Basic Damages Issues in Employment Litigation

/ / CFES Publications, Forensic Economic Analysis in Employment Litigation

In employment-discrimination matters, the basic elements of economic damages are:

  1. Wages /salary
  2. Bonuses
  3. Commissions
  4. Health benefits
  5. Stock options
  6. Stock purchases
  7. Retirement benefits
  8. Search-for-work expenses
  9. Expenses of new employment
  1. Plaintiff's work records and tax returns
  2. Defendant employer's records
  3. Subsequent employers' records
  4. Academic, government and industry studies
  5. Reports of experts, such as vocational specialists
  6. Plaintiff's educational background
  7. Professional licenses or certifications
  8. Family and personal history
  9. Physical or mental problems, medical records

1. Voluntary separation

Would the plaintiff have terminated employment with the defendant voluntarily, absent alleged wrongful acts on the defendant's part? Determinants include the state of the particular industry or business, the plaintiff's health, the plaintiff's family situation, the propensity of the plaintiff to change jobs, likely retirement age and health-benefit portability.

2) Involuntary separation (lawful)

Would the position at issue have been terminated in any event? Determinants include the state of the business or industry, the likelihood of a merger or acquisition, and the likelihood or the actuality of downsizing or demotion.

3) Defendant's impact on mitigation

The effects of defamation or other defendant-imposed limitations on mitigation. Comments by the employer may make it hard or impossible for the plaintiff to find comparable employment. The plaintiff may have similar difficulty in instances where the termination was in retaliation for whistleblowing. Also, restrictive covenants or non-compete agreements may hinder mitigation.

4) Plaintiff's efforts

The plaintiff's mitigation efforts and the job market.

A. Probable tenure with defendant

Certain factors help determine whether the plaintiff would have worked through retirement age for the defendant, or whether market forces, plant closings or other career contingencies would have cut short tenure with the defendant; and whether the plaintiff's financial, health or family situation of the plaintiff would have any bearing on probable tenure with the defendant or the plaintiff's ability to mitigate. These include:

  1. Work history with defendant employer
  2. The plaintiff's economic assets
  3. Available retirement benefits
  4. The health of the plaintiff
  5. Health and job status of the plaintiff's spouse
  6. Likely layoffs or plant closings
  7. Average retirement age within company
  8. Economics of the industry
    • competitors
    • product lifecycle
    • changing skill requirements

B. Mitigation

The plaintiff has a duty to mitigate damages by seeking employment comparable to the job he or she had with the defendant employer. Unlike plaintiffs in bodily-injury matters, plaintiffs in discrimination matters are presumed to be able to work. Indeed, the key assumption underlying a wrongful-discharge, failure-to-hire or failure-to-promote claim is that the plaintiff is perfectly capable of performing the functions of the job at issue (and may be the most-qualified employee) and would have continued to do so but for the alleged discrimination of the defendant employer.

The defendant has the burden of proving failure to mitigate. Robinson v. SEPTA, Red Arrow, 982 F. 2d. 892, 897 (3d Cir. 1993). The defendant must show that substantially equivalent work was available to the plaintiff and that the claimant did not exercise reasonable diligence in seeking alternative employment.

Economists can proffer testimony on job markets, rates of unemployment and other data relevant to job search. Economists can interpret Bureau of Labor Statistics data such as displaced-workers surveys, which are studies on the amount of time it takes workers in various industries and geographical areas to find work when they lose jobs, tenure data, salary surveys and academic studies on employment. However, the question of whether or not the plaintiff exercised due diligence in mitigating the adverse action of the employer may reach beyond the economist's expertise. Experts whose testimony may be brought to bear on this issue may include:

  1. "Head hunters" (recruiters) who may be able to provide information on current job-market demand for the particular industry or profession.
  2. Vocational specialists, usually called on in cases involving physical injury, can provide a list of occupations suitable for the plaintiff.
  3. Outplacement specialists—consultants retained by corporations to help victims of downsizing find work outside the corporation—may know how long it may take a person in a particular profession to find work. (The defendant employer may be able to obtain records of the plaintiff's experience with an outplacement specialist if the defendant retained such a specialist for the plaintiff.)

