The Forensic Accountant’s Role in a Subrogation Claim

Subrogation matters have slightly different circumstances than most litigation matters. However, at the end of the day subrogation cases remain a legal dispute between plaintiff[s] and defendant[s] involving tort damages. The likelihood of “getting the money” increases with an experienced forensic accountant preparing and presenting your damage demand.

In all jurisdictions (and situations) the tort damages that flow from the triggering event do not equate to the business income and extra expenses under the terms and conditions of the insurance contract. Rather, it is the tort damages that the subrogating carrier and its counsel will be pursuing.

Subrogation litigation typically follows the execution of a signed Sworn Proof of Loss or Subrogation Receipt which confirms the amount of money paid by the carrier and actually received by the insured. The insured has a contractual obligation under the insurance contract to fully cooperate with the subrogation efforts. The plaintiff[s] may include both the first-party insurance carrier[s] as well as the insured company damaged by the action.

Regardless of which side of the courtroom you represent, it will be necessary to assemble an appropriate team of experts and consultants including a forensic and investigative (F&I) accountant. Having the unique experience and expertise to measure, reconcile and present the differences between the insurance settlement and the tort damages is important to the success of the litigation.

This article will focus its attention on the pivotal role the F&I accountant plays on a subrogation case in general and in particular on measuring Lost Profits due to a triggering event. Lost Profits involving the actions of a third party is similar to first party property insurance Business Income, but with certain distinctions.

F&I Accounting

Special investigative accounting has been around for a very long time. Financial scandals and certain television shows in recent years have coined the term forensic and investigative accounting and made it more commonplace. However, some attorneys and their clients may not be fully aware of the complete skill set that F&I accountants possess, nor how they can be an important factor in preparing and presenting a successful case.

F&I accountants are used by attorneys in establishing the link between cause & origin physical evidence of the alleged actions. Being able to link the cause & origin physical evidence into the direct cause & effect financial evidence through an analysis of accounting and operational records may help to determine the best course of action in the case.

Depending on timing factors, the subrogation damage analysis can proceed simultaneously with the first-party property adjustment, the cause-and-origin investigation or can occur later as long as the necessary operational and accounting documents are identified and preserved. Remember that historical information is best captured immediately following a loss when it is fresh and in its original format.

They can provide assistance in the following areas:

• Specific business or industry experience, including economic conditions impacting such experience
• Complex accounting systems including cost allocations, revenue recognition procedures
• Accounting conventions, US GAAP, tax, and multi-national protocols
• Determining the relevant and reliable accounting and operational information
• Supplier, customer and/or interplant relationships and interdependencies
• Examining of the supporting documents, reports and calculations provided to the insurance carrier[s]
• Providing a comfort level as to how the loss was adjusted and/or reasonableness of a negotiated settlement basis

The last point is particularly significant as the experienced F&I accountant can quickly determine the scope of previous accounting assessment and diligence undertaken by the first party insurance company in adjusting the claim and making final payment. This initial process also assists in evaluating other steps to be taken in shoring up the case if necessary and the determination of the tort damages including uninsured losses if any.

Choosing The Right Accounting Expert

The field of F&I accounting has been rapidly growing in the broad area of litigation services as attorneys realize that having an accountant on the litigation team is a very valuable resource. However, the attorney should exercise care to ensure that the accountant they retain has the necessary credentials and experience to stay with the case from the discovery phase to its eventual conclusion.

Whereas traditional accountants continue to provide important attestation audits, reviews, compilations, tax and consulting engagements to public and private companies; it should be noted that F&I accounting is a unique discipline with its own special skill set within the accounting profession. Because some accountants wanting to “get in on the action” now advertise themselves as F&I accountants, caution is urged to be sure they possess the necessary forensic accounting and litigation experience to represent your client in the best light.

The role of the F&I accountant typically includes the following tasks:

• Identify the accounting and operational records necessary as part of the request for the production of documents
• Collect, preserve, manage and ensure that the document production is complete
• Accounting conventions, US GAAP, tax, and multi-national protocols
• Provide accounting, financial and technical questions for interrogatories, depositions and cross examination
• Prepare damage scenarios, rebuttal and/or appeal positions as directed
• Continue to evaluate the merits of the damages as more information becomes available
• Offer guidance and direction on financial matters before and during trial
• Serve as a fact or consulting witness; or provide an expert report and testimony as needed

Use Of Previous V. New Accountant

The subrogation professional may be stepping into a case where either no forensic accountant had been previously hired or where one had been retained on behalf of the first-party carrier during the adjustment phase.

