The “discounted cash flow” (DCF) method has increasingly widespread application, notably to compute damages claims. Its purpose is to determine the value of a business or an investment by projecting the anticipated future cash flow before discounting it back to present value (at a specific discount rate). In other words, the DCF method puts a present value on a future loss.
The use of that valuation method continues to generate much discussion within the arbitration community. A major attraction of the DCF approach is its inherent flexibility, in that it can be applied in many different contexts. Arbitral tribunals recognise that the DCF method is a widely accepted and theoretically sound business tool for valuations. However, they remain cautious when applying that valuation method in practice. Like all valuation methods, the DCF method is only ever as good as the data used and the underlying assumptions.
Although the Swiss Supreme Court has, to our knowledge, never specifically discussed the DCF method in the context of damages claims, we see no reason to exclude this method of valuation when assessing a potentially recoverable loss under Swiss law. Having said that, there are general principles of Swiss law on contractual claims of which any party seeking damages on the basis of the DCF method should be aware before resorting to that method.
Under Swiss law, contractual liability is governed by Article 97 of the Swiss Code of Obligations. Under this statutory provision, an obligor who fails to discharge an obligation is liable for the resulting loss, unless he or she can prove that he or she was not at fault.
The potentially recoverable loss suffered by the aggrieved party consists of involuntary diminution of assets, increase of liabilities, or loss of profits. The recoverable loss comprises not only the actual loss sustained (damnum emergens), including costs which would not have been incurred but for the damaging event, but also the profits lost as a result of the breach of contract (lucrum cessans).
Whether and to what extent a loss is recoverable depends on causation. Causation requires a link between the contractual breach and the loss incurred. Under Swiss law, the causation test is twofold. The first is a factual test (the “natural” causation test): did the breach of contract result in the loss? Swiss courts generally apply the formula “conditio sine qua non” to determine natural causation, that is, the damaging event must be a necessary condition for the damage. The second is a legal test (the “adequate” causation test). “Adequate” causation means that, based on general experience, the breach of contract is of such a nature as to cause the loss or damage in question, that is, the breach could have been expected to produce the outcome (in other words, the loss) in question.
Because of the “adequate” causation requirement, a claim for lost profits (lucrum cessans) is more difficult to prove; in particular, it will be awarded only under the condition that the future loss is sufficiently “liquid”. This means that there must be a sufficiently strong probability that the loss will occur in the future and that the damage can at least be calculated with sufficient accuracy at the time when the award is made.
Those principles are also applicable when determining a potentially recoverable loss under the DCF method. Concretely, this means that:
- Unreliable forecasts about future cash flows will result in the dismissal of a DCF analysis.
- A claim for damages based on the DCF method is likely to fail if (a) the company being valued is not a “going concern” or (b) when trying to project future cash flows of a business company with absolutely no track record.
- Recovery of damages valued under the DCF method is likely to be denied if the loss actually suffered could not have been reasonably foreseen by the breaching party.
According to some legal commentators, another objection that is likely to be raised successfully under Swiss law against the application of the DCF method concerns the (in)adequacy of that method depending on the type of loss actually suffered. Defining what precisely is being valued is key. For example, if the loss consists in the loss of future dividends only (lucrum cessans) rather than in the decrease of the value of shares (damnum emergens) the application of the DCF method is likely to be rejected in favour of another valuation method.
In conclusion, the above shows that the DCF method may well be a valuable tool in the quantification of damages. However, this valuation method can only be applied successfully if the requirements of Swiss law on contractual liability are also taken into account. Otherwise, arbitral tribunals applying Swiss law are likely to reject any damages claim based on this method.