C. Statistical Analysis of Damages ("Lost Chance")

Normally, the use of statistics in employment litigation is limited to the question of liability, usually in class actions. The use of statistics to quantify and apportion damages has been avoided in cases involving multiple plaintiffs because courts have deemed damages to be individual in nature. In Allison v. Citgo Petroleum Corp., 151 F.3d 402, 81 FEP Cases 501, (5th Cir. 1998), alleging racial discrimination in hiring, promotions, compensation and training, the appellate court held that class certification was inappropriate where "uniform group remedies" were sought without requiring an inquiry into each plaintiff's individual circumstances and how each plaintiff was affected by the employer's conduct. Some courts have addressed this issue by having a special master address each individual damages claim. Jenson v. Eleventh Taconite Co., 130 F.3d 1287 (8th Cir. 1997); Berger v. Iron Workers Reinforced Rodmen Local 201, 898 F.Supp. 572 (ND Ohio 1995).

Statistical analysis is gaining ground in employment damages cases, however, under a theory of recovery known as "lost chance." Under this theory, a claimant's recovery is limited by the odds or likelihood that the event at issue would have occurred or will occur.

Largely used in failure-to-diagnose medical-malpractice cases and other cases where the injury is an increased risk of future harm, the theory has gained a toehold in employment matters involving failure-to-promote claims where plaintiffs outnumber the available promotions. Rather than making each plaintiff whole by allocating damages as though each plaintiff would have been promoted, the award is divided between the plaintiffs on a pro-rata basis, often based on the percentage likelihood of each individual plaintiff getting the promotion absent the discrimination. Doll v. Brown, 75 F. 3d 1200, 1206-07 (7th Cir. 1995); Bishop v. Gainer, 272 F. 3d 1009, 1015-16 (7th Cir. 2001)

D. Benefits

1) Health Insurance

Damages stemming from lost health-insurance benefits are calculated by finding the cost of replacing whatever coverage the employer provided. Certain plaintiffs will have, depending on their health or age, significantly higher damages in this area.

2) Pension

Pension benefits fall into two distinct classes: defined-benefit pensions, where the employee receives a certain amount on retirement either in a lump sum or via periodic payments as defined in the company's benefit plan, and defined-contribution plans, where the employee and the employer contribute a defined sum to the pension plan. The exact amount of retirement benefits from a defined-contribution plan are a function of earnings and the rates at which the employer and the employee contribute to the plan. A defined-contribution plan provides an individual account for each participant. Defined contribution plans include 401(K) plans, 403(b) plans, employee stock ownership plans and profit sharing plans.

Defined contribution plans are becoming by far the more widely used form of pension benefit. Some employers making a transition from defined-benefit to defined-contribution plans are offering "cash-balance" plans. Under these plans, the present value of the amount vested in the existing defined-benefit plan becomes a contribution to the defined-contribution plan.

The replacement value of a discontinued defined-contribution fund is easily calculated -- it is simply the total contributions that might be expected to be made in the back- and front-pay period. If the front-pay period is expected to last through the plaintiff's probable retirement age, the calculation of lost defined-benefit pension payments is also fairly simple: damages are the additional monies that the plaintiff would have expected had he or she remained employed by the defendant.

Calculating the loss in a situation where the plaintiff had a defined-benefit plan with the defendant employer and the front-pay period does not continue through retirement age is a bit more problematic, since benefits in most plans are a function of years of service and amount of salary toward the end of the worker's career.

3) Vacation Pay

"Vacation pay" is often listed in company manuals as a benefit. However, to count vacation pay as a separate element loss is, almost always, to double-count damages, since "vacation pay" is not normally paid over and above salary. Some employers will "buy back" unused vacation time, however, and if it can be shown that the plaintiff would have sold back vacation days, that amount would indeed be a legitimate item of damages.

On the flip side, an economist might credit an employer with a payout of vacation pay as if it were severance pay. However, only "unearned" vacation pay should be so credited. For example, a plaintiff separated on June 30, 2004 has at that point "earned" two weeks of his annual four weeks' vacation time. Therefore, the employer's offset should be limited to two weeks' salary.

E. Stock and stock options

Equity compensation such as employee stock options (ESOs) and restricted stock gives rise to a variety of damages claims in wrongful-termination suits and other types of employment actions. Often, however, these claims do not take into account some fundamental features of equity-based compensation.

1) Employee Stock Options

An option is a contract giving the option owner the right (but not the obligation) to purchase shares of stock at a preset price for a specified period of time. Employee stock options are used by companies to reward and retain key employees. An employee who has been granted an option must wait until the option vests before the option may be converted into shares of company stock. ESOs vest in accord with the employee stock-option plan (ESOP). If the employee leaves the company, the employee normally loses options that have not yet vested.

