Litigation & Disputes Bulletin: Q2 2019
In This Issue:
Court Says Daubert’s ‘Gatekeeper’ Role Favors Inclusion, Not Exclusion
Ferraro v. Convercent, Inc., 2018 U.S. Dist. LEXIS 209530 (Dec. 12, 2018)
This Daubert case illustrates how courts may interpret the role of “gatekeeper” differently. The dispute featured a company that provided software-based services. The defendants claimed the plaintiff’s expert was unqualified because he lacked the necessary experience valuing that type of company, but the court found the law did not require this degree of specialized knowledge. In contrast, in Weinman v. Crowley, a bankruptcy case turning on insolvency, the court, on its own accord, found the trustee’s expert, who had extensive background in international finance and some accounting experience, lacked the necessary solvency experience. The court suggested that it would have excluded the expert on this basis had the defendant argued for it. Courts also diverge on reliability when it comes to calculating damages. Here, the court said some degree of speculation is common in expert testimony. In contrast, in a recent Texas case, Cargotec v. Logan Industries, an appeals court majority found damages testimony was not admissible because the expert relied on management projections that were based on some unfounded assumptions, notwithstanding the expert’s extensive independent work on the case.
Backstory. In 1994, the plaintiff founded a company, Group Dynamics, that specialized in complex workplace investigations. The company later changed its name to Business Controls and eventually became Convercent, the named defendant. As the company developed, it expanded the services it provided. They included the traditional web-based whistleblower services as well as investigative, consulting, and training services. In 2012, Convercent was worth approximately $6 million to $8 million. The plaintiff began to look for outside investors. The company’s then-president introduced the plaintiff to the leader of a consulting company, Nebbiolo, suggesting Nebbiolo could increase Convercent’s value.
At that time, the plaintiff did not know that Nebbiolo had only just been formed and that Convercent’s president had a personal stake in it. In 2012, the plaintiff and Nebbiolo entered into a professional services agreement (PSA) under which Nebbiolo would provide services for a fee and the ability to buy equity in Convercent. As Nebbiolo lacked the funds to buy the stock outright, it persuaded the plaintiff to accept a four-year note for $1.95 million. Nebbiolo convinced the plaintiff to surrender his role as CEO of Convercent, giving verbal assurances that he could continue to work for Convercent as long as he wished. After the plaintiff’s three-year employment contract was up, Convercent declined to renew it.
In March 2017, the plaintiff sued Convercent, Nebbiolo, and two persons who he claimed had conspired against him. The claims included wrongful discharge, breach of the employment agreement, civil conspiracy, and violations of the Colorado Organized Crime Control Act (COCCA). In an earlier ruling, the court dismissed some claims but allowed others to go forward.
The defendants then filed several pretrial motions, including a Rule 702/Daubert challenge to the plaintiff’s damages expert. The court granted the defendants’ summary judgment motion as to the plaintiff’s claim for breach of the duty of good faith and fair dealing against Convercent. But the court found that there were triable issues as to the other claims.
The court also denied the defendants’ motion to exclude the plaintiff’s expert testimony.
Applicable law. Rule 702 of the Federal Rules of Evidence provides for expert testimony if the expert’s specialized knowledge assists the trier of fact and the expert’s opinions are based on sufficient facts and reliable methods properly applied to the facts. Under Daubert, the evidence must be relevant and reliable. The party offering the expert testimony has the burden of showing the testimony is admissible. The trial court serves as “gatekeeper,” assessing the expert’s reasoning and methodology and determining whether the expert opinion is scientifically valid and applicable to the facts of the case. Here, in explaining the applicable legal principles, the court noted that, being the gatekeeper “is not a role that emphasizes exclusion of expert testimony.”
Expert testimony. The plaintiff’s expert had advanced degrees in economics and professional experience working in that field. He was retained to provide a damages calculation, which included a valuation of the plaintiff’s shares in Convercent as of the end of 2017, the year in which the plaintiff filed suit.
The defendants claimed the testimony failed all the requirements of Rule 702 and Daubert: qualification, relevance, and reliability.
Qualification. According to the defendants, the expert lacked the specialized knowledge to testify to Convercent’s value because he had never valued a software-as-a-service company.
The court disagreed, finding the expert had multiple economics degrees and had been teaching and working in the field of economics for years. He also had prepared business valuations for a cannabis company and for a medical devices company. “Defendants have not stated why a business valuation of a software-as-a-service company is any different than valuing a company in the cannabis and medical devices industry,” the court said. It further noted that, under case law, an expert’s lack of specialized knowledge goes toward the weight of the testimony but does not affect admissibility.
Relevance. The defendants contended the expert testimony was not relevant because it was incongruous with the remedy available to the plaintiff. The plaintiff could only recover the projected value of the company’s shares today before the plaintiff entered into the PSA with Nebbiolo—thus, before March 2012 (when the company did business as Business Controls). The defendants argued this remedy was mandated by the plaintiff’s claim that he would not have made the PSA agreement had he known the facts about Nebbiolo.
In the alternative, the defendants said the expert should have valued the company (then doing business as Convercent) as of 2015, not 2017.
The court rejected this argument, noting that, relative to expert testimony, “relevance” meant the testimony would have to assist the jury in its damages determination. Broadly speaking, the testimony here was helpful because the average juror was unlikely to have the knowledge necessary to value a company based on market indicators, the court observed. It also found the testimony was relevant to the damages issue in the instant case.
