control panel’ that enables the user – including the
tribunal – to adjust inputs for key parameters can be extremely useful.This optional feature
is discussed further below.
If used appropriately, the use of colour-coding of rows, columns or cells can signifi-
cantly help the reader understand how the model works.
Consistency in the structure of the spreadsheet helps to maximise readability and mini-
mise errors. For example, using the same structure for similar tabs (such as consistent order-
ing of data into columns) and using the same formulae where possible can make it much
easier for the reader to understand the model.
One common recommendation is that all input data should include identification of
the precise source for the data. Accurate documentation of the input data can help oppos-
ing experts identify and resolve disagreements.
Presenting hard-coded data (i.e., the numerical results of calculations that are them-
selves not disclosed) is generally disfavoured absent some justification, as it prevents the
other side’s expert from understanding the underlying inputs or calculations used to derive
the hard-coded entries.
It can be extremely useful for the expert to include textual comments or explana-
tions throughout the spreadsheet to allow opposing experts and the tribunal to understand
the model.
Many recommend that calculations proceed step-by-step across multiple cells, rather
than the use of multiple calculations per cell.This simplification of the calculations, together
with clear headings and appropriate comments, can go a long way toward simplifying the
spreadsheet and enabling the reader to understand how the model works.
Whether explained in the spreadsheet itself or in the accompanying expert report, the
expert should indicate if the input data has been adjusted, corrected, cleaned of outliers
or typos, etc. The expert should also explain the basis for any such adjustments and, where
appropriate, identify what changes were made to which data.
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It is often useful for the expert to include cross-checks in the spreadsheet that automati-
cally flag any errors and allow the reader to check the entry of data or the calculations for
accuracy or to check that the output is realistic.
Another common recommendation is that the spreadsheet should, if possible, be audited
by a separate team from the one that created it.
Many other ‘best practices’ on various technical issues regarding the creation of spread-
sheets are frequently recommended to guide experts in developing effective models while
minimising errors.
Although these best practices can help make a spreadsheet easier to understand, imple-
menting them is not always easy and is far from cost-free. Many of these recommendations
can take considerable additional time to implement, which is not always available and can
distract the experts from other tasks and lead to a significant increase in expert fees.
Moreover, it is worth emphasising that many experts have no formal training in Excel,
and some of the best experts or most accurate models may not follow these practices. To
take the most basic example, simple models may not need any of these ‘bells and whistles,’ as
some may call them. However, the more complicated the model, or the larger the amount
in dispute, the more likely it is that some of these recommendations may be advisable and
cost-effective.
Control panels on spreadsheets

One option that can be extremely helpful for the tribunal is for one or both experts
to prepare an interactive model that is set up with a ‘control panel’ tab in the spread-
sheet that enables the user to adjust the input variables. The ‘control panel’ tab typically
includes pull-down options (or ‘radio buttons’ or ‘check boxes’) for various inputs, or, if
the expert wants to provide even more flexibility, the user may have the ability to enter
a specific number. After the user selects all of the required options, the spreadsheet then
calculates damages on the basis of the user-selected input variables. Typically, the ‘control
panel’ includes a summary table of the key components of the damages calculations, which
are updated instantaneously as the user selects different options from the pull-down menus.
The benefit of the ‘control panel’ is that it allows the user to explore the impact on
damages of variations in the input variables – without requiring the user to understand all
(or indeed any) of the calculations in the spreadsheet.The user can also vary the input vari-
ables without fear of making mistakes or destroying the model. The ‘control panel’ is very
user-friendly and can be greatly welcomed by the tribunal.
As a basic example, the ‘control panel’ might include a pull-down option for the user
to select either simple or compound interest. If the user selects compound interest, another
option is enabled, requiring the user to select the compounding period: annual, quarterly,
daily. Another pull-down menu might ask the user to select among certain interest rates,
such as the rate proposed by the claimant and the rate proposed by the respondent. Or, the
expert could enable the user to choose among a longer list of options, including LIBOR +
1 per cent, LIBOR + 2 per cent, Prime + 1 per cent and Prime + 2 per cent. If the expert
wants to provide the user with more flexibility, the ‘control panel’ could include a box in
which the user can enter any interest rate. Or, the expert could enable the user to enter any
interest rate within a certain range of realistic options.The ‘control panel’ could also enable
the user to select start and end dates for the accrual of interest.
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As another basic example, if the damages calculation requires the valuation of a com-
pany using a discounted cash flow (DCF) model, the expert could design the ‘control panel’
to include pull-down options for such input variables as the valuation date, the weighted
average cost of capital (WACC), the cash flow assumptions (e.g., claimant’s or respondent’s)
or the growth rate.
A ‘control panel’ can also include a pull-down menu to select the input data that the
model uses (e.g., claimant’s proposed data or respondent’s proposed data).
The degree of functionality that the expert offers to the user in the ‘control panel’ can
vary tremendously. For example, the expert can set up the ‘control panel’ so that certain
options are disabled or ‘greyed out’ if the user selects another incompatible option. In the
context of the interest rate example above, the expert would likely set up the ‘control panel’
so that the compounding period pull-down is disabled if the user has already selected sim-
ple interest (because no compounding period is relevant).
A ‘control panel’ can also include scenario options. The expert can include a selection
of pre-packaged scenarios that the user can choose from a pull-down menu, such as the
claimant’s position on all of the input variables or the respondent’s position. Numerous
other scenarios are possible. Depending on the design of the spreadsheet, the expert could
also enable the user to vary specific input variables after selecting a scenario option.
The ‘control panel’ might also include a reset button, enabling the user to return to the
default scenario at any time.
The expert can also provide error messages or comments if certain inputs are selected.
So, if the user entered a start date for the accrual of interest that pre-dated the date of the
breach, the spreadsheet could be set up to display an error message explaining why the
input value is not possible.
A ‘control panel’ can even be set up to track an agreed list of issues in dispute prepared
by the parties. For each issue on the list, the ‘control panel’ of the spreadsheet can set forth
the various options available to the tribunal for each issue in dispute (whether through a
pull-down menu or the ability to enter a specific number within a particular range). After
the tribunal has deliberated and decided on how it will decide each of the issues in dispute,
it can enter its determinations into the ‘control panel’ and immediately see the resulting
damages calculation.
Joint models
In some cases, the parties or the tribunal may explore the possibility of the damages experts
submitting a joint report. The idea behind a joint report is to identify areas of agreement
and disagreement and, if possible, to encourage the experts to reach agreement on the
model that they use. Sometimes the tribunal might request the parties to instruct their
experts to work on preparing a joint model that offers certain functionality for the tribunal
to facilitate its calculation of damages.
Again, this may raise significant questions regarding costs and potential delays.
Obviously, a joint model is not always possible or worthwhile to pursue. For example,
in some cases, the damages experts may have created two entirely different models. The
structure of the two models may be so different that there are not easy ways for one expert
to adapt its model to accommodate different assumptions by the other side’s expert. If the
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experts were instructed to prepare a joint model, in such a case, it might merely consist of
copying the two distinct models into one spreadsheet.
However, even that may be of some benefit to the tribunal in some cases. Among other
things, it might enable the tribunal to more easily compare the two models, particularly
if there is a joint ‘control panel’ tab that allows the tribunal to calculate damages under
both models based on the same key input variables. It can also be useful to determine why
the different models reach different conclusions. The key differences may be identified
more easily.
Resolving differences between the parties’ damages experts

One of the most difficult aspects of damages disputes is to identify, understand and resolve
the differences between the experts. The resolution of these differences is ultimately the
responsibility of the tribunal tasked with rendering an award resolving the dispute before
it. However, the parties – through their counsel and experts – can play an important role
in assisting the tribunal in this regard. There are a number of techniques that can assist the
tribunal, but first it is necessary to understand the scope of potential differences between
the experts.
Understanding the assumptions and methodologies

The different assumptions that experts make can lead to differences in the way the experts
construct their models and in the inputs that experts enter into their models, resulting in
different outputs and therefore different damages calculations. Experts may make different
assumptions for any number of reasons, including:
• education or training;
• experience on other matters;
• lack of experience on similar matters;
• communications with the client or counsel about facts and law;
• formal instructions received from counsel;
• understanding of the applicable contracts, treaties, or other legal instruments based on
commercial or other experience of the experts;
• review of documents, data, or other evidence formally introduced in the case (such as
witness statements);
• review of documents, data, or other evidence provided by the client or counsel but not
submitted in the case; and
• review of publications or documents obtained elsewhere.
Frequently, experts make assumptions that are not stated.Their silence can be intentional or
inadvertent. Indeed, in some instances, experts may not even realise they are making certain
assumptions that may prove to be unfounded or, at a minimum, subject to disagreement.
For example, an expert may assume a certain fact as a given based on discussions with the
client or counsel, yet the other expert has assumed a different possibility. These differences
can often be difficult to identify as they are not explained in the expert reports and can
often only be ascertained upon close examination of the damages model. Such details can
be buried deep in an Excel spreadsheet, particularly if it is not designed consistent with
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best practices.This is why experts are encouraged to state all assumptions in their reports to
minimise the risk of such unstated assumptions.
In addition to different assumptions, experts frequently disagree on the methodologies
they employ. Experts may disagree on the appropriate methodology for many of the same
reasons identified above based on their experience, communications with or instructions
from the client, and understanding of the applicable law and facts. The experts may also
disagree on the level of simplification or complexity appropriate in the model.
At its most basic, the experts may disagree on the applicable methodology because they
are seeking to answer different questions. It is therefore important to confirm whether the
experts are assessing damage to the same thing (such as the whole company, a specific busi-
ness unit or particular assets), whether they are assuming the same key dates (such as date
of breach or valuation date) and whether they are on the same page in other key respects.
Key differences between the experts

Experts can and do disagree on any number of issues.To give a few examples, experts often
disagree about:
• the timing of key events, the duration of the events causing the damage and whether
the damage is ongoing or temporary;
• the assumptions underlying the ‘but-for’ scenario – what would have happened absent
the damaging conduct;
• estimates of future cash flows or growth rates;
• the appropriate discount rate;
• whether to rely on information or data after a certain date (such as the valuation date)
and if so what weight to give that information;
• the appropriate statistical approaches, including such basic issues as the use of the arith-
metic mean or the median;
• the level of statistical significance appropriate for the analysis;
• the appropriateness of various benchmarks or comparators and whether adjustments
should be made to benchmarked data and, if so, which ones;
• the applicability of interest and how it should be calculated;
• the proper treatment of currency conversion issues; and
• the proper treatment of tax issues.
The importance of accurate, robust data

Another area for significant disagreement between the experts can be the underlying data
that they input into the damages model. In some instances, it is relatively easy to deter-
mine whether the experts are using the same data. In other instances, that requires fur-
ther investigation.
Another area for disagreement between the experts is the extent to which the data must
be cleaned or corrected before being entered into the model. Many are familiar with the
acronym GIGO, meaning Garbage In, Garbage Out. If the input data is not accurate, the
output will not be meaningful, regardless of the sophistication of the model.
To take an example, assume that the input data consists of sales data from the company
or from some third party (e.g., aggregate data collected by a government statistical agency
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or a third-party commercial vendor). If the data has not been assessed for the inclusion of
possible errors, the model may produce distorted, or even nonsensical, output.
Experts must assess whether the input data needs to be cleaned of errors, outliers,
impossible or unrealistic data, etc.The question then turns to how best to determine which
data points are errors or outliers. Errors or outliers can be identified manually, through
sampling, or through different methods, and the most appropriate method must be assessed
in the circumstances. This depends on the exercise of judgement by the experts, who may
disagree on the need to remove or adjust data points and the proper method for identify-
ing them. Moreover, experts can disagree on what to do with the data points identified.
For example, should the outliers be removed from the data set or corrected? To identify
any such differences between the experts in their approaches to the underlying data, it is
important for each expert to indicate clearly in the expert reports what steps have been
taken in this regard and to explain the reasons and process undertaken.
A related issue is the extent to which the experts agree on the appropriateness of mak-
ing adjustments to certain data, such as comparative benchmarks, to account for differences
between the target and the comparators. The appropriateness of such adjustments and the
specific adjustments to be made again require judgement on the part of the experts. In any
event, it is important for the experts to identify any such adjustments made and provide
explanations of the reasons for them in the export reports.
Procedures and techniques to assist in understanding the experts’ analysis

There are numerous procedures and techniques, some of which are discussed below, that
can assist the tribunal in understanding and resolving the disagreements between the dam-
ages experts. Many are directed at understanding how the experts’ analysis would change
using other data or assumptions (such as data or assumptions relied on by the other expert
or as instructed by the tribunal). Of course, a well-designed damages model (perhaps
including a ‘control panel’) in conjunction with a clear expert report persuasively explain-
ing that model and the reasons for the expert’s disagreement with the other expert may be
the most effective technique.
Sensitivity analysis
A common technique that can be used to demonstrate the impact of certain variables on
the damages calculation is sensitivity analysis. Put simply, sensitivity analysis can show the
impact on damages (or even the impact on a specific component of the model) based on
the increase or decrease of an input variable by certain percentages or absolute values. The
approach offers several potential benefits.
First, as its name suggests, sensitivity analysis is used to demonstrate the sensitivity of
the model to variations in a key input.This helps to demonstrate which inputs are the most
important drivers in the model and which are not. This can be extremely useful to enable
the experts – and ultimately the tribunal – to focus on the key input variables that truly
matter for the damages calculation. It may well be that the experts disagree on any number
of input variables in the model, but not all are equally important to the damages calcula-
tion. Some may simply have no material impact and can, in appropriate circumstances, be
disregarded or at least given less attention than the key input variables. Of course, if the
experts disagree about a number of less significant input variables, the collective impact of
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those variables can matter greatly. And of course there can be disagreements between the
parties and experts as to what significant or material really means. That can depend on the
amount in dispute: a $1 million variation in damages could be material in a smaller dispute
but would be far less determinative in a billion-dollar dispute.
Second, sensitivity analysis can help to demonstrate the numerical range of possible
outcomes (e.g., minimum and maximum values) based on reasonable variation of the par-
ticular input variable. Identifying this range can assist in narrowing the scope of the disa-
greements between the experts.
Third, sensitivity analysis can be used as an effective presentation tool to readily display
the various damages calculations based on the specific values of the input variable that have
been proposed.
A sensitivity analysis can often be presented effectively in a table in the expert report
with the options for the input variable set forth in the first column and the corresponding
damages calculations set forth in the second column. The results of a sensitivity analysis
can also be presented in a chart depicting the line or curve representing the relationship
between the input variable and the damages calculation, with the input variable depicted
on the x-axis and the resulting damages figures displayed on the y-axis. The more sensitive
damages are to the input variable, the steeper the line will be.
Fourth, sensitivity analysis can be used to identify potential flaws in the model where
the output is unrealistic based on a reasonable variation in the input variable.
One common use of sensitivity analysis is to show the extent to which a DCF anal-
ysis varies depending on the discount rate (i.e., the WACC used). An expert can use
sensitivity analysis to demonstrate that increasing or decreasing the WACC can have a
multimillion-dollar impact on the damages calculation, with specific calculations for
each option.
There are many other input variables that can be assessed using sensitivity analysis,
including the applicable interest rate, the growth rate, such as the terminal growth rate of
a DCF model, profit margins, tax rates and many other inputs on which the experts might
disagree. However, attention must be paid to whether the variables are interrelated.
It is also possible to present the results of more complex sensitivity analyses in a matrix
displaying the possible variations of the first input across the columns and the possible vari-
ations of the second input across the rows.
Of course, like most techniques, sensitivity analysis is subject to limitations and can be
misused or ineffectively deployed. The variations in the input variable must be reasonable
for the outcome of the sensitivity analysis to have meaning. In some cases, parties or experts
will include a sensitivity analysis with extreme or unlikely examples meant to convey the
impression that the model is more sensitive to variation in output than it really is when
reasonable variations in the inputs are used. Or, conversely, parties or experts will present
sensitivity analysis with unrealistically narrow variation in the input variable in an effort to
convey the opposite impression.
Sometimes, parties or experts may structure the sensitivity analysis to leave the impres-
sion with the tribunal that the midpoint of the range is the most reasonable, but this depends
on whether the variation in the input variable is equally reasonable in both directions.
A potentially useful variation is scenario analysis in which scenarios that vary multiple
input variables as a package are analysed and compared. For example, one type of scenario
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analysis would be to present the best case, worst case and most likely case. It is also possible
to assign probabilities to each scenario and to weight the outcomes to present a weighted
damages calculation based on all of the scenarios considered. Again, however, such analyses
have limitations.
There are other related, far more complicated analyses beyond the scope of this chapter
that can be used to study the model.
Pre-hearing meetings of experts

Another procedural technique that is often considered is a pre-hearing meeting between
both experts. Although not appropriate in all arbitrations, the idea is that such meetings
may facilitate the identification of areas of disagreement that can be narrowed through
more informal discussions or areas of agreement that have not been clearly identified or
realised. Prior to any such meetings, the experts’ communication will likely have been lim-
ited to the exchange of written expert reports, and they may feel like they are ‘writing’ past
each other. Sitting down together in an effort to identify and understand the basis for any
disagreements may prove to be extremely valuable.
If such a meeting is agreed by the parties or directed by the tribunal, it is important
to arrange the procedure in advance so both experts – and the parties and their counsel –
have a common understanding of how the meeting will occur. Advance preparation can
also maximise the likelihood that the meeting is productive. When to schedule the meet-
ing, or indeed how many meetings to arrange, are important first steps that depend on the
circumstances of the case.
Frequently, the parties agree or the tribunal directs that such meetings will occur on
a without prejudice basis, with the objective to foster open discussion. However, it is not
uncommon for such meetings to be viewed as an unwanted exercise by some and a distrac-
tion from more pressing demands, such as hearing preparation if the meetings are scheduled
to follow closely thereafter.
Often, the question arises whether the experts should meet with or without the pres-
ence of counsel. There are pros and cons to both approaches, but in either case the role of
the expert and the purpose of the meeting must be clearly defined and clearly understood.
Experts are not authorised by the clients that have engaged them to settle aspects of the
dispute or to make binding commitments; rather, the experts have been engaged to assist
the parties and the tribunal in understanding the damages aspects of the case. They cannot
formally resolve the issues on behalf of the parties because they do not represent the parties
in that capacity.
Experts do not run cases on behalf of the clients that engaged them, nor do they nec-
essarily know all aspects of the case. Often, experts have limited roles or roles that do not
perfectly correspond with that of their colleagues.
There are often reasons why the parties and their counsel favour the presence of coun-
sel at the expert meetings to understand the issues being discussed and how they impact
the case and to offer guidance on the relevance of legal or factual issues that the experts
may not know. It is often true that the experts themselves prefer counsel to attend as well,
particularly if they are unfamiliar with the process or uncertain about their roles.
There can be further complications with arranging a joint meeting of the experts in
cases in which there are multiple experts for one or both parties and the experts do not
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necessarily line up on similar issues. One possible solution is to arrange for all of the experts
to attend, but such meetings can become more burdensome, costly and less efficient.
List of agreed/disagreed points

Building on the idea behind pre-hearing meetings of the experts is the related procedural
technique of asking or directing the experts to prepare a list of the key points on which
they agree or disagree. As with pre-hearing meetings, there are differing views among par-
ties, counsel and experts as to the benefits of such a task. For some, the feeling is that the
experts have expressed their opinions in their written submissions, and it is unreasonable to
expect the experts to change these opinions simply by working with their counterparty to
prepare a list of agreed/disagreed points.
Before determining whether such steps are likely to be productive, it is important to
consider the time and cost of pre-hearing meetings or lists of agreed/disagreed points. As
noted, these steps may significantly distract the experts from other responsibilities, includ-
ing preparation for the hearing.
These techniques can be effective if the parties, their counsel, and experts believe that
there is likely to be room for further agreement on key issues or if the scope of disagreement
is not yet clearly identified in the expert reports. In contrast, in cases where the experts are
far apart or have radically different approaches, these techniques may be distractions.
Too often, the experts are so far apart on their positions that the experts end up listing
issues of secondary or tertiary importance simply to find some room for agreement. The
exercise can risk losing its purpose in such circumstances.
Joint reports
Taking the idea of joint lists one step further, in some cases, tribunals have proposed the
possibility of a joint report prepared by both experts. In some instances, the joint report
would be submitted prior to the hearing; in others, it would be submitted after the hearing.
The primary objective in both situations is to encourage or enable the experts to narrow
the scope of disagreements.
The considerations to take into account before proposing a joint report are similar to
those discussed above, with the added concern that a joint report is likely to add signifi-
cantly to costs and delay.
Expert presentations
An effective procedural technique that is used in many cases is the submission of expert
presentations at or before the hearing. These expert presentations are often prepared as
Microsoft PowerPoint slide packs, which are presented orally at the hearing in lieu of direct
examination. The key benefit of expert presentations following the exchange of expert
reports is that each expert can summarise his or her expert opinion on damages issues and
highlight the areas of agreement and disagreement from his or her perspective. It is often
critical to allow experts to summarise their key positions and update the tribunal on devel-
opments at the time of the hearing.
If such presentations are to be made, it is important to reach agreement on the pro-
cedures in advance. For example, questions arise as to when the experts should submit
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written copies of the slide packs – at the hearing or in advance – and whether such presen-
tations should be exchanged simultaneously. Other issues to consider are whether to restrict
the time allowed for oral presentation. Often, these issues are left to the parties to allocate
their time as they best see fit, taking into account guidance from the tribunal about what it
would find most beneficial from its perspective.
Most parties, counsel, and experts believe that expert presentations are time well spent.
They offer the experts an ability to present often very complex concepts with the support
of visuals such as charts, figures, tables, and occasionally even the spreadsheets themselves in
which they have created their models. For example, in some cases, it is extremely useful to
have each expert walk through the organisation and functionality of its model.
Typically, the tribunal is encouraged to ask questions during the oral presentations, but
counsel and experts are not. Rather, counsel typically are expected to save questions for
cross-examination, and experts are expected to wait until expert conferencing, if agreed.
Expert conferencing
It has become increasingly common for the parties to agree or for the tribunal to direct that
the experts appear before the tribunal for questioning simultaneously, a technique generally
referred to as expert conferencing and colloquially called ‘hot tubbing’. The objective is to
provide an opportunity for the tribunal to hear from both experts at the same time, where
the tribunal members and counsel can ask both experts questions and allow the experts to
respond and react to each other.
Again, if expert conferencing is agreed, it is important to establish the specific pro-
cedures in advance. This includes agreement on the order of expert conferencing at the
hearing. Typically, expert conferencing is scheduled to occur after expert presentations
and cross-examination by counsel have occurred. The idea is that differences between the
experts’ positions will be clearer and more defined following cross-examination. Agreement
should also be reached on how much time to devote to expert conferencing and how that
time will be allocated between the parties. Typically, it is allocated equally to both parties.
Other procedural issues to consider are whether the tribunal intends to identify in
advance the areas of discussion that it expects the experts to discuss and whether expert
conferencing will proceed topic-by-topic or all topics at once. It is often useful for the
tribunal to prepare a list of questions in advance and, in some cases, useful to provide the
list to the experts in advance. In addition, it is important to determine who is permitted to
ask questions during expert conferencing: the tribunal members or counsel for the parties,
or both.
If expert conferencing is arranged, it almost always should be in addition to expert
presentations, where appropriate, and cross-examination by counsel. Expert conferencing
is intended to achieve different objectives than presentations and cross-examination and
should not be used be in lieu of the right of the parties to present their case through experts
and to cross-examine the expert engaged by the other side.
As with pre-hearing meetings of experts, it is not always clear which experts line
up on similar issues, further complicating the procedure. If there are multiple experts
on one or both sides, expert conferencing with all experts heard simultaneously could
become unwieldy.
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Tribunal-appointed experts
Another procedural technique that some tribunals consider is whether to engage a
tribunal-appointed expert to assist the tribunal in resolving disagreements between the
party-appointed experts. Given the significant expense and delays that this can create, care-
ful consideration should be given to the likely advantages and disadvantages.
Parties, counsel and party-appointed experts often have significant reservations about
the utility of a tribunal-appointed expert. These may include concerns regarding how
much influence the tribunal-appointed expert may wield in resolving damages issues. It is
important that the tribunal, appointed by the parties pursuant to the agreed appointment
procedure, resolves the parties’ dispute and not a tribunal-appointed expert.
There are also often significant concerns on the part of parties about whether the tri-
bunal has identified the right expert for the dispute. Concerns have been raised by parties
that the tribunal’s selection of the tribunal-appointed expert may inadvertently dictate the
outcome, for example, if the expert holds certain views (e.g., majority or minority’s views)
on the key damages issues in dispute.
The role of the tribunal-appointed expert should be clearly defined in advance. The
tribunal-appointed expert might be engaged to produce a report commenting on the posi-
tions taken by the party-appointed experts (i.e., a third view on the damages issues in dis-
pute). In some cases, tribunals have engaged tribunal-appointed experts solely for purposes
of implementing the tribunal’s decision to ensure that it has properly applied the model in
light of the tribunal’s conclusions.
The process must be clearly defined, including what information will be provided to
the tribunal-appointed expert, what opportunity the tribunal-appointed expert will have
to request further information, what timetable the tribunal-appointed expert will operate
on and whether the tribunal-appointed expert can communicate privately with the tribu-
nal. The precise terms of the tribunal-appointed expert’s instructions should be discussed
and agreed in advance.
The parties must have an opportunity to provide comments on the proposed expert
before appointment, after being provided with background materials setting forth the pro-
posed expert’s education, expertise, and experience and other relevant disclosures, includ-
ing a statement of independence and impartiality.
If a tribunal-appointed expert is engaged, the parties must also have a full opportunity
to be heard. That includes allowing the parties and their experts to respond to any expert
report submitted by the tribunal-appointed expert. That also includes allowing the par-
ties to cross-examine the tribunal-appointed expert at the hearing. That may also extend
to permitting the party-appointed experts to ask the tribunal-appointed expert ques-
tions. The party-appointed experts should also have the opportunity to comment on the
tribunal-appointed expert’s work at the hearing. It may also include the involvement of the
tribunal-appointed expert in expert conferencing at the hearing.
On a related point, some have raised the question whether a tribunal can appoint an
administrative secretary for quantum issues, with the individual having relevant quantitative
skills.This may raise some of the same issues discussed above. Moreover, this raises concerns
about the proper role of a tribunal secretary, who is supposed to be administrative in func-
tion, and whether the secretary is delegated with decision-making power on a de facto basis.
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Another related technique would be for the tribunal itself to engage with its own
damages model. This can have significant negative consequences for one or both parties.
The model can be flawed – ranging from simple mathematical errors with significant con-
sequences to fundamental errors in the methodology employed. The assumptions can be
flawed or incompatible with the model.The model or the assumptions can be incompatible
with the commercial relationship between the parties.
To the extent the tribunal seeks to pursue its own model, it is critical that the parties
and experts have the opportunity to review and comment.
Conclusion
In order to maximise the effectiveness of expert assistance on damages issues, the parties
and the tribunal can consider a wide variety of techniques and approaches. The potential
benefits should be weighed against the potential costs, delays and distractions. Advance
planning and discussion of the procedures is important to reach agreement on which are
best suited for the particular arbitration and how they will be applied.When used appropri-
ately, these techniques and procedures can help the tribunal understand the parties’ respec-
tive damages cases and resolve the parties’ differences in a fundamentally sound manner,
while reducing the risk of conceptual, computational or other errors in the ultimate award.
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Part III
Approaches and Methods for the Assessment
and Quantification of Damages
9
Overview of Damages and Accounting Basics
Gervase MacGregor, Andrew Maclay and David Mitchell1
Introduction
In this chapter, we set out an overview of how damages are calculated in international
arbitration, and we include an explanation of some of the fundamentals of accounting on
which the damages calculation is necessarily based. Unlike law, which may fundamentally
differ between jurisdictions, accounting and damages are based on accounting and eco-
nomic concepts that are common to all jurisdictions – although any damages calculation
for any particular arbitration dispute will need to be rooted in the legal principles of the
law that governs that arbitration.
Accounting basics
Double-entry book-keeping
A fundamental building block of accountancy is the principle of double-entry book-keeping.
This means that every accounting transaction that is recorded in a set of company accounts
is effectively entered twice; this helps ensure that the accounts include all the company’s
transactions and are free from input errors (although the accounts may still include errors
or fraud, where the transactions have been recorded wrongly). For example, if a company
is recording all the payments from a set of bank statements in its accounts, it will record
all these payments as debits to various accounts, such as purchases of raw materials or pur-
chases of machinery, and it will also record all the payments as credits to the bank account
(i.e., reductions in the bank balance – for an accountant, a credit to the bank account is a
reduction, while a debit is an increase).
1 Gervase MacGregor is head of forensic services, Andrew Maclay is a forensic accountant and David Mitchell is
head of the valuations team at BDO LLP.
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The development of computerised enterprise systems means that double-entry is often

hidden from view. But it remains the key structure in accounting and explains why bal-
ance sheets balance and the components of a set of financial statements reconcile with
each other.
A company normally prepares its accounts on an annual basis by extracting a trial bal-
ance from its accounting system and turning this into a set of financial statements. The
trial balance lists the total value of items debited or credited to each particular accounting
category in the year; so, for example, it will include the total of purchases of raw materials,
the total of salaries and other employee benefits, the total of entertaining costs, the total of
purchases of fixed assets and so forth.
Financial statements
From the trial balance, a company prepares its financial statements, which comprise a profit
and loss account, balance sheet, cash flow statement and explanatory notes. The profit and
loss account records the company’s income and expenses, together with certain account-
ing adjustments, such as depreciation, to arrive at the profit or loss after tax for the year.
The cash flow statement also records the company’s transactions for the year, but on the
basis of the money flowing into and out of the company, showing, for example, how the
company has financed its purchases by way of loans or net reduction in its bank balances.
The balance sheet summarises the state of the company at the end of the year, showing
its assets and liabilities, with double-entry book-keeping recording the overall balance as
accumulated profit or loss. The financial statements also include a large number of pages of
notes, which include details of the accounting policies adopted by the company and more
detailed explanations of many of the summary items included in the profit and loss account
and balance sheet.
An important page in the financial statements is the audit report. Most large companies
have to have their accounts audited by a qualified firm of auditors, who review all the com-
pany’s accounting transactions and financial statements on a sample basis, and conclude on
whether or not the financial statements show a true and fair view of the company’s trans-
actions in the year and comply with accounting standards and include all the disclosures
the financial statements are required to include. Audit reports are prepared on a formulaic
basis, whereby the auditors note any exceptions from a ‘clean’ audit report in their report;
consequently, lawyers and other users of financial statements are well advised to consider
carefully the implications of a qualified audit report on the financial statements of any
company they are reviewing.
IFRS
To ensure adherence to accounting principles and to ensure reasonable consistency
between different companies, accountants have developed standard ways of accounting
for specific items. Thus, large international companies are often obliged to prepare their
accounts in accordance with International Financial Reporting Standards (IFRS).2 IFRS
2 Not all companies prepare their accounts in accordance with IFRS. For example, US companies normally
prepare their accounts in accordance with US GAAP, and smaller UK companies may use UK GAAP. There
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sets out standard ways of accounting for particular transactions, such as revenue, fixed assets
and depreciation.
In this short introduction, we will not comment on how accountants account for every
type of transaction under IFRS, but we will briefly comment on a few types of transaction
that often arise in international arbitration cases:
• The accruals concept – accountants record income and expenses on the basis of the
accounting period that is affected by the income or expense. For example, for a company
with a calendar-year accounting period, a payment of 12 months rent in September
will be recorded as four months in the period up to December and eight months in the
following period.
• Revenue – sales are generally recorded at the value received by the company, but IFRS
includes a number of detailed rules, for example, in relation to recording transactions at
‘fair value’, recording revenue on long-term contracts and recording transactions in the
correct period.
• Depreciation – this is a very important accounting concept whereby tangible (e.g., land,
buildings, machinery) and intangible (e.g., IP, patents, goodwill) assets are recorded at
cost or ‘fair value’ in the balance sheet, but are then depreciated over their useful lives.
For example, if a piece of machinery has an estimated life of 10 years, depreciation at
10 per cent of its value is charged as a cost in the profit and loss account each year.
• Impairment – companies are required to test their cash-generating units to ensure that
they remain worth at least the value at which they are recorded in the financial state-
ments. Thus, for example, if a company has overpaid for an asset, it should then record
an impairment provision against the cost of the asset.
• Contingent liabilities – companies are required to recognise a liability when it is likely
that they will be required to make a payment in respect of the item in the future.When
there is less likelihood of having to make a payment or it is not possible to calculate
the amount of such a future payment, the company records a contingent liability in the
notes to the accounts, but does not record the amount as an expense.
• Related-party transactions – companies are required to list transactions with related par-
ties in their financial statements. The related party note can be a useful place to under-
stand the relationship between entities that appear to be under common ownership.
Flexibility, consistency and estimates

Preparers of financial statements often face a choice of ways of applying accounting poli-
cies; for example, the depreciation rate. Indeed, one of the challenging areas of interpreting
accounting information is the fact that one is often choosing between two or more reason-
able treatments. Within this flexibility, there is the need for preparers to be consistent in
their treatment from year to year.
The very nature of business means that preparers are faced with uncertainty, meaning
that estimates must be made. The word ‘reasonable’ is a key adjective in accounting; the use
of judgement is a key task.
are differences in how certain transactions have to be recorded between these different accounting standards –
and these differences may have a material effect on the financial statements.
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And within all of this, one must not forget the ‘dark side’ of accounting: the aggressive
accounting policies in areas like income recognition, provisions and impairment – indeed,
all areas where one is faced with choice, has to use judgement and can push reasonableness
to the limits and beyond.
It is worth bearing all of this in mind in relation to damages claims, because accounts
are the building blocks of quantum.
Basic principles of damages – loss of profit

If an entity has suffered damages, but still continues in operation, the goal of a damages
award is to put the claimant back into the position in which it would have been, had the
company not suffered the damage; for example, if a contract had not been breached. On
this basis, forensic accountants, valuers and economists have developed the ‘but-for’ prin-
ciple as the basis for calculating damages, whereby damages are based on the difference
between what would have happened ‘but for’ the breach of contract or other intervening
event and what actually happened.
The second limb is normally relatively straightforward; for example, the profit the
claimant actually made. What is more difficult is calculating what would have happened if
the contract had not been breached – i.e., the but-for scenario.
The but-for scenario needs to be realistic, and one needs to remember that the calcula-
tion can only ever be an estimate – because nobody can ever actually know with complete
certainty what would have happened in an alternative universe in which the breach of
contract, or treaty, never occurred. The but-for scenario also needs to be possible (e.g., it
takes into account the production capacity of the company’s factory). The following graph
illustrates the basic calculation of economic damages:
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The damages suffered by a claimant in a commercial arbitration are likely to be based

on the profits that it would have earned, had the breach of contract not occurred, but
which it did not actually earn. While in theory one can simply estimate the profits in a
but-for scenario, the calculation is likely to be more accurate if the loss of profit is broken
down into its constituent parts, which are:
• loss of gross revenue;
• gross profit margin, as a percentage;
• variable overheads; and
• fixed overheads.
The damages expert tends to estimate the loss of future revenue of a business as a separate
exercise – this is often the parameter that drives profitability, and it may also be the most
difficult and subjective number to estimate. On the other hand, many companies’ gross
profit margins remain reasonably constant as a percentage of sales, and this constant margin
may be reflected in the company’s budgets – so in many cases it may be fairly uncontro-
versial to assume that the gross profit margin in the future will be the same as in the past.
Overhead costs are the costs a company incurs that are not directly related to produc-
ing its output for sale. When calculating overheads, it is important to distinguish between
variable overheads that are linked to sales (such as transport and distribution costs) and fixed
overheads that remain the same regardless of the level of sales (such as general and admin-
istrative costs). Variable costs need to be deducted in calculating the future loss of profits,
whereas fixed costs may not change at all whether the company is selling anything or not,
and so they are generally not deducted in a loss of profits calculation.
Estimating what would have happened in the future but for…

The most important part of a damages calculation is estimating what would have happened
had the breach not occurred. There are three commonly used ways of doing this:
• The company’s own forecast. If the company had its own forecast of the future profits
it expected to make, this may be the best data to use to estimate what would have hap-
pened, but for the breach. However, before relying on a forecast, one needs to consider
the purpose for which it was prepared, and how accurate it is likely to be. If the forecast
was prepared for the company’s bank, which had carried out due diligence and lent the
claimant money based on this forecast, and if the company’s actual results over the past
five years have always been within 5 per cent of its forecasts, then one could feel reason-
ably confident in relying on the forecast. If, on the other hand, the company’s forecast
was limited to a single sheet of paper prepared by the directors after the breach of
contract occurred, and it had never actually achieved its budget in the past, one would
not feel confident in relying on the forecast without first determining whether serious
adjustments must be made to it.
• Extrapolating from the past to the future. Where a company has been operating for
many years, and has a track record of always achieving a certain level of sales and profit,
and where profits have grown consistently at, say, 5 per cent per year, the best estimate
of future profits may be an extrapolation of past profits. This may be based on profes-
sional judgement, or it may be based on a statistical regression line, which estimates the
future based on the past.
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• Comparison with what actually happened to a similar company or store. If one can find
a similar company operating in the same field, and one can see that the claimant’s results
have been closely correlated with the results of that company in the past, the best way
of estimating what would have happened may be to consider what actually happened
to the comparator company.
Frequently arising issues

Having set out the basic principles of how damages are calculated, some issues that fre-
quently arise in arbitration include the following:
• Lack of trading history – the claimant may have no history of trading. Many claims
arise very early on in a project life cycle, for example, because one party terminated the
contract while the factory was still being built and before it ever started trading. If the
future cash flows can be estimated reasonably reliably, damages can be calculated on the
basis of the net present value model, following which, the value of a project is equal to
the cash flows expected over the project’s life, discounted by an appropriate discount
rate.3 However, if the future profits cannot be estimated reliably, the only fair basis for
damages may be the amount of costs the claimant has actually incurred.4
• How long should one claim for? – If the company has been driven out of business and
has gone into liquidation, normal practice is for the claim to be based on the ‘valuation’
model discussed below. However, if the claim is based on the company using the dam-
ages recovered from the respondent to recapitalise its business and start trading again,
a key question is how long that will take, and what resources it will require for the
company to ramp its business back up to its previous level of operations.
• The use of hindsight – a key legal question is whether or not one should take account
of hindsight in calculating damages. This may depend on the jurisdiction of the claim
– for example, the traditional position in English law was that damages for breach of
contract were evaluated at the date of the claim, but this has been modified by the case
of Golden Strait Corporation v. Nippon Yusen Kubishika Kaisha [2007] UKHL 12 (known
as the Golden Victory), in which the House of Lords held that achieving an accurate
assessment of damages based on the losses that had actually happened was more impor-
tant than considerations of contractual certainty and finality. In other jurisdictions, the
use of hindsight in calculating damages is the default position.
• Sunk costs – generally, costs that have already been incurred at the date of the loss can-
not be claimed in addition to lost future profits.This is because profits can only be gen-
erated if the factory that will be used to generate them already exists, and so it would
be double-counting to claim for both loss of profits and the cost of building the factory.
• Overhead recovery rates – an issue that often arises is the definition of what exactly is a
cost. For example, the cost of employees may be measured as the amount actually paid
to them (including overtime, pension, etc.) divided by the number of hours they work,
or as the hourly ‘charge-out rate’ (which may be equal to direct salary cost multiplied
by a factor of 3 or 4, to take account of the general and administrative and other fixed
3 As, for example, in CMS v. Argentina.

4 As, for example, in Metalclad Corporation v. Mexico.
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cost overheads of the company) or the rate that is charged by a service company in
the group.
• Management time – again, the principles here may vary between jurisdictions, but
generally the rule is that one can only claim damages for lost management time if the
claimant can demonstrate that this management time would otherwise have been spent
on generating profits on other projects.This is because management time is a fixed cost
that would have been incurred whether or not the event causing the loss had occurred.
The chapter on ‘Valuing Damages for Breach of Contract’ in this publication discusses the
valuation of damages for breach of contract in greater detail.
Basic principles of damages – valuation

In circumstances where the asset has been expropriated or the company has gone into liq-
uidation, the normal way of calculating damages is the ‘valuation’ basis. This is because the
actual value of the asset or company tends to be zero, while the but-for value tends to be the
value of the company immediately before the event of expropriation. Consequently, this
approach is commonly used to quantify damages in investment treaty expropriation cases.
On this basis, the loss is calculated in accordance with the normal ways of estimating
‘fair market value’, which are as follows:
• The income (or discounted cash flow, DCF) approach. This approach is commonly
used because it can be applied to any company or project that has reliable projections
of future income.The approach involves estimating the future cash flows from the com-
pany or the project, and then discounting these back to a net present value by applying
a suitable discount rate. The big challenges in applying this approach in practice are
calculating reliable cash flows into the future and calculating the discount rate. This
approach is discussed in further detail in the chapters on ‘Income Approach and the
Discounted Cash Flow Methodology’ and ‘Determining the Weighted Average Cost of
Capital’ in this publication.
The concept of the net present value is this – a dollar today is worth more in eco-
nomic terms than a dollar in a year’s time. Indeed, if I have a dollar today and place it
in a bank account, even with the current low interest rate I will still have more than a
dollar in a year’s time.
This simple insight is the basis for discounting.The key, of course – and one can see
this when one considers how interest rates have changed over the past decade – is what
is a suitable rate to discount at.
• The market (or earnings) approach. This approach values a company by multiplying
its annual earnings by a multiple based on multiples applicable to other similar quoted
companies. This is the method more commonly used for valuing companies being
bought and sold in the real world. It is often used as a check on a valuation given by the
income approach.This approach is discussed in further detail in the chapter o n ‘Market
Approach or Comparables’ in this publication. A company may also be valued on the
basis of comparable transactions in similar companies or of the company itself.
• The net assets approach. This approach values a company on the basis of the value of
its assets. The value of its assets (e.g., its machinery) is based on the resale value of those
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assets, which in practice may be based on their cost, or their second-hand value or
their replacement cost, adjusted for depreciation over the period in which they have
been operating. As this approach does not take any account of the ability of the assets
to generate profits in the future, it tends to give a lower value than the income and the
market approaches, and it tends to be used in situations when the company itself has
gone into liquidation and will never operate again. It is also used in start-up situations
when there is insufficient certainty about future cash flows to use the income approach,
and so tribunals value the company on the basis of the costs incurred to date on build-
ing the plant. This approach is discussed in further detail in the chapter on ‘Asset-Based
Approach and Other Valuation Methodologies’ in this publication.
Other issues
Tax
If the goal of a damages award is to place the claimant in the same post-tax position as it
would have been in if the relevant breach or expropriation had not occurred, the damages
calculation has to take account of tax. Thus, both the actual and the but-for calculations
should be carried out on a post-tax basis. If the tax rates have changed considerably over
time, or if damages awards are taxed on a different basis to income, or if dividends from a
project would have been subject to withholding tax, but a damages award is not, the impact
of tax may be considerable. Consequently, care must be taken to make sure that tax has been
treated consistently in the damages calculation.
Currency
The choice of which currency a claim is made in may have a very considerable impact on
the size of the claim, particularly in developing economies or economies with hyperinfla-
tion. Again, legal principles may vary between jurisdictions, but the general principle is that
the claimant should be compensated for what it has lost. Thus, damages should generally
be calculated in the currency in which the loss of profit or the increased costs have been
suffered. A claimant generally also has a right to be compensated in a freely convertible cur-
rency – so, even if the damages are calculated in a local currency, the tribunal may wish to
translate the award into US dollars or euros at the rate of exchange on the date of the award.
Interest
As some awards are rendered many years after the date of the breach or expropriation, an
award for interest is often a very sizeable element of an award. The purpose of pre-award
interest is to compensate the claimant for not having had their money over the period
from the date of the breach to the date of the award, and consequently, it is often based
on the claimant’s marginal borrowing rate, to compensate the claimant for the additional
cost it incurred in borrowing money. Other bases for calculating interest include the rate
the claimant could have earned from putting the money in a deposit account, the risk-free
rate and the respondent’s borrowing rate, and these are discussed in greater detail in the
chapter on ‘Interest’ in this publication, which also considers the appropriate interest rate
for post-award interest.
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Finally, by way of introduction, the tribunal needs to decide whether to award interest
on a simple or a compound basis; while the simple basis used to be the default basis in some
jurisdictions, and still is in certain countries, it is generally acknowledged today that the
compound basis (which results in a higher award) more accurately compensates claimants
for what they would actually have done with the money if they had had it earlier.
It is also important that the interest rate used is based on the currency of the claim – as
it makes no economic sense for the award to be in a hard currency, with a high interest rate
based on a soft currency that is expected to depreciate.
Data management and modelling

The final topic we consider in this introductory chapter is the use of modelling and statis-
tics in damages awards.
Models
As we have discussed earlier, the but-for and DCF approaches to damages generally require
the damages expert to prepare a model of what would have happened in the future. This
may be a simple one-page spreadsheet or it may be a 100-page interlinked corporate
finance workbook forecasting the future profit and loss account and balance sheet of the
company, showing when all the borrowings would have been repaid, etc. Such complex
models are commonly prepared by banks and project finance initiative transactions, so that
the company and banks can understand when the project is anticipated to produce income
and how borrowings will be repaid.
A model that was prepared at the time and was relied on by a bank for lending money
to a company is likely to be more reliable than a model that was prepared by the company
solely for an arbitration, and that may be biased in favour of the claimant.
There is a major risk that models include errors. Consequently, it is vital that models
are prepared in a systematic way, and that they are systematically checked by an independ-
ent third party. For example, the Institute of Chartered Accountants in England & Wales
has prepared a helpful booklet entitled ‘Twenty principles for good spreadsheet practice’.
Sampling
Where there is a large population of data, it may not be possible or cost-efficient to review
or to test every item in the population, and the most efficient way of considering the
validity of the data may be to use a sampling methodology. If the data population includes
10 large items comprising 90 per cent of the data, a valid sampling methodology may be
to review those 10 items as part of a judgement sample. However, where the population
includes thousands of similar small items, the only statistically reliable method may be to
select a sample of the items and test these. In order to rely on the output of the sample of
items tested, the sample should be selected in a statistically valid way, such as by cumula-
tive monetary sampling, which selects items on the basis of every so many dollars, and thus
includes the possibility of selecting all the items in the population, but biased towards larger
items; if a sample is selected in this way, any errors found can also be extrapolated across the
entire population to give an estimated error rate in the entire population.
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Statistics
Statistics can be a useful tool to use in damages quantification. Two of the most commonly
used statistical tools are:
• Regression analysis. In graphical terms, regression analysis is plotting certain points on
a graph, such as historic profits over the previous 10 years, and then using the past to
forecast future profits, by drawing a straight line into the future. This approach has the
advantage that the output can be shown to have a statistical basis, rather than simply
being based on the damage expert’s judgement, and a coefficient of correlation can be
calculated, indicating how reliable the particular regression analysis is. More compli-
cated regression tools can also be used.
• Seasonal adjustment. If there is a seasonal patter to a company’s sales, seasonal adjust-
ment may be needed to estimate future profits.
Finally, there are other more sophisticated statistical tools that can also be used to improve
the reliability of damages calculations. Many of these have yet to gain traction with decision
makers and experts. However, with low-cost add-ins increasingly available for spreadsheets,
the humble laptop has a powerful means of crunching vast amounts of data in stochastic
approaches that attempt to model more accurately the effects of uncertainty. One can
expect to see more use of stochastic approaches like the Monte Carlo method in damages.
Conclusion
Damages calculations are rooted in a claimant’s financial accounts, and the accounting
principles on which these are based need to be understood in order to arrive at a reli-
able quantification of loss. The basic approach to calculating damages is to compare the
claimant’s actual position with the position it would have been in but for the intervening
event causing the loss; this requires an analysis of revenue, gross profit margin, variable and
fixed costs and projections of the future. Where a claimant has lost all its business, such as
in an expropriation, the normal method of valuation is the fair market value of the busi-
ness immediately before the expropriation, which is normally calculated using the income,
market or assets approaches.
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10
Assessing Damages for Breach of Contract
Ermelinda Beqiraj and Tim Allen1
Introduction
Picture the scene.Your business makes luxury chocolates and you have entered a contract
to install a new state-of-the-art production line in your factory. The installation goes dis-
astrously wrong and your factory has to operate with significantly reduced capacity for
three months while the problem is fixed. You manage to hire some inferior alternative
equipment but you are faced with a stack of customer orders you cannot fulfil, perishable
stock you cannot use, high levels of customer returns and a vastly reduced income. Twitter
and the trade press are alive with rumours of customers defecting to other suppliers and
the potential demise of your business. Luckily, your contract with the equipment supplier
means that you can sue for what you have lost, but how do you work out how much that
is? Your losses are likely to include one or more of the following:
• Loss of profits: you have lost the profits you would have earned had the production line
operated as planned.
• Wasted costs: you have spent significant sums on short-term hire of alternative produc-
tion equipment.You also had a lot of employees sitting around doing nothing because
the factory was operating at reduced capacity.
• Loss of opportunity: despite earlier assurances that the business was yours, a potential
customer heard you were having problems and denied you the opportunity to pitch for
a lucrative new contract. In addition, you were unable to undertake a planned expan-
sion into a new market because all of your management time and energy was focused
on dealing with the crisis.
Valuation of all of the above losses requires consideration of the counterfactual or ‘but for’
scenario. In other words, what would the financial performance of the business have been
1 Ermelinda Beqiraj and Tim Allen are partners in PricewaterhouseCoopers LLP’s UK disputes practice.
155
had the new production line been commissioned on time and operated as specified? What
revenues would have been earned, what costs would have been incurred and what costs
would have been avoided? The difference between the counterfactual and what actually
happened gives rise to the damages incurred. While determining the actual performance
of the affected business should be relatively straightforward, assuming that suitable con-
temporaneous accounting records are available, constructing the ‘but for’ scenario requires
informed professional judgement and this is generally an area where damages experts may
differ. The reasonableness of the assumptions underlying the ‘but for’ scenario and the
extent to which they can withstand scrutiny based on the available evidence is often tested
during cross-examination.
In this chapter, we will explain some of the challenges that damages experts, lawyers
and tribunals need to deal with when valuing damages in breach of contract claims that do
not involve company valuations.
Causation
The causal relationship between the breach and the losses flowing from the breach is a
matter for the lawyers to argue and the tribunal to determine. However, it is also critically
important to the assessment of damages.
A common problem is the existence of more than one potential cause for the loss suf-
fered. It would be naïve to assume that a causal link exists just because a loss occurs around
the same time as a breach. To return to the example of our chocolate manufacturer, let us
assume that around the same time as the botched installation of the production line there
was a poor cocoa harvest leading to shortages in supply and increases in the prices of cocoa.
The damages expert is faced with the challenge of identifying and isolating the various dif-
ferent causes of loss.To what extent would profits have been reduced or sales lost as a result
of this cocoa supply issue and irrespective of any contractual breach? For those sales that
the expert concludes would have been made in the ‘but for’ scenario, forecast profits would
need to be adjusted to take into account the increased price of raw materials as a result of
the shortage, to the extent that these cannot be passed on to the end customer.
External factors may have an effect on damages that was not necessarily foreseeable at
the time of the breach. Disentangling the effects of the global economic crisis in order to
isolate and assess the impact of a breach has been a common feature of breach of contract
disputes arising since 2008, particularly in the energy sector. For example, a 10-year forecast
of profits from an oil and gas concession prepared in December 2008 would look very dif-
ferent from a similar forecast prepared six months earlier.
While causation is primarily a legal and factual issue, it has a direct and potentially
significant impact on the assessment of damages. If experts make different assumptions or
are given different factual information or instructions regarding the causal link between
a breach of contract and a sequence of events, this can lead to vastly different assessments
of damages. In such cases, we would advise tribunals to ask the parties’ experts to provide
alternative calculations that illustrate the impact on the loss calculation of changes to the
assumptions made. Armed with these, tribunals can adjust the calculation of damages to
reflect the tribunals’ views on causation.
Establishing a clear causal link between the contractual breach and the loss incurred is
also important in wasted costs and loss of opportunity claims.
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In cases of lost opportunity, the claimant needs to demonstrate that the opportunity
existed and, but for the breach of contract, they would have won it before they can start
estimating what that opportunity was worth.
Every case is unique and many have unusual features: in one case we had to value lost
profits from an oil rig that could only operate under certain weather conditions, so we had
to use weather maps to plot the likely pattern of cash flows. The ‘right answer’ in each case
will derive from legal, factual and then financial analysis.
Identification of the difference in profits arising from the breach

A lost profits calculation will compare what actually happened to what would have hap-
pened but for the breach.The ‘actual’ profits should be available from the claimant’s records.
Rarely, an expert may be faced with a total lack of accounting records: if the company
holding the accounting records has been liquidated and all of its records have been lost or
destroyed, it can be very difficult, if not impossible, to quantify a claim. In such circum-
stances, an expert may have to look at secondary evidence (e.g., from other businesses that
are similar to the business in question or other sources).
More commonly, while there is financial information available in the accounting records
of the business, it may be difficult to retrieve or insufficiently detailed: a system designed to
record and report information helpful to management in running their business day to day
may be inadequate to support a claim for breach of contract.
In analysing records to support a lost profits claim, an expert may find that income and
costs from several different projects are aggregated within the accounting system; central
costs may need to be analysed and split between different activities; or it may be unclear
which costs are incurred as a direct result of the breach and which would have been
incurred anyway. Even after a review of detailed underlying documents it may be difficult
to ascertain the nature of some of the costs incurred: invoices ‘for services rendered’, for
example, are particularly unhelpful.
The ‘but for’ scenario may well rely on contemporaneous forecasts, budgets or com-
parison to a previous period of trading unaffected by the breach. In determining whether
such forecasts are suitable as a basis for the determination of ‘but for’ profits (or revenue
and costs), an expert and tribunals need to assess how reliable the forecast is and whether
there are facts or circumstances that may not have been known at the time the forecast was
prepared, but were known at the time of breach, that may need to be reflected in the ‘but
for’ calculations.
In assessing whether contemporaneous forecasts are sufficiently reliable to serve as a
basis for ‘but for’ profit (or revenue and costs) one needs to consider the purpose for which
the forecast was prepared, among other things. For example, contemporaneous forecasts
(prepared at the start of the year for the following year) by a management team that has a
track record of forecasting reasonably accurately may be considered reliable. By contrast,
a forecast produced by an inexperienced or new management team, one produced for an
entirely new product or one that is at odds with available information (e.g., market fore-
casts) may be less suitable as a starting point for the expert to build a ‘but for’ scenario. The
quantum expert needs to assess the quality and suitability of such forecasts using his or her
professional judgement and experience, and where appropriate make adjustments to the
forecast to arrive at an appropriate ‘but for’ calculation.
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Consequential loss claims can be more difficult to assess than wasted costs or lost profits
claims, particularly if they involve an element of uncertainty, such as the loss of an opportu-
nity. In this situation, contemporaneous evidence concerning the nature of the opportunity
and the likelihood of the claimant winning is more relevant than accounting records. To
return to our chocolate manufacturer, an expert assessing the value of the lost opportunity
to pitch for a new contract might seek to establish the probability of the claimant win-
ning the work by examining the claimant’s historical track record in similar bid situations,
assessing any relevant evidence as to the claimant’s relationship with the potential customer
and reviewing factual evidence as to the extent of the competition. Ultimately, as with all
aspects of damages quantification, an element of judgement will be required.
Future losses
Future losses tend to be more problematic to assess than past losses. A forecast of profits
and cash flows over a 20-year contract term into the future is inevitably more specula-
tive than an assessment of losses already incurred. However, this does not mean that the
claimant’s situation is hopeless. Swatch, for example, was awarded the equivalent of some
US$450 million in a claim against Tiffany, which largely related to future losses over the
term of a joint venture agreement. So what marks the difference between success and fail-
ure for future loss claims?
As a general rule, the more evidence there is of the ability to generate future cash flows
and profits, the lower the chance of a claim being dismissed as speculative. The nature
of the industry and the stage of development of a project are important factors in this.
For example, participants in the mining or oil and gas industries might base a claim for
future losses on the level of proven reserves. A contemporaneous business plan and forecast
of profitability over the term of the contract may be more compelling than a bespoke
model put together by the expert solely for the purpose of assessing the claim, but even
contemporaneous forecasts should still be allied to an accurate forecasting track record, a
well established market for the product and a credible commercial means of bringing the
product to market. If infrastructure was already in place and agreements signed with future
customers, these factors will contribute to a robust and defensible calculation.
The types of business most likely to experience difficulty with claims for future losses
are those whose plans were at an early stage of development when the breach of con-
tract took place. For example, say you had bought the right to a trademark allowing you
to manufacture and sell a particular brand of luxury good. The financing deal you had
arranged collapsed and you sue the bank involved for the profits you would have made
from the product globally. In terms of evidence, all you may have is the right to a trademark,
a two-page business plan and a great idea. Technology start-ups are similarly vulnerable,
particularly if they are trying to enter new markets with an innovative but untested product
where the size of the market itself is very difficult to determine. In such circumstances, the
expert will have to make a significant number of assumptions in valuing lost profits and
should consider what evidence might be available from other sources besides accounting
records and forecasts; for example, the record of other similar businesses, results from the
sale of a similar product produced by the business or a competitor, or published industry
sector data.
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Where a forecast for future lost profits relies on untested assumptions, a tribunal may
prefer to consider a loss based on a wasted costs approach rather than entertain a claim for
lost profits. However, this does not mean a claim based on future profits from a business in
an early stage of development will never succeed. For example, in Al-Kharafi v. Libya, the
claimants were awarded some US$900 million following the termination of an agreement
to build a hotel and shopping mall, despite the fact that there had been no trading activity
and the ground had yet to be broken as at the date of termination.
Has the claimant really lost profits?

In some circumstances, the expert should consider whether profits have been lost at all,
notwithstanding the court or tribunal’s finding of contractual breach.
In Pope & Talbot Inc v. Canada,2 the claimant claimed lost profits arising from a seven-day
shutdown of its three mills as a result of Canada’s wrongful conduct. However, the tribunal
rejected the claim on the basis that ‘the Investment at all relevant times had inventory suffi-
cient to meet all its sales requirements, notwithstanding that shutdown’ and ‘the Investment
suffered no loss of profits from the shutdown because it was always able to meet the needs
of its customers on a timely basis.’
When the BBC libelled Oryx Natural Resources in 2001, wrongly suggesting that the
diamond mining company was channelling cash to the al-Qaida terrorist network, it caused
significant immediate reputational damage before the BBC issued an apology and retrac-
tion. However, one can see an argument that the diamonds were still in the mine and could
and would be sold at a later date.The issue then becomes one of compensation for delay to,
rather than absolute loss of, profits. Similar considerations may apply to claims for delay in
construction of assets with a known usable life; for example, a two-year delay in construct-
ing a processing plant with a 25-year working life does not necessarily mean that two years’
profits have been lost; instead, those profits have been delayed by two years.
In Celanese International Corp v. BP Chemicals Ltd3 in the Patents High Court, the claim-
ant’s patent was found to be valid and to have been infringed. Despite the claimant’s expert
assessing damages at an excess of US$180 million, the judge held that the illegal use of the
patent did not increase the defendant’s profits and that the requirements of the defend-
ant’s customers could have been met at little or no additional cost using a non-infringing
process. In other words, the patent, although infringed, was of no value to the defendant.
Wasted costs
In wasted costs claims, the claimant may have had the foresight to record separately any
additional costs incurred. For example, in claims related to delays or disruption to con-
struction projects, the claimant may have recorded what it considers to be additional costs
separately. But are all these additional costs the fault of the respondent or were other
sub-contractors or the claimant itself to blame? If the respondent clearly caused part of
a problem but not all of it, is it possible to isolate and allocate the costs accurately? If the
2 Arbitration under the North American Free Trade Agreement, award on damages dated 31 May 2002,
paragraph 84.
3 Celanese International Corp & HNA Holdings Inc (formerly Hoechst Celanese Corp) v. BP Chemicals Ltd & Purolite
International Ltd 1998.
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expert does not have sufficient information to enable him or her to make reasonable
assumptions as to apportionment of wasted costs between those that arise as a result of the
breach and those that do not, such costs may be considered unprovable.
In some cases, the identification of wasted or incremental costs can be relatively straight-
forward. Imagine a single purpose entity formed to operate a concession agreement that
was wrongfully terminated. The costs incurred by that entity in dealing with the aftermath
of the termination should be simple to quantify and the expert may not need to be con-
cerned with matters of allocation and apportionment. In other cases, it can be difficult to
separate incremental costs incurred as a direct result of the breach from costs that would
have been incurred whether the contract was breached or not. A common example of
this is wasted management time. If you are going to pay your managers anyway, can you
get back the time they spend on the claim? How does the expert assess whether the costs
are incremental? And what about research and development costs? Did they relate purely
to the breached contract or did they have wider application within the company? What
would be a fair proportion to include?
In Pope & Talbot Inc v. Canada,4 the tribunal denied a claim for the cost of management
time devoted to the claim on the basis that the management were paid annual salaries that
‘did not vary in respect of the issue or matters to which each of them devoted his or her
working time’ and ‘would have been paid no matter what work related activities those
managers undertook’.
By contrast, in Pegler v. Wang,5 a case in the English High Court relating to a failed
IT system implementation, the claimant was successful in recovering wasted management
time. Pegler claimed £1 million in respect of time spent investigating and installing addi-
tional hardware and software to remedy some of Wang’s breaches, and investigating an
integrated replacement system. The judge allowed half of the amount claimed, taking what
he described as ‘a broad-brush approach’, despite a lack of detailed records.6 This appears to
have been awarded on the basis that the time was diverted from the managers’ proper job
of managing the company and that this represented a loss.
Date of valuation, period of loss and use of hindsight

The date of valuation and period of loss are often clear-cut; for example, you could have
a whole factory shut down for a known period or lose the right to exploit mineral or oil
reserves for a set period of time. However, these matters can be in dispute between the par-
ties, particularly if the breach is ongoing, and if so, that can have a significant impact on the
claim. In our chocolate example, while the problems with the production equipment were
remedied after three months, the impact of these problems on the company’s reputation
and market share may have lasted many months or years.
A damages assessment at the wrong date or over the wrong period can have a serious
impact and may lead to the expert report being dismissed as irrelevant.7 The choice of valu-
4 Award on damages dated 31 May 2002, paragraph 82.

5 Pegler Ltd v.Wang (UK) Ltd [2000] EWHC Technology 137 (25th February, 2000).
6 Pegler Ltd v.Wang (UK) Ltd, paragraphs 335 to 348.
7 In Casado v. Chile (May 2008) the tribunal dismissed the claimant’s expert report on the grounds that it
was based on a valuation date prior to the provisions of the relevant treaty coming into force. In the Yukos
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ation date is particularly significant where cash flows are affected by movements in factors
such as interest, inflation rates and exchange rates, or commodity prices that can fluctuate
significantly over time.
Alongside the valuation date, one issue that often arises is the use of hindsight in valu-
ations carried out at the date of breach. For example, let us assume a 20-year concession
agreement to operate an airport was terminated in 2012. At that time, the relevant authority
had announced plans to build a high-speed rail link to the nearest city, significantly increas-
ing the relative attractiveness of the airport compared to other destinations. Two years later,
following a change of government, the high-speed rail link was cancelled. A valuation of
the concession agreement at the date of termination (without the use of hindsight) might
reasonably value the airport on the basis of passenger forecasts anticipating the rail link.
This might be challenged by a respondent on the grounds that shutting one’s eyes to what
has happened between the date of breach and the date of hearing may lead to the claimant
being overcompensated. Experts should seek advice from their instructing legal team as to
whether the use of hindsight is appropriate; in our experience this varies depending on the
exact facts of each case and on the law applicable to the claim.
Other matters
Aside from assessing the various components of loss and determining the quantum of each
accordingly, the quantum expert and tribunals may have to deal with a number of other
issues that can have a significant effect on the amount of damages. These include corporate
structuring issues, mitigation, contributory negligence, interest and tax.
Issues arising from the claimant’s corporate structure

In some cases, the claimant may not be the entity in which the loss initially occurred. In
such situations, the expert needs to establish whether the losses that arise in a different
entity flow dollar for dollar to the claimant. A joint venture vehicle could suffer a loss but
currency restrictions or tax laws might mean that the ‘but for’ lost profits reaching the
owners of the joint venture by means of a dividend payment would have been significantly
reduced. Complex corporate group structures are another challenge. Companies can be
structured to maximise tax efficiency across the group: recharges between group companies
may lead to particular companies in a group structure not making any profit. The expert
will need to understand the impact of these measures on the cash flows in the counterfac-
tual to assess the extent to which the value of damages is affected by the group structure.
The allocation of shared service costs between different parts of a business or across a
group may also present valuation difficulties, particularly if the related accounting records
are sketchy or there is doubt as to whether such costs are truly incremental.
Mitigation
The claimant has a duty to take reasonable steps to mitigate its loss.The extent to which the
claimant has fulfilled this duty and the nature of the measures to be considered as mitigation
arbitration, neither claimants nor respondent had performed valuations on the dates the tribunal found to be
relevant. The tribunal therefore had to do the valuations itself (Final Award, 1782).
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are matters of law. Damages experts need to work closely with their instructing counsel to
identify mitigating activities and assess the cash flows that should be taken into account in
mitigation of any damages claim. In the example of our chocolate manufacturer, the claim-
ant incurred incremental costs by hiring alternative equipment. Had the claimant failed to
do so, however, this would have resulted in more unfulfilled orders, higher lost profits and
might be considered a failure on the part of the claimants to adequately mitigate their loss.
Contributory negligence
A finding of contributory negligence can lead to a reduction in a damages award. For
example, the installation of a new IT system may result in a breach of contract, but what
if the customer contributed to some of the problems by significantly changing its require-
ments at a late stage? The reduction in the damages award may be a specific sum if that is
possible based on the evidence or a more arbitrary percentage. In MTD Equity v. Chile, for
example, the tribunal reduced the claimants’ damages award by 50 per cent to reflect ‘[the
claimants’] decisions that increased their risk in the transaction and for which they bear
responsibility’.8
Interest
Interest can form a significant proportion of the compensation eventually received by the
claimant and may even exceed the value of damages itself. In PwC’s 2015 research into the
quantum of damages in international arbitration,9 we found that while interest comprised
24 per cent of the value of awards (on average), only some 10 per cent of the pages in the
award are devoted to the subject. The topic of interest is the subject of a separate chapter
in this book. Insofar as it relates to a breach of contract claim, one issue that needs to be
carefully assessed in determining the amount of interest is the timing of the difference in
cash flows between the ‘but for’ and actual scenarios. Unlike claims involving company
valuations, which typically calculate damages at a single date (and interest from that date
onwards), claims related to loss of profits and wasted costs will calculate loss that may span a
period of months or years.To arrive at an accurate figure for interest, a damages model must
identify at what point in time each cash flow difference occurs and apply interest only from
that date on that portion of loss. If the effect is unlikely to be significant, it may be appro-
priate to calculate interest on monthly or even annual cash flows to simplify the calculation.
Taxation
Tax laws can affect the value of the award. Where the rate of tax applicable to profits is
the same as the rate of tax applicable to a damages award, then the damages claim can be
calculated on a pre-tax (or grossed up) basis because the same amount of tax would be paid
whether the claimant made profits or received damages. Care should be taken, however,
to ensure that any claim for interest on the tax payable for the award is calculated in line
with the underlying cash flows. For example, say a claimant lost US$100 pre-tax in 2010,
8 MTD Equity Sdn Bhd and MTD Chile SA v. Republic of Chile, paragraph 242.
9 www.pwc.co.uk/forensic-services/disputes/insights/assets/pdf/2015-international-arbitation-damages-
research.pdf.
162
on which he would have paid US$20 tax. He makes a claim that is settled in 2016 and he
then pays US$20 tax on the damages received. He would be due interest on US$80 (not
US$100) from 2010 until the date of payment of the award. Interest on the tax element of
the claim would be due only if the tax on the award would be payable before payment of
the award itself, and in such a case only from the date of payment of the tax on the award.
If there is a difference in the way in which damages are taxed and the way in which
profits are taxed (as, for example, in Switzerland), the valuation of damages has to start with
a post-tax calculation of lost profits and then adjust for the amount of tax payable on the
damages awarded.
Conclusion
Many of the issues that an expert encounters in the course of calculating damages are
similar, regardless of the cause of the action or type of damage suffered. While an ability
to understand and evaluate accounting information is, of course, essential, the expert must
also bring sound commercial and professional judgement to bear in constructing a robust
counterfactual based on the evidence available.
No expert can hope to navigate these complexities alone. It is the combination of
documentary evidence, evidence from witnesses of fact and other experts as well as clear
instructions from the legal team that will feed into the calculation of damages and help the
expert to establish a robust assessment of the loss.
Tribunals face an even tougher job when evaluating expert evidence on damages to
determine an appropriate award. There are a number of ways in which tribunals can help
themselves. Engaging with the expert process early, for example, in setting the issues or
questions that expert evidence should address, asking the parties’ experts to explain the
reasons for the differences between their opinions and expert witness conferencing, among
others, can go a long way to help tribunals reach a fair damages award.
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11
Overview of Methodologies for Assessing Fair Market Value
Philip Haberman1
Fair market value is frequently referred to by tribunals as a relevant measure in their consid-
eration of damages.This chapter introduces the concept of fair market value, discusses when
it is used, and considers the critical question of the valuation date as at which it is assessed.
It then outlines the three general approaches to assessing fair market value (the income,
market and cost approaches), explaining their uses and their advantages and disadvantages,
before considering the need for adjustments in circumstances where the party concerned
does not own an asset wholly. It ends by summarising the process that most valuers use to
assess fair market value, and how they balance the three approaches to reach an opinion.
Meaning of FMV
Probably the most authoritative source of definitions related to valuation is contained in
International Valuation Standards (IVS), which were issued by the International Valuation
Standards Council (IVSC) in 2013, and are widely referred to by valuers all over the world.
The IVSC has issued exposure drafts of additional standards in 2016, but these do not
change the underlying definitions.
Perhaps surprisingly, IVS does not define ‘fair market value’. Instead, it offers
two definitions:
The estimated price for the transfer of an asset or liability between identified
Fair value knowledgeable and willing parties that reflects the respective interests of those parties.
The estimated amount for which an asset or liability should exchange on
the valuation date between a willing buyer and a willing seller in an arm’s-
Market value length transaction, after proper marketing and where the parties had each acted
knowledgeably, prudently and without compulsion.
1 Philip Haberman is the founder and senior partner of Haberman Ilett LLP.
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The addition of the word ‘fair’ indicates, in IVS terms, that the valuer should take account
of the specific circumstances of the parties involved, and their likely views, rather than
restricting consideration to hypothetical market participants.
The term ‘fair market value’ is found in US valuation literature, where it is defined in
similar terms to IVS’s ‘market value’, but the discrepancy between authorities means that
there remains an uncertainty as to exactly what is meant by ‘fair market value’ in the con-
text of the measurement of damages in international arbitration. This could be significant
in those cases where the particular circumstances of the parties are likely to affect their
views of the value of an asset.
In the remainder of this chapter, the term ‘FMV’ will be used in its US sense, cor-
responding to the IVS-defined ‘market value’. Where the IVS concept of ‘fair value’ is
important, it will be referred to as ‘FV’.
It is important to recognise that, when assessing FMV, a valuer is seeking to assess the
various positions of the population of hypothetical sellers and buyers of the asset con-
cerned, and arrive at an average that represents the likely price at which a transaction would
be expected to take place. In an actual transaction, the price might well differ – possibly
substantially – because of the circumstances of the actual parties, in which case the price
would represent what the parties themselves actually decided was FV.
When does FMV come into play?

