Litigation & Disputes Bulletin: Q1 2023

Hundreds of cases are settled by our courts every day and it can be hard to keep up with the latest rulings. In this quarter’s newsletter, KSM’s Litigation & Disputes team has pulled together some interesting case summaries that obtained a meaningful result in the context of economic damages. Read on to see what’s happened recently.

If you require the perspective of an expert in commercial damages, we’d love to discuss how KSM can help. Please contact a member of our team or complete this form.

In This Issue:

• Appraisers Continue to Be Excluded Most Under Daubert, Per PwC Study
• Expert Excluded for Offering Legal and State of Mind Opinions in Delaware
• Parties Motions to Exclude Each Other’s Experts Are Granted in Part and Denied in Part
• U.S. District Court (New York) Denies Motion to Exclude Expert Witness

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Appraisers Continue to Be Excluded Most Under Daubert, Per PwC Study

Under Daubert, appraisers were excluded more often in 2021 than any other type of financial expert witness, according to the PwC survey, “Daubert Challenges to Financial Experts (2000-2021).”^[1] Of the three most common financial experts (economists, accountants, and appraisers), appraisers had a 38% exclusion rate in 2021, followed by accountants (32%) and economists (27%). Over the 22 years of the study, appraisers have the highest exclusion rate (44%) of the three. The exclusion rate includes full and partial exclusions.

The annual study analyzes challenges to financial expert witnesses (appraisers, accountants, economists, and others) under the Daubert standards from 2000 to 2021. These are the years following the U.S. Supreme Court’s Kumho Tire decision, which expanded Daubert’s reach to financial expert witnesses.

Reliability is the main reason. Overall, lack of reliability continues to be the main reason for excluding financial expert witnesses under Daubert, the study finds. Courts most frequently cited the lack of sufficient data or the use of methods that are not generally accepted as reasons for exclusion, the study says. Relevancy was the second most common reason for exclusion, which is consistent with historical trends. The expert’s qualifications are the least cited reasons for exclusion.

Here are some other interesting takeaways from the study:

• In 2021, there were 272 reported challenges to financial expert witnesses—an increase of 19% from 2020;
• Of the 272 challenges against financial expert witnesses in 2020, 89 challenges (33%) resulted in partial or full exclusion of the expert;
• For the 22 years captured in the study, the highest rates of exclusion for financial expert witness testimony are in these types of cases: breach of contract or of fiduciary duty, intellectual property, fraud, and antitrust matters;
• During 2021, cases involving breach of contract/fiduciary duty resulted in the most challenges to financial expert witnesses;
• In 2021, the 1st Circuit and the 7th Circuit had the highest exclusion rates while the 3rd Circuit and 8th Circuit had the lowest exclusion rates;
• Over the course of the study, there have consistently been about twice as many Daubert challenges to plaintiff-side financial experts (66%) as there have been to defendant-side financial experts (34%), and this pattern held true in 2021.

Rule 702 of the Federal Rules of Evidence governs the admissibility of expert evidence in federal courts, including the Tax Court. There are proposed changes to the rule designed to put more teeth into it and to reemphasize to the triers of fact that, if an expert is not qualified in the matter at issue, then he or she should be excluded.^[2]

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Expert Excluded for Offering Legal and State of Mind Opinions in Delaware

In re Columbia Pipeline Group, 2022 Del. Ch. LEXIS 180 (July 14, 2022)

The plaintiffs filed a motion in limine to exclude the testimony of Guhan Subramanian. The order was granted in part. Rule 702 permitted expert opinion testimony when the expert’s “specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue.” DRE 70-2(a). The Delaware courts had made it clear that an expert cannot displace the court by offering conclusions of law. “An expert also cannot propose factual findings based on his personal view of the evidence.”

An expert can testify as to whether a party’s actions were consistent with industry standards. The expert must articulate the standards he is using. It is not sufficient to just testify as to his own experience.

The plaintiffs were pursuing a claim against TC Entergy Corp. (TransCanada) for aiding and abetting alleged breaches of fiduciary duty by officers of Columbia Pipeline (Columbia) because their decisions were tainted with self-interest, that the officers misled the board of directors into approving a sale to TransCanada at too low a price. “Important questions for the court to decide include whether the officers made decisions that were tainted with self-interest, whether TransCanada knew about and took advantage of their conflicts, and whether the disclosure documents omitted material information.”