The court noted that, under the controlling law, the court could not require the plaintiff to pursue one remedy over another. Rather, a plaintiff alleging fraudulent inducement of a contract could request rescission of the contract to restore the conditions as they existed before the parties entered into the contract or affirm the contract and claim the difference between the actual value of the benefits received and the value of the benefits the defendant had promised.
Therefore, the plaintiff here was entitled “to affirm the PSA and seek the value of his current Convercent shares,” the court said. The expert’s testimony on this point was relevant, the court found, adding it ultimately was the jury’s decision what the appropriate measure of damages here was.
Reliability. The defendants claimed the expert opinion was not reliable because the opposing expert lacked the necessary qualifications (an objection the court rejected) and also because the expert failed to consider mitigation and other pertinent facts. Therefore, his opinion was speculative.
The court dismissed these objections as well. It noted that the defendants would have a chance to challenge the data on which the plaintiff’s expert based his calculation. The plaintiff’s expert appeared to use similar facts and data as the defendants’ expert, the court pointed out. The court said it would not preclude the plaintiff’s expert from testifying “simply because the two experts have reached a different result. This is almost always the case with opposing experts.” Disagreeing with an expert’s approach or his or her reliance on certain data “does not necessarily mean an expert’s opinion is not reliable under Rule 702,” the court said.
Finally, the court noted that there was “some degree of speculation” in the plaintiff expert’s report. However, the court also observed that “there is typically some degree of speculation in expert testimony.” Performing the role of gatekeeper here, the court said its task was to ensure the expert used a reliable methodology. The expert did so by using a market-based approach, the court found.
In sum, the court found there were no grounds under Rule 702 or Daubert to exclude the plaintiff’s damages expert.
Editor’s note: Digests of Weinman v. Crowley and Cargotec v. Logan Industries, as well as the respective court opinions, are available at BVLaw.
Expert’s Use of Wrong Damages Methodology Results in ‘Grossly Inflated’ Damages
Zayo Group v. Latisys Holdings, LLC, 2018 Del. Ch. LEXIS 540 (Nov. 26, 2018)
A Delaware case turned on the interpretation of key provisions in the parties’ sales purchase agreement. But the case includes a damages analysis from the court that deserves attention. The plaintiff claimed the contract required the defendant to make certain disclosures that the latter did not make. The Court of Chancery found the contract was ambiguous; however, based on extrinsic evidence, the court ruled in favor of the defendant. Although the court could have ended its discussion there, it decided to analyze in detail the damages evidence the plaintiff offered. The court noted the plaintiff’s expert lacked experience in valuing going-concern businesses. This shortcoming, the court said, showed when the expert chose a methodology for calculating expectancy damages that did not fit the facts of the case, resulting in a “grossly inflated final damages number.” According to the court, even if the plaintiff had prevailed on the liability issue, it would have lost on damages for failure to present a persuasive damages analysis.
Failure to prove liability. The plaintiff, Zayo Group (Zayo), provided high-tech infrastructure, including fiber and bandwidth connectivity, colocation, and cloud services. Colocation refers to data center facilities in which businesses can rent space to operate their software and hardware. This computing real estate usually includes physical space, cooling, power, bandwidth, and physical security for the customer’s servers and other hardware. At the time of the litigation, Zayo had acquired over 40 fiber and data center companies.
The defendant, Latisys Holdings LLC (Latisys), also offered IT infrastructure services, including data center colocation. In January 2015, Zayo and Latisys executed a sales and purchase agreement (SPA) pursuant to which Zayo bought Latisys for $675 million. The transaction closed on Feb. 23, 2015. The parties later disagreed on the meaning of certain terms in the SPA.
Latisys had two kinds of contracts with its customers: master services agreements (MSAs) and service order forms (SOFs). The SOFs drove the customer relationships; they specified the services a customer bought, including rates, recurring charges, and renewal periods. Customers often had more than one SOF to cover all the services they required. The average term of an SOF was three years. When a contract expired, Latisys would provide services on a month-to-month basis. When a customer relationship had reached the “month-to-month” phase, the customer could terminate its services with Latisys within 30 days of written notice. Thirty percent of Latisys’ revenue was guaranteed only for 30 days.
The average period of Latisys’ SOFs was about four and a half years. Typically, as time went on, customers relied less on Latisys’ services and required less storage space. In negotiating a renewal for an expiring SOF, customers often were successful in extracting concessions from Latisys.
In November 2014, Zayo submitted a letter of interest to acquire Latisys, proposing “a total value in the range of $625M – $655M in cash (approximately 11 – 11.5x Q4 2014E LQA Adjusted EBITDA of $56.8M) on a cash-free, debt-free basis.” For purposes of due diligence, Latisys sent Zayo a spreadsheet that listed each customer (but not by name), the contract with the customer, expiration dates, and recurring revenue by location and product. The spreadsheet included information regarding bookings and loss from turnover (churn) for 2013 and 2014. Zayo received all the MSAs and SOFs for Latisys’ top 30 customers by monthly recurring revenue (MRR).
A Zayo’s financial analyst working on the deal developed a financial model that calculated how many months of revenue were left on the contract for each of the customers and how much revenue was guaranteed for the customers. The eventual dispute centered on five customers. Latisys initially identified them by code name but provided a key to the names in early January 2015.
