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Law Times • apriL 6/13, 2009 Mulroney inquiry off to good start years ago and what those hun- dreds of thousands of dollars were all about. Justice Jeffrey Oliphant of W Manitoba, a serious, soft-spo- ken man seems determined to get to the bottom of things. He's not a showboat either. He works methodically, politely giving each lawyer all the time he needs, and each witness enough rope to sat- isfy the needs of the inquiry. Under the glass dome of the Victoria Hall in the former Ot- tawa City Hall, a magnificent as- semblage of great legal minds has gathered before Oliphant at tens of thousands of dollars a day to sort out the reputation of one Martin Brian Mulroney. It is an august gathering in fine suits like cardi- nals in conclave before an Avignon Pope in medieval times to decide the fate of one of their own. Mulroney wanted this inquiry very badly. He said it would clear his reputation. "I will attend with bells on," he said. The man has a way with words. Prime Minister Stephen Harp- er was never keen on the inquiry. Who knows where these things can lead? But Harper could hardly refuse Mulroney, who led Harper's transition team when he came to power three years ago. But then the Commons ethics committee had a go at Mulroney and new evidence came out about him and his friend Karlheinz Schreiber. Suddenly Mulroney was no way near as sure he wanted this inquiry. But it was too late. Harper tried to limit the scope. No more talking about the Air- bus purchase, he said. Mulroney tried to delay the inquiry fur- ther, but Oliphant told him "no" a couple of weeks ago. So now the inquiry is on. One thing they don't argue about is the money. Both Mulroney and Sch- reiber agree that Schreiber paid hundreds of thousands of dol- lars in cash to Mulroney in hotel rooms in Montreal and New York. They quibble about the amount. Mulroney says $225,000; Sch- reiber says $300,000. Only Rev- enue Canada knows for sure. What they want to establish is what the payment was for. Both agree it was for lobbying. Sch- reiber adds, "lobbying here in Canada." That would have been illegal. Mulroney says no, it was overseas. So the testimony began this week in the same hall where John Gomery did so much damage to the Liberals. He would say they did it to themselves. Same the- atre, a new script, different players. Once again, the best free show in town for those who love the law. The first witness was Bill McKnight, Mulroney's defence minister at the time, but he said he didn't know very much about the military armoured vehicle Schreiber wanted to sell to Mul- roney's government and Mul- roney had never talked to him about it. No lobbying there. In fact McKnight said he know much about the didn't military. His expertise is in wheat e may finally get to know what really happened all those The Hill By Richard Cleroux and business in Saskatoon. He added that we haven't had a de- fence minister who knows much about the military in 30 years. The audience chuckled. The real surprise was Marc Lalonde, one of the most politically powerful men in Canada, the former right hand of Pierre Trudeau, who went on after politics to a great career in corporate and business law. From October 1993 to Sep- tember 1995, Lalonde worked for Schreiber and his Thyssen In- dustries on the Bear Head project to build light armoured vehicles somewhere in Cape Breton or Quebec. They were to be sold to the Canadian military and hope- fully abroad to friendly countries. Lalonde said he billed Sch- reiber at $325 an hour for a total of $55,000 over the two-year pe- riod. The project never got off the ground. The Jean Chrétien gov- ernment said NO. But during all this time, Lalonde testified that never once was there even a sugges- tion to him that Mulroney, a Conservative, was also being paid to lobby the newly elected Chrétien Liberal government. Nor was there a suggestion that Mulroney was lobbying over- seas on behalf of Schreiber, and especially not in China or Rus- sia, as Mulroney claimed before the parliamentary committee. Mulroney lobbying in China and Russia for Schreiber? "Inconceivable!" said Lalonde. Canada didn't allow military weapons to be sold to Communist China or Russia. And still does not. Lalonde testified Schreiber always paid Lalonde's bills with cheques or bank draft, never in cash or without receipts, and never in secret hotel room meetings. But not all went badly for Mulroney (who was not in the room at the time of Lalonde's testimony). Lalonde said three things would be required for the light armoured vehicle project to go through. First, the vehicles would have to be price competitive with other bidders. (The competition was GM in London, Ont.). Second, the Canadian government would have to buy about 200 of the vehi- cles. Third, there would have to be overseas sales for the project to be profitable for Thyssen Industries. Now that's something that Mulroney's lawyer Guy Pratte can build upon. Just because Lalonde says he was never told that Mul- roney was working overseas for Schreiber doesn't mean that Mul- roney wasn't. There are a lot of things Schreiber has not told ev- erybody about his business. It will be up to Mulroney to prove his case when he appears before the inquiry later this year.This inquiry isn't over by a long shot. LT Richard Cleroux is a freelance re- R COMMENT Something gained BY LARRY ANDRADE & ENZO CARLUCCI For Law Times ecent developments in class action cases in Canada have opened the door to gain- based claims. Although this approach has yet to be accepted at the trial level, it appears to be on its way. From an accounting perspective, here's what legal counsel might want to consider when faced with this new development: As class action lawyers are well aware, several recent cases, especially Serhan Estate v. Johnson & Johnson, have allowed plaintiffs to obtain certifi- cation without the traditional onus of having to establish proof of loss. In this celebrated and con- troversial matter, the proposed plaintiff was a diabetic who had used SureStep, a home monitoring system to de- termine glucose readings by means of a small meter and testing strips manufac- tured by the Johnson & Johnson Family of Compa- nies. The monitor was determined to have provided inaccurate readings. Although no diabetic appeared to have suffered any known health effects, a class action launched in Ontario was certified in 2004 by Ontario Superior Court Justice Maurice Cullity under the doctrine of waiver of tort and upheld two years later by the Divisional Court. At the crux of the claim was the contention that Johnson & Johnson should not be allowed to retain any profits generated from knowingly hav- ing sold a defective product. An aggregate award based on the profits gained from the sale of the product, it was argued, could be assessed and dis- tributed among the plaintiffs. Underlying this determination, which we un- derstand has arisen in several