Subramanian submitted a report that purported to answer three questions: (1) Were TransCanada’s negotiation tactics and strategy reasonable and consistent with negotiation best practices? (2) were Columbia’s negotiation tactics and strategy reasonable and consistent with negotiation best practices? and (3) did the proxy statement omit facts that were significant? “Subramanian disavowed any desire to opine as to legal issues or make findings of fact.”

The court stated some aspects of the report went too far. His answer to the third question was really a legal opinion of materiality. Materiality was an issue for the court. He was precluded from providing his opinions on facts omitted from the proxy statement.

Subramanian’s answers to the first two questions were a mixture of proper and improper expert opinion. The court provided two examples of where his report provided proper information that was helpful to the court.

Other aspects fell into a gray area. However, his report did not provide a meaningful basis for evaluation. It was largely personal thinking and judgment. “His opinions on the sale process in this case thus differ from the helpful analysis he offered about the management-led buyout in Dell, which rested not only on his thinking and judgment, but also on a data set of management buyouts he collected.” The court erred on the side of permitting these opinions because they were gray. But he may only frame his testimony on whether the actions were consistent with best practices in negotiation. By opining on reasonableness, Subramanian was expressing a back-door legal opinion.

Another gray area was his thoughts on intent or knowledge. Here, again, the report lacked any real expert analysis. However, because of his expertise in the area of negotiations, the court allowed his testimony in this area. He cannot in this area testify as to the state of mind of some of the principals during the negotiations. The court must make those factual determinations.

Other aspects of his report clearly crossed the line. For example, his opinion that “the Columbia board was independent, sophisticated, and involved.” Most of that section read like a Delaware judicial opinion. Nothing was provided in the nature of expert analysis to support his assertions. “Subramanian may not offer testimony on the opinions expressed in Part III.B of his Report.” The court noted other areas where Subramanian offered what were in effect findings of fact and invasions of the court’s prerogative. Instead of providing helpful researched information, he simply looked at what was in evidence just as a court would do. He did not support his opinions as he did in the Dell case, also presided over by Laster. The court was disappointed in his report in this case.

“Subramanian may not testify on the subjects identified in this order, regardless of where they appear in the Report.” The motion in limine was granted in part.

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Parties Motions to Exclude Each Other’s Experts Are Granted in Part and Denied in Part

Redcell Corp. v. A.J. Trucco, Inc., 2022 U.S. Dist. LEXIS 154217; 2022 WL 3700148 (Aug. 26, 2022)

This action involving claims by Redcell Corp. et al. against A.J. Trucco Inc. et al. under the Defend Trade Secrets Act (DTSA) and for breach of contract involved the parties’ motions to exclude each other’s experts. Both parties’ motions were granted in part and denied in part.

Background

The parties’ relationship. Trucco imports and distributes produce. Redcell is a technology company that develops computer software and provides technology services. Redcell provided Trucco with software development and IT services from 2008 to 2019. The parties jointly developed the IMP Software system. One product was PLEXUS IMP, designed for management of a produce importer.

The parties had a software development agreement (SDA) since 2008. Under the SDA, Redcell owned the copyright to the code until Trucco made its final payment to Redcell, at which time the copyrights transferred to Trucco. There was also a nonsolicitation agreement prohibiting Trucco from soliciting or hiring any of Redcell’s employees for a three-year period. “Redcell alleges Trucco induced Redcell’s chief software programmer, Jean Paul Arce (‘Arce’) to stop working for Redcell and affiliate with Trucco, taking with him Redcell’s source code for the IMP software.” Redcell asserts two claims, one for misappropriation of trade secrets in violation of the DTSA and one for breach of contract “and seeks damages for Trucco’s unjust enrichment in an amount equal ‘to the entire value and profitability of Trucco’s business[,]’ as well as punitive damages, attorneys’ fees, and costs.”

The Westland report. J. Christopher Westland, CPA, was the damages expert for Redcell. He is a professor at the Information and Decision Sciences Department at the University of Illinois—Chicago. He is the editor-in-chief of “Electronic Commerce Research.” He is widely published and has familiarity with 13 computer languages. He issued two reports on Redcell’s damages, his primary report and a rebuttal report. He opined that Redcell’s damages for unjust enrichment for Trucco’s misappropriation is $14,596,902, “comprised of Trucco’s $684,489 in excess profits on sales, $12,287,400 in savings from cost efficiencies, and a $1,625,013 increase in enterprise value.” Westland explained the steps he employed. His ultimate opinion was that Trucco’s benefit flowed from the licensing and implementation of PLEXUS IMP and other evidence presented. During his deposition, Westland stated that he had computed inflation factors for the retail fruit industry from a book by Aswath Damodaran, “the valuation guru in this industry.” He admitted that he had received additional information on Trucco’s financial statements and tax returns after his report was filed. He did a simple analysis that indicated the change would not be more than 10% higher. He was “guessing the damages might be a little bit higher under the actual numbers.”