The most common circumstances when a tribunal may be required to decide the FMV of
an asset are:
• when a party has been deprived of an asset (for example, an expropriation) – the dam-
age may be measured as the FMV of the lost asset;
• when an asset has been harmed – the damage may be measured as the FMV of the
undamaged asset less the FMV of the damaged asset; and
• when a party has been misled (caused, for example, by a breach of warranty) – the dam-
age may be measured as the difference between the FMV of the asset in the condition
promised and its actual FMV.
In other cases, it may be appropriate for a tribunal to depart from FMV and move towards
FV as a basis for assessing damages. A common example would be a quasi-partnership
company, where several owners are cooperating under a shareholders’ agreement: while an
individual shareholding might have a modest FMV (because no external market participant
would want to purchase it), its FV as between the existing shareholders may be substantial.
There may also be circumstances where a tribunal reaches the view that the FMV of
an asset is not a suitable measure of the damages to be compensated. An extreme example
might be as follows:
• Suppose the asset concerned is a specialised and irreplaceable piece of equipment that
makes a highly profitable product.
• Suppose the equipment is destroyed by fire.
• The owner’s loss would normally be measured at the moment the fire occurred, so
would be the FMV of the equipment on the day of the fire.
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• But suppose the product was banned globally a week after the fire, because it was dis-
covered to be carcinogenic. Had the equipment not been destroyed, its FMV would
now be zero.
• What is the appropriate measure of damages? A tribunal may not wish to compensate
the owner with damages that would appear to be a windfall, even though that seems to
be theoretically correct.
Valuation date
FMV is determined at a particular date (the ‘valuation date’). Choosing a valuation date
imposes a requirement that information emerging after that date must not be taken into
account in arriving at the valuation. In effect, valuers put themselves back in the past and
pretend that they are standing at the valuation date and assessing the value of the asset
concerned so, by definition, they cannot know what is in the future at that date and can
only forecast it.
There are times when adherence to the valuation date seems to carry the danger of not
achieving ‘justice’ in the circumstances of a dispute (for example, the situation described
above). There are no fixed guidelines for how to treat such a situation: much will come
down to argument and pragmatism rather than theoretical niceties. Some courts, for exam-
ple, tend to justify looking at subsequent events by regarding it as a check that a valuation
is giving a reasonable result – from a theoretical point of view that is unjustifiable, even if,
from a pragmatic point of view, it helps to produce a fair result.
The choice of valuation date is important from a pure quantification perspective,
because an asset is likely to have different values at different times.We see obvious examples
of this every day, in the fluctuations of share prices on stock markets, and movements in
property values. Some of these changes are driven by underlying movements in the market
and competitive position, others by changes in the supply or demand for the product or
service being sold, but all are a function of timing.
Deciding on the date for a valuation is primarily a legal issue, depending on the under-
lying legal basis of a claim, and requires careful analysis. The most frequently encountered
dates used for valuations in the context of damages claims are:
• the date when the cause of action arose – this is the usual basis for investment treaty
expropriation cases, where compensation may be defined by the treaty as the FMV of
the asset immediately prior to the action being complained of;
• the date when the damage occurred – this will often be the same as the cause of action
date but might be more appropriate in circumstances where the cause of action did not
have an immediate impact;
• the date a claim is made – this is argued on the basis that it is the date when the dam-
age crystallises;
• the date submissions are made – this does not seem to have any sound theoretical basis,
but is often seen as a more comfortable basis than estimating a value at an unknown
future date when the award is likely to be issued; and
• the anticipated date of award – this is argued on the basis that it measures the loss at the
point when the loss will be compensated.
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Any choice of date raises complexities, so it might be argued that tribunals should give
some early indication of their view as to the appropriate date for the assessment of loss,
without committing themselves on liability.
Examples of timing issues include:
A claimant may argue that fair compensation requires the respondent

Investment treaty cases where the to compensate it for the increase in value that it is unable to benefit
asset is appreciating (such as a from, hence requiring a valuation at the anticipated date of award. A
natural resource) claimant might also justify this on the basis that the respondent will
otherwise benefit from an unjust enrichment.
Cases where external circumstances Either party may argue that FMV does not give appropriate
changed in an unexpected way after compensation because it fails to take account of the subsequent
the loss was caused external event that has actually occurred.
Dealing with these issues might require a tribunal to depart from a theoretically correct
valuation at a given date, or to require that specified assumptions should be used in arriving
at FMV, even though those assumptions might not have been made at the time.
Approaches to FMV
There are three general approaches to arriving at FMV of an asset: the income approach,
the market approach and the cost approach. In this chapter, we will outline each of these
approaches in turn, explaining what they mean and their basic characteristics, before dis-
cussing when to use each method and how to reconcile their sometimes different results.
All three approaches rely on two fundamental principles:
• that the owner of an asset has no special reason to want to own the asset apart from its
ability to generate a return, whether that comes in the form of income from the asset,
the eventual sale of the asset, the saving of cost through ownership of the asset, or a
combination of these factors; and
• that the owner is indifferent as between assets if they are all capable of generating the
same expected income with the same likelihood.
In practice, this is not always the case: some owners (collectors, for example) are not wholly
rational about the assets they own, and some assets (such as works of art) are valuable for
non-financial reasons (in addition to the ability to sell them in due course). Such assets may
not be susceptible to a rational valuation approach, or it may be necessary to limit the use
of the approaches that follow.
Income approach
The income approach relies on the underlying financial theory that the value of an asset
is equal to the value of the future income that the rational owner can expect to obtain
from the asset. The two underlying themes of the income approach are (1) that it relies
on information on the asset itself, in the form of views as to the likely future income that
an asset can generate, and (2) that all value is assumed to arise from the ability to generate
future income.
In an ideal world, there would always be a sound basis for the assessment of future
income, over a reasonable period of prediction. The reality might be different (few
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businesses are entirely predictable), but that is not the same as saying that it is too uncertain
or speculative to form a reasonable basis for the assessment of value.
The most common form of the income approach is to focus on cash (rather than an
accounting measure like income) and use a discounted cash flow (or DCF) method. This
sounds, and is sometimes interpreted, as though it requires a detailed knowledge of the
business and a long history of past performance, but neither is necessary. A DCF valuation
is based on the valuer’s assessment of two fundamentals:
• the expected future cash flows of the entity being valued (whether that is an entire busi-
ness, an asset, a project, shares, etc); and
• the appropriate discount rate that allows for risk and uncertainty (the probability that
the future cash flows will not turn out exactly as expected) and the time value of money.
Both of these can be arrived at from detailed underlying information (in the same way as
businesses plan for the future), or can be assessed on an overall basis (in the same way as
external shareholders often do).
Where there is an absence of a historical track record, it is often argued that the DCF
method (or the income approach in general) is inappropriate because it is too specula-
tive. From a valuer’s perspective, this is not true: while a track record may give the valuer
greater confidence that a similar level of expected future cash flows will be achieved, it is
not a necessary requirement for a reasonable valuation because it can be compensated for
through the discount rate. Indeed, perhaps the most important aspect of a DCF valuation
is the selection of a discount rate that takes account of the degree of uncertainty in the
underlying cash flow projections.
Market approach
The market approach is based on the underlying theme that the wider market has already
done the work of valuing companies and businesses of all kinds, using all the information
available, so the valuer simply needs to find a quoted company (or a company that has been
sold) that is the same as the company being valued, and then use its quoted valuation (or
the sale price) as the value of the subject company.
In reality, of course, no two companies are identical, so there is a never a quoted com-
pany, or a company that has been sold, that is an identical twin to the company or busi-
ness being valued. The valuer, therefore, seeks ‘comparables’, companies that are similar to
the entity being valued, in the knowledge that adjustments will need to be made to take
account of the differences between the entity and the comparables. This gives rise to the
two forms of the market approach:
• trading comparables, based on contemporaneous quoted share prices of comparable
companies; and
• transaction comparables, based on the sales prices of comparable companies that have
been sold and acquired around the time of the subject valuation.
The search for comparable companies is usually based on companies operating in the
same industry sector as the subject entity, at a similar scale, in the same part of the world,
and perhaps at a similar stage of development, because those are the companies that are
exposed to the same business risks as the subject entity. While there are unlikely to be any
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comparables that meet all of these requirements, the individual aspects of comparability can
be considered separately by the valuer and assessed appropriately.
Once comparable companies have been identified, the valuer considers which statistics
to use as a basis for comparison, focusing on those that the market uses as a guide when
valuing companies in the sector, and arrives at relevant multiples of those statistics (whether
trading multiples or transaction multiples). The most commonly used statistics include:
• profit after tax (which might be referred to as ‘earnings’ or ‘net income’) – the amount
generated each year for the benefit of shareholders;
• earnings before interest, tax, depreciation and amortisation (‘EBITDA’ or ‘operating
profit’) – the amount generated by the business before taking account of its financing,
the replacement of fixed assets, and tax (which is affected by non-operating decisions);
• turnover – the total amount generated from sales, before taking account of any costs; and
• book value of assets.
The statistics for each comparable company might need to be adjusted to remove the
impact of non-recurring matters, as might the corresponding statistic for the subject entity.
Whichever statistics are used, it is common to find a wide range of relationships between
the values of comparable entities and their statistics, so valuers usually focus on an average
of some kind as a basis for a market valuation. While this might be thought to cast some
doubt on the entire premise of comparability, because it implies that the comparables are
not in fact comparable with one another, the usual approach is to remove the most extreme
relationships by using the median (the specific number for which there is an equal number
of values higher and lower) rather than the mean (the average of the values).
This process provides an initial view of value but the valuer then considers (to the
extent feasible) the reasons why the subject entity might be different from the comparables.
This is a judgemental process and might include the consideration of qualitative matters,
such as brand name and reputation, and quantitative matters measured through statistics like
rate of growth, sales per square foot, or gross margin.
Probably the most important aspects of the market approach are the existence of com-
parables (many cases involve entities that are arguably unique), the degree of their compa-
rability to the subject entity and how the differences should be interpreted.
Cost approach
The cost approach rests on the principle that a buyer would not pay more for an asset than
the cost of replicating that asset, either by buying an alternative or by recreating it. This
is not the same as the historical cost of the entity or business – historical cost tells us the
amount actually spent buying or building the asset at some past date or over a period of
time, rather than the cost of buying or replicating the asset on the valuation date, which is
better thought of as replacement cost.
A valuation based on the cost of buying alternative assets might also be thought of as
a variation on the market approach, because it is based on the availability of similar (or
comparable) assets in the wider market.
When the cost approach is considered, historical cost is of little significance: more
important are replacement cost and break-up value (which is realisable value rather
than cost).
169
Most businesses are more than just the sum of a series of individual assets – they include
some know-how on the use of those assets, management skill, or unique intellectual prop-
erty. Where that know-how is readily replicable, and there is no unique intellectual prop-
erty, the replacement cost of the individual assets (including management) represents a
ceiling on the valuation of the business – after all, no buyer would pay more for an easily
replicated business than the cost of replicating it.
Any entity always has an implicit choice between continuing in business or winding
up, so the cost approach can also be used to find a floor value of the entity, based on the
break-up value of its assets – after all, no owner would continue to run a business if they
could realise more by breaking it up.
Thus, the most usual purpose of the cost approach is to provide a ceiling or floor on the
valuation of an operating business.
Choosing the approach

Each of the three approaches to valuation has its advantages and disadvantages, and the
choice of approach will, therefore, depend on the balance between these various factors.
Income approach
The income approach is the usual starting point for the valuation of an entire or controlled
entity, whether that entity is a company, a business or a project. This is because the owner
or controller of the entity is likely to have the detailed information needed to undertake a
realistic assessment of expected future cash flows.
It is also useful for unique assets, where market-based comparables are difficult to find,
because the unique features of the asset can be taken into account in the valuation.
From a theoretical point of view, the income approach is almost always suitable, pro-
vided there is some reasonable basis for forecasting future cash flows. This is because it
enables the valuer to make assumptions that are explicit and capable of being both varied
and separately considered.
When an asset is not wholly owned or controlled, the valuer is likely to have less
detailed information available from which to project future cash flows, with the result that
there may be less certainty about the forecast and, hence, probably a need to be conserva-
tive in expectations.
Market approach
The market approach rests on the use of comparables, whether trading or transaction, so
the critical issue to consider is the availability of such comparables. When dealing with a
common type of asset, such as a business operating in a well established sector, there may be
a wide selection of comparable companies to use as a basis, along with extensive research
on the features of each company that enable the valuer to pinpoint reasons for differences
and hence arrive at a well founded valuation.
The difficulty with the market approach lies in its reliance on implicit rather than
explicit assumptions, which makes it difficult for the valuer (and, in due course, a tribunal)
to understand what is really influencing the result. Rather than focus on the key features
of the business being valued, the market approach assumes that all businesses operating in
170
the same sector are subject to the same influences and that the entity being valued is likely
to perform in future in a similar way to the average of other businesses. There is less scope
to take account of why some businesses perform better than others, and less scope to rec-
ognise entity-specific features such as faster growth, lack of growth, new developments or
the need for restructuring.
Cost approach
The cost approach is suited to more limited circumstances, especially asset-based (rather
than trading) entities and those that own readily replicable assets.
Apart from those cases, its most common use is as a check on the reasonableness of the
valuations derived from the income and market approaches.
Adjusting the approach

The discussion so far has focused on the valuation of assets as a whole, but there are many
situations where the FMV of part of an asset is needed, such as shares in a company, part
of a joint venture or an interest in a project. Adjustments are needed to take account of
the differences between valuing the whole of an operating business and valuing only part.
Control
Before looking at the adjustments, it may be helpful to consider why the ownership of part
of a business is valued at less than its proportionate share of the whole; this can be thought
of as the premium for control, or the discount for being a minority, which are two sides of
the same coin.
The owner of the whole of a business has unfettered control of the business itself, the
cash flows that the business will generate, and the decisions as to how those cash flows will
be used. The owner can decide the balance between reinvesting cash flows and extracting
them as dividends, whether to expand or contract the business, which opportunities to
pursue, and which efficiencies to exploit. These are all benefits of control, for which the
owner is entitled to a premium.
In contrast, the partial owner or shareholder is dependent on decisions made either by
others or by consensus, may have limited influence on those decisions and may be at the
mercy of others when it comes to the opportunity to realise some cash flow (in the form
of dividends) from the investment.This lack of control is the reason why owners are willing
to pay a lower price, reflecting a minority discount.
The most obvious place to see this in action is when an offer is made for all the shares
in a quoted company. Prior to an offer, the share price represents the price for a small
ownership share in a larger organisation; when an offer is made for all the shares, the buyer
is expected to (and does) offer a higher price including a premium for control; if the offer
fails, the share price often falls back to reflect the individual shareholders’ inability to obtain
the control premium.
All three approaches discussed above (income, market and cost) focus on entities as a
whole, so automatically take into account a premium for control, with one exception: the
market approach based on trading multiples.This uses data based on the quoted share prices
of comparable companies, and those share prices represent the market’s assessment of the
171
value of a small minority holding in a quoted company, so the result is the value of a small
minority in the subject entity, not the whole. Moving from there to the value of the whole
would require the addition of a control premium.
If the valuer is dealing with a non-controlled asset, such as a partial shareholding in a
larger entity, any valuation arrived at as a proportion of the entire entity will need to be
reduced by a discount for lack of control.
In practice, control is not always an absolute. It is common to find situations where
control is shared, or where a minority owner is protected by limitations on the control
exercised by the majority, usually achieved through a shareholders’ agreement of some kind.
In such case, judgement is required as to the extent of any discount for sharing control.
Marketability
Another factor that is widely recognised as influencing FMV is a lack of marketability; in
other words, an inability of the asset’s owner to realise its value at any chosen time.
Marketability is related to control, in that a controlling owner always has the right
to dispose of the asset, and it is therefore marketable in his hands. Some non-controlling
owners, especially those with relatively small shareholdings in quoted companies, also have
marketability, as they can realise value by disposing of shares in the market at the market
price (larger shareholdings need separate consideration and may have a value below or
above the quoted market price, depending on the wider share ownership structure). Other
non-controlling owners, however, are unable to realise value, perhaps because they cannot
dispose of shares without approval from others, or because there is no ready market for the
shares. This lack of marketability depresses the FMV of the partial ownership.
All the valuation approaches discussed above assume that the owner of the asset has the
ability to realise it, either because they are based on controlling ownership or because they
are based on the share prices of quoted companies, which are normally (by definition) mar-
ketable. If the valuer is dealing with a minority shareholding in a private company, its owner
will normally have little or no opportunity to realise its value, and a discount is therefore
required to take account of this lack of marketability.
FV compared to FMV
The adjustments discussed above are one of the key areas where FV may diverge from FMV.
FMV is focused on the value that the external market would put on an asset, whereas FV
considers the value of the asset as between the parties concerned.
FV is commonly required in situations where parties share control, or where parties
use a corporate entity as the body through which they trade, with no intention or need to
realise value from it. In such circumstances, it may be inappropriate to apply any discount
for lack of control or marketability, even when dealing with a minority shareholding.
Reaching a conclusion
Having considered the different approaches to valuation, most valuers will reach a conclu-
sion on FMV from a combination of approaches.
Provided sufficient information is available on the subject entity, most valuers will begin
with the income approach, using DCF, to reach a valuation of the entire entity, and will
172
regard this as their primary valuation. They will then use the market approach as a second-
ary valuation, to check that the income-based valuation falls within the range that the
market approach would expect.
If there is too little information on which to base a DCF valuation, most valuers will
use the market approach as their primary valuation, recognising the approximations that
it entails, and then use a simplified DCF as a secondary valuation approach to check that
the value given by the market approach is reasonably supported by the business’s expected
future cash flows.
When dealing with trading or operating businesses, most valuers will make little refer-
ence to the cost approach, other than to use it as a sense check on the results obtained from
the income and market approaches.
Some valuers reach a conclusion by taking the results of each approach (or of the
approaches they have selected) and averaging them, rather than choosing what they believe
to be the most appropriate approach and then using the others as checks. This might be
regarded as indecisive and a means of avoiding expressing a view.
Having reached a view on the value of an entity as a whole, the valuer then moves on
to deal with any issues of lack of control (or shared control) and lack of marketability, in
order to arrive at the FMV of the specific asset concerned.
Finally, the valuer should review the conclusion alongside any other relevant data, to
check that the valuation arrived at makes sense in the light of the wider market and in
the context of alternative investments, and to rationalise the result by explaining why it is
higher or lower than might have been expected.
173
12
Income Approach and the Discounted Cash Flow Methodology
Alexander Demuth1
Introduction
When applying the income approach, the theory of business valuation determines the
value of a business by assessing the present value of its future net cash flows.2 Since the
requirement of full compensation is generally interpreted to put the damaged party into
the same economic (i.e., financial) situation it would have been in but for the wrongful act,
the methodology and approaches widely accepted for business valuation are also applied in
the determination of damages.3
The following sections briefly introduce the discounted cash flow (DCF) methodology
and its approaches, and then discuss, in the context of international arbitration, its appli-
cation to the assessment of damages, the assumptions required to adequately and reliably
deploy this methodology and the documentation required to support its results.
1 Alexander Demuth is co-head of A&M GmbH Wirtschaftsprüfungsgesellschaft’s international arbitration

group and leader of its German disputes and investigations practice.
2 Cf. Aswath Damodaran, Damodaran on Valuation – Security Analysis for Investment and Corporate Finance,
Second Edition, 2006 (Damodaran (2006)), page 10; Tim Koller, Marc Goedhart and David Wessels, Valuation
– Measuring and Managing the Value of Companies, Sixth edition, 2015 (Koller et al. (2015)), page 137; Mark
Kantor, Valuation for Arbitration – Compensation Standards,Valuation Methods and Expert Evidence, 2008 (Kantor
(2008)), pages 8 ff. or Joseph J. Galanti, Business Valuation, in Litigation Services Handbook – The Role of the
Financial Expert, Fifth Edition, 2012 (Galanti (2012)), pages 8 ff.
3 Cf. Mark A. Allen, Robert E. Hall and Victoria A. Lazear, Reference Guide on Estimation of Economic
Damages, in Reference Manual on Scientific Evidence, Third Edition, 2011 (Allen et al. (2011)), page 448; or
Michael K. Dunbar, Elizabeth A. Evans and Roman L. Weil, Ex Ante versus Ex Post Damages Calculations, in
Litigation Services Handbook – The Role of the Financial Expert, Fifth Edition, 2012 ((Dunbar et al. (2012)), page 1.
174
The discounted cash flow methodology

Introduction
The DCF methodology determines the business value as the present value of expected
future net cash flows discounted at a rate reflecting the time value of money and the
risks attributable to these cash flows.4 Within the different approaches applied for valu-
ing a business, it ‘comes with the best theoretical credentials’5 and ‘remains a favourite of
practitioners and academics because it relies solely on the flow of cash in and out of the
company, rather than on accounting-based earnings’.6 It is, therefore, less prone to manipu-
lation through the use of accounting policies7 and avoids divergent results from the use of
different accounting principles (e.g., International Financial Reporting Standards (IFRS),
US-Generally Accepted Accounting Principles (US-GAAP)).
The DCF method distinguishes two general approaches, depending on whether the
value is determined for only the equity investment in the business (known as ‘equity valu-
ation approach’) or the entire business (known as ‘enterprise valuation approach’). Both
approaches are broadly accepted but vary with regards to the relevant cash flows and dis-
count rates.8
The equity valuation approach

The equity valuation approach calculates the value of equity by discounting the future net
cash flows after debt payments and reinvestment needs (known as ‘free cash flow to equity’)
at a rate reflecting only the cost of equity.9
The enterprise valuation approach

The enterprise valuation approach calculates the enterprise value of the business through
discounting the future net cash flows before debt payments and after reinvestment needs
(known as ‘free cash flow to the firm’) at a rate reflecting the cost of all sources of capital,
applying a blended cost of capital.10 The equity value can be derived from the enterprise value
by deducting the market value of non-equity claims11 (i.e., primarily interest-bearing debt).
The weighted average cost of capital (WACC) approach is the most commonly used
enterprise valuation approach. It is often used applying a constant discount rate, which
would require a stable capital structure (i.e., a constant ratio of the market value of debt to
the market value of equity). But, since the capital structure typically changes over time, the
4 For an overview of other valuation methodologies, see the chapter on ‘Overview of Methodologies for
Valuing Fair Market Value’ in this publication.
5 Damodaran (2006), page 10; cf. Kantor (2008), pages 131 f.
6 Koller et al. (2015), page 137.
7 Cf. Patrick A. Gaughan, Henry Fuentes and Laura Bonanomi, Cash Flow Vs. Net Income In Commercial
Litigation, Litigation Economics Digest 1(1), 1995 (Gaughan et al. (1995)), page 13.
8 Aswath Damodaran, Investment Valuation - Tools and Techniques for Determining the Value of Any Asset, Third
Edition 2012 (Damodaran (2012)), pages 12 ff.
9 Cf. Damodaran (2006), page 12; or Damodaran (2012), page 351.
10 Cf. Damodaran (2006), pages 11 and 209; Damodaran (2012), page 380; or Koller et al. (2015), page 138.
11 Cf. Koller et al. (2015), page 150 f. for a list of the most common non-equity claims.
175
use of a constant WACC may not be appropriate. Instead, it needs to be adjusted through-
out the valuation period to reflect the changes in the capital structure.12
Alternatively, the adjusted present value (APV) approach can be employed, which deter-
mines the enterprise value by first calculating the enterprise value of the business assuming
no leverage (i.e., no non-equity claims), and second, adding thereto the value of the tax
implications of debt financing (i.e., the value of the tax-deductibility of interest expenses).
This approach uses cost of equity to calculate the unlevered enterprise value and cost of
debt to calculate the present value of the tax-savings from debt financing.13 Theoretically,
the APV and WACC approaches should determine an identical business value, as the only
distinction between them is how the impact of debt financing is considered.14
Application of the discounted cash flow methodology to the assessment of

damages in international arbitration
Introduction
The use of the DCF methodology discussed above will generally require some modifica-
tion to quantify damages in international arbitration, as the required full compensation
may necessitate a ‘damages computation that is markedly different than a standard business
valuation’.15
The standard approach to determine this full compensation is a comparison of the
damaged party’s actual situation with the situation it would have been in ‘but for’ the
wrongful act (i.e., the ‘but-for method’).
Depending on the facts and circumstances, damages will be assessed as a loss in business
value or as lost profits.
Also, while business valuation is typically based on the information available at the
valuation date (the ex ante approach) the quantification of damages also regularly considers
information available up to the date of the assessment (the ex post approach).
Furthermore, in some instances the quantification of damages may be easier by directly
assessing the cash flow resulting from the wrongful act (direct assessment) than by com-
paring two sets of cash flows with and without the influences of the wrongful act (indi-
rect assessment).
Finally, a prerequisite of a useful damage quantification is the consistent application of
these concepts, including the use of a proper valuation model.
12 Even though modelling these changes requires an iteration and is therefore more complex than using a
constant WACC, the use of a period-specific WACC has become market standard as supported by Damodaran
(2006), page 194: ‘one of the biggest strengths of the [WACC] model is the ease with which changes in the
financing mix can be built into the valuation through the discount rate.’
13 Cf. Koller et al. (2015), page 137 and pages 155 ff.; Damodaran (2006), pages 211 ff; or Damodaran (2012),
pages 398 ff.
14 Cf. Koller et al. (2015), page 137; or Damodaran (2006), page 215.
15 Everett P. Harry, Lost Profits and Lost Business Value – Differing Damages Measures, Dunn on Damages, Issue 1,
Winter 2010 ((Harry (2010)), page 6.
176
The but-for method

The but-for method determines the amount required to compensate the damaged party by
comparing its actual position to the hypothetical position it would be in but for the wrong-
ful act.16 The but-for scenario always refers to a hypothetical situation, and thus cannot be
established with certainty, but needs to comply with the principle of reasonable certainty
and avoid undue speculation. In contrast, the actual situation is generally observable (e.g.,
from the damaged party’s accounting records). Nonetheless, the actual situation may also
require adjustments, most importantly with regards to the identification, assessment and
elimination of other factors that may have influenced the actual situation but are not attrib-
utable to the wrongful act17 (e.g., external factors such as a market decline). Furthermore, to
the extent the damages continue beyond the date of the damages assessment, the actual sce-
nario will necessarily also include a financial forecast of the expected actual development.18
Loss in business value v. lost profits

Applying the income approach, damages may be assessed as the loss in business value or
as lost profits.19 While the loss in business value is determined as the difference between
the present value of all future earnings or cash flows of the business with and without the
wrongful act (i.e., by comparison of two business values), lost profits represent the differ-
ence between the earnings or cash flows with or without the wrongful act during the
damages period.20
Even though the loss in business value is conceptually comparable to a standard busi-
ness valuation, the latter aims to determine the fair value of a business based on objective
measures, which may not be applicable to the damaged party, thus rendering its results
inappropriate for the determination of damages.21 These approaches only converge for
damages incurred through the destruction of a business, since these are generally assessed as
the market value of the business at the time of loss.22
The lost profit approach calculates damages as but-for profits less actual profits, where
but-for profits are determined as but-for revenues, which would have been earned during
the damages period but for the wrongful act, less the avoided cost (i.e., the incremental
costs that were not incurred because of the loss of revenue).23
16 Cf. Allen et al. (2011), page 432; or European Commission, Practical Guide, Quantifying Harm in Actions for
Damages based on Breaches of Article 101 or 102 of the Treaty on the Functioning of the European Union,
2013 (EC (2013)), page 7. While this guide is concerned with antitrust issues, the methods discussed equally
aim for full compensation of the damaged party.
17 Cf. Richard A. Pollack, Scott M. Bouchner, Craig M. Enos, Colin A. Johns and John D. Moyl, AICPA Practice
Aid 06-4, Calculating Lost Profits, 2006 (Pollack et al. (2006)), page 20.
18 Cf. Pollack et al. (2006), page 27.
19 Cf. Harry (2010), page 6.
20 Cf. Kenneth M. Kolaski and Mark Kuga, Measuring Commercial Damages via Lost Profits or Loss of Business
Value: Are these Measures Redundant or Distinguishable?, Journal of Law and Commerce, Fall 1998 (Kolaski/
Kuga (1998)), page 1.
21 Cf. Harry (2010), pages 6 f.
22 Cf. Kolaski/Kuga (1998), page 5.
23 Cf. Pollack et al. (2006), para. 4; or Elizabeth A. Evans, Joseph J. Galanti and Daniel G. Lentz, Developing
Damages Theories and Models, in Litigation Services Handbook – The Role of the Financial Expert, Fifth Edition,
177
In comparison, an important conceptual distinction between the loss in business value

and lost profits is the time horizon considered in the damages assessment and the additional
assumptions and considerations required for the loss in business value as a result thereof
(e.g., the discussion of a terminal value or growth rate).24 Since, ceteris paribus, both concepts
should theoretically determine the same amount of damages for a finite damages period
during which a reduction of earnings or cash flow has been caused by a wrongful act, the
use of the lost profits approach appears preferable to avoid these additional assumptions
required for the loss in business value approach.
Another important distinction relates to the information used. While the assessment
of the loss in business value typically only considers information available (i.e., known or
knowable) at the date of the wrongful act, the determination of lost profits typically also
includes information available until the date of the damages calculation (i.e., makes use of
hindsight).25
As lost profits are theoretically a subset of the loss in business value, double recovery
needs to be avoided when both concepts are applied in parallel.26 Furthermore, it is dis-
cussed whether a claim for lost profits may be limited by the business value at the date
of loss.27
Ex ante v. ex post approach

When assessing business damages, the ‘unavoidable issue of temporal perspective’28 needs to
be decided (i.e., whether to apply the ex ante or the ex post approach).The ex ante approach
‘relies only on information that was known or knowable as of the date of the breach’29
and requires all damages to be discounted back to the date of the wrongful act. In contrast,
the ex post approach ‘relies on all information that is known or knowable up to the date of
trial’30 and requires prior damages to be compounded, if permitted,31 and later damages to
be discounted to that date.
One argument for the ex ante approach refers to the allocation of risk as it properly
measures the damages at the time of the wrongful act capturing the probability of the
entire spectrum of outcomes, whereas the ex post approach converts a risky business into a
certain outcome.32
While the ex ante approach is thus ‘confined to reasonable expectations at the time’,33
the reconstruction of the information available and reasonable expectations as of the date
2012 (Evans et al. (2012)), page 29.

24 See ‘Developing and reviewing terminal value and terminal growth rate’, infra.
25 See ‘Ex ante v. ex post approach’, infra.
26 Cf. Kolaski/Kuga (1998), pages 10 f.
27 Cf. Kolaski/Kuga (1998), page 9; or James L. Plummer, Is the Value of a Firm the Upper Limit of Future Lost
Profits in Business Litigation?, Litigation Economics Digest 1(1), 1995 (Plummer (1995)).
28 John D. Taurman and Jeffrey C. Bodington, Measuring damage to a firm’s profitability: ex ante or ex post?, The
Antitrust Bulletin, Spring 1992, (Taurman/Bodington (1992)), page 59.
29 Pollack et al. (2006), page 36; cf. Dunbar et al. (2012), page 2.
30 Pollack et al. (2006), page 36; cf. Dunbar et al. (2012), page 3.
31 Cf. Pollack et al. (2006), pages 33 f. for a discussion of prejudgment interest on past losses.
32 Cf. Dunbar et al. (2012), pages 4 f.
33 Taurman/Bodington (1992), page 71.
178
of the wrongful act may prove difficult and is ‘vulnerable to actual data’.34 To overcome
these difficulties, typical reference materials include historic financials, contemporaneous
forecasts and budgets, industry or market studies, including studies published shortly after
the time assuming that the information was available prior to their publication, or contem-
poraneous analyst coverage. To ensure consistency with this approach, subsequent infor-
mation, including about mitigation, should not be considered.35 Nevertheless, sometimes
subsequent information is used as a benchmark to assess the reasonability of the contem-
poraneous financial forecast.36
The ex post approach is arguably better suited to warrant full compensation (i.e., put-
ting the damaged party in the same position it would have been in but for the wrongful act
at any time),37 not least through the use of hindsight, which reduces uncertainty. But, the
use of hindsight may also influence the development of the hypothetical but-for scenario,
potentially allowing for subtle manipulation.38 Furthermore, the ex post approach may
result in the damages award exceeding the fair value that the damaged party was deprived
of, as hindsight will clarify whether risks have materialised (i.e, ‘the claim for compensation
may appear to be worth more than the opportunity itself.’)39 Finally, damages will vary over
time until the end of the damages period as new information becomes available.40
In practice, a hybrid approach can sometimes be found ‘in which all lost profits are dis-
counted back to the date of the breach, but the practitioner would rely on all information
that was available up to the date of trial’,41 thereby using the book of wisdom to eliminate
‘some speculation as to what the cash flows would have been’.42
Since both approaches are widely accepted and neither is theoretically unsound, their
applicability and reasonability needs to be carefully assessed, considering the facts and cir-
cumstances of the individual case, as their results may vary significantly.43
Direct v. indirect assessment of damages

Damages can be assessed directly or indirectly, depending on whether the impact of a
wrongful act on the relevant cash flow can be identified and quantified distinctly.
As the direct assessment of damages avoids the need for comparison and the cash flows
used are identified based on their causal dependence on the wrongful act, this approach
appears preferable from an evidential perspective. But, this approach may underestimate the
amount of damages by failing to identify all direct influences on the cash flow and its inabil-
ity to capture consequential damages or mitigating factors. Furthermore, even if identified,
34 George P. Roach, Correcting Uncertain Prophecies: An Analysis of Business Consequential Damages, The
Review of Litigation, Winter 2003 (Roach (2003)), page 68; Cf. Dunbar et al. (2012), page 4.
35 Cf. Dunbar et al. (2012), page 5.
36 Cf. Taurman/Bodington (1992), page 77; or Roach (2003), page 38.
37 Cf. Dunbar et al. (2012), pages 8 f.
38 Cf. Taurman/Bodington (1992), page 71.
39 Taurman/Bodington (1992), page 79; cf. Dunbar et al. (2012), page 9.
40 Cf. Dunbar et al. (2012), page 9.
41 Pollack et al. (2006), page 36; cf. Taurman/Bodington (1992), footnote 16, discussing the mixture of ex ante
and ex post information as being flawed.
42 Dunbar et al. (2012), pages 10 f.
43 Cf. Roach (2003), pages 35 ff.; or Taurman/Bodington (1992), pages 67 and 97.
179
these consequential damages or mitigating factors are typically not directly quantifiable
(i.e., their impact on the cash flow cannot be assessed in isolation). Consequently, the direct
assessment of damages is practically limited to narrowly defined damages occurring over a
reasonable, short time period.
In contrast, the indirect assessment of damages is based on a comparison of the actual
with a hypothetical cash flow but for the wrongful act44 and thus implicitly considers all
financial impacts, including consequential damages and mitigating factors. However, this
approach may overestimate the amount of damages by including financial impacts unre-
lated to the wrongful act. Therefore, one of the most important issues is to identify, to
quantify and to exclude the financial implications of unrelated influences from the damages
calculation to the extent possible.45
The use of a valuation model

Practically, the choice of whether to use a rather simple or a more sophisticated valuation
model is often influenced by the availability of financial and other information and the
approach applied. While the direct assessment of damages lends itself to a simpler model,
the indirect assessment of damages typically necessitates an integrated model.
Accordingly, a simple model may include only a cash flow projection, while an inte-
grated financial model typically includes financial projections for the income statement,
the balance sheet and the cash flow statement. The integration refers to financial and other
interdependencies modelled between input parameters, calculations and results (e.g., a
change in revenue resulting in an adjustment to trade receivables and thereby also to net
working capital).46
Best practice requires a financial model to distinguish between input parameter, the cal-
culation itself and the output of results.47 Best practice further requires simplicity as ‘more
detail creates the need for more inputs, with the potential for error in each one, and gener-
ates more complicated models.’48 This will also improve the reviewability of the financial
model, thus enabling an easier understanding and assessment of the mathematical accuracy
and the applicability of the financial model for the specific damages quantification.49
In conclusion, a financial model should focus on the most important issues (i.e., the key
value drivers or key financial parameters with a more than insignificant influence on the
result), but at the same time should not oversimplify the reality.
44 See ‘The but-for method’, supra.

45 Cf. Pollack (2006), page 20.
46 Given the complexity of integrated financial models, the use of computer-based tools, e.g. a spreadsheet
software, is market standard.
47 Cf. Koller et al. (2015), pages 229 ff.
48 Damodaran (2006), page 8.
49 Cf. Kantor (2008), pages 301 ff., suggesting that the arbitral tribunal should obtain the financial models.
180
Assumptions required to adequately use the discounted cash flow

methodology in international arbitration
Introduction
The determination of a business value, as well as the determination of damages, is based on
a few general but key parameters that need to be determined depending on the individual
facts and circumstances (i.e., the valuation object, the valuation date and the valuation or
loss period).
Once these parameters have been decided, the financial information that coincides
with these decisions must be determined, including the relevant prospective financial infor-
mation to be used; for example, a business plan or a financial forecast, whether or not to
consider a terminal value, the applicable currencies and exchange rates, if any, and whether
or not inflation needs to be considered expressly.
Upon determining the relevant cash flows, the time value of money and the riskiness
of the cash flows need to be considered by calculating the present value of the cash flows
through compounding of past cash flows, if applicable, and discounting of future cash flows
to the valuation date.
Finally, to fully compensate for the wrongful act, the tax implications of the potential
award need to be considered.
Key parameter
The valuation object
The valuation object represents the business to be valued or the damages to be assessed.The
appropriateness of the result is directly dependent on a distinct and definable identification
of the valuation object, considering the prerequisite of causation.50 The more narrowly
the valuation object is defined, the fewer other influences will impact the result of the
calculation and, consequently, the less information and fewer adjustments will be required.
Therefore, damages should be determined on the basis of the smallest entity or unit for
which individual cash flows can be determined; for example, a company, a business unit, a
profit centre or a product.51 The identification of the valuation object will typically involve
a review of the existing internal and external financial reporting; for example, annual,
quarterly or monthly financial statements, (monthly) management reporting, profit or cost
centre reporting, or reporting on cost units such as products or projects.
The valuation date

As the value of businesses varies over time as a consequence of changes in the markets or
the business itself, the appropriate date as of which the valuation object is to be valued must
be identified.52 The valuation date is a technical issue, as it represents the point in time to
which all past cash flows are compounded and all future cash flows are discounted53 and
50 Cf. Pollack et al. (2006), pages 19 f., discussing the requirements of transaction causation and loss causation.
51 Cf. the concept of IFRS’ Cash Generating Units as defined in IAS 36.6, or the similar concept of US GAAP’s
Reporting Units as described in the ASC 350-20-35-33 ff. of the FASB.
52 Cf. Damodaran (2006), page 5; or Galanti (2012), page 7.
53 See ‘Considering an adequate discount rate’, infra.
181
determines which information can, should or must be used.54 As discussed above, a later
valuation date may enable the use of more timely information, even when applying the ex
ante approach.
The valuation or loss period

While business valuation generally assumes a perpetual valuation period, the loss period
needs to consider the time from the commencement of the wrongful act until the cessation
of its economic impact on the damaged party.55 Therefore, the loss period will generally
be limited, for example, by the contractual terms or the return of the business to custom-
ary levels.56
In a breach of contract matter, the loss period will usually extend over the remaining
contract term, which may include contract renewals based on an analysis of the history of
renewals, considering potential negotiations prior to the breach and other facts and cir-
cumstances as a result of which a renewal could not have been avoided (e.g., a sole supplier
agreement).57
In the absence of a contractual limitation, there is a rebuttable assumption that the dam-
aged business will return to its customary levels over a definite period of time, thus limiting
the damages period.
Other than with regard to the destruction of a business,58 damages will have a perpetual
or indefinite effect only in rare circumstances. In these situations, a terminal value needs to
be considered,59 suggesting the use of the loss in business value approach.
Financials
Introduction
Determining the free cash flow to firm as a basis for the business valuation or assessment
of damages requires the existence or projection of an integrated set of financial statements
(i.e., an income statement, a balance sheet and a cash flow statement).60
Furthermore, when damages extend for an indefinite time, a terminal value and a ter-
minal growth rate must be considered.
Finally, depending on the facts and circumstances, special attention may be required
with regard to currencies and exchange rates or inflation.
54 See ‘Ex-ante v. ex-post approach’, supra.

55 Cf. James R. Hitchner, Financial Valuation, Applications and Models, Second Edition, 2006 (Hitchner (2006)),
page 1036.
58 Cf. Kolaski/Kuga (1998), page 5.
59 See ‘Developing and reviewing terminal value and terminal growth rate’, infra.
60 Cf. Koller et al. (2015), pages 232 f.
182
Developing and reviewing prospective financial information

The income statement
Introduction
The income statement reports a business’s financial performance over a specific period. It
is used to assess the business’s ability to produce net income for its owners. The analysis of
historic income statements typically reveals relevant information to be used in the prepara-
tion or review of prospective financial information (e.g., financial ratios such as the gross
margin). When assessing income statements, the accounting principles61 applied must be
considered, as material deviations may exist in the way these recognise or measure revenues
or costs.
Developing and reviewing revenue projections

Revenue is generally defined as the gross inflow of economic benefits arising from an
entity’s operating activities, such as sales of goods or services. It represents the product of
the volume of goods and services sold and their corresponding prices.62
The assessment or projection of revenues (or lost revenues) needs to consider the eco-
nomic environment of the business (i.e., the demand for its products or services, the supply
of materials, people and know-how, the type of competition and number of competitors,
and potential disruptive impacts, for example, the substitution of the products or services
by other products or services). Sources to identify or validate such influences are, among
others, market share analyses, market studies, industry studies, analyst coverage, financial
reporting of the business or its competitors, analyst coverage or information derived from
the business itself (e.g., information memoranda).
Revenues (or lost revenues) are at the heart of the financial statement analysis and pro-
jection, as almost every other line item directly or indirectly depends on them63 and their
projection is likely ‘the most controversial part of any damages estimate in a business case
because it requires so many assumptions’.64
The determination of lost revenues (i.e., those revenues ‘that would have been earned
but for the wrongful act’)65 is the first step in establishing lost profits. This concept aims
to identify only incremental revenues and requires a careful analysis of causality to avoid
both the inclusion of revenues unaffected by the wrongful act and the exclusion of rev-
enues affected by the wrongful act. Frequently used approaches to determine lost rev-
enues are: (1) the before-and-after method; (2) the yardstick or benchmark method; and (3)
61 E.g., International Financial Reporting Standards (IFRS), United States Generally Accepted Accounting
Principles (US-GAAP) or other.
62 Cf. IAS 18, Revenue; note that the standard will be replaced IFRS 15, Revenue from Contracts with
Customers, as of 1 January 2017.
63 Cf. Koller et al. (2015), page 233.
64 Allen et al. (2011), page 499.
65 Pollack et al. (2006), page 3.
183
reference to contractual terms.66 Alternatively, time-series models or econometric models

may be employed.67
The before-and-after method compares a period during which the revenue is impacted
by the wrongful act (loss or damages period) with a period of unaffected revenues (bench-
mark or base period). Importantly, the benchmark period needs to be a reliable indica-
tor representative of the damaged party’s reasonable prospects. While generally a longer
benchmark period will produce more reliable observations, sometimes even a very short
period (only a few months) may be acceptable. But, the unavailability of a reliable bench-
mark period, for example, because of a lack of a track record, renders the before-and-after
method inappropriate. As the selection of the benchmark period may have a significant
impact on the damages, it requires a convincing reasoning and consistent application (e.g.,
it should be identical for revenues and cost). The before-and-after method is considered
the most reliable approach, as it relies on verifiable data rather than projections (e.g., the
damaged party’s accounting records.68 The lost revenues are determined as the difference
between the revenues of the benchmark period and the damages period, assuming that
but for the wrongful act the same level of revenue should have been obtained. If a growth
trend is observable during the benchmark period, or revenue growth is expected based on
other information, the projected revenues may consider a growth rate. While typically this
growth rate is derived and extended from the benchmark period, this approach may not
always be suitable, especially with young businesses or in declining markets.69 Finally, the
before-and-after method requires the analysis of whether other factors, such as changes in
the economic conditions (e.g., inflation, general price erosion, changes in demand, changes
in competition or mismanagement of the business) have caused or contributed to the devi-
ation of the actual revenue from the but-for revenue and to control (i.e., eliminate) these
other factors to avoid overcompensation or under-compensation of the damaged party.70
This may also involve the elimination of such factors from the actual financial data to iso-
late the marginal effect of the wrongful act.71 The failure to control these other factors may
result in phantom losses or significantly exaggerate lost revenues, resulting in unreasonable
and unjustified damages.72
The yardstick or benchmark method also relies on observable information but refers to
similar assets or businesses. Therefore, its use and reliability is dependent on the identifica-
tion of a truly comparable business and the availability of the required information. Possible
66 Cf. Pollack et al. (2006), page 25; or EC (2013), pages 14 ff., referring to comparator-based methods.
67 Cf. Carroll B. Foster, Robert R. Trout and Patrick A. Gaughan, Losses in Commercial Litigation, Journal of
Forensic Economics 6(3), 1993 (Foster et al. (1993)), pages 184 ff.
68 Cf. Robert M. Lloyd, Proving Damages for Lost Profits: The Before-and-After Method, 2014, University of
Tennessee (Lloyd (2014)), page 1; or EC (2013), page 16.
69 Cf. James Plummer and Gerald McGowin, Key Issues in Measuring Lost Profits, Journal of Forensic Economics,
Vol. 6, No. 3, 1993, page 232 (Plummer/McGowin (1993)); or Kolaski/Kuga (1998), page 2; and refer
to ‘Developing and reviewing prospective financial information’, infra, for a further discussion on the
determination of growth rates.
70 Cf. Pollack et al. (2006), pages 20 and 25 f.; or Lloyd (2014), pages 6 ff.
71 Cf. Roach (2003), page 56.
72 Cf. Jonathan T. Tomlin and David R. Merrell, The Accuracy and Manipulability of Lost Profits Damages
Calculations: Should the Trier of Fact be “Reasonably Certain”?, The Tennessee Journal of Business Law,Volume
7, 2006 (Tomlin/Merrell (2006)), pages 303 ff. ; or EC (2013), page 16.
184
yardsticks or benchmarks include revenue from the same business in a different geographic
market, revenue projections developed prior to the wrongful act, revenues of a similar busi-
ness with comparable market characteristics, sufficiently similar revenues of third parties,
or industry averages. Importantly, the use of the comparable information typically involves
adjustments to eliminate any differences between the valuation object and the comparable
business (e.g., with regard to sales volume or geographic footprint). Finally, the yardstick or
benchmark method requires controlling other factors that may have influenced the actual
results of either the valuation object or the comparable business to avoid overcompensation
or under-compensation.73
In a breach of contract matter, the contract typically provides details for material assump-
tions that must be considered (e.g., the sales volume, prices, (remaining) contract term).74
Finally, the projection of (lost) revenues must be sense-checked to ensure the rea-
sonableness of the results. These checks may refer to external information, such as market
studies, market share analysis, analyst coverage, competitor analysis or industry experts, or
may use internal information, such as capacity constraints or the assessment of earlier per-
formance, including budget-to-actual comparisons.75
Developing and reviewing cost projections

While generally costs cover a business’s gross outflow of economic benefits (i.e., the money
used), the concept of avoided cost referred to in the assessment of lost profits considers
only ‘those incremental costs that were not incurred because of the loss of the revenue’.76
Just like lost revenues, the ‘calculation of avoided costs is a common area of disagreement
about damages.’77
In an income statement compliant with the internationally prevailing cost of sales
method, the major cost categories are cost of goods sold, selling, general and administrative
expenses, and other expenses.78 The costs of goods sold reflect the costs directly attributable
to the production of goods or services rendered and typically include direct labour and
material costs. While they are generally expected to vary directly with revenues, they may
also include fixed costs (e.g., the depreciation of machinery and equipment used in the pro-
duction). Conversely, selling, general and administrative expenses, as well as other expenses,
primarily include costs not directly related to revenue (e.g., compensation of officers, office
supplies or vehicle costs) but they may also include costs that vary with levels of revenue
(e.g., marketing spend or advertising costs).79
The distinction between variable and fixed costs is an important aspect of the identifi-
cation and quantification of avoided costs, as these do not consider fixed costs that would
have been the same with or without the wrongful act.80 The assessment of whether or
73 Cf. Pollack et al. (2006), page 26; or EC (2013), pages 19 f.

76 Pollack et al. (2006), page 3.
77 Allen et al. (2011), page 449.
78 In other formats of the income statement, e.g., the nature of expense method, the distinction between variable
and fixed costs can be even less discernible.
79 Cf. Allen et al. (2011), page 450; or Foster (1993), pages 183 f.
80 Cf. Pollack et al. (2006), page 29; Allen et al. (2011), page 499; or Plummer/McGowin (1993), page 233.
185
not costs are variable (i.e., will change with each unit of production) or fixed (i.e., will
not change irrespective of the units of production) needs to consider that almost no cost
is purely variable or fixed. Depending on the level of production, some costs are fixed
within certain levels but vary outside these levels (e.g., semi-variable cost). Furthermore,
the length of the loss period needs to be considered, as a longer loss period will result in
more costs being considered variable because they could be avoided.81 And, while some
costs may vary directly with revenues, they may, nonetheless, not or no longer be avoid-
able; for example, costs of goods sold already incurred for finished products that cannot be
delivered because of the wrongful act.82 Consequently, the application of the concept of
avoided costs requires a thorough understanding of the damaged party’s cost structure to
identify the major cost drivers and other factors that may affect particular costs.83 This also
entails the identification and adjustment for extraordinary and other unusual costs to reflect
the ordinary business activity.84
Generally, external financial reporting will not provide a sufficient level of detail to
differentiate between fixed and variable costs and, therefore, more detailed information is
required on the level of individual cost categories, cost centre or cost units,85 which will be
available at varying degrees and in various formats. A thorough review and analysis of this
actual cost information, typically involving monthly, quarterly or yearly cost information, as
well as useful planning measures (e.g., standard costs) forms the basis for the development
or review of cost expectations. Based thereon, either non-statistical or statistical methods
may be applied to determine which costs vary with revenue.
Non-statistical methods include an account analysis (i.e., a review of a detailed general
ledger or chart of accounts to subjectively identify variable costs); the identification of
direct costs related to an activity or product (e.g., direct labour and material costs); the use
of standard costs or other reports available from the damaged party; the use of ratio analy-
sis (i.e., cost allocation in proportion to a specific measure – e.g., labour hours or unit of
production); reference to industry standards (i.e., based on industry studies or comparable
information); or a per cent of sales approach (i.e., the determination of a per cent quota for
each avoided cost in relation to revenues). These approaches may capture incremental costs
incompletely, are prone to errors and are highly subjective. Their application, therefore,
requires comprehensive and reasonable documentation.86
More reliable statistical methods87 include regression analysis,88 which identifies pat-
terns in the relationship between revenues and costs, including the extent to which cer-
tain costs are influenced by revenues. In addition, the quality of the regression analysis
(i.e., the predictive power of the regression model) can be back-tested to the benchmark
period and statistically corroborated by an analysis of the correlation coefficient. The
81 Cf. Foster et al. (1993), page 193; or Plummer (1995), page 31.

82 Cf. Pollack et al. (2006), page 30; or Allen (2011), page 450.
83 Cf. Pollack et al. (2006), page 29; or Foster et al (1993), page 193.
84 Cf. Damodaran (2006), pages 91 f.
85 Cf. Plummer/McGowin (1993), page 233.
86 Cf. Pollack et al. (2006), pages 30 f.
87 See the chapter on ‘The Use of Econometric and Statistical Analysis and Tools’ in this publication.
88 Cf. Pollack et al. (2006), page 31; Allen (2011), page 450; Foster et al. (1993), page 191; or Plummer/McGowin
(1993), pages 233 f.
186
reasonable use of a regression analysis is primarily dependent on a sufficient number of

observations (i.e., data)89 and a thorough understanding of the business to formulate valid
hypotheses. Econometric techniques may further improve the assessment but require even
more information.90
To the extent available and existent, contractual agreements will need to be considered
irrespective of the approach, and may determine, for example, the purchase price and vol-
umes for materials and services.
To assess the reasonability of the resulting costs, cost ratios may be compared internally
to prior periods, other markets and other products, or externally to competitors or market
information.91 In addition, the reasonability is frequently assessed by reference to margins,
especially to the gross margin.92 This comparison, however, needs to recognise the lack of
comparability, as lost profit does not equate to the definition of net income. Instead, the lost
profit margin is best described as incremental profit margin (i.e., the change of net income
as a result of the lost revenues). Because of its composition it should typically fall between
the historic gross profit margin and historic net profit margin.93 Furthermore, for longer
loss periods, this incremental profit margin should decline over time, reflecting the business
adjustments of the damaged party (i.e., mitigation).94
Considering corporate income taxes

While business valuation typically considers after-tax results,95 damages are generally deter-
mined on a pre-tax basis, assuming that any compensation will be taxed at the level of the
damaged party.96
When corporate income taxes are considered, it needs to be decided whether a mar-
ginal tax rate or the effective tax rate is applied. While the marginal tax rate can be read
from the applicable tax law and assumes that the corporate income tax for the business or
damages is independent from any other tax issues, the effective tax rate is determined by
reference to actual financial information comparing the tax payments with the income
before tax, thereby considering any company-specific tax issues.
To the extent existent, corporate income tax loss carry-forwards need to be considered
to the extent they are applicable to the damaged business and could be used to offset its
future tax payment obligations. Determining the timing and amount of this offsetting typi-
cally requires detailed tax planning.
A further complication may result from the business’s operation in multiple tax juris-
dictions. Not only will these likely provide for different corporate income tax rates, they
may also define taxable income differently. Furthermore, based on local tax law or double
tax treaties, international taxation will usually involve the deduction of foreign taxes or the
exemption of foreign income from local corporate income taxes under certain restrictions.
89 Cf. EC (2013), pages 24 f.

90 Cf. EC (2013), page 32.
92 Cf. Foster et al. (1993), page 181.
93 Cf. Plummer/McGowin (1993), page 232; or Foster et al. (1993), page 181.
94 Cf. Plummer/McGowin (1993), page 235; or Allen et al. (2011), page 450.
95 Cf. Damodaran (2006), pages 92 ff.
96 See ‘Considering a tax step-up’, infra.
187
The balance sheet

Introduction
The balance sheet is a financial statement that captures a business’s assets, liabilities and
equity at a specific point in time. The review of historic balance sheets and their devel-
opment over time typically reveals relevant information to be used in the preparation or
review of prospective financial information (e.g., financial ratios such as the equity ratio
or liquidity ratios and their development over time). When assessing balance sheets, the
accounting principles97 applied must be considered, as material deviations may exist in the
way these rules recognise or measure assets, liabilities or equity.
For the valuation of a business or the assessment of damages as a loss in business value,
the balance sheet, in addition to the income statement, is required as a basis on which to
develop the statement of cash flows.98 As the determination of damages as lost profits typi-
cally assumes lost revenues and avoided cost to be equivalent to cash flow, a balance sheet
is not always required.
Developing and reviewing projected capital expenditures

Capital expenditure (CAPEX) refers to the use of funds to acquire or to improve the use-
ful life of long-lived assets (i.e. assets, providing future economic benefit to the business
beyond the current year or reporting period).These costs will be recognised in the income
statement of the business as depreciation or amortisation over the useful life of the asset.
The analysis of past investment spending should identify and differentiate between
investments for growth and investments for maintenance to assess the level of investments
required to sustain the business and the related cash outflow in future periods. It should also
review past patterns of investments to identify issues such as cyclicality that would require
periods of peak investments.
The analysis of the financial projection should focus on whether the investment spend-
ing is in line with actual observations, or if any changes thereto are reasonable and suf-
ficiently explained; for example, after a period of growth the business may reach a more
steady state, resulting in a decline of growth investments or, conversely, the budget may
consider significant growth that requires increased investment spending in the near term.
To assess the reasonability and consistency of the projected financial information, the
level of long-lived assets may be compared to the level of revenue, assuming that a certain
level of long-lived assets is required to deliver the business’s products or services.99 In addi-
tion, a comparison of the sales volumes required to obtain the projected revenues with the
volumes of production may identify capacity constraints.
Furthermore, benchmarking against competitors or industry standards may identify
inconsistencies that could indicate insufficient investment spend. This analysis should also
involve an assessment of the market size (volume) and the respective market shares (vol-
ume) to ensure that sufficient capacity is available to service the expected market share of
97 E.g., International Financial Reporting Standards (IFRS), United States Generally Accepted Accounting
Principles (US-GAAP), or others.
98 Cf. Brealey et al. (2012), pages 63 ff., the so-called indirect approach derives the cash flow statement from the
income statement and changes in balance sheet positions.
188
the business and to compare the expected growth of the market with the growth assumed
for the business.
Developing and reviewing projected net working capital

Net working capital is generally defined as current assets less current liabilities at a specific
point in time. It is used to assess the business’s short-term financial health and its efficiency
in converting products into revenue. While in practice there are numerous definitions to
match the requirements of a specific business, the narrowest definition will typically entail
inventories, trade accounts receivable and trade accounts payable.100
To analyse actual levels of net working capital and to project future levels of net work-
ing capital, the working capital turnover ratio101 can be considered, which measures the uti-
lisation of working capital to generate revenues. Furthermore, the key metrics days sales of
inventory (DSI),102 days sales outstanding (DSO)103 and days payables outstanding (DPO)104
are frequently referred to.105 While DSI is a measure of inventory effectiveness indicating
the number of days it takes to convert inventory into revenue, DSO indicates the number
of days it takes to collect the cash following the sale, and DPO indicates the number of days
the business uses to pay its suppliers after the purchase or acquisition of their products or
services. These metrics can be combined into the cash conversion cycle,106 which indicates
the length of time the cash used to acquire resources needs to be financed before cash is
received from the business’s operation.
The analysis of these metrics over time may indicate changes in the business (e.g., new
products or markets), or in the business processes (e.g., in the introduction of a just-in-time
production), or changes in the financing of the business (e.g., by extending the period
before paying creditors). Significant changes will require an explanation and an assessment
of their sustainability (e.g., a projected increase in working capital may result from an unre-
alistic assumption regarding payment terms).
Benchmarking these metrics with comparable companies or industry standards will fur-
ther indicate the competitiveness of the terms and thus their likely market acceptance (e.g.,
a much longer DPO in comparison to competitors may not be sustainable with suppliers).
Developing and reviewing projected financing (net debt)

Net debt is generally defined as interest bearing short-term and long-term debt less cash
and cash equivalents (i.e., current assets that can quickly be liquidated for cash) at a specific
point in time. It indicates the business’s ability to pay off its debts using its available cash
and highly liquid assets.
The analysis of historic levels of net debt should indicate the level and structure
of financing required to sustain the business’s operations and can be used to assess the
100 These items will generally also be included in any derivation of the net working capital definition.
101 Working capital turnover ratio = Revenue / Working Capital, whereas revenue is typically for a 12 months
period and working capital is the average working capital over that same period.
102 Days Sales of Inventory = (inventory / cost of sales) * 365, assuming a period of one year.
103 Days Sales Outstanding = (trade accounts receivable / revenues) *365, assuming a period of one year.
104 Days Payables Outstanding = (trade accounts payable / cost of sales) * 365, assuming a period of one year.
106 Cash conversion cycle = Days Sales of Inventory + Days Sales Outstanding – Days Payables Outstanding.
189
reasonableness of financial projections. While long-term debt will typically be based on

contractual agreements (e.g., loans), which should form the basis for the projection of these
debt items, including a potential repayment or renewal, short-term debt is often agreed
as an overdraft facility or a borrowing limit. Consequently, a financial projection needs to
consider these limits.
Benchmarking with comparable companies or industry standards may identify vari-
ations of the level or structure of indebtedness and may indicate an adjustment to the
debt level.
Considering special items

In addition to the above, there are special items that may be subject to discussion and
potentially disagreement as their inclusion or exclusion in working capital, net debt or the
valuation as such will directly impact the business value.
First, non-operating assets should be excluded from the valuation as they do not con-
tribute to the generation of income or cash flow in the normal course of operations (e.g.,
an investment into unused land). If required, these assets should be valued at their fair value
as of the valuation date and added to the business value.107 But, in the context of deter-
mining damages, these assets will usually be unaffected by the wrongful act and thus their
consideration is not required as their value will be equivalent in both the but-for and the
actual scenario.
Second, while cash is generally directly assessable, there may be circumstances that
require special attention. Trapped cash is cash on the balance sheet that is not available for
use in the business or distribution to its owners, as it is designated for some other purpose
(e.g., as a collateral or fiduciary deposits). Also, sometimes there is a discussion of the level
of cash required to operate the business,108 which, if one agrees with this concept, would
not be available for use in the business or distribution to its owners, thereby reducing the
value of the business.109
Third, financial instruments may require a thorough analysis to determine whether
or not they are financial assets or liabilities and what their impact is on the future net
cash generation.
Fourth, debt-like items (i.e., items that will result in future cash outflows and typically
bear interest) are frequently subject to disagreement and dispute as the inclusion or exclu-
sion within net debt will directly result in different business values. Examples of debt-like
items are, among others, pension accruals, which reflect the future pension payments to
then former employees and are recorded on the balance sheet at their present value, capital
leases or environmental contingencies.
107 Cf. Koller et al. (2015), pages 149 and 247.

109 See ‘The Discounted Cash Flow Methodology: Introduction’, supra.
190
The cash flow statement

The cash flow statement is a financial statement that provides information about cash
receipts and cash payments of a business during a specific period to, among others, support
the assessment of the business’s ability to generate future net cash flows.110
It usually distinguishes between the cash flows from operating, investing and financing
activities. The cash flow from operations resembles the main revenue-producing activities
of the business that are not investing or financing activities (i.e., the production and sale
of products or services). The cash flow from investing activities depicts the amount of cash
invested in the purchase of, or received from the sale of long-lived assets.111 The cash flow
from financing activities112 provides information about the funding of the business by both
equity and debt investors.113
For the valuation of a business or the assessment of damages as a loss in business value,
the cash flow statement is typically derived from the projected income statement and bal-
ance sheet.114 The analysis of the actual or historic free cash flow to the firm may provide
support in assessing or reviewing the reasonableness of the projected free cash flow to
the firm.
Otherwise, the determination of damages as lost profits typically does not require the
preparation of a statement of cash flows in full compliance with the applicable account-
ing standards but will focus directly on the cash flows derived from lost revenues and
avoided costs.
Developing and reviewing terminal value and terminal growth rate

The terminal value represents the present value of all future cash flows at a specific point
in time. To consider a stable growth of these cash flows a terminal growth rate is applied
(perpetual growth model).115
When the valuation or damage period is not limited (i.e., infinite), the detailed plan-
ning period116 must be extended to consider what is known as a ‘terminal year’. The ter-
minal year represents the income or cash flow expected for every year after the detailed
planning period and thus, utilising the present value of an ordinary annuity,117 captures the
value of the business for all periods beyond the detailed planning period. As the terminal
value frequently contributes the majority of the business value, its determination requires
caution and should be based on reliable assumptions.118
110 Cf. Statement of Financial Accounting Standards No. 95, Statement of Cash Flows, para. 4 f.
111 See ‘Developing and reviewing projected capital expenditures’, supra.
112 Note that interest expenses related to financial debt can be included either within the cash flow from
financing or the cash flow from operations in compliance with IFRS, whereas it is included within the cash
flow from operations in compliance with US-GAAP.
113 Cf. Statement of Financial Accounting Standards No. 95 or Statement of Cash Flows and International
Accounting Standard 7, Statement of Cash Flows.
114 In contrast to this so-called indirect cash flow method, the so-called direct cash-flow method is based on an
identification and allocation of transfer of funds.
116 See ‘The valuation or loss period’, supra.
117 An ordinary annuity is a series of equal payments made at the end of consecutive periods.
191
First, the business should be in a steady state at the end of the detailed planning period
– i.e., no major changes or disruptions should be expected for the business or its environ-
ment as these could not be captured in the terminal year. Accordingly, to the extent such
events and circumstances are known or foreseeable, they must be considered in an extended
planning period prior to the terminal year.119
Second, it is generally assumed that a business will grow over time. The growth rate
can have a major impact on the business value and must therefore be determined very
diligently. To determine a reasonable growth rate the historic development of the busi-
ness, its competitors and its markets should be considered. In addition, fundamental data
like long-term inflation forecasts or projected growth of the relevant economies, e.g. GDP
forecast, should be considered. It seems reasonable to argue that ‘[a] company’s growth
rate typically approaches industry growth rates very quickly, and few companies can be
expected to grow faster than the economy for long periods.’120
Practically, growth rates vary significantly, depending on the geography’s economic out-
look or the business’ industry outlook, among others. For developed countries, the growth
rate will typically be lower than the expected inflation rate, assuming that in mature mar-
kets the business will not be able to pass on the entire cost increase to its customers.
The financial projection should consider that growth requires investments, specifically
in long-lived assets and net working capital, which in turn require financing.121 An inte-
grated financial model will consider these requirements which will reduce the free cash
flow and thus the business value.
Common pitfalls in the use of the growth rate include the wrongful application of the
growth rate to all line items of the income statement individually, thereby ignoring the
relations of revenues, and an understatement of growth resulting from an overly conserva-
tive perception of uncertainty.122
Considering currency and exchange rates

A business value as well as damages needs to be determined in a specific currency.Therefore,
financial projections denominated in another currency need to be converted applying an
appropriate exchange rate.
Theoretically, the most precise approach would be to translate all foreign currency
transactions with the exchange rate at the date of the transaction. In practice though, bal-
ance sheet items are typically converted applying the exchange rate as of the date of the
balance sheet, while income statement items are converted applying an average exchange
rate for the period covered.
For the conversion of cash flows, two methods are commonly applied: the forward-rate
method or the spot-rate method. The forward-rate method uses forward exchange rates to
convert the projected cash flows from foreign to domestic currency. Accordingly, the dis-
count rate applied must consider domestic cost of capital. In contrast, the spot-rate method
converts the present value of the projected foreign currency cash flows into a domestic
119 Cf. Damodaran (2006), page 153; or Koller et al. (2015), page 542.

120 Koller et al. (2015), page 263; cf. Damodaran (2006), page 146.
122 Cf. Koller et al. (2015), pages 271 ff.
192
present value applying the exchange rate as of the valuation date. Consequently, the dis-
count rate applied must consider the foreign cost of capital. Both approaches are broadly
accepted, but the consistent use of the appropriate discount rate must be ensured.123
Considering inflation
Inflation is defined as an increase in the price level of goods and services in an economy
and is measured by the inflation rate, generally the annual percentage change in consumer
prices.124 Generally, valuation as well as damages assessment implicitly considers inflation
(i.e., the financial forecast includes any potential adjustment for expected inflation and thus
inflation must not be considered separately).125 But, in instances of very high and unstable
inflation, or even hyperinflation (i.e., an extremely rapid or out of control inflation in
excess of 50 per cent per month), inflation must be considered separately.126
Considering an appropriate discount rate

To consider the time value of money and the specific risks associated with the business,
when applying the DCF methodology, the free cash flow to the firm is compounded or
discounted to the valuation date applying an appropriate discount rate.127 The same princi-
ples apply to the determination of damages; i.e., past and future lost profits or cash flows are
compounded or discounted to the valuation date applying an appropriate discount rate,128
which may significantly differ from the discount rate appropriate for the valuation of a
business. The appropriate discount rate is usually a matter of substantial dispute.129
While there are many approaches to determine the appropriate discount rate, depend-
ing on the cash flows to be discounted, the concept of WACC is the most commonly used
methodology and enjoys broad acceptance.130
Sometimes, risk adjustments in addition to the risk premium already captured within
the WACC are discussed to reflect facts and circumstances specific to the market or the
valuation object; for example, a country risk premium, a small firm premium or an infla-
tion premium.
The country risk premium is usually derived from a comparison of two countries’ bond
rates (i.e., as a country bond default spread). It considers the additional risk that a specific
country with an immature market may present in comparison to the mature markets from
which the financial information to determine the WACC has been derived; for exam-
ple, a WACC based on US-listed companies is adjusted to reflect the different risk of an

124 Cf., for example, U.S. Bureau of Labor Statistics, on www.bls.gov.
125 Cf. Allen et al. (2011), pages 451 ff. for further discussion.
126 Cf. Damodaran (2006), page 36.
128 Cf. Pollack et al. (2006), pages 35 ff.; or Robert L. Dunn and Everett P. Harry, Modeling and Discounting
Future Damages, Journal of Accountancy, January 2002 (Dunn/Harry (2002)), page 3.
129 Cf. Allen et al. (2011), page 500.
130 Cf. Koller et al. (2015), page 148; or Pollack et al. (2006), pages 35 ff.; see the chapter on ‘Determining the
Weighted Average Cost of Capital’ in this publication.
193
investment in an emerging country with little historical data or data too volatile to yield a
meaningful estimate of the risk premium.131
Some empirical studies indicate that the capital asset pricing model,132 which is used to
determine the equity risk premium within the WACC, may understate the more volatile
returns of small firms. A small firm premium is discussed to consider the additional risk or
the additional return an investor would require when investing into a smaller firm than
those included in the determination of the WACC components (i.e., stock-listed compa-
nies). While this premium is regularly applied in the valuation of privately held businesses,
its existence is seriously questioned.133
When expectations with regard to inflation rates differ between the market used to
derive the risk premium included in the WACC (e.g., the United States) and the market in
which the valuation object operates and generates cash flows (e.g., an emerging country),
an inflation premium may be used to bridge the gap between expected inflation rates.134
Considering a tax step-up

Compliant with the objective of full compensation and its assessment on the basis of
after-tax free cash flow available to the damaged party, the tax implication of receiving a
damages award needs to be considered to avoid double taxation.135
In case of an after-tax analysis, as commonly applied in business valuation and the
determination of a loss in business value, the award should, therefore, include both the
present value of the after-tax cash flows and the taxes payable on the award.136 In contrast,
since lost profit damages are generally taxable as ordinary income, these damages should be
determined on a pre-tax basis.137
For lost profits, a commonly used approach to calculate pre-tax damages is to apply
the after-tax discount rate to the pre-tax cash flow.138 However, this approach will only
produce the correct damages when the corporate income tax rate applicable to the lost
profits is identical with the corporate income tax rate used in the taxation of the award.
This prerequisite may not be fulfilled as a result of changes in tax law139 (e.g., changes of
the corporate income tax rate, or different corporate income tax rates applicable in differ-
ent tax jurisdictions). For example, income and cash flow may be generated and subject
to corporate income tax globally at various corporate income tax rates while the claimant
resides in a specific country, resulting in the damages award being taxed at the corporate

132 Cf. Pollack et al. (2006), pages 38 ff.; or Allen et al. (2011), page 459.
135 Cf. Robert P. Schweihs, Measuring Lost Profits Economic Damages on a Pretax Basis, Dispute Resolution
Insights, Summer 2010 (Schweihs (2010)), page 11; see the chapter on ‘Taxation and Currency Issues in
Damages Awards’ in this publication.
136 Cf. Schweihs (2010), page 10.
137 Cf. Merle Erickson and James K. Smith, Tax Treatment of Damages Awards, in Litigation Services Handbook –
The Role of the Financial Expert, Fifth Edition, 2012 (Merle/Smith (2012)), page 1; Pollack et al. (2006), page 43;
Allen et al. (2011), page 449; Schweihs (2010), page 10; or Hitchner (2006), page 1041.
138 Cf. Pollack et al. (2006), page 43; or Schweihs (2010), pages 12 f., including a numerical example.
139 Cf. Schweihs (2010), page 13.
194
income tax rate applicable in that country. In these circumstances, the after-tax present
value of damages need to be grossed up, utilising the corporate income tax rate applicable
to the damages award.140
Documentation required to support the results of the discounted cash flow

methodology in international arbitration
Documentation is an essential part of determining damages in international arbitration, as
ultimately, the arbitral tribunal should be provided with sufficient evidence for its evalua-
tion of whether the damages have been substantiated with reasonable certainty.141
To establish reasonable certainty, an opinion should be based on the use of an accepted
methodology, on its reliable application to the facts and circumstances of the matter, and on
sufficient, reasonable and unbiased source data, facts and assumptions.142
As discussed above, the discounted cash flow methodology is widely used and accept-
ed. Furthermore, it can be reliably applied to the measurement of damages in interna-
143
tional arbitration.144
Therefore, the acceptance of the damages assessment primarily depends on a complete
documentation of the source data and facts, reliable evidence for the assumptions used and
a comprehensible explanation of the analysis and calculations employed. Sources reasonably
referred to in damages measurement include, but are not limited to, official government
publications and databases, independent researches and studies, audited financial statements
and company filings, accounting records maintained in the ordinary course of business,
management reports prepared in the ordinary course of business or documents produced
for the arbitration.145
140 Cf. Pollack et al. (2006), page 43; or Schweihs (2010), page 10.

141 Cf. Pollack et al. (2006), page 3; for discussion of the ‘reasonable certain’ criteria refer to AICPA, Forensic &
Valuation Services Practice Aid, Attaining Reasonable Certainty in Economic Damages Calculations, 2015
(AICPA (2015)); or Robert M. Lloyd, The Reasonable Certainty Requirement in Lost Profits Litigation: What
It Really Means, University of Tennessee, 2010 (Lloyd (2010)).
143 See ‘The discounted cash flow methodology’, supra; cf. Allen et al. (2011), page 431.
144 See ‘Application of the discounted cash flow methodology to the assessment of damages in international
arbitration’, supra.
145 Cf. Allen et al. (2011), page 484.
195
13
Determining the Weighted Average Cost of Capital
Charles Jonscher1
Introduction
The financial impact of a damaging action normally stretches some years into the future;
indeed, it may continue without limit, as when a firm loses a line of business that might
otherwise have lasted indefinitely. If a damages calculation were based on a simple arithme-
tic summation of the estimated damage for each future year, the claimant could be greatly
overcompensated – for permanently damaged businesses, infinite awards would result.2
To correctly assess financial damages it is necessary to apply a conversion factor, which
discounts a forecast loss in a future year for the purpose of compensating it reasonably today.
The measure used to effect this discount is known as the weighted average cost of capital,
or WACC.
This chapter sets out the principles underlying the WACC as applied in damage assess-
ments, and presents current best practice in its estimation.
Basic principles
A damages award often compensates a claimant in advance: the claimant receives pay-
ment, now, to replace income which absent the damaging act would have been earned in
the future. Money has time value, and it is self-evident that an award must incorporate an
adjustment – a downwards adjustment, or discount – to reflect any advance component
of compensation.
A first step to effect this adjustment would be to discount future years’ assessed losses by
a prevailing interest rate (more specifically by what it known as the risk-free interest rate; at
1 Charles Jonscher is president of CET Capital Ltd, London.

2 If a DCF model shows damage to a business in all future years, and no time discount is applied, the loss
calculation will consist of an infinite sum of (undiscounted) future losses; mathematically this is likely to yield
an infinite compensation figure.
196
the time of writing this is in the vicinity of 1.5 per cent per annum).3 Applying a discount
based on an interest rate would ensure that the financial award has been adjusted to reflect
what we might term the pure time factor – the passage of time between the award and any
future losses that the award is intended to compensate.4
However, while discounting on the basis of an interest rate would adjust an award
for the fact that future losses to the business are paid in advance, it would not adjust the
award for fact that the future losses are subject to uncertainty. It is not reasonable or fair to
recompense, dollar for dollar, uncertain future losses with a certain payment today. A fair
compensation in respect of future years’ lost earnings must incorporate an adjustment to
reflect the uncertain character of those future earnings.
The discipline of financial economics has established a procedure to convert forecasted
future cash flows of a business to an equivalent present day value, to reflect both the pas-
sage of time and the uncertainty of those future cash flows. The procedure is to calculate,
by analysis of financial market data, the cost of capital of the business, and more specifically
the WACC. The WACC is a blend of the firm’s cost of debt (interest) and cost of equity,
the average being weighted by the proportions (or ‘weights’) of debt and equity financing
available to the firm.
The WACC is built up from a number of inputs, or components. One of the com-
ponents is the prevailing (risk-free) interest rate; the inclusion of this component will
account in the completed financial damages calculation for the time value of money in the
economy. Other components of the WACC are concerned with the volatility and riskiness
of business investment; the inclusion of these components will ensure that the completed
financial damages assessment accounts for the uncertainty associated with a business’s future
earnings. The components of the WACC are discussed in detail later in this chapter.
Effectively the WACC teases out the consensus of the broad business community –
investors, executives, analysts – as to the fair discount to apply when replacing a future
uncertain gain by a current and certain one. Just as information on prevailing interest rates
in an economy reveals the time value of money to participants in that economy, so securi-
ties market data (information, for example, on share prices) can reveal the reasonable adjust-
ment to apply to forecast company earnings to account for the uncertainty and volatility
associated with those earnings.
Like an interest rate, the WACC is expressed as a percentage per year; for illustration, a
WACC of 7 per cent per annum signifies that money received this year is worth 7 per cent
more to the business than money that it forecasts to receive next year. Also like an interest
rate, its effect compounds through time. It is noteworthy that WACC’s are inevitably much
higher than prevailing interest rates, meaning that – unsurprisingly – the fair adjustment in
respect of uncertainty of earnings is in practice significantly larger than the adjustment in
respect of the passage of time.
The WACC is now universally accepted in commercial arbitration practice as the cor-
rect figure to apply as the discount rate in the financial discounted cash flow (DCF) model
3 The risk-free interest rate is discussed later in this chapter.