Around Christmas 2014, Zayo sent a letter of intent in which it proposed a base acquisition for $655 million. Among other things, Zayo wanted to change one of the SPA provisions to include the following sentence: “No Latisys Company has received any written notice that any party to Material Contract intends to cancel, terminate, materially modify, refuse to perform or refuse to renew such Material Contract.” (emphasis added)
Latisys accepted all of the proposed language but struck the phrase “or refuse to renew” from Zayo’s draft. Zayo returned the redline to Latisys, accepting Latisys’ change. Zayo then performed a number of calculations, including a synergies analysis, which indicated significant cost saving as a result of the deal. Zayo also undertook a comparable analysis that indicated “recent comparable transactions” at “13.6 X Avg Reported LQA EBITDA Mult.” Moreover, Zayo’s financial analyst performed a 30-year discounted cash flow analysis, a net present value sensitivity analysis, and an internal rate of return analysis.
In the end, the parties settled on a price of $675 million. Latisys also agreed to indemnify Zayo for losses stemming from various breaches, assuming cumulative aggregate damages exceeded $3.375 million (the basket). The final SPA did not make representations or include warranties as to churn, churn rates, revenue, or expected revenue.
In late 2016, Zayo sued Latisys in the Delaware Court of Chancery, demanding indemnification for damages resulting from breaches of representations, warranties, and covenants included in the SPA.
Zayo claimed that Latisys failed to disclose that five customers had notified Latisys of their intent not to renew their contracts or renew the contract under different terms. Zayo contended Latisys had an obligation under the SPA to disclose this information. According to Zayo, nonrenewal of certain contracts was captured by the terms “terminate” or “cancel,” which appeared in the SPA. Latisys responded that, under the specific language of the SPA, it had no obligation to disclose the nonrenewals to Zayo.
In ruling on the liability issue, the court found the SPA was ambiguous in that both parties’ interpretations of the contractual language were reasonable. To resolve the dispute, the court then considered extrinsic evidence, including the drafting history of the SPA, the sales negotiations between the parties, and trial testimony as to the parties’ understanding of what representation Latisys would or would not have agreed to when negotiating with Zayo. A Latisys representative testified the phrase “refuse to renew” suggested an allocation of risk between the buyer and the seller. This language would make the seller liable to the buyer for undisclosed upcoming churn. According to the witness, Latisys purposefully did not include this language in the contract because it would impose on the company an unreasonable obligation to isolate and disclose potential nonrenewals. The court concluded extrinsic evidence supported Latisys’ interpretation of the SPA. Latisys did not commit a breach of contract as to any of the five customers. There was no liability.
Benefit-of-the-bargain method. The court’s liability conclusion meant the end of the plaintiff’s case. However, “for the sake of completeness,” the court also considered whether the plaintiff would have been able to prove recoverable damages.
The court explained that the standard was high: The plaintiff had to prove damages by a preponderance of the evidence. “Contract damages are not like some works of abstract art; the plaintiff cannot simply throw its proof against the canvas and hope that something recognizable as damages emerges,” the court said. It added that this case, in particular, required precise calculations because the contested SPA had an indemnification provision. Zayo would only qualify for damages exceeding the basket, i.e., the cumulative aggregate amount of $3.375 million.
The court said the plaintiff’s expert was “certainly qualified to calculate damages in the ordinary course.” However, the expert acknowledged that she had never valued a business. This lack of valuation experience “proved a disadvantage to her and ultimately rendered her opinions in this case unpersuasive,” the court said. It pointed out that the defense expert had “significant experience in benefit-of-the-bargain damages and business valuations,” including experience serving as an expert in post-transaction disputes related to representations and warranties made in sales and purchase agreements. The defense expert testified that, “to the extent the damage is derived by an alleged change in the value of what the deal should have been, then, of course, the valuation experience is pretty critical.”
The plaintiff’s expert based her expectancy damages on a multiple (14.1) of EBITDA, but this methodology was inappropriate under the facts of the case, the court said.
Expectancy (or “benefit-of-the-bargain”) damages seek to capture the difference between the as-represented value of the purchase price and the value the buyer actually received, the court explained. “The actual value the purchaser received, in turn, must assume, and account for, a diminution of the company’s earnings into perpetuity,” the court said. It further noted that the benefit-of-the-bargain methodology is only appropriate if the alleged breach causes a permanent diminution in the value of the business (lost revenues into perpetuity) and the business has been permanently impaired.
The court noted that, in deposition testimony, the plaintiff’s expert acknowledged as much. She said that this method was only appropriate where there was a loss of monthly recurring revenue “into the foreseeable future.” She defined “foreseeable future” as “one year.” At trial, she admitted that all the contested contracts expired in less than one year. She recognized that, if Zayo knew that a contested contract was in the month-to-month phase, the maximum amount a customer would be liable for would be 30 days of revenue.
The court noted that Zayo made no attempt to prove diminution of value into perpetuity; nor did its expert, by her own admission, perform a post-closing valuation of Latisys. In contrast, the opposing expert reviewed the plaintiff’s internal calculations of value and found the plaintiff, in effect, believed the value of Latisys actually increased after the deal closed. In other words, the acquisition resulted in positive returns on the plaintiff’s investment.
The court also noted there was no support in the record for the plaintiff expert’s testimony that Zayo would not have paid $675 million for Latisys had Zayo known about the renewal situation.
The court said it could “appreciate why Zayo may have avoided taking on the challenge of proving that Latisys was worth less ($22 million less to be precise) after Closing.” Zayo knew it was buying a business based on short-term contracts, with customer loyalty somewhere between four and five years, the court observed. The contested contracts expired in less than a year from the time Zayo was considering an acquisition of Latisys. If the contracts were near expiration or in the month-to-month phase at the closing of the deal, Zayo was not in a position to claim expectancy damages beyond one month of monthly recurring revenue, the court pointed out.
