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Summary:
Wildfire swept through a small city
devastating most of the homes and all the businesses. One of the
destroyed businesses was an iconic hotel that was family-owned and
operated for 125 years under long-term land leases. The hotel business
included a popular restaurant frequented by hotel guests and local
residents, and significant retail space that was fully leased at the
time of the fire. Right before the fires, the land leases had been
extended for multiple decades and the business was, by any measure, successful.
Unfortunately, destruction of the hotel was total; there was nothing
physical left. Arxis was retained to quantify the financial loss to the
business owners.
How Do You Define Loss?
When a business is destroyed there
are two potential definitions of loss: loss of income and loss of
value. Lost income is relevant when the business can and will be
rebuilt and will eventually resume normal operations. Loss of value is
relevant when either the business will never resume operations or there
are circumstances that make it impossible for the business to ever
return to pre-disaster operations. If the business never resumes
operations the value immediately before the fire must be determined and,
generally, that is the loss since it has no value after the fire. If
the business will resume altered or minimal operations the business
must be valued before the fire and valued after resumption of
operations to determine the loss of value. Any scenario requires access
to historical financial records for the business, and the development
of extensive projections.
Arxis Analysis:
In the case of the hotel, both
methods (loss of income and loss of value) were considered. Multiple
elements made the decision difficult. First, the owners' emotional
devastation of seeing a family's efforts, through several generations,
completely destroyed in a matter of minutes. The unique memories,
décor, furniture, and all records of that history contained within the
physical walls of the buildings had been reduced to ashes. The current
owners were elderly and plans to pass the business to the next generation
that were in place before the fire were now in question. The future
owners were not certain they wanted to assume the risks and challenges
of rebuilding.
A second complication was the local
government. The city indicated that they saw this event as an
opportunity to re-zone the land to change the authorized use away from
redevelopment as a hotel/restaurant. They also made clear that the
permitting process would be very complex as the current code
requirements were very different than when the buildings were built 125
years ago. Even if they were allowed to rebuild the hotel, it would
have to be based on entirely new designs and architecture. Further, it might
be a few years before the zoning issues were resolved.
The most significant assumption in a
business loss calculation is always the future expectations for the
business. In this case, the questions were monumental but had to be
resolved long before several factors could be known or even knowable.
If the assumption was that the hotel owners were going to just
"walk away," the business would be valued at the date of the
fire. This was certainly the easiest path. If, however, the owners
decided to try to rebuild, multiple more assumptions were necessary
such as the eventual zoning, timing of the zoning decisions, ongoing
costs during the waiting and rebuilding period, date of eventual
re-opening, and the period of time it would take to restore the
financial activity after re-opening to where it would have been, but
for the fire. The decision was to calculate the loss under both
scenarios assuming it would re-open as a hotel.
Result:
The loss of business value was
relatively easy to determine once the issue of destroyed financial
records was overcome. The second calculation (lost income) was complex
and involved probability analysis and, of course, assumptions that
could be easily challenged. The loss period ended up being so far into
the future that the present value of projected future business income
was near zero. Therefore, lost business income ended up being
essentially the same as lost business value. Several years on, the local
government still has not allowed any construction. The assumptions used
in the lost income calculation have proven to be accurate.
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Arxis Financial's "Litigation
Consulting" practice provides objective and
independent evaluation of the economic and financial issues involved in
commercial and civil litigation. We have extensive experience working
with legal counsel to resolve disputes in a wide variety of matters.
Our professionals can perform an analysis to calculate lost revenues,
lost profits, lost opportunities, and unjust enrichment, as well as to
provide assistance in the defense against such claims. We investigate
and analyze the financial evidence and provide meaningful insights.
Arxis Financial's
professionals work with litigators through the evaluation of opposing
party's claims, assistance in preparation of deposition and
cross-examination questions, document request lists, other discovery
assistance, analysis and calculation of damages, preparation of trial
exhibits, and expert witness testimony.
Clients are particularly pleased with
Arxis Financial's
abilities to clearly, persuasively, and accurately present economic and
financial evidence and opinions. Expert analysis and conclusions are
presented in depositions and trial at local, state and federal court
levels as well as mediation and arbitration. If you have a commercial
litigation matter that you would like to discuss, please feel free to contact
us.
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