4 The successful claimant could place on deposit that part of the award which relates to any given future year’s
losses; by the time that year arrives the deposit would have grown, by accumulation of interest, to be equal to
the amount which the claimant is estimated to lose in that year through the damaging action.
197
used to assist in damages assessment.The line of business for which the WACC is calculated
is the damaged business of the claimant, and the resulting WACC figure is entered as the
discount rate in the financial damages calculation.
In summary, when the WACC is applied to a financial damages model, the calculation
of damages adjusts properly – or as well as modern finance theory allows – for both the
pure time effect (that money available now is more valuable than money received later)
and in respect of risk and uncertainty (a damages award should compensate fairly, with a
definite payment now, a loss of profit that the claimant’s business may incur in the future).
Estimating the WACC

The WACC has not been developed specifically for damage assessment; it is a very widely
used analytic tool. For example:
• a firm’s management applies the WACC to help it decide whether to proceed with an
investment proposal, such as a new capital project or corporate acquisition;
• auditors use a firm’s WACC for the purposes of financial reporting;
• brokers and investment bankers use WACCs in connection with the purchase, sale or
issuance of shares and in connection with acquisitions, mergers or spin-offs; and
• government bodies use WACCs to assess fair and allowable prices and profits in regu-
lated industries.
In a damages assessment, the figure arrived at for the WACC is likely to have a very impor-
tant effect on the level of financial claim – particularly if, as in most major claims, long-term
losses are alleged.5 By way of example, with all other inputs to the financial analysis of dam-
ages kept constant, a movement of the WACC estimate by just 1 percentage point (say from
7 per cent per annum to 6 per cent per annum), could increase the final claim by 15 per
cent.6 In a proceeding involving long-term damage, there will almost certainly be no other
single figure entering the financial model to which the final claim is as sensitive.
For this reason, the correct assessment of the WACC is of great importance in com-
mercial arbitrations. The professional expertise required differs from that required to create
the financial (DCF) model into which the WACC figure is inserted.The creation of a DCF
model of a firm requires very detailed knowledge of the industry in which the firm oper-
ates, to ensure that the model contains high quality line-by-line data on revenues and costs.
By contrast, as will become clear in this chapter, WACC estimation requires very detailed
5 If the damage can be completely remedied in the short term – if, for example, equipment is damaged and is
replaced – then the level of WACC will have only a modest effect on the final level of the financial claim. If,
however, the claim is for the loss of a business position or business opportunity, the claim will be for damage
which is permanent, or at least very long term, and the level of the WACC will have a large effect on the level
of the claim.
6 If a broadly constant long term loss of earnings is alleged the final calculation of damages will respond, very
roughly speaking, in inverse relation to a change in the assessed annual percentage WACC. However, this is
an approximate heuristic guide only; many factors will affect the detailed mathematical relationship between
the WACC estimate and the final claim level; a greater weight on near term losses will tend to reduce the
sensitivity of the final claim to the level of the WACC, while the inclusion of a perpetual growth factor in the
DCF model will tend to increase the sensitivity.
198
knowledge of financial markets – of stock market volatilities, bond market yields and the
quantitative analysis thereof.7
The WACC is estimated on the basic of six components or inputs; each is discussed below.
The risk-free rate

A starting point for assessing the WACC is the ‘risk-free rate’, the prevailing rate of interest
paid on debt to a lender considered completely credit-worthy. Broadly speaking, the remain-
ing inputs to a firm’s WACC act to increase the cost of capital above the risk-free rate.8
The risk-free rate does not have an objective existence – there is no such thing as
a loan without risk of default. Like other parameters entering the WACC formula, the
risk-free rate is a construct of finance theory, and must be estimated by means of proxies
or approximations.
The accepted approximation to the risk-free rate is the yield on government bonds
issued in the relevant currency. In the case of a claim based on US dollars, this is the return
to US Treasury bonds. While holding such bonds is not completely risk-free, the chance
of repayment is considered extremely high – or, in any event, ‘as good as it gets’. When
the currency of the financial model is other than US dollars, the risk-free rate is estimated
on basis of the return on bonds issued in that currency – usually the bonds issued by the
relevant national treasury.9
The actual estimation process for the risk-free rate typically involves calculating an
average yield for primary offering tenders taking place close to the damages reference date,
for bond maturities of (say) five, 10 and 20 years.10
The debt risk premium

The debt risk premium is the additional return, above the risk-free rate, which a firm
must pay to its debt holders to compensate for the risk that the terms of the loan will not
be honoured.
The debt risk premium is relatively easy to assess if the claimant firm issues bonds: the
return on those bonds is compared against the return on bonds with similar maturity issued
by government. If the firm itself does not issue bonds – or as further input to the estima-
tion procedure even if it does – the premium can be estimated by analysing the return to
7 WACC estimation has therefore become a distinct sector of expertise in damages proceedings (and indeed
merits a specialised chapter in this book).
8 The exception is the Tax Rate, which acts to reduce the firm’s cost of capital due to the tax deductibility of
debt repayments.
9 Complications arise if the bonds of the national treasury in question are considered a poor risk. Fortunately
for estimation purposes, national treasuries typically issue bonds both in their own currency and in a global
reserve currency such as US dollars or euros. The premium which the government in question pays on (say)
its US dollar bonds over US government rates serves as a measure of the perceived risk of that government
defaulting, and can therefore be used to adjust the rate on its local currency bonds to arrive at a good estimate
of the local currency risk-free rate.
10 The selection of bond maturities is important, as bonds of different maturities typically have significantly
different yields, and an incorrect selection of maturities can introduce significant errors into the WACC.
Broadly speaking, the basket of bond maturities should be selected which best reflects, in the judgement of a
qualified expert, the future time pattern of damages in the financial model.
199
the bonds of firms with similar perceived risk profiles, such as competitor businesses of
similar size.
The debt risk premium is widely studied by investment banks, stockbrokers and other
institutions. Experts assigned to a proceeding can supplement a direct analysis of this WACC
input with a review of the estimates published by reputable third parties.
The equity risk premium

The equity risk premium is the amount by which, over a long term, stock markets generate
higher returns for investors than do holdings in (near risk-free) government bonds. As its
name implies, it is the premium paid to equity investors to compensate them for the risk –
volatility, uncertainty – of stock market investing. It is a figure that applies to stock markets
generally, rather than to a firm specifically.
Experts in arbitrations do not attempt to calculate this parameter from primary data
sources – which would be a major computational task. The figure is stable over quite long
time periods, and general practice allows the expert to review financial and academic lit-
erature and apply a consensus estimate. Currently the equity risk premium stands at about
5 per cent per annum for major stock markets.
The beta
While the equity risk premium (discussed immediately above) reflects the return inves-
tors expect to make by investing in shares generally, it does not reflect the return investors
expect to make by investing in a particular firm’s shares. Finance theory holds that the
firm-specific return is obtained by multiplying the equity risk premium by a ‘risk multi-
plier’ known as ‘beta’ (after its Greek symbol). The beta is a measure of the volatility of the
firm’s share value relative to volatility in the stock market as a whole.11
The estimation of a firm’s beta is one of the most difficult parts of a WACC estima-
tion.12 While competent finance professionals can undertake the necessary computations
themselves, in an arbitration setting experts typically rely on third-party estimates published
on commercial database services such as Bloomberg. A value of beta obtained by careful
selection and averaging of reputable third-party estimates may be more reliable, and easier
to defend, than a fresh set of calculations produced by the expert.13
While the estimation of beta is complex, its interpretation is relatively straightforward.
A firm’s beta reflects the degree to which the firm’s business is affected strongly or weakly
11 Mathematically, the beta of a firm’s shares is the covariance of the return on the firm’s equity and the return to
the stock market, divided by the variance of the return to the stock market.
12 The estimation of beta is sensitive to the selection of data analysed. To increase the sample size it is
recommended that the estimation is supplemented by inclusion of companies considered comparable in their
riskiness to the firm in question – to the extent possible, of companies in the same line of business and of
similar scale. The application of beta values from a comparable company group is not straightforward (even if
the betas are taken from third party sources); good practice requires that the comparisons are made not directly
on the basis of firms’ betas but on the basis of a related parameter known as the asset beta. A discussion of the
conversion of betas to asset betas and vice versa is beyond the scope of this chapter.
13 Care must be taken when interpreting other parties’ beta estimates (and indeed in working generally with the
beta parameter) to differentiate between what are known as the unlevered beta and the levered beta. Again, a
discussion of these variants of the beta parameter is beyond the scope of this text.
200
by general economic turbulence. Broadly speaking, a firm whose business has a high degree
of resilience in the face of economic cycles will have a beta (or ‘risk multiplier’) of less
than 1; examples are firms supplying staple or essential goods. A firm whose business is
heavily affected by economic cycles will have a beta of greater than 1: examples are firms
supplying discretionary goods. Fortunately, the expert in an arbitration does not have to
speculate as to whether the firm’s output has greater or lesser risk – the assessment of beta
is a mathematical process that relies only on analysis of share price volatility data.
The debt-equity ratio

The debt-equity ratio generates the ‘weights’ in the weighted average cost of capital. Like
the beta, its estimation presents significant challenges to the expert in an arbitration set-
ting: there is a number of alternative approaches to its assessment, which produce differ-
ent results; there is little by way of directly applicable published assessments; and the final
WACC computation is quite sensitive to the figure selected.
The expert must seek to identify the ratio of debt to equity that optimises the value of
the firm to its owners. The degree to which a firm sources its capital from debt as opposed
to equity markets is (within limits) a matter of its choice – it can issue more debt or more
equity; consequently one approach to estimation is simply to take the ratio of debt to equity
present in the firm at the time of the assessment. However, in practice, direct measurements
of the actual debt and equity levels of the firm in question may not produce a good esti-
mate of the optimal debt-equity ratio as required for a WACC estimation.14 Practice has
shown that a better estimate is achieved by taking an average (such as the median) of the
debt-equity ratios of a group of companies deemed by the expert to be comparable for the
WACC estimation purpose – typically companies in the same industry.
Other measurement problems arise because there are conflicting definitions as to what
constitutes debt; good practice requires the expert to follow quite detailed guidance as to
what debt categories should be included when calculating the debt-equity ratio for the
purpose of assessing a WACC.15
Nevertheless, this ratio can, with diligence and by following good practice, be assessed
to a good standard of accuracy.
The tax rate

The presence of the tax rate as an input to the WACC calculation arises because payment
of interest on debt is offsetable against a company’s taxable profits. This tax deductibility,
known as a tax shield, reduces the effective cost of debt capital compared to the cost of
equity capital; there is no analogous offsetting of dividend payments (i.e., payments to
equity shareholders) against corporation tax.
14 Firms do not as a practical matter continually fine-tune their ratio of debt to equity to maintain an optimal
level implied by finance theory; among other difficulties, they would have to issue or retire debt every time
their share price moved.
15 Debt should normally include all borrowings, capital leases, license fee liabilities and liabilities embedded in
financial instruments, and should be reduced by the level of cash holdings, marketable securities, investments
available for sale and receivables from financial instruments.
201
Generally, the determination of the tax rate for a WACC estimation is straightforward:
the expert applies the marginal rate of tax on corporate profits, as specified in the tax stat-
utes applicable to the jurisdiction in which the relevant profits are taxed.
There are, nevertheless, some precautions to be observed: the tax rate entering the
WACC calculation may be different from the tax rate used to estimate post-tax cash flows
in the DCF model;16 and the tax rate must be adjusted downwards for WACC estimation
purposes if the profits of the firm are, over a relevant period, insufficient to cover all interest
payments; in that event, the tax shield will not be fully effective.
With the six above inputs correctly estimated, the calculation of the WACC itself and its
insertion into the DCF model of damages are straightforward. The six inputs are entered
into a standard formula that generates the WACC figure.17 This is then entered as the
discount rate input into the financial model. The mechanics of the model ensure that any
future cash flows are discounted back by the discount rate to the present day (strictly, to the
reference date), compounded annually.
Concluding reflections
The development of a technique to determine the fair present day value of future (and
uncertain) cash flows by analysis of objectively measurable data, such as share price volatil-
ity, was a landmark in financial economics.18 For damages proceedings, the development has
meant that the discount rate – the WACC – entering a financial model can be calculated on
the basis of evidential data, lending objectivity to the seemingly intractable task of account-
ing for forecasting uncertainty.
What the theory and practice of WACC estimation has done for dispute resolution is
to introduce objectivity (and some degree of precision) into what would otherwise be a
highly speculative aspect of claim evaluation. When an arbitration proceeding is presented
with a model of how the business would have performed in an undamaged scenario, it is
clear that predicted profits must in general be discounted to arrive at a fair compensation
– a forecasted gain (or loss) is not equal in value to a certain gain (or loss). The WACC
methodology requires that the experts estimate this discount by analysing the best available
current data (on such metrics as stock price volatility). The experts can still disagree on the
discount, but the disagreement can resolved by reference to evidence.
It is essential, however, that those involved in commercial arbitrations have crystal clar-
ity as to which forecasting uncertainties are, and which are not, taken into account by the
inclusion in the financial model of a WACC-based discount.
16 The Tax Rate entering the WACC calculation must be the marginal rate of tax on each extra unit of profit
generated. The tax rate used to calculate post-tax cash flows in the same DCF model will be average rates of
tax on the total profit (for a given period).
17 The formula is: WACC = [Rf + ( × ERP)] × (1 – g) + [(Rf + DRP) × (1 – T)] × g, where g = DER/(1 +
DER) and the remaining symbols have the following meanings: Rf is the Risk Free Rate; is the Beta; ERP
is the Equity Risk Premium; DRP is the Debt Risk Premium; DER is the Debt-Equity Ratio; and T is the
Tax Rate.
18 The theory, developed in the 1960s, earned its authors the Nobel Prize in Economics.
202
The WACC takes into account the discount that is generally applied by market practi-
tioners – investors, executives and analysts – to the value of forecasted future cash flows, to
reflect the level of risk and uncertainty normal in a firm and a line of business comparable
to the one under review.
The WACC cannot and does not take into account the possibility that the forecast
(typically, of undamaged cash flows) may simply be biased. In lay terms, the forecast must,
at the time of its creation, be equally likely to be too low as too high.19 The WACC adjusts
the claim for the effects of business risk and randomness, not for the possibility that the
forecast was set too high, perhaps by one of the parties. The judgement as to whether an
expert forecast is deliberately biased, rather than merely uncertain, remains one for the
arbitral process, on which the WACC is silent.
Finally, and obviously, the WACC adjustment does not adjust a claim for errors or bias
in the estimation of the extent to which the undamaged and damaged cash flows differ.
The above limitations having been noted, the WACC remains a powerful and now
standard tool in discounted cash flow calculation of damages, bringing a high level of
objectivity to accounting for the time value of money and for the uncertainties of busi-
ness outcomes.
19 In mathematical terms, the forecast must be set at the centre of the probability distribution of future outcomes.
203
14
Market Approach or Comparables
José Alberro and Paul Zurek1
Introduction
This chapter discusses the market or comparables approach to valuation. This approach is
also referred to as the relative valuation method because it estimates the value of an asset
relative to the observed values of similar assets, typically called ‘comparable assets’ or simply
‘comparables’. When the value of comparable assets is based on observed transactions (e.g.,
prior acquisitions of companies in the same industry), the approach is also referred to as the
guideline transaction method.2
Valuing an asset typically involves establishing the value that would be assigned to
it by participants in an arm’s-length transaction. The most obvious and simple valuation
approach is to use the price at which the asset most recently exchanged hands. Yet, this
approach may be unfeasible or impractical if the asset has not traded recently or if such
trading does not fit the criteria of an arm’s-length transaction, as may be the case when
valuation disputes arise.
Financial economic theory posits that rational, utility-maximising economic agents
assign values to assets by discounting expected future cash flows realised from owning
them. This idea underlies the discounted cash flow (DCF) valuation model and approach,
which requires explicitly spelling out an asset’s expected cash flows and discounting them
using a risk-adjusted discount rate. Comparables valuation is an alternative – and com-
plement – to the DCF approach. When correctly executed, it too is an implementation
of the fundamental insight that economic agents assign asset values based on expecta-
tions of discounted future cash flows, because the observed values of the comparable assets
1 José Alberro is co-head of the international arbitration and litigation practice and a senior adviser and Paul
Zurek is principal at Cornerstone Research.
2 Note that observed values do not need to be transactions on an exchange – it is sufficient to observe agreed
upon transaction prices or values outside of the public market context.
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reflect future cash flow expectations. As we show in this chapter, the comparables valuation
approach is a technique that can be used to value assets in the international arbitration and
litigation context in a way that is consistent with more traditional methodologies such as
the DCF approach.
The comparables approach assigns value to an asset by reference to the observed values
of other assets with similar, but not necessarily identical, characteristics. The technique
relies on the proposition that assets having similar characteristics, especially risks and cash
flow prospects, will trade at similar prices because otherwise arbitrage profits would be
possible.3 An example of a comparables valuation is when a prospective buyer of a house
decides how much to offer by looking at prices paid for similar houses in the same neigh-
bourhood. This is a reasonable approach, because house prices are generally thought to
be driven by common factors that can be enumerated and quantified (e.g., size), and they
respond similarly to economic trends, at least within a specific geographical area.4
One key difference between the comparables approach and the DCF model is that
comparables valuation does not explicitly spell out the economic agents’ expectations of
future cash flows or discount rates. Instead, the expectations and discount rates are embed-
ded in the observed prices of the comparable assets. For example, transaction prices of
comparable houses can be thought of as discounted values of expected future rents (cash
flows) that can be realised by an investor who purchases the house. Because being explicit
about expectations and discount rates is not needed to perform a comparables valuation,
the methodology is potentially simpler to implement, but it is generally less transparent
regarding the underlying assumptions. Still, it is important to recognise that even though
the cash flow and discount rate assumptions are not explicitly spelled out in a comparables
valuation, they are drivers of the valuation. Thus, to the extent that the assumptions under-
lying the values of the comparable assets are not appropriate to value the asset at hand, the
comparables approach may not yield the correct valuation.
Because even assets that may appear similar can differ in significant respects, the appro-
priate use of the comparables valuation technique requires making adjustments to take into
account the impact of those differences on asset values. Valuation ratios (also referred to
as valuation multiples) are the most direct method of accounting for observed differences
along a single dimension, typically some measure of size, because they are defined as meas-
ures of value divided by a scaling factor such as size. For example, the prospective buyer of
a house may adjust her offer price to reflect differences in square footage of comparable
properties in the neighbourhood by using a valuation ratio of average price per square foot
to inform her offer. Suppose that houses in the neighbourhood that were sold in the recent
past fetched an average price of $400 per square foot. Using the price per square foot valua-
tion ratio, a buyer may expect to pay $400,000 for a 1,000 square foot house. In addition to
adjustments for size, other adjustments may be called for to ensure comparability. Suppose
the prospective house buyer also wants to take into account the age of the house, the size of
3 Economists define arbitrage as a trading strategy that yields profits without risk. Arbitrage opportunities are
often assumed not to exist in well-functioning markets, because market participants would otherwise trade on
these opportunities, thereby moving the market price and eliminating them.
4 The impact of property characteristics and economic conditions on house prices is ultimately an empirical
matter. In our example, we focus on general findings for the US real estate market.
205
the property, the presence of a garage, etc. Adjusting the valuation ratio for these character-
istics could be implemented by, for example, a regression of the price-per-square-footage
ratio on observed characteristics such as age of the house, or, alternatively, by focusing only
on observed sales of homes that are similar across all these dimensions. Such adjustments are
ways to transform the implicit and varying assumptions and characteristics underlying the
observed values of comparable assets (in our example, prices of recently sold houses in the
same neighbourhood) into a valuation ratio that is compatible with the asset being valued
(the particular house the buyer is offering to purchase).
In addition, because the overall market conditions may change between the time prior
transactions are observed and the valuation date, practitioners also consider the recency of
comparable prices. In our house sale example, a buyer making offers during the begin-
ning of an economic expansion (which generally sees house prices rise), but informed by
observed prices during a period of a contraction, may undervalue the house.
Note that the $400,000 estimate for the value of the house above based on its square
footage was computed using an average measure of value.5 It may be useful to know that
actual sales occurred in the range of $300 to $500 per square foot, which implies a range
of valuations from $300,000 to $500,000. In general, even though a valuation may be pre-
sented in terms of a single point estimate ($400,000 based on average sales prices), it can be
instructive to understand the range of possible values implied by comparable transactions.
In theory, when information about values of other, similar assets is available, the com-
parables approach may be used to value any asset. This includes entire assets or equity of
businesses and companies, as well as other types of assets, such as real estate and financial
securities. The key to implementing the comparables approach is identifying similar assets
with observable values, using an appropriate valuation ratio, and controlling for any relevant
differences. What constitutes relevant differences will vary depending on the asset being
valued. For instance, older homes with the same square footage may sell for less than other-
wise similar newer homes, which implies that either only sales of homes of comparable age
should be considered or that age should be explicitly factored into the calculation of the
multiple. When valuing companies and businesses, expectations regarding the growth rate
of the company’s future earnings and cash flows must be accounted for.
Next, it is worth remembering that any methodology that does not directly use an
observed arm’s-length price embeds a degree of uncertainty with respect to the valuation.
Unless a transaction price for the exact asset being valued is observed on the valuation date
(and potentially even at the exact valuation time in the case of some financial assets), all
valuation methodologies will involve assumptions and adjustments and, therefore, judge-
ment on the part of the appraiser. This is equally true of both the DCF methodology and
the comparables approach.
Finally, because the comparables approach typically relies on market prices of other
assets, it assumes that the market is valuing those assets correctly. Therefore, if the market
is overvaluing comparable firms, the valuation of a firm will be too high relative to its
5 As discussed later in this chapter, valuation ratios based on median valuations may be preferred to average
valuations, because averages can be sensitive to outliers.
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‘fundamental value’.6 When deciding whether to bid for an asset for investment purposes,
one may be concerned about the relationship between the asset’s ‘fundamental’ value and
its prevailing market price. However, when deciding how much to bid, one would want to
bid an amount informed by the value the market would place on the asset.
The chapter is organised as follows. First, we describe seven steps that will typically
be undertaken when performing a comparables valuation and discuss what makes for an
appropriate comparable asset. We then discuss in more detail the relationship between a
comparables valuation and the DCF approach and conclude with a discussion of when the
comparables approach is appropriate and when it is not.7
Typical steps in performing a comparables valuation

The process to perform a comparables valuation entails, at a high level, seven distinct but
complementary steps:
• Understand the asset being valued and its relevant valuation drivers.
• Identify a set of potentially comparable assets.
• Assess comparability and understand relevant differences.
• Identify valuation ratios or multiples.
• Collect data and perform calculations.
• Apply the comparables-based ratio to the asset being valued.
• Understand key sensitivities and compare results to estimates obtained using alternative
methodologies, if available.
While different valuation practitioners may use a different number or ordering of the steps,
we consider that most comparables valuations will take into account the analyses associated
with these seven steps.
Step 1: Understand the asset being valued and its relevant valuation drivers
The first step in performing a comparables valuation (in fact, any valuation) is to understand
the asset being valued, its characteristics, and the associated valuation drivers.When valuing
a company, for example, one may be interested in knowing the value of the whole enter-
prise or the value of common equity.8 While the overall valuation approach may be similar
6 Note that many economists believe that, absent a party having access to value-relevant private information, the
market price is the best indication of ‘fundamental’ value, especially when participants in a well-functioning
market are rational economic agents.
7 Given the inherent space limitations when writing an overview, readers interested in additional information
about the comparables approach (including a more detailed exposition of commonly used valuation ratios) are
encouraged to consult a valuation textbook. E.g.,Valuation: Measuring and Managing the Value of Companies by
Tim Koller, Marc Goedhart and David Wessels; Investment Valuation:Tools and Techniques for Determining the Value
of Any Asset by Aswath Damodaran; and Corporate Valuation:Theory, Evidence & Practice by Robert W. Holthausen
and Mark E. Zmijewski.
8 The value of the whole enterprise is the value of the company’s assets, regardless of ownership. Ownership
claims to assets typically belong to a combination of equity holders, debt holders and other claimants; the
claims may be distinguished by different priorities and rights. Equity claims are typically junior in payment
priority to claims by debt holders. Preferred and common equity claims typically differ in cash flow rights and
payment priority, with common equity being the most junior claim on the company’s assets. For a company
207
regardless of the particular asset, it is important to be aware of any complications that may
be present as a result of the specific nature of the asset at hand. Suppose that an appraiser
wants to value a particular class of equity such as preferred equity. If the valuation method-
ology used yields a combined estimate of value for all equity classes, additional adjustments
may be necessary to account for different rights (e.g., voting or cash flow rights) associated
with the different classes of equity; that is, it may not be appropriate to divide the total
estimate of value by the total number of shares if all the shares are not identical.
Next, the appraiser should develop a general understanding of the value drivers for
the particular asset class or in the particular industry. To value a home, the appraiser would
consider macroeconomic trends and individual characteristics of the property, such as size
and age.To value a business, the appraiser would study the particular segment of the market
being served by a company, which may impact its valuation as a result of differences in, say,
profit margins.
As an example, consider two hypothetical companies, LuxuryPC and BeigeBox,
both involved in selling computers to consumers. Suppose it is generally understood that
LuxuryPC caters to the high end of the computer market, while BeigeBox offers more of
a commoditised product, which tends to have lower profit margins. If a revenue ratio (i.e.,
company value divided by revenues) were to be used to value the operations of a computer
maker, it may not be appropriate to compare a $1 billion revenue company in the high-end
segment (such as LuxuryPC) to a $1 billion commodity player (such as BeigeBox) without
adjusting for the difference in profit margins. Knowing such fundamental value drivers is
useful when selecting comparable assets and the valuation ratios to be used, because, as dis-
cussed later, certain ratios are more sensitive to certain value drivers than others.
In addition to understanding fundamental economic forces that affect valuations, an
appraiser may also become familiar with the relevant data on the performance of the asset
being valued. Examples include the asset’s recent performance metrics, such as trends in
revenue growth and costs, as well as any management or analyst projections for the per-
formance of the asset in the future, including expectations about the overall asset class or
industry. This information can be useful, among other things, in understanding the impact
of any differences between the comparable assets chosen and the asset being valued.
Step 2: Identify a set of potentially comparable assets

The second (and arguably most important) step in a comparables valuation is the appropri-
ate identification assets that are comparable. The goal is to select assets that have observ-
able valuations and are similar to the asset being valued. For assets to be comparable they
should be similar across relevant valuation drivers; the key issue is whether the assets under
consideration have similar future prospects; that is, expected future cash flows, growth rates
and risks. While the exact valuation drivers will vary with the particular value ratio being
used, growth and discount rates are a common and important general category of drivers.
There are some additional guidelines to consider when selecting comparable assets.
First, the comparables must have observed prices or values. Ideally, these assets should trade
that only has debt and common equity in its capital structure, one can derive the value of the common equity
by subtracting the value of debt from the value of the whole enterprise.
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in a liquid market so that their observed values reflect recent assessments of their future
prospects. In practice, one often finds assets that have unique characteristics such that no
comparable assets trade in a liquid market. In such cases (or even when there are traded
assets that are dissimilar on key dimensions), values derived from comparable private trans-
actions can also be used.
If the comparable transactions are observed only infrequently, they may be less useful
as a result of changes in market conditions between the time the transactions occurred
and the valuation date. This again is not uncommon in practice. For example, one may
observe sales of assets, divisions, or entire companies that are quite similar in the underlying
valuation drivers but relatively far removed in time. Judgement is required to evaluate the
trade-off between relevance and recency of valuation information; in some circumstances,
non-recent transactions may still provide an adequate estimate of value.
Second, in addition to observed prices or values, adequate information about the finan-
cial performance or operations of the comparable assets must be available to allow for the
calculation of valuation ratios. For example, some analysts compare telecommunication
businesses based on enterprise value per subscriber ratios. To perform such a comparison,
information about subscribers must be available for the comparable assets, as well as for the
particular asset being valued.
Although this is certainly circumstance-specific, multiple comparables are generally
preferred to a single comparable; yet, it may be the case that a single, truly similar asset
would yield a better estimate of value than multiple assets that are dissimilar on important
dimensions. There is ultimately no formal rule for the number of comparables needed for
a valuation; judgement is often required. We have seen valuations, especially in the context
of investor-state arbitration, where the asset at issue is so unique that only a few potential
comparable projects exist, and still they differ on some dimension, such as the country in
which the asset is located. Nevertheless, these comparables may yield an acceptable indica-
tion of value.
Finally, different approaches can be taken to the initial selection of candidate compara-
ble assets. For example, an analysis may start with all assets within a certain industry (e.g., all
public companies in the same GICS classification)9 or class (e.g., all publicly traded finan-
cial institution retail preferred shares or all subprime-mortgage backed securities of recent
vintage). Alternatively, an analysis may focus on a narrower set of potential comparables as
identified using the appraiser’s industry knowledge, market analyst commentary, or in the
case of company valuation, information from the company’s management or public filings.
Again, a trade-off arises: while a larger number of comparable assets provides potentially
more data, the likelihood that all those comparables are truly similar (have similar growth
rates and risks) is lower, which requires more effort to account for the differences.
Step 3: Assess comparability and understand relevant differences

Armed with an understanding of the key valuation drivers (growth rates, discount rates and
potentially other factors specific to a given valuation ratio) and having chosen a potential
9 GICS is an industry classification system that classifies companies based on, among other factors, principal
business activity. See www.msci.com/gics. Examples of other industry classification systems are SIC
and NAICS.
209
set of comparable assets, an assessment of comparability should be performed to confirm

that the chosen comparables are indeed similar on relevant dimensions.This exercise gener-
ally requires significant judgement and is circumstance-specific, as there are no standard and
generally accepted criteria to determine whether a particular comparable asset is similar
enough to be used in the analysis. For this reason, it is generally more transparent to apply
a set of objective, replicable and disclosed criteria, although subjective adjustments may
nevertheless be necessary and should be documented if used.
The particular set of metrics used to assess comparability will depend on the asset being
valued. Both quantitative and qualitative factors can be assessed. We next present some
commonly applied heuristics when choosing comparables. However, it is ultimately the
similarity in expected future cash flows (including their growth and risk) that determines
whether a given asset is a good comparable. In practice, when valuing an asset using the
comparables approach, it is common to rely on proxies for cash flows and risks.
Quantitative factors that may be considered when choosing comparables are quantifi-
able characteristics of the asset itself (e.g., age, size or scale), various measures of historical
or expected profitability or performance (e.g., return on equity, return on assets and profit
margins), historical and expected growth rates, as well as measures of variability in these
factors (e.g., earnings volatility).
In the home purchase example, the quantitative factors could be the number of bed-
rooms, the number of bathrooms and the number of years since construction or last reno-
vation. The quantitative factors could be controlled for by either restricting the choice of
comparables to only those that match closely on the values of the factors or by modifying
the observed multiples for the comparables to account for the differences in factors by
using a regression or other methodology.
Qualitative factors are characteristics of the asset that cannot be measured using a quan-
titative variable. Common qualitative factors include the industry and business model (e.g.,
products and services, customers or distribution channels), differences in cash flow rights or
any contractual restrictions on the asset (e.g., control rights, priority in any bankruptcy pro-
ceedings or liquidation, or ability to dispose of the asset freely without restriction), and the
location of the asset or company (e.g., geography, accounting, regulatory and tax regimes).
The qualitative factors in the home buying example may include the quality of the
neighbourhood, the desirability and location of the parcel of land upon which the house is
built (e.g., a cul-de-sac), and the quality of local schools, among others. Qualitative factors
such as these cannot generally be easily controlled for by modifying the multiple. However,
adjustments such as restating financial quantities under a common accounting treatment
are sometimes possible.
An additional diagnostic can be performed once the relevant valuation ratios are cho-
sen and calculated, namely examining the dispersion in ratios across the comparables set. A
wide dispersion in ratios may indicate that the comparables have value-relevant differences
and therefore are not all comparable to the asset being valued. Understanding the drivers
of the dispersion can be useful in making appropriate adjustments or selecting the appro-
priate ratio.
For example, companies with high fixed costs (high operating leverage) may be par-
ticularly vulnerable to an economic downturn, in which case, understanding differences
in cost structure across companies may be important when gauging comparability, because
210
companies with relatively lower operating leverage may trade at higher valuations because
of lower risk.
Having assessed comparability, the decision of whether a given comparable will be
kept in the analysis or removed needs to be made. If a decision to use the given asset as a
comparable is made, it should be further ascertained whether adjustments will be needed
for relevant differences between the comparable and the asset being valued. At the very
least, the impact of including an asset of uncertain comparability may need to be quantified
when discussing valuation sensitivities.
Step 4: Identify valuation ratios or multiples

After selecting comparable assets, identifying the valuation ratio or multiple is arguably the
second most important decision in a comparables valuation. As discussed previously, valua-
tion ratios or multiples are typically measures of value in the numerator divided by a scaling
factor such as size in the denominator. In the home valuation example, we used the price
per square footage ratio.
The choice of the valuation ratio is ultimately a matter of judgement. However, there
are some general guidelines. First, based on the nature of the asset being valued, there are
different valuation drivers, and thus different types of valuation ratios as distinguished by the
value in the numerator (e.g., enterprise value or market value of common equity)10 and the
value in the denominator (e.g., different measures of earnings, revenues or other quantities).
For example, when valuing firms and businesses, values can be assessed using ratios based on
earnings (e.g., price-to-earnings or PE ratios, and enterprise-value-to-EBITDA11 ratios),
based on revenues (e.g., enterprise-value-to-sales ratios), based on book value or replace-
ment value (price-to-book ratios), or based on other measures that are specific to firms in
a particular sector. Consistent with the intuition that valuations are a function of expected
future cash flows, some academic literature has found what are know as forward-looking
multiples (such as multiples that use forecasted future earnings) to be more accurate in
explaining equity prices than multiples based on historical performance. In addition, some
academic research supports the notion that multiples based on measures that are relatively
far removed from cash flows (such as revenues) may not perform as well as other measures.
Second, certain ratios are more common in some applications than others. For exam-
ple, price-to-book ratios such as market-value to book-value of common equity multi-
ples are commonly considered when valuing equity in financial institutions.12 Enterprise
value-to-subscribers ratios are sometimes used by telecom analysts. EBITDA-based ratios
are used in recapitalisations, because EBITDA may be considered independent of the cap-
ital structure. For asset-backed securities, ratios such as value-to-notional or outstanding
principal may be relevant. In the oil and gas industry, ratios based on earnings before
10 As explained previously, enterprise value is a measure which reflects the value of a whole business. It is the
sum of values of claims by all claimants: creditors (secured and unsecured) and shareholders (preferred and
common). In turn, equity value is the value of the company available to owners or shareholders.
11 EBITDA is defined as earnings before interest, taxes, amortisation and depreciation and is a measure of
earnings commonly used in valuations.
12 Market capitalisation (commonly referred to as market cap) is the market value of the outstanding shares of a
publicly traded company, and equals to the share price times the number of shares outstanding.
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interest, taxes, depreciation, depletion, amortisation and exploration costs (EBITDAX) are
used in addition to ratios based on traditional earnings measures such as EBITDA; more-
over, enterprise value-to-proven (or alternatively total reserves or daily production) ratios
are utilised to compare companies.
Third, certain ratios, even though common for a given industry or asset class, may
not be applicable in every case. For example, earnings multiples (i.e., ratios of value and
a measure of earnings) are not well defined when earnings are negative. However, even
companies with negative earnings generally have positive valuations, since losses are not
expected to continue forever. In those cases, market analysts often use ratios based on rev-
enues instead of earnings, since revenues are generally non-negative.
Fourth, it is important to understand which fundamental drivers impact the multiple,
and, in particular, how the multiple is expected to vary across firms with differences in
observed characteristics.This knowledge, together with an assessment of comparability and
relevant differences between the asset being valued and the comparables set, can then be
used to select a multiple that is relatively less sensitive to such differences.13
Finally, it may be appropriate to consider more than one valuation ratio to estimate the
value of a given asset. In practice, different valuation ratios may yield different valuations.
Understanding the reasons for such differences in implied valuations and the relative pros
and cons of each multiple chosen can be informative to an overall value assessment.
Step 5: Collect data and perform calculations

Once comparable assets have been identified, financial and other data on these assets
should be collected to assess comparability and calculate valuation ratios. Potential sources
of information include primary sources such as stock exchange feeds, public filings and
offering prospectuses, and secondary sources, for example, data aggregators such as S&P
Capital IQ and Bloomberg. When using data from secondary sources, and especially when
using pre-calculated valuation ratios, it is important to make sure that the secondary source
is consistently calculating ratios for each asset, making appropriate adjustments as needed.
Consistency in valuation ratio calculations is a key consideration. First, there is often
not one unique, agreed upon definition for many of the commonly used valuation ratios.
For example, PE multiples, broadly defined as share price divided by earnings per share,
can be calculated in several different ways using alternative measures of earnings (e.g.,
trailing, reported historical, forward-looking, with and without adjustments for one-time
items, etc.) and alternative measures of shares outstanding (e.g., measures that do and do
not account for dilution because of the exercise of outstanding employee stock options).
Abstracting from the relative merits of the various measures, it is critical that the valuation
ratios be calculated using the same definition for all assets in the comparables set and for
the asset being valued.
13 Note that an argument could be made that the selection of the valuation ratio should be made first, before
selecting comparable assets, because different valuation ratios can potentially have different valuation drivers,
and the selection of comparable assets should be made with the associated valuation drivers in mind.
Depending on the circumstances, either approach may be acceptable; in fact, the process can sometimes be an
iterative one.
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Second, ratios should ideally be computed over a common time period, which may not
be straightforward. For instance, a trailing measure of 12 month earnings can be challenging
to calculate when the comparable assets have different reporting periods. When perform-
ing a historical valuation as of some past date, a further timing issue arises. Suppose that
the valuation date is in February of year 2 and the appraiser would like to use a valuation
ratio based on historical year 1 earnings, which are not released until March of year 2. It
can be argued that year 1 earnings are knowable as of the valuation date. However, market
prices may not fully reflect such earnings since they are not public information at the time.
Whether actual year 1 earnings can be used or whether an estimate as of the valuation date
should be used is to some extent a matter of judgement, and the totality of the circum-
stances surrounding the valuation should be considered.
Finally, inputs used in computing ratios should, to the extent possible, be standardised
for differences in accounting standards (e.g., US GAAP v. IFRS) and for certain other
factors. While accounting standards have generally been converging over time, the treat-
ment of certain items is not always consistent across firms. Failing to account for different
accounting treatments and other factors may distort the calculation of multiples. Examples
of adjustments that are sometimes made when calculating multiples include standardising
inputs to consistently account for pension obligations, operating leases, capitalised expenses,
one-time items, potential share dilution, minority interests and excess cash.
Step 6: Apply the comparables-based ratio to the asset being valued

At this point, we have identified a set of potential comparables, assessed their degree of
similarity to the asset being valued, and selected and computed valuation ratios. In this step,
the valuation ratios are applied to the asset being valued to arrive at an estimated valuation.
An obvious question that arises is how to translate the calculated ratios of multiple
comparables into a prediction of value for the asset at issue. Several approaches can be
utilised. One may use the median or average ratio to produce a valuation, report the range
of valuations associated with the range of observed ratios for the comparables, or estimate
a regression to account for observed differences in the comparable assets. In practice, the
most commonly used approach is to report a valuation based on the median multiple. Such
an approach should generally produce a reasonable estimate of value as long as the compa-
rable assets are similar to the asset being valued on relevant dimensions such as cash flow,
growth and risk expectations.
Valuations based on the median ratio are more commonly used than valuations based on
averages (i.e., arithmetic means) because averages can be influenced by outliers and missing
data to a larger extent than medians. Outliers that occur as a result of measurement issues
are of particular concern. For example, when using multiples based on reported past earn-
ings, companies with recent low earnings may appear to trade at unusually high multiples.
In addition, if ratios can be calculated for only a subset of comparables because of a lack of
data, the average measure may be biased. Again, suppose that a historical earnings multiple
is used and that some companies had negative earnings. In that case, one can only use the
multiple for companies with positive recent earnings. This may result in an upwards biased
estimate of the multiple if companies with negative earnings have lower relative valuations.
Unless there is reason to believe that the asset being valued is most like the comparable
associated with the median multiple, reporting a range of valuations may be informative.
213
Even if the midpoint is the best estimate, a reported range can be useful in quantifying the
uncertainty of the estimated valuation.
So far, the discussion has assumed that an assessment of comparability led to the conclu-
sion that the comparables included in the set are similar enough to the asset being valued,
such that the median valuation is the best point estimate. However, in practice, it is often
the case that there are differences between comparables and the asset being valued that
may be impacting the appropriateness of the median valuation. One possible solution is to
use subjective judgement to restrict the set of comparable assets to those deemed the most
similar to the asset being valued. If this is done, best practice would be to document the
basis for such judgement.
Some authors and valuation practitioners describe an alternative approach. They pro-
pose using quantitative techniques to control for the impact on valuation ratios of observed
differences between assets. One such technique we have already mentioned is regression
analysis. Suppose that a PE multiple based on historical earnings is used. This ratio meas-
ures the price (in terms of common equity value) that the market assigns to one dollar
of reported earnings. Economic theory suggests that the price paid per dollar of earnings
should be higher if the earnings are expected to grow at a faster rate, higher if the com-
pany is expected to pay more of its earnings as dividends, and lower if there is more risk
associated with the particular company.14 A regression analysis of the PE ratio could be
performed using measures of earnings growth, the payout ratio (how much of the earnings
are paid out as dividends) and risk. Results of such a regression for the US stock market are
available from Professor Aswath Damodaran’s website.15 Based on the most recent results
available as of the writing of this chapter in 2016, there is a statistically significant relation-
ship between PE ratios and the variables described. In fact, the three variables can explain
approximately 40 per cent of the variation in PE ratios in the US equity markets.
Having estimated an appropriate regression for the valuation ratio of interest (with
the explanatory variables ideally chosen according to economic theory), the values of the
explanatory variables for the asset being valued (the earnings growth, payout ratio and risk)
can be ‘plugged in’ to output an estimated valuation ratio (and an associated confidence
interval) that can then be used to perform the valuation (and quantify the uncertainty
inherent in the estimate). We do note that while this approach is intuitively appealing, its
applicability can be limited by the number of observed valuation ratios for the comparable
companies, because coefficients in a regression are estimated less precisely in small samples.
However, this is nevertheless a tool that can be helpful, even if only to inform how observed
differences across assets impact valuation ratios in terms of direction and magnitude.
Yet another approach to dealing with differences in comparability is to apply an adjust-
ment directly to the valuation resulting from the application of valuation ratios. Examples
of such adjustments that are sometimes seen in practice are adjustments for marketability,
control premiums and minority discounts.
14 See the discussion in the section titled ‘The Relationship Between the Comparables and Discounted Cash
Flow Approaches’ for more details on the PE ratio and its fundamental drivers.
15 Aswath Damodan is a Professor of Finance at New York University. See http://pages.stern.nyu.
edu/~adamodar/New_Home_Page/datafile/MReg16.html for this data.
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Discounts for lack of marketability are sometimes applied to the valuation of privately
held assets when the valuation is based on values of publicly traded assets. The economic
intuition is that it is more costly (in terms of time and marketing or search costs) to convert
closely held assets into cash than it would be to convert publicly traded assets such as public
equity, which can generally be sold quickly in the public market with relatively low trans-
action costs. Therefore, buyers of closely held assets may demand a discount to compensate
for these costs. There is also some evidence that buyers are sometimes willing to pay a
premium for a controlling stake in a company but demand a discount for a minority stake.
The exact magnitudes of any such discounts or premiums vary depending on the particular
study and can also vary when using different metrics and across countries.
The requirement for making any adjustments is to have an empirical basis for the amount
of the adjustment, such as cross-sectional studies in the academic literature. However, even
if information about average discounts or premiums is available from cross-sectional studies,
making an adjustment requires a degree of judgement to account for the particular circum-
stances of the asset being valued. Therefore, adjustments should be performed with care, as
transparently as possible, and likely after considering a range of reasonable adjustments as
opposed to relying on a point estimate.
Step 7: Understand key sensitivities and compare results to estimates obtained

using alternative methodologies, if available
The final step of the comparables valuation process includes ‘sanity checking’ and under-
standing the results of the valuation exercise and its potential limitations. Key valuation
drivers, the comparability of the asset set, as well as reporting a range of possible valuations,
when appropriate, have been addressed previously.
Having arrived at an estimated valuation, it is often useful to step back and develop
some economic intuition for where the asset being valued might fit in the valuation range
implied by the comparable assets.This can be done by examining the magnitude and direc-
tion of differences in valuation drivers between the asset and its comparables. For example,
when dealing with a privately held company and valuing it using publicly traded compara-
bles without making explicit adjustments for marketability, a median-based valuation may
overstate value.This may imply that, as opposed to being valued at the median multiple, the
asset should be valued in the lower end of the multiples’ range or even below it. On the
other hand, if the asset being valued is expected to experience a relatively higher rate of
cash flow growth than its comparables, its valuation may be more likely to fall in the upper
end of the multiples’ range. Note that such a directional analysis is not a substitute for hav-
ing an adequately comparable set of assets; however, if the remaining differences are small,
it does provide some directional intuition about the result.
When the comparables set is relatively small, it may also be worth examining the effect
of removing assets from that set on the median multiple. With a small number of compa-
rable assets and sufficient variation in multiples, even a relatively small change in the com-
position of the set can affect the median multiple. For example, consider the following set
of multiples: 4.2, 4.7, 5.0, 7.3 and 7.4. Removing the observation with the lowest multiple
(4.2) would change the median from 5.0 (the middle value of the original set) to 6.2 (the
average of 5.0 and 7.3, the middle two remaining values), which could substantially change
the ultimate valuation result. Of course, the observed range of multiples may indicate that
215
the comparables were not truly comparable to begin with and that the observed differences
need to be controlled for in some fashion.
Next, if using more than one ratio, the closeness of the valuations implied by the dif-
ferent ratios should be assessed. To the extent that the results are not sufficiently close (the
exact threshold being circumstance dependent), it is important to understand the reasons
for the difference. For example, a valuation based on a revenue ratio may be higher than
one based on an earnings multiple for a company that has relatively higher costs than com-
panies in its comparable set.
Finally, if a DCF valuation was also performed, the appraiser may consider investigating
meaningful differences in results between the two approaches. The relationship between
DCF valuations and comparables valuations is discussed in the following section.
The relationship between the comparables and DCF approaches

In the introduction, we explained that the comparables approach is an alternative – and a
complement – to the DCF approach. When correctly executed, it too is an implementa-
tion of the fundamental insight that economic agents assign asset values based on dis-
counted expectations of future cash flows, because, when performing a comparables valua-
tion, those expectations are embedded in the observed values of the comparable assets. We
now expand on this intuition. Because DCF analyses are most commonly performed when
valuing companies and businesses, we will use company valuation as an example.
Underlying a DCF valuation are assumptions about expected future cash flows and
assumptions about the cost of capital and the discount rate. In addition, it is customary to
build a model of future cash flows by making assumptions about fundamentals such as net
revenues, investment, profit margins and earnings, including their rates of growth.
Several of the previously discussed multiples can be derived from a fully specified DCF
calculation. For example, an EBITDA multiple can be computed by dividing the DCF
implied value of the company by a measure of EBITDA based on the projected financials
used to derive the cash flows. Similarly, the PE ratio can be computed by subtracting the
value of debt from the DCF implied value of the enterprise (to estimate equity value) and
then dividing by a measure of earnings used in the cash flow projections. A comparison
between DCF-implied multiples and multiples obtained directly from a comparables set
can be informative. Finding that the two are close is consistent with the underlying assump-
tions in the DCF model being compatible with the implicit assumptions embedded in the
valuations of the assets in the comparables set.While such a finding may provide a degree of
comfort, it does not prove that the valuations are necessarily correct, because assumptions
underlying both the DCF valuation and the comparables valuation may nevertheless be
inappropriate for the asset being valued. If the DCF-implied value is meaningfully different
from that implied by multiples, it may be useful to understand why the difference exists.
An observed multiple may also be expressed as a function of its underlying fundamental
components that can then be mapped to DCF inputs. For example, the forward PE mul-
tiple (value of equity scaled by expected future earnings) can be shown to be a function
of a discount rate (r), a growth rate (g), and a measure of investment intensity called the
plowback or retention ratio (pb). As a general matter earnings can either be reinvested into
the business or paid out as dividends, and the plowback or retention ratio is defined as the
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fraction of earnings that is reinvested. These three variables (r, g and pb) are also inputs
(either directly or indirectly through related assumptions) into a DCF valuation.16
The forward PE ratio is defined as:
Market Price Per Share

P/E =
Expected Forward Earnings Per Share
The market price per share can be thought of as the discounted sum of all future divi-
dends.17 The market price per share can thus be written as follows, under certain assump-
tions (stable constant growth and discount rates) and using a perpetuity formula: 18
Expected Forward Dividend Per Share

Market Price Per Share =
r–g
The expected forward dividend per share is the amount of expected forward earnings per
share paid out as dividends, i.e., not reinvested in the business. Given that the plowback
ratio (pb) is the fraction of earnings that is reinvested, the fraction of earnings that is paid
out as dividends is equal to one minus the plowback ratio. Therefore, replacing expected
forward dividends per share (next period’s dividend) with the product of forward earnings
per share (next period’s earnings) and one minus the plowback ratio (the amount of next
period’s earnings that is not reinvested but paid out as dividends), yields:
Expected Forward Earnings Per Share * (1 – pb)

Market Price Per Share =
r–g
Plugging this expression into the definition of the PE ratio above yields:
1 – pb
P/E =
r –g
This decomposition shows that PE ratios depend on investment policy (pb or how much of
earnings is reinvested in each period) growth (g), as well as risk, which affects the discount
rate (r).19 Therefore, when applying PE ratios in a valuation, the assets in the comparables
set should embed similar investment policy, growth and risk expectations.
Similar calculations can be performed for other valuation multiples. For example, under
certain assumptions, an enterpries value to EBITDA multiple can be expressed as a function
16 Given that the PE ratio is used to value common equity, we are making a comparison to a discounted
cash flow valuation of common equity, which is a variation of the DCF methodology for valuing the
entire company. Therefore, the discount and growth rates discussed here are rates that are applicable to
common equity.
17 This is known as the Gordon growth model.
18 Readers interested in a more detailed discussion are invited to consult a corporate finance textbook (e.g.,
Corporate Finance by Stephen A. Ross, Randolph W. Westerfield and Jeffrey Jafe). The expression is based on a
perpetuity discounted cash flow formula using a constant over time growth and discount rate.
19 Note that investment and growth are linked, which is not explicitly shown above.
217
of the weighted average cost of capital (WACC), a growth rate, net investment, change in
working capital and the tax rate, which are all components of a DCF valuation.
Finally, it is useful to note that DCF valuations sometimes rely on inputs calculated
using comparables.This most often arises in two instances. First, it is customary to calculate
inputs to cost of capital calculations using peer companies. Second, some DCF valuations
apply terminal exit multiples to calculate the terminal value of cash flows instead of mak-
ing explicit terminal growth rate assumptions. Such exit multiples may again be based on
comparable companies. The caveats when choosing the right comparables set would then
apply to the DCF valuation as well.
When to use the comparables approach

The comparables approach can be a useful valuation technique, either stand-alone or in
conjunction with other approaches such as the DCF approach. It is widely used by practi-
tioners and can be useful in a number of valuation contexts. As discussed in this chapter, the
use of this approach may be suitable when appropriate comparables can be identified and
when they have recently observed values. Generally, four conditions need to be fulfilled.
First, comparables that are similar to the asset being valued in terms of future prospects
(expected cash flows and discount rates) must be available. To the extent that differences
do exist, they must not materially affect the valuation. If the differences do have a material
effect, their impact on valuation should be properly controlled for.
Nevertheless, even in instances when there are material differences that cannot be con-
trolled for, a comparables valuation can still provide useful information, such as an upper
or lower bound on value, as long as the directional impact of the material differences can
be determined. For example, a valuation of a private company based on publicly traded
comparables that are otherwise comparable would generally overstate its value because pri-
vate companies may be subject to marketability discounts and thus have lower valuations
than otherwise comparable publicly trading companies, which therefore provide an upper
bound for the valuation.
Second, comparables need to have observable values. The values can either be observed
transaction prices in public markets, values assigned in private transactions, or potentially,
but less commonly, some other measures of value.
Third, the observed values of the comparables should be recent enough so as not to be
stale. Assessing this criterion requires judgement regarding how much valuations would be
expected to change over time.
Finally, appropriate valuation ratios need to be calculated consistently across the com-
parable set, using the same definition for each comparable.
When the comparables approach can be applied, its use can be quite appealing. The
advantage is that it is intuitive and is relatively easier to apply than the DCF method, since
it does not require making explicit assumptions about cash flows and discount rates. The
downside of the approach is that these assumptions are still being made, albeit implicitly,
in the choice of the comparables set and in the valuation ratios being used. In a sense, the
valuation of the asset at issue ‘inherits’ the assumptions embedded in the valuations and
valuation ratios of the comparable assets. For this reason, if feasible, it can be informative to
compare a valuation obtained using the comparables approach to a DCF valuation and to
attempt to understand or reconcile any differences in valuations.
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15
Asset-Based Approach and Other Valuation Methodologies
Mark Bezant and David Rogers1
Asset-based valuations: Valuation floor or flawed valuation?

Synopsis
Asset-based valuations, such as ‘book value’, are often applied in one of two ways: (1) as a
floor or cross-check for values assessed using Discounted Cash Flow (DCF) or market-based
approaches; or (2) to value assets not reflected in a DCF or market valuation, such as
non-operating assets. However, the utility of these applications is sometimes misjudged
because of misunderstandings about the content of financial statements – in particular,
because the requirements (or ‘financial reporting standards’2) governing the preparation of
financial statements have changed and become more complex in recent decades.
In this chapter, we discuss the application of asset-based methods and, in particular,
why asset values and related information in financial statements both need to be carefully
assessed as part of an overall valuation or damages analysis.
Background
An asset-based valuation is a method of valuing an entity as the sum of the value of each of
its assets and liabilities. Strictly speaking, it does not represent a valuation approach3 (such as
the market, income and cost approaches, which are based on economic principles of price
equilibrium, anticipation of benefits or substitution4). Rather, an asset-based methodology
1 Mark Bezant is a senior managing director and David Rogers is a senior director in the economic and
financial consulting practice at FTI Consulting.
2 References to financial reporting standards in this chapter are predominantly to International Financial
Reporting Standards (IFRS), although similar issues may arise under other financial reporting regimes.
3 Paragraph C14 of the 2011 edition of International Valuation Standard (IVS) 200: Business and
Business interests.
4 Paragraph 55 of the International Valuation Standards Framework.
219
provides a framework in which individual assets and liabilities are identified and valued, but
which does not specify the approach(es) to apply when valuing those assets and liabilities.
Asset-based valuations are often performed using balance sheet information from the
financial statements of an entity. This connection to financial statement information (par-
ticularly where that information has been independently audited) is sometimes considered
attractive to tribunals because of a perception that such information is comprehensive and
reliable and can, therefore, be used directly in the valuation or damages analysis. However, as
we explain in this chapter, financial reporting standards govern the recognition and meas-
urement of assets and liabilities, and the details of these standards need to be considered
carefully when applying an asset-based approach.
In the remainder of this chapter, we discuss: (1) the identification of assets and liabili-
ties for financial reporting purposes and their recognition in financial statements; (2) the
measurement or valuation of those assets and liabilities eligible for recognition; and (3) the
application of the asset-based valuation approach in different circumstances. We give spe-
cific examples to illustrate the issues.
Identification and recognition of assets and liabilities in financial statements

A common starting point for identifying an entity’s material assets and liabilities is the assets
and liabilities identified in the financial statements; in particular, those recognised on the
balance sheet.
There are two potential limitations to this approach:
(1) the balance sheet may not include all relevant assets and liabilities. That is, there may be
assets and liabilities that have economic value, but that are not recognised in the finan-
cial statements because they do not meet the definitions of assets and liabilities under
the relevant accounting standard;5 or
(2) there can be circumstances where certain assets meet the relevant definition of an ‘asset’
(and similarly for liabilities) but are, nevertheless, not permitted to be included on the
balance sheet under the relevant accounting standard.
The first of the above limitations can apply in respect of what are termed ‘contingent’ assets
or liabilities; that is, resources or obligations for which the future economic benefits or costs
are contingent on uncertain future outcomes or hard to quantify, such as securing a major
contract, the granting of intellectual property rights, the outcome of litigation, the extent
of environmental or clean-up obligations, or the exercise of an option over certain of the
entity’s assets. These contingent assets or liabilities may well affect the economic value of
the entity but will not be reflected on the balance sheet, given the associated uncertainties.6
5 Under IFRS, an asset is defined as ‘a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity’, and a liability is defined as ‘a present obligation of
the entity arising from past events, the settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits’ (part 2.6.2 of the International Accounting Standards Board’s
Conceptual Framework).
6 Notwithstanding this, the narrative reporting and notes to the financial statements may still provide guidance
as to the existence and potential value of contingent assets and liabilities that are not included on the
balance sheet.
220
The second of the above limitations can apply to entities with significant intangible
assets. For example, companies that prepare their financial statements in accordance with
IFRS generally do not include on their balance sheet intangible assets that are internally
generated.7 These assets, which can be highly valuable, may include brands, customer con-
tracts and relationships, technologies and skilled workforces.8
Notwithstanding the above, where one entity acquires another entity, many accounting
standards (such as IFRS and US GAAP) require that as well as revaluing acquired tangi-
ble assets and inventory previously included in the financial statements, what are termed
‘separately identifiable’9 intangible assets and liabilities are recorded in the consolidated
financial statements (the purpose being to inform the user of the accounts of the nature of
the underlying assets and liabilities obtained via the purchase of the acquiree’s shares). In
these cases, information may become available on the assessed value of certain intangibles,
including those which previously were not recognised on the acquiree’s balance sheet (for
instance, because they were internally generated). One may, therefore, end up with a mixed
outcome, whereby, following the acquisition, the acquiror’s financial statements include
values for intangible assets it has acquired but not those it has generated itself.
The categories of intangible assets capable of recognition in financial statements follow-
ing an acquisition vary between accounting regimes. There is also, in our experience, no
clear consensus as to how certain assets are treated. For example, in some cases trademarks,
customer contracts and customer relationships may be recognised and valued separately,
and in other cases they may be subsumed into a composite ‘brand’ value.10
As we discuss below, the values of intangible assets reported in financial statements, and
assets more generally, need careful review, given the assumptions and conventions adopted
for financial reporting purposes.
7 ‘International Accounting Standard (IAS) 38 – Intangible Assets’, paragraphs 63 and 64. Similar considerations
apply under other accounting standards such as US Generally Accepted Accounting Principles (GAAP).
8 The economic benefits from such assets should typically be reflected in a DCF or market-based valuation
of the subject entity as such valuations seek to capture the entity’s ability to generate profits using all of its
operating assets and liabilities. As a consequence, when a DCF or market-based valuation is performed, it is
typically appropriate not to value such assets separately.
9 The assumptions as to ‘separability’ for the purposes of financial reporting may not (fully) reflect the
contractual or commercial position as regards the ability to separate from an entity and then dispose of a
specific intangible asset.
10 For instance, ‘IFRS 3 – Business Combinations’ states the following at paragraphs IE20 and IE21: ‘The
terms brand and brand name, often used as synonyms for trademarks and other marks are general marketing
terms that typically refer to a group of complementary assets such as a trademark (or service mark) and its
related trade name, formulas, recipes and technological expertise. IFRS 3 does not preclude an entity from
recognising, as a single asset separately from goodwill, a group of complementary intangible assets commonly
referred to as a brand if the assets that make up that group have similar useful lives’.
221
Measurement and valuation

In principle, an entity’s discrete assets and liabilities can be measured, or valued, using one
or more valuation approaches. In practice, valuers will often rely, at least to some extent, on
the amounts reported in the entity’s balance sheet:
• the simplest application adopts the balance sheet amounts for all assets and liabilities.
This is sometimes described as a ‘book value’ approach and uses the balance sheet both
for the list of assets and liabilities to be assessed and their respective values; and
• more complex applications entail replacing some or all of the balance sheet amounts
with an alternative assessment of value.This is sometimes described as an ‘adjusted book
value’ approach.
The amounts reported in financial statements can be the result of a more complex valua-
tion approach than is often appreciated. As explained below, the amounts for many assets
are valuations drawing on standard valuation techniques such as DCF and market-based
methods. However, there is sometimes a misunderstanding that the balance sheet amounts
(or ‘book values’) for assets necessarily reflect historical costs, for example:
Book value is an accounting concept; it represents the original (historic) cost of an asset, which
is adjusted downward for the loss in value associated with the ageing of the asset (depreciation
or amortisation).11
While some types of asset may be measured for accounting purposes by reference to their
historical cost, other assets and liabilities are measured based on their assessed value. For
instance, IFRS and US GAAP require or permit a variety of assets (including common-
place assets such as plant, property and equipment) to be measured at their ‘fair value’.12 In
this context, fair value is effectively a measure of market value.
Different types of assets and liabilities can be reported on a book value basis that may
not accord with either historical cost or market value. Whether or not this is the case
depends on the circumstances of the entity, the relevant accounting standards and the
application of those standards. However, by way of illustration, the types of assets and liabili-
ties whose book value may differ from (and often be lower than) market value includes
the following:13
(1) Fixed assets such as plant, property and equipment may be reported at historical cost,
subject to annual depreciation.14 However, the current value of an asset may differ
11 Page 221 of Damages in International Investment Law (2008) by Sergey Ripinsky and Kevin Williams.
12 Under both IFRS and US GAAP, fair value is defined as ‘the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date’
(paragraph 9 of ‘IFRS 13 – Fair Value Measurement’ and paragraph 5 of the Financial Accounting Standards
Board’s ‘Statement of Financial Accounting Standards No. 157 – Fair Value Measurements’).
13 The following list is intended to illustrate the issues as they can affect the application of asset-based methods,
and is not intended to be a comprehensive summary of the accounting considerations or standards, or
valuation implications.
14 Specialist properties or plant and machinery are sometimes valued on a ‘Depreciated Replacement Cost’
basis, as opposed to by reference to historical cost, with the replacement cost of the asset reduced to reflect
technological or economic obsolescence (such as through use or age) of the asset at issue.
222
materially from its historical cost,15 so the latter may not be a reliable guide to the
former.16 Furthermore, assets that are substantially or fully depreciated (such as storage
facilities, pipelines, dies) for financial or tax accounting purposes may still have signifi-
cant economic value.
(2) Inventory is held at the lower of cost and what is termed ‘net realisable value’.17 The
market value of inventory may, therefore, differ from its carrying amount in the finan-
cial statements where the inventory is subject to long development or sales cycles, such
as whisky or diamonds, or involves commodities whose value can fluctuate markedly
over short periods of time.
(3) Investments in associates (namely influential but non-controlling interests in other enti-
ties) are often ‘equity accounted’. Broadly, this involves taking a pro rata share of the
associate’s net asset value as the carrying value in the entity’s financial statements, rather
than the market value of that holding.
(4) Other assets may be held at fair value as at a historical date, such as acquired intangibles
and real estate developments.
(5) Several asset classes, such as tangible and intangible fixed assets and investments in asso-
ciates and subsidiaries, should also be subject to regular impairment reviews to assess if
what is termed the ‘recoverable amount’18 exceeds the amount reported in the financial
statements. If not, the carrying amount is written down (that is, reduced) such that the
revised amount reflects an estimate of the recoverable amount. In contrast, if their value
increases above their cost or assessed fair value on their original acquisition, their car-
rying values are not increased.
(6) Financial assets and liabilities, depending on how they are classified by the entity, may be
‘marked-to-market’. In effect, they are repriced, to the extent possible, to reflect market
changes since the last financial statements were prepared.
As a result, the accounting policy and other notes in the financial statements need to be
reviewed carefully to understand the basis on which different assets and liabilities have
been assessed.
As a further illustration of the complexity that can arise, in one valuation of a real
estate company in which we were involved, the underlying properties were held at a mix
of historical cost, fair value (investment and development properties), and the lower of cost
15 For instance, the current value of many properties is significantly different to the expenditure historically
made to acquire or construct the asset.
16 As one commentator noted, ‘the single greatest limitation of the book value method is that it ignores the
value management may have added to the assets. The whole point of management is to make the assets worth
more than their cost. By building and training a work force, by developing a reputation in the marketplace,
by learning how to produce the goods or services at low cost, by creating opportunities for expansion, and
in other ways, management (and past managements) should have – and in most cases has – created value in
excess of the cost or book value of the assets’ (Financial Statements Analysis and Business Valuation for the Practical
Lawyer (2006) by Robert Dickie).
17 Under IFRS, net realisable value is defined as ‘the estimated selling price in the ordinary course of business less
the estimated costs of completion and the estimated costs necessary to make the sale’ (‘IAS 2 – Inventories’).
18 ‘IAS 36 – Impairment of Assets’ defines the recoverable amounts as ‘the higher of an asset’s or cash-generating
unit’s fair value less costs of disposal and its value in use’ (see paragraph 18).Value in use is usually assessed with
a DCF approach, and market value using methods such as the valuation multiples of comparable companies.
223
and net realisable value (properties considered as ‘trading stock’). The picture was further
complicated by some of the properties being held via subsidiaries or minority interests in
associated companies, as opposed to directly, which had resulted in the investments being
held at historical cost and not always revalued (upwards, given market movements in the
interim) based on the underlying property assets.
It is also important to appreciate the valuation requirements or conventions under
financial reporting standards, and the extent to which these accord with the valuation or
damages question that the expert is addressing. For example:
(1) Interests in quoted shares may be valued using the prevailing share price. However, this
price typically reflects the price at which small parcels of shares are traded, and may not
reflect the price that a significant block of shares would command (where a premium
or discount (termed a ‘block discount’) to the prevailing share price may be appropri-
ate, depending on the specific circumstances of the sale, the depth of the market in the
shares, and the distribution of ownership of the entity’s share capital).
(2) Intangible assets, such as acquired trademarks, are valued on the presumption the trade-
mark is capable of sale for use by a third party. However, the acquisition strategy may
involve retiring an acquired brand and migrating the brand value to the acquiror’s brand,
such that the value of the acquired trademark is not, in reality, separately realisable.
(3) The fair values of intangible assets acquired via a share acquisition may be increased
(‘stepped up’) for potential tax effects on the acquisition of an asset directly, when these
tax benefits may not be available in practice.
The book value of various classes of liabilities is often adopted unadjusted for an asset-based
valuation. This can be appropriate for liabilities such as trade payables and debt when (as
is often the case) the amount owed is both unambiguous and taken as the book value.
However, the measurement of book value can be more complicated for financial liabilities
where these are marked-to-market and for pension obligations. The different bases on
which any financial liabilities or pension deficit are assessed (or reported) need to be under-
stood in assessing their value under an asset-based valuation analysis.
Materiality19 can also be an important consideration when considering whether it is
appropriate to rely on the book value of assets and liabilities for an asset-based valuation.
This issue can be particularly pertinent where a subsidiary or operation that forms part of
a (much) larger group is sold (which circumstance is relevant for many post-acquisition
disputes). The financial statements of members of the seller’s group may reflect materiality
considerations for the overall group as opposed to the company disposed of on a standalone
basis, including as regards recognition and measurement of assets and liabilities. That is, the
audited financial statements of the company sold may have been prepared in one context
(namely as part of a larger group) and not in the context of a disposal where different
materiality thresholds may apply.
19 ‘Information is material if omitting it or misstating it could influence decisions that users make on the basis
of financial information about a specific reporting entity. In other words, materiality is an entity-specific
aspect of relevance based on the nature and magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report’ (International Accounting Standards Board’s
Conceptual Framework).
224
In summary, the calculation of the balance sheet amounts for assets and liabilities can
involve complex and subjective assessments (in particular, where the carrying amount is
calculated as a fair value20). This is not always appreciated as it often assumed that because
a figure is taken from the audited financial statements it must be objective and reliable. As
noted by one observer:
despite the fond hopes of many arbitrators and commentators, looking to asset values rather than
income-based methods does not eliminate the subjectivity of business valuations. The proper
amount to be shown on the balance sheet for many items calls for the exercise of judgement by
the company’s management and its accountants.21
It is important, therefore, for the valuer to understand the basis on which the balance sheet
amounts have been assessed so that they can consider whether to adopt that amount or
perform their own valuation. In the context of an arbitration, it may assist the tribunal if
the expert valuer explains:
(1) the basis on which material assets and liabilities are measured for financial reporting
purposes; and
(2) their decision regarding whether to adopt the balance sheet amount or replace that
figure with a different valuation.
Where valuers choose not to adopt a balance sheet amount, this is often because:
(1) the relevant amount has been measured by reference to historical cost. As explained, the
current value of an asset may differ from the price paid to acquire it at some past date,
so historical cost may not provide a reliable guide to current value; or
(2) there has been a material change since the balance sheet date such that the balance sheet
figure is not a reliable measure of value at the valuation date.
Use of asset-based valuations

Asset-based valuations are typically not the primary method used to value a company or
business. However, they are often applied:
(1) where the business is not a going concern (for instance, because it is not profitable or
is financially distressed) and the highest and best use of its assets would be realised by
liquidating the business;
(2) for start-up or early stage businesses that do not have a track record of generating prof-
its; or
(3) where the underlying assets, as opposed to the ongoing operations, are responsible for a
significant proportion of the value of the firm.This is sometimes the case for companies
whose value principally stems from physical assets (such as property-based businesses
that own, for example, offices, hotels, care homes, restaurants or shopping centres), natu-
ral resources (where the financial statements may already contain a valuation of the
20 ‘IFRS 13 – fair value measurement’ extends to over 100 pages, illustrating the issues at hand.
21 Page 244 of Valuation for Arbitration – Compensation Standards,Valuation Methods and Expert Evidence (2008) by
Mark Kantor.
225
underlying asset), or financial assets (as held by hedge funds, private equity vehicles, or
investment trusts).
More generally, the net asset value of the company or business is often seen as a lower
bound cross-check when a value has been assessed using another valuation approach.
Valuation in liquidation
An asset-based valuation approach is often used when a business is to be liquidated. In such
circumstances, the value of the assets is determined based on their ‘liquidation value’, which
is defined as ‘the amount that would be realised when an asset or group of assets are sold on
a piecemeal basis, that is without consideration of benefits (or detriments) associated with
a going-concern business’.22
Where the subject company has in fact been liquidated, the valuer may be able to
rely on the amounts actually realised. If not, the valuer will need to consider the amounts
expected to be realised. This can depend on the circumstances of the expected or notional
liquidation. In particular, valuers distinguish between:23
(1) an orderly liquidation, where there is a reasonable period of time to find a purchaser (or
purchasers); and
(2) a forced sale, where the compulsion to sell is such that a proper marketing period is
not possible.
Book values act as a starting point for liquidation valuations (other than where, as noted
above, valuable intangible assets are not reported on the balance sheet). However, because
financial statements are generally prepared on a going concern basis, the book values may
need to be adjusted to reflect a liquidation or break-up basis.
Valuation of start-up or early stage businesses

Tribunals sometimes prefer asset-based valuations when the subject business has only
recently been established and does not have a track record of generating profit, which may
be the case in arbitrations concerning, say, the expropriation of a mining concession or
exploration rights, or a production facility under construction. In its award for the Siemens
AG v. the Argentine Republic arbitration, the tribunal stated:
Usually, the book value method applied to a recent investment is considered an appropriate
method of calculating its fair market value when there is no market for the assets expropriated.
On the other hand, the DCF method is applied to ongoing concerns based on the historical
data of their revenues and profits; otherwise, it is considered that the data is too speculative to
calculate future profits.24
22 Paragraph 80 of International Valuations Standard 104 – Bases of Value (Exposure draft, dated 7 April 2016).
23 Paragraphs 170 and 180 of International Valuations Standard 104 – Bases of Value (Exposure draft, dated
7 April 2016).
24 Paragraph 355 of the award.
226
Uncertainty about a new business’s ability to generate profits also concerned the tribunal
in the Asian Agricultural Products Ltd (AAPL) v. Republic of Sri Lanka arbitration. This led the
tribunal to award damages based on an asset-based valuation and further to limit, given the
early stage of the business, the award to the value of the tangible assets (in other words,
excluding any value in respect of goodwill and other intangible assets).25
In the context of a dispute relating to a start-up or early stage business, a tribunal
may be minded to allow the claimant to recover the cost of their investment.26 However,
depending on whether costs are capitalised or expensed, reported book values may not
accord fully with the cost incurred.
Book value as a cross-check

As noted above, the primary valuation method(s) applied to going concern businesses will
typically be the discounted cash flow method (DCF) or multiples method (whereby value
is assessed by reference to a value multiple observed for comparable businesses that are
either listed on a stock exchange or have been acquired relatively recently).27 Nevertheless,
the book value variant of the asset-based approach may still provide a helpful lower bound
value to cross-check the value calculated under the primary valuation method(s). For
instance, an equity value derived from the DCF or multiples method can be compared
with the net asset value at the balance sheet date immediately prior to the valuation date.
The reason that the book value may provide a lower bound indication of value is that
the balance sheet has inbuilt conservativism (from a value perspective) when assets:
• are not recognised for accounting purposes; or
• are carried at less than their current value (for instance, because they are measured by
reference to their historical cost, or are not revalued upwards following an acquisition).
Notwithstanding the above, the value of a business at a particular time may be less than the
book value in the most recent financial statements. This may be the case where:
(1) the financial statements have not been prepared on a basis suitable for the cur-
rent purpose;
(2) there are significant off-balance sheet liabilities, such as tax charges that would arise on
disposal of assets; or
(3) the valuation date is after the balance sheet date and value has declined in the interim.
A further important cross-check is whether the treatment of an asset or investment in the

financial statements is consistent with a position being advanced in a dispute. For exam-
ple, a claimant may contend that they overpaid substantially for an acquisition because of
a breach of warranty or misrepresentation, or that a breach of contract has damaged the
value of an investment. However, this may be inconsistent with the position adopted in the
25 Paragraphs 113 and 100 of the award.