other class action cas- es, is also the understanding that, depending on the circumstances, even if the class of plaintiffs could prove a loss had occurred, it would be far too dif- ficult and expensive to calculate the loss that may have been suffered by each of them. In matters involving consumer products, for ex- ample, where countless thousands or even millions of purchases might have transpired, an alternative ap- proach would be to calculate the defendant's unwar- ranted profits and divide them among the plaintiff class or apply them to a remedial course of action. Whether the gain-based remedy in class actions is accepted at the trial level will likely be determined in the near future. In the meantime, it seems beneficial to highlight some of the key accounting issues coun- sel might have to contend with when confronted with a gain-based claim that requires an accounting of the defendant's profits. Determining the profit earned by the defendant from the product in question is rarely a simple matter. From an accounting perspective, profit earned from a specific product is considered to be the dif- ference between the incremental revenue earned from the sale of that product less the incremental costs and other reasonably attributable costs re- lated to the product. Profit as reported by a company's financial ac- counting system, and as disclosed in financial state- ments prepared in accordance with GAAP (Gener- ally Accepted Accounting Principles), is seldom the right starting point to calculate the profit in a gain- based claim because they usually have limited appli- cability in an accounting for profits matter. For example, a GAAP-based profit-and-loss statement typically encompasses the financial re- sults of the entire company's products, services, offices, and geographic regions. It rarely discloses the level of detail necessary to determine the profit earned on an individual product. Unless the com- pany makes only one product or sells one service there's a lot of work to do before identifying the profits that relate to the class action claim. Determining the revenue that relates to the sale of a specific product may not be as straightforward. Revenue might extend beyond the sale of the sub- ject product of the class action. "Convoyed" prod- ucts or services, which are sold in conjunction with the subject product, might be considered relevant for purposes of calculating profits. Other cash in- flows associated with the sale of the product may also be relevant such as government subsidies, tax www.lawtimesnews.com credits, research grants, and other incentives that would not have otherwise been obtained if it were not for the sale of the subject product. GAAP-prepared financial statements typically include a variety of estimates, accruals, cost alloca- tions, and non-cash expenses that are not necessarily relevant when assessing the profits in question. Care- ful deciphering of the relevant costs and expenses is required. Needless to say, the more costs or expenses deemed to be applicable the smaller the reported profit in question — and vice versa. What are the relevant "costs" that should be con- Speaker's Corner sidered? When it comes to accounting for profits in a litigation context, one of the most important bat- tles is usually fought over the question of whether profits should be determined using an incremental-cost or full-cost method. The incremental-cost ap- proach is naturally favoured by plaintiffs, who likely argue that the only allowable costs are those that relate directly to the product or service in question. Defendants, not surprisingly, tend to lean towards the full-cost approach, claiming as many al- locable costs as possible. Depending on what costs are ultimately consid- ered relevant, the difference in the reported profit can be significant. For an accounting expert to advise counsel on what costs can reasonably be offset against revenues, he or she must acquire an in-depth under- standing of the business sector where the product or service was sold. This should not be done in a generic fashion or by applying a type of checklist approach. Each case will be different and the nuances of how the business actually works need to be determined and understood from as many perspectives as possible. Research and development costs for a pharma- ceutical product, for example, can be substantial. The deductibility of R&D costs may depend on their contribution to the revenue generated by the subject product, which needs to be assessed on a case-by-case basis. For example, under GAAP, costs incurred in the preproduction stage of a product are typically expensed in the period in which they are incurred, which might be years before the revenue from the product is realized. It may be necessary to match the expensed research amounts from one ac- counting period to the revenue generated in a later period from the subject product to calculate profit. Likewise with marketing costs. In a marketing campaign related to 10 products, what portion of the marketing costs can be reasonably allocated to one product? The costs associated with designing and executing a company's marketing and advertis- ing campaign may not be directly tied to any spe- cific product or the overall volume of product sold. Therefore, it is more difficult to relate such costs with a specific product. Is a CEO's salary an allocable cost? It can be ar- gued that the CEO's salary is a fixed cost that would have to be paid by the company regardless of the sale of the subject product. A counter-argument might be made that the salary of a director of R&D when he is responsible primarily or exclusively for the sale of the subject product is a deductible cost. And so on. There is also the issue of "bundling" to consider. A large manufacturer of appliances might sell a washer and dryer combination, or a fridge and stove. If one of the paired appliances is defective and a class action suit results, the calculation of unwarranted profits might need to factor in a determination of how many of the non-defective appliance were sold as a result of being paired with the faulty one. And, how much, if any, of the resulting profits apply to the suit. In addition to the accounting for profits discus- sion, there is also the issue of the return earned by the defendant on the profits ("profit on profit") over the relevant period in question. This article has noted only some of the many factors to consider when determining profit in a gain-based claim. As it seems that the gain-based approach is currently being accepted at the certifi- cation stage of some class action suits, legal counsel should be aware that it is here at least for the time being and the underlying accounting concepts supporting the calculation of profit/gain need to be understood. LT Larry Andrade, CA, CBV, and Enzo Carlucci, CA, CBV, are partners in the forensic and investigative ac- counting practice at Cole & Partners. Their web site is PAGE 7