Additionally, the court noted that there was no evidence that Zayo based its purchase price on a multiple of EBITDA, as Zayo’s damages expert did for her calculation. Therefore, “it is difficult to understand why [the expert] would choose an EBITDA multiple as the most accurate and comprehensive metric for valuing damages.” A Zayo executive in testimony explained that the sales price was based on a number of different factors. The court said it was unsurprising that the plaintiff’s expert later struggled to explain why she selected 14.1 as the EBITDA multiple in her calculation. The damages calculation lacked any foundation in the evidence, the court found.
On the other hand, the court found the defendant’s expert proposed several damages scenarios that were credible. All the calculations showed that, under the SPA’s indemnification clause, the realized damages would not exceed the $3.375 million base amount. The court said it found most persuasive an out-of-pocket cost analysis for lost revenue through the remaining contract term of each of the contested contracts for the five customers. This defense calculation was based on the assumption that the customers would renegotiate contracts after the expiration of the existing contract based on the state of the market. The calculation achieved a total damages amount of $2.1 million, below the required $3.375 million.
The court observed that a calculation that considered damages for a period longer than the remaining terms of the contested contracts produced a total damage amount of $3.4 million, a number that was only slightly above the indemnification threshold. “[A] damages calculation that assumes Zayo would have realized revenue beyond the bargained-for SOF does not comport with the evidence of record,” the court said, pointing to market reality and the need for service companies often to offer significant price concessions to customers.
In a last-ditch effort to advocate for benefit-of-the-bargain damages, the plaintiff claimed that the AICPA Practice Aid considered those damages appropriate where “a buyer’s subjective expectation has been materially affected.”
Not so, the court said. Defense expert testimony as well as the AICPA Practice Aid confirmed that a multiples methodology for calculating damages was only appropriate “where there is a permanent impairment to the value of the business and the value the buyer receives is less than the value for which the buyer bargained.”
The Court of Chancery found that, even if the plaintiff had met its burden of proving liability, it would have been unable to prove damages. The defendant’s expert provided the only credible damages evidence, and it showed that the plaintiff had not suffered damages above the amount to which the parties had stipulated in their indemnification agreement, the court concluded.
Court Concludes Plaintiff Cannot Satisfy Three-Part New York Lost Profits Test
MY Imagination v. M.Z. Berger & Co., 2018 U.S. Dist. LEXIS 184346 (Oct. 29, 2018)
A contract case that was subject to New York law provides a helpful review of the test a plaintiff must meet to qualify for lost profits. Here, the plaintiff’s case was poorly litigated and ultimately made it impossible for the plaintiff to advocate for lost profits. On the record, the plaintiff initially conceded that it was a new business with no track record and that lost profits or lost opportunities damages would be speculative. Later efforts to walk back these statements were unsuccessful. The court also found flawed the plaintiff expert’s methodology for calculating lost profits. The expert seemed unaware of key facts and relied blindly on statements from the plaintiff as to possible sales and profit margins, the court noted. This case illustrates how a damages case falls apart when it lacks a consistent damages theory, the participants are not on the same page, and the expert is not fully informed of the facts and the record.
Litigation history. The plaintiff, MY Imagination, was a new stationary company that wanted to enter the school supply market. For this purpose, it bought the assets of the defendant, M.Z. Berger, a well-established consumer-goods wholesaler. The defendant had a number of valuable license agreements including ones with LEGO, Universal Studios (Universal), and One Direction, a very successful English-Irish pop boy band.
The plaintiff claimed that, under the parties’ asset purchase agreement, which was governed by New York law, the defendant had agreed to make “commercially reasonable” efforts to help the plaintiff in transferring those licenses. Also, the plaintiff said, the defendant had promised to leave the stationary industry.
After the sale, the parties’ relationship broke down. The plaintiff obtained the LEGO license, the most lucrative license, but not the others. The record showed that there was a dispute between the plaintiff’s principals as to whether to pursue other licenses. For example, the plaintiff twice turned down a licensing agreement with Nickelodeon. A Universal representative later testified that Universal decided on its own not to transfer the stationary license from the defendant to the plaintiff.
In suing the defendant, the plaintiff brought contract and tort claims, alleging the defendant breached the asset purchase agreement. The federal district court adjudicating the case granted the defendant’s summary judgment motion as to all claims. Regarding the contract claims, the court found the plaintiff failed to prove actual damages.
The plaintiff appealed the findings with the 6th Circuit Court of Appeals, which affirmed the dismissal of the tort claims but reinstated the contract claims. The appeals court found there were genuine issues of fact as to: (1) whether the defendant made “commercially reasonable” efforts on behalf of the plaintiff; and (2) whether the defendant, after selling its goodwill, solicited former retail customers on behalf of Universal’s new product line.
In addition, the 6th Circuit noted “the [district] court’s emphasis on actual damages was misplaced. In New York, nominal damages are ‘always available for breach of contract.’” It sent the case back to the district court.
Inconsistent damages theory. In deposition testimony, the plaintiff’s two principals admitted that it was difficult to predict how much profit the plaintiff would reap from a particular license. Importantly, in a court brief, the plaintiff conceded:
Here, Plaintiff was a new business with no established history and approval of specific license transfers would be difficult to establish. Under these circumstances, due to the admittedly speculative nature of Plaintiff’s damages relative to lost profits or lost business opportunities, rescissory damages are an available, appropriate and proper measure of damages for Breach of Contract.
On remand to the district court, the plaintiff suddenly asked for lost profits and presented expert testimony to support its position. In response, the defendant filed another summary judgment motion, arguing the plaintiff was unable to meet the legal requirements for lost profits and asking the court to limit the remedy to nominal damages.
The court found the expert testimony unreliable and ruled for the defendant.