26 The approach (as sometimes adopted by tribunals) of disregarding DCF analysis for early stages businesses is
contentious: in principle, a DCF approach may be appropriate for valuing such businesses.
27 The DCF method represents an application of the income approach, whereas the multiples method represents
an application of the market approach.
227
financial statements if the investments are not treated as impaired by the matters that are
subject of the dispute (or not to the same extent).
Similarly, summary28 valuation information such as forecasts, discount rates, and growth
rates informing a DCF valuation that is referred to in the financial statements (such as for
an impairment review) may need to be reconciled to the assumptions in a DCF-based
damages calculation if they are materially different.
Summary
Asset-based valuations can appeal to tribunals, especially where the financial statements
from which the information is taken have been audited. However, the accounting standards
applying to recognition and measurement of a company’s assets can be complex and need
to be interpreted and applied with care to ensure the valuations are fit for purpose.
Book values or adjusted book values remain useful, provided the meaning and natu-
ral limits of the information are properly understood. Importantly, financial statements
often contain extensive information that reflects valuation judgments by management (or
an entity’s auditors). This can inform a valuation prepared in a dispute, or be used to
cross-check a valuation or its key inputs.
28 The valuation-related information presented in financial statements will typically be the resulting valuation
and potentially summary valuation information, rather than detailed supporting calculations or commentary.
228
16
Taxation and Currency Issues in Damages Awards
James Nicholson and Sara Selvarajah1
Summary
This chapter describes some of the issues that can contribute to the distortion of the value
of awards received by claimants arising from the treatment of taxes and currency, and
explores some possible approaches to reducing or eliminating potential distortions from an
economic point of view.
Taxes, and particularly taxes on profits, are a fact of corporate life in the majority of
jurisdictions. As a result, the treatment of tax in the calculation of awards of compensa-
tion made by tribunals in international commercial and investment treaty arbitration can
have a significant impact on the value of an award to a recipient. Overcompensation and
under-compensation are possible where taxes are not considered appropriately or at all.
The treatment of taxation in relation to awards of damages may, depending on the cir-
cumstances, be a question of the law of damages before it is a question of the assessment of
economic loss. In the taxation part of this chapter, we focus on questions of economic loss
arising in this context. These issues can be complex, given the nature of the calculation of
an award, its timing and the international context in which many claims are made. Perhaps
partly as a result, this area has often been given limited attention by tribunals and parties
to disputes.2
Similarly, the treatment of currencies in the calculation of awards of damages can have
a very significant effect on the value of damages received by a claimant, again potentially
giving rise to overcompensation and under-compensation.
1 James Nicholson is senior managing director in FTI Consulting’s economic and financial consulting segment
and Sara Selvarajah is a managing director in FTI Consulting’s European tax advisory team. Neither author is
legally qualified and nothing in this article should be taken as opinion or advice on matters of law.
2 Sara Selvarajah collaborated with James Nicholson on the parts of this article relating to taxation, which draw
on an article the authors recently published in The International Arbitration Review (7th ed, 2016); the remainder
of the article was prepared by James Nicholson.
229
Calculating damages in international arbitration

Famously, the calculation of an award of monetary damages in bilateral investment treaty
arbitrations is based on the principle established by the Permanent Court of International
Justice (predecessor to the International Court of Justice) in the Chorzów Factory case of
1928: ‘reparation must, as far as possible, wipe out all the consequences of the illegal act
and re-establish the situation which would, in all probability, have existed if that act had
not been committed.’ The ex ante position should be restored. A substantially similar prin-
ciple generally applies in international commercial arbitration: that the claimant should be
restored to the position it would have enjoyed but for the breaches found by the tribunal.
We shall call this the ‘principle of full compensation’.
The principle of full compensation implies that any award should restore the claimant
to the same position that it would have enjoyed but for its injuries, taking account of all
relevant factors, including applicable taxation and relevant currency movements, both in
considering the financial position the claimant would have been in but for the breach or
breaches and the financial position it in fact finds itself in.
Tax treatment of arbitration awards

Why does tax matter?
Taxation of corporate profits is well established in most jurisdictions.3 Such taxes would
often have applied to additional profits a claimant would have made but for its injuries, and
also often apply to any award received by a claimant.
The treatment of taxation by tribunals in setting awards can make an important differ-
ence to the net proceeds of an award to a claimant and, therefore, whether the principle
of full compensation has been met. Most simply, if an award itself is subject to tax and
the value of the award has been calculated by reference to profits lost on a post-tax basis,
under-compensation of a claimant is likely to arise. In such circumstances, the principle of
full compensation might at its most straightforward imply that it would be necessary for the
claim to include a gross-up for tax payable on the award.
However, in our experience, the question of tax is often largely and sometimes entirely
disregarded by the parties to a dispute. The sources of this neglect are understandable:
• damages calculations are often already complex, time-consuming and expensive for the
parties to prepare, before consideration of tax issues;
• tax is itself a complex area often requiring separate experts if it is to be examined in
detail; and
• because the amount of taxes that would have been or will be paid in certain scenarios
can depend on the performance in the future or hypothetical position of both the legal
entity and its corporate group, treatment of tax issues may require an even broader
scope for analysis and estimation than that required for other aspects of loss assessment.
Moreover, to assess the extent of taxes that a claimant will pay on any award, it is often
necessary to make estimations concerning the future actual performance of the claimant
3 Although individuals are often parties to international arbitration, we focus in this article on the situation
of corporations.
230
(because, for example, a loss-making company may pay no taxes on an award, while the
same company, if profitable, would pay taxes). When such estimation is compared to the
future actual performance of the business it may result in dissatisfaction for one of the par-
ties affected by an award of damages.
Below, we discuss some of the conceptual issues involved in considering the tax impli-
cations of damages awards, before giving an overview of tax issues in selected jurisdictions.
The issues raised by tax analysis

To illustrate the issues at hand, consider a relatively straightforward case in which a claimant
is only seeking compensation for trading losses suffered in its home jurisdiction.
To analyse fully the tax treatment of the hypothetical lost profits, the following would
need to be taken into account:
• Over which periods would the profits have arisen?
• What is the effective tax rate that should be applied to those profits, which itself depends
on the answer to the following questions:
• What is the applicable corporation tax rate in each period?
• What is the basis of the calculation of taxable profits in each period (e.g., taking
account of allowances, depreciation of assets for tax purposes and other factors)?
• To what extent are other losses available for offset either within the period, brought
forward from earlier periods, or surrendered from affiliates?
A similar analysis would be required in relation to the award claimed in compensation for
the lost profits, which would need to take into account:
• On what basis will the award be subject to tax? It may follow the taxation of the lost
profits or be treated as a separate source of income or gains subject to different rules.
• In which period would it be subject to tax? At the time of the claim, both the timing
of any future award payment and the tax position of the claimant in the tax periods in
which the award may be received are likely to be uncertain.
Further considerations come into play when the injury causes loss to an asset. Depending
on the applicable jurisdiction, damage to an asset may result in a deemed disposal or part
disposal of the asset for tax purposes and any compensation for such a loss may be treated
as proceeds for such a disposal.This may apply when the asset is tangible property, or intan-
gible property such as a brand, which may be a recognised asset on the claimant’s balance
sheet.The capital gain/loss will be calculated according to applicable tax principles, deduct-
ing allowable costs (of acquisition, etc.) from the proceeds of disposal. This calculation may
not be consistent with the method used to calculate the award, which may be by reference
to loss of revenue, and this would need to be taken into account to ensure appropriate
post-tax compensation.
Further refinement would be needed in cases in which a claimant seeks compensation
for profits that would have been generated partly or entirely in jurisdictions other than
its home jurisdiction. This is very often the case in bilateral investment treaty cases, for
jurisdictional reasons, and also for those commercial cases in which a parent company is
claiming for losses suffered by its foreign subsidiaries.
231
Although international law may apply to the arbitration process, tax law is not interna-
tional. Each jurisdiction has sovereign power to determine the taxation of companies resi-
dent or active in that jurisdiction.The exercise of this sovereignty can result in conflict with
other jurisdictions or supranational bodies as demonstrated recently by the intervention
of the European Union in Apple’s tax arrangements in Ireland, agreed by the Irish fiscal
authority but attacked under EU State Aid principles. The diversity of approach to taxa-
tion generally is illustrated by the table below, which summarises headline corporation tax
rates for 2015.4 The method of identification of the profits subject to tax, taking account of
reliefs, exemptions, losses and affiliated company tax positions, also varies.
Corporation tax rates in selected jurisdictions (2015)

Jurisdiction CT Rate (2015)
China 25%
France 33.33%
Germany 15%
Hong Kong 16.5%
Ireland 12.5%
Singapore 17%
Switzerland 8.5%
UAE 0%*
UK 20%
US 35%
Venezuela 34%
*
Corporation tax on branches of foreign banks.
In cross-border cases, therefore, it is necessary to consider whether there is symmetry of

taxation between the lost profits on one hand, hypothetically subject to tax in the home
jurisdiction of the injured company, and the award on the other hand, potentially tax-
able as income or capital gains when received by the injured company or an affiliate, in
another jurisdiction.
This situation also raises the question, in relation to commercial cases, of equity between
jurisdictions, as well as between claimant and defendant; where tax is lost in one jurisdic-
tion as a result of the injury inflicted on one company and paid in another jurisdiction as a
result of compensation paid to a parent or affiliate in that other jurisdiction, some form of
settlement might be expected between tax authorities in different jurisdictions. However,
there is no mechanism in the established tax treaty system for tax fortuitously received in
one jurisdiction to be reimbursed to another, so such a process is not yet formally possible,
in commercial cases at least.5
There is also the possibility of a claimant receiving an award calculated on a pre-tax
basis, which is then not subject to tax; for example, where circumstances change or an
4 OECD Tax Database, www.trading economics.com, local fiscal authority sources.

5 Although see below for the tax treatment in France (and potentially other jurisdictions) of compensation for
expropriations, as may be awarded under a bilateral investment treaty and otherwise.
232
alternative tax return position is taken. Such over-recovery would also be a violation of the
principle of full compensation.
Perspectives from the UK, US and France

As the brief survey above indicates, the issues involved are complex, and a detailed analysis
of tax issues risks creating a separate arbitration within the arbitration, requiring further
evidence of fact, evidence from tax experts, etc. We have never sensed appetite from parties
or tribunals for such a detailed investigation; an understandable attitude given the potential
for excessive technical detail, creative assumptions and uncertainty of tax outcomes outside
the control of the tribunal.
Before we discuss the steps that parties and tribunals can take towards implementing the
principle of full compensation as far as taxation is concerned, we explore certain perspec-
tives arising in the UK, US and France.
UK perspective
The case of British Transport Commission v. Gourley (HL 1955) confirmed a general principle
of compensation consistent with the principle of full compensation. However, the degree
of approximation with which this principle is applied to the treatment of taxation on dam-
ages is variable.
The UK corporation tax treatment of an award of compensation is determined by the
nature of the loss to which the award refers.When corporate trading activity has been dam-
aged, and the award is calculated by reference to the loss of trading profits, it will be treated
as taxable trading income. The timing of taxation of an award is likely to follow the period
in which the award is recognised in the recipient’s accounts.
When compensation is claimed for damages other than loss of trade profits, it is neces-
sary to determine whether the claim is in respect of a capital or revenue loss, and for capital
losses, whether the loss relates to an underlying asset treated as chargeable for corporation
tax purposes. A significant body of case law addresses the capital or revenue distinction, and
UK statute defines chargeable assets. The area is complex and the facts will determine the
UK tax treatment.
When compensation is claimed for permanent damage or deprivation of use of a fixed
capital asset, it is possible that an award will be treated as a capital receipt.The tax treatment
of the award will then be determined by whether the damage can be related to underlying
property that is a chargeable asset for purposes of calculating corporation tax on disposal
(e.g., plant and machinery). In such cases, an award may be considered a deemed disposal
or part-disposal of the asset, and a capital gain or loss would then arise for corporation tax
purposes. It was established in the case of Zim Properties, that the right to take court action
in pursuit of compensation or damages is of itself an asset for capital gains tax purposes.6
This case related to damages for professional negligence, and under current UK practice, a
punitive tax cost can arise.
Intangible assets such as goodwill were also historically treated as chargeable assets for
corporation tax purposes; however, specific rules now apply to intangibles acquired (from
6 Zim Properties Ltd v. Proctor 58 TC 371.
233
third parties) or created after April 2002, such that gains or losses on disposal will be treated
as revenue income or loss.
A capital receipt not related to an underlying chargeable asset will not be subject to
corporation tax under general principles. However, the basis on which receipts are charac-
terised as non-taxable capital is dependent on the underlying facts, subject to a wide range
of case law precedent, and, therefore, not clearly defined.
A UK-based claimant would, therefore, need to identify the nature of the lost profits
(whether capital or revenue) to analyse the tax treatment of the amount claimed.To restore
the ex ante position, the calculation of the amount of the award should take account of the
tax treatment of both the loss and the award itself.
US and French perspectives

US courts have approached the issue of taxation of arbitration awards in the context of
employment tribunal cases adopting a ‘make whole’ purpose that is broadly consistent with
the principle of full compensation.7 These anti-discrimination cases are not directly rel-
evant to the discussion relating to international commercial and investment treaty awards,
but some insightful guidance emerges, such as the tribunal’s emphasis on the significance of
the particular facts of each case and placing the burden of proof on the claimant to establish
any adverse tax consequences to be taken into account.
Turning to investment treaty cases involving US-based claimants, the award in the
case of Chevron and Texaco v. Ecuador included lengthy analysis of the tax consequences
in Ecuador of profits lost.8 After the Republic of Ecuador agreed that no further tax nor
penalties or interest would be payable on the award, the award was rendered calculated on
a net of tax basis.
In Corn Products v. Mexico, the net of tax award was made to a US parent rather than
to the Mexican subsidiary to ensure no additional taxes were payable in Mexico.9 It is not
clear whether US taxes would ultimately have been payable by the claimants in these cases
or whether this was relevant in the calculation of the award. If the awards were subject to
tax in the US, the ex ante position may not have been restored unless the profits lost in
Mexico would also ultimately have been subject to US tax.
A final point of fairness arises in the context of investment treaty awards (analogous to
the point above relating to jurisdicational fairness in commercial cases). In the case of the
expropriation of a company by a government, the value taken by the expropriating govern-
ment is as a first approximation the after-tax value of the relevant entity. If an award against
a government based on the pre-tax value of the entity is paid to the parent company, as
is often the case for BIT awards, on the grounds that the award will be taxed in the par-
ent company’s jurisdiction, then the losing government will pay an award greater than the
7 Eshelman v. Agere Systems Inc.

8 Chevron Corporation (USA) and Texaco Petroleum Company (USA) v. Republic of Ecuador (March 2010), PCA
Case No. 2009-23, cited in Nhu- Hoang Tran Thang, Tax Gross-Up Claims in Investment Treaty Arbitration,
February 2011.
9 Corn Products International Inc v United Mexican States (March 2010), ICSID case ARB(AF)/04/1, cited in
Nhu- Hoang Tran Thang, Tax Gross-Up Claims in Investment Treaty Arbitration, February 2011.
234
value taken. The excess between the value taken and the amount paid would then effec-
tively be a tax windfall for the government of the parent company’s jurisdiction.
It is perhaps to guard against such an outcome that the French Code général des impôts
(tax code) stipulates that the French state will levy no taxes on awards paid in relation to
expropriation or similar measures by a foreign government.10
Calculating the tax impact in practice

One approach we often see used by a claimant is to state its claim before any corporation
taxes the affected entity would have paid, on the grounds that any award will itself be taxed,
leaving the claimant’s net position in line with the principle of full compensation. This
approach is appropriate if the taxation of the lost profits would have been broadly in line
with taxation of the award, both by reference to the method of calculation and marginal
tax rate for the periods in question.
An alternative approach often used is for a claimant to state its claim after deduct-
ing the taxes the entity would have paid, and to leave it to the tribunal to award such an
amount that leaves the claimant’s position after the taxation of the award such that the
award it receives post-tax constitutes full compensation. This approach essentially defers
the question of taxation to the hearing or post-hearing stage. Such an approach would be
appropriate if it is clear that the award itself would not be subject to tax. However, when
the tax treatment of the award is not addressed at all, the claimant would be at risk of
under-compensation.
As the great John Maynard Keynes was reported (after his death) to have said, ‘It is
better to be roughly right than precisely wrong.’ In view of the limitations of the above
approaches, it may improve the appropriateness of awards at an acceptable cost to pursue
the issue of taxation slightly further, in order to move in the direction of the ‘right’ award,
than to leave this undone.
Given the complexities involved in assessing taxes, even at a relatively simplified level
it is likely to be useful to secure the input of individuals with hands-on experience of tax
assessment in the relevant jurisdictions, to validate the approach being undertaken. Such
input may come from the parties’ own finance teams, or existing external taxation advisers.
A number of consulting firms active in the assessment of losses in international arbitra-
tion, including our own firm FTI Consulting, have tax groups that also offer expertise in
this area.
Arbitration awards and currency

Why does currency matter?
Issues of currency arise very frequently in assessing losses in international arbitration. The
critical issue is not so much the currency in which any award is to be paid – unless the cur-
rency is truly exotic (unlikely) or subject to exchange controls (at least sometimes explicitly
ruled out),11 a payment in one currency can today be quickly and very cheaply exchanged
10 Article 238 bis C.

11 Ripinsky and Williams in their 2008 book Damages in international investment law cite the tribunal in the
Vivendi v. Argentina ICSID case, and the Iran-US Claims Tribunal, both of which state that it is the ‘frequent’
235
into another currency if the recipient wishes.The critical issue is, instead: in what currency
is the award to be calculated, and at what dates are any amounts in other currencies to be
translated into the award currency?
The following example (which mirrors several of our recent cases) illustrates the impact
this can make. Consider a loss suffered most immediately in a local currency, of 100 million
currency units, and an award five years later. During the intervening period local currency
interest rates have been at 10 per cent, euro interest rates at 5 per cent, and the exchange
rate has depreciated from 10 to 20 local currency units to the euro, all as shown in the
table below.
Loss calculated in local currency Loss calculated in euros

Local Local
currency Exchange currency Exchange
value rate Euro value value rate Euro value
Loss at date of
breach 100 million 10 €10 million 100 million 10 €10 million
Interest rate 10% 5%
Years to payment
of award 5 5
Award including €12.8
interest 161 million 20 €8.1 million million
Assume further that it is uncontentious between the parties that the award is to be paid
in euros.
Straightforwardly, the euro value of the loss at the date of breach was €10 million. The
respondent argues that the award is to be paid at the euro equivalent of the loss after it has
been assessed in local currency and brought forward at the applicable rate of interest. Using
such an approach, the value of the award when paid is €8.1 million, as shown above (this
is lower than the €10 million value of the loss at the date of breach, because the effect of
the weakening of the local currency exchange rate more than offsets the relatively high
interest rate).
The claimant, however, argues that the correct approach is to translate the loss into
euros at the date of breach, using the then-prevailing exchange rate, and then to add interest
to the present. This gives rise to an award of €12.8 million, more than 50 per cent higher
than the figure proposed by the respondent.12
The approach to currency selected by the tribunal will, therefore, have a very significant
effect on the amount recovered by the claimant.The impact of this general point can be far
more dramatic than the illustrative example above; one case that was ultimately decided by
the UK’s House of Lords involved an award of the local currency equivalent at the date of
or ‘usual’ practice of tribunals to provide for payment of damages in a convertible currency (footnote 2 to
Chapter 10).
12 If conversely the local currency had appreciated, the reverse would apply and the claimant would be better off
under the former approach.
236
payment of US$20,000 that would have been nearly US$3 million if translated into dollars
at the date of breach.13
Legal approaches to currency and damages

The evolution of English law relating to currency and damages further illustrates the
importance of this issue. For much of the twentieth century, English law held that damages
awarded in the English courts must be awarded in pounds sterling.14 Damages claimed in
contract law were to be converted into pounds sterling at the date of the alleged breach,
disregarding subsequent fluctuations in relevant exchange rates.
While such treatment may have been appropriate for a claimant predominantly doing
business in pounds sterling, it exposed claimants operating primarily in other currencies to
fluctuations in the value of the pound, in the same way as in the example above. This ben-
efited the claimant at the expense of the defendant when the value of the pound appreci-
ated over the relevant period by more than the differential between the applicable interest
rate in each currency, and vice versa. During the Bretton Woods era of pegged exchange
rates, such currency fluctuations, and hence the risks thereby imposed on parties to dis-
putes, were very limited, apart from occasional devaluations. However, with the emergence
of floating exchange rates from 1968, the associated risks grew.
The practice changed in two steps. The first step arose in 1974 when the Court of
Appeal confirmed an award by commercial arbitrators expressed in a foreign currency,
which had for some time been the practice among commercial arbitrators in appropri-
ate circumstances.15 Then, in 1975, the House of Lords, citing the development of float-
ing exchange rates, explicitly repudiated the principle that claims for damages must be
expressed in sterling.16 From that point forward, claims for breach of contract under English
law could be expressed in foreign currency; if any conversion was needed for enforcement
purposes, such conversion would take place at the date the court authorised the claimant to
enforce the judgment (the ‘date of payment’).17 This decision reduced the scope for foreign
exchange rate movements to affect parties to a dispute inappropriately.
This then leaves the question, often hotly disputed in international arbitration today,
of in which currency to express an award. The English law approach, as summarised in
McGregor on Damages, starts with an examination of the relevant contract; however, the
mere fact that payments under the contract are to be made in a particular currency does
not necessarily imply that that is the appropriate currency for the award of damages.18 The
correct treatment, per Lord Wilberforce, is that damages should be calculated:
13 Attorney General of the Republic of Ghana v.Texaco Overseas Tankships, The Texaco Melbourne, cited in McGregor
on Damages 18th Edition, McGregor, Sweet & Maxwell 2009, 16-045.
14 Neither of the authors has legal training on these issues; our understanding of the English law on currency and
damages is derived in general from McGregor on Damages 18th Edition, McGregor, Sweet & Maxwell 2009,
chapter 16, and in this paragraph at 16-019 of that work.
15 Jugoslavenska Oceanska Polvidba v. Castle Investment Co Ltd, 1974.
16 Miliangos v. George Frank Textiles, 1975.
17 All as outlined in more detail in McGregor on Damages 18th Edition, McGregor, Sweet & Maxwell 2009,
16-028.
18 McGregor on Damages 18th Edition, McGregor, Sweet & Maxwell 2009, 16-038.
237
in the currency in which the loss was felt by the plaintiff or ‘which most truly expresses his loss’.
This is not limited to that in which it first and immediately arose. In ascertaining what this
currency is, the court must ask what is the currency, payment in which will as nearly as possible
compensate the plaintiff in accordance with the principle of restitution, and whether the parties
must be taken reasonably to have had this in contemplation.19
Under this principle, for example, a loss suffered by a French charterer under a contract
denominated in dollars, for delivery to Brazil of goods that were damaged as a result of a
breach of the ship-owner, was subject to an award in French francs, because the charterer
had had to use French francs to buy the Brazilian cruzeiros with which to compensate the
cargo receiver.20
International courts and tribunals, as noted above, have consistently expressed compen-
sation in freely convertible currencies. So, for example, in Biloune v. Ghana, the claimants
were compensated in relation to investments made in pounds sterling, Deutschmarks, US
dollars and Ghanaian cedis, this last currency not being freely convertible. The tribunal
awarded compensation in the first three currencies but awarded the fourth amount in
US dollars.21
In selecting the appropriate convertible currency (or currencies) for an award, inter-
national law reached similar conclusions to English law at an earlier point in time, but,
perhaps unsurprisingly, they are not as systematically applied.The tribunal in the Lighthouses
arbitration between France and Greece stated in 1956:
The injured party has the right to receive the equivalent at the date of the award of the loss suf-
fered as the result of an illegal act and ought not to be prejudiced by the effects of a devaluation
which took place between the date at which the wrongful act occurred and the determination of
the amounts of compensation.22
Other institutions, including the United Nations Compensation Commission and the
Iran-US Claims Tribunal, have adopted a similar approach.
Ripinsky and Williams note several mechanisms that have been used by international
tribunals to implement this principle in cases in which the foreign exchange value of one
of the possible currencies of the award had depreciated by more than any differential in
the applicable interest rate. First, and as discussed above, the loss can be converted into the
currency of the investor at the date of the breach. This is the approach taken by the tribu-
nal in Sempra Energy v. Argentina, faced by depreciation in the Argentine peso of more than
three times since the date of the breach. Second, and rather more unusually, the loss could
be assessed in some third currency that has not depreciated – Ripinsky and Williams give
the example of the 1956 Lighthouses arbitration between France and Greece, which related
19 Commenting on Services Europe Atlantique Sud (SEAS) v. Stockholms Rederiaktiebolag SVEA, often known as
The Folias, as quoted in McGregor on Damages 18th Edition, McGregor, Sweet & Maxwell 2009, 16-039.
20 The Folias, per McGregor on Damages 18th Edition, McGregor, Sweet & Maxwell 2009, 16-037.
21 Award on Damages and Costs of 30 June 1990, as quoted in Damages in International Law, Ripinsky and
Williams, BIICL 2008, p395.
22 Award on Damages and Costs of 30 June 1990, as quoted in Damages in International Law, Ripinsky and
Williams, BIICL 2008, p395.
238
to events in the 1920s, since which time the French franc had depreciated by 90 per cent
and the Greek drachma by even more. This tribunal accepted the claimant’s request to use
the US dollar, which had been relatively stable in value over this period, as the money of
account. Third, and even more unusually, some special adjustment could be made by the
tribunal – for example, in SPP v. Egypt, the tribunal adjusted the amount awarded in US
dollars for the (relatively high) general dollar price inflation that had applied between the
1978 breach and the 1982 award, using the change in the US Consumer Price Index.23
Finally, compensation may still be made in the depreciating currency if the associated award
of interest is sufficient to offset the effect of foreign exchange depreciation.24
A valuer’s approach to the treatment of currency in damages awards

Absent specific instruction, and as with questions of taxation, the valuation expert will
assess currency issues by reference to the principle of full compensation, by assessing the
financial position of the claimant but for the breach, and comparing that to the financial
position of the claimant in actuality. The impact of taxation on an award calculated in one
currency by reference to a loss suffered in another, and associated currency differences, may
also need to be considered to achieve full compensation.
To implement this principle, the valuation expert must form a view as to the likely use
by the claimant of the cash flows lost as a result of the breach. This, it would seem, involves
grappling, from a valuation point of view, with the same issues as those addressed under
English law when an arbitrator or judge considers ‘which [currency] most truly expresses
[the claimant’s] loss’.
A valuation expert may, however, be able to bring financial evidence relevant to address-
ing this question of which currency most truly expresses the claimant’s loss. Examination of
a claimant’s financial statements or other accounting information may allow a valuer to test
assertions made by the claimant relating, for example, to the currency mix of a claimant’s
revenues, costs, assets and liabilities, to a company’s foreign exchange hedging strategy, and
other relevant elements.
Moreover, if a loss relates to a lost stream of cash flows – as in the case of most lost
profits assessments, some expropriations, and many cases in which losses are assessed as of
a present date rather than as a value of a business or asset at a past date – then the timing
of those lost cash flows may be doubly important. First, because, as in any assessment of
loss, the later in time a loss in a particular currency is felt, the less the value of that loss in
that currency at the date of assessment. Second, however, because if for award calculation
purposes each lost cash flow is translated into a different currency at the date it would
have been incurred, then the date of each lost cash flow will determine the exchange rate
applicable to it. The interaction of the timing of the lost cash flows with movements in the
relevant exchange rate may have a major effect on the overall value of the claim.
Finally, the international law examples cited above focus on methods to insulate claim-
ants against situations in which depreciation in the currency of the respondent state would
reduce the value of an award to the (inappropriate) detriment of the claimant. However, it
23 The manner of awarded interest in dollars in this matter being inadequate to make such compensation.
24 See Ripinsky and Williams Section 10.1.2 for further discussion of these points.
239
can arise that the respondent state’s currency appreciates rather than depreciates after the
date of the breach. From a valuation expert perspective, the principle of full compensation
would insulate claimants from any associated benefit – as in the case of currency depre-
ciation, the loss would be translated into the award currency at the date it was felt. To do
otherwise would be to give claimants a one-way bet on currency movements subsequent to
the date of breach – a one-way bet with a potentially significant financial value, that could,
in principle, be quantified using options-pricing techniques.
240
17
Interest
James Dow1
Issues regarding pre-award interest arise in most cases where damages are awarded.Typically
tribunals assess damages as of a date in the past, and interest is applied to this amount up
to the date of the award. Because the entire arbitration process (from the date of dam-
ages, to filing, through to an award) can take a long time to complete, and the rate of
pre-judgment interest may be quite high, interest can make up a substantial proportion
of total damages. For example, in case ARB/11/26 at the International Centre for the
Settlement of International Disputes (ICSID), principal damages totalled US$87.3 million
and pre-judgment interest totalled US$85.5 million, close to 50 per cent of total dam-
ages (principal + interest). In case ARB(AF)/99/1, principal damages totalled 9.5 mil-
lion Mexican pesos and pre-judgment interest totalled 7.5 million pesos – 44 per cent of
the total.
Interest in financial markets

Interest is used in finance to bring amounts of money forward in time to find equivalent
amounts of money at a specified future date. Interest rates may also be used for discount-
ing; that is, to bring amounts of money backward in time. Positive interest rates reflect the
‘time value of money’ – lenders require an inducement to lend money because it requires
them to postpone their own consumption or their business use of the money, while bor-
rowers are willing to pay this because they have immediate consumption needs or because
they can use the money now for their own business purposes. Together, these economic
considerations as they apply to actual and potential lenders and borrowers determine the
‘time value of money.’ Notice that governments and their agencies are among the actual
and potential lenders and borrowers.
1 James Dow is Professor of Finance at London Business School.
241
Interest
Apart from the pure time value of money there are a number of additional factors
that may determine market interest rates. These include a premium in case the borrower
defaults, a premium for liquidity or an adjustment reflecting the tax treatment of the loan.
Interest rates are normally greater than zero. They change over time just like any other
market price (and default and liquidity premiums change too). Since the financial crisis of
2008, interest rates have been very low and some interest rates have even been negative.
For example, in mid-2016, yields on many German, Swiss and UK government bonds
were negative, although US Treasury bond yields were still positive. Even high quality
euro corporate bond yields had turned negative. Many economists believe that these very
low interest rates largely reflect government and central bank policy in many countries in
response to the financial crisis of 2008/9 and its aftermath, as well as reflecting underlying
fundamental economic conditions such as poor prospects for growth and productivity that
lead to poor opportunities for investment.
Pre-award interest
Interest rates are used to bring amounts of money backward and forward in time. Arbitration
cases typically involve amounts of money at many different times, and these are brought
forwards and backwards using different rates such as the cost of capital and the pre-award
interest rate (the differences between cost of capital and pre-award interest rate and the
reasons why they are different will be explained below).
Suppose a claimant owns or owned an asset that, the tribunal decides, is rendered less
valuable by an act of the respondent (the ‘bad act’). We assess how much money the claim-
ant would have expected to receive if the claimant had not taken this act. Since the claimant
did take the act, this is a hypothetical situation that is referred to as the ‘but-for world’; in
other words, the world that would have been expected to prevail but for the respondent’s
bad act. The difference between the money the claimant actually received and the money
the claimant would have received in the but-for world is the basis for damages.
However, both in reality and in the but-for world, these amounts of money occur at
different dates, and we need to allow for this. Suppose the bad act occurred at date 0. The
asset yields, or would have yielded, cash flows at dates 0, 1, 2, … n.The tribunal’s award takes
place at date t, which could be before or after date n.Typically, the damages figure is assessed
as of the date of the bad act by bringing the cash flows from the asset back to date 0 (this is
known as the ‘present value’ as of date 0).The difference in asset value at date 0 between the
actual and but-for worlds is damages as of that date.This amount is then brought forward in
time using the pre-award interest rate. Further interest (post-award interest) is then added
until the payment is actually made, which could be considerably later.
The rate used to bring actual or expected (but-for) cash flows backward in time is typi-
cally the cost of capital for the asset. This rate normally includes a risk premium reflecting
the fact that the asset is a risky endeavour with uncertain cash flows.The rate used to bring
the asset value forward in time to the award date, however, is a different rate – often a risk-
less rate – as I will discuss below.
Post-award interest
Tribunals often award post-award interest in addition to the amount specified in the
award. Post-award interest is added until the award is actually paid. The starting point for
242
Interest
post-award interest could be the date of the award, or it could be a later date. For example,
the tribunal might specify that the award should be paid by a date within a few months of
the award (without the addition of post-award interest), but that any further delay would
attract post-award interest from that date.
Post-award interest is often applied at the same rate as pre-award interest. This reflects
the view that interest is just compensating for the time value of money. An alternative
view is that post-award interest should be higher that pre-award interest to discourage late
payment. If the respondent has to pay a significant default premium on its borrowing, any
post-award interest rate that is lower than its cost of borrowing, such as the risk-free rate,
can create an incentive to delay payment.
In the rest of this chapter, I will refer mostly to pre-award interest, but most of the mate-
rial will apply equally to post-award interest.
Different interest rates that may be used for pre-award interest

A number of different interest rates might be mentioned in the context of pre-award inter-
est. Here is a guide to the most common ones.
Contractual rates
The claimant and respondent might be bound by a contract, an alleged breach of which
gave rise to the dispute. The contract might specify an interest rate to be used in case of
late payment. Many arbitrations concern claimed breaches of bilateral investment treaties
(BITs), which sometimes specify interest rates.
Benchmark rates (or reference rates)

Many financial contracts use interest rates that are expressed relative to a benchmark rate.
Often the interest rate in the contract is not equal to the benchmark rate but is equal to the
benchmark plus a spread. For example, the rate on a floating rate security or a swap could
be Libor plus 50 basis points (a basis point is 0.01 of a percentage point, so 50 basis points is
0.5 per cent). Common benchmarks are Libor, Eonia, Euribor and US prime. Sometimes,
the benchmark rate is not an interest rate; for example, the benchmark could be inflation
as measured by the increase in the consumer price index (CPI), and the contract might
specify interest at inflation plus 1 per cent.
Interbank rates
These are rates at which banks borrow and lend to each other.These loans can be of various
maturities but the majority of interbank loans are overnight.They are unsecured. In the US,
the interbank rate is the federal funds rate. In the eurozone it is Eonia (for overnight loans)
or Euribor (for longer maturities). There are various other measures of interbank rates that
vary according to the currency of the loan, the maturity of the loan, the place where the
banks are based, and the method of collecting the data (survey responses or actual transac-
tions).These include Libor, Sonia, USD Libor and Saron. Not all banks can borrow at these
rates, but in normal times the major banks can. The federal funds rate is different from the
other measures of interbank lending rates in that the US Federal Reserve directly targets
this rate, while the other measures are only indirectly influenced by central bank actions.
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Interest
The risk-free rate

Loans to some governments are generally considered risk-free. For example, the US gov-
ernment is considered certain to repay its US dollar borrowing and the German govern-
ment is considered certain to repay euro borrowing (notice that the US government can in
any case create more US currency to repay such loans, but the German government cannot
create euros at will). Thus, the yields on securities issued by those governments are used as
a measure of the risk-free interest rate. Finance textbooks often refer to ‘the’ risk-free rate,
but there are different rates for different currencies and maturities. As explained below, dif-
ferent currencies naturally have their own different rates. Also, government securities with
different maturities have different yields, so the ‘risk-free rate’ needs to specify which matu-
rity is being referred to. Government securities with maturities of less than one year are
known as treasury bills (T bills). Government securities with maturities of more than one
year are known as government bonds or (in the US) as treasury bonds or treasury notes.
Although not risk-free, interbank rates have at times been very close to risk-free rates.
The difference between US dollar T bill yields and US dollar LIBOR is known as the
TED spread. In normal times the TED spread is well under 1 per cent, typically around
0.25 per cent to 0.5 per cent, although in times of crisis it is considerably higher (over
1 per cent from summer 2007 to early 2009, peaking at over 4 per cent for a short while
in October 2008). Since the TED spread is normally less than 0.5 per cent, tribunals might
use interbank rates for pre-award interest on the basis that they represent an appropriate
yield with very little premium for risk.
The cost of debt of the respondent

This is the cost at which the respondent could borrow. For example, if the respondent is a
sovereign state, it is the yield on the bonds of that state.Typically, the state would borrow in
a currency it does not issue, such as US dollars, so this would be higher than the risk-free
rate. The cost of debt of the respondent is often used to determine pre-award interest.
The cost of capital

The cost of capital is often used in arbitrations, sometimes in connection with pre-award
interest. This could refer to the cost of capital of the project at issue in the arbitration, or
the cost of capital for the claimant more generally. Cost of capital means a rate that reflects
risk and combines the cost of borrowing with a required return on equity. The most com-
mon notion of cost of capital is the weighted average cost of capital (WACC). A company’s
WACC is a weighted average of its cost of debt and its cost of equity (assuming the com-
pany issues only debt and equity; if other financing such as preferred stock is used, this
could be factored into the calculation).The weights correspond to the share of the amount
of debt and the amount of equity in the total value of the company’s assets. An adjustment
is made for corporation tax, reflecting the deductibility of interest payments or the opti-
mum shares for corporation tax. For a company whose assets are all of similar risk, the cost
of capital for the company as a whole is similar to the cost of capital for the project. If the
project has a different risk to the company’s other assets, the cost of capital for the project,
in principle, requires adjustment, although this refinement is often considered impractical.
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Interest
Bank deposit interest rates

These are rates offered by banks for deposits. They vary by maturity and currency. For
example, if a depositor does not have the right to withdraw within a year, the rate is nor-
mally higher than for a deposit that can be withdrawn without notice.
Fixed and floating rates

Some loan contracts are at rates of interest that are fixed over the life of the loan, while
others make provision for the interest rate to change. When a loan is at a floating rate, the
contract specifies a reference interest rate and a spread relative to the reference. For exam-
ple, US Treasury bonds are at fixed rates. In the US, many residential mortgages are at fixed
rates, while others are at floating rates tied to LIBOR. In other countries, mortgages are
typically at floating rates but may be fixed for a period such as five years before reverting
to floating rates.
Pre-award interest is often awarded at a risk-free rate based on T bills, or at an overnight
interbank rate, or at such a rate plus a spread. Since these short-term yields change daily,
this implies that the pre-award interest rate also changes, and is effectively a floating rate.
Real and nominal rates

Interest rates most commonly specify the interest payment in an amount of currency (US
dollar, euro, etc.). These are called nominal interest rates. Somebody who lends money
in this way can expect to receive a predictable amount of money, but does not know the
extent to which inflation will erode the purchasing power of that money. Therefore, some
loans specify interest payments that are indexed to a price index such as the CPI. For
example, the US government has issued ‘treasury inflation protected securities’ (TIPS).The
return on such a loan, expressed in units of currency, consists of the inflation rate plus a real
return (strictly speaking, the mathematical relationship between nominal rates, inflation
and real rates also includes a ‘compounding’ term, which is usually small and frequently
ignored). Unless otherwise specified, rates are normally understood as nominal rates.
The problem of inflation uncertainty for loans expressed in nominal terms is more
severe when a loan contract is longer term. For a very short-term loan, such as a T bill,
indexing the payment to the CPI would serve little purpose because inflation is unlikely
to change much over the course of the loan. So short-term (nominal) rates effectively offer
inflation protection anyway.
Real interest rates and real discount rates arise quite frequently in the context of arbitra-
tions. For example, the dispute may concern long-term contracts that are specified in real
terms. However, tribunals normally specify pre-award interest in nominal terms. It is never
or hardly ever specified in real terms. One reason why this makes sense is that pre-award
interest is often awarded at the T-bill rate, at another short-term rate, or at a short-term rate
plus a spread, and for short-term rates there is no need for indexing.
Compound and simple interest

With any kind of loan contract, interest is specified as a percentage of the amount bor-
rowed (the principal). With simple interest, the interest is a percentage of the original
amount. With compound interest, for each period the interest is added to the amount of
245
Interest
the loan and then interest is calculated as a percentage of this new amount. For example,
the balance on a loan of US$100 at 10 per cent simple interest accumulates to US$120 after
two years with simple interest. Compounded annually, it accumulates to US$121 after two
years (after one year, principal plus interest totals 110, and the second year’s interest is 10 per
cent of that amount, i.e., 11).
Interest can be compounded at different intervals of time. Compound interest origi-
nated around four millennia ago in Babylon. Interest on silver loans was set at 20 per cent;
loans were usually for durations under one year with no compounding. However, loans of
several years’ duration sometimes incurred compound interest once the accrued interest
equalled the principal. At 20 per cent annual interest this implies a compounding interval of
five years.To repay a loan of 100 mina would have cost 180 mina after four years, 200 mina
after five years and 240 mina after six years (because in the last year the 20 per cent interest
rate would have been applied to the new balance of 200 mina, while up until then it would
have been applied to the original balance). Nowadays compounding intervals tend to be
one year or less. For example, a loan at 10 per cent annual interest with quarterly com-
pounding actually means (although the compounding convention may vary) that every
quarter, 2.5 per cent interest is added to the previous quarter’s balance (since 2.5 per cent is
one-quarter of 10 per cent). Although the difference made by the compounding interval is
smaller when comparing compounding intervals of less than one year, it is worth checking
the compounding conventions when using data on interest rates. For consumer loans in
the US, the APR (annual percentage rate) does not reflect the true economic cost because
it ignores the effect of compounding, while the APY (annual percentage yield) allows for
compounding. In other countries, consumer legislation often requires similar disclosure but
under a different name to APY.
At any point in time, different fixed income securities with the same credit quality (and
any other relevant features such as tax status) but different compounding intervals will trade
at the same yield. The yield on a security is a measure of return that makes appropriate
allowance for compounding frequency.
Tribunals sometimes award simple interest and sometimes award compound interest.
The choice may be determined by legal considerations. For example, legal principles may
require that a legal expropriation requires simple interest, while an illegal expropriation
requires compound interest. It is not the purpose of this article to offer any guidance on
appropriate legal considerations.
However, regardless of such legal requirements, in most situations economists favour
compound interest for pre-award interest. The reason is that yields (which are based on
compounding) are the economic benchmark for market interest rates.While financial con-
tracts with simple interest do exist and are straightforward to value, the market values
of such contracts are ‘reverse-engineered’ to make sure that they trade at market yields.
Applying a market yield without compounding would not make the claimant whole.
Interest rates in different currencies

Different currencies have different interest rates. It is important not to take an interest rate
that refers to loans in one currency and apply it to amounts of money in another currency.
Arbitrations frequently concern international disputes. In a typical case, the claim-
ant makes an investment in an asset in another country. Different parts of the damages
246
Interest
calculation might involve the currency of the country where the investment is made, as
well as the investor’s home currency or an internationally used currency, such as the US
dollar. Issues arise concerning the interest rates or cost of capital to be used for amounts
denominated in the different currencies.There is standard way to handle such issues, known
as the principle of uncovered interest parity (UIP). UIP requires that expected exchange
rate at future dates depreciates or appreciates to offset the differential in interest rates. For
example, if interest rates in US dollars are 1 per cent and in Swiss francs are 0.25 per cent,
then the US dollar should be expected to depreciate against the Swiss franc as a rate of
(approximately) 0.75 per cent annually. If UIP is applied, calculations carried out in either
currency will reach the same result.
However, while cross-currency considerations very often arise in damages calculations,
they arise less often in relation to that part of the calculation that relates to pre-award inter-
est. Typically, damages at the time of the bad act are assessed in one currency, they will be
paid in that currency, and the pre-judgment interest rate used to bring this amount up to
the date of the award (or the date of payment) is derived from market interest rates on that
currency’s securities. Cross-currency considerations can arise in some situations, however.
For example, if the tribunal decides to use the respondent’s borrowing cost for pre-award
interest to be applied to a US dollar damages figure, it needs to check this is an interest rate
applicable to US dollar borrowing or to convert it to US dollars using UIP.
Which interest rate is preferred on economic grounds?

There are two theories that are generally offered on economic grounds to determine an
appropriate interest rate for pre-award interest.
One theory supports the use of the risk-free rate of interest. The argument is that once
the damages sum has been determined to compensate the claimant at the date of the bad
act, the purpose of adding interest is merely to bring that amount forward in time. The
claimant is not bearing any risk because the amount of damages, from then on, does not
rise or fall in line with economic circumstances, unlike the return on risky assets. It is a
fixed amount. By contrast, the stock price of an oil company or the value of an oil field are
examples of risky assets whose returns depend on a host of economic factors such as oil
prices, economic growth, inflation, management skill or geological risk. For example, the
economists Franklin Fisher and Craig Romaine argue that:
[I]n depriving the plaintiff of an asset worth Y at time 0, the defendant also relieved it of the
risks associated with investment in that asset.The plaintiff is thus entitled to interest compensat-
ing it for the time value of money, but it is not also entitled to compensation for the risks it did
not bear. Hence prejudgment interest should be awarded at the risk-free interest rate.2
The other economic theory of pre-award interest is the ‘forced loan’ theory. We take as a
starting point that, if the respondent had paid the damage as of the date of the bad act, the
claimant would have been made whole. Effectively, therefore, the claimant has not only
2 Fisher, Franklin M. and R. Craig Romaine.; Janis Joplin’s Yearbook and the Theory of Damages. Journal of
Accounting, Auditing & Finance,Vol. 5, Nos. 1/2 (1990), p. 146.
247
Interest
been deprived of the use of money since the date of the bad act, but this money has been
available to the respondent. It is as if the claimant has made a loan to the respondent. If
the claimant had received the money then, and then lent it to the respondent, the claimant
would be in exactly the same position they are in. In terms of economic incentives, the
forced loan theory ensures that the respondent does not have an incentive to expropriate
assets merely as a cheap source of finance.
The difference between the risk-free rate theory and the forced loan theory amounts to
a different view of default risk.The risk-free rate theory takes the view that the respondent
will pay the award. The reason why the respondent, at the time of the bad act, had to pay
more than the risk-free rate for its borrowing is that lenders considered the respondent
might default. Under this theory, there is no reason for the tribunal to build a premium
into the damages award to offset the possibility that the award might not be paid. Instead,
the tribunal sets its award on the assumption that the award will be paid.
Some investment treaties refer to the use of a ‘normal commercial rate’, and some arbi-
tral awards use this phrase, sometimes to justify the use of LIBOR or LIBOR plus a spread.
However, all market rates could be described as ‘commercial’; the difference between dif-
ferent rates is that they relate to different risks. The commercial rate for a risk-free loan is
not the same as the commercial rate for a risky loan.
What rates do tribunals actually use?

I have described the different interest rates that arise in arbitration cases and given the
rationales for two possible choices for pre-award interest rates, namely the risk-free rate and
the respondent’s borrowing cost. But what do tribunals actually use for pre-award interest?
Since many awards are confidential, it is not possible to conduct a comprehensive study
of all arbitral awards. However, some awards are published. ICSID, a unit of the World Bank,
conducts many important arbitrations and publishes its awards.
I have studied all the cases published on the ICSID website. Out of 167 decisions with
published awards, I have selected 60 where pre-judgment interest was awarded. Most of
the remaining cases are cases where the claimant did not prevail and no damages were
awarded (34 cases) or the tribunal ruled they had no jurisdiction (29 cases) (in the remain-
ing 44 cases the award is not available for the analysis in this chapter for a variety of reasons,
such as the case was settled or discontinued, there is no English language award document,
the award document is redacted, or insufficient detail is provided about pre-award interest).
Simple or Compound Interest

Award Year Compound Simple Grand Total
1992 1 1
2000 3 3
2002 1 1 2
2003 2 2 4
2004 1 1 2
2005 1 1
2006 1 1
2007 5 2 7
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Interest
2008 2 2 4
2009 4 1 5
2010 5 5
2011 2 2
2012 6 1 7
2013 3 3
2014 2 2
2015 8 8
2016 3 3
Grand Total 48 12 60
In 80 per cent of cases (48 out of 60), compound pre-award interest is awarded, which
is what economists would normally recommend. However, all but one of the 12 cases
with simple pre-award interest are prior to 2010. For 2010 onwards, compound pre-award
interest was awarded in 29 out of 30 cases. Thus, in recent cases tribunals have preferred to
award compound interest. In the single exception, ARB/07/29, it appears that the tribunal
awarded simple interest because the claimant did not request compound interest. In some
recent cases, tribunals have cited economic as opposed to legal reasons for preferring com-
pound interest. For example, in ARB/05/18 the tribunal observed that:
Simple interest has the great advantage of simplicity; but it is often a simplicity combined with
arbitrariness.When the question is, what amount has the Claimant lost by being wrongly denied
payment of a sum on a certain date in the past, in circumstances where the Claimant could
have invested an equivalent sum, or could only have borrowed an equivalent sum, on terms of
compound interest, the award of compound interest is appropriate. The Tribunal takes the view
that an award of compound interest is appropriate in this case.
In ARB/05/24 the award stated that ‘The Tribunal has little difficulty accepting that inter-
est should be compounding. In modern practice, tribunals often compound interest, and
the Claimant referenced a number of such awards ... In essence, compounding interest
reflects simple economic sense.’ In ARB/07/17:
The Arbitral Tribunal notes that there is no uniform case-law on this matter but considers that
compound interest is in the present case to be preferred in order to eliminate the consequences of
the conduct which the Tribunal has found to give rise to an obligation to pay damages.
In other cases, reasons given for preferring simple interest include ‘Ecuadorian law prohib-
its compound interest in the present case’ (ARB/04/19). In ARB(AF)/04/5, the tribunal
gave a legal reason for preferring simple interest:
However, since this is not an expropriation case, but rather concerns the appropriate compensa-
tion to be paid to Claimants for the injury caused as a result of the Respondent’s breach of
the national treatment and performance requirements obligations under Chapter Eleven, the
Tribunal’s view is that simple interest is appropriate in the present case.
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Interest
Adder
Political Grand
Base 1.0% 2.0% 4.0% 5.0% MRP* None
Risk Total
3.4% 1 1
4.5% 1 1
5.0% 3 3
6.0% 5 5
9.0% 3 3
18.0% 1 1
Average bank
lending rate in 1 1
country
BRIBOR 1 1
Ecuador central
1 1
bank rate
EURIBOR 2 2
LIBOR 2 9 4 1 5 21
Mexican
government 1 1
bonds
ROBOR 1 1
US 6MO CDs 2 2
US Prime 1 2 3
US Treasury 2 1 10 13
Grand total 2 14 4 1 1 1 37 60
*Market Risk Premium
Turning to the rates awarded, we can see that the interest rates fall into three categories.
In 23 of the 60 cases, pre-award interest is a base rate (a market rate of some kind) plus an
adder (or spread), such as LIBOR plus 1 per cent or US Treasury bills plus 2 per cent. In
14 cases, pre-award interest was simply a number specified by the tribunal, such as 4.5 per
cent or 9 per cent. In the remaining 23 cases, interest was a base rate (a market rate) without
a spread.
Of the 46 cases with a base rate (with or without addition of a spread), 13 cases used
the US Treasury bill rate, and 27 used an interbank lending rate (including BRIBOR,
EURIBOR, LIBOR and ROBOR). As noted above, interbank rates are normally close to
T bill yields, and since the adders chosen by tribunals are bigger by comparison, for practi-
cal purposes the 13 cases based on a T bill rate can be viewed as not too dissimilar to the
27 cases with an interbank rate.
Some cases stand out for levels of pre-award interest that are sharply higher than a
risk-free rate. In ARB (AF)/00/2, the tribunal awarded pre-award interest of 6 per cent
at a time (May 2003) when T bill yields were in the region of 1 per cent. In ARB/07/16,
the tribunal awarded pre-award interest of 9.11 per cent based on the risk-free rate plus
an equity market risk premium. By way of illustration, a 6 per cent pre-award interest rate
will give total damages (initial damages plus pre-award interest) that are about 50 per cent
higher than a 1 per cent pre-award interest rate, if the award date is eight or more years
250
Interest
later than the date of the bad act (1.068/1.018=1.47). If we compare a pre-award interest
rate of 9.11 per cent to a 1 per cent interest rate, the same is true after five or more years
(1.0915/1.015=1.47). These calculations assume compounding. So interest rates that are
substantially higher than the risk-free rate will lead to damages that are heavily increased
by the addition of pre-award interest, if several years have elapsed between the date of the
harm and the date of the arbitral award.
Tribunals give diverse reasons for their choice of pre-award interest. In some cases it
appears that the claimants have provided a calculation in their claim that incorporates a
particular pre-award interest rate, and respondents have not specifically challenged this cal-
culation, so the tribunals had used the interest rate applied by the claimants. In other cases,
tribunals have used risk-free rates or interbank rates as appropriate market benchmark rates.
For example, as stated in ARB/05/24:
The purpose of interest is to ‘compensate the injured party for not having had the use of the
money between the date when it ought to have been paid and the date of the payment.’ It is
therefore appropriate that the rate of interest represents a reasonable and fair rate that approxi-
mates the return the injured party might have earned if it had had the use of its money over
the full period of time ... The Tribunal observes that it is common in investment treaty cases to
tie the interest rate to LIBOR – although in the present case, where the currency is euros, it is
more appropriate to use EURIBOR. This represents an objective, market-orientated rate, well
suited to ensuring that the consequences of the breach are indeed wiped out.
The forced loan theory is explicitly referred to in several awards, for example, in
ARB/07/23 as follows:
Claimant has argued for compound interest at a rate of 9.34% based on the rate that
Respondent paid to private and public creditors in 2006 and on the notion of a coerced loan
from Claimant to Respondent. Respondent has suggested a pre award interest rate equivalent
to six-month LIBOR plus two percentage points. The Tribunal disagrees with the coerced loan
rationale of Claimant to arrive at the proposed rate of interest. ... The Tribunal considers that
the rate proposed by Respondent is a commercially reasonable rate.
In ARB/11/26, it appears that claimant’s expert applied the forced loan approach, while
the respondent’s expert applied a ‘country risk’ approach leading to a quantitatively similar,
but smaller rate, and the tribunal chose a rate that was close to both those proposed:
In examining the use of an appropriate ‘borrowing rate’, the Tribunal notes that Claimants
(making reference to the language of the Portuguese Treaty) have argued that the interest
rate should be equivalent: ‘to the rate Venezuela would have had to pay to borrow money in
April 2008 (9.75%).’ Taking a different approach, Respondent’s expert, … discusses the use
of such rates in other awards which are then supplemented by a factor covering political risk
and other macroeconomic factors (Country Risk Premium). … Comparing this rate with the
9.75% borrowing rate for the government of Venezuela propounded by Claimants, the Tribunal
concludes that 9% is a reasonable and fair rate for pre-award interest.
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Interest
Some awards refer to interest rates specified in treaties. In ARB/09/16:
The relevant standard for purposes of compensation would be that provided in Article 5 of the
BIT, ‘namely the market value of the investment adjusted for interest calculated on the annual
LIBOR basis’ ...The Tribunal finds it appropriate to use the LIBOR rate of interest as speci-
fied in Article 5.
ARB/10/13 uses similar reasoning.

Finally, it is worth noting that tribunals appear to be aware of the issues concerning
the appropriateness of different interest rates for different currencies. ARB/05/24 states
‘The Tribunal observes that it is common in investment treaty cases to tie the interest rate
to LIBOR – although in the present case, where the currency is euros, it is more appro-
priate to use EURIBOR.’ In other cases where awards were made in Canadian dollars,
Mexican pesos, etc., the tribunals have explicitly recognised the need for a rate applicable
to the currency.
252
18
Costs
Micha Bühler1
Introduction
The legal and other costs of resolving international disputes by arbitration are regularly
substantial given the often significant amounts at play, arbitration’s nature as a privately
funded process and the ever-increasing technical and legal complexity of the cases. Cost
awards exceeding US$1 million have become ordinary and can amount to tens of mil-
lions in ‘big-ticket’ arbitrations.2 From the parties’ perspective, cost recovery builds part of
the total compensation they are seeking as damages, as the arbitrators’ cost decision often
becomes a significant factor in the overall outcome of a case.Yet, a lack of uniformity as to
the standards applied by arbitrators when deciding on costs impacts on predictability of the
outcome and thus on the parties’ faculty to make an informed choice whether to invest in
litigation or to settle.
Significant work has been done by the arbitration community in recent years to
address growing concerns over increasing cost and length of arbitral proceedings, result-
ing in the proposition of a number of techniques and guidelines for promoting time- and
1 Micha Bühler is a partner at Walder Wyss Ltd, Attorneys at Law, Zurich.

2 In the three parallel arbitrations brought by the former majority shareholders of Yukos Oil Company against
the Russian Federation under the Energy Charter Treaty and the 1976 UNCITRAL Rules the arbitral
tribunal awarded to the claimants US$60 million as costs for legal representation and assistance out of an
amount of approximately US$81.5 million claimed as costs.
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Costs
cost-efficiency,3 including the use of expedited procedures for small claims,4 cost orders to
dissuade disruptive tactics5 and incentivising the arbitrators to render their award expedi-
tiously by lowering or increasing their fees depending on the delay or rapidity of their work.6
Similar efforts have been made with the aim of increasing the transparency and pre-
dictability of cost decisions and facilitating the emergence of a ‘best practice’ in interna-
tional arbitration for awarding costs.7 Of particular significance in this respect is the ICC
Commission Report on ‘Decisions on Costs in International Arbitration’ of 2015.8 The
revision of several arbitration rules to now include an express, yet rebuttable presumption
that the successful party is entitled to recover its reasonable costs goes in the same direction.9
This chapter looks at how international arbitral tribunals decide on the parties’ cost
claims making use of their considerable discretion. Other costs issues, such as, e.g., the
financing of the arbitral proceedings through cost deposits or the securing of a cost award
by an order for security for costs, will not be addressed in this contribution.
The arbitrator’s duty and power to decide on costs

The costs of the arbitration can be divided into two main categories: (1) the ‘arbitra-
tion costs’ (or ‘procedural costs’), which include the arbitrators’ fees and expenses and the
administrative charges of any arbitral institution, as well as charges for any other assistance
3 See, in particular, the ICC Commission on Arbitration and ADR’s 2012 Report on ‘Techniques for
Controlling Time and Costs in Arbitration’ and its 2014 Guide on ‘Effective Management of Arbitration:
A Guide for In-House Counsel and Other Party Representatives’, both available at www.iccwbo.org/
About-ICC/Policy-Commissions/Arbitration/; Philipp Habegger, Chapter 13, Part V: Saving Time and Costs
in Arbitration, in: Arbitration in Switzerland:The Practitioner’s Guide (Arroyo ed., 2013), 1393 et seq.; David W.
Rivkin and Samantha J. Rowe, The Role of the Tribunal in Controlling Arbitral Costs, (2015) 81 Arbitration, Issue 2,
pp. 116-130.
4 See, e.g., Article 42(2) of the 2012 Swiss Rules which provides for an Expedited Procedure for all cases with
an amount in dispute not exceeding 1 million Swisss francs.
5 In that sense: Michael Schneider, Lean Arbitration: Cost Control and Efficiency Through Progressive
Identification of Issues and Separate Pricing of Arbitration Services, 10(2), 1994 Arb. Int’l, pp. 119-140; see also
para. 85 of the ICC ‘Techniques for Controlling Time and Costs in Arbitration’.
6 See the ICC International Court of Arbitration’s ‘Note to Parties and Arbitral Tribunals on the Conduct of
the Arbitration’ of 22 February 2016, paras. 43 to 46, introducing a malus/bonus system as the general practice
of the ICC Court of Arbitration. See, also Article 24(3) and 37(5) of the 2012 ICC Rules and Article 15(7)
of the 2012 Swiss Rules emphasize the duty of all participants in the arbitral proceedings to contribute to
efficient proceedings without unnecessary costs and delays.
7 See in particular: ICC Commission on Arbitration and ADR’s 2015 Report on ‘Decisions on Costs in
International Arbitration’ (hereinafter the ‘2015 ICC Report on Decisions on Costs’), available at www.
iccwbo.org/About-ICC/Policy-Commissions/Arbitration/ and the previous study of ICC cost awards by
Eric A. Schwartz, The ICC Arbitral Process, Part IV:The Costs of ICC Arbitrations, in ICC Ct. Bull.,Vol. 4 (1993),
pp. 8-23; the ‘Guideline on Drafting Arbitral Awards Part II – Costs’ published by the Chartered Institute of
Arbitrators (the 2016 CIArb Guidelines on Cost Awards), available at www.ciarb.org/guidelines-and-ethics/
guidelines/practice-guidelines-protocols-and-rules.
8 The 2015 ICC Report on Decisions on Costs identifies the prevailing approaches and practices to the
allocation of costs with a view ‘to consider how the allocation of costs between the parties can be used
effectively to control time and costs and to assist in creating fair, well-managed proceedings matching users’
expectations’. The report is available at www.iccwbo.org/About-ICC/Policy-Commissions/Arbitration/ >.
9 Such as, in particular, Article 40(2) and 42(1) of the 2010 UNCITRAL Rules and Article 28.4 of the
1998/2014 LCIA Rules.
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Costs
required by the arbitral tribunal;10 and (2) the ‘party costs’, which include legal costs and
other expenses incurred by a party for the arbitration, including the fees and expenses of
outside counsel, party-appointed experts, witnesses, translators, etc.
The main ‘cost driver’ is usually the legal fees: a study conducted by the ICC analysing
the proportion between the two cost categories in recent ICC final awards showed that
the party costs accounted for more than 80 per cent of the total costs of the arbitration.11
Given this and considering the fact that determination of the arbitration costs is, at least in
institutional arbitration,12 fairly straightforward and rarely poses problems in practice, this
chapter will focus on the party costs only.
The arbitral tribunal’s power to decide on costs is regularly derived from both the lex
arbitri and the parties’ agreement, be it the applicable arbitration agreement or the chosen
arbitral rules:
Most legal systems frequently hosting international arbitrations have arbitration statutes
that either expressly confer on the arbitral tribunal the power to decide on costs13 or simply
consider such authority as inherent in the arbitrator’s mission as conferred by the parties
to resolve a dispute.14 Indeed such mission cannot be completed without a decision as to
which party shall bear, and in what proportion, the procedural costs and, where claimed,
the party costs.15 The situation is somewhat different in the United States where, reflecting
the so-called ‘American Rule’, an arbitral tribunal is only considered to be empowered to
shift party costs if so provided by the arbitration agreement, the applicable arbitration rules
or the (foreign) lex arbitri.16
Similarly, most national arbitration laws do not limit the parties’ autonomy to regu-
late cost issues by agreement, be this directly in their written arbitration agreement, by
incorporating arbitration rules by reference in the arbitration agreement or by common
arrangements in the course of the arbitration.17 However, certain national laws do include
mandatory provisions as to the allocation of costs18 or provide specific guidelines, which
10 E.g., the fees and expenses of any tribunal-appointed expert.

11 See the 2015 ICC Report on Decisions on Costs, para. 2.
12 In institutional arbitration, the fixing of the arbitrators’ remuneration is made, or at least supervised, by the
institution administering the arbitration, and its amount is determined on the basis of the amount in dispute
and the applicable fee schedule (ad valorem system) or the hourly rates applied by the institution (‘time spent’
method). Furthermore, the institutions regularly issue guidelines for accounting of the arbitrators’ expenses,
specifying, for instance, what travel fares or per diem allowance will be considered reasonable by the institution.
13 Cf., e.g., Section 61 of the English Arbitration Act 1996; Sect. 1057 of the German Code of Civil Procedure
and Sect. 609 pf the Austrian Arbitration Act.
14 As it is the case in France and Switzerland, the two leading jurisdictions for hosting arbitrations.
15 Cf. Gary B. Born, International Commercial Arbitration, p. 3095 (2nd ed. 2014); Marco Stacher, Article 38 /
Article 40, in: Zuberbühler/Müller/Habegger (Eds), Swiss Rules of International Arbitration, Article 38 N
3 and Article 40 N 2e, noting that under Swiss law a failure of the arbitral tribunal to do so entitles both
parties to request an additional award.
16 For details, cf. Thomas H. Webster & Michael W. Bühler, Handbook of ICC Arbitration (3rd ed. 2014), paras
37-82 to 37-84.
17 This may include a tacit agreement, e.g. when both parties submit a concordant request to be reimbursed a
specific cost item, e.g., in-house legal cost.
18 See, e.g., Section 60 of the English Arbitration Act 1996, providing that ‘[a]n agreement which has the effect
that a party is to pay the whole or part of the costs of the arbitration in any event is only valid if made after
the dispute in question has arisen.’
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Costs
may not be effectively derogated by a reference to less specific institutional rules.19 Hence,
prudent parties and arbitrators will want to make sure that any particular arrangements and
resulting decisions on costs do not contravene any mandatory provision of the lex arbitri or
potentially the law of the likely place of enforcement.20
Prevalently, arbitration agreements do not, however, include any specific agreements as
to costs; and none of the standard arbitration clauses of any of the major arbitral institutions
suggest addressing cost issues. If sometimes parties do, it is usually to state in their arbitra-
tion clause either that each party shall bear its own costs, or that the successful party shall
be awarded its costs.
By contrast, virtually all of the commonly chosen arbitral rules expressly empower the
arbitrators to award the costs as between the parties.21 They also broadly describe which
costs, and in particular which costs incurred by the parties are recoverable and invariably
limit recovery to ‘reasonable’ party costs. Certain institutional rules provide for a rebuttable
presumption that the successful party will be entitled to recover its reasonable costs, while
other rules simply authorise the arbitral tribunal to apportion party costs and vest it with
unfettered discretion concerning how to allocate such costs, or expressly allow it to con-
sider the parties’ conduct in the arbitration for its cost decision.22
Notwithstanding these differences as to the starting point for the cost allocation deci-
sion, all prevalent institutional rules confer broad discretion upon the arbitrators to not only
consider the outcome but also all other relevant circumstances of the case for the deter-
mination of the final allocation of costs.23 Similarly, the principles of ‘reasonableness’ and
‘proportionality’ as the criteria usually applied for determining which costs are recoverable,
both provide the arbitral tribunal with wide discretion and make sure that the arbitrators
retain the necessary flexibility to decide costs as appropriate in the specific case.
Finally, there is wide consent that arbitrators are not bound to follow national cost rules
applicable to judicial proceedings at the place of arbitration, where the lex arbitri and the
19 Section 61(2) English Arbitration Act 1996 provides that ‘[u]nless the parties otherwise agree, the tribunal shall
award costs on the general principle that costs should follow the event …’. It is doubtful that this provision is
effectively derogated by a reference to, e.g., Article 37(4) ICC Rules, which leaves unfettered discretion to the
arbitral tribunal as to the method for deciding the allocation of reasonable party costs; see Thomas H. Webster
and Michael W. Bühler, op. cit., paras 37-87 and 37-88.
20 2015 ICC Report on Decisions on Costs, para. 52. See also: Simon Greenberg, Chapter II: The Arbitrator and
the Arbitration Procedure, Law Applicable to Costs Claims in International Arbitration: Why Does It Matter?
in: Austrian Yearbook on International Arbitration 2015, pp. 181-182, regarding rules of public policy in the
enforcement jurisdiction (with references to case law).
21 Article 52(1) of the 2015 CIETAC Rules; Article 35.1 of the 1998 DIS Rules; Article 33.1 of the
2013 HKIAC Rules; Article 37(4) of the 2012 ICC Rules; Article 28.3 of the 2014 LCIA Rules; Article 34 of
the 2014 ICDR Rules; Article 42(2) of the 2012 PCA Rules; Article 44 of the 2010 SCC Rules; Rule 33 of
the 2016 SIAC Rules; Article 40(1) and (2) of the 2012 Swiss Rules; Article 42(2) of the 2010 UNCITRAL
Rules; Article 74 of the 2014 WIPO Rules.
22 Article 37(5) of the 2012 ICC Rules; Article 28.4 of the 2014 LCIA Rules.
23 Article 52(2) of the 2015 CIETAC Rules; Article 35.2 of the 1998 DIS Rules; Article 33.2 of the
2013 HKIAC Rules; Article 37(5) of the 2012 ICC Rules; Article 28.4 of the 2014 LCIA Rules; Article 34 of
the 2014 ICDR Rules; Article 42(1) of the 2012 PCA Rules; Article 44 of the 2010 SCC Rules; Rule 31.1 of
the 2016 SIAC Rules; Article 40(1) and (2) of the 2012 Swiss Rules; Article 42(1) of the 2010 UNCITRAL
Rules; Article 74 of the 2014 WIPO Rules.
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Costs
applicable institutional rules fail to provide any guidance.24 Rather, modern arbitration laws
and institutional rules give the arbitrators the subsidiary power to determine the procedure,
which includes the applicable standards for cost determinations. Indeed,‘one of the benefits
of the discretion that arbitrators enjoy in relation to awarding costs is precisely that they are
freed from [applying laws or rules which] may be complex and/or ill-suited to the deter-
mination of cost claims in international arbitration.’25
Despite the emergence of prevailing trends as to which costs are considered recoverable
and how the costs of arbitration shall be allocated in international commercial arbitration,
the practices adopted by arbitral tribunals remain far from uniform.26 Considering the
important autonomy of the parties and the wide discretion afforded to the arbitrators when
deciding on costs combined with different cultural expectations reflecting the approach
found in one’s own national legal system, it is no surprise that in practice arbitral awards
reveal a broad diversity of approaches and variety of different outcomes.
In order to remove uncertainty and improve predictability for the parties, arbitral tribu-
nals should consider to briefly address cost issues together with the parties at the outset of
the proceedings, e.g., at the occasion of the initial organisational conference; particularly so,
when the case involves parties and arbitrators of several nationalities and different legal and
cultural traditions.27 The ICC Commission Report on ‘Decisions on Costs in International
Arbitration’ identifies a number of aspects of cost management that the arbitral tribunal
might consider discussing with the parties, including:28
• informing the parties that it ‘intends to take into account the manner in which each
party has conducted the proceedings and to sanction any unreasonable behaviour by a
party when deciding on costs’;
• ‘what cost items the tribunal considers may potentially be recoverable’;
• ‘what records will be required to substantiate cost assessment claims’;
• ‘sensitive matters, such as whether there is third-party funding and any implications it
may have for the allocation of costs’; and
• the timing and sequence of submissions on costs.
A proactive approach is also recommended by the ‘Guideline on Drafting Arbitral Awards

Part II – Costs’ of the Chartered Institute of Arbitrators,29 which moreover suggests that
the tribunal should issue its directions to cost issues following a discussion with the parties
at the initial organisational conference. If it does so, it is suggested here that the tribunal
24 Thomas H. Webster & Michael W. Bühler, op. cit., para 37-98. See also Article 28.3 of the 2014 LCIA Rules
stating that ‘[t]he Arbitral Tribunal shall not be required to apply the rates or procedures for assessing such costs
practised by any state court or other legal authority’.
25 Simon Greenberg, op. cit., p. 175.
26 2015 ICC Report on Decisions on Costs, para. 101; see, e.g., the variety of ICC tribunal findings reproduced
in Appendix A – Analysis of Allocation of Costs in Arbitral Awards, pp. 21-24.
27 Micha Bühler, Awarding Costs in International Commercial Arbitration: an Overview, 22 ASA Bulletin
(2/2004), p. 279; contra: Paolo Michele Patocchi, Deciding on the Costs of the Arbitration – Selected Topics, ASA
Special Series No. 29 (2007), p. 62.
28 2015 ICC Report on Decisions on Costs, para. 32.
29 2016 CIArb Guidelines on Cost Awards, Article 1 and the Commentary on Article 1, Paragraphs 2 and 3.
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Costs
should be mindful to include adequate wording indicating that its discretion to consider
all relevant circumstances of the arbitration when deciding on costs remains unaffected.
As a rule, the arbitral tribunal is to decide in its (partial or final) award which party
shall bear which costs and in which proportion. For that purpose, a two-tiered assessment
is required with respect to both cost categories – i.e., the tribunal must determine, on the
one hand, the allocation of liability for costs and, on the other hand, what types of costs
are recoverable and to what extent. Part 3 of this chapter will summarise the prevailing
standards and approaches adopted by arbitral tribunals when exercising their discretion for
deciding the allocation of costs. Part 4 will then take a closer look at the recoverability
of various party cost items and how arbitrators tend to apply the test of reasonableness
in practice.
Cost allocation considerations

Basic cost allocation principles
While there is a great variety of different approaches or practices for allocating cost, two
primary yet opposing approaches stand out: the rule of ‘costs follow the event’ and the
‘American Rule’. The ‘costs follow the event rule’ requests the losing party to compensate
the winner for its costs, while the American Rule means that each party is to bear its own
legal costs (and its own share of the arbitration costs).
The ‘costs follow the event’ rule is reported to be almost universally recognised in both
common and civil law jurisdictions.30 The rationale behind allocating costs to a successful
party is that a party ‘should not be out of pocket as a result of having to seek adjudication
to enforce or vindicate its legal rights’.31 It also has a strong foundation in economic theory:
by penalising the losing party for bringing an unsuccessful suit it serves as a deterrent for
frivolous claims. There is recent empirical data32 to support the position that ‘costs follow
the event rule’ has become the prevailing approach in international commercial arbitra-
tion in recent years, in the sense that ‘where a party is entirely successful in its claims or in
defending against a claim, the arbitral tribunal is likely to allow it to recover some or all of
its reasonable costs from the losing party’.33
The American Rule providing that each party should bear its own legal fees is not
only applied in US litigation but also in China and Japan. Moreover, it correlates with the
traditional practice in interstate disputes,34 and is applied in interstate arbitrations, where it
is customary that, as a matter of international comity, each party bears its own legal costs
30 Micha Bühler, op. cit., p. 250.

