Applying The Appropriate Discount Rate
In Commercial Litigation
William C. Cleveland and William T. Dawson III
Determining the discount rate is a jury issue
on which conflicting expert testimony is often
presented.
William C. Cleveland
is head of the Business Litigation Practice Group
of Buist Moore Smythe McGee P.A., in Charleston,
South Carolina. Mr. Cleveland has handled a broad
range of business litigation and products liability
lawsuits for over 30 years. He concentrates his
practice in the areas of business consulting and
business, commercial, securities, products lia­
bility (including pharmaceuticals), and intellectual
property litigation. Additionally, he is certified as a
mediator, with substantial experience mediating
complex business disputes. He can be reached at
[email protected].
William T. Dawson III
is an associate with Buist
Moore Smythe McGee
P.A. Mr. Dawson focuses
his practice on real estate
transactions, business
transactions, development,
banking, bankruptcy, and
business litigation. He can
be reached at wdawson@
buistmoore.com. This
article is based on a paper the authors prepared
for a seminar sponsored by the ABA Tort Trial &
Insurance Practice Section and Construction Litigation
Committee.
Damages awarded for future loss are reduced
by applying a discount rate. “The ‘reduction to present worth’ requires application of an assumed rate of
interest, sometimes called the ‘discount rate,’ in order
to determine the present value of dollars due in the future.” Michael A. Rosenhouse, Annotation, Effect of Anticipated Inflation on Damages for Future Loss: Modern Cases, 21
A.L.R.4th 21 (1983) (hereinafter Rosenhouse). According
to Corpus Juris Secundum, “[a] defendant is entitled to
have an economic damages recovery discounted to present value.” 25A C.J.S. Damages §381 (2002). Calculating
a discount rate, however, is not without controversy. “Issues can arise concerning the appropriate discount rate.”
John R. Trentacosta, Damages in Breach of Contract Cases,
76 Mich. B.J. 1068, 1070 (Oct. 1997). Generally, a defendant would seek a higher discount rate in order to effectuate an economic reduction to the damage award. “The
higher the discount rate used by the court, the lower…the
amount of dollars awarded presently to compensate for
any given future loss.” Rosenhouse, supra, at §6[a]. “Theoretically, the rate used is only the amount by which the
rate of return exceeds inflation.” Terry Lloyd, Calculation
Issues in Commercial Damages, 536 PLI/Lit 287, 298 (Nov.
1995). The theoretical approach, however, is not always
The Practical Litigator | 37
38 | The Practical Litigator
the approach used in court proceedings and “expert testimony is often required.” Robert E. Hall
and Victoria A. Lazear, Reference Guide on Estimation
of Economic Losses in Damages Awards, in Reference
Manual on Sci. Evid. 277 (Federal Judicial Center
2d. 2000). Although the Supreme Court has addressed discount rate in several cases, such as Jones
& Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523 (1983);
Monessen Southwestern Ry. Co. v. Morgan, 486 U.S. 330
(1988); and Chesapeake & Ohio Ry. Co. v. Kelly, 241
U.S. 485 (1916), a general approach to calculating
a proper discount rate has not been established.
Christopher P. Bowers, Comment, Courts, Contracts,
and the Appropriate Discount Rate: A Quick Fix for the Legal Lottery, 63 U.Chi.L.Rev. 1099, 1100 (1996). “The
case law concerning the selection of appropriate
discount rates for measuring lost future profits in
contract disputes is in disarray.” Id. The purpose of
this article is to summarize the various approaches
to discount rate as applied by the courts.
SUPREME COURT PRECEDENTS • In Pfeifer, the District Court had calculated the plaintiff ’s
damages using a total offset method in which it
assumed that the gains the plaintiff would obtain
from inflationary growth in his wages would be totally offset by the return he would receive from investing the present-day award. Therefore, the court
did not include any cost of living adjustments that
the plaintiff was certain to receive in his wages and
did not discount the future lost income stream to
present value. The Supreme Court held that the
total offset method was not required, as had been
held in the court below. Proponents of a low discount rate argue that the plaintiff ’s future damages should not be discounted based on the return
provided by risky investments. “In all cases where
it is reasonable to suppose that interest may safely
be earned upon the amount that is awarded, the
ascertained future benefits ought to be discounted in the making up of the award.” Chesapeake &
Ohio Ry. Co., supra, at 490. The Supreme Court,
July 2008
however, tempered this assertion by explaining this
method was necessary as a duty to mitigate damages. Id. at 489-490. Pfeifer elaborated by providing
“the best and safest investments.” Pfeifer, supra, 62
U.S. at 537-538. However, Pfeifer’s applicability is
limited as the case deals with an injured employee
under the Longshoremen’s and Harbor Workers’
Compensation Act (“LSHWA”) and does not apply generally to all discount rate calculations. Id. at
547. The analysis of the discount rate, however, is
noteworthy:
“[A]lthough the notion of a damage award representing the present value of a lost stream of earnings in an inflation-free economy rests on some
fairly sophisticated economic concepts, the two elements that determine its calculation can be stated
fairly easily. They are: (1) the amount that the employee would have earned during each year that he
could have been expected to work after the injury;
and (2) the appropriate discount rate, reflecting the safest
available investment.”