Applicable law. The court explained that, under the applicable New York case law, the party seeking lost profits has to satisfy a three-part test. See Kenford Co. v. County of Erie, 67 N.Y.2d 257 (1986) (available at BVLaw).
Causation. In the controlling Kenford case, the New York high court said the plaintiff first has to show causation. Put differently, the plaintiff has to establish a causal connection between the alleged wrongdoing and the alleged harm to the plaintiff.
Here, the court explained the plaintiff had to show on a license-by-license basis that, “but for” the defendant’s alleged failure to make “commercially reasonable efforts” to transfer the individual licenses, the plaintiff would have obtained them. The court noted the defendant never guaranteed the licenses would be transferred.
In addition, the plaintiff had to show that the defendant’s alleged solicitation of former retail customers directly caused the plaintiff to lose business.
The court observed that the plaintiff failed to take discovery from any licensor other than Universal. The plaintiff could not point to any statement that, “if [the defendant] had done X, then Licensor A would have transferred the license to [the plaintiff],” the court said. As regards Universal, at deposition, the plaintiff never asked the witness what impact the defendant’s “commercially reasonable efforts” at the relevant time might have had on Universal’s decision, the court added.
Based on the record of the case, the court said to conclude that a license would have transferred, but for the defendant’s conduct, and that the plaintiff would have accepted a particular license, was nothing more than speculation. The plaintiff failed to meet the causation requirement.
Reasonable certainty. Secondly, the plaintiff had to show lost profits with “reasonable certainty.” This requirement has particular importance when the plaintiff is a new business, the court pointed out. The bar in effect is higher because there is no “reasonable basis of experience upon which to estimate lost profits with the requisite degree of reasonable certainty,” the court explained (citing Cramer v Grand Rapids Show Case Co., 223 N.Y. 63 (1918)).
The court further noted that expert testimony was necessary to establish that lost profits damages were “capable of measurement based upon known reliable factors without undue speculation” (citing Schonfeld v. Hilliard, 218 F.3d 164 (2d Cir. 2000) (available at BVLaw).
The court found the plaintiff’s expert was unable to do so. He did not offer an “advanced and sophisticated method for predicting the probable results of contemplated projects,” the court said (citing Kenford). Instead, the expert relied on the plaintiff’s projections and interviews with the principals, ignoring the fact that those principals on the record had admitted that lost profits would be speculative.
Further, the expert used the defendant’s 2013 sales data but applied a profit margin from the plaintiff’s 2014 projection of sales. He also failed to consider that not every license would be transferred. In doing so, he contradicted the record, which showed that Universal, on its own, had declined to transfer its license to the plaintiff and that the plaintiff, on its own, twice had declined a license with Nickelodeon, the court said.
New York courts have found that relying on what the plaintiff thinks “might” have happened fails to meet the applicable test, the court noted. Here, the expert assumed a profit margin based on the plaintiff’s representations that it would have sales of $25 million in 2014 and its profit margin would increase over that of the defendant. The expert also seemed unaware of actual sales data as to the important LEGO license, the court noted. Ultimately, his calculation assumed a series of transactions—all hypothetical—would occur. This approach “constitutes precisely the sort of conjecture that the reasonable certainty standard prohibits,” the court said.
The court also rejected the expert’s alternate, more conservative, calculation that was based solely on the Universal license. The court said the plaintiff never asked for actual sales figures from any licensee, including Universal, or any customer (such as Target or Walmart).
In a footnote, the court dismissed the plaintiff’s late claim that it was not a new business because its principals were “experienced business men with extensive familiarity with product licensing.” The court pointed out that the plaintiff’s expert in his report said the plaintiff was a “new business.” Further, the 6th Circuit earlier also found the plaintiff was a “new stationary company.”
Parties’ contemplation. Thirdly, the applicable test required the plaintiff to show that the parties contemplated lost profits as a remedy for breach of contract. Here, the parties disagreed over whether the asset purchase agreement provided lost profits.
For its current ruling, the court said it did not have to resolve this issue because the plaintiff failed to meet the other two requirements for lost profits.
Nominal damages. The court noted that, under New York law, the plaintiff was limited to nominal damages assuming it could show liability, i.e., the defendant breached its obligations under the controlling agreement.
Futile course change. The court noted, and dismissed, the plaintiff’s efforts to “down play the statements in the record in which it conceded that lost profits are not a viable damage theory and statements indicating that [the plaintiff] was a new business entity.”
The court pointed out that in those very statements the plaintiff admitted that it was: (1) a new business; (2) had no history of sales; (3) could not establish which, if any, of the licenses would transfer; and, most importantly, (4) conceded that any lost profits were speculative.
The court also rejected the plaintiff’s claim that the defendant failed to address the plaintiff expert’s theory for loss of business value. In actuality, the court said, the expert did not present a loss of business value calculation. Instead, the expert said that, under the circumstances, “a short horizon lost profits calculation is more appropriate than a calculation of business value based on long-term projections.”
For all of these reasons, the court granted the defendant’s summary judgment motion, finding that lost profits were not a remedy available to the plaintiff.
Daubert Ruling on How to Satisfy Apportionment When Using Benchmark Licenses
Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 187897 (Nov. 2, 2018); Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 167104 (Sept. 28, 2018)
A short but insightful Daubert opinion sheds light on how a damages expert may meet the apportionment requirement where the expert uses benchmark license agreements to develop a reasonable royalty. For purposes of admissibility, the issue in this case was whether the plaintiffs’ expert could assume the prior licenses apportioned for patented and unpatented features, as the plaintiff initially claimed or, as the defendant would have it, whether the expert had to quantify the value of the patented features to the licensed product in the benchmark licenses and show the apportionment was comparable to the value assigned to the patented features in the accused product. The court here found a middle ground.