On complex matters, the subrogation lawyer is faced with the decision to hire an accountant for the first time, use the previous accountant or retain a new firm. The decision to retain or not retain the previous accountant may be influenced by whether or not the insured is still participating and seeking uninsured damages, and some of the following considerations:

Pros:

• No learning curve, understands business and impact of loss on operations
• Familiarity with accounting personnel, financial and operational records
• Has conducted some level of accounting analysis and developed opinion on damages
• Less chance for duplication of effort and additional cost
• Discovery cut off and time constraints

Cons:

• May not be considered a qualified or competent expert witness
• Not experienced in the distinction and measurement of tort damages v. insurance policy contractual obligation
• Limited scope due to cost constraints, policy limits or other factors in the handling of the first party claim
• Unacceptable quality of work product or lack of due diligence and work product
• File may contain notes, calculations and correspondence that could be problematic on cross examination
• May have been privy to conversations or communications that subrogation counsel does not want discoverable
• Findings in first party loss measure may contradict subrogation position and/or uninsured losses
• Opinion or parts thereof may not be credible and undermine subrogation case

Having an accounting firm with experience on both the insurance contract and tort damages sides can be a powerful resource to the trial lawyer.

Cause & Effect

Qualified investigators and engineers are typically involved in the cause & origin aspects of the subrogation case. However, this section will deal with the cause & effect phase where F&I accountants take a more active role.

There is important underlying operational and financial information to the subrogation case with which a F&I accountant is also quite familiar. These documents while technically not part of financial reporting can be very useful in determining the cause and effect on recoverable damages. By drilling down into the financial, operational, downtime, maintenance, inspection reports and/or capital project records and logs, a careful forensic analysis can often times support the findings of other consultants or give rise to further investigation.

It is essential that the accounting consultant be able to fully comprehend the insured’s business network, operations, accounting and cost systems. In addition, it is important to understand the insured’s business in terms of its industry, manufacturing processes, sales and distribution channels, and inter-dependency on other internal or outside operations.

Distinguishing the direct from the indirect economic damages is essential to presenting a fair measurement of Lost Profits, and therefore a credible tort damage position.

Requesting the Right Information

Acquiring the appropriate information can be accomplished through early meetings with the COO and CFO, liaising with their designated operations and finance personnel and establishing a comprehensive document production protocol. Some of the accounting and finance topics at preliminary meetings might include:

• Discuss the types and frequency of available operational reports, logs and financial reporting
• Confirm that original documents key to the case will not be destroyed in the normal course of business
• Sift through the detail to identify the proper level of necessary documentation
• Inquire as to the company’s outside auditor and types of reports issued
• Identify all detailed fixed asset ledgers, depreciation records and applicable tax returns
• Understand all construction projects in progress as of the date of the incident
• Identify all regular outside general contractors as well as their subs
• Create a matrix of evidence for the investigative and financial analyses
• Prepare a historic and ongoing document request protocol
• Collect and catalog the necessary documents on a timely basis

Record Retention

As will be discussed later, subrogation cases can take many years to be completed. You cannot afford to be searching for important original documents five to ten years later only to find that they have been lost or destroyed in the normal course of business.
It is therefore imperative that a proper framework be established to:

• Determine if original or scanned documents will be required for evidence
• Develop a matrix all necessary information by expert discipline to eventually be relied upon at trial
• Discuss the need to save all supporting documents or only those over a certain dollar threshold
• Save, catalog and store all source documents in either their original or an electronic format
• Develop a protocol to retrieve the documents many years later in an orderly manner
  These measures when put into place from day one will save time and expense down the road and certainly reduce your pre-trial stress level.

Getting Your Evidence Admitted

Again, it is important for the attorney to conduct a proper initial interview to determine if the forensic accountant will make a credible expert witness if necessary. Previous courtroom experience and the forensic accountant’s ability to handle potential voir dire examination and a Daubert challenge are key factors to ensuring evidence is admitted at trial [1]. One of the things you want to avoid is investing considerable time and expense in a case for your client only to later find that your accounting expert will be excluded by the court.

Because accounting matters can be complex, it is helpful to work with a forensic accountant who presents his or her findings with easy-to-understand expert reports, trial exhibits and/or be ready to provide trial testimony.

In most instances, judges and juries alike respect and will give additional weight to the testimony of a witness that makes it easy to understand the intricacies of the case, as well as an accountant that they trust and like.

Another objective is to present the proper balance of evidence and understand what documents and/or trial graphics will or will not be permitted in the jury room during deliberations. Because this can vary from one jurisdiction to the other, understanding and ensuring that the most important information is actually in the jury room is critical.