The Gottlieb report. Trucco submitted the report of Mark S. Gottlieb, CPA. He is a CPA in Connecticut and New York. He is also Accredited in Business Valuation (ABV) and Certified in Financial Forensics (CFF). His summary of speaking engagements over the past two decades includes presentations on business valuation, forensic accounting, appraisals, and taxation issues.

His assignment was to “independently review” the Westland report and opine on the reasonable certainty of economic losses alleged within the Westland report. He explained the research and process he used in determining whether the “such damages are supported by the ‘procedures that were deemed relevant and valid.’” Gottlieb described what he perceived as five errors in the Westland report. “Gottlieb opines, ‘within reasonable certainty, that the alleged economic losses opined by [Westland] fail to provide a valid and supportable computation of damages sustained by [Redcell].’” Gottlieb asserted that Westland made a computational error in applying the inflation factors resulting in inflated damages estimates, resulting in an overestimate of damages by $6,919,807. Estimated damages would be reduced accordingly, to $7,677,095.

Gottlieb admitted in his deposition that some of his staff did part of the financial analysis, computations, and financial issues. With the help of a colleague, Gottlieb determined that Westland had made an error in his calculations.

The Westland rebuttal report. Westland responded to each of Gottlieb’s critiques and faulted Gottlieb for failing to provide an alternative damages calculation.

Discussion

Trucco’s motion to exclude Westland. Trucco argued that Westland’s reports and testimony should be excluded for five reasons.

Westland’s data. The first two arguments were taken together. Trucco criticized Westland for basing his opinions on “self-manufactured financial data,” i.e., the “pro-forma financial statements” Westland created “without reviewing Trucco’s actual financial statements or income tax returns.” Trucco also complained that Westland failed to produce those reports.

Redcell responded that the information Westland used for his report came from the joint database available to Trucco. The court rejected Trucco’s argument that Westland’s opinions should be stricken based on failure to provide data on which he relied. Trucco had the documents requested. “The fact that Gottlieb discerned computational errors in Westland’s calculation of excess profits from sales and savings from cost efficiencies undermines Trucco’s assertion that Westland failed to provide sufficient data or methodologies to permit Gottlieb to test the reliability of his opinion.”

Second, Trucco’s criticism that Westland did not do a full analysis once he belatedly received financial statements did not provide a basis for Westland’s exclusion. Westland stated that he did a “simple” analysis to determine that any change would not be more than ±10%. To allow exclusion based on Trucco’s own failure to provide timely discovery (i.e., the delayed receipt of statements) would not be fair to Redcell. Westland did not receive the actual statements until after his report was submitted, so using pro formas bolstered by a subsequent “simple” analysis was not sufficient to exclude the Westland report and his testimony.

Calculation accuracies and input. Trucco argued Westland’s opinions should be excluded because of his computational errors and “major variables that could have changed his calculations.” Particularly criticized was Westland’s method of calculating the impact of inflation on damages. Trucco’s expert, Gottlieb, recalculated using the “correct average inflation multipliers.” This dropped the estimated damages from $12.9 million to $6.1 million.

Redcell responded by pointing out the control factors used in his calculations and noting that, in his rebuttal report, Westland pointed out why the asset market and income approaches that Trucco used were inapplicable and why Gottlieb’s analysis and recalculations were flawed. “The Court finds that neither Westland’s computational errors nor his choice of variables warrants exclusion of his opinions.” A jury can determine the differences between the two experts and corrections of calculation errors.

To the extent that Westland (and Gottlieb, discussed later) provided arguments in support of the significance to Trucco’s growth of the IMPUS IMP software versus Pacia’s business acumen, he was offering an inappropriate factual narrative. That portion of Westland’s rebuttal report was excluded.

Westland’s qualifications. Trucco argued Westland was not qualified because his main focus was not business valuation and he was not a member of the AICPA, and courts did “not exclude the testimony solely on the ground that the witness lacks expertise in the specialized areas that are directly pertinent.” Rather, the liberal interpretation was the ability to testify as the valuation of business without regard to the particular industry. Westland wrote two books on the valuation of technology companies, one of which Aswath Damodaran praised. Westland was also a licensed CPA. No evidence was offered requiring membership in the AICPA as a qualifying issue. Trucco can push these points on cross-examination. In short, the court determined that Westland was qualified to testify.

