Antitrust, But Verify: Financial Considerations for the Private Antitrust Plaintiff
By Gary Reilly
“I was never ruined but twice: once when I lost a lawsuit, and once when I won.”
Litigation is a costly endeavor in terms of both time and money. An injured party must seriously consider many factors in deciding whether to bring a lawsuit. Can I prove injury? Can I prove liability? Does the law provide an adequate remedy? And if the answer to all of the above is yes, can I get relief? That last question is the focus of this post.
The Sherman Act (15 U.S. Code § 1 et seq) provides an excellent set of remedies including treble damages (15 U.S. Code § 15), injunctive relief (15 U.S. Code § 26) and recovery of costs (including reasonable attorney fees) to the successful plaintiff. But what about a defendant‘s ability to pay?
Here are some basic ways to analyze the financial issues that need to be considered by an antitrust plaintiff.
Plaintiffs’ counsel should evaluate early on the financial condition of all potential defendant(s) in an action and continue to monitor their status as the litigation progresses.
For companies that are publicly held or have otherwise issued securities in the United States, the SEC’s EDGAR database provides a wealth of free information on finances, corporate structure, and management’s outlook that allows you to get started right away.
Reliable data on privately held companies is more difficult to come by in the pre-discovery period. Research companies such as D&B Hoovers, Privco, Pitchbook, and others collect and sell financial data, but their databases are necessarily incomplete when it comes to private companies.
Westlaw and Lexis-Nexis offer reports that provide information on litigation, UCC filings, liens and judgments, and other data points that can help gauge a potential defendant’s condition when financial statements are not available. At the outset of discovery, your first set of Requests for Production to any privately held entity should include a request for the company’s annual financial statements.
Defendant Financial Analysis – The Basics
Once you have financial statements in hand it is time to conduct some basic analysis. An attorney evaluating the financial wherewithal of a potential defendant uses the same toolset that a financial analyst for a lender or investor would use. Some key universal metrics to consider include measures of profitability, cash flow, liquidity, and leverage. These metrics should be considered in the context of other relevant factors, including industry benchmarks, market outlook and the defendants’ access to capital markets.
The first step is to read through the financial statements and accompanying notes, taking into account any statements of concern from the auditors, noting the accounting practices used, and noting any changes in presentation year over year.
The second step, based on the calculations you plan to make, is to input the data you need to evaluate into a spreadsheet or financial analysis program. Inputing data from multiple years will allow you to evaluate trends over time, which helps to understand if a company’s financial condition is stable, improving, or deteriorating. If quarterly data is available, with some additional work you can calculate results for the most recent rolling 12-month period. This is particularly helpful when the most recent annual results are nearly a year out of date.
Below is a sampling of some of the most commonly used metrics:
Balance Sheet Measures
Quick Ratio [(Current Assets – Inventory)/Current Liabilities]
This measure of liquidity focuses on the relative level of assets that could reasonably be expected to convert quickly to cash.
Debt-to-Equity Ratio [Total Debt/Total Equity]
A measure of solvency that measures the relative use of debt financing. A high Debt-to-Equity ratio may indicate limited capacity for additional borrowing. But it might also reflect a practice of distributing all or nearly all profits to shareholders.
Gross Margin (%) [((Revenue – Cost of Goods Sold)/Revenue) x 100]
A simple measure, the higher the gross margin, the more money the company has for all other expenses.
Operating Margin (%) [((Revenue – Cost of Goods Sold – Operating
Expenses)/Revenue) x 100]
A narrower profitability measure that reflects operating efficiency of ongoing operations.
Net Margin (%) [((Revenue – All Expenses)/Revenue) x 100]
The narrowest profit measure, Net Margin reflects the net profitability of the company after all expenses including provisions for taxes, interest expense and income, and non-operating gains and losses.
Cash Flow Measures
EBITDA [Net Income + Interest + Taxes + Depreciation + Amortization]
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is a commonly used measure of cash flow available to service debt.
All of these measures must be considered together with your understanding of the industry dynamics, defendants’ business practices, and common sense.
A very profitable business may have relatively weak balance sheet ratios if all profits are taken out as cash distributions. A company may have understated profit margins due to high discretionary compensation to officers/shareholders.
Consider two Companies, A and B. Each has a net profit margin of 1%. Each pays its sole shareholder a salary of $100,000 per year. But the notes to the financial statements indicate Company B has also paid its sole shareholder bonuses of $500,000, $700,000, and $1,000,000 over the past three years. All else being equal, Company B is in a much better position to absorb the costs of a judgment than Company A.
A solid understanding of the defendant’s financial position is essential not only for measuring its capacity to pay a court judgment, but also for structuring a potential settlement agreement. For example, a plaintiff might forego an immediate cash payment in favor of a long-term business arrangement on advantageous terms … if plaintiff is comfortable with defendant’s viability as a going concern.
Joint and Several Liability
As noted at the outset, the Sherman Act provides an excellent set of remedies for the antitrust plaintiff, but there is one more factor of enormous consequence to the financial analysis: joint and several liability.
Every participant in the antitrust violation which caused injury to the plaintiff may properly be named as a party defendant – but need not be. Defendants are jointly and severally liable for treble damages, and have no right to contribution from named or unnamed co-conspirators. See, e.g. Texas Indus., Inc. v. Radcliff Materials, Inc., 451 U.S. 630 (1981).
As a practical matter this affords the plaintiff some flexibility to strategically negotiate early settlements with certain conspirators while still maximizing recovery. It also affords astute defendants an incentive to “do the right thing” by settling early for a fraction of their potential liability.
While there are many other factors to consider, a firm grasp of the relative financial condition of the various named defendants is necessary to maximize the plaintiff’s recovery.
Written by Gary Reilly
Edited by Gary J. Malone