Tactical Aspects of Supporting Business Litigation

Business litigation often in­volves so much detailed infor­mation and data that counsel as well as the court are hard put to comprehend it. As complexity in­creases, the need becomes pressing for someone with sufficient knowl­edge and expertise to put data into perspective, explain how it is used, what it means, and why it is rele­vant. There is a frequent need to re­late certain events and actions to normal business practices and to convey this knowledge in a compre­hensible, understandable manner to the court in a written report or ver­bally as an expert witness.

Because management consul­tants frequently work with both large and small companies in almost all phases and functions of manage­ment, they can offer a unique and useful source of experience and knowledge to litigation counsel.

For example, in a business practice suit, past actions and events or the future effect of these may have to be evaluated in the context of what is usual and acceptable. It may be as important in one instance to show that a series of discrete ac­tions tends to develop a pattern and in another instance to show that a single event was a deviation from a normal method of business conduct.

Serving as an expert witness is no job for a Walter Mitty. Ideally, a consultant should prepare for the task as carefully as for any important consulting engagement.

Adequacy of capital and other resources, value of a closely held corporation, appraisal of business strategies, and appropriateness of executive actions are examples of areas which may come under scru­tiny by a court or regulatory agency. Litigation of such business matters often includes involved issues that judge and jury must have explained. Courts frequently draw conclusions not only from actual performance but also from indications of intent regarding economic power or condi­tions existing in an industry or mar­ket. Without explanation, the dis­tinction between normal competitive actions and those which may be an­ticompetitive may not be readily apparent.

The knowledge, experience, and skills of a management consultant in litigation support quite closely par­allel those required in most business consulting assignments. Even though the objective is not to effect or im­plement change or to make some­thing happen, similar written and verbal skills of analyzing, reasoning, and explanation are called upon. Take the following examples of cases in which management consultants played pivotal roles.

The estate of a minority stock­holder in a closely controlled com­pany was faced with what ap­peared to be an unreasonably large valuation claim by tax authorities. Analysis and research showed that competitors had drastically altered marketing and merchandising practices to capitalize on changing customer preferences, whereas this company’s outlets were old, too small, and poorly located. Analysis of market changes, competitive conditions, and comparative re­sources revealed the need to abandon certain of its major facili­ties, the inadequacy of its capital, and its inability to secure funds needed to remain competitive over the long term. A carefully sup­ported and reasoned valuation con­clusion presented in a thoroughly documented, logical report was convincing, and obviated litigation.

The Changing Environment of Management

Since the turn of the century and especially since the late forties, major changes have occurred in almost all large busi­nesses and many middle-sized ones. Ownership and management are no longer synonymous. Management, which used to be able to manage through divine right of ownership, now has to be acutely aware of spe­cial needs, requirements, and de­mands of owners. Business is also subjected to increasing internal and external demands. Many decisions which management felt were its sole prerogative, such as the hiring and tiring of employees and the opening or closing of a plant, are no longer private, internal matters. Coupled with these changes has been an in­crease in the external review and control of companies; rules and reg­ulations at all levels of government have risen dramatically. No longer is the conduct of a business reviewed only by its senior management, di­rectors, and stockholders, but, in­creasingly, by many internal and ex­ternal groups and agencies.

• An investigative reporter’s news article revealed possibly question­able actions by a corporation’s chief executive. Stockholders and lend­ers demanded an investigation by an outside counsel. Charting of companies, divisions, subsidiaries, antecedents, major suppliers, and customers developed a number of previously undisclosed corporate affiliations and relationships. The management consultants’ analyses assisted counsel in expanding in­terrogatories and depositions to re­veal previously undisclosed busi­ness practices.

Use of Management Audits

The broadest and most encom­passing appraisal and evalua­tion of a total business entity is frequently called an organization audit, a business review, or a man­agement audit. For organizations that are subject to public scrutiny, such as utilities, health care, and ed­ucational institutions, these audits have been encouraged and some­times mandated by external forces. Financial institutions often seek similar in-depth analyses to satisfy due diligence requirements before issuing new debt or equity financ­ing. Recognizing a larger role and responsibility beyond today’s profit­ability also has caused many corpo­rate boards and managements to seek management audits.