It is often difficult for juries to absorb and recall all of the testimony given during trial. If the jury can reexamine some of your key evidence during deliberation, the jury is more likely to recall your important points. For example, if the courts and/or the attorneys agree to allow the witness to present a PowerPoint presentation, consult with your lead counsel to see if the judge and jury would be permitted to be provided with their own copies of the slides to make notes during testimony.

Damage Reconciliations

Typically, there are differences between the insurance settlement as actually paid and the Lost Profits demanded in a subrogation action. In addition, there are likely to be differences between the plaintiff’s demand and the defendant’s measure of damages.

First-party property insurance has specific contractual language to guide the adjustment process and loss settlement. Subrogation litigation on the other hand is without policy restrictions, but does require attention to tort damages guidelines. These differences can be significant.

While the legal principles governing the recoverability of Lost Profits are quite involved, the underlying tenants are closely linked to accounting considerations when presenting Lost Profits in a subrogation matter:

• Proximate Cause
  The recovery of Lost Profits must be as a direct result of the wrongful conduct of the defendant, and exclude indirect and/or unrelated impacts on the business during the Period of Recovery .
• Reasonable Certainty
  The claimed Lost Profits demand must be non- speculative capable of being proven with reasonable certainty using the business records and financial statements of the plaintiff or related industry documentation .
• Foreseeability
  Whether and to what extent the Lost Profits would have been earned by the plaintiff had no wrongful action taken place by the defendant. This concept differs when measuring Lost Profits on breach of contract claims in that the damages must have been foreseeable as a result of the breach when the contract was originally made, as opposed to the Period of Recovery following the wrongful action.

Some of the more notable business interruption policy limitations that may not impact the measurement of Lost Profits include:

• Perils covered
• Special exclusions
• Policy limits and sub-limits
• Deductibles
• Waiting periods
• Indemnity periods
• Coinsurance

However, it may also be the case that the first-party policy provides broader coverage than under tort damage law.

• Stated amounts per unit or pre-agreed amounts or rates of profit/revenue in the policy
• Inventory paid at net selling price per the policy v. replacement cost
• Fair market v. carry value
• Replacement cost v. actual cash value
• Proper overhead factors and add ons

The forensic accountant must also reconcile the most substantial differences between the damage positions asserted by the plaintiff and the defendant. However, the majority of differences generally revolve around a limited number of major issues. A reconciliation by line item will provide the attorney the tools to focus the case on the significant issues. This reconciliation may also be beneficial in the courtroom to help focus the jurors on the substantive issues.

Special Accounting Designations

To keep pace with the times and the increasing demand for specially trained accountants, colleges and universities across the nation now offer both undergraduate and graduate programs in forensic accounting. In addition, the AICPA and other organizations offer additional professional designations which are useful in subrogation matters. These include:

Certified Valuation Analyst (CVA)

The National Association of Certified Valuation Analysts supports and provides a framework for asset valuation services.This is extremely important when an independent valuation of a business is required before and after a wrongful act.

Certified Fraud Examiner (CFE)

The Association of Certified Fraud Examiners (ACFE) is an association dedicated to providing anti-fraud education and training to reduce business fraud and inspire public confidence within the profession.

Certified in Financial Forensics (CFF)

The AICPA established this credential in 2008. It is granted to CPAs who demonstrate significant expertise in the field of financial forensics.

When it is felt fraud could be involved in the underlying documents, records and/or the presentation of damages, this is a key accounting credential for your witness to have.

Although these professional designations have their own specific attributes, each credential increases the stature and public perception of both the CPA who possesses them and the accounting profession in general. Additionally the CPA, CFE, CVA and other related designations, all require continuing professional education and have strict professional codes of conduct, which further strengthen the forensic accountant’s commitment to provide an objective and impartial analysis.

Conclusion

Subrogation litigation involves a team effort, requiring professionals with unique training, experience and qualifications. An experienced forensic accountant can assist with the financial analysis required by the case, which may include analysis of operational data as well. The investigative analysis is important in the discovery and investigative phase of the case, and becomes critical in the preparation for and attendance at settlement conferences and/or trial. An effectively utilized forensic accountant will be an invaluable resource for the subrogation recovery team.

 

The statements or comments contained within this article are based on the author’s own knowledge and experience and do not necessarily represent those of the firm, other partners, our clients, or other business partners.

1. The Daubert Challenge stems from a legal precedent established in 1993 in Daubert v. Merrill Dow Pharmaceuticals, Inc. In this case, the U.S. Supreme Court established that trial judges for federal courts have a special responsibility to ensure that scientific testimony must meet the two-pronged relevancy and reliability test for admissibility during a legal proceeding. In essence, this test determines whether the expert’s evidence fits the facts of the case and the reliability of the techniques used in researching the expert’s conclusions.