Id. at 537-538 (emphasis added). Therefore, according to the analysis in Pfeifer, the appropriate
discount rate, at least in the context of the LSHWA, should be determined by analyzing the “safest
available investment.” The Supreme Court did not
undertake an economic analysis under the LSHWA
as it believed such an analysis was better left for the
legislature. “The legislative branch of the federal
government is far better equipped than we are to
perform a comprehensive economic analysis and to
fashion the proper general rule.” Id. at 551.
Monessen Southwestern Ry. Co. v. Morgan
A consistent theme of the cases is that determining the discount rate is a jury issue about which
the parties may offer expert testimony. The Supreme Court addressed a different aspect of the
discount rate in 1988 when examining a claim under the Federal Employers’ Liability Act (“FELA”).
Discount Rate | 39
In Monessen Southwestern Ry. Co., supra, the Supreme
Court examined whether it was proper for a state
court judge to instruct a jury to apply a zero discount rate as a matter of law to future damages.
Id. at 342. The Supreme Court held “[the] instruction improperly took from the jury the essentially
factual question of the appropriate rate at which to
discount…[the] FELA award to present value….”
Id. After analyzing Pfeifer, the Supreme Court concluded “nothing in Pfeifer…suggest[s]…the judge
rather than the jury is to determine the discount
rate in FELA actions.” Id. at 341. In an opinion
concurring in part and dissenting in part, Justices
O’Connor and Rehnquist examined the jury’s role
in determining the discount rate. “I do not agree,
however, that juries must in all circumstances be
left free to choose among the total offset rule and
alternative methods of accounting for anticipated
future inflation.” Id. at 350. Additionally, the Court
stated:
“Although…[it is] clear that no single method for
determining present value is mandated by federal
law and that the method of calculating present
value should take into account inflation and other
sources of wage increases as well as the rate of interest, it is equally clear that an utter failure to instruct the jury that present value is the proper measure of a damages award is error.”
Id. at 350 citing St. Louis Southwestern Ry. Co. v. Dickerson, 470 U.S. 409, 412 (1985). O’Connor and Rehnquist further state “the best method for calculating the approximate present value of an award for
loss of future earnings could become the subject
of reasonable debate in almost any case…. Absent
congressional action, Pfeifer cautiously declined to
impose any one method of accounting….” Id. at
351.
In summary, in Pfeifer, the Supreme Court endorsed a discount rate based on returns generated
by the safest available investment. However, that
analysis was limited to the statute at issue. The
Court elaborated on the procedural aspects of discount rate analysis in Monessen, supra, holding that
the discount rate is a jury question. However, the
holding was strongly qualified in the concurring
and dissenting opinions.
STATE AND CIRCUIT PRECEDENTS •
The following precedents can be divided into two
groups: pre-Pfeifer and post-Pfeifer.
Pre-Pfeifer: Lehrman v. Gulf Oil Corp.
In Lehrman v. Gulf Oil Corp., 500 F.2d 659 (5th
Cir. 1974), cert. denied, 420 U.S. 929 (1975), the Fifth
Circuit Court of Appeals addressed future profits
in the context of antitrust laws. Lehrman brought
suit under the Sherman Act alleging “illegal pricing policies drove him out of his service station
business….” Id. at 661. The Fifth Circuit Court of
Appeals, hearing the case for the second time on
appeal, addressed only the damages issue, holding that although it would have been proper to instruct the jury that it must discount future damages,
failure to so instruct was not grounds for reversal:
“Gulf also claims that the jury should have been
instructed to award only the present value of lost
future profits, and we agree that this would be the
better practice.” Id. at 664.
Post-Pfeifer: Lambert v. Mississippi State
Tax Commission
In a Chapter 11 bankruptcy case, the Fifth Circuit Court of Appeals declared that the discount
rate should reflect the market rate for loans, adding that it is appropriate to include consideration
of risk. Citing the Ninth Circuit Court of Appeals,
the Fifth Circuit Court of Appeals stated:
“[t]he appropriate discount rate must be determined on the basis of the rate of interest which is
reasonable in light of the risks involved. Thus, in
determining the discount rate, the court must con-