31 2015 ICC Report on Decisions on Costs, para. 86, with reference to Harold v. Smith (1860) 5 H. & N. 381.
32 2015 ICC Report on Decisions on Costs, para. 13 and Appendix A; see also the study ‘Costs of arbitration
and apportionment of costs under the SCC Rules’ conducted by the Arbitration Institute of the Stockholm
Chamber of Commerce on 148 SCC awards issued between 2007 and 2014 in domestic and international,
available at www.sccinstitute.com/about-the-scc/news/2016/new-scc-report-on-apportionment-of-costs/.
33 Jason Fry, Simon Greenberg, Francesca Mazza, The Secretariat’s Guide to ICC Arbitration, ICC Publication
729 (Paris, 2012), 3-1488. See also Wendy J. Miles, Costs Allocation in Investor-State Arbitration,
(2014) 80 Arbitration, Issue 4, p. 413 et seq., stating: ‘It is now beyond serious debate that in the majority
of international commercial arbitration cases, there is at least some costs allocation in favour of the
successful party’.
34 Cf. Article 64 of the Statute of the International Court of Justice.
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Costs
and half of the procedural costs.35 Awards applying the American Rule are less common in
international commercial arbitration, but remain frequent in investor-state arbitrations.36
As justification for the American Rule, it is often advanced that legal costs are properly
considered as a normal cost of doing business and that it lowers barriers to access to justice.
As an intermediate position, as contemplated by Article 40 of the 1976 UNCITRAL
Rules, arbitral tribunals may allocate the procedural and the party costs differently; namely
by awarding a claim for reimbursement of the procedural costs to the winning party, while
not shifting legal or other party costs. However, this approach has become less frequent
in recent years, reflecting the growing awareness that engaging external counsel is often
appropriate, or even necessary, for conducting an arbitration.37
Degree of success as prevalent criterion and starting point for cost allocation
The starting point for any decision on costs is the applicable arbitration rules and, if con-
taining relevant rules, the arbitration agreement and the applicable lex arbitri.
Many international arbitration rules now expressly provide that the costs of arbitra-
tion shall in principle be borne by the unsuccessful party, and hence expressly provide for
fee shifting: see Article 52(2) of the 2015 CIETAC Rules; Article 35.2 of the 1998 DIS
Rules; Article 28.4 of the 2014 LCIA Rules; Article 42(1) of the 2012 PCA Rules and
Article 42(1) of the 2010 UNCITRAL Rules. Other rules, including the ICC Rules in
particular,38 simply authorise the tribunal to make an award apportioning costs but do
not stipulate any presumption in favour of the ‘costs follow the event’ rule as the guid-
ing principle for allocation and simply command the tribunal to take into account the
circumstances of the case; see Article 33.2 of the 2013 HKIAC Rules; Article 37(5) of the
2012 ICC Rules; Article 34 of the 2014 ICDR Rules; Article 44 of the 2010 SCC Rules,39
Rule 37 of the 2016 SIAC Rules and Article 74 of the 2014 WIPO Rules.40 Article 40(1)
of the 2012 Swiss Rules provide that the cost of arbitration shall in principle be borne by
the unsuccessful party, while Article 40(2) gives the arbitral tribunal discretion to apportion
the party costs as it deems fit.
However, the express or implied will of the parties is also to be followed where the
applicable rules do not include a ‘costs follow the event’ presumption. If, for example, both
parties request the tribunal to order the other party to compensate it for its legal costs in
35 Cf. the note of the Permanent Court of Arbitration in Appendix A to the 2015 ICC Report on Decisions on
Costs, pp. 33-34.
36 Cf. Wendy J. Miles, op. cit., p. 417; Kateryna Bondar, Allocation of costs in investor-State and commercial
arbitration: towards a harmonized approach, ArbIntl,Vol. 32 No. 1 (2016), p. 57.
37 In this sense, Article 2.2 of the 2016 CIArb Guidelines on Cost Awards now states that if arbitrators
decide to treat the allocation of procedural and party costs differently, they should provide an explanation
in the cost award for their decision. Similarly, the 2010 UNCITRAL Rules do no longer provide for a
different allocation standard depending on whether procedural or party costs are at issue; see Article 42(1)
2010 UNCITRAL Rules.
38 Article 37(5) of the 2012 ICC Rules provides: ‘In making decisions as to costs, the arbitral tribunal may
take into account such circumstances as it considers relevant, including the extent to which each party has
conducted the arbitration in an expeditious and cost-effective manner’.
39 Referring, however, to ‘the outcome of the case and other relevant circumstances’.
40 Referring, however, to ‘all the circumstances and the outcome of the arbitration’.
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Costs
their prayers for relief, the arbitral tribunal may reasonably conclude that the parties agree
on an allocation of the costs linked to the outcome on the merits; and particularly so where
both parties invoke in their submissions their success on the merits as reason for a cost
award in their favour.41
One of the main findings of the ICC Commission’s analysis of cost allocation deci-
sions made in arbitrations administrated by major arbitral institutions worldwide was that
a majority of tribunals adopt the ‘costs follow the event’ rule as a prevalent criterion and
starting point for cost allocation.42 This result is of no surprise where the applicable arbi-
tration rules include an express presumption that the successful party will be entitled to
recover its reasonable cost.43 However, the outcome was the same under those arbitration
rules that simply authorise the tribunal to make an award apportioning costs, and notably
also in ICC arbitrations. Hence, the recent study seems to corroborate that the ‘costs follow
the event’ rule has indeed become the prevalent approach for cost decisions in international
commercial arbitrations.44
Yet, it should be noted that the ‘costs follow the event’ rule is prevalently applied in a
‘bespoke way’45 by arbitral tribunals, namely taking into account the parties’ relative suc-
cess and failure in the award, or the relative degree of success of their claims and defences
respectively. It is submitted here that a strict ‘net winner’ or ‘winner takes it all’ approach
as traditionally applied in High Court litigation in England is, in contrast, rarely recom-
mended for international arbitrations. Not only is this latter approach intrinsically linked
to the English practice of ‘sealed offers’,46 but in extreme cases it may even be regarded as
irreconcilable with the tribunal’s duty of equal treatment of the parties.47 Conversely, allo-
cation based on the parties’ relative success should not be seen to reduce the cost decision
to a purely arithmetical exercise, and in particular does not speak against awarding full costs
where a party, while not fully, still very predominantly succeeded with its claim or defence,
or against equal apportionment where neither side came out as a winner.
Determining the relative success is not necessarily straightforward, in particularly in
complex cases with multiple causes of action and claims.48 In purely monetary awards, and
absent particular circumstances, it will in many cases be appropriate for assessing the rela-
tive success of each party to determine the success ratio by simply comparing the amounts
claimed by the parties in their prayers for relief and the amounts ultimately awarded to each
41 Micha Bühler & Marco Stacher, Chapter 13, Part IV: Costs in International Arbitration, in: Arbitration in
Switzerland:The Practitioner’s Guide (Arroyo ed., 2013), para. 69.
42 2015 ICC Report on Decisions on Costs, para. 13.
43 See para. 22 above.
44 The same finding is not warranted with respect to investor-state arbitration, where the emergence of a clear
trend in favour of the ‘costs follow the event’ rule is not (yet) recognisable. See for details: Wendy J. Miles, op.
cit., pp. 413-431 and Kateryna Bondar, op. cit., pp. 45-58.
45 Simon Greenberg, op. cit., p. 177.
46 Cf. Micha Bühler, op. cit., p. 263 et seq.
47 In a decision on domestic arbitration, the Swiss Federal Supreme Court held that it is arbitrary to award a
claim for the reimbursement of the arbitration and party costs to a party which only prevailed with about
2.5 per cent of its claim; see BGer. 4A_288/2008 para. 4.
48 2015 ICC Report on Decisions on Costs, para. 59; see also ICC Case No. 5029 (1991), quoted in ICC Ct.
Bull.,Vol.4 (1993), p. 32.
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party.49 In other cases, the pro rata rule will only be a starting point and the arbitral tribunal
will look beyond a mere computation of the amounts claimed and awarded. The arbitral
tribunal enjoys discretion when evaluating the parties’ relative successes and failures in the
arbitration. For instance, the tribunal may take into consideration that a party, although
unsuccessful in the end, succeeded on certain preliminary issues on which a large amount
of time and effort had to be spent by the parties or the tribunal.50 To the same effect, a
tribunal may take into account case-specific difficulties in assessing and valuating damages
and, in particular, where such assessment was made difficult by the uncooperative attitude
of the counterparty, may decide to award full costs to a claimant, although the monetary
award obtained was lower than the claimed amount (or to not reduce the cost award pro-
portionally to the ratio between the amounts claimed and awarded). Moreover, a tribunal
may decide to assess the costs separately for certain procedural applications, and may allo-
cate the costs based on the outcome of such issue rather than based on the overall outcome.
For instance, it may consider it appropriate in a given case to allocate the estimated costs
generated by an unsuccessful plea of jurisdiction or request for security of costs against the
applicant even though that party prevailed on the merits.51
In summary, when awarding costs based on the outcome of the dispute, arbitral tribu-
nals measure success in various ways, effectively adjusting the ‘costs follow the event’ rule
to the specific case.52
Other factors
While the majority of arbitral tribunals take the outcome of the arbitration as a guiding
principle and starting point for cost allocation, they regularly use their discretionary powers
to adjust the allocation of costs by taking account of other factors relevant in the particular
case.53 Indeed, none of the arbitration rules mentioned earlier that include a presumption
that costs follow the event, makes cost-shifting to the successful party an absolute rule.
Rather, they all allow the tribunal to depart from the principle where appropriate or rea-
sonable. Additional factors that arbitrators consider for cost allocation include, for example,
the following.
Parties’ conduct
Arbitral tribunals routinely take into account improper conduct and bad faith proce-
dural behaviour by a party when deciding costs, and may penalise with their cost award
49 Cf. Micha Bühler & Marco Stacher, op. cit., para. 71. Set-off defences will to be considered in the same way
as counterclaims.
50 Idem.
51 Idem.
52 Cf. the 2015 ICC Report on Decisions on Costs, para. 61, stating: ‘Arbitrators may take into account the
relative success of the prevailing party by: (i) assuming that if a claimant or respondent succeeded in its core or
primary claim or outcome, then it is entitled to all of its reasonable costs; (ii) apportioning costs on a claim-by-
claim or issue-by-issue basis according to relative success and failure; or (iii) apportioning success against the
amount of damages originally claimed or the value of the property in dispute’ and ‘[w]hatever approach is
used, it is important to take into account differences in the complexity and importance of different issues’.
53 See also the Appendix A to the 2015 ICC Report on Decisions on Costs, p. 21, listing the 10 factors most
commonly considered by tribunals in the ICC awards reviewed by the Secretariat to the ICC Commission.
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unreasonable, obstructive, abusive or otherwise improper behaviour aimed at derail-

ing or delaying the arbitration.54 In fact, both Article 37(5) of the 2012 ICC Rules and
Article 28.4 of the 2014 LCIA Rules now expressly encourage the tribunal to take party
conduct into consideration in the decision on costs. Where a party undermines an expedi-
tious and cost-efficient conduct of the arbitration, the tribunal should consider ordering
that party to reimburse the other party for additional costs incurred because of its unco-
operative behaviour, or reducing any costs award to such party because of its inefficiency.55
Events that the tribunal may wish to take into account include filing of grossly exaggerated
or spurious claims; unreasonable procedural applications; unnecessarily lengthy submissions
or applications; abusive document production requests or failure to comply with produc-
tion orders; repeated filing of belated or unsolicited submissions; repeated unsuccessful
challenges against the appointment of an arbitrator; or other ‘guerrilla tactics’ aimed at
derailing the arbitral process.56
Issue-based allocation of preliminary issues

Arbitral tribunals regularly consider, as a factor mitigating cost-shifting, that an ultimately
unsuccessful party prevailed on preliminary issues, particularly if a procedural defence or a
set-off claim was dismissed, or if the claimant succeeded on liability, but lost on quantum.57
As shown above, this approach can be considered a refinement of the loser-pays principle
rather than an exception.
Cause of the dispute; failure to avoid the dispute

Arbitral tribunals also look into the parties’ conduct that gave rise to the arbitration, and
in particular whether the arbitration could have been avoided if one party had acted dif-
ferently in earlier settlement discussions58 or dealings or whether the winning party shares
responsibility for the escalation of the conflict or the root cause of the dispute.59 For
instance, one tribunal held against the winning party that ‘only the strength of the con-
tract has caused [its] success,’60 whereas another panel did not grant costs to the prevailing
respondent because the claim brought was ‘far from being reckless’ and partly arose out of
54 See the examples of ICC tribunal findings in Appendix A to the 2015 ICC Report on Decisions on Costs,
pp. 23-24.
55 Jason Fry, Simon Greenberg, Francesca Mazza, op. cit., 3-1488.
56 Cf. the 2015 ICC Report on Decisions on Costs, paras. 78-85.
p. 23; further examples from ICC cases are: ICC Case No. 8786 (1997) in 13 ASA Bulletin 1 (1995), p. 57 et
seq. (security request dismissed by interim award); ICC Case No. 5901 (1992) in ICC Ct. Bull.,Vol.4 (1993),
p. 40 (Respondent only partially successful on its ‘initial procedural defences’), ICC Case No. 6914 (1992) in
ICC Ct. Bull.,Vol.4 (1993), p. 48 (unfounded objection regarding locus standi).
58 Regarding the practice by certain arbitral tribunals to take into account settlement offers made prior to the
final award brought to the tribunal’s attention as well as the practice of ‘sealed offers’, see: Article 2.1.iii) of the
2016 CIArb Guidelines on Cost Awards; cf. also: Jason Fry, Simon Greenberg, Francesca Mazza, op. cit., 3-1488.
pp. 21-22.
60 ICC Case No. 7761 (1995), (1997) 22 Y.B. Com. Arb. 163.
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Costs
a confusion created by the respondent’s conduct.61 In another case, the tribunal considered
in its cost decision that the dispute arose out of the unclear terms of the parties’ contract
and that therefore each party should ‘bear a share of the responsibility for this uncertainty
and the resulting costs’.62 In contrast, where the tribunals found that the prevailing claimant
acted reasonably in pursuing its claim in arbitration and was left with no choice other than
to enter into arbitration, given the unreasonable position adopted by the other side, such
circumstances were considered in support of allocating legal fees.63
Claims raised bona fide

Arbitral decisions show a wide range of further mitigating factors considered by arbitrators
when deciding on costs, including understandable difficulties of a party in providing suf-
ficient evidence,64 the sheer complexity of a case and the novelty of issues to be decided.65
Finally, cost awards sometimes reflect an approach of leniency towards an economically

weaker party that lost the arbitration or, which seems more delicate, a compromise made
within the arbitral tribunal to reach an unanimous decision on the merits of the case.66
The determination of recoverable party costs

Legal and other costs reasonably incurred by the parties
In international arbitration, all costs incurred in relation to the arbitral proceedings are
in principle regarded as recoverable provided they have been proportionally and reason-
ably incurred, recovery has been claimed by the parties and unless otherwise agreed by
the parties.67 In particular, it is generally accepted that a party’s recoverable costs for legal
representation and assistance are not limited to the costs of outside legal counsel but also
include costs for other (external) professional services and expert advice as necessary for
accurately presenting the case, notwithstanding that the wording found in some arbitration
rules seems to suggest a narrower understanding.68
Hence, the costs as effectively incurred by a party are, in principle, both the starting
point and the upper limit for cost recovery.Yet, it is also an essential requirement of fairness
that the costs one party may request its opponent to reimburse are limited in some way.69
Such limits are provided by (1) the requirement that recoverable costs must have been
61 ICC Case No. 6728 (1992), ICC Ct. Bull.,Vol.4 (1993), p. 47.
62 ICC Case No. 8332 (1996, unpublished).
63 See Appendix A to the 2015 ICC Report on Decisions on Costs, p. 21 (‘No alternative for Claimant but to
bring this arbitration to enforce its rights.’).
64 ICC Case No. 6042 (1991), ICC Ct. Bull.,Vol.4 (1993), p. 41.
65 Cf. Romak SA v.The Republic of Uzbekistan, PCA Case No. 2007-6 , Award, 26 Nov. 2009, § 50.
66 See Bernard Hanotiau, The Parties’ Costs of Arbitration in: Evaluation of Damages in International Arbitration,
Dossiers of the ICC Institute of World Business Law,Volume 4 (2006), p. 220, stating: ‘One should also be candid
and recognize that the final allocation of costs is in some cases an argument put forward by a member of the
panel to have him accept a result that is different from the one he wanted to reach, with the consequence, for
example, that the claimant wins the case in totality but is not awarded the totality of its costs.’
67 Cf. Jason Fry, Simon Greenberg, Francesca Mazza, op. cit., 3-1488.
68 Micha Bühler, op. cit., pp. 270-271.
69 Micha Bühler & Marco Stacher, op. cit., para. 74.
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specifically incurred for the arbitration and be directly linked to it, and (2) the standard
of reasonableness.
Only costs incurred for developing and presenting the case before the arbitral tribu-
nal can be recovered. Costs incurred prior to the commencement of the arbitration are
only recoverable if incurred in contemplation and for the purpose of the arbitration,70
but are usually not, for example, costs related to negotiations or mediation initiated prior
to filing for arbitration.71 Conversely, costs incurred following the final award, such as
costs for its enforcement or resisting annulment proceedings cannot be considered costs of
the arbitration.72
Likewise, costs incurred for ancillary judicial proceedings are generally considered to
lack a sufficiently close nexus to the arbitration and, hence, not form part of the costs of
the arbitration.73 Exceptionally, costs incurred in ancillary proceedings might be regarded as
recoverable if they have not been brought in breach of the arbitration agreement74 (but rather
before the ‘juge d’appui’) and no cost decision was made in such ancillary proceedings.75
Arbitral tribunals have usually not taken into consideration third-party funding arrange-
ments when determining the amount recoverable by a successful claimant, but consider the
legal fees paid by the funder to the funded party’s lawyers as ‘incurred’ by the funded party,
as long as the latter has incurred the liability to pay legal fees to its counsel.76 Indeed, a
successful claimant who was funded by a third-party funder will usually at the least have
to repay the costs of the arbitration advanced by the funder from the sum awarded.77 As a
result, the successful party will then be ‘itself ultimately out of pocket … and may therefore
be entitled to recover its reasonable costs’.78
Arbitration rules invariably include a proviso that costs must be ‘reasonable’ to be recov-
erable. However, there is no definition of reasonableness in any of the prevalent arbi-
tration rules or national arbitration statutes. The ICC Report on Decisions on Costs in
International Arbitration suggest that ‘a common-sense approach is to assess whether the
70 E.g., for case evaluation, fact finding, arbitrator selection, etc.

71 Cf. Bernard Hanotiau, op. cit., p. 213, with reference to ICC Case No. ICC Case No. 5896 of 1992 in ICC Ct.
Bull.,Vol. 4 (1993), p. 38; 2016 CIArb Guidelines on Cost Awards, para. 1.h) to Article 3; Marco Stacher, op. cit.,
Article 38 N 12.
72 Cf. Bernard Hanotiau, op. cit., p. 214. See also Marco Stacher, op. cit., Article 38 N 12a, specifying that the costs
for submitting cost statements as well as the (expected) costs for studying and reviewing the award still qualify
as cost of the arbitration.
73 Cf. Bernard Hanotiau, op. cit., p. 213; Marco Stacher, op. cit., Article 38 N 13 and 14.
74 The cost incurred for defending against proceedings brought in breach of the arbitration agreement will
usually give raise to a substantive law claim for damages, see: Marco Stacher, op. cit., Article 38 N 13 and 14.
75 Paolo Michele Patocchi, op. cit., p. 63.
76 Cf. Bernard Hanotiau, op. cit., p. 215; see for an in-depth analysis: Jonas von Goeler, Third-Party Funding in
International Arbitration and its Impact on Procedure, International Arbitration Law Library,Volume 35, § 10.02,
with reference to arbitral case law.
77 By contrast, in the investment arbitration case Quasar de Valores SICAV SA et al. v.The Russian Federation (SCC
Arbitration No. 24/2007, Award of 20 July 2012) the funded party was denied recovery of its costs because
the third party had funded the legal costs in a mere concern to create favourable precedent without any
entitlement to repayment from the funded party in case of success.
78 ICC Report on Decisions on Costs, para. 87.
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costs are reasonable and proportionate to the amount in dispute or value of any property in
dispute and/or the costs have been proportionately and reasonably incurred’.79
While the standard of reasonableness confers considerable discretionary power to the
arbitrators, they should be slow to impose their own views as to how much a party should
have spent on making its case. Not only are the parties free to select legal counsel of their
choice but the fact that a party paid legal fees without knowing whether or not it would
ultimately prevail and recover such costs is ‘a strong indication that the amount billed was
considered reasonable by a reasonable man spending his own money, or the money of the
corporation he serves’.80 Where they are satisfied that the amounts claimed were effectively
spent, arbitrators tend to intervene only if the legal and other professional fees claimed by
one party are manifestly disproportionate to the importance of the case and the amount
in dispute and, moreover, if there are no objective circumstances justifying the increased
costs.81 Tribunals will usually compare the amounts of costs claimed by each side and if
comparable sums are claimed or if the winning party’s costs are lower, consider this as an
indication that the costs claimed are reasonable. Inversely, even an important imbalance
between the amounts claimed by each party may not automatically signify that the party
claiming higher costs acted unreasonably or inflated its cost claim.82 However, arbitrators
may take this as a cause for requesting further explanations for the disparity83 and reviewing
any cost documentation submitted more closely.
Specific categories of party costs

Outside counsel cost
It is widely accepted that parties will usually need to retain specialist outside legal counsel
for conducting an international arbitration and, accordingly, that the reasonable lawyers’
fees payable to outside counsel are recoverable. When assessing their reasonableness, the
arbitral tribunal ‘should compare the amounts claimed by each party, taking into account
the time spent, hourly rates and level of skill engaged in the light of the complexity and
duration of the case as well as the amount in dispute’.84 The level of scrutiny varies and
will usually depend on the specific circumstances: if the legal fees claimed by each party
are comparable, the hourly rates charged in line with market practice and the billing is
transparent, an arbitral tribunal usually accepts the reasonableness of the legal costs claimed
without further ado, as long as the legal fees and their reasonableness remain unchallenged
by the other party.
Success-fee arrangements and third-party funded costs

Contingency fees or similar arrangements between the prevailing party and its counsel or
funder that provide for an uplift in case of success can be problematic in several aspects with

80 Separate opinion of Judge Holtzmann in Sylvania Technical Sys Inc v. Government of the Islamic Republic of Iran,
(1985) 8 Iran-US C.T.R. Rep. 329, p. 333.
82 Appendix A to the ICC Report on Decisions on Costs, p. 26.
83 For instance, as a consequence of the burden of proof.
84 2016 CIArb Guidelines on Cost Awards, p. 11.
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regards to the allocation of costs. First, it may be doubtful whether the fee arrangement was
validly entered into between the party and its counsel (or funder) in light of the applicable
ethical rules and whether the lex arbitri in turn allows the arbitrators to give effect to such
agreement. Second, the success element or premium is unlikely to be considered ‘reason-
able’ by the arbitral tribunal when assessing the recoverable fee amount, unless both parties
entered into such arrangements and requested recovery of such additional cost portion.
It is argued that the losing party’s liability should not be increased as a result of the win-
ning party’s choice to rely on risk sharing with a third party and that ‘in a system where
the costs are, in principle, to be borne by the unsuccessful party such arrangements would
allow the parties to shift, with respect to the success premium, their fee exposure entirely
to their counterparty’.85 As a result, international arbitral tribunals have usually refused to
shift the cost of the success premium to the losing party,86 but there are exceptions.87 In
contrast, arbitral tribunals tend to allow the funded party to claim legal fees on the normal
hourly rates that the party would have incurred if no third-party agreement had existed
(and to the extent such fee amount does not exceed the sum payable to the funder).Yet, a
higher level of substantiation of the time spent on the case may be required to enable the
arbitral tribunal to determine whether the ‘normal fees’ claimed by the funded party are
reasonable.88 Accordingly, the parties to success-fee arrangements should be mindful when
drafting the fee agreement that such documents may have to be disclosed for the purpose
of substantiation of the cost claim and should state the normal hourly rates of the lawyers
engaged as well as the requirements as to the recording of the time spent on the case. The
same applies mutatis mutandis to agreements with a litigation funder.
In-house counsel costs

Arbitral tribunals are increasingly recognising that the cost of in-house legal advice is, in
principle, recoverable provided the use of in-house lawyers leads to a reduction of work
otherwise done by external legal resources, and goes beyond mere management involve-
ment.89 In support of the recoverability of in-house counsel costs, it is argued that arbitral
tribunals should not interfere with the party’s right to choose between external counsel
and in-house counsel and that ‘no privilege should be attached to the choice of external

86 See also Bernard Hanotiau, op. cit., p. 218, stating that ‘[s]uch success fees are normally not included in the costs
fixed by the Arbitral Tribunal. They are not properly defence costs, since they do not cover real costs exposed
for the defence of the case. They are rather a reward granted in consideration of the success obtained in the
defence of the case and should be fully supported by the party concerned’.
87 In Essar Oilfield Services Limited v. Norscot Rig Management Pvt Limited [2016] EWHC 2361 (Comm) the
High Court upheld the decision by the sole arbitrator in ICC Case No. 15790 to award the cost of litigation
funding, i.e. the fee of 300 per cent of the funding or 35 per cent of the recovery owed to the funder in the
event of success, against the losing respondent. It is, however, submitted here that this was an extraordinary case
where the claimant’s impecuniousness was brought about by the respondent’s bad faith conduct leaving the
claimant, in the Sole Arbitrator’s view, with ‘no alternative, but was forced to enter into the litigation funding’.
Arguably, the better approach would have been to consider the funding costs as damages. See in this respect:
Jonas von Goeler, op. cit., p. 413 et seq.
88 Jonas von Goeler, op. cit., p. 400 et seq.
89 Thomas H. Webster & Michael W. Bühler, op. cit., para 37-47. See also idem, para 37-50 with an excerpt from
ICC case No. 12124 (2006); Bernard Hanotiau, op. cit., p. 215.
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counsel’.90 Moreover, it has become increasingly common that both parties request, in
their prayers for relief, compensation for in-house counsel costs from the outset. Such
concordant approach by the parties can be seen as tantamount to an implied agreement on
the recoverability of in-house costs.91 Yet, while external counsel fees are expenditures that
can be clearly identified and evidenced, substantiating in-house costs is often problematic.
A clear determination of both the exact time spent by the internal lawyer specifically on
the case, and the exact cost incurred by the company for such time, is usually difficult. As a
result, proper time sheets recording the activity and time spent by the in-house lawyers, or
some other in-house documentation, will regularly be essential for successfully substantiat-
ing and evidencing the costs claimed for in-house counsel involvement.92
Management and employees’ costs

While the conduct of an arbitration may necessitate substantial involvement of the staff
of a party, arbitrators are generally reluctant to allow claims for the costs of a party’s own
employees.93 In particular, most arbitrators regard the time spent by members of the man-
agement for managing conflicts as part of the normal cost for running a business enterprise,
which is not recoverable. Hence, except for reasonable out-of-pocket expenses necessar-
ily incurred in the arbitration, the parties’ internal costs for instructing external counsel,
reviewing case documents and draft submissions or attending the hearings are ‘normally
irrecoverable on the general principle that they fall under the general operational expenses
of the company’.94 However, as emphasised by the Chartered Institute of Arbitrators, it may
well be appropriate to decide differently where the work done internally obviates the need
for outside assistance and leads to an overall saving of costs; for example, where necessary
technical expertise or accounting skills are available internally, certain aspects of the case
may be more efficiently dealt with than when engaging external experts.95
Expert witness and support services costs

As mentioned above, the costs for experts appointed by the parties to assist them in assess-
ing or proving their case are generally considered recoverable to the extent such assistance
90 Paolo Michele Patocchi, op. cit., p. 63; see also ICC case No. 6564 of 1993, partly reproduced in ICC Ct. Bull.,
Vol.4 (1993), p. 46.
92 See ICC case No. 6564 of 1993, refusing to allow in-house legal costs on the grounds that ‘…it appears
justified to require some substantiation inter alia with respect to the nature of the cost, the personnel involved
and type of work performed. In the present case, neither Party satisfied these requirements. Their claims are
too general to permit an assessment of the justification and reasonableness of the costs claimed’ (ICC Ct.
Bull.,Vol.4 (1993), p. 46). For further examples of tribunal findings see Appendix A to the ICC Report on
Decisions on Costs, p. 27 (e.g., ‘[i]f well documented by bills etc. hourly rates, proof of when and why those
hours were related to the arbitration proceedings, they shall be accepted by the Arbitral Tribunal, otherwise
they have been rejected’).
93 Thomas H. Webster & Michael W. Bühler, op. cit., para 37-55; Paolo Michele Patocchi, op. cit., p. 64; Bernard
Hanotiau, Paolo Michele Patocchi, op. cit., p. 218.
94 2016 CIArb Guidelines on Cost Awards, p. 12.
95 Jason Fry, Simon Greenberg, Francesca Mazza, op. cit., 3-1491; 2016 CIArb Guidelines on Cost Awards, p. 12.
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appears appropriate and relevant for the case and the resulting costs seem reasonable.96
The recoverable costs will include the expert’s fees, costs of travel and ancillary expenses.
Where tribunals decide not to give any weight to an expert’s report and testimony because
of a lack of credibility of the expert evidence, they will usually also dismiss any claim for
reimbursement of the costs incurred for such expert. Other recoverable costs for exter-
nal professional services may include the costs of interpreters, translators, court reporters,
IT-support services, investigative services, paralegal services, etc., depending on the particu-
lar needs of the case, provided such costs were incurred specifically for the purpose of the
case and appear justified for presenting the case to the arbitral tribunal.97
Costs for fact witnesses and evidence

Expenses incurred for witness and other evidence are generally regarded as recoverable to
the extent reasonably incurred. Witness costs include not only those for attendance at the
hearing but also for preparing witness statements. In cases where the fact witnesses are not
employees of a party, the latter may agree to reimbursement for loss of income and for his
time.98 However, they should be mindful that such arrangement may need to be disclosed
and that any such compensation should remain modest to avoid an appearance of undue
influence on the witness.99 Although it is not rare that parties also claim costs for the time
spent by internal witnesses, arbitral tribunals can be expected to be slow to accept such
costs as recoverable,100 mainly for the same reasons that they are reluctant to allow compen-
sation for management time.
Timing and contents of decisions on costs

Parties will usually have made a claim for cost reimbursement at the very outset of the
proceedings – i.e., with the notice of arbitration or the answer thereto – by including a yet
unquantified claim for costs in their prayers for relief. As a general rule, an arbitral tribunal
must not award legal costs to a party absent a claim submitted to that effect.101 Counsel
coming from jurisdictions where legal costs are awarded as a matter of course in state court
proceedings, even without submitting an express claim to that effect, should be wary of not
forgetting to include a cost claim in their prayers for relief.
Before deciding on the costs of arbitration and prior to rendering the final award, the
arbitral tribunal must give the parties an opportunity to file cost statements.102 The tribunal
will usually do so at the close of the hearing or shortly thereafter by setting the parties a

97 Cf. also Bernard Hanotiau, op. cit., p. 214; Micha Bühler & Marco Stacher, op. cit., para. 78.
98 Thomas H. Webster & Michael W. Bühler, op. cit., 37-53.
99 Idem.
100 Cf. Thomas H. Webster & Michael W. Bühler, op. cit., para 37-54.
101 Thomas H. Webster & Michael W. Bühler, op. cit., para 37-74; Paolo Michele Patocchi, op. cit., p. 66, suggesting
that ‘[i]f no costs are claimed by the parties (..), an arbitrator may nevertheless ask the parties to clarify their
prayer for relief in this respect, especially if no party has claimed costs; the situation is certainly more difficult
where a party has claimed legal costs and the other has not’.
102 See also the decision DTF 142 III 284 dated 16 March 2016 of the Swiss Federal Supreme Court, stating that
an arbitral tribunal sitting in Switzerland may not decide on the costs of arbitration without first hearing the
parties in this respect (paras. 4.1 and 4.1).
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Costs
time-limit for the filing of simultaneous cost submissions, be this together with their clos-
ing submissions or, for practical reasons, shortly thereafter.
The tribunal is well advised to clarify in advance the degree of substantiation and proof
it requires, in order to avoid subsequent discussions. On the one hand, the arbitral tribunal
will need to be satisfied that the costs claimed for reimbursement have in fact been incurred
by the claiming party (and with respect to external counsel fees that they have either been
paid or are outstanding for payment). On the other hand, detailed supporting documents
such as copies of fee invoices or proof of payment may not always be required. In particular,
invoices for legal fees often contain confidential and privileged information, which makes
them inappropriate for disclosure. For that reason, arbitral tribunals often accept cost state-
ments made in the form of an itemised list of the legal fees invoiced by outside counsel
during the arbitration, unless the invoices or their amounts are challenged by the other
party. Other arbitrators may ask from the outset for more detailed information and request,
for example, a written confirmation by the party that it has paid the legal fees claimed, or
require the parties to indicate the time spent and hourly rates charged by the specific law-
yers deployed in the arbitration.
Tribunals usually request simultaneous cost submissions by both sides in order to pre-
vent that a party is tempted to adapt its cost claim in light of the amounts, hourly rates and
numbers of hours spent on the case as invoked by the opponent. The parties must be given
an opportunity to comment on their opponent’s statement of costs,103 in particular as to the
recoverability and reasonableness of the costs claimed. If neither party objects to the other
side’s costs, the arbitral tribunal will usually see this as an indication that the costs are rea-
sonable. Depending on the issues raised in the parties’ comments, and in case of substantial
disparities between either the parties’ degree of substantiation and proof or the amounts
claimed, it may be appropriate to invite the parties for a second round of cost submissions
and to file (further) supporting documents.104 While tribunals will usually strive to avoid
that the exercise of determining the recoverable costs degenerates into a mini-arbitration
on costs, the party requesting reimbursement of a given cost item ultimately bears the bur-
den of proof of establishing that such cost was effectively and reasonably incurred.
In most of the cases, the arbitral tribunal will decide on the costs of the arbitration in
its final award. Indeed, it is at this stage of the arbitration only that the tribunal knows the
outcome of the case and can fully assess all other circumstances capable of influencing its
decision as to how the costs shall be allocated.105
This notwithstanding, under many arbitration rules and national arbitration statutes,
the arbitral tribunal may make interim decisions on costs106 and allocate costs in partial
awards when finally determining preliminary issues (e.g., jurisdiction, locus standi, liability
or a time-bar defence) or when deciding on procedural applications (e.g., an application for
interim measures or security for costs). Rendering a cost decision during the course of the
proceedings may be appropriate where a given self-contained issue has been finally decided
103 Cf. Thomas H. Webster & Michael W. Bühler, op. cit., para 37-75; DTF 142 III 284, para. 4.1.
105 ‘[F]or arbitral discretion is best exercised when an arbitrator has the full picture before, and the whole
arbitration behind, him’, Paolo Michele Patocchi, op. cit., p. 50.
106 Note, however, that Article 37(3) of the 2012 ICC Rules limits such powers to decisions on party costs.
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Costs
on which the parties spent significant expenses or as a sanction against frivolous unsuccess-
ful procedural applications.107 In any event, a tribunal should only award costs prior to the
final award if it is satisfied that such cost allocation, for the issues for which it is made, shall
be definitive.108 If the cost decision is intended to be immediately enforceable, the arbitral
tribunal should issue a partial award rather than a mere procedural order, as the latter may
not be considered enforceable under the New York Convention.109
Bearing in mind that their mandate ends once they issue their final award, arbitrators
should make sure to include their decision on costs in the final award. All major arbitration
rules expressly require that the final award shall include a determination as to costs. Such
determination should specify the recoverable cost items and their respective amounts. Any
cost claim awarded to a party is to be repeated, and the amount owed indicated, in the dis-
positive section of the award in order to provide a proper basis for enforcement.110
Arbitral tribunals will usually be slow to grant a claim for pre-award interest on the spe-
cific cost items based on the argument that the claim for cost reimbursement only becomes
due upon notification of the cost award.111 On the other hand, one would expect that a
party entitled to the reimbursement of costs based on a final and binding cost award will,
under many national laws, be entitled to claim post-award interest if payment is delayed.
Nonetheless, and not least because of possible controversies as to which national law deter-
mines the issue of interest,112 the award of post-award interest should be expressly requested
in the cost submission, whereas the arbitral tribunal should expressly specify in its cost
award which interest rate applies and from which date.
Finally, arbitrators should be mindful that they are required to give reasons for their
decision on the allocation of costs and that any final award should at least explain the basic
rationale underlying the decision on costs.113

110 Cf. also 2016 CIArb Guidelines on Cost Awards, p. 16.
111 Cf. Bernard Hanotiau, op. cit., p. 214-215, observing that in the few reported cases dealing with a claim for
pre-award interest on costs, ‘this request has always been rejected’.
112 In the case of a cost award made by a tribunal seated in Switzerland, a default rate of 5 per cent p.a. applies
based on Swiss law as from the date of notification of the award, and the accrued default interest can be
enforced in Switzerland together with the award itself.
113 Note, however, that the Swiss Federal Supreme Court held in a (singular) decision that an international arbitral
tribunal is, in principle, not required to provide reasons for its cost decision (BGer. 4P.99/2000 para. 5, ASA
Bull. 2001, pp. 102-112).
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19
The Use of Econometric and Statistical Analysis and Tools
Boaz Moselle and Ronnie Barnes1
While writing this chapter, we asked a number of lawyers we have worked with what they
would like to know about econometrics or regression analysis (the two terms are largely
synonymous for our purposes). One particularly colourful response captured the general
mood: ‘even the words “regression analysis” send a chill down my spine!’
We understand the genesis of these feelings. At its worst, the part of an expert report
that presents econometric analysis is dense and hard to follow, while the debate between
experts can soon become incomprehensible as terms like ‘heteroscedasticity’, ‘omitted vari-
able bias’, ‘mis-specification’ and ‘failure to reject the null hypothesis’ fly back and forth like
guided missiles.
To the extent that our chapter has a message, however, it is that econometric analysis
provides a powerful set of tools for handling data. Used correctly and presented clearly, it
can be central to estimating damages in a robust and reliable manner. At the highest level,
we would suggest that:
• There are some fundamental elements of regression analysis that practitioners of inter-
national arbitration should feel comfortable with (just as many antitrust lawyers do).
This chapter attempts to lay out some, though certainly not all, of those elements.
• It is true that regression analysis can give rise to complex technical debates. Nonetheless:
1 Boaz Moselle is senior vice president and Ronnie Barnes is principal at Cornerstone Research. The views
expressed herein are solely those of the authors, who are responsible for the contents of this chapter, and do
not necessarily represent the views of Cornerstone Research. We thank the staff of GAR; our Cornerstone
colleagues, particularly Tiffany Eu and Lauro Remmler; and Matthew Vinall of Dentons and James Freeman of
Allen and Overy for their input and advice. All mistakes, of course, are ours.
271
• As with other technical subjects, it is the duty of the expert to present the core
issues in a clear, concise fashion, eliminating all unnecessary complexity.2 The use of
graphics, simple examples and plain language can help considerably.
• In any given context, if the technical concerns are material then it should be pos-
sible to explain, in a reasonably intuitive way, each concern and why it matters.
• Where appropriate, arbitrators can facilitate the debate by requiring opposing experts
to use the same data, and to explain how their results would change if they used the
other expert’s assumptions.
In this short chapter, we focus on the first point only.We are aware that many of our readers
will be lawyers – both counsel and arbitrators – reading this because they are faced with
an expert report containing econometric analysis, and they need to understand some more
or less complex points contained in that report. We cannot promise that this chapter will
address the exact points at issue. However, we are confident that understanding the main
points covered by this chapter is a necessary condition for anyone wishing to be a compe-
tent consumer of econometrics.
What is econometrics?
Econometrics is usually described as the application of statistical techniques to economic
data. Economists use econometrics to quantify economic relationships; for example, to
estimate how demand for a product varies with its price, or to estimate trends in a nation’s
imports over a given time period. For our purposes though, perhaps the most useful char-
acterisation, albeit it is a partial one, is that econometrics is one of the principal tools that
economists use to construct and quantify counterfactual scenarios. For example, econo-
metric techniques might be used to estimate the level of imports in scenarios with different
levels of import duties, so as to assess alternative trade policies; or to assess how the presence
of a bidding cartel affects prices in a procurement auction, so as to estimate the impact of
the cartel on consumers and profits.
Put in those terms, it is clear why econometric techniques are so important to the esti-
mation of damages, which routinely involves comparing the actual scenario with a ‘but-for’
scenario so as to estimate a relevant measure of value. This measure might be profits, with
the difference between the actual and ‘but-for’ scenarios representing lost profits, which is
often the metric for damages in relation to alleged breach of contract. In cases of alleged
expropriation, the appropriate metric might be the value of an asset, with the difference
between scenarios representing the loss in value resulting from the expropriation.
This chapter provides a brief introduction to regression analysis, which is by far the
most commonly used econometric tool in the estimation of damages. Our approach is a
practical one: we use a single example to explain how one should understand regression
output as the reader will typically encounter it in an expert report; how the output can
be used to provide a damages estimate; and how to understand some of the basic statistical
concepts that will often be invoked by one expert or the other, touching on the validity of
2 At the risk of appearing self-serving, we would add that we believe that a suitably qualified expert (generally
someone with appropriate formal qualifications) is more likely to have the kind of deep understanding that is
required in order to simplify without misrepresenting.
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the regression analysis itself, the accuracy of the damages estimate, and so-called ‘statistical
significance’. A second example provides further illustrations of a number of these points,
and is also of interest in itself because it utilises the ‘event study’ methodology, which is
particularly useful for estimating damages.
This chapter obviously does not seek to be comprehensive, and there are a number of
important topics that we have not touched on, in part for reasons of space. To mention just
two, these include:
• Issues around compiling and preparing data sets. The quality of data used is of funda-
mental importance. Even the most sophisticated econometric techniques will struggle
in the face of a poorly constructed, error-filled, or misunderstood dataset: the cruel
but often accurate acronym GIGO (Garbage In, Garbage Out) describes the prob-
lem succinctly.
• Techniques used to estimate consumer choice and ‘willingness to pay’. A very large
body of work over some decades has focused on understanding how consumers choose
between discrete alternatives, and this is potentially relevant to damages estimation in
many settings.
Example 1: lost profits

Obviously, the basis on which damages should be calculated in a given matter is, in many
respects, a legal question. However, in many cases, this basis is conceptually straightforward:
namely, damages are intended to provide monetary compensation that puts the claimant in
the same position that it would have been in absent the alleged wrongdoing.
As a specific example, consider the case of a large multinational consumer goods com-
pany (HugeCo) that produces and sells mouthwash, among many other products, in many
countries. In 2006, HugeCo entered a new market, the rapidly emerging economy of
Ruritania.To do so, it entered into a joint venture with a local partner (LocalCo). As part of
the joint venture agreement, LocalCo made extensive commitments to undertake advertis-
ing and other promotional activities (which for various reasons it was uniquely well placed
to do). HugeCo’s entry was successful, and by 2008 its mouthwash was an established
consumer product in Ruritania. However, relations between HugeCo and LocalCo began
to deteriorate in 2013, for reasons unrelated to the mouthwash business. Beginning in
January 2014, LocalCo abruptly stopped all the advertising and other promotional activi-
ties it had previously undertaken in line with the joint venture agreement. This lasted
for 30 months until June 2016, when HugeCo sold its interest in the joint venture, at
which point LocalCo resumed its promotional activities. However, the arrangement left
unresolved the question of compensation for LocalCo’s alleged failure to comply with its
obligations under the joint venture agreement. HugeCo is therefore now seeking damages
in the form of compensation for lost profits between January 2014 and June 2016, on the
grounds that its mouthwash sales (and consequently its profits) over that period were lower
than they would have been if LocalCo had met its obligations.
To quantify damages in this example, it is therefore necessary to estimate what
HugeCo’s mouthwash sales would have been over the time period from January 2014 to
June 2016 had LocalCo undertaken the promotional activities, and to compare these to
the actual sales generated over that period. A simplistic approach to estimating sales in the
‘but-for’ scenario of full promotional activities might be to take the actual monthly sales
273
from 2013 – or maybe an average over, say, 2010 to 2013 – and assume that this level of
sales would have persisted in the future. Suppose, however, that 2014 saw a new company
entering the mouthwash market and aggressively cutting prices relative to their prior levels.
In that case, it seems intuitively obvious that HugeCo’s sales in 2014 would, even in the
presence of full promotional activities, have been lower than in previous years as a result of
the loss of market share to this new entrant. Regression analysis is the economist’s way of
formalising that intuition and of taking into account quantitatively the various factors that
might affect HugeCo’s mouthwash sales when estimating what the ‘but-for’ sales in 2014 to
mid-2016 would have been.
More specifically,to estimate what HugeCo’s mouthwash sales in 2014 to mid-2016 would
have been had LocalCo engaged in full promotional activities, an economic expert would
first need to consider what factors might reasonably be expected to affect these sales.This is
an important step. It is possible to estimate a regression on any set of variables – for exam-
ple, we could use regression analysis to estimate the relationship between daily ice-cream
sales, and the sterling/US dollar exchange rate. However, in the absence of an economic
rationale as to why and how these variables are interrelated, the results of such a regression
must be interpreted with extreme caution. To give another example, a regression between
wholesale electricity prices and the price of crude oil may indicate a strong correlation
between the two.3 However, one cannot necessarily conclude that there is a causal rela-
tionship between the two: in some markets there may be such a relationship (e.g., because
wholesale power prices reflect the cost of running gas-fired power stations, and natural gas
is imported at prices that are indexed to the price of crude oil); in other markets there is
not (rather, there is a correlation between the price of different forms of energy, because
demand for energy responds to common macroeconomic factors such as GDP growth). As
we noted earlier, econometrics can be described as the application of statistical techniques
to economic data, i.e., data that is generated by some economic process.Without an under-
standing of this process, there is a danger that no matter how sophisticated the economic
techniques that are utilised, the exercise becomes one of what is disparagingly referred to as
‘data mining’, where chance correlations are confused with meaningful relations.
Let us return to the example. In reality – and this example is based on a real case, albeit
well disguised – the economist would identify a number of variables, such as price, adver-
tising expenditure and the previous month’s sales (technically referred to as the ‘explana-
tory variables’ or ‘independent variables’), that are economically relevant to determining
HugeCo’s mouthwash sales volume (technically referred to as the ‘dependent variable’). Of
course, the previous month’s sales do not directly cause sales this month, but they are a good
proxy for factors that may cause sales this month: notably, the fact that people have tried the
product, know whether they like it or not, and if they do like it, have gotten into the habit
of buying it. The regression analysis will then measure how material this relationship is: the
estimated coefficient for that variable captures this relationship between the explanatory
and the dependent variable, and the size of the estimate indicates its materiality.
For expositional purposes, we now simplify and assume that it is sufficient to focus
only on the previous month’s sales, and on the presence or absence of promotional activity.
Given that the question at issue is the extent to which, if at all, the alleged failure to engage
3 For more on this see our later discussion of ‘R2’, and in particular footnote 13.
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in promotional activity depressed HugeCo’s mouthwash sales volume, the economist can
estimate a regression (e.g., using actual data of monthly sales volume, and which months
had promotional activity, covering the 90 months from January 2009 to June 2016) where
the dependent variable is sales volume in a given month (measured in units of 1,000 bot-
tles), and the explanatory variables are:
• sales volume in the previous month; and
• a ‘dummy variable’ that is equal to one if it is in a month in which no promotional
activity was taking place, and zero otherwise.
Suppose that the results of this regression (presented in the potentially confusing tabular
form in which such results often appear in expert reports and which we will explain below)
are as follows:4
Table 1: Regression output

Sales Coefficient
7,163
***
Intercept (1,438)
0.58
***
Prior Month Sales (0.084)
-1,956
***
No Promotion Dummy (255)
R2 53%
N 90
Notes: Standard errors in brackets; *p<0.1; **p<0.05; ***p<0.01
Turning the table into something comprehensible

As noted above, this presentation immediately looks confusing. Before any discussion as to
meaning, we first explain in a more or less mechanical fashion how to turn the table into
something more comprehensible.5
Our recommendation here is, as a first step, to ignore large parts of this output: the
bottom two rows; the figures in brackets, which the note tells us are ‘standard errors’; the
little stars below some of the figures in the rightmost column; and the note beginning
‘*p<0.1…’.These figures describe various statistical properties of the data that may or may
4 Unfortunately there is no single standard format for presenting regression results. We explain later some
alternative forms of output that the reader may encounter in practice.
5 Apart from the tabular format we note two other common sources of confusion. The first arises from the
difference between the Anglo-Saxon and continental European uses of commas and periods. In this chapter
we use a period to represent a decimal point, and a comma to count off thousands. So 0.5 is one half, and
7,163 is seven thousand one hundred and sixty three. The second arises from the question of units: the expert
should specify clearly the units being used – in this case, HugeCo ships mouthwash to retail outlets in boxes
containing 1,000 bottles, and sales are therefore measured in units of 1,000, as noted earlier.
275
not, depending on the specific issues in contention, be relevant.6 Ignoring them, for now,
gives a much simpler table:
Table 2: Simplied regression output

Sales Coefficient
Intercept 7,163
Prior Month Sales 0.58
No Promotion Dummy -1,956
The numbers in the right-hand column are the ‘coefficients’ of an equation that relates the
dependent variable (‘Sales’, in the top left-hand corner) to the explanatory variables. The
result can in fact be written in equation form7 as:
Sales = 7,163 + 0.58 × Prior Month Sales – 1,956 × No Promotion Dummy
The coefficient of 0.58 on ‘Prior Month Sales’ represents the estimated sensitivity of this
month’s sales to last month’s sales: each additional 100 units of sales last month gives an
additional 58 units this month. Mechanically speaking, the intercept of 7,163 represents
the expected sales volume assuming both explanatory variables are equal to zero – i.e.,
where there were no sales in the prior month and there is promotional activity by LocalCo
(however, as we explain later, this interpretation should be handled with extreme care).This
leaves the mystery of the ‘No Promotion Dummy’. As explained above, a dummy variable
is one that takes on just two values, zero or one. In this instance, it takes on the value one
when LocalCo does not engage in promotional activity and zero otherwise. We can most
easily explain what that means by suggesting that the equation above be thought of as
two equations. In months when LocalCo engages in promotional activity, the value of the
dummy variable is zero, so for those months the equation is:
Sales = 7,163 + 0.58 × Prior Month Sales
In months when LocalCo does not engage in promotional activity, the value of the dummy
variable is one. This only impacts the intercept and so for those months the equation is:8
Sales = 5,207 + 0.58 × Prior Month Sales
6 The value of ‘N’ in the last row is straightforward however: it is the number of data points used for the
regression (recall we have 90 months of data in this example).
7 We do not subscribe to the Stephen Hawking view that each equation we include will scare off half of our
potential readers. Our preferred philosophy is one that has been attributed to Albert Einstein: ‘make things as
simple as possible, but no simpler.’
8 The figure of 5,207 comes from taking the overall equation (‘Sales = 7,163 + 0.58 × Prior Month Sales –
1,956 × No Promotion Dummy’), setting ‘No Promotion Dummy’ to one, and noting that 7,163 – 1,956 × 1
= 5,207.
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Interpretation of the regression output

At its core, regression analysis is essentially a technique for determining the relationship
between the dependent and explanatory variables that best explains the data on which the
analysis is based, and the equation that results from the analysis is the equation of the ‘line of
best fit’. Figure 1 illustrates what this means in the case of a single explanatory variable.The
intercept here represents the expected value of the dependent variable when the explana-
tory variable is equal to zero (again, subject to the ‘health warning’ below).
Figure 1
Given the introductory nature of this article, we do not expand on exactly what is meant
by the term ‘best,’9 but the basic idea is that given values of the explanatory variables for a
given month, plugging these values into the equation above yields the best estimate of the
sales volume for that month. So, for example, if the sales volume in the prior month were
12,000, the best estimate of the sales volume in the current month (assuming LocalCo is
providing promotional activities) would be 7,163 + 0.58 x 12,000 = 14,123. If the current
month were one in which LocalCo failed to provide promotional activities, this estimate
would be 1,956 lower at 5,207 + 0.58 × 12,000 = 12,167.
From this discussion, it is clear why, as explained above, the coefficient on prior month
sales (0.58) may be interpreted as a measure of the impact of past sales – an increase of
100 in the prior month sales volume would lead to an increase in the best estimate of the
current month sales volume of 58, all else being equal. This should be thought of as a kind
of expected average effect: it is unlikely to hold exactly in any given month, but the statisti-
cian believes that it will be accurate on average (or more precisely, it is the statistician’s best
9 To give a brief hint: the regression is seeking to estimate the relationship between the dependent and the
explanatory variables, represented by the coefficients (i.e., the numbers) in the regression equation. These
coefficients are unknown, and we want to estimate them as well as possible. Statisticians think of the ‘best
estimate’ as the one that is produced using the best methodology for estimating (which makes sense, since
there is no way of judging whether an individual estimate is good or bad, unless one already knows the true
value – in which case there is no need to estimate). So statisticians define various criteria for assessing different
estimation methodologies, such as requiring the methodology to be ‘unbiased’ (i.e., right on average, and not
systematically under- or over-estimating) and ‘minimum variance’ (lowest possible average size of estimation
error). The methodology that produces regression analysis meets many of these criteria.
277
estimate of what the effect will be on average). The qualifier ‘all else being equal’ (equiva-
lently, ‘ceteris paribus’) is important: each coefficient in the regression output measures the
effect of changes in the corresponding variable, holding all the other variables constant.
If we remember that the No Promotion Dummy is equal to one in a month in which
LocalCo failed to engage in promotional activities and zero otherwise, the interpretation
of the coefficient of -1,956 becomes clear: in a month in which LocalCo fails to promote
HugeCo’s mouthwash, HugeCo’s sales volume is, on average, 1,956 units lower than it
would otherwise have been.
We therefore derive an estimate of lost profits as follows:
• Take the regression’s estimated monthly effect of the alleged breach: a reduction in sales
of 1,956.
• Multiply by the duration of the alleged breach, i.e., 30 months, to get 1,956 × 30 =
58,680.
• Estimate the profit margin on each sale. Suppose (for simplicity) it is $1 per bottle
of mouthwash.
• Multiply the volume of lost sales (remembering that each unit of sales in the above
analysis is 1,000 bottles) by the profit margin to get lost profits of 58,680 × 1,000 × 1
= $58,680,000.
The data on which this example is based is artificial, but a few useful observations can still
be made. First, one possible criticism of the analysis might be that it does not accurately
estimate sales for certain periods of time. Opposing counsel might argue: ‘this alleged rela-
tionship is clearly implausible and does not fit the facts: back in 2006 when HugeCo began
to sell mouthwash, its sales in the first month were just 10 units. But according to the other
side’s so-called expert, the first month’s sales should have been 7,163’.10
However, that criticism is misplaced, because the statistician does not (or at least should
not) claim that the relationship they have estimated applies for all level of sales, and the use
of the results of the analysis in the damages exercise certainly does not require that this be
the case. Recall that the regression is estimated using 90 months of sales data. Suppose, for
example, the observed sales volume over those 90 months ranges from 8,832 to 19,289.
Then the regression analysis captures the relationship between the dependent and explana-
tory variables over this range, and a responsible statistician will be cautious in claiming that
the results of the analysis apply outside of this range (and a volume of 10 is almost as far out
of that range as it can possibly be in the downward direction). In general, understanding
both the data on which the analysis is based and any potential limitations in that data is a
crucial part of the interpretation of any regression output.
Second, there is nothing to say that the relationship between the variables in the regres-
sion has to be linear – this is just an assumption, and an assumption that the statistician
should test against the evidence. There are many ways of doing so, including the simplest
of all, which is to visually depict the data on a chart and see if it appears to follow a lin-
ear pattern.
10 Recall the equation is Sales = 7,163 + 0.58 x Prior Month Sales, so if Prior Month Sales are zero (as was the
case, by definition, for the first month of sales) then the equation predicts Sales of 7,163.
278
Figure 2 below shows two examples, the one on the left where an assumption of a linear
relationship appears appropriate, the other on the right where it does not.
Figure 2
In that respect, it is worth noting that a commonly used alternative assumption is a linear
relationship between the logarithms of the variables. For example, the statistician might
estimate a relationship of the form:
Log [Sales] = 2.67 + 0.60 × Log [Prior Month Sales] – 0.24 × No Promotions Dummy
This may appear daunting. However, it may also be necessary, because it better represents
the true relationship between the variables. Moreover, in reality, the use of a logarithm in
a regression equation has a fairly intuitive interpretation: it can be understood to represent
proportional (i.e., percentage) change. So, the figure of 0.60 in the equation above describes
the relationship between a 1 per cent change in Prior Month Sales and the corresponding
percentage change in Sales: it means that, on average, a difference of 1 per cent in prior
month sales volume corresponds to a difference of 0.60 per cent in the current month sales
volume. Similarly, the figure of -0.24 describes the percentage difference in sales between
months where the dummy takes the value zero (promotional activity occurs) and where
it takes the value 1 (no promotional activity): it means that the statistician expects sales to
be lower by (approximately) 24 per cent in the absence of promotions.11 Again, whether a
linear relationship or a relationship involving logarithms is more appropriate depends on
the economics of the situation under consideration – representing the data graphically may
well be a useful first step in addressing this question.
11 The figure of 24 per cent is only approximate because things get a little more complex when one relates the
logarithm of the dependent variable to something that is not a logarithm (as here, relating log (sales) to the
dummy variable). It is still true that we are looking at the proportionate impact of the explanatory variable: in
this case, how the presence of promotion affects sales in proportionate (i.e., percentage) terms. However, the
effect is actually measured by the exponential of the coefficient: so the more accurate statement is that sales
without promotion are predicted to be exp(-0.24) of sales with promotion, which is 78.7 per cent, i.e., lack of
promotion reduces sales by 100 per cent minus 78.7 per cent, which is 21.3 per cent, not 24 per cent. Clearly
it is the job of the expert to guide a tribunal through such complexities.
279
The complicated stuff: R2, standard errors, etc.

A few pages back we showed a table of regression output, and began by suggesting that
the reader could ignore, for the time being, a large part of the table. We imagine this will
have been welcome advice. However, it will often be necessary to understand some of the
additional output in order to use it correctly and to understand commentary from oppos-
ing experts.
‘Coefficient of variation’ (usually written R2, pronounced ‘R-squared’)

In our example, the opposing expert might say ‘the R2 is too low. R2 is a measure of the
strength of a regression, and it should be at least 70 per cent for the regression to be reli-
able. A regression with an R2 of just 53 per cent is not reliable.’ Unfortunately, we have seen
comments along these lines in actual ‘expert’ reports. They suggest a fundamental lack of
understanding of regression analysis: there is no such thing as ‘strength of a regression’, and
there is no ‘threshold value’ for R2. In fact, whether or not the R2 value matters depends
on the context and the aim of the exercise.
The R2 is a percentage, between zero and 100 per cent that indicates the proportion of
variation in the dependent variable that can be explained by the observed variation in the
explanatory variables.12 So, in the example of electricity prices and oil prices discussed ear-
lier, a high R2 would indicate that variations in oil prices ‘explain’ a very high proportion of
the variation in electricity prices. In our HugeCo example, the R2 of 53 per cent indicates
that the explanatory variables used (Prior Month Sales and the No Promotions Dummy)
explain 53 per cent of the observed variation in monthly sales. The rest is a result of other
factors. However, that is per se not directly relevant to the quantum exercise, because the
goal of the quantum exercise is not to identify all of the determinants of sales, or to predict
future sales. It is to estimate the impact on sales of LocalCo’s promotions, all else being
equal. Recall that we estimate that impact through looking at the coefficient on the No
Promotion Dummy, which was -1,956. The relevant question, therefore, is ‘how accurate
is the estimate of -1,956?’ and not ‘how well does this equation capture all the factors that
explain monthly sales?’
In some instances, a low R2 may also suggest that the chosen form of the equation is
incorrect – for example, if the regression uses a linear equation when the underlying rela-
tionship is non-linear, then that may show itself in a low R2, because ‘the wrong equation’
will generally not be able to explain or predict well the variation in the dependent variable.
The standard error and confidence intervals

How then does one answer the question ‘how accurate is the estimate of -1,956?’To answer
that, one turns to the ‘standard error’, as reported in Table 1 (which gave a value of 255).
The standard error is a measure of the accuracy of the estimate. As a rule of thumb, the
likely range of estimation error can be taken for many purposes to be approximately two
standard errors. So the figure of -1,956 can be interpreted as being the middle of a range
whose lower bound is -1,956 – 2 × 255 = -2,466 and whose upper bound is -1,956 + 2
12 It is often expressed as an absolute number, rather than a percentage. So, for example, an R2 of 0.53 is the same
thing as an R2 of 53 per cent, expressed in a different way.
280
× 255 = -1,446. The statistician may say that their best ‘point estimate’ of the impact of
the alleged breach is a reduction in monthly sales of 1,956 units, and they are confident,
statistically speaking, that the reduction falls within a range of between 1,446 and 2,466.
That range will give rise to a corresponding range of damage estimates. It is sometimes
argued that a very wide range should call into question whether the estimate provides suf-
ficient legal certainty to be a basis for awarding damages.That is essentially a legal question.
We would observe, however, that the estimate produced by regression analysis (i.e., the
‘point estimate’, in this case the figure of -1,956) is in various senses (discussed very briefly
in footnote 10 above) the best available estimate of the effect of the alleged breach.
The ‘rule of thumb’ described above may appear rather mysterious. A more accurate and
rigorous elaboration of the rule is the statement that 95 per cent of the time the regression
methodology should produce an estimate that is within approximately two standard errors
of the true value.13 The exact number is not two, but depends on the sample size and the
number of explanatory variables: in our case with 90 data points and two explanatory vari-
ables, the number is 1.9876. The range obtained by taking the coefficient plus or minus (in
this case) 1.9876 times the standard error is referred to as a ‘95 per cent confidence interval’.
There is no magic to the figure of 95 per cent. Different confidence intervals can be
obtained by using different multiples of the standard error: a bigger multiple means a wider
range, which obviously corresponds to a higher degree of confidence, but at the cost of a
lower degree of precision. Commonly used values are 90 per cent, 95 per cent and 99 per
cent (although this is to some extent conventional, there is no magic to those values). For
instance, in the example being discussed, the 90 per cent confidence interval is obtained by
taking plus or minus 1.67 standard errors.14
Statistical significance
We note also that in this example the range of error (the 95 per cent confidence interval)
for our estimate does not contain zero – in other words, the statistician is confident that the
true impact of the alleged breach was not zero.That is the meaning of the commonly heard
phrase ‘statistically significant’. Regression analysis estimates coefficients, whose true values
are unknown. An estimate is ‘statistically significant’ if the regression analysis indicates that
the estimate is sufficiently far from being zero for it to be unlikely that the true value of the
coefficient is zero.The finding implies that the variable in question has a genuine impact on
the dependent variable, and that the relationship is not just random ‘noise’.
In our opinion, statistical significance is often of little relevance to estimating dam-
ages, as this example illustrates. Often, the fact that one variable has an impact on another
is obvious, and not a point of contention between the parties. Moreover, if it is a point of
contention then the disagreement is more likely to arise in the context of assessing merits
rather than quantum. For example, suppose that LocalCo had changed the nature of its
13 Caveat: this is subject to various assumptions about the underlying data. Those assumptions may or may not be
reasonable, depending on the specific circumstances; they are also to some extent testable, and the statistician
should check them before using the standard error in this way (or various others).
14 So the lower bound is -1,956 – 1.67 x 255 = -2,382 and the upper bound is -1,956 + 1.67 x 255 = -1,530.
The multiples used (in this case 1.67) are obtained using something called ‘Student’s t-distribution’, which is
similar to the well-known ‘normal distribution’ (the ‘bell curve’).
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promotional activities rather than stopped undertaking them; and that HugeCo claimed
that the change had led to a drop in sales, and was a breach of a contractual commitment
to make best efforts to promote HugeCo’s mouthwash. LocalCo might then use regression
analysis to show that any change in sales following the change in promotional activity was
not statistically significant, and argue that this indicated that the change had not been due
to a less effective form of promotional activity, and therefore could not be a breach of its
best efforts obligation.
‘Little stars’ and p-values

Recall that the regression output in Table 1 also included some ‘little stars’ beneath the coef-
ficients, and a note that referred to the ‘p-value’. These relate to the question of statistical
significance, and therefore, as suggested above, are often not central to the dispute. However,
we attempt to explain them here, at the risk of entering into a rather detailed discussion.
We said above that the fact that the 95 per cent confidence interval for our estimate of
the impact of promotional activities (the coefficient on the No Promotions Dummy) does
not contain zero means that the estimate is ‘statistically significant’. However, this depends
on the confidence interval used. For example, suppose that the regression analysis showed
a standard error of 800 (instead of 255). Then:
• the 95 per cent confidence interval would be given by -1,956 +/– 1.9875 × 800, and
still does not contain zero; however
• the 99 per cent confidence interval would be given by -1,956 +/– 2.61 × 800, and does
contain zero.
In those circumstances we say that the estimated coefficient is statistically significant at a

5 per cent level of significance, but not at a 1 per cent level of significance.15 The ‘little
stars’ attached to the coefficients in Table 1 (and found in the note ‘*p<0.1; **p<0.05;
***p<0.01’) can now be explained. A single * indicates that the estimate is statistically sig-
nificantly at a level of 10 per cent. In the note, p denotes the level of significance, so ‘p<0.1’
means statistically significant at 10 per cent (which is the same thing as 0.1). Two stars cor-
respond to 5 per cent (0.05) and three stars correspond to 1 per cent (0.01).16
To be more rigorous, the statement p<0.1 means ‘if the true value of the coefficient
being estimated were zero, then the probability that the methodology we have used to
estimate it would, as a result of sampling error, give an estimate as large as (or larger than)
the estimate here, is no more than 0.1.’
In the example given three paragraphs above where we assumed that the standard error
on the estimate of the coefficient for the variable No Promotions Dummy was 800, we
found that the estimate was statistically significant at 5 per cent but not at 1 per cent. In
presenting the result, we would therefore report the estimate with two stars: -1,956**.17
15 Confusingly, the level of significance is 100 minus the level of confidence (so a 95 per cent confidence
interval means a 5 per cent level of significance, and a 99 per cent confidence interval means a 1 per cent level
of significance).
16 As with confidence intervals, the figures of 1 per cent, 5 per cent and 10 per cent are conventionally used, but
there is no magic to that choice.
17 The stars can also often be found written adjacent to, rather than beneath, the number, as shown here.
282
Remaining with that example, rather than say that the level of significance is less than
5 per cent but more than 1 per cent, one can find exactly what value it has. In this case
the answer is that it is statistically significant at 1.6 per cent. That figure is known as the
‘p-value’. Clearly if you know the p-value then the ‘little stars’ are otiose (although it is not
unheard of for authors, nonetheless, to present both).
Other commonly encountered forms of presenting regression output

Unfortunately there is no uniform template for presenting regression output. Some authors
present the standard errors, others do not. Often the author will not present the standard
error, but will instead present something called the ‘t-statistic’. In our opinion this is almost
always inappropriate for a non-technical audience. However, the standard error can be
recovered from the t-statistic: for each estimated coefficient, the standard error is the esti-
mate itself, divided by the t-statistic. So for example, if we had reported that the estimated
coefficient on the No Promotion Dummy was -1,956 and the t-statistic was -7.67 then the
reader could find the standard error to be -1,956 / -7.67 = 255.
As an additional source of confusion, the standard error is often reported with different
names or abbreviations (or simply unlabelled, with the reader expected to guess that it is
the standard error). Common labels include ‘SE Coeff ’ (‘Standard Error of Coefficient’),
‘SE’ (‘Standard Error’), ‘StDev’ or ‘Std Dev’ (‘Standard Deviation’).
Example 2: Event studies

As a second example of how regression analysis may be used to construct a ‘but-for’ sce-
nario in the context of a damages assessment, consider the case of firm ZedCo, a large part
of whose business comprises long-term contracts with foreign governments to provide
pharmaceutical products such as vaccines in bulk. On 11 January 2016, it announced –
completely unexpectedly – that one of its major governmental customers had unilaterally
decided to terminate with immediate effect all of its contracts with the firm, with a total
value of £1 billion. ZedCo has launched a breach of contract case against this government,
and is looking for an assessment of damages in the event that it prevails on the merits.
At first glance, this would appear to be a very straightforward question – what else
could damages be other than £1 billion? However, a little thought shows that the situation
is rather more complex than that. For example, £1 billion is the value of the revenues that
the contracts would have generated – what about the costs that ZedCo would presumably
save as a result of the contracts’ termination? In any case, is the £1 billion a contractually
guaranteed amount, or is it a figure (e.g., an estimate or a maximum) that depends on other
factors? What ability does ZedCo have to mitigate its damages – for example, will the ter-
mination free up resources that will enable the firm to work on other contracts (perhaps
even more lucrative ones)? Will the actions of this one government cause ZedCo’s other
customers to follow suit?
Answering these and other similar questions is clearly a challenging exercise. It is often
feasible to undertake such an exercise in a robust and objective way, but equally there are
instances where it requires a number of somewhat subjective assumptions, to which the
assessment of damages may be quite sensitive. However, if the shares of ZedCo are publicly
traded, the econometric methodology known as an ‘event study’ offers an alternative way
of tackling the damages question. This methodology is based on the simple idea that the
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change in a firm’s share price following the release of a particular piece of news represents
the market’s18 assessment of the implications of that news for the value of the firm.
To illustrate, suppose that on the day of the announcement, the share price of ZedCo
fell by 7 per cent, wiping £1.4 billion off its market capitalisation19 of £20 billion, as shown
in Figure 3.
Figure 3
A comprehensive review of the business press on that day reveals no other news relating to
ZedCo. Does this mean that the £1.4 billion reduction in market capitalisation reflects the
market’s estimate of how much value has been destroyed as a result of the contract termi-
nations, and that this amount is an appropriate measure of damages? Unfortunately, things
are again a little more complex than that. The future profitability of ZedCo is certainly
affected by factors specific to the firm itself – but it is also affected by factors relating to the
economy and/or stock market as a whole, and to factors relating to the industry in which
it operates. So, while there may have been no other news on 11 January 2016 relating to
ZedCo specifically, there may well have been market-wide or industry-wide news that was
relevant to ZedCo.
We can then ask how much of the 7 per cent (£1.4 billion) fall can be attributed to
such news, and how much can be attributed to the news relating to the contract termina-
tions? It is only the latter element that can potentially be considered as damages. To use an
extreme example, if it could be shown that all of the fall was driven by an industry-wide
piece of news – for example, the imposition of an unexpected excess profits tax on the
pharmaceuticals industry – the implication would be that the market perceived the contract
18 Here, the term ‘market’ is used to describe the collective of investors – individual and institutional – who are
(or could be) buying and selling the shares in question.
19 Market capitalisation means the total market value of a firm’s outstanding ordinary shares.
284
terminations to have had no impact on the value of ZedCo. Taken in isolation, this analysis
would then suggest zero as the appropriate measure of damages.
This is where the event study methodology and regression analysis come into play. As
a concrete illustration, suppose that on that day, the FTSE 350 index fell by 1.14 per cent,
while the market capitalisation of a portfolio of firms that operate in the same industry as
ZedCo (‘the Pharma Index’)20 falls by 2.75 per cent, as shown in Figure 4. For the ease of
visual comparison, ZedCo, FTSE 350 and the Pharma Index prices are all shown to start at
100 on the first date of the chart, 1 October 2015.
Figure 4
The idea here is that changes in the FTSE 350 are a proxy for the market’s reaction to
market-wide news, while changes in the Pharma Index are a proxy for the market’s reac-
tion to industry-wide news. Changes in the share price of ZedCo that are attributable
to market-wide or industry-wide news can be explained by changes in the FTSE 350 or
the Pharma Index respectively. What remains is the change in the share price that reflects
firm-specific news, and as explained above, the only firm-specific news on the day in ques-
tion was the cancellation of the contracts.
To break down the 7 per cent fall in the share price of ZedCo into market-wide,
industry-wide and firm-specific elements, we need to determine the relationship between
changes in the share price of ZedCo, changes in the FTSE 350, and changes in the Pharma
Index. This is where econometrics comes in. Using regression analysis, we can estimate
how, on average, the firm’s share price moves with the FTSE 350 (all else being equal),
and with the Pharma Index (again, all else being equal). To do so, we perform a regression
20 Such a portfolio is commonly referred to as an industry index.
285
using data on the firm’s share price, the FTSE 350 and the Pharma Index. Suppose that the
output from our regression is:
Log (ZedCo share price) = 2.4105 + 0.7918 Log (FTSE 350) + 0.4837 Log
(Pharma Index)
Recall that the presence of a log term in a regression equation can be read as ‘percentage
change’. The equation above therefore tells us that, according to our best estimates (and
rounding the coefficients to two decimal places), on average, a 1 per cent change in the
FTSE 350 leads to a 0.79 per cent change in the share price of ZedCo; and on average, a
1 per cent change in the Pharma Index leads to a 0.48 per cent change in the share price
of ZedCo.
This means that on a day like 11 January 2016, when the FTSE 350 fell by 1.14 per cent
and the Pharma Index fell by 2.75 per cent, we would expect the share price of ZedCo
to fall by:
0.79 × 1.14% + 0.48 × 2.75% = 2.22%
In other words, of the 7 per cent fall observed on that day, 2.22 per cent is explained
by changes in the market (the FTSE 350) and the industry (the Pharma Index). In a
‘but-for’ scenario with no firm-specific news, we would have expected a 2.22 per cent
fall. The additional 4.78 per cent fall in the actual scenario can only be attributed to the
firm-specific news regarding the contract terminations.
Given the initial market capitalisation of £20 billion, this implies that the market has
assessed the impact of the terminations on the value of ZedCo to be £0.96 billion (4.78 per
cent of £20 billion).That figure is, therefore, our estimate of the loss in value, and therefore
of the quantum of damages.
Regression analysis has many applications, and depending on the case the inferences to
be drawn from a regression analysis may vary considerably. We hope that this chapter has
provided a useful insight into the application of regression analysis in the context of litiga-
tion. As indicated earlier, we believe that the fundamentals of regression analysis should be
comprehensible to a non-technical user, while it is the role of the expert to guide that user
through the more technical details, to explain and illuminate as necessary, and to eschew
the presentation of misleading analysis or ill-founded criticism.
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Part IV
Industry-Specific Damages Issues
20
Damages in Energy and Natural Resources Arbitrations
Manuel A Abdala1
The importance of energy and natural resources matters in arbitration

According to the 2016 ICSID caseload statistics report, 26 per cent of currently registered
cases are related to disputes in the oil, gas and mining sectors.2 Similarly, a look at the ICC
caseload data reveals that the energy sector made up the largest segment of arbitrations in
2014, comprising 18.6 per cent of the entire ICC caseload in that year.3 It is no coinci-
dence that about one-quarter of total treaty and commercial arbitration cases are related to
energy and natural resources. These sectors share at least two key economic attributes that
make them susceptible to disputes: their output prices are subject to substantial volatility
and their investments soon become sunk (i.e., cannot be easily moved to alternative uses).
These features make energy and natural resources assets particularly vulnerable to oppor-
tunism, where the parties with an economic stake in their generation of profits (private or
public) are likely to seek to change terms to their favour.
When market prices of natural resources change dramatically, parties that are involved
in long-term contracts might have strong incentives to renegotiate – and when renegotia-
tion is not viable or feasible, disputes arise. The increased volatility in commodity prices
that started in 2003, for example, illustrates why so many crude oil, natural gas and gold
1 This chapter was written by Manuel A Abdala, with contributions from economist Rob Mulcahy, who
provided valuable support and insights. Manuel A Abdala is executive vice president at Compass Lexecon in
Washington, DC. The opinions expressed here are exclusively his own.
2 The ICSID Caseload Statistics (Issue 2016-1), available at: https://icsid.worldbank.org/apps/ICSIDWEB/
resources/Documents/ICSID%20Web%20Stats%202016-1%20(English)%20final.pdf.
3 International Chamber of Commerce (ICC), Arbitration of Oil and Gas Disputes, www.iccwbo.org/
Training-and-Events/All-events/Events/2015/Arbitration-of-oil-and-gas-disputes/.
289
mining arrangements agreed upon prior to this point in time are ending up in renegotia-
tion, mediation, arbitration or litigation.4
Price evolution on key natural resource prices (crude oil brent and gold)5
Average annual price

Brent crude oil Gold
Year
(US$ per barrel) (US$ per troy ounce)
1990 23.76 383.73
1991 20.04 362.34
1992 19.32 343.87
1993 17.01 360.17
1994 15.86 384.16
1995 17.02 384.07
1996 20.64 387.73
1997 19.11 330.98
1998 12.76 294.12
1999 17.90 278.85
2000 28.66 279.29
2001 24.46 271.19
2002 24.99 310.08
2003 28.85 363.83
2004 38.26 409.53
2005 54.57 444.99
2006 65.16 604.34
2007 72.44 696.65
2008 96.94 872.40
2009 61.74 973.56
2010 79.61 1,226.32
2011 111.26 1,573.23
2012 111.57 1,668.95
2013 108.56 1,408.96
2014 98.97 1,265.79
2015 52.32 1,159.36
2016 40.69 1,244.62
4 See, e.g., Murphy Exploration & Production Company International v. Republic of Ecuador, Partial
Final Award, UNCITRAL, PCA Case No. AA434 (6 May 2016), available at: www.italaw.com/
cases/1198#sthash.7KDeLgdo.dpuf (regarding imposition of windfall levy on oil profits);Yukos Universal
Limited (Isle of Man) v.The Russian Federation, Judgment of Hague District Court, UNCITRAL, PCA Case
No. AA 227 (Apr. 20, 2016), available at: www.italaw.com/cases/1175#sthash.HuBDPx1p.dpuf (regarding
nationalization of oil and gas assets); Crystallex International Corporation v. Bolivarian Republic of Venezuela, Award,
ICSID Case No. ARB(AF)/11/2 (4 April 2016), available at: www.italaw.com/cases/1530#sthash.Vl53ATnE.
dpuf (regarding unlawful expropriation of untapped gold deposits); Gold Reserve Inc. v. Bolivarian Republic of
Venezuela, Award, ICSID Case No. ARB(AF)/09/1 (22 September 2014), available at: www.italaw.com/
cases/2727#sthash.fkDkRO8b.dpuf (regarding unlawful expropriation of untapped gold deposits).
5 US Energy Information Administration, Europe Brent Spot Price FOB, available at: www.eia.gov/dnav/
pet/hist/LeafHandler.ashx?n=PET&s=rbrte&f=D (last visited 23 August 2016); Quandl, Gold Price:
London Fixing, available at www.quandl.com/data/LBMA/GOLD-Gold-Price-London-Fixing (last visited
23 August 2016).
290
The likelihood for price renegotiation and changes in the regulatory regime is high in
energy and natural resource projects given the high capital investment necessary to develop
reserves and unleash production. Once the exploration risks have been overcome and the
associated investment costs have been sunk, governments may be tempted to act opportun-
istically, knowing that investors cannot move their sunk assets to alternative uses.6 Under
these circumstances, sovereigns may attempt to increase their ‘government take’ on natural
resources, either through increasing taxation, royalties, fees, rights and duties by altering the
pre-existing profit-sharing or revenue-sharing agreements with the private sector, or by
demanding that private companies relinquish shareholdings in their companies to the state
or to a state-owned oil company.7 Similarly, private parties may renege to their obligations
if deemed to have become too onerous. Disputes among shareholders will equally become
more likely given that the volatility of prices may alter the initial allocation of risks between
partners in ways that were unforeseen or unexpected.
Key valuation issues affecting damages methodologies in extractive

resources matters
Estimating damages compensation in international arbitration disputes in extractive
resources industries poses several challenges from the perspective of a damages valuation
expert. A valuation expert must ask the following basic questions:
• What is the size and quality of reserves that are economically extractable?
• At what price can these reserves be sold and what is the exposure to price volatility?
• What is the nature of the contractual rights to exploit the resource (i.e., how long is the
term of the contract, and what type of exposure to regulatory and country risk exists)?
• What is the underlying legal theory of the case and how does such theory determine
the date of valuation?
The size and nature of economically extractable reserves