Once the option vests, the employee may realize the value of the option by exercising it -- the company permits the employee to buy a specified number of shares of the company's stock for the price specified in the option contract. This preset price is called the strike price. The value the employee realizes is the difference between the market price of the stock and the strike price.

If the strike price is less than the price of the company's stock on the open market, the employee may make an immediate profit by buying the stock at the lower, preset price and then selling it at the current market price. However, the employee might choose to hold on to the option, betting that the market price of the stock would rise even further. A third alternative is to exercise the option and keep the stock shares, rather than selling them on the open market for an immediate profit.

If the strike price is greater than the market price at the time of vesting, the employee may hold the option, hoping that the market price goes up above the strike price. ESOs, unlike exchange-traded options, cannot be sold directly in the open market. Unlike marketable options, which are traded daily in a market similar to the stock market, employer stock options are not negotiable. (Also, employee option plans are not regulated by ERISA.)

The period during which the option may be exercised is called its duration, which for ESOs is usually ten years. Under many option plans, if the employee is terminated, the duration window is shortened to a few months following the employee's separation from the company.

2) Questionable claims

In suits brought by terminated employees, damages claims involving ESOs may rest on questionable assumptions, or may overlook some fundamental features of options.

For example, an employee who has left the company before the options in question have vested may claim to have lost the current market price of the company stock, minus the option strike price. This claim, however, is, in effect, a prediction of the stock's price on the day the options would have vested.

A terminated employee forced to exercise vested options within a short time frame may claim that he or she lost out on future gains in company stock. However, the exercise of an option does not require immediate sale of the stock. The employee could have purchased the stock at the strike price and then held on to the stock to enjoy future appreciation, although if the option represents a large portion of the employee's wealth, the sale of some shares may be required to pay the acquisition cost of the stock. Also, income-tax considerations may determine the year of exercise.

Terminated employees who have lost options have also claimed as damages the highest price of the stock between termination from the company and present. This is actually a claim that the employee would have sold at the top of the market. However, accurate market timing is extremely rare and difficult, and a trier of fact should look skeptically at such a claim. In essence, the plaintiff is asserting a conversion theory of damages.

3) Black Scholes

When valuing stock options in employment litigation, economists often rely on the Black Scholes methodology. Black-Scholes is a theory of options pricing devised in 1973 by Fischer Black and Myron Scholes, two finance professors. Scholes was later awarded the Nobel Price for it (Black had passed away). The Black-Scholes option pricing model is the method of options valuation required by the Financial Accounting Standards Board in accounting for the cost of employee stock-options plans.

In calculating the value of an option, Black-Scholes employs a complex formula that considers the current price of the stock, the strike price, the risk-free interest rate (e.g., the current rate on Treasury securities), the amount of time until the option expires, the company's dividend on the stock, if any, and the volatility of the stock. All of these variables are known with certainty except the volatility of the stock, which must be estimated. Usually, volatility is calculated as the historical standard deviation in the stock's price, i.e., the past as predictor of the future. This can pose a problem if the company is changing in fundamental ways. IBM, for example, was a leader in the computer industry from 1950s until the mid-1980s, then precipitously lost its place during the microcomputer revolution. Thus, the historical volatility of IBM would not, in 1985, be a good predictor of the future volatility of IBM.

It should also be noted that Black-Scholes strictly applies when the option is negotiable, yet company-issued employee stock options are not negotiable. To be useful in determining damages in an employment matter, arguably, a "lack-of-marketability" discount would need to be included in the Black-Scholes calculation.

4) Restricted Stock

Restricted stock is another form of equity-based compensation claimed by executives in wrongful-termination or failure-to-promote claims. Restricted stock is stock that cannot be traded or transferred for a period of time (usually between one and five years). For litigation purposes, restricted stock is valued in much the same way ESOs are valued, with some differences. Restricted stock, once it is tradable, is an outright grant to the recipient, unlike options, which require the recipient to pay for the underlying shares at the price specified in the options contract. Some economists, when valuing restricted stock, assume a "zero cost collar," which is a strategy of locking in future stock profits using puts and calls. However, this strategy cannot be used legally with restricted stock since such stock cannot be assigned and, in order to write a call, the writer is essentially assigning the stock.

F. Retirement Age

Determining when a plaintiff is likely to retire can be a critical component of damages evaluation in employment matters, especially is age-discrimination claims. Aside from the plaintiff's own testimony as to anticipated retirement age, testimony from the economist can be helpful, as well as, in some cases, testimony by industry specialists.

