Goodbye Kaczkowski? A Recent Ruling Reopens the Door to Debate

by Chad L. Staller, MBA, JD, MAC

Could the beginning of the end be in sight for Kaczkowski v. Bolubasz, the 1980 state Supreme Court opinion on the awarding of damages that is widely regarded by defense counsel as an unwarranted gift to plaintiffs?

In a dissenting opinion to the court’s December ruling in Helpin v. Trustees of the University of Pennsylvania there was a signal that Kaczkowski may soon be history. On the other hand, the majority opinion in the case appears to actually expand Kaczkowski to encompass business-loss claims as well as future lost-earnings claims in personal-injury matters.

A remarkable opinion in a breach-of-contract matter, the 4-3 majority in Helpin held that lost future income derived from business profits should be calculated based on methodology mandated for injury and death torts byKaczkowski .

At the same time, the dissent, led by Justice Thomas G. Saylor, openly invited challenges to Kaczkowski in any context — business or injury.

Kaczkowski holds that lost future earnings must be calculated using the “total offset” method, which almost always favors plaintiffs. The question in Helpin was whether Kaczkowski should be used to calculate damages in a breach-of-contract claim involving future profits of a dental practice.

Helpin, a dentist, entered into an employment contract with the University of Pennsylvania in 1996. Under the contract he received a salary and 50 percent of the profits of a dental clinic. He resigned in 2004 after a transfer to a suburban clinic, alleging constructive discharge, and brought an action for tortious interference with a prospective economic relationship and breach of contract. The trial court granted the defendant’s motion for nonsuit regarding the tort claim, but the contract claim was upheld. The jury awarded $4.04 million.

On appeal, the high court held that the Kaczkowski methodology should be applied to the award, even though it was to compensate for lost business profits under a breach-of-contract theory, and not a personal-injury claim.

The Helpin majority noted that to not apply Kaczkowski would be to deny the plaintiff compensation for the effects of future inflation.

The dissent enumerated many of the problems inherent in the Kaczkowski methodology — not only its application to breach-of-contract damages, but its application in the tort context. The dissent pointed out that the total-offset methodology has been rejected in every other state where it has been applied, except Pennsylvania. The dissent noted that allowing for productivity increases while not effectively discounting results in a double recovery, concluding overall that Kaczkowski is “overly compensatory.”

Open for Challenge

The majority’s extension of Kaczkowski to business-loss claims will certainly raise vigorous challenges. The accepted methodology for business-loss analysis takes into consideration many variables that are ignored in the total-offset method, most notably a discount for risk factors inherent in business. Abandoning adjustments for risk provides plaintiffs in business-loss claims an even greater advantage than Kaczkowski offers in the personal-injury context.

Kaczkowski has engendered controversy since it was decided in 1980. Defendants argue that the opinion does not comport with economic reality and that it unfairly rewards plaintiffs at the expense of the defense.

Kaczkowski was a wrongful-death and survival action brought by the family and estate of a 20-year-old student of computer science.

The Kaczkowski court adopted an innovative approach to the calculation of the decedent’s lost future income. Earnings tend to grow due to adjustments for inflation, and also due to productivity — the increasing value of an individual worker’s experience and skill, and increases in national productivity due to the adoption of new technology and other factors.

Awards for lost future earnings generally take these increases into consideration, but awards are also discounted to present value. The plaintiff receives the award for lost future earnings as a lump sum. This lump sum can, if invested, accumulate interest over time. To guard against overcompensation of the plaintiff, the total amount of future lost earnings is reduced to the sum that, if invested in a safe instrument, will yield what the plaintiff would have earned in the future absent the tort.

The discount rate used to reduce damages to present value is commonly based on the rate of return on such relatively safe investments as high-grade municipal bonds or U.S. Treasuries.

Pennsylvania is the only state that requires the “total offset” method in determining the present value of future lost earnings, as specified in Kaczkowski .

The total offset method is based on the theory that, over time, inflationary growth in wages roughly equals, and thus offsets, the interest rate. Under the total-offset method, the present value of lost future wages is current earnings times the number of years the earnings will be received, adjusted upward to account for both individual and national productivity increases. (Prior to Kaczkowski , Pennsylvania injury and death awards for future damages were discounted uniformly at 6 percent.)

A Difference in Calculations

Kaczkowski normally will yield a significantly higher bottom line for the plaintiff than the generally accepted discounting methodology outlined in the 1983 U.S. Supreme Court decision Jones & Laughlin Steel Corp. v. Pfeifer, which reduced future lost-earnings damages to present value using the “real” rate of return — the rate of return on a safe investment minus the estimated rate of inflation.

For example, under Kaczkowski , a $50,000 per year loss for ten years would yield $500,000. Under Jones & Laughlin , discounting by the “real” rate of 1.5 percent (a return of 4.5 percent minus an inflation rate of 3 percent), the present value of the loss is $461,109. That’s an 8 percent difference between the two calculations.

If a productivity growth factor is warranted, Kaczkowski simply adds the enhancement to the bottom line. UnderJones & Laughlin , productivity increases are reduced to present value using the real rate of return.

Kaczkowski is controversial in that it is explicitly biased in favor of plaintiffs, and also due to the fact that rates of inflation and interest rates do not necessarily — in fact, rarely — offset each other exactly in any given period.

The Kaczkowski court justified its pro-plaintiff holding: “There is no measure [of discounting to present value] that can assure absolute accuracy. An additional feature of the total offset method is that where there is a variance, it will be in favor of the innocent victim and not the tortfeasor who caused the loss.”

The Kaczkowski court also noted that its streamlined total-offset methodology offers the advantages of simplicity and predictability.

Critics of the total-offset method, however, point out that interest rates are a function of many variables beside inflation, and that interest rates must offer a “real rate of return” over and above inflation, the rate at which borrowers must compensate lenders in order for lenders to stay in business. Critics have also pointed out that current interest rates are no mystery — an award can be easily discounted by the prevailing rate of return for a safe investment.

The Pennsylvania legislature implicitly rejected Kaczkowski in the 2002 Medical Care Availability and Reduction of Error Fund, which mandates that damages in medical-malpractice claims be reduced to present value using a real rate of return, not the total-offset method.

Criticism of Kaczkowski is sure to escalate now that the total-offset methodology has been applied to business-loss claims.

In the personal-injury arena, Kaczkowski benefits plaintiffs; in the business-loss context, Kaczkowski represents a potential plaintiff bonanza.

Normally, future business income is discounted to reflect the risks inherent in any business, such as general economic conditions, specific industry conditions, the financial health and stability of the business and the quality of management. Risk-adjusted discount rates typically range from 15 to 25 percent. Assuming an annual $50,000 loss of future profits over ten years, Kaczkowski yields $500,000, where a risk adjusted discount rate of 20 percent yields a present value of $209,624.

In Helpin , the court conflates lost future profits with lost future wages. From an economic standpoint, these are not the same. Confusing the two can lead to inequitable awards.

Given Helpin ‘s expansive reading of Kaczkowski , the debate is sure to intensify, which may pave the way for a full review of Kaczkowski by the state Supreme Court and a possible repeal. For now, litigants on both sides have a lot to consider when making lost-future-income claims.  •

This article appeared in The Legal Intelligencer, May 20, 2011. Reprinted with permission of ALM Properties Inc.