Assets in energy and natural resources markets derive a significant portion of their value
from their potential to extract estimated resources at some future date. As a result, the
6 See Roderick Duncan, Price or Politics? An Investigation of the Causes of Expropriation, Australian Journal
of Agricultural and Resource Economics,Volume 50, Issue 1, p.85-101 (March 2006) (explaining expropriation
as opportunistic behavior by host governments when profits of investments are high); Brian Levy & Pablo
T. Spiller, Regulations, Institutions, and Commitment: Comparative Studies of Telecommunications 202, 203
(ed. 1996) (linking sunk costs and opportunism in the telecommunications industry, making that industry,
like the energy industry, vulnerable to expropriation). In sectors like mining, oil and gas wells, and pipeline
networks, assets are said to be ‘sunk’ since they are not moveable or easily transferable to other locations or
alternative uses.
7 See Ibid. 5; Venezuela Holdings B.V. and others v. Bolivarian Republic of Venezuela, Award, ICSID Case No.
ARB/07/27 (9 October 2014), available at www.italaw.com/cases/713 (regarding oil and gas assets
expropriated in 2007); Shell Philippines Exploration B.V. v. Republic of the Philippines, ICSID Case No.
ARB/16/22 (filed 20 July 2016), available at www.iareporter.com/articles/shell-files-investment-treat
y-claim-against-the-philippines/ (regarding the imposition of additional taxes by the State); ConocoPhillips
Petrozuata BV, ConocoPhillips Hamaca BV and ConocoPhillips Gulf of Paria BV v. Bolivarian Republic of Venezuela,
ICSID Case No. ARB/07/30 (pending), available at: www.italaw.com/cases/321#sthash.1QaYeZNl.dpuf
(regarding the expropriation of heavy crude oil and upgrading assets).
291
amount of economically extractable reserves plays a significant role in value determination

for any energy or natural resources asset.
Reserves estimates are largely a function of the current and future expected price
of that resource in the market. As market prices rise, a greater portion of the resource in
the ground becomes economically viable for extraction. The opposite is also true. In fact,
the decline in crude oil prices that began in the second half of 2015 and continued into
2016 caused many large oil companies, such as BP, Shell, Total and Exxon Mobil to cut
back billions in investment, affecting the size of their future reserves.8 Similarly, in the
Canadian oil sands, where producers have some of the highest break-even costs globally,
the price of crude oil plays a significant role in the decision to extract. In August 2015, for
example, it was estimated that as a result of low crude oil prices, more than three-quarters
of Canada’s 2.2 million barrels per day of oil sands production was no longer economi-
cally recoverable.9
Economically extractable reserves can be categorised into proven developed (PD)
reserves and proved undeveloped (PUD) reserves, a distinction that can provide useful
insight when calculating damages in energy and natural resources disputes. PD reserves
are those that can be produced with existing wells, or from additional reservoirs where
minimal additional investment is required. PUD reserves, on the other hand, require addi-
tional capital investment, such as the drilling of new wells, to extract the resource from
the ground.
In oil and gas industries, proven reserves are referred to as 1P, denoting a ‘reasonable cer-
tainty’, or high degree of confidence, of being recovered.10 Valuation experts, however, may
also consider the inclusion of unproven reserves weighted (or ‘risked’) by their probability
of extraction, since unproven reserves have a lower level of technical certainty of recovery.
Unproven reserves are classified as probable (together with proven reserves, referred to as
2P) and possible (together with proven and probable reserves, referred to as 3P). 11
In mining industries, reserves are simply the part of an identified resource that could
be economically extracted or produced at the time of determination.12 Additionally, in
8 Matthew West, Just How Low Can Oil Prices Go and Who is Hardest Hit?, BBC News, 18 January 2016,
www.bbc.com/news/business-35245133. Even US shale oil producers, who some thought could tolerate
lower prices, were not expected to continue production below certain price thresholds, which means that
their level of reserves had actually dropped due to low output prices.
9 Nia Williams, At $22, Three Quarters of Oilsands Production is Underwater and Losing Up to $3 on
Every Barrel, Financial Post, December 17, 2015, http://business.financialpost.com/news/energy/at-2
2-three-quarters-of-oilsands-producers-are-underwater-and-losing-3-on-every-barrel?__lsa=1c8a-d893.
10 Proven reserves are reserves that have 90 per cent certainty of commercial extraction. See SPEE Petroleum
Resources Management System Guide for Non-Technical Users, Society of Petroleum Engineers
International, 2007, p.10-11, available at: www.spe.org/industry/docs/Petroleum_Resources_Management_
System_2007.pdf.
11 Probable reserves have a 50 per cent certainty of commercial extraction. Possible reserves, in turn, have a
10 per cent certainty of commercial extraction. See Ibid. p.11.
12 In the mining industry, reserves can be further classified into ‘marginal’ reserves, ‘sub economic resources’, and
‘undiscovered resources’. Each of these definitions has a decreasing level of certainty of economic extraction.
See definitions for mineral resources and reserves at U.S. Department of the Interior, US Geological Survey,
Mineral Commodity Summaries 2001 (Washington, DC: GPO, 2001), Appendix C, available at: http://wps.
prenhall.com/wps/media/objects/2513/2574258/pdfs/E10.4.pdf.
292
mining, particular attention is paid to the cut-off grade, which is used as the level of mineral
in an ore, below which it may not be economically feasible to mine – an important distinc-
tion when measuring reserves for use in the valuation of assets.13
Valuation experts would typically rely on technical assessments from reserve experts
or outfits that certify the size of extractable reserves at any given point in time. Given that
output prices are volatile, it is important that the reserve certification be contemporaneous
to the date of valuation, as otherwise the size of economically extractable reserves might be
overestimated or underestimated.
Impact of price forecasts and volatility on value

Forecasting output prices involves making decisions about future values that might be too
volatile and difficult to predict. Valuation experts can seek to mitigate these features by
using price forecasts based on either market-based data or by resorting to specialised outfits
that model supply and demand so as to obtain expected model equilibrium prices.
Market-based data on price forecasts can be derived by looking at futures contracts14
and spot prices. Futures contracts are useful in that they provide forecasters with market
evidence of contractual agreements between the buyers and sellers of a particular com-
modity, and therefore might serve as a benchmark for future price levels. Spot prices, on
the other hand, provide forecasters with a current view of the market, but could have
the shortcoming of not anticipating changes in supply and demand conditions that are
expected in the marketplace. Given the wide array of price forecasts that are present in the
market for most commodities, valuation experts can derive an opinion of expected output
prices based on both existing market information and the myriad forecasts established by
specialised outfits.
By using all information available, possibly discarding projections that are considered
extreme or outliers to the sample, and adopting a path that is consistent with the majority
of forecasts and information from futures contracts, valuation experts can make informed
and comprehensive decisions about price expectations in the future.
Contractual terms and adjustment for proper regulatory and country risk
exposure
While typically challenging to quantify, contractual, regulatory and country-specific risks
play an equally important role in calculating damages in energy and natural resources dis-
putes. Contractual terms and regulatory conditions can significantly impact the risk inher-
ent in the valuation of any asset, and therefore adjustments are required to account for the
risk exposure of the specific asset being valued.
13 On technical grounds, the term ‘cut-off grade’ refers to a unit of measure that represents a fixed reference
point for the differentiation of two or more types of minerals. See Estimation of Mineral Resources and
Mineral Reserves Best Practice Guidelines, CIM Council, 23 November 2003. See also Nyrstar 2015 Mineral
Resource and Mineral Reserve Statement, Nyrstar, 27 April, 2016.
14 A futures contract is an agreement to buy or sell a particular commodity at a predetermined price at a
specified time in the future. Futures prices typically take into account the current spot price, interest rates,
time to maturity, storage costs, convenience yield, and any other relevant variables, which make them potential
candidates for use in price forecasts.
293
Contract length, for one, can have a direct impact on the estimate of reserves at a
particular site. Shorter production contract terms imply a lower economically extractable
reserves estimate, given the time constraint inherent in the contract itself. For that same rea-
son, contract renewal provisions play an important role in the valuation of natural resources
assets, particularly in the calculation of their terminal value.
Similarly, the location of an asset matters, as the associated risks of operating the asset
from a particular jurisdiction depend on whether the asset is located in a country with a
predictable economy and strong institutions, such as the United States and Germany. The
term ‘exposure to country risk’, therefore, is used to capture incremental risks such as:
• The additional volatility of domestic demand, which may be more prone to recessions
and booms as compared to a more developed economy.
• The infrastructure of a developing economy, which may expose the asset to supply risks
as services, logistics and suppliers may be unreliable.
• Governmental actions and macroeconomic policy affecting businesses, which may be
unstable, thereby affecting volatility and thus increasing the overall risks of doing business.
• Exposure to changes in taxation, royalties and other forms of ‘government take’.
A distinction must be made between general country risk and the specific exposure that
any particular asset might have to this risk. General country risk measures the incremental
risk that an average investor faces from investing in a particular country. The specific expo-
sure of country risk, by contrast, is the incremental risk that an investor in the target asset
faces taking into account the particular protections and safeguards that such asset might
have, which may differ from that of an average investor with assets in any other industry.15
Because energy and natural resources assets involve sunk investments and are particu-
larly prone to government opportunism, they typically exhibit characteristics that shield
them, at least in part, from the full extent of the general country risk associated with the
assets’ location. Most notably, significant portions of revenue from these assets are isolated
from country-specific demand risk, given that their products (i.e., commodities) are traded
worldwide.16 In addition, from a regulatory perspective, many contracts include explicit
protections against egregious tax measures and the size of the ‘government take’, or simply
provide tax stabilisation clauses.
As a result, it is important that valuation experts take into account the specific exposure
of the project to country risk, and not simply apply a standardised measure of country risk
to the asset, without any adjustment. In fact, in the Gold Reserve v. Venezuela award, the
Tribunal rejected the discount rate proposed by one of the parties’ experts, noting that it
‘was based on both full and “generic” country risk for an investment in Venezuela’, and
therefore did not adjust for the risk that was specific to the assets in question.17
15 See, for example, Aswath Damodaran, Measuring Company Exposure to Country Risk: Theory and Practice,
Stern School of Business, 2003.
16 Of course, not all projects have access to exports and not all countries are free from trade barriers which may
distort the domestic price of the commodity from that prevailing in the international market (net of transport
and other fees).
17 See the Gold Reserve Award, paragraphs 840 and 841.
294
The fit to the legal theory and the choice of date of valuation
In addition to the intrinsic value of the asset in question, the valuation expert must take
into account the underlying legal theory, which in turn can influence the choice of date
of valuation. In international arbitration, the standard concerning remedies for damages
arising from an illegal act is the judgment of the Permanent Court of International Justice
in the Chorzów case.18 Under this judgment, restitution in kind is the primary remedy;
payment of compensation is to take its place if restitution is not possible.19 There is some
consensus that the Chorzów judgment requires tribunals to award the highest of (1) the
value on the date of expropriation (plus interest) or (2) the current value as of the date of
the award (plus historical lost profits). Subsequent tribunals have applied this ‘highest of ’
standard in cases where the legal theory fits with a principle of restitution (typically related
to a finding of an expropriation being unlawful).20
The selection of valuation dates and to what extent the damage expert should use the
benefits of hindsight information in performing a valuation is of considerable importance,
given the volatility of commodity prices.21 Whereas in cases of lawful expropriation it
might be important to value the asset using expectations as of the time of the taking (also
known as an ex ante valuation exercise), it is equally important to use hindsight information
in cases in which the date of valuation is set as the date of award (also known as an ex post
valuation exercise).22
In ex ante valuations particularly, the selection of a pre-judgment interest rate plays a
central role in the amount of compensation awarded as of a current date. The wrong inter-
est rate could result in a monetary award that does not fully restore the position of the
damaged party in the absence of the measures.23 While the use of either ex post or ex ante
18 Factory at Chorzów, Indemnity, Merits, 13 September 1928, P.C.I.J., Series ANo. 17, P.47.
19 Christopher Schreuer, Alternative Remedies in Investment Arbitration, The Journal of Damages in International
Arbitration,Volume 3 Number 1, 2016.
20 See S. Ripinsky and K. Williams, Damages in International Investment Law, BIICL (2008) at 256 and
M. Abdala, P. Spiller and S. Zuccon, Chorzów’s Compensation Standard as Applied in ADC v. Hungary,
Transnational Dispute Management Volume 4, Issue No. 3, June 2007. See, for instance, Marion Unglaube v.
Republic of Costa Rica, Award, ICSID Case No. ARB/08/1 (16 May 2012), available at: www.italaw.com/
cases/1134#sthash.U50Z5yox.dpuf (on the application of the criteria of the ‘highest’ of valuation dates).
21 I have previously discussed this topic extensively, and thus will not provide an in-depth explanation in this
chapter. See Manuel A. Abdala, Key Damage Compensation Issues in Oil and Gas Arbitration Cases, American
University International Law Review,Volume 24, Issue 3 (2009).
22 Using hindsight information combined with a date of award valuation captures any elevated value due to
improved business conditions which claimants were deprived of due to the measures by the party inflicting
damages. In addition, it provides incentives for parties not to act opportunistically when business conditions
are expected to improve, thus acting as a deterrent. Finally, its use provides accurate and adequate damage
estimates, given that with the benefit of hindsight the damage expert can compute actual damages as time
passes. The latter is critical information that panels usually welcome and are not likely to ignore.
23 For further discussion on the importance of determining a reasonable pre-judgement interest rate, see
Clemmie Spalton, An Unexpected Interest in Interest, Global Arbitration Review, 12 May 2015, available
at: http://globalarbitrationreview.com/news/article/33795/an-unexpected-interest-interest/; see also,
Dan Harris, Richard Caldwell, & M. Alexis Maniatis, A Subject of Interest: Pre-Award Interest Rates in
International Arbitration, The Brattle Group, 12 May 2015, available at www.brattle.com/system/publications/
pdfs/000/005/173/original/A_Subject_of_Interest_-_Pre-award_Interest_Rates_in_International_
Arbitration.pdf?1433164385.
295
information is valid in determining damages in energy and natural resource arbitrations,

each is likely to yield a different damages result, mostly due to price volatility over the
relevant period.
Unfortunately, there is no established academic consensus as to the selection of the
pre-judgment interest rate and this is true not only for international arbitration but also
for US litigation cases. This lack of consensus is predictably reflected in tribunals’ decisions,
which have granted pre-judgment interest rates using a variety of different criteria, or even
granted no interest at all. Notable criteria for a pre-judgment interest rate include interest
based on the borrowing rate of the respondent, as proposed by Professors Patell, Weil and
Wolfson,24 use of a risk-free interest rate, as proposed by Professor Fisher,25 or interest based
on the opportunity cost of the lost investment, as advocated by John and Robin Keir.26
Methodologies to assess damages in energy and natural resources cases

There are several approaches to value assets in energy and natural resources disputes. In this
chapter, I briefly review the most common valuation methodologies used by practitioners.
Income approach
Income-based approaches, such as the Discounted Cash Flow (DCF) method, are quite
suitable to value energy and natural resources assets because they provide a direct way to
measure expected revenues (and their corresponding cash flows) into the future. In fact,
the DCF method is the most common methodology used in valuation analyses involving
assets in the energy and natural resources industries (as well as most other industries).27
First, it is widely supported by professional literature, and its workings are well understood.
Indeed, most investors rely on a DCF analysis to determine whether or not to undertake
a particular project.28 Second, the DCF approach is a widely accepted method to estimate
24 James M. Patell, Roman L. Weil & Mark A. Wolfson, Accumulating Damages in Litigation: The Roles of
Uncertainty and Interest Rates, 11 J. Legal Stud. 341, 362 (1982) (instructing that the rate should reflect both
the extent to which the plaintiff was forced to alter his consumption and investment plan and the possibility
that the plaintiff bore risks which differed from those inherent in his undamaged position).
25 See Franklin M. Fisher & R. Craig Romaine, Janis Joplin’s Yearbook and the Theory of Damages, 5 J. Acct.
Auditing & Fin. 145, 146-48 (1990) (noting that compensating the plaintiff at the rate it reasonably expected to
earn on the destroyed asset is flawed because the plaintiff would be entitled to interest compensating it for ‘the
time value of money . . . [but not] also entitled to compensation for the risks it did not bear.’).
26 See John C. Keir & Robin C. Keir, Opportunity Cost: A Measure of Prejudgment Interest, 39 Bus. Law. 129,
147 (1983) (noting that the Company’s lost return reflects the opportunity cost of the deprived cash flows or
monies to the damaged party).
27 William C. Lieblich, Determinations by International Tribunals of the Economic Value of Expropriated
Enterprises, 7 J. Int’l Arb. 37, 38 (1990) (explaining that the DCF method is the most common valuation
method because it is the only method that can measure the amount of cash estimated to be earned by an
entity on a day-to-day basis).
28 See Carlos Trejo, Real Options: Understanding the Basic Concepts 1 (September 2000) (unpublished
assistantship project, Mississippi State University), available at: www.rstc.msstate.edu/publications/99-01/
rstcofr01-042a.pdf (contrasting DCF with other methodologies, illustrating its predominance in the
valuation field).
296
damages and fair market valuations in international disputes; in many energy and mining
cases panels have adopted the DCF method without hesitation.29
In practice, the DCF method calculates future cash flows for the particular asset to be
valued, and discounts them back to the agreed-upon valuation date. The method therefore
requires several key inputs such as: revenues, extraction, investment, retirement and cleaning
costs, discount rate, and terminal value, in addition to any other project-specific assumptions.
While the DCF method is widely used, some tribunals have been reluctant to adopt it
unless the business in question was a going-concern at the date of valuation.30 Imposing
this limitation on natural resources assets, however, is counterintuitive from an economic
perspective, since once the exploration stage is surpassed and the reserves are certified, there
should be little doubt that reserves can be monetised into future cash flows. Operational
risks would still exist, but such risks can be modelled through a discounted cash flow analy-
sis, even if the asset is not yet operational.
Relative multiples approaches

A relative multiple is simply an expression of the market value of an asset relative to a key
statistic that is assumed to relate to that value. Expressing market value in terms of a specific
key statistic such as EBITDA, revenues, asset value, or size of reserves standardises the value
of the asset and thus allows for comparison across assets of varying absolute value. Generally,
multiples can be derived from information about comparable assets or companies that
trade in public markets (trading multiples) or from information about recent transactions
of comparable assets or companies (transaction multiples).
In the energy and natural resources industries, specifically, multiples are typically based
on cash measures, such as EBITDA or net profits, or on a market-specific metric, such as
amount of 1P reserves in the oil and gas industry or to proven and probable equivalent
reserves in mining.31 There are, however, a number of criticisms against the use of multiples
29 See Jarrod Hepburn, Quiborax v. Bolivia: Tribunal Majority Uses ‘Ex Post’ Data to Assess Discounted
Cash-Flow Damages for Unlawful Expropriation – and Applies Country-Risk Premium Discount, IA
Reporter, 22 September 2015; Clovis Trevino, In-Depth: Unpacking the Damages Calculations That Led
to $450,000 Arbitral Payday for Owens-Illinois, IA Reporter, 19 March 2015; Luke Eric Peterson, Another
Expropriation Ruling Against Venezuela, as ICSID Arbitrators Award Tidewater $60 Million (Inclusive
of Pre-Award Interest), IA Reporter, 15 March 2015. Examples of cases in which the DCF approach was
adopted by panels in international disputes include: Gold Reserve Inc. v. Bolivarian Republic of Venezuela, Award,
ICSID Case No. ARB(AF)/09/1 (22 September 2014), available at: www.italaw.com/cases/2727#sthash.
fkDkRO8b.dpuf; Occidental Petroleum Corporation and Occidental Exploration and Production Company v.The
Republic of Ecuador, Award, ICSID Case No. ARB/06/11 (5 October 2012), available at: www.italaw.com/
cases/documents/768#sthash.ZwfDxsoi.dpuf.
30 See Rusoro Mining Ltd. v. Bolivarian Republic of Venezuela, Award, paragraph 785, ICSID Case No.
ARB(AF)/12/5 (22 August 2016), available at: www.italaw.com/cases/2048#sthash.X1DyyKnG.dpuf (in
which the Tribunal recognised ‘very special characteristics surrounding Rusoro which make the use of
DCF approach inappropriate’, including, among other factors, the fact that ‘Rusoro lacks a proven record of
financial performance’).
31 In addition, and unique to the mining industry in particular is the net asset value (NAV) multiple, which
compares the price of a mineral property to the net present value of the mining company’s assets (gold,
silver, etc.), which are, in turn, evaluated on the basis of its reserves and resources valued at a uniform real
discount rate.
297
as a tool for valuing damages in energy and natural resources disputes. For one, multiples
are relatively simplistic and static – that is, they distill a great deal information into a single
number that represents a snapshot of the value of an asset at a particular point in time, and
thus do not capture the dynamic and ever-changing nature of energy and natural resources
markets. Similarly, multiples are based on historic data or near-term forecasts, which there-
fore may fail to capture differences in projected growth, expected life term of the reservoir,
and performance over the longer term. Additionally, damages valuations based on relative
multiples approaches must be adjusted to account for, among other considerations, large or
small sample size issues, and control premiums.32
Stock market capitalisation

Generically, the market capitalisation approach refers to techniques that use either the stock
market price of the underlying asset (or that of its parent company) or stock market indices
of benchmark companies, as a tool to evaluate and assess damages.33
Computing damages in investment arbitration under the market capitalisation approach
is recommended when the equity shares of the target asset under analysis are publicly
traded. In addition, when the shares of the parent company of the target asset are traded
and the target asset represents a significant part of its portfolio, it is also feasible to identify
changes in value of the parent company attributable to changes in the value of the underly-
ing target asset.
Under this approach, one can distinguish at least two techniques that can be used to
construct a counterfactual scenario that excludes the effects of the actions by the wrong-
doer. These are event studies and market trends of benchmark companies.34
32 In valuing assets based on comparables, the size of the sample with which the target asset or assets is being
compared can have an impact on value. A larger sample size is more representative of the population, which
limits the influence of outliers or extreme observations, and broadens the range of possible data which
forms a better picture for analysis; however, it is often hard to find an observable comparable set that fits the
counterfactual scenario (i.e. that reflects the reality of the target asset in the absence of the damaging actions).
Small-size samples, in turn, may introduce bias if the comparable assets are not too close to the target asset. In
addition, a control premium may need to be added when valuing assets based on relative multiples derived
from stock market data, as stock market capitalisation would typically reflect the value to (unprotected)
minority shareholders. Relevant examples of recent arbitrations in which relative multiples valuation
methodologies were adopted include: Crystallex International Corporation v. Bolivarian Republic of Venezuela,
Award, ICSID Case No. ARB(AF)/11/2 (Apr. 4, 2016), available at: www.italaw.com/cases/1530#sthash.
iACLVKfv.dpuf (in which the tribunal accepted both a market multiples approach and a stock market
valuation approach to assessing damages); Antoine Abou Lahoud and Leila Bounafeh-Abou Lahoud v. Democratic
Republic of the Congo, Award, ICSID Case No. ARB/10/4 (7 February 2014), available at: www.italaw.com/
cases/2391#sthash.YaHsIZp6.dpuf (in which the Tribunal considered the market comparables approach as one
of two damages methodologies that factored into the computation of damages).
33 See Rosa M. Abrantes-Metz, Santiago Dellepiane, Using an Event Study Methodology to Compute Damages
in International Arbitration Cases (2011) 28 Journal of International Arbitration, Issue 4, pp. 327–342.
34 Although there are very few precedents on the use of the market capitalisation approach based on trends
of benchmark companies in investment arbitration, the technique has been widely applied in securities
litigation. Cornell and Morgan (1990), for example, analyse the application, similarities and differences of the
two techniques under the market capitalisation approach, as applied to securities litigation: the market trends
of benchmark companies (referred to as the ‘comparable index approach’) and the event study. See Cornell,
Bradford and Morgan, R. Gregory. 1990. ‘Using Finance Theory to Measure Damages in Fraud on the Market
298
An event study is a statistical tool that analyses the response of a stock price to certain
market announcements (i.e., events related to expropriation threats, or unfair treatment of
investments), controlling for other factors producing stock price movements, such as gen-
eral market and industry trends, or other company-specific announcements.35 The assump-
tion behind an event study is that the effect of an event is reflected immediately in the price
of the company shares, making it possible to statistically isolate and quantify the impact of
the wrongful actions.36
The market capitalisation approach that looks at the trends of stock prices from bench-
mark companies consists of building a but-for scenario in which the stock price of the
target company that existed (or would have existed) in the absence of the wrongful actions
is adjusted until the date of valuation following the evolution of an index (or a basket of
indices) of publicly traded benchmark companies. Using an index of benchmark com-
panies to mimic the but-for scenario of the target asset allows the valuation expert to
incorporate two of the major factors affecting stock prices: (1) the movements reflecting
economy-wide information and (2) movements reflecting industry-related information.
This method is particularly well-suited for investment disputes involving full expropria-
tion of traded assets, provided that the expert can properly establish the latest clean date
prior to any threats or actions of expropriation and a set of benchmark companies that are
also traded and whose evolution and trends prior to the measures are comparable to the
target company.37
Cases’, UCLA Law Review 37, No. 5: 883-924. In investment arbitration, the market capitalisation technique
has been used in a few instances in both mining and crude oil cases. In the Quasar matter, the claimant
successfully argued that its shareholding in Yukos had been adversely affected by the actions of the State, as
evidenced by the significant decline in the stock price of Yukos, which commenced in April 2004 just before
the State’s first expropriation actions. Damages were derived by constructing a but-for scenario based on an
index of four Russian Yukos competitors whose stock was traded, and whose past evolution was comparable
to that of the actual stock price of Yukos prior to the measures. See Renta 4 S.V.S.A, Ahorro Corporación
Emergentes F.I., Ahorro Corporación Eurofondo F.I., Rovime Inversiones SICAV S.A., Quasar de Valors SICAV S.A.,
Orgor de Valores SICAV S.A., GBI 9000 SICAV S.A. v.The Russian Federation, SCC No. 24/2007, available at:
www.italaw.com/cases/915#sthash.VkFo5hKM.6KIxzC8y.dpuf. In the mining sector, the Tribunal on the
Crystallex v.Venezuela matter likewise accepted the use of a market capitalisation approach to valuation, noting
that it accurately reflected the market’s actual assessment of the present value of Crystallex’s future profits and
was suitable given that Crystallex was effectively a one-asset company holding the target asset of Las Cristinas’
gold mine in Venezuela. See Crystallex International Corporation v. Bolivarian Republic of Venezuela, ICSID Case
No. ARB(AF)/11/2, available at: www.italaw.com/cases/1530#sthash.iACLVKfv.dpuf.
35 The roots of event studies can be traced to the 1969 seminal work of Fama, Fisher, Jensen and Roll. See Fama,
Eugene, Fisher, Lawrence, Jensen, Michael C., and Roll, Richard. 1969. ‘The Adjustment of Stock Prices to
New Information’, International Economic Review 10: 1–21. See also MacKinlay, Craig. 1997. ‘Event Studies in
Economics and Finance’, Journal of Economic Literature 35: 13-30, and Binder, John J. 1998. ‘The Event Study
Methodology Since 1969’, Review of Quantitative Finance and Accounting 11: 111-137.
36 See Patell, James M. and Wolfson, Mark A. 1984. ‘The Intraday Speed of Adjustment of Stock Prices to
Earnings and Dividend Announcements’, Journal of Financial Economics 13: 223–52.
37 In cases other than full expropriation, the affected asset might still be traded after the wrongful conduct of
the state. In such cases, distinguishing the relevant time period of the wrongful actions and the movements in
stock price related to firm-specific information directly attributable to the state’s conduct makes the exercise
more complex, possibly requiring the use of the event study technique. In addition, other adjustments might
be needed such as accounting for differences between a marketable minority stake (as reflected by traded stock
299
Other approaches
Various other valuation methodologies exist. Asset-based approaches, utilising either
replacement values or book values of assets, and liquidation value can be advocated but are
not likely to be very useful in determining damages in energy and natural resources cases
because they would typically depart from market values. Such methods provide an histori-
cal account of past investments and thus will not represent the value that shareholders can
extract from future cash flows, thus failing to account for the true value (and risks) related
to the activity.
Liquidation value, in particular, assumes the assets are no longer a going concern and
thus assigns value based on prices at which physical assets, such as real estate, fixtures, equip-
ment and inventory could be sold, typically at a discount to market value. Book values, in
turn, will incorporate accounting rules and principles that typically fail to track the market
value of the assets. In addition, in emerging countries, accounting legislation might not
even require companies to attempt to price their assets in the books according to market
values.Thus, discrepancies between market values and book values are likely to be common
and relevant, in particular given the volatility of commodity prices, which directly affect the
market value of natural resource companies.
Cost-based approaches are not likely to be useful either, as they value assets based on the
cost of the land and construction, less any depreciation, and would most likely fail to rep-
resent the value that shareholders could extract from future cash flows. The only instance
in which cost-based valuation approaches may be appropriate would be for valuing energy
or natural resources assets that are in an exploration stage, at which point in time the value
of the asset may be restricted to its cost given that there would not yet be any reasonable
expectations of future cash flows.
prices) and the asset under analysis, and taking into account lost dividends during the relevant period under
analysis, among others.
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21
Damages in Construction Arbitrations
Wiley R Wright III and Mark Baker1
Introduction
Damages to a contractor can result from a number of employer-caused events that may
occur before a project commences or during actual contract performance. These events
can include project delays and disruptions, shutdowns or suspensions of work, resequencing
of work, incomplete or incorrect designs, excessive change orders and untimely responses
to requests for information from the employer. Each of these events will likely cause the
contractor to incur increased costs. While mathematical precision is not a prerequisite in
the calculation of damages, it is important to establish and calculate damages to a reasonable
degree of certainty to clearly associate these increased costs (i.e., damages) with the under-
lying, employer-caused events, and to substantiate the proof for additional costs incurred.
To quantify the impacts and successfully establish the cause-and-effect relationship, there is
a variety of damages pricing techniques and models that can be used.
The purpose of this chapter is to provide the reader with an overview of the types of
damages typically experienced by contractors, and the pricing techniques and models used
for the quantification of the resultant increased costs.The types of damages discussed below
are limited to increased costs. This chapter does not address the concept of lost profit dam-
ages, which contractors often also experience as a result of these or similar events.
Damages calculation methods

Total cost approach
The total cost approach, often referred to as the method of last resort, simply calculates the
difference between the actual contract costs and the tender amount. This method assumes
that the full amount of the overrun is due from the employer as a result of the claimable
events. The total cost method is typically used in situations where there are pervasive and
1 Wiley R Wright III is managing director and Mark Baker is director at Secretariat International.
301
continuous effects on performance that cannot be easily segregated into a single event or
groups of events subject to measurement. To prevail when using the total cost method,
there are typically four conditions that should be satisfied. The four conditions are:
• there is no other practical or viable method for calculating the damages;
• there are no tender errors or underbids;
• the cost overruns are a result of the employer’s actions; and
• the actual costs are reasonable.
Modified total cost approach

A more accurate method for quantifying damages is known as the modified total cost
approach. Under this approach, the contractor identifies and removes from its damages
calculation the costs that are unrelated to the employer-caused events.These would include
cost increases resulting from the contractor’s actions, errors on the contractor’s part, rework
to correct any contractor mistakes, and tender errors or underbids.The other conditions for
the use of a total cost approach are still applicable.
Direct or discrete pricing approach

The direct or discrete pricing approach is the most accurate method for quantifying dam-
ages, as it ties and associates actual costs, taken from the contractor’s books and records, to
the specific events for which the contractor is seeking compensation from the employer.
Delays
Delay analysis – scheduling
Delay damages are often determined in conjunction with the contractor’s schedule analysis,
which both measures and demonstrates the causes of the increased contract duration. The
increased duration can manifest itself as additional days of performance, idle time or less
than fully productive performance.
Delay analysis – quantum

Once a schedule analysis has been completed and the additional contract duration days are
linked to the employer’s actions, the increased costs to the contractor can be calculated.
The increased costs usually fall into the following categories: extended general conditions,
unabsorbed home office overhead, idle equipment and escalation.
Extended general conditions costs

These are the direct costs that result from extended contract performance time and include
such items as: the cost of the project manager; project administrative personnel, like the
field office accountant; job site trailers; utilities; personnel relocation costs; and job site
security.When quantifying extended general conditions, care must be taken to only include
costs that are incurred as a function of the extended performance period. Costs that would
have been incurred irrespective of the delays, such as utility hookups and job site trailer
mobilisation or delivery, as well as computer or other infrequent purchases, should be
removed from the calculation. Once the time-related costs are isolated, a daily rate for the
general conditions can be calculated. Additional considerations for the calculation of the
302
general conditions daily rate are initial performance period costs and end of project per-
formance costs. These daily costs can significantly differ from, and are typically less than,
the costs for the period of actual delay impact, and should be excluded from the daily rate
calculation. To the extent the delay days are isolated to specific time periods, care should
be taken to calculate the daily costs for those discrete time periods to best isolate the
cause-and-effect relationship.
Unabsorbed home office overhead costs

Another effect of delays is on the contractor’s ability to absorb its fixed home office over-
head costs. These costs are normally priced into and recovered through a contractor’s ten-
der amount. When a contractor experiences a delay or suspension of its work, it is often
unable to fully recover its home office overhead through the anticipated level of revenue.
Home office overhead includes the costs for the contractor’s corporate management per-
sonnel other than direct job site project management, payroll and human resources depart-
ment costs, engineering support, and other home office costs. Care should be taken to
exclude any direct project costs or general conditions costs to avoid duplication within the
quantum calculation.
There are several well-known and widely accepted formulas used to calculate a con-
tractor’s unabsorbed home office overhead, including the Hudson, Ernstrom, Emden and
Eichleay formulas.2
Hudson formula3
This formula calculates a daily home office overhead and profit rate based on the contrac-
tor’s tender amount, and assumes that this rate is applicable throughout the duration of the
project. The formula is as follows:
[Tender Overhead Markup] x [Original Contract Amount/Original Contract Duration] =

Daily Contract Home Office Overhead.
The resulting daily rate is extended by the compensable delay days. When using this for-
mula, the issue of how much of the tender markup consists of overhead v. profit will need
to be addressed.
Ernstrom formula4
This formula calculates home office overhead in relation to all project labour costs and
applies the resulting ratio to the labour costs incurred by the contractor for the impacted
project during the delay period. The formula is as follows:
[Total Home Office Overhead for Contract Period]/[Total Company Project Labour Costs]
= Project Labour to Overhead Ratio.
2 Others include the Manshul and Allegheny formulas.

3 J F Finnegan Ltd v. Sheffield City Council, 43 Build. L.R. 124 (Q.B. 1989).
4 The Construction Lawyer, Volume 3, Number 1, Winter, 1982.
303
The next step is to apply the project labour to overhead ratio to the labour costs incurred
during the delay period, with the end result being the unabsorbed home office overhead
for the delay period.
Emden formula5
This formula calculates home office overhead and profit using the relative amount of home
office overhead to the total company revenue applied to the planned project revenue on a
per-day basis to arrive at the allocable daily overhead rate for the project and the delay.The
formula is as follows:
[Total Company Overhead and Profit/Total Company Revenue] x [Planned Contract

Revenue/Planned Project Duration] = Allocable Daily Overhead Rate.
The allocable daily overhead rate is extended by the number of delay days. As with the
Hudson formula, an important consideration is that the result includes both home office
overhead and profit.
Eichleay formula6
Similar to Emden, this formula allocates home office overhead for the contract period to
the impacted project, and determines a daily rate that is applied to the number of compen-
sable delay days. The formula is as follows:
[Contract Billings/Total Company Billings During the Contract Period] x [Total Company
Home Office Overhead During the Contract Period] = Home Office Overhead Allocable to
the Project.
The next step is:
[Allocable Home Office Overhead]/[Actual Contract Duration Days] = Daily Home Office
Overhead Rate.
The final step is:
[Daily Home Office Overhead Rate] x [Compensable Delay Days] = Total Unabsorbed
Home Office Overhead.
Considerations when calculating unabsorbed home office overhead:

• Was the contractor able to mitigate its losses by shifting project resources or personnel
to other projects and generate revenues that absorbed home office overhead?
• Did the contractor experience a significant change in revenues and home office over-
head unrelated to the delays on the project at issue?
5 Alfred McAlpine Homes North Ltd v. Property & Land Contractors Ltd, 76 BLR 59 (1995).
6 Eichleay Corporation, ASBCA No. 5183, 60-2 BCA (CCH) paragraph 2,688 (1960).
304
• Did the contractor absorb any part of its home office overhead through change orders
or other claims?
To the extent that events such as the above occurred, an adjustment to the home office
overhead calculation should be considered.
Idle equipment costs

During a period of delay, another impact to the contractor often results from equipment
that is idled as a result of the delay. While the idle equipment does not incur operating
costs, such as fuel, it does continue to depreciate during the delay period. Depreciation
is one element of a contractor’s equipment ownership costs. For leased or rented equip-
ment, the contractor may continue to incur rental or lease charges, despite not being able
to use the equipment in a planned, productive manner. Both ownership and lease or rental
costs are components of idle equipment costs. For the pricing of the impact of leased or
rented equipment, the contractor’s measure of damages is simply the rental or lease charges
incurred during the delay period. For owned equipment, the calculation is more difficult, as
the contractor may not have developed or maintained internal equipment costs or rates. In
the absence of an internal equipment cost or rate, there are a variety of equipment manuals
that can be used to calculate idle equipment costs. Examples of equipment rate manuals
are the Alberta Roadbuilders & Heavy Construction Association (ARHCA) Equipment
Rental Rates Guides and the US Army Corps of Engineers (USACE) Construction
Equipment Ownership and Operating Expense Schedules. These rate guides are used to
approximate a contractor’s owned equipment costs and include provisions for calculating
idle equipment costs. Care should be used in selecting the proper make and model of the
equipment, its age and condition, and the geographic location.
Escalation costs
As a result of a delay or an extended project performance period, a contractor often experi-
ences increases in its costs for labour and materials. To quantify these cost increases, a com-
parison of baseline costs or rates to the actual costs or rates incurred during the delayed or
extended period is necessary. The cost or rate differential experienced by the contractor is
the resulting measure of damages. It is important to only include the differential in the costs
or rates, as the underlying work would have been performed absent the delay or extension.
Delay mitigation
In addition to the costs a contractor incurs as a result of delays, there may be costs incurred
to mitigate delays and maintain the programmed schedule. These mitigation costs may
include additional overtime, additional equipment, acceleration through added manpower,
increased crew sizes, process modifications and improvements, additional shifts, extended
work weeks, additional supervision, quality improvements and productivity improvements.
Costs for these activities are better quantified on a discrete pricing basis. For example,
additional manpower costs can be determined using salary and wage records in conjunc-
tion with time records reflecting the actual time spent on the project by the additional
manpower. It is important to establish that the need for increased manpower is the result of
305
employer-caused events, and is not the result of contractor performance issues or underbid-
ding the project.
Loss of productivity
In addition to, or as a result of, delay impacts, contractors can also experience disruptions
to their productivity. Loss of productivity is often a significant component of a contrac-
tor’s damages.
Contractors typically rely on their past experience and the nature of project work
to develop productivity rates they will use to estimate for the tender for new work. On
many construction projects, the single element most susceptible to risk of cost overrun is
craft labour. There are a variety of forces on a construction project that have the potential
to negatively impact a contractor’s workforce. Among these forces are broad categories,
including: acceleration of the work; excessive change orders; stacking of trades; resequenc-
ing work; excessive overtime; changes to the work; and natural or environmental condi-
tions at the worksite. All of these potential impacts to labour productivity can cause the
contractor to suffer losses on the project resulting from inefficiencies. To the extent it can
be established that the employer is responsible for the causes of labour inefficiencies, the
contractor has available to it a variety of methodologies to quantify labour inefficiency
damages, including: a measured mile approach (Zink, 1985); industry/trade or scholarly
studies; modified total cost approach; and total cost approach.
Measured mile approach

The measured mile approach compares a contractor’s actual rate of productivity, achieved
during an unimpacted portion of the project, to the rate of productivity achieved in the
impacted portion of the project. In terms of construction, productivity can be defined as
the craft hours necessary to produce a unit of work. The following formula can be used to
calculate a contractor’s productivity rate:
Productivity rate = Output (units completed)

Input (labour hours)
A contractor experiences a loss of productivity, and resulting cost overruns, when its actual
productivity rate is less than the baseline, or planned, productivity rate. This comparison of
baseline, or planned, productivity to actual productivity is typically measured using produc-
tivity or performance factors. A performance factor is calculated by dividing actual produc-
tivity by planned productivity. As such, a performance factor of greater than 1.0 indicates a
loss of productivity, or inefficiency. An example of the calculation of the performance factor
is provided below:
306
Actual productivity rate (Labour hours per linear metre (LM) of

pipe) 3.25
÷ ÷
Planned productivity rate (Labour hours per LM of pipe) 2.65
= =
Performance factor 1.23
In the above example, the contractor has incurred a loss in productivity of 23 per cent.
To quantify the damages associated with the loss of productivity using the measured mile
approach, the contractor should recalculate the productivity on the impacted work as if
it was performed during the unimpacted period. Assuming that the contractor expended
16,250 craft labour hours at an average hourly cost of €65 to install 5,000LM of pipe in
the impacted period, and an unimpacted productivity rate of 2.95, the calculation of the
contractor’s damages is demonstrated below:
Actual output (LM of pipe installed) 5,000

x x
Measured mile productivity rate (Labour hours per LM of pipe) 2.95
= =
Should-have expended labour hours 14,750 (a)
Actual expended labour hours 16,250 (b)
Additional labour hours expended on impacted period work 1,500 (b-a)
x x
Average hourly labour cost €65
= =
Damages due to productivity loss €97,500
Potential issues encountered when utilising the measured mile approach

Lack of an unimpacted period of work
Some projects are impacted by employer causes throughout the project from inception to
final completion, thus, there is no baseline or unimpacted portion of work to be used in a
measured mile calculation. In these circumstances, an alternate approach would be needed
to quantify productivity loss. Alternatives include using the tender productivity factors as a
baseline to the extent they can be established as reasonable. Other measured mile baselines
include similar projects’ productivity factors.
Insufficient project productivity data or information

Contractors do not always maintain production records with enough detail to perform
the calculations necessary for the measured mile approach. As in the above paragraph, an
alternate approach to quantifying productivity loss would be necessary.
Comparability of the work

When selecting periods of unimpacted work, it is very important to select work that is
comparable to the impacted work and performed under similar circumstances. An example
307
of work that is not comparable is the installation of large and small bore pipe as compared
to electrical cable tray installation. Another example is the comparison of straight runs
of duct work with duct work for corners, bends and tie-ins. It is also important that the
circumstances for the comparable work be similar. For example, changes in work crews or
supervision could have an impact on productivity. Under these circumstances, an adjust-
ment to the calculation is necessary to account for these changes.
Sufficient sample size

The work performed should be representative of the impacted work, from the standpoint
of both the nature and the amount of the work. The nature of the work is covered in the
above paragraph. Selecting unimpacted or less impacted work that comprises less than 5 per
cent of the subject or impacted work may not be considered as representative of the work.
Isolation of negative variables in impacted work

It is important for the contractor to identify and isolate other variables that have the poten-
tial to affect productivity and are unrelated to the claimed impacts. Ideally, the impacts of
these variables should be removed from both the impacted and unimpacted periods.
Industry/trade or scholarly studies

Second to the use of actual costs, the measured mile approach is the most preferred
method for calculating a loss of productivity.7 When the measured mile method cannot
be performed, contractors have other options available. One such option is the use of
industry/trade or scholarly studies. Although not the traditionally preferred method for
quantifying damages resulting from lost productivity, studies have been used by contractors
in the absence or insufficiency of contemporaneous productivity data. Studies can also be
used as a tool to support the integrity of a contractor’s claim using other alternate methods,
such as a measured mile or modified total cost approach.
Two commonly used studies to quantify damages due to labour inefficiencies are pub-
lished by the Mechanical Contractors Association of America (MCAA) and the National
Electrical Contractors Association (NECA). The MCAA study, entitled Factors Affecting
Labor Productivity, lists 16 factors that may cause inefficiency, including overtime, stacking
of trades and crew size inefficiency. Each of the 16 factors has a range of losses expressed
in percentages for minor, average and severe. The percentages are added to the impacted
labour costs to arrive at a damages amount. The NECA study, entitled Overtime and
Productivity in Electrical Construction, is based upon a survey of electrical contractors.
The study indicated how productivity was impacted by the varying levels of overtime. The
source of the data presented in both the MCAA and NECA studies is based upon surveys
of contractors and not an empirical study of actual job productivity.
The effect of overtime on labour productivity is the subject of two other well-known
studies, the US Army Corps of Engineers’ Modification Impact Evaluation Guide and
the Business Roundtable’s Scheduled Overtime Effect on Construction Projects. Both
of these studies show the relationships between varying amounts of overtime to levels of
7 Calvey and Zollinger 2003, W.G.Yates, U.S. Industries.
308
productivity, and generally demonstrate that, as overtime is sustained, a continual decrease

in productivity occurs.
Two additional studies, conducted and published by Charles Leonard and William Ibbs,
analyse the effect of change order size, frequency and proportion on efficiency of contrac-
tor labour. Both studies note correlations between levels of productivity and number of
change order hours.
Caution should be used when using any study to support a claim for loss of productiv-
ity, as they do not rely on actual project data or costs to quantify loss of productivity.
Bond and insurance premiums

Bond and insurance premiums are often determined as a percentage of the contract price.
As such, any bond or insurance increases anticipated on the claim amounts should be
included in the quantum calculations.
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22
Damages in Financial Services Arbitrations
Chudozie Okongwu1
Introduction
In recent years, there has been increased interest in the use of international arbitration to
resolve financial services disputes – and, in particular, disputes involving financial instru-
ments such as swaps and other derivatives.2 Parties to an ‘over the counter’ (OTC) trans-
action may agree to arbitration in the case of a dispute (for example, in the contractual
documents governing the transaction).3 In addition, cross-border investor-state disputes
involving financial instruments (e.g., shareholdings or sovereign debt) may be subject to
arbitration under bilateral investment treaties (BITs), in particular, where there is a claim
of state expropriation.
One of the primary advantages of using international arbitration for financial ser-
vices disputes is the ability to select arbitrators who understand the financial markets and
products. To this end, in 2012, the Panel of Recognised International Market Experts in
Finance (P.R.I.M.E. Finance) was formed, providing an international arbitration forum
for financial disputes and a roster of arbitrators with specialised knowledge of complex
financial transactions.4
1 Chudozie Okongwu is a managing director at NERA Economic Consulting. He would like to thank Erin
McHugh (associate director), Trang Nguyen (senior analyst) and Chris Li (associate analyst) for their assistance
in the preparation of this chapter.
2 ‘The use of arbitration under an ISDA Master Agreement’, Memorandum for Members of the International
Swaps and Derivatives Association, Inc. from Peter Werner to ISDA Financial Law Reform Committee,
19 January 2011, available at: www.isda.org/uploadfiles/_docs/FLRC_ISDA_Arbitration_Memo_Jan11.pdf.
3 In 2013, ISDA published model arbitration clauses for use in ISDA Master Agreements governing over the
counter (OTC) derivative transactions. With these clauses, counterparties to an OTC derivative transaction
can agree to have any disputes decided using arbitral rules such as those of the International Chamber of
Commerce (ICC), the Hong Kong International Arbitration Centre (HKIAC) or P.R.I.M.E. Finance.
4 http://primefinancedisputes.org/about-us/.
310
The types of financial services disputes that may be brought before an international arbi-
tration tribunal include claims for losses resulting from expropriation, suspension of pay-
ments or default on a financial instrument, or disagreements on the value upon close-out
or termination of positions. Estimating quantum in these types of disputes often involves
the valuation of complex financial instruments and typically requires expert evidence. This
chapter first discusses general concepts that are applicable to the valuation of all financial
instruments. It then explains more complex concepts that are particularly important in the
context of valuing derivatives. Finally, this chapter provides examples of how changes in
financial regulation can affect the valuation of financial products.
Valuation of financial instruments

The most direct method of valuation for most financial instruments involves estimating the
present value of the expected future cash flows from the asset. This means that the sum of
future cash flows is adjusted to reflect the time value of money. Below, I discuss some com-
mon types of financial instruments and methods used to estimate their value.
Types of financial instruments and their associated cash flows

An equity investment (for example, a share of stock) represents an ownership inter-
est in a company. Cash flows received on equity investments include income (e.g., divi-
dend) payments.
A bond is a debt obligation. Cash flows received on bonds typically include interest
payments and the repayment of principal at maturity.
Derivatives are financial instruments whose cash flows depend upon the performance
of one or more underlying assets, indices or rates. The payment amounts are determined
with reference to a specified payment formula.
Examples of derivatives include call options, put options, interest rate swaps and credit
default swaps:
• A call option gives the holder the right, but not the obligation, to buy an asset (for
example, shares of stock) at a specified (‘exercise’) price on (or before, in some cases) a
specified date.
• A put option gives the holder the right, but not the obligation, to sell an asset at a speci-
fied exercise price on (or before, in some cases) a specified date.
• An interest rate swap is a transaction in which two parties agree to exchange cash flows
at specified dates. In the most common of such transactions, a plain vanilla interest rate
swap, one counterparty agrees to pay a cash flow calculated using a fixed rate of interest,
while the other counterparty agrees to pay a cash flow calculated using a floating rate
of interest (for example, LIBOR), with both cash flows being in the same currency.
• A credit default swap (CDS) is a transaction in which one party (e.g., Counterparty
A) agrees to make periodic payments to the other (e.g., Counterparty B). In exchange,
Counterparty B agrees to make Counterparty A whole should there be a credit event
(e.g., a missed interest or principal payment) associated with a reference obligation (e.g.,
a bond).
It should be clear from the above examples that the amount and timing of cash flows from
an asset are not always known with certainty. The level of future dividends, if any, to equity
311
holders is uncertain. A company might at some point become insolvent or miss an inter-
est payment and both of these have implications for bondholders. With options there is
uncertainty regarding whether the underlying will ever reach the exercise price as well as
the level it will attain before maturity. For an interest rate swap, the level of future floating
rates of interest is uncertain. And for a credit default swap, there is uncertainty both about
whether a credit event will occur and its timing (and severity) if it does.
Nevertheless, to value an asset one frequently needs an estimate of these cash flows.
Below, I describe some of the methods that are commonly employed.The list is not exhaus-
tive, but it provides a basic understanding of some of the methods used in the area.
Estimating future cash flows

Companies
There are at least three ways that the value of future cash flows can be estimated. One could
use a cash flow forecast for the firm in question. Such a forecast might be available as part
of planning by the firm or may be the result of work by a third party such as a credit or
equity analyst. Alternatively, one could analyse historical cash flows and use this to posit a
pattern of future cash flows. This approach generally requires some assumption about the
growth rate of such flows over time. Lastly, one might look at expected future cash flows5
as of the valuation date for comparable companies in similar circumstances and assume that
the pattern of future cash flows for the company of interest would have followed (or will
follow) a similar pattern. Depending on the circumstances, one or more of these techniques
may be appropriate.
Equities
Broadly speaking, the valuation of equity in a firm requires an estimate of the future cash
flows to equity holders. This can require assumptions regarding payout ratios6 and future
growth rates.
Debt
Generally, the agreed terms of cash flows to the holders of debt are known.These may take
a variety of forms including a fixed rate of interest, a rate of interest linked to a reference
rate (i.e., a floating rate), and some variety of a payment-in-kind option (PIK) provision.
The cash flows to be received on a floating rate debt instrument will be affected by move-
ments in the reference rate in the future. Where there is an option to pay all or some of an
interest payment in kind or in cash, an expert will consider this feature when valuing the
security. Many types of debt also have call or put provisions that can affect future cash flows
and hence must be considered.
Adjusting future cash flows

Once future cash flows to be received from a financial instrument are estimated (more on
this below), these must be valued as of a selected valuation date. Future cash flows must be
5 Management forecasts or forecasts by analysts, for example.

6 The payout ratio is the percentage of a company’s profits that is paid out as dividends.
312
adjusted to determine their present value, typically by discounting. This is, in part, because
of a concept known as the ‘time value of money’ – i.e., that $1 today is worth more than
$1 to be received in the future because (if interest rates are positive) money received today
can be invested in a risk-free interest bearing asset.
The discount rate applied to estimated future cash flows should also reflect the different
types of risks associated with those cash flows. All else being equal, the more risky the cash
flows, the higher the discount rate that should be applied to those cash flows (and hence
the lower the value of those cash flows today).
Another way to think about the discount rate is that it is the rate of return required by
investors to hold a given financial instrument. All else being equal, the riskier the invest-
ment, the higher the expected return demanded by investors.
Different types of risks

There are several different types of risks that should be considered when valuing a financial
instrument. These include:
• Market risk: this is the risk that a financial instrument’s value will change as
a result of market-wide factors.7 This type of risk is also referred to as systemic or
non-diversifiable risk.
• Country risk: this is the risk that a financial instrument’s value will change as a result
of changes in the business environment in a country, including macro-economic and
political conditions.
• Credit risk: this is the risk that an obligor will fail to make payments in accordance with
agreed terms. This is largely a function of the creditworthiness of the obligor (i.e., the
ability and willingness to make the contractual payments).
• Counterparty risk: this is the risk that the counterparty to a derivatives transaction may
not pay the amounts due. For example, in an interest rate swap transaction, each party
has the potential to have positive net claims against the other party in the present and
in the future (depending upon how interest rates move) and each party is therefore
exposed to counterparty risk.The counterparty risk that each party faces is, therefore, a
function of the current value of the contract (market risk) and the creditworthiness of
the counterparty (credit risk).
• Liquidity risk: liquidity refers to the speed and ease with which an investor can enter
or exit a position.8 All else being equal, an investor is willing to pay less for a financial
instrument that is less liquid because, if and when he decides to sell that security, this
will be more difficult (i.e., have higher costs).
• Regulatory risk: this is the risk that changes in laws or regulations may materially affect
a company’s or financial instrument’s value.
7 Zvi Bodie, Alex Kane, and Alan J. Marcus, Essentials of Investments, Fifth Edition, McGraw-Hill Irwin, 2004, pp.
170 – 171.
8 Nassim Taleb, Dynamic Hedging: Managing Vanilla and Exotic Options (New York: John Wiley & Sons, 1997),
p. 68.
313
Valuing exchange-traded and over-the-counter financial instruments

If a financial instrument is traded on an exchange and in a highly liquid market, it may be
relatively straightforward to determine the security’s value. For example, if one wanted to
know the value of a share of stock in Apple, the current price of the company’s shares on
the NASDAQ stock exchange is likely the best estimate. This price represents the market
consensus view as to future cash flows and the risks associated with the stock.
However, many financial instruments (e.g., some bonds and derivative products) do
not trade on exchanges. Instead they are traded over the counter. The OTC market is
comprised of parties (e.g., dealers and investment managers) who trade bilaterally or via
interdealer brokers. Even for those instruments that are traded on exchanges, some may not
trade frequently enough (or in large enough quantities) to allow any observed prices to
provide a reliable estimate of the security’s value at a particular point in time.
Where there is less transparency as to pricing, values may need to be estimated using
observed benchmarks or valuation models. The next section discusses some concepts that
are important when estimating values for derivatives.
Important concepts for valuing derivatives

For the purpose of explaining some basic derivative valuation concepts, I will use the
example of a simple European9 call option on a publicly traded stock.There are three main
approaches used to value such derivatives: the Black-Scholes model, the binomial model
and Monte Carlo simulation.10 While variants of these approaches are also employed for
some derivatives, a description of these approaches is sufficient to provide an illustration of
some key concepts.
The payoff at maturity to a call option will either be zero (if the then-current market
price is less than or equal to the exercise price, also referred to as ‘out of the money’) or
positive (if the then-current market price is greater than the exercise price, also referred to
as ‘in the money’). The valuation approaches discussed below attempt to estimate the value
of the option at a time prior to maturity given the then-available information.
Note that use of a model to value a financial instrument can introduce an additional
risk – model risk. Model risk is the risk that the valuation may be unreliable due to flaws
in the assumptions of the model or in its implementation.
Black-Scholes model
The Black-Scholes model provides pricing formulas for European call (and put) options
on non-dividend paying stocks. The formulas have a closed-form solution meaning that
they can be solved when the input parameters are known. The pricing formulas require at
least five inputs: the current price of the underlying stock, the exercise price of the option,
the risk-free rate of return, volatility of the underlying asset, and time to expiration of
the option. Most of these inputs are usually relatively easy to determine – the exception
being volatility. Volatility is a measure of the uncertainty or variability of returns on an
9 A European option can only be exercised at the maturity date. An American option can be exercised at any
date prior to the maturity date.
10 While one could employ a Monte Carlo simulation, this is uncommon for these types of derivatives.
314
asset. Volatility, if necessary, may be estimated from historical returns on an asset (referred
to as ‘historical volatility’). The volatility of the underlying asset can also be estimated (or
derived from) the observed prices of options traded in the markets (referred to as ‘implied
volatility’). Note that in the latter case, the market price of the call is an input and is used
in conjunction with the other inputs described above (except volatility, of course) to solve
the equation for the volatility of the underlying asset implied by the values of the inputs.
A discussion of the derivation of the Black-Scholes formulas is beyond the scope of this
chapter. However, it is worth noting that, at its core, the model relies on a model of how
the stock price moves and on a ‘non-arbitrage’ argument. In brief, the argument rests on
the fact that at any given moment one can combine the underlying shares and the option
in question to create a riskless portfolio – one whose value is known with certainty regard-
less of how the stock price moves. This implies that the portfolio earns the risk-free rate of
return (as it is riskless because its value is known with certainty) and allows one to solve
for the value of the option.11
Variations and extensions of the Black-Scholes option pricing formulas can be used
to value other types of derivatives (e.g., options on dividend paying stocks and options
on futures).
Binomial model
The binomial model is a numerical method, meaning that it employs an algorithm to
estimate the solution being sought, in this case, the price of a call option. Similarly to the
Black-Scholes formula, it is based upon a ‘non-arbitrage’ assumption. The model divides
the life of the option into discrete time intervals, and assumes that in each interval the share
price can either go up or go down. By combining positions in shares and options, one can
create a hedged portfolio where the payoff at the end of each time interval is known with
certainty. Again, this means there is no risk associated with the hedged portfolio and that
it must earn a risk-free rate of return. By discounting the (known) payoff of the hedged
portfolio at the risk-free rate, one can solve for the value of the option at the beginning
of each time interval. This process can be used iteratively (through backwards induction)
to solve for the value of the option at the beginning of the first time interval (i.e., on the
valuation date).
A link between valuation using the Black Scholes model and that using the binomial
model is that as the time intervals considered get smaller the value obtained using the bino-
mial model will converge to that using the Black Scholes model.
Estimating actual probabilities of an up or down movement of the share price in each
interval is not required in the binomial model, as the outcome for the hedged portfolio is
the same regardless of these. However, one can use the binomial model to solve for what
are referred to as ‘risk-neutral’ probabilities of an up or down movement in the share price.
These probabilities are just mathematical (modelling) devices and are generally different
from the actual probabilities of an up or down movement of the share price.
11 Also, the Black-Scholes formula does not make any assumptions regarding investor preferences. This means
that derivative securities can be evaluated for any investor regardless of their risk preferences.
315
Monte Carlo simulation

Monte Carlo simulation is a method of modelling an uncertain outcome (for example, the
movement of a share price) by sampling randomly from a universe of potential outcomes.
For the value of a European call option, for example, Monte Carlo techniques involve sim-
ulating potential paths that the underlying share price could take (using a standard model
of asset price behaviour such as that in the Black-Scholes model) and then determining
the payoffs to the option for each of those various paths.The average of the – appropriately
discounted – values that one computes is the estimated solution to the exercise. In general,
the accuracy of estimates increases with the number of paths or universes that the model-
ler generates. When valuing a European option, as the time intervals in the simulation get
smaller, the valuation result converges to that given by the Black-Scholes formula.
Choice of model
One or more of these models may be appropriate for a particular valuation exercise,
depending upon the characteristics of the derivative to be valued. For a simple European
call option, use of the Black-Scholes option pricing formula may be appropriate. Another
approach (for example, the binomial model) could be used to provide further support to
the valuation result.
While the Black-Scholes option pricing formulas are relatively straightforward to use,
for certain types of derivatives a numerical method may be more appropriate. For exam-
ple, American options are often valued using the binomial model, as this approach allows
for the possibility of early exercise. Some derivatives (for example, Asian options) are path
dependent, meaning that their value is determined not only by the price of the reference
asset at the derivative’s maturity, but also by the path that the reference asset’s price took
prior to maturity. Such cases are among those where practitioners typically use Monte
Carlo simulation techniques to estimate prices.
Some reasons why practitioners may arrive at different values for the same
financial instrument (and hence differing damages in some cases)
In financial services arbitrations, both claimants and respondents may rely upon expert
evidence regarding the valuation of financial instruments. It is not unusual for practitioners
to arrive at different values. Some of the reasons for this are discussed below. In sum, they
boil down to differences in approach and assumptions.
Differing valuation dates

Practitioners may choose (or be instructed to use) different valuation dates, which may
result in different valuations for the same asset.
Differing estimates of future cash flows

Practitioners may arrive at different estimates of future cash flows to be received from
an asset. For example, when valuing a private company, practitioners may make different
assumptions about the company’s future profitability. A practitioner may rely upon man-
agement’s projections of cash flows, while another may adjust the estimates (or develop
316
independent forecasts) to reflect different assumptions about future revenue growth or

future costs.
Assumptions about a company’s future profitability may have implications for the con-
clusions an expert reaches concerning the company’s ability to make interest payments on
debt and pay dividends to equity investors, thereby affecting the practitioners’ estimates of
the value of those instruments.
Differing estimates of risk premia

Practitioners may also arrive at different estimates of the applicable discount rates to be
applied to estimated future cash flows. If one is valuing the equity of a company, the appli-
cable discount rate applied to estimated future cash flows to equity is referred to as the cost
of equity. Similarly, estimated future cash flows to debt are discounted at the company’s cost
of debt.Total estimated future cash flows to the firm are discounted at the weighted average
cost of capital (WACC), which is the average of the company’s cost of equity and cost of
debt, weighted by the relative proportion of each type of financing within the company’s
capital structure.
A company’s cost of equity reflects the expected return demanded by equity investors.
There are different models that practitioners can use to estimate a company’s cost of equity.
One widely used model is the capital asset pricing model (CAPM). While a full discussion
of the model and its assumptions is outside of the scope of this chapter, in short, the CAPM
model estimates a company’s cost of equity as a function of a risk-free rate of return, a
market equity risk premium, and the company’s beta. Beta is a measure of a company’s
exposure to market risk.12 Practitioners may also incorporate additional risk premia in their
cost of equity estimates for a company. Examples of these are a country risk premium and
a size premium. A country risk premium reflects the additional risk of an equity investment
in a particular country (typically an emerging market) relative to an equity investment in
a more mature market (for example, the United States). A size premium reflects the addi-
tional risk of an equity investment in a smaller company (by market capitalisation) relative
to an equity investment in a larger company. Practitioners may make different assumptions
regarding the presence and size of risk premia in a cost of equity estimate.
The cost of debt is the rate at which a company can borrow money.13 The rate (or yield)
demanded by debtholders will be a function of both the general level of interest rates and
issuer-specific credit risk. All else being equal, the higher the risk of default on the debt, the
higher the yield that will be demanded by debtholders. If a company has issued debt, the
yield on that debt may be an estimate of the company’s cost of debt. If a company has no
debt, the cost of debt for comparable companies (e.g., companies in the same industry or
with the same credit rating) may be used as a proxy. Adjustments may be required to reflect
the unique circumstances of the issuer and issue. Experts may disagree on the presence and
nature of such adjustments.
12 Aswath Damodaran, Investment Valuation, Second Edition, p. 182.

13 Aswath Damodaran, Investment Valuation, Second Edition, p. 669.
317
Differing estimates of the value of control

When valuing an ownership stake in a company, an important consideration is the value of
control. Market participants may be willing to pay a premium for an ownership stake that
gives the purchaser control over the direction of the company (e.g., a majority stake). This
premium is referred to as a control premium. Similarly, a minority stake of a company may
be deemed to be worth less than the pro rata portion of the company’s value as a result of
the absence of control. In such a case, application of a minority discount may be appropri-
ate. In performing a valuation, practitioners may make different assumptions regarding the
presence and magnitude of any control premium or minority discount.
Differing models and model inputs

In valuing derivatives, practitioners may use different models. Moreover, even if practition-
ers use the same model, they may use different inputs in the model, resulting in different
valuations. For example, when using the Black-Scholes model, practitioners may have dif-
ferent estimates of expected future volatility. When using Monte Carlo simulation tech-
niques, practitioners may use a different number of simulations, which can affect the results.
All else equal, the higher the number of simulations, the more precise the valuation result.
Differing assessments of market conditions

Valuation results may need to be adjusted to reflect market conditions on the valuation
date. For example, if markets for a particular asset are relatively illiquid, model-derived valu-
ations may need to be adjusted to reflect this. Practitioners may make different assumptions
regarding the presence and size of any such adjustments.
How changes in financial regulation can affect valuation

In general, the likelihood and timing of future cash flows to be received from an asset
can be affected by financial regulation. Moreover, an unstable regulatory environment can
increase the risk to investors.While country risk is meant to capture this risk, in some cases
it may not (or may not fully).
Actions by governments and financial regulators can affect the value of financial instru-
ments, potentially resulting in disputes. In some cases, these disputes may be subject to
international arbitration under bilateral investment treaties. Experts may be called upon
to estimate damages to an investor, which may require estimating the effect of an alleged
action on an instrument’s value.
For example, several disputes arose in relation to oil hedging deals between Ceylon
Petroleum Corporation (CPC), a Sri Lankan state-owned enterprise, and a number of
banks, including Standard Chartered Bank (SBC), Citigroup, and Deutsche Bank. Between
2007 and mid-2008, CPC entered into derivative contracts with the banks in an attempt
to hedge its exposure to oil prices. When oil prices declined, leaving CPC faced with sub-
stantial payments to the banks, the Sri Lankan Central Bank issued an order that suspended
payments on the transactions.14 This order affected both the likelihood and timing of cash
14 Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka, ICSID Case No. ARB/09/2, ‘Award,’
31 October 2012, § 425.
318
flows, thereby affecting the value of the transactions. SBC brought a case in London High
Court,15 while Deutsche Bank16 and Citigroup17 filed arbitration claims with ICSID and
the LCIA, respectively, claiming losses as a result of the Sri Lankan Central Bank’s actions.
A more recent example of a central bank’s actions affecting the value of financial instru-
ments involves Novo Banco of Portugal. In 2014, Banco Espírito Santo collapsed. In the
restructuring process, the Bank of Portugal separated the bank’s assets and creditors into
a so-called ‘good bank’ and a ‘bad bank’. Senior creditors and the bank’s relatively more
sound assets were transferred to Novo Banco, the ‘good bank’, while subordinated creditors
and equity holders were left with the other assets in the ‘bad bank’, Banco Espírito Santo.
In late December 2015, the Bank of Portugal approved the transfer of €2 billion of
senior bonds from Novo Banco back to Banco Espírito Santo,18 causing the bonds’ values
to plummet.19 By early April 2016, nearly 30 separate cases had been filed by investors who
had suffered losses as a result of the bond transfer.20 To date, most, if not all, of the affected
investors have chosen to file their suits in courts. However, it is possible that there could be
arbitrations in future, depending, in part, on the bilateral investment treaties that Portugal
has in place with other countries.
Conclusion
An increasing number of financial services disputes are being heard before international
arbitration tribunals. Estimating quantum in these types of disputes often involves the valu-
ation of complex financial instruments and typically requires expert evidence. It is not
unusual for practitioners to arrive at different values for financial instruments because of
various differences in approach and assumptions.
15 Thomson Reuters, ‘UPDATE 1-Sri Lanka’s CPC owes nearly $162 mln over oil hedge,’ 11 July 2011.
Thomson Reuters, ‘Sri Lanka’s CPC loses $162 mln appeal against London ruling,’ 27 July 2012. The Sunday
Times of Sri Lanka, ‘Rs. 7 billion settlement ends oil hedging dispute with SCB,’ 30 June 2013.
16 Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka, ICSID Case No. ARB/09/2, ‘Award,’
31 October 2012.
17 Thomson Reuters, ‘Arbitrator voids Sri Lanka oil hedge deal with Citibank-sources,’ 1 August 2011.
18 The transfer was to help recapitalising Novo Banco after the ECB’s stress test in November 2015 showed
capital shortfall. Bloomberg, ‘BlackRock Leads Novo Banco Bondholders Suing Bank of Portugal,’
5 April 2016.
19 Financial Times, ‘Fourteen asset managers sue Portuguese central bank,’ 4 April 2016.
20 Reuters, ‘Fund firms sue Portugal’s central bank over Novo Banco debt,’ 5 April 2016.
319
23
Damages in Life Sciences Arbitrations
Gregory K Bell, Andrew Tepperman and Justin K Ho1
Introduction
At a conceptual level, many of the methodologies discussed elsewhere in this volume apply
equally to arbitrated disputes in the life sciences sector. The goal of the damages inquiry in
this sector is the standard one: to restore the claimant to the financial position it would have
achieved had the improper conduct not occurred. Standard approaches are used to attain
this goal, namely determining the claimant’s ‘but-for’ profits at each point in time during
the damages period and subtracting from these the claimant’s actual profits (if any).The dif-
ferences between these amounts are then brought forward (in the case of past damages) or
discounted back (in the case of future damages) to the relevant date (often the date of the
hearing, or the expected date of the award), using appropriate interest and discount rates. As
we articulate in this chapter, however, there are some complexities to damages calculations
in the life sciences industries that are worthy of further discussion.
The chapter is organised as follows.The next section provides a brief overview of salient
characteristics of the life sciences sector, with a focus on the biopharmaceutical industry.We
then outline some of the main types of disputes that are heard in life sciences arbitrations.
Following this, we discuss some of the life sciences-specific aspects of common analyses
that are used to determine damages in these types of disputes.
Industry overview
Many of the companies in the life sciences industries are multinationals, operating on
a global scale with respect to the discovery, production, marketing and sale of products
1 Gregory K Bell, group vice president, leads Charles River Associates’ global life sciences practice, Andrew
Tepperman is a vice president in the practice and Justin K Ho is an associate principal in the practice. The
views expressed herein are the views and opinions of the authors and do not reflect or represent the views of
Charles River Associates.
320
promoted for human health. These products are generally grouped as diagnostics, medical
devices and pharmaceuticals. Our discussion will focus on prescription pharmaceuticals
and the biopharmaceutical industry; many of the insights, however, are equally applicable
with respect to damages issues involving diagnostics or medical devices.
Research and development

The value chain for the biopharmaceutical industry is composed of three principal func-
tions: research and development (R&D), manufacturing, and sales and marketing. A prin-
cipal characteristic of the industry is the long-term, high-cost, high-risk endeavour that is
R&D. It is suggested that it takes more than seven years for a new drug to be discovered and
brought to market, that only one in 10,000 substances that begins the development journey
emerges as a marketed pharmaceutical and that only one in five marketed pharmaceuticals
earn enough to cover the hundreds of millions of dollars that tend to be associated with the
R&D costs of new pharmaceuticals.2 The R&D function tends to extend from the basic
and applied lab research related to identifying a potential pharmaceutical compound, to
pre-clinical testing and development work, and finally through to clinical trials in humans.
Prior to product approval, the last step in the development process involves an exten-
sive and exhaustive summary of the development work and results that is packaged as
submission dossiers for regulatory approval to market the product in different countries.
Regulatory approval leads to indications and usage instructions on country-specific prod-
uct labels.3 Additionally, there may be price negotiations and negotiations regarding reim-
bursement by the country’s public health system or private insurers. Launch of the product,
however, does not necessarily mean the end of R&D focused on the product. There may
be ongoing efforts to explore new indications, address significant side effects, and develop
new formulations.
R&D is the primary value driver of the pharmaceutical industry. Products are the scarce
resource and thus it is the intellectual property developed through the R&D process that
captures the residual profits generated by sales. Manufacturing capacity and sales represent-
atives may be contracted, thus they only need to be rewarded with normal profit margins;
any margin that remains accrues to the intellectual property that led to the product in the
first place.
Manufacturing
Broadly speaking, two types of manufacturing processes characterise the production of
pharmaceuticals. Most pharmaceuticals are pills or tablets, taken orally and generally dis-
pensed at a retail pharmacy. For these products, manufacturing tends to be relatively well
understood: there is primary manufacturing of the active pharmaceutical ingredient (API)
2 Hay et al., ‘Clinical development success rates for investigational drugs,’ Nature Biotechnology, 32:1, 2014, pp.
40-51; Joseph DiMasi and Henry Grabowski, ‘The Cost of Biopharmaceutical R&D: Is Biotech Different?’
Managerial and Decision Economics, 25, 2007, pp. 469-479;Vernon et al., ‘Drug Development Costs When
Financial Risk Is Measured Using the Fama-French Three-Factor Model,’ Health Economics, 19:8, 2010,
pp. 1002-1005.
3 Note that indication approval and associated usage instructions for one country need not imply a similar
approval in other countries.
321
and then secondary manufacturing to formulate and package the tablets. In contrast, most
of today’s high-priced pharmaceuticals are biologics. These tend to be injected or infused
and may be administered by a medical professional. The production processes for biologics
tend to be less standard and significantly more expensive.
Marketing
Once priced and approved for marketing in a country, the pharmaceutical is ready to be
launched.The launch of a pharmaceutical tends to be an expensive process, initially focused
on raising awareness of the product, generating trial and finally habituating usage by pre-
scribing physicians.4 As a result, it is not unusual for marketing costs to represent a high
percentage of sales, and may even exceed sales in the first year or two of a product’s launch.
The principal marketing tactic is the use of sales representatives who visit prescrib-
ing physicians to educate them about the product. This activity is known as ‘detailing’ the
product. For detailing to be effective, it is critical that the sales representatives visit the
right types of physicians and deliver the right message regarding appropriate use of the
product with the right patients at the right time.5 As a result, effort is spent on segmenting
the physicians and patients and testing the messages so as to determine the best use of the
detailing activity. It is important to note that sales representatives typically promote more
than one product. Often, they will be responsible for promoting three products on a detail;
the product in first position tends to dominate the time with the physician; the product in
second position tends to be used as a reminder for the physician; and the product in third
position often warrants only a sample drop.
From a marketing and branding perspective, one tends to consider two types of phar-
maceuticals: acute care and chronic care products. Acute care products, such as antibiotics,
are typically taken for only a short period of time so as to address or cure a condition.
Chronic care products, such as blood pressure medications, are to be taken much longer,
often for the remainder of the patient’s life. As a result, utilisation of chronic care products
may be less volatile than utilisation of acute care products.
Life cycle
Over time, pharmaceutical products tend to move through a life cycle. Initially, sales are
low as significant marketing effort is expended to build awareness and generate trial for the
product. Sales tend to climb through the growth phase of the life cycle as opinion-leading
physicians promote use of the product and prescribing becomes habituated among tar-
geted physicians. During maturity, sales grow more slowly and marketing efforts tend to be
reduced; sometimes detailing for the product becomes no more than a delivery of product
samples. Decline may come about for a variety of reasons. The product may be eclipsed by
a next generation of therapeutics or patent protection may expire and the product becomes
subject to generic or biosimilar competition. In decline, there may be no marketing and
promotional support for the product; to the extent that there is continued product use, it
4 This is the awareness, trial, usage (ATU) model of sales.