Background. The plaintiffs alleged that the defendant’s “10X Genomics platform” had violated a number of their patents having to do with “methods for conducting an auto catalytic reaction in a microfluidic system.”
Both parties raised Rule 702 and Daubert challenges to the opposing expert’s damages testimony. The accused products had patented and unpatented features.
The court, in its earlier opinion, admitted the defense expert’s reasonable royalty analysis, but it rejected the plaintiff expert’s lost profits calculation, assuming a two-supplier market. The court found the expert had failed to support his analysis with economic or financial data but had relied on qualitative evidence only.
The plaintiffs’ expert also calculated a reasonable royalty. He relied on three benchmark licenses to determine a royalty rate the parties would agree on in a hypothetical negotiation. The court found the expert made a “showing of baseline comparability between the licenses.”
At the same time, the court found the analysis failed the apportionment requirement. Specifically, the court objected to the expert’s superficial analysis, which asserted, without more, that the benchmark licenses had apportionment “built in,” such that the parties making the agreements would have apportioned for the contribution of the patented feature to the protected products. Therefore, the expert suggested, no further apportionment analysis was necessary.
In its earlier ruling, the court noted that, even assuming the parties to the benchmark agreements dealt with the apportionment requirement in calculating a reasonable royalty, did not show the same royalty rates applied in the instant case. By way of example, one comparable agreement might use a 15% reasonable royalty in a situation in which the patented technology accounted for 50% of the product. Another comparable agreement might use a 3% royalty where the patented technology accounted for 10% of a different product. While there was no doubt that the agreements incorporated apportionment, further analysis was necessary to show that either rate was apportioned in a comparable way to the value of the patented technology to the accused product(s), the court said. See Bio Rad Labs. v. 10X Genomics, Inc., 2018 U.S. Dist. LEXIS 167104 (Sept. 28, 2018).
Although the court rejected the expert’s reasonable royalty calculation, it allowed the plaintiffs to supplement the expert report.
Subsequently, the issue was whether the expert’s supplemental report adequately addressed the apportionment issue for admissibility purposes. The court found it did.
Applicable legal principles. The court explained that Rule 702 imposed a trilogy of requirements: qualification, reliability, and relevance (fit). Under the qualification prong, the witness must qualify as an expert by way of “a broad range of knowledge, skills, and training.” Reliability requires the expert testimony to be based on the “methods and procedures of science” rather than “subjective belief or unsupported speculation.” Relevance or fit means the testimony has to be helpful to the trier of fact when deciding the issues in the case.
Apportionment is a cornerstone of patent infringement cases. It seeks to ensure the patent holder is compensated for the infringement that can be attributed to the patented feature, and not more.
‘Approximation and uncertainty.’ In the supplemental report, the plaintiffs’ expert compared the unpatented features of the accused products with what he considered to be the unlicensed features of the products at issue in the benchmark licenses. He determined that there were unlicensed features analogous to the unpatented features. He also found the relative value of the licensed technology to the licensed products was comparable to the relative value of the patented technology to the accused product. He concluded that the royalty rates in the comparable licenses were apportioned in a comparable fashion to the royalty rate in the hypothetical license.
The defendant argued the opposing expert relied on qualitative rather than quantitative analyses and therefore did not satisfy the apportionment requirement.
The court disagreed, noting the defendant’s argument conflicted with a general principle that “any reasonable royalty analysis necessarily involves an element of approximation and uncertainty.” Also, the court said, “it may be impossible to quantitatively determine the exact percentage of a royalty rate that corresponds to each component of a licensed product.”
The court said it found the following commentary accurate:
The challenge is that apportionment is inherently imprecise. There’s never going to be a perfect basis to apportion … Licensors and licensees are not doing [rigorous scientific analyses] to decide the royalty rate. They negotiate based on their perception of the value being contributed—based on a lot of qualitative information typically … To require that sort of level of scientific discipline, (a) increases the cost of every case, and (b) divorces us from real life.
The court concluded that the plaintiff expert’s supplemental report filled the analytic gap in his initial report, “at least to the extent necessary to make his reasonable royalty opinion admissible.” The court allowed the reasonable royalty testimony into evidence.
Court Rejects Expert’s Reliance on Other Celebrity Royalty Agreements to Develop Damages Analysis
Olive v. General Nutrition Centers, 2018 Cal. App. LEXIS 998 (Nov. 2, 2018)
In a California intellectual property case, a model/actor/professional athlete sued General Nutrition Centers (GNC) over the unauthorized use of his likeness. The plaintiff retained three damages experts, including an expert in branding, licensing, and valuing intellectual property and an expert for quantifying damages. The trial court found both of these experts’ opinions inadmissible, saying the analysis was “nearly data free and methodologically primitive.” The appeals court agreed. Among other flaws, the court found the expert opinions were based on “speculative assumptions,” including an unsubstantiated assumption that a causal connection existed between the company’s revenue increase and the unauthorized use of the model’s image.
Limited use of image. The plaintiff was Jason Olive. His modeling career peaked in the mid-1990s, when he earned up to $25,000 per day working on campaigns for Ralph Lauren, Versace, Armani, and other brands and magazines. Olive later turned to acting. He also was a professional volleyball player.