Redcell’s motion to exclude Gottlieb. Redcell argued for Gottlieb’s exclusion based on: (i) he relied on witness interviews, documentation of which has not been produced; (ii) set forth impermissible nonexpert conclusions; (iii) was unfamiliar with Bayesian A/B testing; and (iv) improperly relied on the expertise of a subordinate.

Trucco responded that Gottlieb properly relied on witness interviews and work performed by a colleague and was qualified to opine on business valuation. The court noted that the standard for a rebuttal witness was the same as for any expert witness. “A district court has discretion, however, to limit a rebuttal expert’s opinions to responding to the principal expert and preclude the rebuttal expert from offering ‘[an]other method’ altogether.” The court found that none of Redcell’s arguments warranted excluding Gottlieb’s testimony. However, as in the case of Westland, the court will exclude portions of Gottlieb’s testimony. Where Gottlieb offered a “Condensed History” of Trucco, it will be excluded— the same as to testimony as to the reasons for Trucco’s growth and success. Those opinions went to an ultimate issue of fact for the jury and were not appropriate expert testimony.

Gottlieb was a CPA and Accredited in Business Valuation and was qualified to testify in this matter. Additionally, he formed his own opinions in this matter and relied properly on the work of his subordinate.

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U.S. District Court (New York) Denies Motion to Exclude Expert Witness

Manbro Energy Corp. v. Chatterjee Advisors, LLC, 2022 U.S. Dist. LEXIS 165342; 2022 WL 4225543 (Sept. 13, 2022)

“This lawsuit arises out of Plaintiff Manbro Energy Corporation’s (Manbro) investment in Winston Partners Private Equity, LLC (WPPE or the Fund). Plaintiff (P) seeks damages from Defendants, Chatterjee Advisors, LLC et al. Defendants (D) managed the Fund.

“Ds move for summary judgment on the four remaining claims. P cross-moves for partial summary judgment on the breach of fiduciary duty claim and moves to dismiss D’s counterclaims for indemnification and implied covenant of good faith and fair dealing. D’s motion for summary judgment is for the most part denied and P’s motion for summary judgment is denied. P’s motion to dismiss the counter-claims is granted. Defendants’ motion to preclude the opinions of Plaintiff’s valuation expert, Dr. Antoinette Schoar, is denied.”

The last element, relating to the denial of a motion to preclude the opinions of the plaintiff’s valuation expert is of most interest to valuation professionals. The other issues argued in the case dealt primarily with distribution to the plaintiff of an interest in a petrochemical company located in India. The dispute centered around the value of the shares in that petrochemical company, Haldia, and the plaintiff considered their distribution in-kind to be inadequate in part because the result would be that the plaintiff would hold a minority interest alone instead of as part of a majority block formerly held in conjunction with the defendants. Most of the remaining opinion dealt with the claims of lack of good faith and breaches of fiduciary duty. The focal point for valuation issues was the defendants’ Daubert motion to exclude the opinion of Dr. Antoinette Schoar. Schoar was proposed to testify as to the value of the Haldia shares. The court denied the motion to exclude.

The court then discussed the reasons for the denial, starting with a review of Rule 702 and the Daubert requirements, and noting that trial judges have broad discretion to determine the admissibility of expert testimony. “[V]igorous cross-examination, presentation of contrary evidence, and careful instruction on the burden of proof are the traditional and appropriate means of attacking shaky but admissible evidence.” (Amorgianos v Amtrak) Expert testimony should be excluded if it was speculative, conjectural, or based on bad assumptions.

The defendants’ argued that Schoar was unqualified to testify and her methodologies were flawed. Schoar was a tenured professor at MIT, had taught graduate courses on corporate valuation, and had valued 100 companies, including in India. “She is unquestionably qualified to provide a valuation opinion in this case.” The court also determined that Schoar’s use of the “unmodified” version of the CAPM did not render her opinion unreliable for Daubert purposes. The court also noted that the selection of comparable companies was inherently “expert judgment.” Schoar explained why she identified the companies as comparable. The defendants’ criticisms of her methodology and process went to the weight and not the admissibility of her opinions. Thus, the motion to exclude Schoar’s testimony was denied.

VIEW PREVIOUS BULLETINS

[1] pwc.com/us/en/services/consulting/deals/assets/daubert-study-2022.pdf
[2] “Proposed Rule 702 Change Targets Unqualified Experts,” Business Valuation Update, Vol. 28, No. 4, April 2022