Management audits examine how the company was managed in the past, how prepared it is to meet the future, and whether it satisfies its internal and external obligations. In many broadly based litigation matters, the contested issues that may require the testimony of ah ex­pert witness are those that a man­agement audit discloses.

From such an objective analysis and establishment of evaluative cri­teria, an expert witness is prepared to analyze and support testimony on an enterprise’s plans, programs, and executive actions, such as the fol­lowing:

• Should a subsidiary with a record of losses or marginal profitability have been sold at a price well below book value?
• Was a bankruptcy predictable? Were signals duly noted and acted on? Were actions prudent?
• Were corporate resources properly allocated and shepherded in view of changing market, economic, or technological opportunities and challenges?
• Were the price, terms, and condi­tions of an acquisition fair and rea­sonable? When the business had to be abandoned three years after ac­quisition because of continuous losses, was it because management did not exercise due diligence be­fore the negotiations?

How Much Is the Business Worth?

Business valuations are a spec­ialized form of management audit and are among the most frequently used forms of litigation assistance. In stockholder appraisal rights and estate tax cases, there is usually more regulation, statute, case, and opinion law to be consid­ered and evaluated than in a normal business audit. More than passing attention must be given to legal and tax requirements and precedents, even if the situation does not imme­diately involve either gift or estate issues. While many valuations will not ultimately be tested or chal­lenged in an administrative hearing or trial court, the possibility can never be discounted when interests in closely held companies or public, but thinly or inactively traded, se­curities are involved. The purposes and limitations of any appraisal esti­mate should be clearly defined, but there is always the possibility that the estimate may be cited for other uses should the company become in­volved in litigation.

Book values and earnings his­tory form the bases for most esti­mates of value; however, inflation has added a new dimension, since as­set values may far exceed those re­corded by traditional accounting practices. Similarly, sales and earn­ings, when adjusted for inflation, may show a quite altered trend. Management’s quality, skill, and ca­pability in seizing opportunities and utilizing available resources are what past financial statements and future projections represent. One of man­agement’s major contributions is the creation of intangible values, such as goodwill. The separability or inde­pendence of management contribu­tions, whether by death or depar­ture, is one of the unique considerations of this form of management audit. So, while finan­cial statements based on generally accepted accounting principles are an essential starting point for most estimates of business value, many other factors must be considered. Here is an example.

• A gift tax valuation of a closely held stock was challenged as being too low. A thorough study of cor­porate executive actions confirmed the highly personal and separable nature of the president’s relations with major suppliers and cus­tomers, which justified a sizeable “keyman” discount.

Litigation Settlement Strategies

Another adaption of consulting skills is litigation settlement analysis and planning. The financial risks that come with rapidly accelerating costs for pre­paring and conducting litigation and what often appear to be strato­spheric settlement awards are caus­ing management to consider pretrial settlement in many cases. Compa­nies also are becoming aware that vast amounts of executive and staff time can be taken up in depositions, interrogatories, and trials that in­terfere with the conduct of regular corporate business. Other hidden but not inconsiderable costs include the wages spent in scouring files to produce necessary documents.

Corporate executives recognize that the risks of litigation and settle­ment can frequently be as crucial, in their total cost and future impact on a company, as the decisions on prod­ucts, processes, and plants. Because of that impact, many managers now recognize that they should not just passively participate but actively engage in litigation settlement— treating it as another risk decision they must make for their company.

To counteract the cost, delay, and frustration of litigation, the techniques employed in strategic planning, probability assessment, and alternative decision analysis are being utilized by corporate litigants. Ex­perience with advanced planning and analysis techniques offers a consul­tant opportunities to provide guid­ance to clients in the timing, amount, strategies, and probability of accept­ance of settlement offers or, con­versely, in countering, delaying, or declining acceptance.