The defendant was GNC, a retailer and manufacturer of vitamins and nutritional products with roughly 8,000 retail stores. In 2010, GNC undertook a “Live Well” advertising campaign for which it wanted models who were, among other things, “everyday relatable people.” The plaintiff and about 15 other people were hired for a one-day photo shoot. The plaintiff executed a “Photograph and Likeness Release” that gave GNC the right to use and reuse his “image and likeness and photograph to be taken at the photoshoot scheduled for September 24, 2010.” The plaintiff was paid $4,000 for the three-hour shoot and also received an $800 agent fee. The release was for one year from GNC’s first use in print media. GNC had the unilateral right to agree to a one-year renewal for the same amount of compensation. GNC’s right to use the plaintiff’s likeness expired sometime in late 2011 or early 2012.
Later, in November 2010, the plaintiff executed a second release that allowed the defendant to use his image and likeness on print media displayed on any company trucks and other vehicles in North America. The plaintiff received $8,000 in compensation. The contract was valid through Dec. 31, 2021.
GNC used the plaintiff’s image sometime in January 2011 in various settings: outdoor billboards, bus shelters, kiosks, social media websites, direct mail advertising, in-store posters, and signage. The plaintiff said he believed he had agreed to a “very small job” given the small fee he obtained and that he was “shocked” and “angered” over the far-reaching use of his image.
Later, GNC failed to keep track of the expiration of the model release agreements. While it eventually negotiated extensions with every model that participated in the September 2010 campaign (paying between $7,500 and $32,000 for five-year extensions), it failed to obtain a release extension from the plaintiff. Sometime in late 2012, GNC offered the plaintiff $150,000 for such an extension, which he rejected. Instead, he sued. GNC removed his image from any marketing materials at the end of 2012, incurring about $350,000 in take-down expenses.
In his lawsuit, the plaintiff alleged common law and statutory misappropriation of likeness (Cal. Civ. Code § 3344.1). He also claimed unjust enrichment and sought disgorgement of any profits GNC had made from the unauthorized use of his image. He asked for over $23.5 million in damages. Before trial started, GNC admitted liability; it recommended damages of $4,800.
Expert testimony wants data and science. In a pretrial motion, GNC asked the trial court to exclude the testimony of two of the three experts the plaintiff designated to testify to GNC’s profits attributable to the misappropriation.
Expert 1 was to testify to actual damages and to apportionment—how much of the defendant’s profits was attributable to GNC’s misappropriation of the plaintiff’s likeness. Expert 2 was to calculate the defendant’s revenue, expenses, and profits. He also was to perform an apportionment analysis and give an opinion on whether the defendant had committed fraud or intentional misconduct. (The plaintiff initially proposed testimony by a third expert, but it’s not clear from the court’s opinion what the purpose of this testimony was. Ultimately, the plaintiff did not call this witness.)
In challenging Expert 1’s testimony, GNC argued the opinion was speculative and lacked a foundation and an objective methodology. Expert 2’s testimony was inadmissible because it relied on Expert 1’s defective analysis, GNC contended.
Expert 1. In the relevant year, 2012, GNC’s revenue was approximately $2.4 billion. Expert 1 claimed that 1% to 3% of the revenue was attributable to the infringement. He said his conclusion was based on a review of royalty agreements for various other celebrities, including, for example, George Foreman, Kathy Ireland, Barry Bonds, Michael Jordan, Alex Rodriguez, and Tyra Banks. He also claimed GNC’s president and CEO had admitted in his deposition that at least 1% of the company’s revenue resulted from in-store advertising. Further, Expert 1 said GNC’s revenue increased during the subject period. He noted that the median compensation for a celebrity endorsement was 5% but believed a more conservative figure was appropriate in this case.
Expert 1 also determined that actual damages for the plaintiff were between $500,000 and $1 million for 2012 and $1 million for 2013. He based these figures on a statement from the plaintiff that he would not work for any less compensation as well as on testimony from the plaintiff’s agent that the minimum fee acceptable for the plaintiff would have been in the “high six figures.” Further, Expert 1 considered a list of earnings of top male models that appeared in Forbes magazine.
Expert 2. Expert 2’s quantification of damages relied on Expert 1’s opinion that 1% to 3% of the defendant’s profits were attributable to the misappropriation. Expert 2 acknowledged that he did not perform an independent calculation, noting that Expert 1 had “a long track record” as well as a reputation as an expert in branding, licensing, and intellectual property valuation. Expert 2 said he had met Expert 1 and reviewed the work Expert 1 had done, “so I would feel comfortable with it.”
The trial court rejected both expert opinions, saying they were based on “mere wishful thinking” rather than science and data. Expert 2’s opinion was “directly tethered” to Expert 1’s inadmissible determination opinion; therefore, Expert 2’s opinion was inadmissible. Further the issue of fraud and intentional misuse of the plaintiff’s image was not the proper subject of expert testimony. Therefore, Expert 2 was not able to testify on this point.
A jury ultimately awarded the plaintiff about $1.1 million in damages, including $213,000 in actual damages and $910,000 for emotional distress. The jury found the plaintiff had not proven that any of GNC’s profits were attributable to the unauthorized use of his image. Also, the jury found GNC had not acted with malice or committed fraud.
The trial court itself ruled for GNC on the unjust enrichment claim. But the court denied GNC’s post-trial motions for a new trial and judgment notwithstanding the verdict on the emotional distress award.
Analytical gap ‘too great.’ The plaintiff appealed the verdict on various grounds. It argued the trial court improperly applied the germane statute. Moreover, the trial court’s exclusion of the damages experts was an abuse of discretion.