5 Appropriate physician targeting is usually of principal importance; for example, it is not likely that there will
be much value in detailing an Alzheimer’s dementia product to a cardiologist.
322
tends to be as a result of ingrained physician prescribing habits and brand loyalty among
patients for chronic care products.
Once the patent or some other form of market exclusivity expires, generic products (or
biosimilars for biologics) may be marketed. As generics and biosimilars are essentially copies
of original branded products, they do not require such large, risky investments in R&D, but
they still require regulatory approval.6 Generic products comprise the same chemical entity
but are sold without the benefit of the original brand name; they do not need clinical trials
to prove safety and efficacy, they need only show that they are bio-equivalent to the related
branded product. Generics are seen as interchangeable for the related brand and tend to
compete to be the version of the product dispensed at the pharmacy. As a result, they may
not be marketed directly to physicians; instead, generics may rely on the awareness and
habituated prescribing practices that the brand built over time. In slight contrast, biosimilars
(because of the more complex nature of biologics) are not exactly the same chemical entity
as the related branded product. As a consequence, they rely on limited clinical trials to show
safety and efficacy that is sufficiently similar to the branded product. Biosimilars may not
be approved as interchangeable with the original branded product; as a result, they may be
branded themselves and marketed to physicians on their own. Because of these differences,
biosimilars are not expected to offer as large a price discount and may account for a smaller
share of sales than may be the case for generic products.
Data
The biopharmaceutical industry is replete with data regarding product sales and associated
marketing efforts. Sales may be tracked on a weekly basis and one is often able to discern
shares of unit sales among competing products. Publicly available unit price data are con-
siderably less accurate. Most pharmaceuticals have list prices that tend to vary by country,
but the net price that a pharmaceutical manufacturer ultimately may realise is typically
not reported to the data companies. There also tends to be a fair amount of data regard-
ing marketing efforts; there are audits that measure detailing activity, sampling, journal
advertising and medical education. As a result, companies are often able to measure them-
selves against their competitors with respect to unit sales and associated marketing efforts.
In contrast, there is little publicly available data regarding research and development and
manufacturing costs, other than what may be reported at an aggregate level in a company’s
financial disclosures.
Collaborations and disputes

Collaborations in the pharmaceutical industry enable companies to seek partners with
complementary sets of expertise in different phases of drug development, commercialisa-
tion and geography. As such, collaborations and related contractual arrangements pervade
the pharmaceutical value chain. As examples, in R&D, companies license intellectual prop-
erty to others to continue development and commercialisation, or companies may enter
co-development agreements and jointly agree to pursue development and commercialisa-
tion. Companies may also outsource various aspects of the R&D function, contracting with
6 Regulatory issues regarding generics and biosimilars tend to be country-specific.
323
others to perform certain types of analyses or to manage their clinical trials. In manufac-
turing, companies may contract with others to develop and scale up the manufacturing
process, or they may outsource all or part of the manufacturing process. In marketing, there
are co-marketing and co-promotion agreements. In a co-marketing agreement, another
company markets the same product under a different brand, recording its own sales; in
co-promotion relationships, two companies agree to jointly market the product but only
one records the sales. In other circumstances, companies may grant to others the right to
commercialise the product in a certain geography or for a certain indication. In addition,
companies may contract for sales representatives. All of these types of collaborations and
contractual relationships may give rise to disputes, including early or otherwise inappropri-
ate termination of the agreements. Typically, damages from these disputes tend to involve
lost profits as a result of unrealised or delayed opportunities.
Commercially reasonable efforts

Many of the disputes that plague collaborations and related contractual arrangements tend
to involve the execution of commercially reasonable efforts (CRE) or some variant there-
of.7 Whether it is a co-development, co-marketing, co-promotion or other type of col-
laboration or related contractual engagement, contracting is limited in its ability to define
and articulate performance requirements for all types of situations. To be successful, the
parties need to be able to respond appropriately to the environment. In this respect, there
is no substitute for the sound exercise of professional judgment regarding strategic choices
in the development and commercialisation of pharmaceuticals. Thus, these collaborations
and types of contractual engagements tend to impose an obligation for the performance of
commercially reasonable efforts, often defined as efforts that may be reasonably expected
given the drug’s potential, stage of development, and other market circumstances, includ-
ing competitor activity. CRE thus encompass a range of appropriate strategic alternatives.
Typically, there is no one right answer with respect to what constitutes CRE; if there were,
the parties could have contracted for the performance of those specific services. In these
types of disputes, the arbitral tribunal typically must determine whether the CRE obliga-
tion was met and if not, what are the efforts that would be considered commercially rea-
sonable and what are the damages that result.
Intellectual property
Parties in the biopharmaceutical industry frequently enter into contracts involving access
to intellectual property rights. In some cases, parties may choose to resolve intellectual
property infringement and damages disputes via arbitration, rather than through the more
conventional national court system.
Arbitrated damages inquiries involving intellectual property tend to be categorised into
those involving the royalty base (the volume of sales deemed to incur royalty obligations)
and the royalty rate payable per unit. With respect to the royalty base, for example, parties
7 For example, Sucampo and Takeda entered arbitration in 2010 due to Sucampo’s allegations that Takeda’s lack
of sufficient marketing of Amitiza had led to poor sales (Siddiqui, Z., ‘Sucampo seeks Takeda talks after losing
legal battle,’ Reuters, 6 July 2012).
324
to a licensing agreement may dispute the inclusion of sales in certain geographies or for
certain indications (approved uses) of the biopharmaceutical product at issue. Disputes may
also extend to what future products and developments are covered by the agreement and
what limitations are placed on the companies pursuing follow-on products or research.8
Various circumstances can arise that require tribunals to make a determination of the
applicable royalty rate. For example, a contract may specify a framework for determining
royalty rates assuming certain conditions hold.The most favoured nation clause is common
in licensing agreements, and may allow the licensee to obtain a lower royalty rate in light
of royalty rates charged by the licensor to other parties.
Investment treaty claims

Investment treaties provide a framework to allow for fair and equitable treatment of private
investment by investors in host states. Pharmaceutical companies make significant invest-
ments in the development of their products, including manufacturing and research facili-
ties. As such, companies may argue that such assets should be considered ‘investments’ under
international treaties and given due rights. As an example, regulatory decisions have sig-
nificant impacts on the timing and extent of a pharmaceutical product launch. Investment
treaty claims provide a framework for foreign companies to challenge state regulatory deci-
sions and adjudicate disputes in arbitration.9
Damages considerations
As noted above, damages analysis in the biopharmaceutical industry proceeds by comparing
how well off a claimant would have been but for the improper conduct. Typically, a partial
characterisation – or at least a description – of this ‘but for’ world is an outcome of the
theory of liability in the case; for this reason, it is critical that liability and damages theories
are mutually consistent. For example, in a dispute concerning contractual performance or
CRE, a particular liability theory may lead to the conclusion that activities undertaken
by the respondent were insufficient. Key questions for damages include: (1) What would
constitute a ‘sufficient’ level of activities? and (2) How would the changed level of activity
translate to sales and profits?
Damages related to lost sales

To assess damages as a result of lost sales, it is necessary to identify the improper conduct,
then determine conduct that would be considered appropriate, and finally consider the
8 For example, Genentech and Biogen Idec entered arbitration beginning in 2006 to resolve a dispute on what
follow-on products to their successful Rituxan product Genentech could pursue independently (‘Biogen Idec
Announces Conclusion of Arbitration with Genentech,’ Biogen Press Release, 16 June 2009).
9 For example, Apotex initiated a NAFTA arbitration proceeding against the U.S. seeking damages due to
a FDA import ban from 2009 to 2011 (‘NAFTA Tribunal Dismisses Apotex Claims,’ U.S. Department of
State, Office of the Spokesperson, 27 August 2014). As another example, in 2009 Servier initiated claims
against Poland resulting from Poland’s decisions not to renew marketing authorisations for certain Servier
products (Les Laboratoires Servier, SAA, Biofarama, SAS, Arts et Techniques du Progres SAS v. Republic of Poland,
UNICITRAL, Final Award, 14 February 2012.).
325
consequent impact on incremental sales, costs and profits.10 These situations often arise
with respect to contract breaches, including a failure to execute commercially reasonable
efforts, and regulatory conduct under investment treaty disputes.
First: assessing conduct

CRE provisions are intended to be a low-cost, contractually efficient mechanism ensuring
that the party undertaking the obligation takes appropriate actions given the contempora-
neous circumstances. The party’s efforts are expected to be in line with what similarly situ-
ated businesses would normally do, relative to the commercial gains that could be expected
from successful efforts. For these reasons, determining what level of effort would be con-
sistent with meeting the CRE obligation is not an exact science. As might be expected,
efforts are likely to be different for a large and rapidly growing marketplace that is highly
competitive than for one that is small and served by few sellers. For any pharmaceutical
product, therefore, it is recognised that efforts would need to be adjusted appropriately as
the magnitude of the opportunity is revealed and the life cycle of the product progresses.
From a business perspective, the standard requires efforts to be large enough that they are
consistent with business practices in the circumstances, but not too large in light of the
perceived profit opportunity available.
Consider the example of a co-development agreement.The party responsible for devel-
oping and launching the product will have made certain expenditures relating to clinical
trials, the securing of regulatory approval or launch preparation. Where liability hinges on
an allegation that certain indications (approved uses) for the drug were either not pursued,
or were pursued with insufficient urgency, published data on the timing of clinical develop-
ment for comparable drugs in the same or similar geographies may be used to estimate how
development should have proceeded. Where the allegation is that the partner has made
insufficient launch preparations, a useful benchmark for the effort level may be the com-
mercialisation plan agreed upon by the parties (subject to adjustment for any subsequent
unanticipated changes in the market environment) or data regarding the actual market-
ing and promotion efforts surrounding the launches of potentially competing products or
other appropriate analogues.
With respect to manufacturing, efforts in terms of production planning and invest-
ment in manufacturing capacity can be considered in relation to standard industry prac-
tices. Investments in highly specific manufacturing capacity may be perceived as unduly
risky until there is a strong basis to conclude that regulatory approval is reasonably likely.
Similarly, the competitive environment into which a product is expected to launch affects
manufacturing capacity decisions. If the drug is first-in-class, demand is likely to ramp
up as experience with the product and commercialisation efforts take root, allowing for
a ramp-up in manufacturing capacity synchronised with (or leading) product uptake. For
products expected to launch in therapeutic areas with similar products already available,
demand will often be more established and easier to forecast, reducing the risk attendant to
significant capacity investments at launch.
10 An exception would be a circumstance in which the expert is instructed to assume a particular level of
effort(s) as a direct consequence of the liability theory.
326
Regarding marketing, a properly executed promotional strategy should result in a share

of voice (based on sales representative meetings with doctors and other promotion initia-
tives) that leads to prescribing behaviour. Share of voice (SOV) places the detailing effort
in the context of other competitors in the marketplace who would be presumed to be
executing CRE on behalf of their products. Other metrics that may prove useful in evalu-
ating promotional performance might include survey results on the extent to which the
approved message was delivered, measures of intent to prescribe as reported by doctors in
surveys, and the prominence accorded to the drug within the set of products promoted by
the company’s sales force.
The appropriate effort level should be attuned to the product opportunity, the stage in
the life cycle and the competitiveness of the marketplace. In a large and growing market,
other things being equal, it may be commercially reasonable to deploy a larger promotional
effort to better exploit the opportunity. A product at an earlier stage in its life cycle will
require more substantial promotional efforts to generate awareness and secure trial than
a more established product. And with more competing products, it may be desirable to
pursue a higher SOV in order to generate awareness, secure trial and build share for the
product. Data regarding efforts put forth on behalf of other products or analogues may
provide indicators of CRE, after adjusting for market potential, stage of life cycle and com-
petitiveness of the marketplace.
Second: determining unit sales impact

Given ‘but for’ conditions, the next question is: how would these conditions translate to
marketplace outcomes, particularly with respect to incremental sales and incremental prof-
its? Some may attempt to base ‘but for’ sales on initial forecasts and sales plans of the parties;
such an approach, however, is unlikely to have anticipated and accounted for factors that
may have been beyond the control or influence of the parties, including competitor behav-
iour, changes in treatment paradigms and shifts in disease incidence. Rather, the mechanism
that links efforts, revenues and costs should be explicitly characterised, if possible.
Consider a co-development agreement. It may be alleged that failure to exert CRE
led to a decision to not pursue development of certain indications for the drug in ques-
tion, with the result that marketing for these indications may be delayed. To be a plausible
source of damages, CRE would imply an obligation to pursue regulatory approval for these
indications; otherwise, it would not be apparent that any alleged delay in the launch of
these indications would generate damages. Should this condition be satisfied, the damages
model should provide a link between the lack of CRE and the alleged delay in indication
approval, including the likelihood and timing of approval and the associated costs.
Regarding marketing collaborations, the mechanism linking efforts to sales and costs
might be modelled as deriving from share of voice for the product. The key empirical
relationship here is related to the standard concept in pharmaceutical marketing (and the
marketing of most other products) that the level of promotional effort influences the share
of market (SOM) that a seller could capture. Given the role that awareness and trial plays in
the prescribing of pharmaceuticals, the stock of accumulated promotional effort on behalf
of a product may have a bearing on the influence of the flow of SOV. Other things being
equal, the longer a product has been effectively promoted on the market, the less significant
is current promotion relative to the cumulative experience that physicians have received.
327
The relationship between SOV and SOM may be determined based on market data,
and supported by reference to the relevant academic and professional literature. Based on
these data, it may be possible to construct a model of the effects that the accumulated stock
of past detailing effort and the flow of current detailing effort would have on SOM. The
modelling here would not have to incorporate the full analytical complexity that appears in
the academic literature; typically, it would be sufficient for the model to capture the effects
driving sales (i.e., past and current promotional efforts) in an analytically tractable manner.
It is then a matter of determining how SOV would have differed had CRE been pursued,
what would have been the costs of that additional effort, and how (and when) SOM would
have reacted.
Third: calculating incremental profits

Incremental revenues
Once the incremental volume of lost unit sales has been determined, the lost incremental
revenues need to be calculated. For relatively small increments of unit sales, the average net
price that was realised at the time is likely to be an appropriate approximation of the net
revenue per unit that would have been realised.To the extent that there is an expectation of
a relatively large volume of lost unit sales, it may be appropriate to consider any consequent
anticipated effects on net price.The economics of the pharmaceutical industry, however, in
which a physician determines the product to be used, a third party pays a significant share
of the price of the product and the patient directly benefits from the consumption of the
product, tends to lead to circumstances in which incremental changes in product volume
may not imply incremental changes in product price.
Incremental manufacturing costs

Incremental unit sales imply incremental costs associated with manufacturing and market-
ing. There are two principal issues associated with the incremental costs of manufacturing
pharmaceuticals.The first concerns fixed costs and variances, elements of the cost account-
ing system that the claimant may be using. Like other manufactured products, pharma-
ceuticals are typically assigned a standard cost of production; these standard costs tend to
be updated on an annual basis.11 Standard costs, however, typically include an allocation of
fixed and sunk costs (such as facility rent or depreciation, respectively) that would not be
incurred if more units of the product were produced. As such, it is important to determine
the incremental costs of manufacturing the product (such as raw materials) and not assess
and undervalue damages based on the average costs of manufacturing the product. Further,
it may be important to assess the costs incurred at the time, in case the standards were set
such that material variances from the standard costs (such as an unanticipated increase in
the cost of raw materials) were actually incurred.
The second issue regarding manufacturing cost estimates in assessing damages result-
ing from lost unit sales of pharmaceutical products concerns transfer pricing. Because of
the global nature of the pharmaceutical industry and the value of the intellectual property
11 Bulk API is likely to cost the same on a global basis, but secondary manufacturing costs could differ based on
the product presentations that are approved for sale in a particular country.
328
represented by the R&D that led to the discovery of a pharmaceutical product, many
multinational pharmaceutical companies use transfer pricing agreements among their sub-
sidiaries. Typically, these agreements are designed to ensure that those subsidiaries involved
in manufacturing receive a reasonable return on their manufacturing efforts and those
involved with marketing receive a reasonable return on their marketing efforts. As noted
above, the remainder of the profits tends to accrue to the owners of the product-based
intellectual property that led to the ability to generate the profits for the subsidiaries in
the first place. As a result, the transfer pricing ‘cost’ that may be associated with importing
a product for sale in a country would include not only an allocation of fixed and sunk
manufacturing costs, but also an allocation for the return on intellectual property that led
to the discovery of the product. Thus, to the extent that a damages assessment is based on
the transfer pricing cost of the product, damages would be undervalued.12
Incremental marketing costs

The principal incremental costs associated with marketing additional unit sales tend to be
the cost of the additional samples (if any) that would have been distributed plus the cost
of any additional incentive compensation for the sales representatives as a result of greater
sales. In addition, it may be appropriate to consider the opportunity costs of the sales rep-
resentatives. For example, as a result of lost sales, sales representative efforts may have been
assigned to other products; but for the lost sales, however, that time may have been allocated
to the product at issue and thus would be considered to be an incremental cost related to
the lost sales. Note that some marketing costs, such as brand management, are fixed and
typically invariant to lost unit sales. As a result, these types of costs typically would not
be considered to be part of a lost profits calculation due to lost unit sales, unless the lost
opportunity represented all sales of the product such that, but for the allegedly inappropri-
ate activity, a brand manager would have been required.
Damages in intellectual property disputes

Disputes over royalties payable under licensing contracts can take various forms; it is not the
goal of this chapter to review the approaches that may be taken for each possible scenario.
Instead, we make some general observations that are applicable across a range of disputes.
First, actual market transactions for the same or for comparable intellectual property are
likely to yield the most reliable information on the value of a particular intellectual prop-
erty asset and how that value would be shared between a licensor and licensee. Nonetheless,
it is rarely appropriate to simply apply observed royalty rates – either the levels from other
specific licensing agreements or averages across numerous agreements – without adjust-
ments compensating for the particular circumstances at issue. Second, it is important to
keep in mind that intellectual property assets are unique. For this reason, ‘rules of thumb’
such as the once-common ‘25 per cent rule’ are not generally reliable guides to the royalty
rates that should apply in a given situation.
12 The extent to which damages incurred by the global corporate entity (as opposed to the national subsidiary)
are at issue in the litigation is typically a legal question.
329
The damages expert may be expected to offer an opinion on a royalty rate or other
licensing terms that are consistent with what would have been agreed by the parties had
they conducted a good faith negotiation as willing licensor and licensee. A methodology
that is commonly used is analogous to the ‘hypothetical negotiation’ framework employed
in court litigation in the United States. In this context, experts typically make reference
to the ‘Georgia-Pacific factors’.13 While arbitrated disputes may not be bound to adopt
the same approach, it is worth noting that the ‘Georgia-Pacific factors’ cover the issues of
concern: what is the value of the intellectual property; how would that value have been
split between the licensor and licensee; and what are the key sources of bargaining power.
Damages and sales forecasts

There are a number of circumstances that may arise in which a damages analysis calls
for the use of estimated sales levels for a biopharmaceutical product when no actual data
on sales are available. For example, a contract may be prematurely terminated, requiring
the damages expert to estimate the level of sales that would have occurred had it contin-
ued. Another example might be in an investor-state treaty arbitration in which regulatory
authorisation is either improperly revoked or has failed to be granted.
It may be asserted that sales are adequately set out in the business plans and projections.
Whether this is appropriate is likely to depend upon the rationale for development of the
projections, the assumptions used, and the extent to which the projections appropriately
incorporate actual market events. For example, the forecast may have been based on certain
assumptions regarding the product, competitors, and the marketplace that did not come to
pass. Similarly, the forecast may not have anticipated events that did occur and that were
independent of the allegedly inappropriate activity that is otherwise at issue.
For these reasons, it may be preferable to prepare a projection of ‘but for’ sales based on
standard approaches used in the biopharmaceutical industry. A ‘bottom-up’ forecast of sales
in the product category may be prepared using past data on population, disease incidence
and treatment rates, and projections for each of these values that may be available from
independent third parties. Once category sales have been projected, the ‘but for’ share of
sales for the product can be applied. This may be determined using market research results
related to anticipated physician prescribing behaviour.
13 Georgia-Pacific Corp v. United States Plywood Corp, 318 F. Supp. 1116, at 1121 (S.D.N.Y. 1970).
330
24
M&A and Shareholder Arbitrations
Kai F Schumacher and Michael Wabnitz1
We have seen M&A and shareholder arbitrations becoming more litigious over the past
years. This is for different reasons for M&A and shareholder arbitrations. With regard to
M&A disputes, the intensified personal liabilities of the board members and managers to
investigate all business matters potentially relevant to their business have left many market
participants no choice but to analyse transactions for million-dollar purchase price recov-
eries. Concerning shareholder disputes, it is foremost because of increased transparency
and the self-awareness of shareholders to enforce their rights and maximise their eco-
nomic position.
From a damages perspective, M&A and shareholder arbitrations are only partially com-
parable. Damages in M&A arbitrations involve accounting, forensic or corporate finance
aspects, sometimes in addition to valuation issues. In contrast, damages in shareholder dis-
putes most often deal with the correct valuation of a specific business. From a damages
point of view, methodical valuation matters dominate the controversy.
Therefore, M&A and shareholder arbitrations will be discussed separately.
M&A disputes
Usually, neither sellers nor buyers intend for a conflict related to M&A transactions.
Nevertheless, such conflicts are more common than generally thought because of the high
purchase prices involved and the economic impact associated with these one-off transac-
tions. Moreover, these disputes can be of critical economic importance for the parties
involved.The authors have witnessed purchase price adjustments of more than 50 per cent,
worth millions of euros, during their practical activity.
1 Kai F Schumacher is director and member of the management and Michael Wabnitz is managing director of
AlixPartners GmbH, Munich.
331
Post-contractual M&A disputes often cannot be prevented. There is an abundance of

issues that may lead to a dispute in the course of a transaction. An incorrect purchase price
adjustment, a dispute concerning the calculation of an earn-out or a breach of a balance
sheet warranty is familiar to most M&A experts. However, cases such as breaches of exclu-
sivity, failures to close a transaction, directors and officers liabilities, an ‘unlawfully flattering’
business plan or the non-disclosure of decision-relevant information are more likely to be
themes that some may not have been exposed to.
To structure the most frequent types of M&A disputes, a clustering by time of occur-
rence (before and after signing or closing) and by potential issues is provided below.
Generally, M&A disputes can be structured as follows:
• pre-signing issues that require either forensic investigations, accounting analysis or
hypothetical valuations (or any combination thereof);
• issues that are attributable to the period between signing and closing of the transaction,
which deal with investigative or valuation questions; and
• post-closing related issues that are valuation and accounting-related.
SIGNING CLOSING
• Breach of representations and • Hidden material information • Purchase price adjustments

warranties • Failure to close the • Earn-out dispute
• Hidden material information transaction • Management misconduct
• Breached exclusivity or letter • Material adverse change • Solicitation of customers or
of intent (MAC) employees
Investigation, accounting or
‘hypothetical’ business valuation Investigation and valuation issues Accounting and valuation issues
issues
The expertise of the quantum expert analysing the facts underlying the dispute and deter-
mining the damages might differ for each issue. A flawed purchase price adjustment or the
violation of a balance sheet warranty can be relatively easily identified and documented on
the basis of closing accounts, financial data, financial statements and due diligence docu-
ments. In cases of suspected balance sheet manipulation, fraud or an ‘unlawful sugar-coated’
business plan, however, the evidence is much harder to find. In this category of damages,
most often forensic email reviews and interviews of key personnel are required in addition
to the regular data analysis. For example, the email from an accountant to a colleague or
the thoughtless statement of an operating manager have been the sought-after evidence for
purchase price reductions worth millions of euros.
The success of a claimant in any arbitration not only depends on whether the claim-
ant is able to expose and prove the facts justifying his or her claim, but also how the often
interdependent claims are dealt with. In contrast to most other areas of arbitration, M&A
disputes often involve several claims that might be financially interdependent. For exam-
ple, an incorrect balance sheet guarantee might also affect the purchase price adjustment
claimed, the earn-out adjustment and the allegation that not all relevant information was
332
disclosed.The interdependencies between the claims should be carefully analysed, so as not

to award the same effect twice or more.
The fact that not all price-relevant information was provided during the due diligence
phase is especially sensitive. It could lead to a situation in which the buyer claims that he
has wilfully – thus intentionally – been deceived by the seller. In many jurisdictions, such
a claim enables the buyer to lever out contractually agreed liability limitations of the pur-
chase agreement.
The proof of damages in practice

The fundamental objective of every damage assessment is to restore the injured party – i.e.,
put them in a position they would have been in without the injuring event. However, this
relatively simple principle of damage determination must be adjusted depending on the
jurisdiction and the underlying purchase agreement. And these adjustments may be rela-
tively complicated in practice.
M&A damage quantification – often misunderstood

If an M&A-related dispute has occurred, there is not only the need for evidence, but there
is also the question of how to quantify the compensation. If, for example, a provision was
omitted in the balance sheet, even some experienced litigators still believe that the damage
represents ‘only’ the shortfall in the account balance – leading to a euro-for-euro indem-
nity. For example, if a provision was omitted amounting to €1 million, it is quite often seen
in practice that claimants claim exactly the same amount as damages. However, in some
jurisdictions, some provisions might not even have a full future cash flow effect because of
prudence principles. Moreover, the provision might be influenced by interest rate effects,
tax effects, interdependent damages and (overlooked) mitigations.These effects can quickly
accumulate to deviations of plus or minus 40 per cent or more, compared to the simplified
euro-for-euro approach.Thus, not only when confronted with valuation-related issues, but
also with contested accounting errors and high-impact breaches of balance sheet represen-
tations and warranties, it is advisable to opt for a more precise approach to quantify damages.
The most commonly used form of the damage assessment is the ‘differential method’,
applying the widespread ‘but for’ theory in damage calculation. It represents the actual
situation (including the damage) compared with the counterfactual (without damage).The
difference in value between the two financial situations represents the damage.
For larger disputed amounts it is advisable for buyers and sellers to verify whether the
damage should be calculated applying the ‘differential method’. If confronted with larger
indemnifications that affect more than one year, the but-for analysis is most often the
preferable approach because of its increased accuracy. For indemnifications that are either
smaller in size or are limited to one (accounting or tax) period, an adjusted euro-for-euro
approach could be advisable. This adjusted approach looks for additional financial implica-
tions that are considered in isolation, without the need for the differential method.
Financial statements might not be 100 per cent accurate

In M&A arbitrations it is often asserted by the respondent that the underlying financial
statements are audited and, therefore, the amounts stated in these financial statements must
333
be correct. This is a common misunderstanding. Financial statements are generally deemed

to provide the stakeholder (e.g., investors or creditors) with a ‘true and fair’ view or a faith-
ful presentation of the relevant financial situation of a company. Financial statements are
described as showing a ‘true and fair view’ when they are free from material misstatements
and faithfully represent the financial performance and position of an entity. However, the
interpretation of what constitutes a material misstatement of a single balance sheet item in
a M&A arbitration might be different from an auditor’s entity perspective.
For practical reasons, auditors have to rely on a risk-based auditing approach that applies
statistical sampling. Audits are neither designed nor are they intended to scrutinise each
position of the set of financial statements every year. Consequently, auditors have defined
thresholds with regard to total assets and revenues. Up to these thresholds, misstatements in
the financial statements are not considered ‘material’. This assumes already that other mis-
takes have not even been identified. However, for a one-time M&A dispute the thresholds
of the controversial parties might be different to that of an audit.This supports our conclu-
sion that a euro-for-euro compensation should be treated with even more caution if based
solely on the information of financial statements.
The fortune and misfortune of purchase price adjustment mechanisms

Corporate transactions are frequently associated with very material purchase price pay-
ments. Therefore, it is understandable that both buyers and sellers often agree to adjust the
purchase price on the date of economic transfer given the actual financial situation. This is
done by means of contractually agreed purchase price adjustment mechanisms. In theory,
such purchase price adjustment mechanisms should include several interdependent key
financial parameters such as net debt, net working capital, investments, capital expenditures
and off-balance sheet items to cover significant price-related aspects up to the economic
transfer date. In practice, the parties frequently agree on a simplified purchase price adjust-
ment mechanism for the sake of a reduction in complexity. This simplified purchase price
adjustment might be limited, for example, only to the net financial debt and selected items
of the working capital. This simplification comes at a price: it allows the shrewd seller as
well as the price-conscious buyer to influence the purchase price payable and to open
a discussion for a price adjustment, depending on the party that prepares the transac-
tion accounts.
No financial statement is free of subjective assessments of the party who prepared the
financial statement. Allegedly ‘aggressive’ valuation assumptions or asserted still tolerable
inaccuracies accepted by auditors might give rise to subsequent purchase price claims.With
full access to all information of the transaction object as well as with updated knowledge
since the last financial statement was prepared, many buyers come to different conclusions
on the value of the acquired target than at the time of the signing of the purchase agree-
ment. However, even sellers can use simplified purchase price adjustment mechanisms to
their advantage (e.g., when they use accounting discretion in the preparation of the transac-
tion financial statements).
When a ‘locked box’ is not really locked

In general, the economic transfer of an M&A target takes place with the closing. However,
given that the closing occurs weeks or months after the financials have been analysed and
334
after the purchase price has been agreed, an adjustment of the purchase price is often incor-
porated in the purchase agreement. This adjustment of the purchase price should reflect
the economic changes that have occurred between the last reference date underlying the
purchase price basis and the closing. Unfortunately, these purchase price adjustments are a
frequent source for disputes.
The ‘locked box mechanism’, a price mechanism that is meant to avoid purchase price
adjustment disputes, is regularly used in today’s seller’s market. Given the scarcity of attrac-
tive M&A targets, the sellers are currently about to reduce their risk of price adjustment
disputes with the locked box mechanism. With the locked box mechanism, the economic
transfer of ownership takes place at a point in time in the past. Most often, the date of the
last audited financial statements is chosen for practical reasons. Given that the past financials
rarely change, in theory, the locked box mechanism should erase all purchase price adjust-
ment disputes.
However, what is intended to not be adjustable, and thus to avoid conflicts, will often
be diluted for other sub-goals. Generally, ‘no leakage’ clauses and other adjustments might
dilute the locked box mechanism allegedly preventing cash outflows until the actual trans-
fer date. Consequently, transactions might be labelled as ‘locked box’ but still be disputable.
Adjustments to the locked box mechanism are often an invitation for a contestation.
Purchase price multipliers – when damages soar

Purchase price multiples have a special status in M&A disputes. If, for example, the damage
relates to the normalised earnings before interest and taxes (EBIT) or earnings before interest,
taxes, depreciation and amortisation (EBITDA), which would be the basis for the purchase
price derived by a EBIT/EBITDA-multiplier, then the question arises whether the damage
is to be compensated only once or several times (equal to the EBIT/EBITDA-multiplier).
This is an interesting question, and not only from a financial perspective. A remarkable
leverage effect for the buyer can be noted if the data is able to support the reimbursement
of damages based on a multiplier. Even relatively minor EBIT/EBITDA adjustments might
suddenly be followed by large compensations. Therefore, each identified potential adjust-
ment needs to be analysed and assessed as to whether it affects the long-term profitability
of the business, and thus should be included in such multiplier analysis. Alternatively, it may
comprise a one-off effect (e.g., for only one specific period). While an ongoing reduction
in profitability or lowered growth assessment usually effects such multiplier calculation, a
unique failure of a balance sheet treatment might not. In general, it can be concluded that
a recurring financial impact (e.g., recurring customers that were lost but have still been
included in the business plan) might be claimed several times, while one-time effects like a
neglected non-recurring provision should be claimed only once.
Shareholder disputes
There are a number of different types of cases in which evidence of the valuation of
shares is disputed. For example, the termination of shareholder agreements, compulsory
‘squeeze-outs’ of minority shareholders, going private transactions, takeover bids by insid-
ers, related party transactions and corporate restructurings where shareholders have dis-
sent right, often end in contentious proceedings about the correct valuation of a certain
company or a certain stake in this company. Often, shareholders are compensated with the
335
reference to market value or fair (market) value.What may sound like a straightforward task
turns out to be highly controversial in practice.
Differences most often stem from three different areas. First, the meanings of ‘market
value’ and ‘fair (market) value’ are often confused with each other. Second, there are sev-
eral different valuation approaches that might or might not come to similar values. Third,
adjustments of the values derived by a certain methodology might be needed to reflect the
individual circumstances of each specific case.
‘Market value’ v. ‘fair value’ v. price paid

There seems to often be confusion regarding the term ‘market value’.2 Unfortunately, it
is used quite inconsistently within the appraisal profession, as well as in academic books.
Therefore, it is not surprising that this confusion spills over to shareholder arbitrations.
In general, a ‘market value’ reflects the economic concept of an equilibrium price in a
perfect market. It ignores influences on prices resulting from imperfect knowledge, unusual
circumstances or the specific situations of the buyer or seller. According to the International
Valuation Standards, which form a foundation of international valuation best practice, mar-
ket value is defined as ‘the estimated amount for which an asset should exchange on the
valuation date between a willing buyer and a willing seller in an arm’s length transaction,
after proper marketing and where the parties had each acted knowledgeably, prudently and
without compulsion.’3 The market value of an asset will reflect its highest and best use.4
In contrast, a ‘fair value’ reflects the estimated price for the transfer of an asset or liability
that may include subjective interest of one or both parties. Usually, the value that is fair
between two parties will equate to that obtainable in the market.5 However, there will be
cases where the assessment of fair value requires adjustments from the market value and
vice versa. For example, the price that is fair for two shareholders in a non-quoted business
may mean that the price is fair between them, but it could be different from the price that
might be obtainable in the market.6 Finally, the price actually paid might be different to the
market value and the fair value because of negotiation skills, time pressure, liquidity needs,
etc. It is for good reasons that there is a famous quote from the star investor Warren Buffett
that says: ‘Price is what you pay; value is what you get.’7
Thus, to increase transparency, arbitrators and experts need to analyse and determine
what the basis for the potential compensation is and if and how it has to be adjusted to
represent the correct valuation perspective.
2 International Financial Reporting Standards for example generally define ‘market value’ as ‘fair value’. The
International Private Equity and Venture Capital Association (IPEV) uses the term ‘Fair Value’ in a way that is
essentially equivalent to ‘Market Value’. IPEV: IPEV Guidelines, August 2010, para. 3.2.
3 International Valuation Standards, IVS Framework, 2011, para. 30.
6 International Valuation Standards, IVS Framework, 2011, para. 43 (a).
7 Wiley: Warren Buffett quotes, without date, http://eu.wiley.com/WileyCDA/Section/id-817935.html [last
accessed on 27 August 2016].
336
Valuation approaches
There are a number of methods that can be used to derive the value of a business or asset.
Different valuation methods often come to (slightly) differing results. Thus, the matter of
the valuation method is an important decision for the quantification of damages in share-
holder arbitrations. Arbitrators might be confronted with differing results stemming from
different valuation methods. Then, they must decide which method to prefer. If the range
of the values derived by different methods is wide, it is important to consider what weight
or importance to attribute to each method.
The possible methods can be categorised into three overall approaches:
(a) market approach (e.g., active publicly traded stock, recent transactions of the company
in focus, recent observable transactions in substantially similar companies);
(b) income approach (e.g., discounted cash flow (DCF) methods); and
(c) cost approach (e.g., net asset values, reproduction values).
Each of these overall valuation approaches includes different detailed methods of applica-
tion. The goal in selecting a specific valuation method for a damages assessment is to find
the most appropriate method under the particular circumstances of a specific case.This also
depends on the information available, the profitability of the company and other specifics
of the case at hand.
For the quantification of damages in shareholder disputes, there might be established
nuances in the valuation profession. For example, for squeeze-outs in Germany, the courts
have shown a tendency towards the higher of the market approach (represented by the
weighted average of the three-month share price considered the as minimum hurdle) and
income approaches (using the DCF or earnings value method). In other areas of busi-
ness valuations, the preferable method in most cases is seen as the market approach.8 For
example, transaction prices on active markets are considered as reflecting the market value.
However, in the event that no transaction price or no prices of similar assets or liabilities are
available – which is quite often the case because of the unique nature and individual specif-
ics of the business or asset – the income approach is often the appropriate method. Lastly,
if even the income approach might not be applicable (e.g., for continuously non-profitable
entities) the cost approach should usually be considered. Hereafter we will discuss the
peculiarities of the three different valuation approaches in more detail.
8 The International Private Equity and Venture Capital Association (IPEV), for example, has issued more
detailed guidelines, which set out recommendations intended to represent current best practice on the
valuation of private equity and venture capital investments. Although the IPEV is not related to disputes
or shareholder arbitrations it provides a guideline from an industry that relies on the buying and selling of
enterprises and consequently their appropriate valuation. According to the IPEV Guidelines the valuer should
be biased towards market-based measures of risk and return to derive fair values. It should be noted that
IPEV uses the term ‘Fair Value’ in a way that is essentially equivalent to ‘market value’. See IPEV: International
Private Equity and Venture Capital Valuation Guidelines, December 2015, para. 3.2., p. 28.
337
Market approach
The International Valuation Standards state:
The market approach provides an indication of value by comparing the subject asset with identi-
cal or similar assets for which price information is available.
Under this approach the first step is to consider the prices for transactions of identical or similar
assets that have occurred recently in the market. If few recent transactions have occurred, it may
also be appropriate to consider the prices of identical or similar assets that are listed or offered
for sale provided the relevance of this information is clearly established and critically analysed.
It may be necessary to adjust the price information from other transactions to reflect any differ-
ences in the terms of the actual transaction and the basis of value and any assumptions to be
adopted in the valuation being undertaken.There may also be differences in the legal, economic
or physical characteristics of the assets in other transactions and the asset being valued.9
The International Valuation Standards perfectly summarise the basic concept of the market
approach. Moreover, they indicate to the expert that further adjustments might be needed.
Income approaches such as the DCF method

The DCF method is the most commonly used valuation method to evaluate international
investments10 and is frequently applied in business valuations.11 Income-based valuation
approaches, such as the DCF method, have also become increasingly popular for the quan-
tification of damages in international arbitrations over the past years.12
There are various methods of using discounted cash flows in valuation. All DCF meth-
ods involve calculating the value of future cash flows at a certain reference date – this is
known as ‘present value’. Present values are derived by discounting the cash flows to a
reference date allowing for a specified discount rate. Discount rates used to derive the
compensation reflect (1) the time value of money associated with the cash flow of a future
period and (2) the riskiness of the cash flows to be discounted.
The undisputed advantage of the DCF method is its flexibility not only for shareholder
disputes but also for many other valuation settings. In cases of privately held companies,
exotic structures or debt instruments it is often the preferred option for quantum experts.
However,‘because of its inherent reliance on substantial subjective judgements, and because
of the general availability of market based techniques, the valuer should be cautious’.13
Despite its subjectivity, the DCF model might be the only reasonable solution for many
arbitrations where market-based techniques are inappropriate or not available.
9 International Valuation Standards, IVS Framework, 2011, para. 57-58.

10 Tom Keck, Eric Levengood, Al Longfield: Discounted Cash Flow analysis in an international setting: A survey
of issues in modeling the cost of capital, Journal of Applied Corporate Finance, fall 1998, volume 11.3, p. 82.
11 The DCF method represents the so-called income approach; ‘The income approach is frequently applied
in the valuation of businesses and business interests’; International Valuation Standards Council: IVS
200 Businesses and Business Interests, exposure draft, 2 June 2016, para. 60.1, p. 6.
12 PricewaterhouseCoopers: 2015 – International arbitration damages research, 2015, p. 3.
13 IPEV: International Private Equity and Venture Capital Valuation Guidelines, December 2015, para. 3.8, p. 40.
338
Cost approaches such as net asset value

This methodology involves deriving the value of a business by reference to the value of
its net assets on the current cost to purchase or replace an asset. The cost approach is an
important tool for determining the fair value of a property or asset, particularly where
reliable data relating to sales of a comparable asset is not available and where the asset does
not directly produce an income stream. Furthermore, the cost approach is more applicable
when the asset could be exchanged or substituted for another asset. On the other side,
this valuation methodology is not appropriate where the company is realising an adequate
return on its assets and its value derives predominantly from its income streams.
Adjustments to the values derived by certain valuation approaches

When using a variety of valuation methodologies, it is important to consider that the
values derived from differing methods may need to be adjusted to enable comparability.
Some valuation methodologies enable a direct valuation as they are directly related to the
company to be valued (e.g., price of recent transactions in shares in the company, net asset
value). Others allow for specific factors in their calculation to be adjusted (e.g., discounted
cash flow and earnings of underlying business), while others assume that the subject of the
valuation is identical to a group of comparable companies. Adjustments may be required to
reflect the fact that this group, although comprising the most comparable companies avail-
able, still remains incomparable in key respects.
Hereafter, we will highlight the most popular adjustment concepts that are usually dis-
puted in shareholder arbitrations, such as the illiquidity discount and the control premium:
When using an income approach it may also be necessary to make adjustments to the valua-
tion to reflect matters that are not captured in either the cash flow forecasts or the discount rate
adopted. Examples may include adjustments for the marketability of the interest being valued
or whether the interest being valued is a controlling or non-controlling interest in the business.14
In general, the effects of a discount or a premium should ideally be included in the estima-
tion of future cash flows. However, there are often situations where the cash flows stem-
ming from these discounts or premiums can hardly be adjusted because of a lack of infor-
mation. Then, a discount or premium is often applied as a percentage multiple to the final
estimate of the equity value. Moreover, there can sometimes be the necessity to make use
of both, applying sequentially a premium (e.g., for control) but to also consider a discount
(e.g., for illiquidity).
Illiquidity discount
When valuing an asset that will be bought and sold via a private sale, it is common to
consider the extent to which the investment is liquid15 or marketable. Market liquidity
14 International Valuation Standards Council: IVS 200 Businesses and Business Interests, exposure draft,
2 June 2016, para. 60.10, p. 8.
15 The concepts of liquidity and illiquidity refer to the degree of ease and certainty with which assets can be
converted into cash.
339
risk relates to the inability of trading at a fair price with immediacy.16 Liquidity in a market
ensures that an asset can be sold rapidly, with minimum transaction costs and at a competi-
tive price.17 Consequently, liquidity risk is applicable to most equity investments not listed
on an organised exchange or traded in an active over-the-counter market.
If an asset is not liquid, it is appropriate to consider to what extent its value needs to be
adjusted.18 In business valuation this aspect is referred to as ‘illiquidity discount’ or some-
times as ‘marketability discount’ or ‘fungibility discount’:
Both the theory and the empirical evidence suggest that illiquidity matters and that inves-
tors attach a lower price to assets that are more illiquid than to otherwise similar assets that
are liquid.19
Marketability discount studies exist for both minority and majority interests. For minor-
ity interests, restricted marketability can usually be observed through two different lines of
studies: restricted stock studies and IPO-based studies. While restricted stock studies com-
pare the prices of listed companies that have been paid in private placements with that of
stock market prices, IPO-based studies compare the value of minority shares of companies
with that paid in an IPO. However, it should be noted that selection bias and other biases
inherent in these studies need to be considered.
Illiquidity discounts for majority interests can be observed from studies that compare
the transaction multiples for majority stakes for private and public listed companies and
the respective discounts considering systematic differences between the different groups of
companies and different company sizes.
The marketability discount is applied whether or not the equity interest is a control-
ling or non-controlling interest. However, individual characteristics of the legislation that
might influence the specific valuation principles are to be considered as well. For example,
illiquidity and marketability discounts are not considered in German court cases.
Control premiums and discounts for lack of control

These are applied to reflect differences between the unadjusted value underlying a certain
valuation method and the subject asset with regard to the ability to make decisions.20 As
an example, share prices of public companies usually reflect minority stakes and, therefore,
shareholders generally lack control, having no ability to make decisions related to the
operations of the company. As such, when a value is derived from non-controlling shares
but it is intended to reflect the controlling rights of a shareholder, a control premium
may be appropriate. The value of controlling a firm lies in being able to run it better than
16 European Central Bank: Liquidity (Risk Concepts) – Definitions and Interactions, February 2009, p. 18.
17 European Central Bank: Liquidity (Risk Concepts) – Definitions and Interactions, February 2009, p. 14 f.
18 Pratt & Niculita: Valuing a Business, Fifth Edition Mc Graw Hill, 2007, p. 416-457.
19 Aswath Damodaran: Marketability and value: measuring the illiquidity discount, Stern School of Business,
July 2005, p. 34.
20 For example, anything less than 100 per cent of the shares leaves room for attacks by minority shareholders,
more than 50 per cent are usually required for certain corporate actions and more than 25 per cent usually
represents a blocking minority (e.g. ,‘Sperrminorität’ according to German stock corporation act).
340
the current decisive shareholders and to increase the own cash flows. Hence, Professor
Damodaran of New York’s Stern Business School has concluded that: ‘Consequently, the
value of control will be greater for poorly managed firms than well run ones.’21
First, it needs to be analysed whether the business plan assumptions (explicitly or
implicitly) on which the valuation is based already include the premise of having control
over a business. In such cases, a further consideration of a control premium might be mis-
leading. Similarly, a discount for lack of control would be appropriate if the disputed valu-
ation relates to a minority issue and the minority shareholder would not be able to equally
participate on the value of the future cash flows as reflected in the initial business plan.
Controversies arise as to how the control premiums, in particular, the discount for a
lack of control, are quantified in practice. Theoretically, they are calculated based on the
cash flows attributable to control. However, in practice, control premium studies are often
applied that compare the observed prices paid for controlling interests in publicly traded
securities with the publicly traded price before such a transaction is announced. Examples
can be found in studies like one by FactSet Mergerstat.22 However, control premium stud-
ies have to be assessed critically. They may overstate or understate the effects resulting from
synergies, competitive pricing or other individual specifics. Therefore, each transaction has
specific factors that affect its pricing, which means it needs to be examined critically before
any conclusion is drawn.
Summary
As shown above, the specific questions that arbitrators typically face in M&A arbitrations
and shareholder arbitrations are diverging. M&A arbitrations often tend to incorporate
several claims that might not only be valuation-related, but also driven by accounting and
investigative issues in dispute. One of the major difficulties is not to double-count the
frequently interrelated claims. In contrast, shareholder arbitrations usually deal with very
technical valuation questions like the appropriate valuation method and its correct adjust-
ment to the specific case.
It can be assumed that the trend to exercise and enforce rights of purchase agreements,
as well as shareholder rights, will further increase in the future. Because of the immense
economic importance that accompanies many of these arbitrations, this consequence is
more than understandable and should come as no surprise.
21 See Aswath Damodaran: The Value of Control: Implications for Control Premia, Minority Discounts and
Voting Share Differentials, June 2005, p. 2.
22 The FactSet Mergerstat/BVR Control Premium Study is an online searchable database that generates
empirical support for the quantification of control premiums, see www.factset.com/data/company_data/
mergerscps.
341
25
Damages in Intellectual Property Arbitrations
Trevor Cook1
Introduction
The party autonomy that is an especial feature of arbitration provides the parties and the
tribunal with the freedom to determine the approach to be adopted to the issue of dam-
ages2 in an intellectual property dispute. This contrasts with the general approach in litiga-
tion, in which the court must generally apply the law applicable to the contract in issue
or the law or laws that apply to the various intellectual property rights in issue. The flex-
ibility afforded to parties in arbitration provides an opportunity in international intellectual
property disputes by allowing the parties in a submission agreement or in an arbitration
clause to tailor the approach to be adopted by the tribunal in assessing damages by, for
example, providing for a single applicable law for such assessment in place of many, provid-
ing an option to recover the defendant’s profits as an alternative to the damage suffered by
the rights holder, or providing that triple damages not be awarded. But it also provides a
challenge in those very types of intellectual property disputes that are particularly suited
to arbitration – the multi-jurisdictional infringement disputes where, on the face of mat-
ters, and absent guidance in the submission agreement, damages fall to be determined by
reference to the different applicable laws that apply to intellectual property in different
countries, an approach that risks unnecessarily complicating the assessment of damages.
Such issues of applicable law are not a problem with a dispute that relates only to
intellectual property in one country – the natural approach in such a case is to apply the
law of that country, although there is nothing to stop the parties from taking the unlikely
course of specifying another law. Similarly, disputes that arise under an arbitration clause
1 Trevor Cook is a partner at Wilmer Cutler Pickering Hale and Dorr LLP.
2 ‘Damages’ in this chapter is meant to include any type of financial award received by the rights holder, other
than that of legal costs, and so would include not only damage as suffered by the rights holder but also the
profits secured by the infringer, where the law applicable to such assessment provides for their disgorgement.
342
in an intellectual property licence or other agreement, even where the territory of the
licence includes many countries, present less of a challenge from this perspective than
multi-jurisdictional infringement disputes that are the subject of a submission agreement,
as the applicable law under which damages are most naturally assessed in the former case
will generally be the proper law of the agreement itself.
There is a need for parties and for tribunals in international arbitrations to be better
informed of the variety of approaches to damages in intellectual property disputes that
different jurisdictions adopt. This allows the identification of areas of similarity and of dif-
ference, and so will allow parties to tailor the best approach to the assessment of damages,
especially where the tribunal faces a situation that does not compel one single approach.
Given the vast amount of scholarship and case law that already exists on the US approach to
the issue of damages for the infringement of intellectual property rights this chapter seeks
in a small way to redress the balance by outlining, at a general level, the different approaches
to the assessment of such damages at an international level and under some of the differ-
ent legal systems in Europe.3 This chapter will conclude with observations about certain
approaches to the assessment of damages that are adopted in some jurisdictions but which
when applied in the context of an arbitral award may give rise to issues of enforceability
under the New York Convention.
Although this chapter focuses on matters of substantive law, it should be noted that
different jurisdictions will also adopt different procedural approaches to the assessment of
damages and that an arbitral tribunal is not constrained as to which such approach it adopts.
Arbitral tribunals have broad discretion on issues such as discovery and expert evidence,
which if not properly managed can add significant delay and expense in connection with
the assessment of damages. In addition, one can identify two other significant procedural
issues specific to the assessment of damages.
One is the scope these assessments offer to bifurcate, by which the tribunal4 can deter-
mine damages in a separate stage of proceedings that are only initiated after there has
been a determination as to liability. Such bifurcation avoids the need for costly discovery
and elaborate expert accounting evidence directed to quantum; if there is no liability this
exercise can be avoided. Although in litigation this can result in a delayed recovery in the
event that an initial finding of no liability is reversed on appeal, as most arbitration clauses
or submission agreements do not provide for an appeal route, this should not be an issue.5
3 For a thorough comparative treatment of damages for patent infringement see Thomas F. Cotter -
Comparative Patent Remedies: A Legal and Economic Analysis (Oxford University Press 2013), which is
supplemented by entries on the Comparative Patent Remedies blog at http://comparativepatentremedies.
blogspot.com/.
4 Some national courts also take this approach. Both English and German courts bifurcate patent infringement
disputes as between liability and quantum. The draft rules of procedure of the EU Unified Patent Court
also envisage that assessing the amount of damages awarded to the successful party may be the subject of
separate proceedings.
5 Indeed, in those jurisdictions which bifurcate the two, it is not uncommon for the parties, once liability is
established, and either because what really mattered commercially was an injunction, or recognising the costs
involved with a determination as to quantum, to settle this by negotiation, resulting in less reported case law
on such determinations.
343
A related procedural issue can arise where the applicable law, as discussed below, permits
the right holder to choose between an assessment of the damage that it has suffered as a
result of the infringement and the benefit that the defendant has secured as a result of it.
Both involve some measure of discovery on the part of the infringer, but whereas the for-
mer also involves discovery on the part of the rights holder, the latter does not. Accordingly,
the courts in some jurisdictions require that the rights holder elect which approach it wants
to adopt once liability has been established; however, because the rights holder will have
insufficient information on which to base such election, a court can order a limited amount
of financial discovery before it does so to enable it to make a more informed choice.6
The TRIPS Agreement

An internationally recognised set of minimum standards in intellectual property, applying
to most countries of the world, is provided by the TRIPS Agreement of 1994, Article 45 of
which addresses the issue of damages:
Article 45 – Damages
1.The judicial authorities shall have the authority to order the infringer to pay the right holder
damages adequate to compensate for the injury the right holder has suffered because of an
infringement of that person’s intellectual property right by an infringer who knowingly, or with
reasonable grounds to know, engaged in infringing activity.
2. The judicial authorities shall also have the authority to order the infringer to pay the
right holder expenses, which may include appropriate attorney’s fees. In appropriate cases,
Members may authorize the judicial authorities to order recovery of profits and/or payment of
pre-established damages even where the infringer did not knowingly, or with reasonable grounds
to know, engage in infringing activity.
Thus, TRIPS requires that compensatory damages be available under the applicable laws
of Member States and envisages that these are to be the primary financial remedy, but that
innocence on the part of the infringer is a permitted defence to such an award, although in
practice few legal systems show much sympathy to innocent infringers.
It also envisages that as an alternative to compensatory damages, the courts may order
the recovery of the infringer’s profits or payment of pre-established damages, even where
there is innocent infringement. One assumes that these two approaches are intended, where
they are both available, to be alternatives in any one case. However, TRIPS does not man-
date either of them, and just as the remedy of an ‘account of profits,’ as it is referred to in
English law, is not available in all countries,7 neither is that of the award of pre-established
6 See Island Records v.Tring International [1995] FSR 560 (English High Court).
7 Although US law in general also allows recovery on an unjust enrichment basis in cases of infringement of
intellectual property rights, it precludes this for infringement of utility patents (but not design patents, i.e.,
registered designs from a European perspective) by virtue of legislation in 1946 and 1952, the effect of which
was confirmed by the US Supreme Court in Aro Mfg C v. Convertible Top Replacement Co 377 US 476, 507.
This has been criticised – see, for example, Roberts, C L; The Case for Restitution and Unjust Enrichment
Remedies in Patent Law, ([2010] Lewis & Clerk Law Review Vol. 14:12, pp 101-132).
344
damages, such as ‘statutory’ damages, a form of financial relief that is sometimes encoun-
tered with copyright infringement.8
European approaches to assessing damages

Although national jurisdictions in Europe have widely differing approaches to, and tradi-
tions of, assessing monetary compensation for intellectual property infringement,9 a basis
for harmonisation now exists and is starting to emerge within the EU by virtue of Article
13 of Directive 2004/48/EC on the enforcement of intellectual property rights,10 and the
interpretations now starting to be placed on this, by national courts in Europe and the
Court of Justice of the EU. Article 13 provides:
(1) Member States shall ensure that the competent judicial authorities, on application of the
injured party, order the infringer who knowingly, or with reasonable grounds to know, engaged
in an infringing activity, to pay the right holder damages appropriate to the actual prejudice
suffered by him/her as a result of the infringement.
When the judicial authorities set the damages:
(a) they shall take into account all appropriate aspects, such as the negative economic conse-
quences, including lost profits, which the injured party has suffered, any unfair profits made by
the infringer and, in appropriate cases, elements other than economic factors, such as the moral
prejudice caused to the right holder by the infringement; or
(b) as an alternative to (a), they may, in appropriate cases, set the damages as a lump sum on
the basis of elements such as at least the amount of royalties or fees which would have been due
if the infringer had requested authorisation to use the intellectual property right in question.
(2) Where the infringer did not knowingly, or with reasonable grounds know, engage in infring-
ing activity, Member States may lay down that the judicial authorities may order the recovery
of profits or the payment of damages, which may be pre-established.
This provision, representing as it does a legislative compromise, and couched as much of

it is in permissive, rather than prescriptive, terminology cannot be said to be entirely clear
as to the relationship between these various bases of assessment. In particular, as discussed
below, presenting ‘unfair profits made by the infringer’ as a type of damage suffered by the
rights holder is a potential source of confusion as to whether such ‘unfair profits’ should be
calculated wholly without reference to the actual damage so suffered. Unfortunately, the
8 Samuelson, P, Hill, P, & Wheatland, T; Statutory Damages: A Rarity in Copyright Laws Internationally, But
For How Long? ([2013] 60 J Copyright Soc’y U.S.A.), observing that although the USA provides for statutory
damages for copyright infringement, Australia, France, Germany, the Netherlands and the UK do not.
Statutory damages may, however, sometimes result in a disproportionate level of damages award which may, in
the context of international arbitration, expose an award to challenge as a penalty.
9 See, for example, Table 1 at p 667 of Graham, SJH, & Van Zeebroeck, N.: Comparing Patent Litigation Across
Europe: A First Look; ([2014] 17 Stan Tech L Rev 655). It should be noted that such variability, to a degree, is
also a consequence of the different approaches that such jurisdictions take to the issue of discovery.
10 Directive 2004/48/EC of 29 April 2004 on the enforcement of intellectual property rights (OJ
L195 2.6.2004 p.16) (replacing by way of corrigendum the version published in OJ L 157 30.04.2004) and
Statement by the Commission concerning Article 2 of Directive 2004/48/EC (OJ L94 13.04.2005 p. 37).
Article 68 of the Agreement on a Unified Patent Court (OJ C 175, 20.6.2013 p.1) is in similar terms.
345
corresponding Recital 26 does little to assist except to make it clear, as it does in its final
sentence, that the Article provides no mandate for damages (in the general sense), however
assessed, to be punitive:
With a view to compensating for the prejudice suffered as a result of an infringement committed
by an infringer who engaged in an activity in the knowledge, or with reasonable grounds for
knowing, that it would give rise to such an infringement, the amount of damages awarded to
the right holder should take account of all appropriate aspects, such as loss of earnings incurred
by the right holder, or unfair profits made by the infringer and, where appropriate, any moral
prejudice caused to the right holder.
As an alternative, for example where it would be difficult to determine the amount of the actual
prejudice suffered, the amount of the damages might be derived from elements such as the royal-
ties or fees which would have been due if the infringer had requested authorisation to use the
intellectual property right in question.
The aim is not to introduce an obligation to provide for punitive damages but to allow for com-
pensation based on an objective criterion while taking account of the expenses incurred by the
right holder, such as the costs of identification and research.
Thus Article 13(1) establishes the following four bases for assessing damages where the
infringer knew, or ought to have known, that it was infringing:
at least the amount of royalties or fees which would have been due if the infringer had requested
authorisation to use the intellectual property right in question ...
the negative economic consequences, including lost profits, which the injured party has suffered ...
any unfair profits made by the infringer ...
in appropriate cases, elements other than economic factors, such as the moral prejudice caused to
the right holder by the infringement.11
If Member States choose also to render innocent infringers liable for damages, Article 13(2)
permits them to provide for the ‘recovery of profits’, which can only mean the same as ‘any
unfair profits made by the infringer’ or, as an alternative, ‘the payment of damages, which
may be pre-established.’12 The first three of these bases of assessment are met in most legal
systems in one context or another, and are discussed further below.
‘At least the amount of royalties or fees which would have been due if the infringer
had requested authorisation to use the intellectual property right in question’
If the rights holder does not itself exploit an intellectual property right at all, or does not
exploit it other than by licensing, there is no logical basis on which it can claim a loss of
11 In Case C-99/15 Christian Liffers/Producciones Mandarina SL et Gestevisión Telecinco SA (EU Court of Justice
17 March 2016), a copyright case, the Court held that claiming the amount of royalties or fees that would
have been due if the infringer had requested authorisation to use the intellectual property right in question
did not preclude the right holder from also claiming compensation for ‘moral prejudice’, a concept that
appears to be popular in Spain, where it is also applied to patent cases.
12 See footnote 8, supra, and associated text.
346
manufacturing or other profits from exploitation of such intellectual property and so, unless
it can claim an account of the infringer’s profits or pre-established damages, it is limited to
recovering royalties.13 Even a rights holder that does use intellectual property to protect its
own sales but that is infringed may not be able to show that, but for the infringement, it
would have captured all of the infringer’s sales, leaving it to recover royalties on those that
it could not have captured. Although unpaid royalties can be seen as a form of lost profit
under Article 13(1)(a) for an entity that licenses out its patents, royalties are expressly treated
as an alternative, appropriate for innocent infringers, under Article 13(1)(b).
Much has been written and many courts have opined on how to determine an appro-
priate royalty rate in any given case.14 In Europe, the primary approach of the English and
German courts has been to use the rates set out in comparable licences, to the extent that
these exist and can meaningfully be compared, as a starting point for such determination.
Of these the German courts have adopted the more generous approach, often applying an
uplift of up to 100 per cent on a case-by-case basis to the royalty rate found in compara-
ble licences to reflect the fact that most real life negotiations of royalty rates, unlike those
notional negotiations envisaged by the courts after a finding of liability, concern rights that
have not yet been held to be either valid or infringed by the activity in question. Such an
‘infringer surcharge’ should, however, be distinguished from a specific ‘infringer supple-
ment’ applied on a flat-rate basis in every case, which would probably constitute a penalty.15
English courts also recognise as an alternative where there is no satisfactory comparable
licence, the ‘profits available’ approach, involving an assessment of the profits that would be
available to the licensee, absent a licence, and apportioning them between the licensor and
the licensee.16
13 This is why it is common in much infringement litigation for a rights holder to join as a co-plaintiff an
exclusive licensee that does exploit the right in issue.
14 The US approach established in Georgia-Pacific Corp v. United States Plywood Corp, 318 F. Supp. 1116, 1119-20
(S.D.N.Y. 1970), modified and aff ’d, 446 F.2d 295 (2d Cir. 1971) is well known internationally. However, it has
been observed that ‘The principal legal framework for determining a reasonable royalty – the Georgia-Pacific
list of fifteen factors, including a hypothetical negotiation test – has been widely criticized as ambiguous,
unworkable, inherently contradictory, and circular.’ in Graham, S, Menell, P, Shapiro, C, and Simcoe, T; Final
Report of the Berkeley Center for Law & Technology Patent Damages Workshop 15 August 2016; (Texas
Intellectual Property Law Journal, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2823658).
15 See Case C-481/14 Jørn Hansson v. Jungpflanzen Grünewald GmbH (EU Court of Justice 9 June 2016), and
also the decision of the referring Düsseldorf Appeal Court, concerning the infringement of a Community
plant variety right, an intellectual property right which is established under Regulation (EC) 2100/94 of
27 July 1994 on Community plant variety rights, Article 94 of which provides for ‘reasonable compensation’
as a financial remedy for infringement. Although the enforcement Directive applies also to this right and is
discussed to an extent in the body of its judgment, the conclusions of the Court of Justice are expressed only
in terms of the Regulation, as to which it concludes ‘that article [94] cannot serve as a basis either for the
imposition of a flat-rate “infringer supplement” or, specifically, for the restitution of the profits and gains made
by the infringer’.
16 See, for example, Ultraframe (UK) Ltd v. Eurocell Building Products Ltd [2006] EWHC 1344 (English Patents
Court) at [47], point (viii), quoted below. As the licensee bears the greater risk such apportionment should
favour it, which has led to what has been called the ‘25 per cent rule’ to describe the licensor’s share - see
Goldscheider, R, Jarosz, J and Mulhern, C; Use of the 25 per cent Rule in Valuing IP ([2002] Les Nouvelles,
page 123), testing its factual underpinnings by reference to actual royalty rate data. See also KPMG
Profitability and Royalty Rates Across Industries: Some Preliminary Evidence [2012], which concludes
347
‘The negative economic consequences, including lost profits, which the injured
party has suffered’
A convenient, and it is suggested uncontroversial, set of principles for assessing the lost
profits suffered by a rights holder that exploits an intellectual property right that has been
found to have been infringed were set out in Ultraframe (UK) Ltd v. Eurocell Building Products
Ltd,17 a decision of the English Patents Court:
(i) Damages are compensatory.The general rule is that the measure of damages is to be, as far
as possible, that sum of money that will put the claimant in the same position as he would have
been in if he had not sustained the wrong.
(ii) The claimant can recover loss which was (i) foreseeable, (ii) caused by the wrong, and (iii)
not excluded from recovery by public or social policy. It is not enough that the loss would not
have occurred but for the tort.The tort must be, as a matter of common sense, a cause of the loss.
(iii) The burden of proof rests on the claimant. Damages are to be assessed liberally. But the
object is to compensate the claimant and not to punish the defendant.
(iv) It is irrelevant that the defendant could have competed lawfully.
(v) Where a claimant has exploited his patent by manufacture and sale he can claim (a) lost
profit on sales by the defendant that he would have made otherwise; (b) lost profit on his own
sales to the extent that he was forced by the infringement to reduce his own price; and (c) a
reasonable royalty on sales by the defendant which he would not have made.
(vi) As to lost sales, the court should form a general view as to what proportion of the defend-
ant’s sales the claimant would have made.
(vii) The assessment of damages for lost profits should take into account the fact that the lost
sales are of ‘extra production’ and that only certain specific extra costs (marginal costs) have been
incurred in making the additional sales. Nevertheless, in practice costs go up and so it may be
appropriate to temper the approach somewhat in making the assessment.
(viii) The reasonable royalty is to be assessed as the royalty that a willing licensor and a willing
licensee would have agreed. Where there are truly comparable licences in the relevant field these
are the most useful guidance for the court as to the reasonable royalty. Another approach is the
profits available approach. This involves an assessment of the profits that would be available
to the licensee, absent a licence, and apportioning them between the licensor and the licensee.
(ix) Where damages are difficult to assess with precision, the court should make the best
estimate it can, having regard to all the circumstances of the case and dealing with the matter
broadly, with common sense and fairness.
that reported royalty rates ‘tend to fall between 25% of gross margins and 25% of operating margins’. In US
litigation the use of the ‘25 per cent rule of thumb’ was criticised in Uniloc USA Inc and Uniloc Singapore
Private Ltd v. Microsoft Corp (Federal Circuit, 4 January 2011) as ‘a fundamentally flawed tool’ because it did
not differentiate between different industries, technologies, or parties, but rather assumed the same profit
split regardless of the size of the patent portfolio in question, or the value of the patented technology, but see
Binder, C and Nestler, A;Valuation Of Intangibles And Trademarks - A Rehabilitation Of The Profit-Split
Method After Uniloc ([2015] Les Nouvelles, page 203).
17 Ultraframe (UK) Ltd v. Eurocell Building Products Ltd [2006] EWHC 1344 at [47] (English Patents Court).
348
The application of the first two of these principles has allowed a patentee to recover dam-
ages that exceed its turnover in the articles that actually infringe, by taking account of fore-
seeable consequences such as loss of sales of spare parts and of servicing contracts, even after
patent expiry.18 The sixth principle is especially applicable in the not uncommon situation
of a market in which there are other competitors, when an assessment of the patentee’s sales
prospects absent the infringement has to be made.19
‘Unfair profits made by the infringer’

As already observed, the obscure drafting of Article 13 of the enforcement Directive invites
the question of what, if any, relationship exists between the lost profits that the injured
party has suffered and the ‘unfair profits’ made by the infringer. Thus, although ‘negative
economic consequences, including lost profits which the injured party has suffered’ are
clearly a type of ‘damages appropriate to the actual prejudice suffered by [the right holder]
as a result of the infringement’ it is less easy to see how, as a matter of logic, ‘unfair profits
made by the infringer’ can properly be so characterised. Article 13(1)(a) appears to treat
both lost profits and ‘unfair profits’ in the same way, while saying nothing about the rela-
tionship between them. Are they alternatives, or should they both be taken into account,
and if so which one predominates? To conflate the two concepts, as does Article 13(1)(a),
and to characterise a remedy for unjust enrichment as another type of damage suffered
by the right holder, rather than as a separate and alternative basis for securing recompense
from the infringer, is a recipe for confusion, as has indeed proved to be the case in practice.20
Thus, in its 2010 review of the national implementation of the enforcement Directive,21 the
Commission commented in the Report that accompanied the Staff Working Paper that:
The main aim of awarding damages is to place the right holders in the same situation as they
would have been in, in the absence of the infringement. Nowadays, however, infringers’ profits
(unjust enrichment) often appear to be substantially higher than the actual damage incurred by
the right holder. In such cases, it could be considered whether the courts should have the power
to grant damages commensurate with the infringer’s unjust enrichment, even if they exceed the
actual damage incurred by the right holder. Equally, there could be a case for making greater use
of the possibility to award damages for other economic consequences and moral damages.
18 Gerber v. Lectra [1995] RPC 383 (English Patents Court); [1997] RPC 443 (English Court of Appeal).
19 As in Fabio Perini v. LPC [2012] EWHC 911 (English Patents Court). Here the patentee had a 70 per cent
market share that was coming under attack, and its loss of profit was assessed on the basis that it had a 65 per
cent chance of selling a machine at €3,824 million to practise the patented process, plus a 65 per cent chance
of receiving income for ancillaries and aftersales, and a 25 per cent chance of selling a more speculative
machine at €2,157 million, plus a 65 per cent chance of aftersales.
20 For a fuller discussion of this issue see Cook, T, Making sense of Article 13 of the Enforcement Directive:
Monetary compensation for the infringement of intellectual property rights; in Torremans, P, (Ed) – Research
Handbook on Cross-border Enforcement of Intellectual Property (Edward Elgar 2014) and Johnson, P,
‘Damages’ in European law and the traditional accounts of profit (Queen Mary Journal of Intellectual Property,Vol.
3 No. 4, pp. 296–306).
21 Commission Report COM (2010) 779 final 22.12.2010 and Commission Staff Working Document SEC
(2010) 1589 final 22.12.2010.
349
The Commission in its Staff Working Document recognised that the recovery of profits
unlawfully made by an infringer was a new concept in many EU Member States and that in
this respect Article 13 was being implemented in a variety of different ways, some of which
effectively capped such an assessment at the level of damage suffered by the rightholder,
which would render any assessment of the profits made by the infringer pointless. However,
even without involving the Court of Justice, national courts of different EU Member States
have moved towards accepting that these two bases for assessment should be regarded as
alternatives, with neither having any bearing on the other.
Such approach has been adopted by the English and German courts (which have long
been able to provide for recovery on this basis) in assessing the profits to be recovered from
those who infringe trademarks by selling repackaged goods parallel imported from else-
where in the EU without complying with the requirements for so doing as established by
the Court of Justice.22 The English Court of Appeal,23 reversing the judge at first instance,
but consistent with a decision of the German Federal Supreme Court in a similar case,24
held that the damage caused to the trademark proprietor by the infringement had no
bearing on a recovery based on determining the infringer’s profits. In France, a decision of
the Paris Court of Appeal in 1963 having excluded the possibility of claiming the profits
of a patent infringer,25 the law was then changed expressly to permit it as a result of the
enforcement Directive.26 However, there was controversy as to quite how the profits made
by the infringer should be determined, and whether or not the loss actually suffered by
the infringer was of any relevance in making such assessment. Recent cases have, however,
shown the French courts, when assessing the level of financial recovery on the basis of
the profits of the infringer, doing so without any reference to the actual loss suffered by
the patentee.27
As recovering the infringer’s profits becomes a more popular approach, the courts are
starting to clarify some of the issues that it raises, such as how to apportion profits in patent
22 As established in Case C-348/08 Boehringer Ingelheim KG and anr v. Swingward Ltd (EU Court of Justice
26 April 2007).
23 Hollister Incorporated v. Medik Ostomy Supplies [2011] EWPCC 40, [2012] EWCA 1419. In so holding the
English Court of Appeal, while observing that the scope of Article 13(1) of the enforcement Directive was
‘not entirely clear’ observed: … ‘the Community legislature may well have used the term ‘damages’ in a
broad sense to include both reimbursement of the right holder’s lost profits and the return of profits made by
the infringer, and that Member States must, through their judicial authorities, provide a right holder with a
remedy against a defendant who has knowingly, or with reasonable grounds to know, engaged in an infringing
activity, which remedy is appropriate to the prejudice suffered by the right holder and takes account of all
relevant circumstances such as the profits the right holder has lost and the profits the infringer has made.
Certainly I do not understand Article 13 to preclude the award of an account of the profits made by the
infringer in such a case. Nor do I understand it to require a court undertaking an account of the profits made
by the infringer to adjust that account by reference to the profits lost by the right holder.’
24 Case IZR 87/07 Zoladex (Bundesgerichsthof 29 July 2009).
25 Paris, 4th chamber, 22 February 1963, Ann. P.I 1963, p. 377; TGI Seine, 3rd chamber February 1964, JCP Ed.
G, 1965, 14334.
26 Article L 615-7 of the French Intellectual Property Code as amended by Act No 2007-1544 of
29 October 2007.
27 Colmar Court of Appeal, 1st civil chamber, 20 September 2011, Docket No. 10/02039, Jurisdata No.
2011-029869; PIBD 2012, No. 953, III, 6; Propr. industr., 2012. comm 11; Paris Court of Appeal 5th Division,
1st chamber, 7 November 2012 (Quest Technologies v. SARL Distrisud).
350
cases where the infringing process is part of a larger one28 or the infringing goods do
not correspond to the inventive concept underlying the patent that has been held to be
infringed,29 and the extent to which the infringer’s overheads may be deducted.30
Constraints on enforcement of certain types of award as penalties