Choosing and Using an Expert Witness

At the outset of discussions with a prospective expert witness, counsel should thoroughly present the nature of the case, any major anticipated problems, legal precedents, or proscriptions that may be involved, counsel’s prelimi­nary strategy, and what is to be ex­pected of the expert. Only with a complete understanding of all as­pects of a case can the expert know whether it will be possible to provide necessary and supportive but un­biased opinions. It should never be forgotten by either counsel or con­sultant that an expert’s role is not one of advocacy but of total objectiv­ity and lack of bias. It should not matter for which side of a case an ex­pert is testifying.

Some experts will only work for trial counsel and eschew corpora­tions or individuals as clients. A good trial lawyer willingly accepts the truth, unpleasant or unfavorable as it may be. Those who avoid cor­porations or individuals as clients do so from sad experience-such clients may, on occasion, be less objective and less willing to accept unfavorable facts or conclusions.

Credentials in a specific indus­try are important in certain cases, and some consultants specialize within an industry. But in the main, consultants deal in fresh ideas, transferable management tech­niques, and information on potential problems and opportunities. A deci­sion has to be made as to whether the situation calls for a broadly ori­ented expert or one knowledgeable in a specific management technique or a particular industrial area. Most management consultants will usu­ally have little prior experience with a particular industry, but it is part of their normal preparation for any comparable consulting assignment to collect and analyze industry data and competitive information and, frequently, to interview outside or secondary sources for background on which to base conclusions, rec­ommendations, and opinions. Since a qualified expert in a particular in­dustry is frequently impossible to find, counsel must choose a consul­tant who is knowledgeable in sub­jects relevant to the particular case.

While each court has final say on who may testify as an expert wit­ness and on any limits to that testi­mony, generally an expert may be qualified whether his knowledge has been gained entirely through practi­cal experience, entirely through study, or through a combination of the two. Because expert testimony is opinion evidence, it is vitally im­portant that qualifications be thor­oughly presented to court and jury. These may include work history as well as formal education, continuing training, publications, and speeches.

Specific educational degrees may not be as important as they are for other experts, since management and management consulting require an agglomeration of skills, knowl­edge, leadership, reasoning, inquisi­tiveness, and judgment. There is no single source of expertise, pattern of training, or type of experience that assures success in management or management consulting.

If counsel will attempt to estab­lish a point that is clearly contrary to established law-in effect, to “write new law”—both sides of the issue must be clearly defined. In such cases, an expert should be prepared to give an opinion based on existing law, in the event that the court rules against the counsel’s premises.

Preparing for a Litigation Assignment

In business litigation a manage­ment consultant can offer trial counsel a broad understanding of management, business, and var­ious industries, and an approach to problem solving attuned to the var­ied and complex issues encountered in business. What a consultant may lack in knowledge of a specific busi­ness enterprise or industry is usu­ally balanced by a number of advan­tages, not the least of which are impartiality, objectivity, and credi­bility. While an expert will be paid by one side or the other, it is essen­tial that whoever is chosen must not only maintain an attitude of impar­tiality and objectivity but be able to convey credibility in attitude, man­ner, and presentation. A skilled op­posing counsel will usually be able to expose advocacy, much to the em­barrassment of the expert and the destruction of the testimony.

Preparing for a business litiga­tion assignment is time-consuming and complex, requiring numerous decisions based on a wide variety of knowledge and experience. The ma­terial selected must be pertinent, so that the expert’s analysis and opin­ion are consistent with acceptable business and legal practices. It is im­portant, before the trial, that coun­sel thoroughly understand the inter­relationships of the factors and actions of a company or its competi­tors and the overall industry. Both counsel and consultant have a pre­trial advantage that is available to neither judge nor jury—that of being able to develop, examine, and reex­amine the complexities under re­laxed and informal conditions. Be­cause the judge and jury will not enjoy a similar opportunity, it is es­sential that simplified, logical, sup­portable, and easily comprehensible presentations be developed on each major issue.

