This article is part of our 10 Lessons from 10 Years series, marking a decade of Forensic & Litigation Consulting in Australia. Explore how we deliver forensic insights, resolve complex disputes and support clients through critical challenges.
In recent years, we have seen a notable rise in legal proceedings that require quantifying an account of profits in addition to damages, either by independent experts engaged by the plaintiff or defendant or joint or court-appointed experts.
An account of profits is an equitable remedy, elected by plaintiffs as an alternative to claiming damages. It aims to prevent unjust enrichment and requires the defendant to identify and relinquish the profits gained from their wrongful conduct. Thus, it focuses on the defendant's financial position, while an assessment of damages, which is compensatory in nature, focuses on the plaintiff's financial harm.
However, plaintiffs often cannot choose between an account of profits and damages until each has been quantified (at least in a preliminary manner), so it is common to see both remedies pleaded initially — this is typically when our involvement as expert advisors begins. And while the concept of quantifying an account of profits may appear like a straightforward accounting process to lawyers that plead them, it can present a number of complex challenges.
This remedy, in particular, frequently requires an expert with sufficient skill and experience in assessing these types of claims in order to arrive at the correct result. Experts not familiar with these challenges can unintentionally quantify an account of profits that does not reflect the actual profit generated by the defendant from its wrongful conduct.
In our experience, there are six key challenges to consider and potentially overcome to ensure an accurate and robust account of profits quantification.
Accessing Relevant Documents
When acting for the plaintiff, a significant initial challenge lies in obtaining the necessary documents to allow the expert to properly quantify the account of profits. This is usually due to insufficient knowledge by the plaintiff's lawyers and appointed expert around the defendant's business and systems.
An experienced expert has the benefit of past experience, so they can draw on knowledge from similar proceedings to formulate discovery requests based on what they expect ought to exist and may be in the possession of the defendant. For example, to ensure the appropriate level of detailed financial data is obtained, we have been asked to assist with court processes and hearings over discovery by providing affidavit evidence on documents required, including explanations to the court on the relevance of each document request to the quantification of an account of profits.
Identifying Infringing Products or Services
The next step involves identifying the infringing products or services, which form the basis for calculating the associated infringing revenue. In many cases, identifying these items is relatively straightforward. However, in some matters, the infringement relates only to a component or feature of a product, which necessitates apportionment of profits.
For example, in the well-known case Dart Industries Inc v The Decor Corporation Pty Ltd (1993) 179 CLR 101, the Court dealt with the complexity of apportionment where the infringement related only to 'press button' seals on the lids sold as a part of a whole product being plastic canisters. Similarly, in Aristocrat Technologies Australia Pty Ltd v Konami Australia Pty Ltd (No 3) [2022] FCA 1373 — where FTI Consulting acted as expert for Aristocrat — Konami argued that the infringement was limited to a "feature/trigger" within its electronic gaming machines and not the entire machine. The Federal Court found apportionment appropriate and determined that 35% of the total profits from the sale of the infringing gaming machines should be included in the account.
Ancillary Products and Services
In conducting an account of profits analysis, experts should also consider any ancillary products or services linked to the infringing product. For example, if the defendant sold infringing washing machines and also operated a repair and maintenance division that serviced those washing machines, the profits from these services may need to be included in the account of profits.
In order to identify ancillary products and services, experts need to ensure they have a sufficient understanding of the defendant's business operations, which can be obtained from examination and analysis of the defendant's financial documents, other relevant discovery material, publicly available information such as business websites and/or instructions.
Quantifying Relevant Costs
There is typically general agreement between parties on deducting direct costs of sales—such as manufacturing or purchasing costs, freight and delivery. However, disputes often arise between opposing experts regarding the treatment of indirect and general overhead costs (including depreciation) in determining how much, if any, should be deducted from the infringing revenue.
An expert needs to consider many things in relation to the allocation of overheads, such as:
- What percentage of the business's total sales relate to the infringing products?
- What is the nature of each overhead expense?
- Could the overhead expense have been reduced if the infringing products had not been sold, or would they have been incurred regardless?
- Was it possible that the overhead expense would have been recovered through the sale of other products if the infringing products had not been sold?
In Aristocrat, for example, the Court acknowledged the complexity of allocating overhead: "It is notoriously difficult in some cases to isolate those costs that are attributable to infringement from those that are not. Approximation may be necessary in allocating overheads."
Likewise, in Dart, the majority observed: "In arriving at an answer, the Court must consider such questions as whether the overheads in any particular category were increased by the manufacture or sale of the product, whether they represent costs which would have been reduced or would have been incurred in any event, and whether they were surplus capacity or would, in the absence of the infringing product, have been used in the manufacture or sale of other products. Dealing with the last of these questions may require the use of the concept of opportunity cost."
Importantly, a defendant is not entitled to deduct opportunity costs for profits it could have earned from producing and selling alternative products. However, overhead costs that would have supported the capacity to produce alternative products — but were instead used for producing the infringing items — may be deducted.
Future Unrealised Profits
Typically, an account of profits encompasses actual profits earned up to a specified date. However, in one of FTI Consulting's early matters — discussed by our colleague Marcin Smalec in a recent article— the Court broke new ground in Australia by including future profits as part of an account of profits compensation order.
In recent years, we have seen claims arise for future profits based on the 'springboard effect' argument. Essentially, the springboard effect refers to the 'unfair advantage' or 'head start' a defendant has gained and may continue to benefit from even after the wrongful conduct has stopped. These alleged wrongful gains are much more difficult to isolate and quantify than a historical account of profits and experts will often require detailed assumptions from their instructing lawyers to be able to quantify.
Treatment of Loss Periods
Often, as experts, we identify certain financial years within an Infringing Period where we quantify actual losses from the sale of the infringing products as opposed to profits generated. This poses an interesting question: Can the losses in these periods be used to offset (or reduce) the infringing profits identified in other years? Or can the plaintiff simply elect not to include these loss-making years in their election for an account of profits?
In Aristocrat, this precise issue arose, as there were years during the relevant period where Konami reported operating losses rather than profits from the sale of infringing products. The parties disagreed on whether these losses should be offset against profits in other years.
In this case, the Court held that losses could only be offset if they were directly attributable to the same infringing activities that generated the profits. As Konami did not establish this connection, the loss years were excluded from the calculation.
Conclusion
As the previous discussion shows, while quantifying an account of profits may seem a straightforward accounting exercise, it is, in fact, a complex process that necessitates a thorough evaluation of various legal, factual and financial considerations often overlooked by experts unfamiliar with the issues that can arise in these types of claims.
For lawyers whose clients are involved in proceedings where an account of profits is a potential remedy, proactively acknowledging the intricacies and complexities inherent in quantifying an account of profits and engaging an experienced expert to assist is the first step in ensuring the best possible outcome for clients, yielding an accurate and robust account of profits quantification. Engaging a specialist accounting expert at an early stage in the proceedings is also crucial, as they can utilise their expertise to bridge the knowledge deficit in the discovery phase and provide valuable guidance and support in navigating these complexities through to quantification.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