As discussed above, one important advantage of arbitrating international intellectual prop-
erty disputes is that the parties can specify in their arbitration agreement a particular
approach to the calculation of damages. Whatever approach the arbitral tribunal takes to
the assessment of damages it should be mindful of the issue of enforceability under Article
V(2)(b) of the New York Convention, under which enforcement of an arbitral award can
be refused if the recognition or enforcement of the award would be contrary to the public
policy of the country in which enforcement is sought. There is thus a concern that the
enforcement of an award that can be characterised as a penalty, for example, because it is
for pre-established, or ‘statutory’, damages, out of all proportion to the scale of the infringe-
ment, or it has been enhanced on grounds of ‘wilful’ infringement, may not be enforced in
a country that does not allow for penal awards of damages, even if the award is in accord-
ance with the applicable law as chosen by the parties. While such a concern is real and
should be addressed, one should perhaps not overstate it, as in practice, certain jurisdictions
that have a ‘rule’ against penalties have not necessarily, at least in relation to contractual
penalties, been prepared to characterise it as a rule that is so fundamental as to constitute
‘public policy’ for the purposes of Article V(2)(b) of the New York Convention.31
28 Celanese International Corp v. BP Chemicals Ltd [1999] RPC 203 (English Patents Court).
29 Design & Display Limited v. OOO Abbott & Anr [2014] EWHC 2924 (IPEC), [2016] EWCA Civ 95 (English
Court of Appeal).
30 Hollister Incorporated v. Medik Ostomy Supplies [2011] EWPCC 40, [2012] EWCA 1419 (English Court of
Appeal); Design & Display Limited v. OOO Abbott & Anr [2014] EWHC 2924 (IPEC), [2016] EWCA Civ 95
(English Court of Appeal), in both of which the English Court of Appeal extensively cited Dart Industries Inc v.
Decor Corp Pty Ltd, [1994] FSR 567 (High Court of Australia).
31 Amaltal Corporation Ltd v. Maruha (NZ) Corporation Ltd (New Zealand Court of Appeal, 11 March 2004),
applied in Pencil Hill Limited v. US Citta di Palermo S.p.A. (English High Court, 19 January 2016).
351
26
Damages in Competition/Antitrust Arbitrations
Carlos Lapuerta and Richard Caldwell1
Many arbitrations involve competition law claims. In arbitration proceedings that involve
contracts, one party may claim that a particular contractual provision is anticompetitive, or
that market power or abusive conduct has distorted the market in a manner that is relevant
to the question facing the tribunal. For example, we have seen competition issues raised
in disputes over the review of prices in major long-term contracts for the sale or purchase
of energy. Competition claims can also arise in investor-state disputes, as when the state’s
actions or omissions are alleged to distort competition. Below we address several issues that
are relevant to the calculation of damages from competition claims: the determination of
market shares, calculating overcharges in price-fixing and monopolisation cases, and finally
a prominent recent debate on whether awards for damages in investor-state disputes can
themselves lead to distortions of competition or set adverse precedent that would under-
mine the future enforcement of competition law.
Determining market shares

To estimate damages from a competition law claim, the expert must compare the financial
position of the claimant under two alternative scenarios. One scenario is the actual scenario
that reflects the distortions of the alleged anticompetitive conduct. The other scenario
is inherently hypothetical: one in which the alleged anticompetitive conduct had never
occurred. Market shares are relevant because the respondent’s alleged conduct may well
have suppressed the market share of the claimant, so the damages analysis must assess the
market share that the claimant could have reasonably expected to obtain in the absence of
the disputed conduct.
1 Carlos Lapuerta and Richard Caldwell are both principals of the Brattle Group, based in the London office.
They have worked closely together for many years.
352
Assessing a hypothetical scenario is not actually unique to competition law claims; it

follows directly from the broader principle of making the claimant whole, which governs
the estimate of damages from a broad spectrum of legal claims. When someone breaches
a contract, the estimate of damages must consider what would have happened, but never
did, had the respondent continued to honour the contract. However, claims for damages
from competition claims are particularly susceptible to challenges of speculation, because
it seems relatively straightforward to reconstruct a hypothetical scenario of uninterrupted
contract performance, as opposed to reconstructing a scenario in which the market shares
of various competitors differ significantly from reality.
For claimants there are several responses to allegations of speculation over market shares.
A general logical response is that the respondent is itself responsible for the need to specu-
late; the respondent’s conduct has distorted the actual distribution of market shares, requir-
ing the very inquiry that the respondent declares speculative. A more specific evidentiary
response involves a careful review of the records retained in the ordinary course of business
by the claimant. Most claimants retain business plans and financial projections that they
developed in the ordinary course of business prior to the commencement of the disputed
conduct. Those plans often contain projections of the market shares that the claimants
anticipated, and a sound analysis of damages should investigate their reasonableness. Their
reasonableness should command particular weight if the claimant demonstrated a willing-
ness to invest, or was able to attract financing, in reliance on the specific projections of
future market shares.
To check the reasonableness of a claimant’s projections there are two common tech-
niques: an analysis of time series data, and comparisons to other geographic or product
markets in which the claimant is also present. The time series approach looks at the market
share that the claimant had prior to the initiation of the disputed conduct, and may entail
extrapolations from growth that occurred beforehand. Comparison to other geographic
and product markets can test the ability of the claimant to succeed in other areas where the
conduct in dispute never occurred.
The economic literature has developed several useful tools for assessing market shares
under alternative hypotheses. Many tools are variations of a basic ‘Cournot’ model that
assumes logical responses by producers as customers and their competitors react to changes
in prices and quantities. A key ingredient for these models is the elasticity of demand,
which measures the sensitivity of consumers to price changes. Techniques have developed
for estimating demand elasticities, and it is often possible to find independent papers that
estimate elasticities for products ranging from electricity to alcohol. Competition authori-
ties often use variants of Cournot models to assess the potential effects of proposed mergers
on prices, so it is logical to extend the use of the models to estimate damages from claims of
anticompetitive conduct in arbitration proceedings. Nevertheless, our experience has been
that the models may not work well if the specific claim involves a shock to the market that
is exceptionally strong in magnitude, as the empirical literature often derives elasticities
based on time periods that do not involve significant market disruptions.
When determining market shares, it is important to adopt a dynamic focus. A static
analysis would simply impute a value to lost market share, as if the claimant had lost the
share permanently. However, if the arbitration itself puts an end to the disputed con-
duct, then the claimant may eventually catch up with the market share that it could have
353
reasonably anticipated in the absence of the disputed conduct. If so, then an appropriate
damage analysis should look forward over time, and consider that the lost market share will
diminish with the passage of time, and eventually cease as the claimant fully regains the
same position it would occupy in the hypothetical competitive scenario. It would, there-
fore, be reasonable to measure future damages that diminish over time; the challenge is to
determine the pace of the claimant’s catch-up.
With respect to catch-up, the tables reverse with respect to allegations of speculation. A
respondent may ordinarily feel inclined to levy accusations of speculation, but the respond-
ent has a natural incentive to support a damage estimate that looks into the future to project
a rapid catch-up rate that reduces the total damage estimate. A respondent can legitimately
complain that the greater speculation lies in a fully static analysis that refuses to contemplate
future changes. If the claimant simply imputes a value to lost market share, as if it had lost
the share in perpetuity, then the calculation contains an internal contradiction: the analysis
presumes that disputed conduct has caused a loss in market share, without considering that
the cessation of the disputed conduct could lead to a restoration of market share. We can
imagine reasons why a claimant’s lost market share may in fact be irreversible, but a sound
analysis of damages should be able to identify and articulate the reasons.
Calculating overcharges in price-fixing and monopolisation cases

The specific claim confronting an arbitration tribunal may be that the respondent has
charged an excessive price to the claimant, either as a result of the respondent’s participa-
tion in a cartel or as an abuse of its dominant position. As with the discussion of market
shares above, the calculation of damages requires the analysis of an alternative scenario that
never occurred: one in which the respondent charged a reasonable price.
If the members of an arbitration tribunal are not themselves experts in competition
law, they may look to prior decisions by competition authorities for guidance. However,
tribunals should recognise limitations to the precedent. Competition commissions often
have access to detailed data concerning the costs of companies involved in price-fixing and
monopolisation, and respondents have an incentive to claim that a tribunal cannot award
damages for overcharges unless the claimant first demonstrates that the prices charged bear
no reasonable relation to underlying costs. However, arbitration tribunals may not have the
ability to compel the respondent to produce detailed cost data, and must therefore strike
a balance. Cost information can be useful, but it is not reasonable to insist on data if the
tribunal cannot compel its production.
As an example, in the electricity industry, it is possible to estimate the costs of electricity
generation using publicly available studies concerning the costs of building and operating
different types of power stations. Many electricity companies use publicly available studies
to create models that estimate the costs of power stations owned by competitors, which
they integrate into market-wide models that provide insight into how different types of
competitive behaviour will affect market prices. The models are well-suited to estimating
overcharges from anticompetitive conduct, and provide a good example of a reasonable
alternative to a respondent’s internal cost data.
In the absence of the respondent’s cost data or publicly available industry estimates, the
most logical assessment of overcharging will involve a reference to a competitive bench-
mark. Commodities exchanges provide natural competitive benchmarks for products
354
ranging from metals to energy. In such cases there are two principal challenges to measur-
ing overcharges. First involves the distinction between geographic markets. Often the price
in the exchange will involve a separate geographic market than the one in dispute – the
exchange may reflect effective competition by buyers and sellers, while the dominance or
cartel involves reduced competition in a distinct geographic market. If the exchange does
not reflect trading in the same geographic area as the disputed conduct, then the analysis
of damages should determine whether and how to adjust the traded prices. Depending
on the circumstances the correct answer may involve no adjustment or adding or deduct-
ing transportation costs or taxes, or considering other economic variables that can distin-
guish markets.
A second challenge is whether the respondent sells the product subject to other terms
and conditions that render it fundamentally distinct from the contracts traded in a com-
modity exchange. In the natural gas industry, for example, producers have claimed that the
provisions for flexibility under their long-term contracts render the product more valuable
than indicated by prices on traded markets. A reasonable damage analysis will consider the
possible merits of such claims, and whether an appropriate adjustment would be to raise or
lower the exchange traded price when deriving a competitive benchmark for the calcula-
tion of overcharges.
Estimating an overcharge is most difficult where the product is not a commodity, and
there is no independent exchange with traded prices that can provide insights into the
competitive price. In such cases the best available data may come from research such as
surveys, or statistics such as average import prices compiled by government agencies. If the
quality of the data is not good, then tribunals should impose a greater evidentiary burden
before awarding damages for overcharges. For example, if the price charged exceeds the
average indicated by import data in 10 other countries, and there is no logical explanation
for a premium, then the evidence would appear strong enough to create a presumption
of overcharging. In contrast, showing that the price is the third or fourth highest within a
sample of 10 countries might not be enough.
Claims that damage awards can distort competition

Several recent disputes have involved a perceived conflict between competition law issues
and the breach of legitimate investor expectations under bilateral investment treaties. The
common fact pattern involves a long-term agreement between the state and the investor,
which the state then breaches. The investor claims damages for the breach, and the state
responds by saying that the long-term agreement distorts competition. Examples include
long-term agreements that the government of Hungary signed to purchase power from
electricity generators; the government subsequently claimed that the agreements distorted
competition inappropriately. Similar arguments arise in arbitrations involving aid to inves-
tors in renewable energy sources such as wind, hydroelectric and solar power.The investors
allege the breach of legal obligations to provide certain levels of financial support to renew-
able energy, and a debate emerges over the consistency of the previous levels of financial
support with European law on state aid, which is designed to avoid distortions of competi-
tion. Another example is the case brought by the Micula brothers, involving a long-term
agreement in which the government of Romania offered tax benefits for a number of
years in exchange for the investors’ commitment to invest in an economically deprived
355
area of Romania. As Romania approached its accession to the European Union, it decided
to cancel the tax benefits prematurely, on the grounds that they distorted competition in
conflict with European law.
The tribunal rejected the state’s argument in the Micula case, deciding that an award
of damages could reconcile the perceived conflict: the state had the right to terminate the
agreement on competition grounds, but should still pay damages to honour the legitimate
expectations of the investors under the relevant investment treaty. Nevertheless, the per-
ceived conflict between competition law and investor expectations has re-emerged during
the enforcement phase of the Micula case. The European Commission has published an
amicus curiae brief explaining its view that paying damages would itself distort competition
in violation of European law.
Is there really a conflict between issuing a damages award and respecting the competi-
tion concerns expressed in European law? This chapter does not claim to answer the ques-
tion from a legal perspective, but offers an economic and financial analysis of the alleged
conflict. The analysis engages with the concerns expressed by the European Commission,
but concludes that there is no conflict between competition policy and the award of dam-
ages, as long as tribunals consider the competition issues appropriately when tasked with
determining damages.
For ease of discussion we separate the competition law concerns into short-term and
long-term. A short-term concern is the potential distortion of competition if the investor
remains active, and has not ceased operations upon the breach of the state’s agreement. If
the agreement indeed distorts competition, and the investor receives full compensation as
if the agreement were still effective, then the concern is that the distortion of competition
will continue. However, structuring a damages award appropriately can avoid any ongoing
distortion to competition. The key is to structure the award as is typical in the form of a
lump-sum payment. If the investor receives a single payment, and knows that its continu-
ing operations will not attract any ongoing support, then the investor will behave as if the
agreement no longer exists, while receiving full compensation for the breach.
A simple hypothetical example can help illustrate. Assume that the breach of the invest-
ment treaty involves the cancellation of a long-term commitment to subsidise the coal
used by a coal-fired power station, by €30 per ton. The state argues that continuing the
payments would distort competition, leading the investor to generate more electricity than
warranted. The state further argues that paying the award has virtually the same effect
as continuing the subsidy. However, as an economic matter, the receipt of a lump-sum
award will change incentives significantly relative to the continuation of payments under
the agreement.
After receiving a lump-sum award, the power station in this example must purchase
coal at the market price, which by definition is €30 per ton higher. In the future, all rational
economic decisions concerning the operation of the power station will revolve around
the market price of coal, so there will be no ongoing distortion of competition. The key is
that the investor’s compensation should not depend on the precise amount of coal actually
burned going forward, but solely on the expected amount that a tribunal determined was
reasonable when it approached the task of awarding damages.
We have been involved in one investor-state dispute where the tribunal declined to issue
a lump-sum award for all damages, but issued a specific award concerning past damages
356
while retaining jurisdiction to monitor the state’s future conduct. The tribunal warned the
state that more damages would arise every year if the state continued to breach its obliga-
tion to the investor. In that case there was no specific argument about competition law, but
the case is interesting because one could argue that the contingent nature of the eventual
compensation could affect the investor’s incentives and ongoing management decisions:
shutting down operations, for example, could interrupt the expected flow of future com-
pensation from the state. If a tribunal adopted a similar award structure in a case that pre-
sented competition law concerns, then there would be a legitimate basis for questioning
whether the award itself could distort competition in the future. However, to avoid ques-
tions over future distortions of competition, a tribunal could structure the award to address
all prospective damages, fully discharging the state’s continuing obligations to the investor.
We now turn to a separate long-term concern, which does not involve the potential
distortion of competition from the particular investment at issue. Rather, the long-term
concern is that paying the award will set an adverse future precedent. The argument is that
European competition policy loses its effectiveness if a state can violate it by offering inap-
propriate support to investors, and then upon the detection of the violation simply cashes
out the investors, so that they receive the same total support as if the support had continued.
Conceivably a state that is determined to grant aid will continue to do so, and will continue
to distort competition, rendering the European law ineffective.
For ease of exposition we address the long-term concerns with the same hypothetical
example of subsidies to coal-fired power stations. We adapt the example to illustrate the
long-term issues, by exploring the concern that paying damages to the investor in a cur-
rent power station will permit the state to reintroduce future subsidies of essentially the
same nature, inducing more investors to build new coal-fired power stations.The imagined
future scenario involves a proliferation of coal-fired power stations by investors who have
confidence in the receipt of full compensation upon the cancellation of any subsidies. If the
state wants inappropriate numbers of coal-fired power stations, then the concern is that the
precedent of paying damages will permit the state to attract them in continued violation
of European law.
The long-term concern immediately raises questions concerning the legitimate expec-
tations of investors in the hypothesised wave of future investments. We do not address that
question, which would be a threshold liability question in the hypothesised future arbitra-
tions. Instead, we presume that the investors in the future wave have legitimate expectations
in the continued receipt of the financial support offered by the state, so that the question
of damages arises again.
In the future arbitration, the tribunal needs to determine damages, and depending on
the facts, the state could express several distinct concerns with the distortion of competi-
tion. One concern is that the mere offer of financial support has led to a proliferation
of investments that would never have been made in a scenario of free competition. In
the context of the previous example, the argument is that there should not be so many
coal-fired power stations, and that their proliferation distorts competition.The tribunal can
in fact assess damages in a manner that addresses the concern, and that avoids any distortion
of competition from the grant of an award. That is, if the state is correct that the investor
should never have undertaken the new investment, then the logical approach is to treat the
case as one of full expropriation, in which the investor receives an award for the full fair
357
market value of the plant, and transfers title to the state.The state then has the ability to shut
down the new investment to avoid any distortion of competition.
A damages award can in fact give strong support for competition policy, if it clarifies
the analytical framework discussed above and puts the state on notice: any future inap-
propriate offers of aid will expose the state to the risk of purchasing future investments
outright in the form of future damage awards for expropriation, in order to pave the way
for their subsequent closure. From a policy perspective it is appropriate for the state itself
to bear financial responsibility for the risks that its future aid may pose to competition.
Appreciating their financial responsibility, states will have a natural incentive to ensure the
compliance of future policies with the competition concerns expressed in European law.
To round out the discussion, it may be useful to appreciate the implications of deny-
ing damage awards on the grounds of promoting European competition policy. Denial of
an award introduces a principle of inadequate investor compensation, ostensibly justified
as a tool for competition policy. Again, presuming that investors have formed legitimate
expectations in response to a state’s policies, it is inefficient to start compensating investors
inadequately to steer the state’s future conduct away from fostering investment and towards
competition policy. It is, in fact, possible to foster investment while respecting competi-
tion policy simultaneously, and while punishing states for a failure to implement competi-
tion policy.
A more nuanced case is one in which no question arises concerning the existence of
the future investments, but with respect to the prices that investors charge or their levels of
output. Below we consider a case where some aid serves valid goals such as environmental
or regional development goals, but the concern is that the total amount of aid exceeds
the appropriate level, presumably distorting competition. Specifically, with respect to the
coal example, perhaps there is no question concerning the desirability of building future
coal-fired power stations in a particular location, but the concern is that excessive aid leads
a wave of future investors to burn too much coal and to sell too much electricity at too
low a price in the power market. Here, again, an appropriate analysis of damages can resolve
any perceived conflict between legitimate investor expectations and competition policy.
In most cases, an extended period of time passes in between the termination of the
financial agreement, which prompts the arbitration, and the assessment of damages. In the
above example, assume that the state reduces the support to the investor, ostensibly in the
view of protecting competition policy. At that point, the investor is on notice concerning
the new level of support considered appropriate. We explore two possibilities: the first is
that the state is correct, and the new reduced level of support meets the legitimate goals of
competition policy. If so, then once the investor perceives the new reduced level, its incen-
tives will change and it will scale down its output, possibly by selling at a higher price in
response to the receipt of less support.
The measurement of damages in such a case will inevitably compare two scenarios:
the ‘but-for’ scenario, in which continued support translated into higher output, and an
‘actual scenario’, with the appropriate, reduced level of support. If the investor is actually
engaged in a strategic game that undermines the legitimate goals of competition policy,
then an appropriate damages award would be able to detect the inappropriate conduct, and
make the investor responsible. In such a case, economic and financial analysis could deter-
mine that the investor has not responded rationally to the economic incentives associated
358
with the new reduced level of aid. The analysis could show if the investor is continuing to
produce a higher level of output after the termination of the support, perhaps in the hope
of maximising damages. The natural framework of damages already permits the state to
explore such a possibility, under the principle of mitigation. That is, if aid distorts competi-
tion policy and leads to excessive output, then by implication, rational economic behaviour
should involve lower output upon the reduction of the aid to the appropriate level.
If the investor has continued to produce at a high level of output, despite the reduced
aid, then the state should be able to demonstrate that the investor is not mitigating damages.
A reduction in the total damages award would implicitly shift responsibility to the investor
for the output decision that lies within its control. To be more specific, assume that the aid
on offer was a subsidy of €30 per ton to the purchase of coal, while an appropriate level of
aid was only €20 per ton. If €30 per ton was excessive and €20 per ton is a superior level of
aid from the perspective of competition policy, it can only be because a profit-maximising
decision by a rational investor in response to the receipt of €20 per ton involves less output
than under the prospective receipt of €30 per ton. If the investor has responded reasonably
to the reduction in support, then it is actually mitigating damages while simultaneously
satisfying the state’s concerns over competition policy. Given appropriate mitigation, the
investor should have an entitlement to full compensation. As explained earlier, structuring
the damages award as a lump-sum payment will compensate the investor, while ensuring a
continued rational response to the new lower level of aid.
If, on the other hand, the investor does not respond to the appropriate, lower level
of aid, then it will be producing more output than is rational. The investor will not be
mitigating its damages, and an appropriate damages award will again resolve any perceived
conflict between legitimate expectations and competition policy, as the tribunal will meas-
ure damages by imputing to the investor a rational response that the investor in fact failed
to provide.
Earlier in the discussion, we explained that it is poor policy to introduce the notion
of inadequate investor compensation as a tool to steer the state’s conduct. However, from
an economic perspective it makes sense to respect the legitimate expectation of the inves-
tor while making it responsible for the decisions that lie within its control. Once the state
corrects an inappropriate level of aid, the investor should get full compensation but only as
long as it follows rationally the economic signals provided under the new policy.
Note that the damages analysis in this example should continue to project the equiva-
lent of the €30 per ton in the but-for scenario, despite our assumption for the purpose of
discussion that the €30 per ton is excessive from a competition policy perspective.The state
may urge the tribunal to award damages based on a but-for scenario that assumes an alleg-
edly appropriate support level of only €20 per ton. However, any such argument is simply a
way of denying liability, pointing to zero damages by collapsing the level of support in the
but-for scenario with the level available in the actual scenario. Implicitly, such an argument
asserts the primacy of competition policy, denying the legitimate expectation of the inves-
tors, which represents a liability issue. However, the concern of this chapter is what to do
if the investor has a legitimate expectation, and if so, whether the award of damages creates
tension with competition policy. The answer is that there is no need to assert the primacy
of competition policy, since the principle of appropriate compensation in fact avoids any
conflict between investment treaty obligations and competition policy.
359
We only offer some limited observations on the liability issue of investor expecta-
tions. Economics can play a useful role in assessing the legitimacy of investor expectations.
Specifically, when specific contracts or legislation appear unclear, economic policy analysis
can supplement legal argument to shed light on whether it makes sense to interpret certain
arrangements as embodying long-term commitments to investors. A state may argue that
it was not reasonable for the investor to expect a long-term commitment to a particular
policy like the €30 per ton in the example above, because a long-term commitment would
have constrained the state’s discretion. However, investment treaties inherently presume
that long-term commitments, as opposed to unbridled state discretion, ultimately benefit
both the investor and the state. Nevertheless, the final answer often depends on a combina-
tion of specific legal and economic analysis.
In conclusion, it does not undermine competition policy to award damages under an
international investment treaty. As long as tribunals structure awards as lump sums, the
awards do not affect the economic incentives surrounding future pricing and output. Nor
does a damages award inherently set an adverse precedent that will tempt states to under-
mine their obligations to fulfil the competition policies embodied in European law. In fact,
the principle of adequate compensation makes states financially responsible for any future
steps that may undermine competition policy. Awarding damages will ultimately make
competition policy more effective, as it makes states bear full responsibility for any distor-
tions that their future policies may cause to competition. In contrast, it makes little sense to
introduce a policy of inadequate investor compensation as a tool to steer the state’s future
behaviour. If an investor does not respond adequately to the correction of future economic
signals that distort competition, then the concept of mitigating damages already provides an
appropriate tool for holding the investor responsible for an inadequate response.
360
Appendix 1
About the Authors
Manuel A Abdala
Compass Lexecon
Dr Manuel A Abdala is a PhD in economics from Boston University and an executive
vice president with Compass Lexecon. He has provided written and oral expert testimony
in more than 130 international arbitration cases, many of them involving treaty disputes
between private investors and governments on topics related to damage valuation, as well
as opinions on government conduct with regard to investors’ expectations and regulatory
standards. He also has substantial experience in commercial arbitrations in shareholder dis-
putes, competition clauses, property damages and political risk insurance claims.
He has published extensively on topics covering infrastructure economic regulation,
institutional design, utility privatisation and valuation, industry structure and competition
policy. Dr Abdala has completed projects on ex post privatisation analysis in several coun-
tries, including various research studies led by the World Bank. He has also served as key
economic adviser to Argentina’s Secretariat of Energy on the energy sector reform that
took place in the 1990s. He has conducted numerous works and studies for private com-
panies and public institutions related to business valuation, damage analysis, and regula-
tory analysis of infrastructure projects in multiple countries in the Americas, Europe, Asia
and Africa.
José Alberro
Cornerstone Research
José Alberro co-heads Cornerstone Research’s international arbitration and litigation prac-
tice and specialises in damages estimation. He has been an ICSID arbitrator.
His expertise focuses on applied economic and financial modelling, with particular
depth in natural resources (including hydrocarbons), petrochemicals, consumer goods,
industrial inputs, and telecommunications. Dr Alberro has provided expert testimony in
international arbitrations involving both investor-state and commercial disputes in cases
361
About the Authors
related to investments in oil and natural gas; mining; construction; alcoholic beverages;
telecommunications; distribution of LPG and port operations.
Dr Alberro holds a PhD in economics from the University of Chicago. He was a ten-
ured full professor at the age of 33 and taught economics at universities in the United States,
the United Kingdom and Mexico for 15 years. He has published extensively in academic
journals; one of his papers was cited in the 1995 Nobel Prize in Economics Lecture. He is
a member of the Mexican Academy of Science. His research and analyses have been widely
published, including in the ICSID Review – Foreign Investment Law Journal, The Journal
of Damages in International Arbitration, The International Arbitration Law Review,Transnational
Dispute Management and the International Commercial Arbitration Review.
Tim Allen
PricewaterhouseCoopers LLP
Tim acts as an expert on loss and valuation issues in a wide range of disputes and industries,
with over 25 years’ experience of in excess of 130 expert assignments. He specialises in
substantial cross-border disputes taken to arbitration and has acted as expert in international
arbitration proceedings brought under ICC, UNCITRAL, LCIA, ICSID and AAA rules, as
well as disputes in the English High Court, the English Criminal Court, the Competition
Appeals Tribunal, the US Courts (State and Federal) and in Hong Kong. He has testified
on numerous occasions. He has been involved in disputes arising from breaches of contract,
acquisition disputes and claims arising out of investment treaties in telecoms, mining, oil
and gas, power generation, financial services and manufacturing.
Angélica André
White & Case LLP
Angélica André is an associate in White & Case’s Paris international arbitration practice
group, having spent a year on secondment in the London office. She focuses on commer-
cial arbitration conducted under the rules of the International Chamber of Commerce
(ICC), the London Court of International Arbitration (LCIA), and the United Nations
Commission on International Trade Law (UNCITRAL), with respect to disputes relating
to construction, energy, infrastructure and M&A. She also deals with annulment proceed-
ings with respect to commercial and investment arbitral awards in France, and enforcement
proceedings in France and various other jurisdictions worldwide. A French and German
national, admitted to the Paris Bar, and with degrees in French law and German law
and an LLM in dispute resolution, Angélica regularly engages in English and French lan-
guage proceedings.
Mark Baker
Secretariat International
Mr Baker has over 24 years of forensic accounting experience and specialises in providing
services to the construction industry. He has provided a variety of services including con-
tract closeout audits, contract pricing compliance reviews, termination proposal prepara-
tion and review, change order reviews, pre-contract pricing analyses, claim preparation and
362
About the Authors
review, and fraud-related review services for contractors and owners. Mr Baker has con-
siderable expertise in forensic accounting, construction cost accounting, cost monitoring
and dispute resolution services for owners and contractors. His expertise encompasses the
review and analysis of a variety of cost types, pricing issues, contract pricing mechanisms,
accounting systems and documentation normally associated with the construction industry
for both the private and government contracting sectors. He has performed construc-
tion contract cost audits on a diverse mix of projects. These engagements involved a vari-
ety of construction cost audit types including contract close-outs, concurrent requisition
reviews on cost reimbursable contracts, pricing disputes and terminations. In other forensic
accounting work, Mr Baker has assisted numerous clients in quantifying damages on con-
tract disputes. His work included measuring the financial impacts to a variety of costs that
are associated with delays and inefficiencies. He has testified as an expert witness in matters
concerning construction damages and environmental disputes. In addition, Mr Baker has
eight years of professional accounting experience in public accounting and private industry,
and is a certified public accountant in the State of New Jersey.
Ronnie Barnes
Ronnie Barnes is a UK qualified accountant and an expert in valuation. Over the course
of his career, he has spent time working in accounting, investment banking and economic
consulting. He has been appointed as a testifying expert in a number of cases involving
corporate valuation, cost of capital and financial derivatives. In addition to his work as an
expert, Dr Barnes has worked on a range of high-profile matters involving major financial
institutions, including a European Union investigation into the market for complex finan-
cial instruments and a number of cases involving structured finance products.
Dr Barnes has a PhD and an MSc, both from London Business School, where he served
on the faculty for over 10 years, and where he taught accounting and finance, with a par-
ticular emphasis on complex valuation issues, including discounted cash flow (DCF) analy-
sis, the estimation of the cost of capital and issues arising from valuation in an international
setting. His research was in the intersection of accounting and finance, with a focus on the
impact of accounting disclosures on financial markets.
Gregory K Bell
Charles River Associates
Gregory Bell leads CRA’s global life sciences practice. As an expert witness, he frequently
testifies on damages in intellectual property, finance and antitrust litigation in courts and
arbitration proceedings in North America, Europe, Asia and Australia. Dr Bell’s business
consulting engagements focus on the economics of business strategy, working with firms
to develop sustainable competitive advantages in specific product markets. He has led and
consulted to numerous projects concerning game theory and competitive strategy, global
launch strategy, product pricing and positioning, capital budgeting and real options, and
cost-benefit analyses. Dr Bell is a chartered accountant in Canada and earned his MBA and
PhD in business economics from Harvard University.
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About the Authors
Ermelinda Beqiraj
PricewaterhouseCoopers LLP
Ermelinda Beqiraj is a partner in PwC UK specialising in the provision of expert evidence
on financial and valuation issues in litigation and international arbitration, with a particular
focus on disputes arising from transactions. She has over 15 years of experience as a forensic
accountant during which time she has been involved in the assessment of losses in numer-
ous cases.
Ermelinda has been recognised as a leading damages expert witness in international
arbitration by Who’s Who Legal. She has been responsible for investigating and quantifying
damages in arbitration and litigation cases involving clients in a range of industry sectors
including power generation and utilities, mining, transport and construction, among oth-
ers. She also regularly advises corporate and private equity houses in disputes arising from
transactions such as breach of warranty claims, completion accounts and earn-out disputes.
She has a particular focus on disputes arising in CEE, Russia and CIS.
Mark Bezant
FTI Consulting
Mark Bezant is a senior managing director at FTI Consulting, based in London. He leads
FTI’s Economic and Financial Consulting practice in EMEA, and was formerly a partner
in Arthur Andersen LLP and Deloitte LLP. Mark has around 30 years’ experience of advis-
ing on all aspects of valuing businesses, companies, listed and unlisted securities, intellectual
property rights and intangible assets. He has been appointed as an expert witness or inde-
pendent expert on over 200 occasions, to assess damages, valuation or accounting issues.
His experience includes matters before UK and international courts and tribunals. He has
testified on approaching 50 occasions.
Micha Bühler
Walder Wyss Ltd
Micha Bühler is a partner in the arbitration and litigation team of Walder Wyss and works
in the Zurich office.
His primary focus is dispute resolution in complex cross-border cases, particularly
regarding infrastructure and construction projects, M&A transactions, banking and finance,
as well as distribution contracts. His practice extends from pre-litigation advice, party rep-
resentation in commercial arbitration and court litigation, to serving as an arbitrator in
arbitration proceedings under various arbitration rules.
Mr Bühler studied law at the universities of Basel and Lausanne (1997; summa cum laude)
and received his master’s degree in international commercial law from the University of
Cambridge (LLM 2003). He is a member of the Bar Examination Board of the Canton of
Zurich and regularly publishes and lectures in his fields of specialisation.
He speaks German, English and French, and is admitted to practise throughout
Switzerland (2000).
With approximately 150 lawyers,Walder Wyss is one of the largest Swiss law firms, with
offices in Zurich, Geneva, Basel, Berne, Lausanne and Lugano. It offers a full range of ser-
vices for the business community in Switzerland, as well as public, private and international
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About the Authors
clients. Its practice teams handle business transactions, banking and finance matters, taxes,
arbitration and litigation as well as IP/IT and competition matters.
Petra Butler
Victoria University, Faculty of Law
Dr Petra Butler is associate professor at Victoria University of Wellington Faculty of Law
and co-director of the Centre for Small States at Queen Mary University of London. She
is qualified as a lawyer in Germany and New Zealand.
Petra teaches and publishes in the areas of domestic and international human rights,
public and private comparative law, and private international law with an emphasis on
international commercial contracts. In addition, she teaches and consults on the law of
unjust enrichment. She advises public and private clients in her areas of her expertise and
has been involved in some of New Zealand’s recent high-profile cases. She is a member of
a number of advisory boards of human rights NGOs.
She is New Zealand’s CLOUT correspondent for the CISG and the United Nations
Convention on the Use of Electronic Communications in International Contracts.
Petra has held visiting appointments around the world, inter alia, at the Chinese University
of Political Science and Law (Beijing), the University of Melbourne, Bucerius Law School
(Hamburg), Universidad de Navarra (Pamplona), Hamid bin Khalifa University (Doha) and
Northwestern Pritzker School of Law (Chicago).
Richard Caldwell
The Brattle Group
Richard Caldwell is an economics and financial expert, with experience valuing businesses
and financial instruments across a range of industries, from energy to banking to telecoms,
and in a range of settings. He frequently provides economic and financial advice to private
clients and expert testimony in litigation. His advice covers the areas of corporate finance
and valuation, the pricing of securities and derivatives, and assessments of competition and
regulatory issues. Richard has testified before the UK Competition Appeals Tribunal on the
level of returns for network companies, and on damages and financial issues before tribu-
nals set up under the rules of the Energy Charter Treaty, the London Court of International
Arbitration, the International Centre for Settlement of Investment Disputes, UNCITRAL,
Dutch Law and Swiss Law.
Heather Clark
White & Case LLP
Heather Clark is an associate in White & Case’s London office, where her practice focuses
on international commercial arbitration and investment treaty arbitration. Heather has pre-
viously worked in White & Case’s New York and Paris offices and is qualified in England
and Wales, New York and Ontario. She has a background in engineering and has experi-
ence in intellectual property and construction disputes, including under the ICC rules and
UNCITRAL rules.
365
About the Authors
Clare Connellan
White & Case LLP
Clare Connellan is a partner based in White & Case’s London office and works with the
international arbitration and construction and engineering groups. Clare advises compa-
nies, state entities, contractors, owners and operators on the resolution of complex disputes,
with a particular focus on disputes within the construction and engineering industry. She
has been involved in arbitrations under the ICC, LCIA, LMAA and CRCICA rules, as well
as ad hoc arbitrations, including under the UNCITRAL rules. Clare also advises on alterna-
tive dispute resolution, including mediation, and is a CEDR-accredited mediator. She has
spent time on secondment to the LCIA as counsel. Clare holds degrees in English law and
French law, an LLM in dispute resolution and is qualified as an English solicitor advocate.
Trevor Cook
Wilmer Cutler Pickering Hale and Dorr LLP
Trevor Cook is an English solicitor with nearly 40 years’ experience in intellectual prop-
erty, and notably, global patent litigation. In 2014 Mr Cook joined WilmerHale in New
York from Bird & Bird LLP in London, where he had been a partner since 1981. He is
chairman of the British Copyright Council and spent several years as president of the
UK group of the International Association for the Protection of Intellectual Property
(AIPPI). He is on the World Intellectual Property Organization (WIPO) list of arbitrators.
In addition to numerous articles and book chapters, Mr Cook has authored the follow-
ing books: A User’s Guide to Patents (Butterworths 2002; Tottel 2007; Bloomsbury 2011,
2016); Pharmaceuticals Biotechnology and the Law (Macmillan 1991; LexisNexis Butterworths
2009, 2016); EU Intellectual Property Law (Oxford 2010); The Protection of Regulatory Data
in the Pharmaceutical and Other Sectors (Sweet & Maxwell 2000); and A European Perspective
as to the Extent to Which Experimental Use, and Certain Other, Defences to Patent Infringement,
Apply to Differing Types of Research (Intellectual Property Institute 2006). He is a co-author
of Practical Intellectual Property Precedents (Sweet & Maxwell 1998 to date); and International
Intellectual Property Arbitration (Kluwer 2010). He is one of the general editors of The Modern
Law of Patents (LexisNexis Butterworths 2005, 2009, 2014) and is editor of Sterling on World
Copyright Law (Sweet & Maxwell 2015) and of Trade Secret Protection – A Global Guide
(Globe Law & Business 2016).
Alexander Demuth
A&M GmbH Wirtschaftsprüfungsgesellschaft
Alexander Demuth, co-head of Alvarez & Marsal’s international arbitration group and
leader of its German disputes and investigations practice, is a managing director based
in Munich and Hamburg. He specialises in advising clients in arbitration, litigation and
out-of-court settlement with a focus on post-merger disputes and commercial disputes.
Alexander has acted as party-appointed or tribunal-appointed expert in international arbi-
tration proceedings under DIS, ICC, ICSID, SIAC and VIAC rules as well as in litigation
proceedings. His experience covers various industries, including automotive and auto-
motive supply, pharmaceutical, conventional and renewable energy, biotechnology, manu-
facturing, private equity, retail and software. A German national, Alexander is fluent in
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About the Authors
German and English and has issued reports and testified in both languages. Alexander is a
German Certified Public Accountant (Wirtschaftsprüfer) and has earned his master’s degree
in economics from the University of Passau. He is a member of the German Institute
of Public Auditors, the American Institute of Certified Public Accountants (AICPA), the
AICPA Forensic and Valuation Services (FVS), the German Institution of Arbitration (DIS),
the Vienna International Arbitration Centre (VIAC) and the Swiss Arbitration Association
(ASA).
James Dow
London Business School
James Dow is Professor of Finance at London Business School. He has previously taught
at the European University Institute and the University of Pennsylvania. His main research
interests are in the economics of financial markets, specifically the role of leverage and
intermediation in bubbles, and the role of arbitrage capital in financial fire sales. He has
published in leading research journals and has extensive consulting experience in valuation,
cost of capital, corporate governance and corporate finance. He is an academic advisor at
the Brattle Group.
James Dow has acted as quantum expert on a number of cases, including arbitrations
brought by former Yukos shareholders alleging violation of the Energy Charter Treaty. The
award (online) gave large damages while agreeing with substantial portions of his analysis
(award subsequently set aside on grounds of jurisdiction). Related cases include a claimed
breach of the Spain-Russia BIT, and a claim by RosInvestCo under the UK-Soviet Union
BIT (award online). He has also worked on a cases concerning minority stakes valuation in
energy and hotel businesses, taxes imposed by Ecuador (ICSID ARB/08/6), a privatised oil
company (Rompetrol; ICSID ARB/06/3), an IP dispute, a JV involving a major advertising
company and capital cost measurement in long-term gas supply.
Farouk El-Hosseny
Freshfields Bruckhaus Deringer LLP
Farouk is an associate in the international arbitration group of Freshfields Bruckhaus
Deringer in London, having previously worked in Freshfields’ offices in Riyadh and Dubai.
Farouk is a member of the Quebec and Paris Bars. Prior to joining Freshfields, Farouk was
a legal counsel at the Permanent Court of Arbitration in The Hague and also the Court’s
acting representative in Mauritius. He has experience as sole arbitrator under the Dubai
International Arbitration Centre Rules. He has litigation experience before Quebec courts.
He holds a PhD degree from the Grotius Centre for International Legal Studies at Leiden
University and was a visiting scholar at the Lauterpacht Centre for International Law at the
University of Cambridge. He obtained a bachelor’s degree in civil law from the University
of Ottawa and a LLM from the University of Montreal.
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About the Authors
Mark W Friedman
Debevoise & Plimpton LLP
Mark W Friedman, a partner in Debevoise & Plimpton’s international dispute resolution
group and a litigation partner in the New York and London offices, has broad experience in
civil and criminal matters, with a concentration on international arbitration and litigation.
Mr Friedman has represented clients in disputes in a wide variety of industries, including
energy, mining, construction and telecommunications, and has acted as counsel or arbi-
trator in disputes under the rules of the AAA, ICDR, CPR, LCIA, ICC, UNCITRAL
and ICSID.
Mr Friedman was named 2016 International Arbitration Attorney of the Year by
Benchmark Litigation and has been ranked as a leading individual by Chambers Global, Chambers
UK, Chambers USA, Who’s Who Legal: Commercial Arbitration, Who’s Who Legal: Commercial
Litigation, PLC Which Lawyer? Yearbook and Legal Experts, and as one of the inaugural
‘45 stars under 45’ by Global Arbitration Review. Among other positions, he is a vice presi-
dent of the ICC Court of Arbitration, a member of the editorial board of Dispute Resolution
International, and was previously co-chair of the International Bar Association’s Arbitration
Committee, member of the Court of the London Court of International Arbitration, vice
chair of the International Dispute Resolution Committee of the International Section of
the American Bar Association, and co-rapporteur of the International Law Association’s
Commercial Arbitration Committee. Mr Friedman regularly speaks and publishes on inter-
national arbitration and compliance topics.
Philip Haberman
Haberman Ilett LLP
Philip Haberman is the founder and senior partner of Haberman Ilett LLP, the leading
independent firm specialising in providing accounting and financial expert evidence in
international arbitration and litigation. For the past two years, he has been Who’s Who
Legal’s ‘expert witness of the year’.
He has been actively involved in some 300 matters including commercial disputes,
shareholder disputes, investment treaty claims, transaction-related disputes and disputes
arising out of accounting and financial irregularities. He has given oral evidence on more
than 60 occasions, before international arbitration tribunals under LCIA, ICC, ICSID,
UNCITRAL, Swiss, SIAC and ad hoc rules, as well as UK courts. He has also carried out
many expert determinations to resolve disputes.
Philip has a degree in mathematics from Cambridge University and qualified as a
chartered accountant in 1980. He specialised in forensic accounting from 1990, spending
22 years as a partner in Big Four firms before setting up Haberman Ilett in 2013. He is a
fellow of the Institute of Chartered Accountants in England and Wales, a member of the
Chartered Institute of Arbitrators, a founder member of the Expert Witness Institute, a pro-
fessional member of the Royal Institution of Chartered Surveyors, and a CEDR-accredited
mediator. He is also a trustee of the British Institute of International and Comparative Law.
368
About the Authors
Laila Hamzi
Latham & Watkins LLP
Ms Laila Hamzi is an associate in the London office of Latham & Watkins. She is an
Australian-qualified solicitor and member of the firm’s international arbitration practice
group. Her practice focuses on international arbitration and public international law. Ms
Hamzi also has extensive commercial experience, having worked in banking and finance,
and mergers and acquisitions law in Australia, and in commercial litigation in London.
Prior to joining Latham & Watkins, Ms Hamzi was a judicial assistant at the International
Court of Justice where she worked on several state-to-state disputes. She has also worked
as a legal researcher at the Bingham Centre for the Rule of Law, in London, and the
International Criminal Tribunal for the Former Yugoslavia.
Ms Hamzi graduated from the University of Melbourne in 2010 with a BSc in genet-
ics and an LLB with honours. She graduated from the London School of Economics and
Political Science in 2014 with an LLM in public international law (distinction).
Justin K Ho
Justin Ho is an associate principal in CRA’s life sciences practice. He specialises in indus-
trial organisation and the economic and strategic evaluation of firm behaviour and con-
tracting. Since joining CRA, his projects include assisting counsel in breach of contract,
antitrust and intellectual property disputes, primarily in the pharmaceutical industry. He
has also supported counsel on questions related to contract interpretation and damages
assessment in these and other matters. In addition, Dr Ho has advised pharmaceutical com-
panies in pricing and other strategic matters. He holds a PhD degree in economics from
Harvard University.
Romilly Holland
Romilly is an associate in the international arbitration group of Freshfields Bruckhaus
Deringer in London. She has a wide range of experience in international arbitration pro-
ceedings before the ICC, the LCIA and ICSID, as well as in ad hoc proceedings, including
those carried out under the UNCITRAL Rules. She has particular experience in the
telecoms sector and in disputes arising out of investments in Africa. In addition to acting
as counsel, Romilly has regularly been appointed as secretary to the arbitral tribunal in
international commercial arbitration proceedings. Romilly is an English qualified solicitor
and a member of the Paris Bar.
Charles Jonscher
CET Advisors Ltd
Charles Jonscher has over 30 years of experience in advising on valuations and an exten-
sive track record in international arbitration support. He brings best commercial practice
and state-of-the art theory to all aspects of financial analysis, valuation work and dam-
ages quantification.
369
About the Authors
He and his CET colleagues are commissioned by major US and European law firms
to provide expert reports in complex commercial arbitrations and court disputes. Their
assignments have spanned across many sectors, including but not limited to technology and
infrastructure industries. They are supported by a team of quantitative analysts.
In his earlier academic career, Dr Jonscher was with the economics faculty at Harvard
University before moving to Massachusetts Institute of Technology, where he specialised in
management and finance. He obtained his PhD in economics from Harvard and his under-
graduate degree from Cambridge University. He is now based in London and is president
of the CET group of companies.
Sophie J Lamb
Sophie Lamb is a partner in the London office of Latham & Watkins where she leads the
International Arbitration Practice. A recognised leader in the field of international arbitra-
tion and public international law, Ms Lamb has acted as an adviser and/or advocate in
more than 100 international commercial arbitrations in proceedings involving investment
agreements, long-term supply relationships, concession agreements, stabilisation clauses,
tax disputes, price re-openers, gas pipeline and consortium issues, take or pay obligations,
hardship/fairness clauses, M&A, JOA, JBSA, joint venture disputes, shareholder agreements,
pre-emption rights, share purchase agreements, warranty/indemnity claims and technol-
ogy licensing rights, among many others. Her diverse international caseload has included
arbitrations in Europe, Asia and the United States, many of which have concerned assets
or claims valued in excess of US$1 billion, subject to a wide variety of applicable laws and
international treaties. She has also appeared in the UK Supreme Court, in addition to sit-
ting as arbitrator in energy disputes, including those involving states and state entities.
Carlos Lapuerta
The Brattle Group
Carlos Lapuerta is an expert in economic analysis and financial valuation, which he fre-
quently applies to estimate damages as an expert witness in international arbitration pro-
ceedings, including many disputes between investors and sovereign states over the alleged
breach of bilateral investment treaties. He offers particular experience in the analysis of
investments and contracts in the energy sector, and has provided testimony in several
arbitration proceedings concerning the prices in long-term energy contracts. Within the
energy sector, his work has covered natural gas, coal, electricity and oil.
Mr Lapuerta also offers extensive experience with the analysis of competition, includ-
ing the development of competition in markets subject to liberalization and deregulation,
allegations of anticompetitive conduct such as price fixing, and the competitive impacts of
proposed mergers. His work on competition has been primarily in the energy sector and
the financial services sector.
370
About the Authors
Floriane Lavaud
Debevoise & Plimpton LLP
Floriane Lavaud is a senior associate in the firm’s international dispute resolution group and
litigation department based in New York. Her practice focuses on international investment
and commercial arbitration and enforcement-related litigation, in particular, in the energy
and mining sectors.
Ms Lavaud represents clients in arbitrations conducted under the auspices of the main
arbitration institutions and in related court proceedings. She has advised clients in a variety
of jurisdictions on issues of civil and common law, public international law, treaty and con-
tract interpretation, and maritime boundary. Her expertise also includes the assessment of
damages and the enforcement of arbitration awards, especially under the Foreign Sovereign
Immunities Act and other similar legislation.
Ms Lavaud regularly speaks and publishes on international arbitration. She is admitted
to the New York and Paris Bars, in addition to being a solicitor in England and Wales.
Gervase MacGregor
BDO LLP
Gervase MacGregor is head of forensic services at BDO. He has a bachelor’s degree in geol-
ogy from the University of Liverpool and a master’s degree from HEC in Paris.
He is a chartered accountant and a certified fraud examiner.
He joined BDO in 1982, qualified in 1986, was made a partner in BDO in 1991 and
became head of the London-based litigation support and forensic accounting department
in 1994.
His first forensic investigation, in 1985, was into a contested takeover by a client of his
firm, Caparo Plc. His work into accounting irregularities gave rise to the Caparo case on
auditors’ liability. Since then, he has undertaken a great many investigations and acted as
expert in disputes on a large number of occasions.
He has a particular expertise in valuation and damages disputes, and share purchase
agreement disputes in the natural resources sector.
He has given evidence in the High Court, in international arbitrations and before select
committees of the UK Parliament.
Andrew Maclay
BDO LLP
Andrew Maclay is a forensic accountant who has worked on many different types of
investigations and disputes since 1996. He has an MA in economics from the University
of Cambridge.
He is a chartered accountant, a certified fraud examiner and an accredited accountant
expert witness.
He specialises in the quantification of damages in international arbitration, and has
worked on disputes in many jurisdictions, particularly France and Switzerland, and in
west and east Europe, Africa and the Middle East. Between 1991 and 1994, he worked in
Burundi, Africa and is fluent in French.
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About the Authors
He has given evidence in international arbitration tribunals, the High Court, a criminal
court and by way of deposition in US proceedings.
Craig Miles
King & Spalding LLP
Craig Miles is a partner in King & Spalding’s International Arbitration Group, residing in
the Houston office.
His practice focuses on representing foreign investors in disputes with host govern-
ments, primarily before ICSID, and private parties in commercial disputes before the
ICC, AAA, and other domestic and international arbitral institutions. Mr Miles has first or
second-chaired dozens of arbitral hearings involving disputes throughout North and South
America, Europe, Asia, Africa and the Middle East, with particularly strong experience in
bilateral investment treaty (BIT) disputes in the mining, infrastructure, and oil and gas sec-
tors and in Latin America. Among his recent cases are some of the largest ICSID or BIT
awards and settlements ever obtained by foreign investors, against the likes of the govern-
ments of Argentina, Bolivia, Ecuador, Egypt, Romania and Venezuela. Mr Miles regularly
appears in peer-reviewed rankings such as Chambers, Who’s Who, Best Lawyers in America
and Latin Lawyer, and in 2011 was named in Global Arbitration Review’s ‘45 Under 45’ list of
the leading international arbitration practitioners worldwide under the age of 45. Mr Miles
frequently speaks and publishes on international arbitration issues, occasionally in Spanish,
in which he is proficient along with French.
David Mitchell
BDO LLP
David is head of the valuations team at BDO LLP. He has over 15 years’ valuation experi-
ence and works in a variety of industries, jurisdictions and forums, including the UK courts
and international arbitrations.
He is a fellow of the Association of Chartered Certified Accountants and is a chartered
tax adviser. He is also a member of the Society of Share & Business Valuers, the Royal
Institution of Chartered Surveyors, and a guest lecturer at Brunel University.
He has been appointed as an expert on over 30 occasions and has given oral testimony
in the UK courts, deposition, the Dubai International Financial Centre Court, and to arbi-
tral tribunals in a number of jurisdictions.
He has extensive experience in both contentious and non-contentious matters. His
main areas of expertise are in the field of natural resources, telecom, intangible assets, takeo-
ver disputes, transactions, and in the valuation of companies and damages quantification.
Reza Mohtashami
Reza is an experienced arbitration partner at Freshfields Bruckhaus Deringer who has
represented clients as counsel and advocate in more than 70 arbitrations conducted under
a variety of arbitration rules in many different jurisdictions.
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About the Authors
After spending 15 years working in Paris, New York and Dubai, where he established
the firm’s global arbitration practice in the Middle East, Reza is now based in London from
where he handles disputes in emerging markets with a focus on the energy, infrastructure
and telecommunications sectors. Reza holds positions of responsibility with various inter-
national organisations, including as an officer of the IBA Arbitration Committee, president
of the LCIA’s Arab Users’ Council, member of the International Advisory Committee of
the ICDR and editorial board member of Global Arbitration Review (GAR). He is ranked
as one of GAR’s leading 45 practitioners under 45. Reza is an English qualified solici-
tor advocate. He has law degrees from University College London and the University
of Cambridge.
Boaz Moselle
Boaz Moselle heads Cornerstone Research’s European international arbitration practice.
Dr Moselle is an economist with extensive expertise in international arbitrations and
energy-related disputes. Dr Moselle provides consulting and expert testimony in commer-
cial and investor-state disputes. He addresses issues related to the pricing of natural gas and
LNG, the assessment of damages involving alleged breaches of contract and/or expropria-
tion, and the application of competition law. Who’s Who Legal has named Dr Moselle as a
leading expert witness and competition economist.
As a former managing director of the UK energy regulator and competition authority
(the Office of Gas and Electricity Markets, or Ofgem), Dr Moselle also acts as an expert
adviser on a range of regulatory and competition matters. Dr Moselle is a co-editor and
co-author of Harnessing Renewable Energy in Electric Power Systems:Theory, Practice, Policy; and
co-author of a textbook on econometrics, Managerial Statistics: A Case-Based Approach. He
has extensive scholarly publications on a range of economic topics.
Gabrielle Nater-Bass
Homburger
Gabrielle Nater-Bass is a partner at Homburger. Her practice focuses on domestic and
international arbitration and litigation. She is an experienced party counsel, arbitrator and
legal expert in international commercial arbitration, ad hoc and institutional (including
ICC, LCIA, Swiss Rules, UNCITRAL). She also regularly acts as counsel in commercial
litigations before state courts. Gabrielle Nater-Bass is listed on the panel of arbitrators
of the ICC National Committee (Switzerland) and was recognised by Global Arbitration
Review as one of the magazine’s ‘all female top 30’ women in arbitration. She is a board
member of the Swiss Arbitration Association (ASA), a member of the Arbitration Court
of the Swiss Chambers’ Arbitration Institution, the International Bar Association and the
London Court of International Arbitration (LCIA). Gabrielle Nater-Bass also serves as a
member of the International Board of the Arbitration Institute of the Finland Chamber of
Commerce and is vice president of ArbitralWomen. She was recently invited to join the
SIAC Users Council and ICDR International Advisory Committee. Gabrielle Nater-Bass
has authored numerous publications in the field of international arbitration and is a fre-
quent speaker at arbitration conferences.
373
About the Authors
James Nicholson
FTI Consulting
James Nicholson is senior managing director in FTI Consulting’s economic and financial
consulting segment, leads FTI’s 20-strong Paris disputes and investigations team and is very
active as an expert witness on issues of the quantification of financial damages in the con-
text of international arbitration disputes. James is president of the Standing Committee of
the ICC’s International Centre for ADR, which advises the Centre in the application of the
ICC’s Expert Rules, and was identified by Who’s Who Legal: Commercial Arbitration as one of
the five ‘Most Highly Regarded Individuals’ in Europe in its November 2015 rankings of
164 expert witnesses active in commercial arbitration.
Elizabeth Oger-Gross
White & Case LLP
Elizabeth Oger-Gross is a partner of the firm’s international arbitration group and is based
in the Paris office. Elizabeth advises clients in complex commercial disputes, with a focus
on the construction and energy industries. She also has significant experience in invest-
ment disputes. She is both common law and civil law qualified and acts in both English
and French language arbitrations. She has been involved in arbitrations conducted under
the rules of the International Chamber of Commerce (ICC), the American Arbitration
Association (AAA/ICDR), the United Nations Commission on International Trade Law
(UNCITRAL), and the Swiss Chamber of Commerce. She also has substantial experience
in cross-border litigation, particularly involving the US and France.
Chudozie Okongwu
NERA Economic Consulting
Dr Chudozie Okongwu is the Head of NERA’s European finance, litigation and dispute
resolution group. He has been retained in hundreds of securities-related, financial and busi-
ness valuation matters, many of which concerned the valuation, trading and risk character-
istics of various derivative products. He has testified in international arbitrations in various
forums, including in the International Chamber of Commerce (ICC), the International
Court of Arbitration and the International Centre for Settlement of Investment Disputes
(ICSID), as well as in arbitration proceedings brought under the United Nations
Commission on International Trade Law (UNCITRAL). Dr Okongwu is listed in Who’s
Who Legal: Arbitration’s Expert Witness Analysis and Who’s Who Legal: Consulting Experts.
Prior to joining NERA, Dr Okongwu was a member of Banque Paribas’s Fixed
Income Emerging Markets team in London and New York. He holds a PhD and MA
in economics from the University of California, Berkeley, and an SB in economics from
the Massachusetts Institute of Technology. Dr Okongwu is the lead author of ‘Credit
Derivatives and Mortgage-Backed Securities’ in The Handbook of Mortgage-Backed Securities
(Frank J Fabozzi, ed., 2016), and has authored articles in The Journal of Structured Finance, the
International Journal of Finance & Economics and Wall Street Lawyer.
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About the Authors
Samuel M Pape
Samuel M Pape is an associate in the London office of Latham & Watkins. He is an
English-qualified solicitor advocate and member of the firm’s international arbitration
practice group. His practice focuses on international arbitration, public international law,
and complex litigation in the English and overseas courts. He has represented clients in
arbitrations in Europe, Russia and the CIS, Latin America, Africa and the United States.
He has conducted cases under all of the principal arbitration rules, including the LCIA,
ICC, ICSID, ICSID Additional Facility, as well as ad hoc arbitration. Mr Pape also advises
investors on the structuring of investments to minimise political risk, the protection of
investments under bilateral and multilateral investment treaties, and the enforcement of
arbitral awards before local courts. Mr Pape has experience acting as Tribunal Secretary in
ICC arbitration proceedings.
Mr Pape graduated from the University of Oxford with a BA Hons in philosophy,
politics and economics (PPE) in 2008, and was an awarded an LLB from the College of
Law in London with first class honours in 2010, having completed both his GDL and LPC
with distinctions.
Stefanie Pfisterer
Homburger
Stefanie Pfisterer is an attorney-at-law, qualified in both Switzerland and New York.
She joined Homburger’s dispute resolution practice group in 2014 as associate. Stefanie
Pfisterer’s practice focuses on international and domestic arbitration as well as litigation.
She acts as arbitrator and as counsel in complex arbitrations (including ICC, LCIA, Swiss
Rules, UNCITRAL, ad hoc). She also acts as counsel in arbitration-related court proceed-
ings (setting aside, provisional measures, etc.) and other state court proceedings. Stefanie
Pfisterer earned her law degree from the University of Bern (MLaw, 2007) and holds a
masters degree from Harvard Law School (LLM, 2012) and a doctoral degree from the
University of Zurich (Dr iur, 2012). She is the author of a number of publications in the
field of dispute resolution and is a regular speaker on arbitration-related issues.
David Rogers
FTI Consulting
David is a senior director in the economic and financial consulting practice, and is based
in London. David specialises in the valuation of businesses, shares and intangible assets, and
in the quantification of complex damages, such as those arising from contractual, share-
holder, joint venture, post-acquisition and intellectual property disputes. David advises on
valuation, damages and intellectual property matters in contentious and non-contentious
contexts, and has over 15 years’ experience. Prior to joining FTI Consulting, David was a
senior manager at LECG and, before that, an executive in Ernst & Young’s London corpo-
rate finance practice.
375
About the Authors
Kai F Schumacher
AlixPartners
Kai uses the power of facts and financial analysis to quantify damages in international
arbitrations and litigations, to perform forensic investigations, to evaluate assets and busi-
nesses, to facilitate M&A transactions and to conduct monitorships. Having led more than
150 engagements with values of up to €170 billion and involving entities from 53 differ-
ent countries he has successfully advised clients for about two decades. Kai is one of about
80–160 of the world’s leading experts in commercial arbitration according to Who’s Who
Legal: Commercial Arbitration since 2012–2013. Since 2015–2016 he is nominated as one of
the five ‘most highly regarded individuals’ in Europe in this field. Kai holds an MBA from
Paris’ HEC School of Management, a CPA and a CFA charter.
Sara Selvarajah
FTI Consulting
Sara Selvarajah is a managing director in FTI Consulting’s European tax advisory team
based in London, specialising in UK corporation tax with particular focus on the financial
services sector.
Andrew Tepperman
Andrew Tepperman is a vice president in CRA’s life sciences practice, based in Toronto,
Canada. He specialises in providing economic and damages analyses for clients involved
in arbitration and litigation proceedings. Dr Tepperman has assessed damages in a wide
range of disputes, including intellectual property, breach of contract and antitrust matters.
He has also performed economic analyses of liability issues in arbitration proceedings,
including assessment of commercially reasonable efforts, and antitrust litigation matters,
including analyses of market definition and market power. His work has encompassed a
variety of industries, including pharmaceuticals, biologics, diagnostics, medical devices, tel-
ecommunications and computer hardware and software. He has provided expert testimony
in Canadian and US court proceedings. He holds a PhD degree in economics from the
University of Toronto.
John A Trenor
Wilmer Cutler Pickering Hale and Dorr LLP
John A Trenor is a partner at Wilmer Cutler Pickering Hale and Dorr LLP in the firm’s
international arbitration practice group. Mr Trenor has represented companies, states,
state-owned entities, international organisations, and individuals in a wide variety of dis-
putes in the aviation, defence, financial services, oil and gas, pharmaceuticals, technology,
telecommunications and other industries. He has advised clients regarding commercial,
investor-state and state-to-state arbitrations seated in common law and civil law jurisdic-
tions worldwide under virtually all of the major institutional, as well as ad hoc rules, includ-
ing ICC, LCIA, AAA, SCC, VIAC, ICSID, UNCITRAL and others. He has extensive
experience in matters regarding public and private international law, including such areas
376
About the Authors
as investment protection, state responsibility, reparations, territorial sovereignty, sovereign

immunity, the law of treaties, the law of the sea, conflict of laws and extraterritoriality.
Michael Wabnitz
AlixPartners
Michael Wabnitz has over 20 years of experience and advises corporations, boards and
investors in the areas of M&A transactions, valuations, CFO services as well as arbitration/
litigation matters. Previous roles include managing director of Duff & Phelps and partner at
KPMG. Michael holds a master’s degree in business administration and successfully passed
both the German chartered accountant and the German chartered tax adviser exams.
David Weiss
King & Spalding LLP
David Weiss is a senior associate in King & Spalding’s International Arbitration Group.
Mr Weiss concentrates on investor-state arbitration and international commercial dis-
putes. Mr Weiss has significant experience in investment disputes, energy disputes and dis-
putes in Latin America. He has participated in proceedings before the International Centre
for Settlement of Investment Disputes (ICSID), the International Chamber of Commerce
(ICC) and the Permanent Court of Arbitration in The Hague (PCA).
Mr Weiss graduated from the University of Texas School of Law, with honours, where
he was a member of the Texas International Law Journal and the International Arbitration
Moot Court Team. Mr Weiss spent one semester of law school at the Faculdade de Direito
da Universidade de São Paulo (USP) in São Paulo, Brazil. Before law school, Mr Weiss
graduated, with Phi Beta Kappa honours, from the University of Richmond with majors
in diplomacy and political science. He spent one semester of his undergraduate studies at
the Universidad Torcuato Di Tella in Buenos Aires, Argentina.
Wiley R Wright III

Mr Wright specialises in providing expert witness and forensic accounting services to
governmental agencies, private law firms, construction contractors and government con-
tractors. Mr Wright has testified as an expert witness before numerous state and federal
courts, Boards of Contract Appeals, in domestic and international arbitration, and par-
ticipated in mediations and settlement negotiations, and has provided expert testimony in
over 125 matters. Additionally, Mr Wright has more than 30 years of experience provid-
ing consulting expertise on construction, government contract and environmental matters.
With respect to construction projects, Mr Wright has significant experience with: airports,
oil and gas facilities and pipelines, bridges and tunnels, industrial facilities, power plants,
military and commercial launch facilities, waste water treatment facilities, jails and prisons,
stadiums, aqueducts, subway and transit, and highways and roads. Mr Wright co-authored a
chapter entitled, ‘Types of Financial Reports and Opinions Issued by CPAs and Applicable
Professional Standards’ included in the 2010 book Construction Accounting: A Guide for
Attorneys and Other Professionals published by the American Bar Association Forum on
377
About the Authors
Construction Law. He also co-authored an article published in the Maryland Association

of Certified Public Accountants CPA Statement entitled, ‘Professional Standards Applicable
to Litigation Support’. He is a frequent lecturer and presenter to groups including the
Colorado Society of Certified Public Accountants, American Bar Association and the
Virginia Bar Association on topics such as financial and economic damages. Mr Wright is
a certified public accountant in the State of Virginia.
Paul Zurek
Paul Zurek is a principal at Cornerstone Research, an economic and financial consulting
firm where he conducts analyses in complex litigation matters and testifies in civil and
regulatory proceedings. His representative engagements involve valuations of companies
and complex financial instruments, market microstructure, risk management and share-
holder and investor litigation. Dr Zurek holds a PhD in finance from the Wharton School
at the University of Pennsylvania.
378
Appendix 2
Contact Details
AlixPartners BDO LLP

Sendlinger Strasse 12 55 Baker Street
80331 Munich London W1U 7EU
Germany United Kingdom
Tel: +49 172 8 25 60 41 (K Tel: +44 20 7486 5888
Schumacher)/ +49 172 8555 966 Fax: +44 20 7487 3686
(M Wabnitz) gervase.macgregor@bdo.co.uk
Fax: +49 89 20 30 40 01 andrew.maclay@bdo.co.uk
kschumacher@alixpartners.com david.mitchell@bdo.co.uk
mwabnitz@alixpartners.com www.bdo.co.uk
www.alixpartners.com
The Brattle Group
Aldermary House
A&M GmbH
10-15 Queen Street
Wirtschaftsprüfungsgesellschaft
London EC4N 1TX
Thierschplatz 6
United Kingdom
80538 Munich
Tel: +44 20 7406 7900
Germany
Fax: +44 20 7406 7901
Tel: +49 89 710 40 60 0
carlos.lapuerta@brattle.com
Fax: +49 89 710 40 60 1
richard.caldwell@brattle.com
ademuth@am-wpg.de
www.brattle.com
www.am-wpg.de
379
Contact Details
CET Advisors Ltd Cornerstone Research

100 Pall Mall 125 Old Broad Street
London SWIY 5NQ London
United Kingdom EC2N 1AR
Tel: +44 20 3086 9995 Tel: +44 20 3655 0900
Fax: +44 20 2086 9990 Fax: +44 20 3655 0999
charles.jonscher@cet.co.uk bmoselle@cornerstone.com
www.cet.co.uk rbarnes@cornerstone.com
1919 Pennsylvania Avenue Suite 600, NW

Washington, DC, 20006-3420
200 Clarendon St
United States
Boston, MA
Tel: +1 202 912 8944
USA 02116 5092
Fax: +1 202 912 8999
Tel: +1 617 425 3357
jalberro@cornerstone.com
gbell@crai.com
599 Lexington Avenue 40th Floor

80 Bloor Street West
New York, NY 10022
Suite 1501, Toronto
United States
Ontario
Tel: +1 212 605 5448
Canada M5S 2V1
Fax: +1 212 759 3045
Tel: +1 416 413 4084
pzurek@cornerstone.com
atepperman@crai.com
www.cornerstone.com
1201 F Street, Suite 800
Washington, DC
USA 20004 1229 Debevoise & Plimpton LLP
Tel: +1 202 662 3926 919 Third Avenue
jho@crai.com New York, NY 10022
United States
www.crai.com Tel: +1 212 909 6000
Fax: +1 212 909 6836
mwfriedman@debevoise.com
Compass Lexecon
flavaud@debevoise.com
1101 K St. NW
www.debevoise.com
Washington, DC, 20005
Tel: +1 202 589 3427
Fax: +1 202 312 9101
mabdala@compasslexecon.com
380
Contact Details
Freshfields Bruckhaus Deringer Homburger

LLP Prime Tower, Hardstrasse 201
65 Fleet Street CH-8005 Zurich
London, EC4Y 1HS PO Box 314
United Kingdom Switzerland
Tel: +44 20 7936 4000 Tel: +41 43 222 10 00
Fax: +44 20 7832 7001 Fax: +41 43 222 15 00
reza.mohtashami@freshfields.com gabrielle.nater@homburger.ch
romilly.holland@freshfields.com stefanie.pfisterer@homburger.ch
farouk.el-hosseny@freshfields.com www.homburger.ch
www.freshfields.com
King & Spalding LLP

FTI Consulting 1100 Louisiana
22 place de la Madeleine Suite 4000
75008 Paris Houston, TX 77002
France United States
Tel: +33 1 53 05 36 01 Tel: +1 713 751 3200
james.nicholson@fticonsulting.com Fax: +1 713 751 3290
sara.selvarajah@fticonsulting.com cmiles@kslaw.com
www.fticonsulting.com dweiss@kslaw.com
www.kslaw.com
200 Aldersgate
Aldersgate Street
London EC1A 4HD
99 Bishopsgate
United Kingdom
London EC2M 3XF
Tel: +44 20 3727 1000
United Kingdom
Fax: +44 20 3727 1007
Tel: +44 20 7710 1000
mark.bezant@fticonsulting.com
Fax: +44 20 7374 4460
david.rogers@fticonsulting.com
sophie.lamb@lw.com
www.fticonsulting-emea.com
samuel.pape@lw.com
laila.hamzi@lw.com
Haberman Ilett LLP www.lw.com
City Tower
40 Basinghall Street
London Business School
London, EC2V 5DE
Sussex Place
United Kingdom
Regent’s Park
Tel: +44 20 3096 6500
London NW1 4SA
ph@hiforensic.com
United Kingdom
www.hiforensic.com
Tel: +44 20 7000 8260/8232
Fax: +44 20 7000 8201
jdow@london.edu
www.james-dow.com
381
Contact Details
NERA Economic Consulting Walder Wyss Ltd

Marble Arch House Seefeldstrasse 123
66 Seymour Street PO Box 8034
London W1H 5BT Zurich
United Kingdom Switzerland
Tel: +44 20 7659 8568 Tel: +41 58 658 58 58
Fax: +44 20 7659 8501 Fax: +41 58 658 59 59
www.nera.com/experts/dr-chudozie- micha.buehler@walderwyss.com
okongwu.html www.walderwyss.com
PricewaterhouseCoopers LLP White & Case LLP

1 Embankment Place 5 Old Broad Street
London London EC2N 1DW
WC2N 6RH United Kingdom
United Kingdom Tel: +44 207 532 1622 (C Connellan)/
ermelinda.x.beqiraj@uk.pwc.com +44 207 532 1617 (H Clark)
tim.j.allen@uk.pwc.com Fax: +44 207 532 1001
www.pwc.co.uk/services/forensic- cconnellan@whitecase.com
services/disputes.html hclark@whitecase.com
19 Place Vendôme
Paris 75001
1300 I Street, NW, Suite 400 E
France
Washington, DC 20005
Tel: +33 1 5504 5882 (E Oger-Gross)/
Tel: +1 443 603 0185 (Wiley R Wright
+33 1 5504 1515 (A André)
III – office)/ +1 410 336 9866 (Wiley R
Fax: +33 1 5504 1516
Wright III – mobile)/ +1 202 407 8574
elizabeth.oger-gross@whitecase.com
(Mark Baker)
aandre@whitecase.com
wwright@secretariat-intl.com
mbaker@secretariat-intl.com
www.whitecase.com
www.secretariat-intl.com
Victoria University, Faculty of Law

55 Lambton Quay
Old Government Buildings
6011 Wellington
New Zealand
Tel: +64 4 463 6359
Fax: +64 4 463 6365
petra.butler@vuw.ac.nz
www.victoria.ac.nz/law/about/staff/
petra-butler
382
Contact Details
Wilmer Cutler Pickering Hale and

Dorr LLP
7 World Trade Center
250 Greenwich Street
New York, New York 10007
United States
Tel: +1 212 230 8800
Fax: +1 212 230 8888
trevor.cook@wilmerhale.com
1875 Pennsylvania Avenue, NW

Washington, DC 20006
United States
Tel: +1 202 663 6222
Fax: +1 202 663 6363
49 Park Lane
London
W1K 1PS
United Kingdom
Tel: +44 20 7872 1555
Fax: +44 20 7839 3537
john.trenor@wilmerhale.com
www.wilmerhale.com
383

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Part I: Legal Principles Applicable to the Award of Damages

2 Non-Compensatory Damages in Civil and Common Law Jurisdictions –

3 Damages Principles under the Convention on Contracts for the International

4 Contractual Limitations on Damages .......................................................... 68

5 Overview of Principles Reducing Damages ................................................ 78

6 Damages Principles in Investment Arbitration ............................................. 90

Part II: Procedural Issues and the Use of Damages Experts

8 Strategic Issues in Employing and Deploying Damages Experts ..................123

Part III: Approaches and Methods for the Assessment and

10 Assessing Damages for Breach of Contract .................................................155

11 Overview of Methodologies for Assessing Fair Market Value ......................164

12 Income Approach and the Discounted Cash Flow Methodology ................174

13 Determining the Weighted Average Cost of Capital ...................................196

14 Market Approach or Comparables .............................................................204

15 Asset-Based Approach and Other Valuation Methodologies ........................219

16 Taxation and Currency Issues in Damages Awards ......................................229

19 The Use of Econometric and Statistical Analysis and Tools .........................271

Part IV: Industry-Specific Damages Issues

21 Damages in Construction Arbitrations .......................................................301

22 Damages in Financial Services Arbitrations.................................................310

23 Damages in Life Sciences Arbitrations ........................................................320

24 M&A and Shareholder Arbitrations ............................................................331

25 Damages in Intellectual Property Arbitrations ............................................342

26 Damages in Competition/Antitrust Arbitrations.........................................352

About the Authors ...............................................................................................361

Contact Details ....................................................................................................379

Clare Connellan, Elizabeth Oger-Gross, Angélica André and Heather Clark1

underlying international arbitrations to be governed by a range of applicable national laws,

The law applicable to damages

The parties’ agreement is paramount in international arbitration. This is of course also

Assessing the proof relating to damages

The burden of proof

The standard of proof

Arbitral tribunals usually refer, cumulatively or exclusively, to the applicable substantive

Establishing entitlement to damages

The foreseeability requirement

42 Hadley v. Baxendale (1854) 9 Exch. 341.

54 Formerly Article 1151 of the French Civil Code.

Assessment of the amount of damages

Categories of recoverable loss

Assessment of the amount of damages89

Reza Mohtashami, Romilly Holland and Farouk El-Hosseny1

The concept of non-compensatory damages under common law and civil

Damages as the main form of compensation