Tentative thinking and experi­mentation on the part of an expert may be helpful to trial counsel dur­ing the early, exploratory stages of litigation planning. In rendering an expert opinion, however, these prac­tices must be set aside. One common practice in cross-examination is to pose a hypothetical question; an ex­pert is well warned to resist the temptation to show off analytical skills on the witness stand. To dis­play all the necessary facts and make the necessary analyses while under pressure is not only danger­ous but usually foolish—as an op­posing counsel will often demon­strate. Concentrating on the known specifics of the assigned situation and avoiding the speculative and hy­pothetical should be the rule for the expert witness in verbal as well as written testimony.

An expert witness must always give trial counsel the whole truth, as unpleasant—or unusable—as it might be in trial. It is better to have it known beforehand than to have it arise for the first time during cross- examination. If it is obvious to the expert, it is just as likely that oppos­ing counsel and their experts will ar­rive at the same conclusion. The wit­ness stand is not the place to have to face any predictable fact or situation for the first time, for expert or counsel.

It is important to develop a case in considerable depth, as early as possible, and with the most pain­staking care. A professional can es­timate what opposing counsel or ex­perts may allege, identify additional areas or subjects for discovery or in­vestigation, and determine the rele­vance of documents, testimony, or assumptions, all of which can aid in case preparation, choice of counts to be cited, plea response, and trial strategy. Properly chosen, pre­pared, and utilized, a skilled expert can assist in removing uncertainty and reducing complexity for counsel, court, and jury.

Once an expert is selected, suf­ficient time should be provided to “walk around” the problem requir­ing testimony several times, to view it from all angles, and to obtain as many perspectives as possible. Time should be allowed to develop, test and explore hypotheses, and to se­cure necessary primary and second­ary data. As early as possible, the subject area that the expert will be expected to examine, investigate advise, or give an opinion on should be defined in writing, to assure that the expert will not be expected to testify or be cross examined on mat­ters outside the scope of that ex­pertise.

The expert’s support role should also be defined. How much assis­tance in pretrial preparation will the expert provide? Will the court ap­pearance be made with only notes to work from, or will the expert submit a detailed and documented report which will be entered as evidence; Or will the expert merely act as an adviser and resource for cross-ex­amination of opposing witnesses? If an expert is to be used during the trial to advise counsel on opposing witnesses or expert testimony, the appearance, let alone potential charge, of advocacy must be weighed. In some instances, such advice may be sufficiently valuable so that it will be used instead of expert testimony. Opposing counsel will seek every op­portunity to impeach not only the testimony but also the character reputation, qualifications, and im­partiality of the expert.

Another area in which expert witness assignments differ from usual consulting engagements is the mat­ter of discovery, and the rules of discovery vary from one judicial ju­risdiction to another. If there is any doubt, it is best to clear with counsel what data the opposing side can de­mand. Otherwise, particularly sen­sitive data, working papers, special studies, or incomplete analyses might give the opposition a free ride if they should engage in a fishing expedition.

EDITOR’S NOTE: We acknowledge recent publication of an article on a related topic, “On Being an Expert Witness in Valuation and Other Financial Matters.” by Robert Emmett, SRC Quarterly Re­ports, Winter 1981. Mr. Emmett is ex­ecutive vice president of Standard Re­search Consultants, publisher of this referenced quarterly newsletter.

George S. Arneson CMC heads his own management consulting firm in Leawood, Kansas, a suburb of Kansas City. The firm works primarily with closely held companies on strategic planning, management organization, turnarounds, mergers and acquisitions and business litigation support, often involving valuations. Mr. Arneson has been qualified as an expert witness in several state and federal courts.

Previously he owned and operated a manufacturing company in the graphic arts industry. He also has been CEO of The Vendo Company, vice president of marketing for Wheeling Steel Corpora­tion, and president of its manufacturing subsidiary, Wheeling Corrugating Com­pany.

Mr. Arneson has published articles in Taxes, Mid-America Commerce and Industry, and Bank News.

He is a graduate of the University of Minnesota (bachelor of electrical engi­neering) and the U.S. Merchant Marine Academy (bachelor of science). He is a member of the Academy of Management.