Regarding the first argument, the plaintiff said the trial court erred by failing to instruct the jury correctly on the burden each party had in determining damages related to the defendant’s profits resulting from the misappropriation of the plaintiff’s likeness. According to the plaintiff, the defendant had the burden of proving the amount of its gross revenue that was not attributable to the use of the plaintiff’s likeness. The trial court failed to provide the jury with an instruction to this effect.
The California Court of Appeal disagreed, noting the statutory language was “clear and unambiguous,” requiring the plaintiff (“injured party”) to prove the gross revenue attributable to the defendant’s unauthorized use of the plaintiff’s likeness and requiring the defendant to prove his or her expenses. The appeals court said the approach the plaintiff proposed would turn “that statutory language on its head,” in that it would require the defendant first to prove total gross revenue to determine what portion was not attributable to the infringement. What’s more, this approach “would create the absurd result of effectively placing on each party the burden to prove the same disputed fact [revenue attributable to infringement].”
Regarding the admissibility of expert testimony, the Court of Appeal explained that, under the applicable California law, the trial court, as the gatekeeper, may exclude expert testimony if the court determines that the expert opinion is based on the type of matter on which an expert may not reasonably rely; the expert opinion is based on reasons that are not supported by the material on which the expert relies; or the expert opinion is based on speculation or conjecture. See Sargon Enterprises, Inc. v. University of Southern California, 55 Cal. 4th 747 (2012). Further, the trial court may conclude that the analytical gap between the expert’s data and his or her opinion “is simply too great” and may exclude the opinion as speculative or irrelevant. Ibid. In general, the trial court “must simply determine whether the matter relied on can provide a reasonable basis for the opinion or whether that opinion is based on a leap of logic or conjecture.” Ibid.
The Court of Appeal found none of the reasons Expert 1 gave for attributing 1% to 3% of the defendant’s revenue to the infringement were persuasive. The celebrity royalty agreements Expert 1 relied on to support his opinion were not comparable, the court said, noting the plaintiff did not share “anywhere near the same degree of celebrity as those included in [the expert’s] sample.”
Also, the plaintiff’s agreement with the defendant was nothing like the referenced celebrity agreements, the court found. The expert compared the limited use of the plaintiff’s image from one photo shoot to much more extensive licensing agreements that included the celebrity’s name, signature, voice, initials, endorsement, and copyright. The appeals court dismissed the expert’s claim that the plaintiff became the spokesperson for the company—the “face of the brand” that “finally resonated with everyone.” The court emphasized that the plaintiff “was not the company spokesperson, and the use of images taken from a photo shoot with 15 other models is in no way analogous to a comprehensive celebrity endorsement arrangement.” It is not proper for an expert to base his or her opinion “upon a comparison of matters that are not reasonably comparable,” the Court of Appeal said.
The appeals court also found that, in order to support his claim that 1% of revenue stemmed from the misappropriation, Expert 1 “mischaracterized a statement from GNC’s President and CEO.” The executive, when asked what drove sales, said that in-store marketing had “the least amount of value of anything I’ve told you in regards to whether a consumer buys a product.” When pressed for a percentage, he said it was very little—”I’ll go zero to one.” Also, the executive never apportioned revenue between the Live Well campaign for which the plaintiff’s image was used or other in-store marketing efforts, and he did not apportion between the plaintiff and other models used in the Live Well campaign, the Court of Appeal pointed out.
In addition, the court noted the expert asserted a causal connection between the company’s annual sales increase and the infringement but did not identify “any reliable evidence linking the two, such as data from a focus group.” The court said he did not consider “the macroeconomic conditions” that prevailed during the relevant period, such as the company’s pricing promotions, general sales in the vitamin and supplement industry, other marketing efforts, and “the impact of professional athletic ‘ambassadors’ used by GNC.” The court found the analysis was “conclusory” and as such speculative. The testimony was inadmissible as it would not have reasonably assisted the jury. The trial court did not err in finding the analytical gap between the data the expert used and the opinion he submitted was “simply too great,” the Court of Appeal concluded.
‘No independent evidentiary value.’ In appealing the exclusion of Expert 2’s testimony, the plaintiff seemed to argue the trial court failed to perform an independent review of the expert’s testimony and as such erred.
The Court of Appeal disagreed. It noted that expert testimony may rely on information from others as “long as the information is of a type reasonably relied upon by professionals in the relevant field.” But this expert testimony is only of value if the source is reliable, the court explained.
Here, Expert 2’s opinion hinged on Expert 1’s speculative assumptions. Expert 2 did not perform any investigation to ensure Expert 1’s information was reliable. For example, Expert 2 did not know how Expert 1 chose his sample of royalty agreements. Expert 2 did not independently determine whether the sample was appropriate. He did not ask Expert 1 how the latter ruled out other persons in the sample, and he did not ask Expert 1 “about the parameters for his sample database.” At the same time, Expert 2 said he was “very comfortable” with the way in which Expert 1 performed his analysis, the appeals court observed. Expert 2 also did not offer “compelling evidence” that the misappropriation of the plaintiff’s likeness directly caused an increase in company sales, the appeals court said. In sum, Expert 2’s opinions had “no independent evidentiary value” and therefore were properly excluded.
The Court of Appeals did, however, find the trial court erred when it decided neither party prevailed (noting that both sides were visibly unhappy with the jury verdict) and denied the plaintiff’s motion for attorney fees. The court noted that, even though the plaintiff recovered less than 10% of the maximum damages he sought, the award to the plaintiff was much higher than the defendant’s proposed $4,800. The plaintiff prevailed on a “practical level,” the court said. Therefore, he was entitled to attorney fees under the applicable statute, the Court of Appeal ruled.
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