Economists have been allowed to proffer testimony interpreting academic studies on retirement, as well as government and industry data, in light of the particular plaintiff's situation. Finch v. Hercules, 941 F. Supp. 1395, 75 FEP Cases 1709 (D.C. Del., 1996).

Another consideration is the plaintiff's personal financial situation. It may be that a plaintiff's financial situation is such that early retirement is an attractive possibility; it may be that the difference in income between working and retirement is minimal, and the incentive to remain on the job not so great. Alternatively, the plaintiff's financial needs may be such that he or she may have a strong incentive to continue earning a salary.

A. Common Plaintiffs' Fallacies

  1. Claiming that front pay will last until the end of the plaintiff's worklife. In discrimination claims, the basis of the plaintiff's argument is that he or she is perfectly capable of working. Situations where the defendant's alleged discrimination will affect permanently the plaintiff's ability to earn a living are rare.
  2. Ignoring layoffs, industry downturns or other economic factors that would have meant a layoff for the plaintiff regardless of any discrimination on the defendant's part.
  3. Assuming promotions would happen at the same rate in the future as in the past, ignoring current economic conditions.
  4. Not factoring in a non-marketabilty discount when assigning a value to employee stock options or restricted stock.
  5. Claiming the plaintiff who had left a company before employee stock options vested has lost the current market price off the stock minus the option strike price. This is, in effect, a prediction of future market price.
  6. Claims that a terminated employee who was forced to exercise an option shortly after termination has lost out on future stock gains. The plaintiff was under no obligation to sell the stock after exercising the option; he or she could have held the stock and enjoyed any future gains.
  7. Claims that a terminated employee would have exercised his or her options and sold stock at the top of the market. This would require extraordinary prescience. In essence, the plaintiff is asserting a conversion theory of damages.
  8. Claiming full damages in a failure-to-hire or failure-to-promote claim where several candidates were vying for a single position.
  9. Claiming that the plaintiff's mitigation job search is restricted to a relatively small geographic area.
  10. Claiming a lengthy back-pay period in spite of intervening reductions-in-force, plant closings, after-acquired evidence or other factors that would have cut the back-pay period short despite and alleged discrimination on the part of the defendant.
  11. Ignoring probable raises and promotions the plaintiff could reasonably expect in his or her current job; this tends, misleadingly, to extend the time it would take the plaintiff to "catch up" economically to the point he or she would have been had the discrimination not occurred.
  12. Misinterpreting key aspects of benefit plans by, for example, calculating retirement schemes that are based on a percentage of average career salary by considering only the average of a few highest-years' salaries (ignoring the distinction between "career average" and a "final average" defined-benefit plans) or basing loss stemming from forgone stock-purchase plans on the average stock price over a number of years, rather than actual prices year by year.

B) Common Defendants' Fallacies

  1. Deducting gross revenue rather than net revenue earned in mitigation where mitigation involves self employment.
  2. Claiming in a liability argument that negative employee performance reviews were not a pretext, but claiming in the damages argument that the negative performance reviews would have limited plaintiffs' raises and promotions.
  3. Ignoring the individual plaintiff's particular situation. For example, claiming probable retirement age of 57 where the median retirement age at the defendant's business is age 57, but the 56-year-old plaintiff had several children late in life.
  4. Ignoring gaps in a retirement plan. For example, where a plaintiff's statistical worklife is to age 59 but pension and Social Security will not be available until age 62.
  5. Using collateral benefits as offsets.
  6. Claiming that disability during the back pay period would have limited defendant's back-pay liability, ignoring the fact that, had the plaintiff been employed by the defendant during the back-pay period, he or she would have been covered by disability insurance.
  7. Claiming that the plaintiff's search for work in mitigation should cover an overly large geographic area.

Special Issues in Class Action Cases

Even where an employer has discriminated uniformly against members of a potential class, certification might be defeated due to lack of commonality or similarity in damages.

For example, where there are 200 potential class members and damages center on stock options, a wide range of differences in individual strike prices, holding periods, and uncertainty in vesting may leave scant common criteria by which to calculate damages; the only commonality is that each potential member worked in the division and had options. The significantly wide range of differences in individual damages may make certification unproductive and illogical.

Ignoring the circumstances of individual class members can lead to significant problems in damages testimony. In one matter, the Equal Employment Opportunity Commission withdrew its damages expert, who had proffered damages testimony based on a lost-chance calculation, in favor of its own calculation. This calculation ignored the individual circumstances of the class members, including those who had admitted in writing that they had left the labor force following separation from the defendant.

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