Litigation & Disputes Bulletin: Q3 2020
In This Issue:
- Plaintiff’s Overbroad Damages Calculation Prompts Court Not to Grant Award for Proven Wrongdoing
- Plaintiff Fails Panduit Test Where Lost Profits Analysis Includes ‘Far More’ Than Value of Patents
- Court Decides Daubert Exclusion of Expert Testimony for Failure to Apportion Is Premature
- Court Affirms Plaintiff’s Showing of Loss of Income Pursuant to Business Interruption Policy
- Business Interruption Claim Raises Triable Issue as to Viability of New Business, Court Finds
Plaintiff’s Overbroad Damages Calculation Prompts Court Not to Grant Award for Proven Wrongdoing
Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLP, 2020 Del. Ch. LEXIS 76; 2020 WL 948513 (Feb. 27, 2020)
The Delaware Court of Chancery recently decided damages in a case in which the buyer sued in tort and contract after the subject company lost in value post-acquisition. In a tactical misstep, the plaintiff submitted an expert damages calculation at the liability phase and adhered to it even though the court ended up substantially limiting the scope of liability. The expert’s theory and calculation were not sufficiently tailored to the wrongdoing the plaintiff was able to prove, the court found. Vice Chancellor Glasscock said, “[H]arm is in itself insufficient for a damages award if I have no basis to make a ‘reasonable estimate’ of damages.” The court therefore declined to award any damages for certain established misrepresentations. This case shows that it is not cost-effective for a litigant not to submit an updated, on-point expert report.
Backstory. The case arose over the acquisition of a company, Plimus, that functioned as a “reseller” between small online retailers and consumers. Its success depended on having good working relationships with payment processors. Two of them were critical for Plimus: PayPal and Paymentech. Typically, Plimus would “acquire” products from the retailer and receive payment for that retailer from the payment processor. The payment processor in turn had relationships with credit card companies and their banks.
Problems in the process would arise whenever the retailer’s product was not satisfactory to the consumer and credit card companies had to cancel debt the consumer incurred for fraudulent or mispresented products known as “chargebacks.” In the event of a chargeback, the credit card company imposed a fine on the payment processor, which, in turn, contacted the reseller (e.g., Plimus). In sum, retailers whose products resulted in excessive chargebacks put a strain on the reseller and the payment processor.
The plaintiff (related private equity firms) acquired Plimus by way of merger in 2011. The sale price was based on due diligence, management projections, and representations in the parties’ merger agreement. The merger closed on Sept. 29, 2011. The merger price was $115 million. Shortly after the merger, PayPal terminated its business relationship with Plimus, placing Plimus on the “MasterCard Alert to Control High-Risk Merchant” list (MATCH list). Plimus then entered into an agreement with another payment processor. But, in January 2012, the new partner also terminated Plimus.
In its annual report ending Dec. 31, 2011, the buyer/plaintiff stated that “Plimus was the only portfolio company to experience decline in valuation, as the company removed a number of high-risk clients from its payment platform, resulting in a negative short-term impact.” Plimus’ removal of high-risk customers, its purging of some 500 higher-risk merchants in early 2012, and its giving more scrutiny to new vendors meant a decline in processing volume relative to expectations. The buyer said it therefore expected a lower sale volume into 2012. In August 2012, the buyer fired the CEO of Plimus. The buyer also made what it claimed were many millions in additional investments in Plimus. In 2014, Plimus changed its business model and began to operate as a payment facilitator. This role required it to show more transparency as to its vendors and as such was preferable to model processors and acquiring banks.
The buyer eventually sued the principals, including the CEO, and stockholders of Plimus in the Delaware Court of Chancery, claiming breaches related to the representations and warranties the defendants made in the merger agreement as well as various acts of fraud and fraudulent inducement related to the merger.
The court, in the instant opinion, noted that the litigation was “large,” as concerns the scope of allegations, the cast of defendants, and the damages claims. The court decided to bifurcate the proceedings into a liability phase and a damages phase. In the liability phase, the court rejected most of the plaintiff’s claims.
The damages findings are the subject of the court’s instant decision.
Surviving claims. Based on the liability proceedings, the court found the plaintiff was able to prove two instances of fraudulent misrepresentation, one involving Plimus’ former CEO, as well as several breaches of contractual representations by other defendants.
As for the fraud claims, before the merger closed, Plimus was put on notice by PayPal that it had to terminate one vendor in particular, GoClickCash. This vendor was involved in a “get rich quick” scheme that resulted in high chargebacks. Once Plimus had notice from PayPal, it terminated the account and performed an internal review that resulted in terminating another 16 potentially compromising vendors. About a week before the merger closed, Plimus received notice that PayPal would impose a $200,000 fine related to GoClickCash.
The court found, prior to closing, the buyer had organized a “bring down call” with Plimus’ management to discuss changes in the business that might require amending the disclosure schedule accompanying the initial merger agreement. Internally, Plimus’ CEO noted the fine was a business issue, but he chose not to disclose it to the buyer at that call or before the closing of the merger.
Further, the court found that, in early August 2011 and numerous times after that, PayPal informed Plimus that the latter had incurred excessive chargebacks and that PayPal might issue a 30-day termination notice and end its relationship with Plimus. On the date of closing, PayPal had not yet decided whether or not to terminate Plimus.
The court found that, while the CEO likely disclosed to the buyer that Plimus had some dispute with PayPal, he did not disclose the extent of the problem or the threat of PayPal’s terminating the relationship. Nondisclosure of PayPal’s threats and the GoClickCash fine were false representations, the court found, where Plimus principals stated that the company followed credit card network rules and that no suppliers of goods or services had threatened termination.
The court specifically noted that Plimus’ CEO “intended” for the buyer to rely on these false representations to induce the buyer to go ahead with the merger, recognizing that the PayPal problems could negatively affect the merger. Plimus knew that the loss of PayPal would mean a major disruption of its business, the court noted. In contrast, the buyer relied on representations by Plimus, and its reliance was reasonable where due diligence related to the merger was completed before PayPal made termination threats and Plimus had a contractual obligation to disclose the information. The court noted Plimus’ CEO later testified that he did not believe PayPal would go through with its threats to terminate. Although the court believed the testimony was truthful, it found problematic the CEO’s awareness of the threats and said he “fraudulently concealed them” from the buyer.
As for liability related to contractual breaches, the court noted Plimus had stated in the merger agreement that it followed the rules of the card systems, payment card industry standard, the National Automated Clearing House Association, regulations applicable to the credit card industry, and its member banks. At the same time, Plimus had received numerous violation notices from its two major payment processors, Paymentech and PayPal. The defendants conceded a number of breaches related to excessive chargeback issues.
Further, the defendants’ vouching in the merger agreement that there were no suppliers of products or services that had notified Plimus of an intent to terminate their business relationship with the company was misrepresentation.
Damages calculation submitted. All told, the court “greatly circumscribed” liability for Plimus in the first phase of the proceedings. It found that “the bulk of [the plaintiff’s] wide-ranging allegation were unproved” and could not support damages.
The court noted that, regardless of the limited scope of liability, the plaintiff entities “were content” to rely on a damages report and testimony that they had presented at trial based on their “generously-proportioned allegations.”
In post-trial damages oral argument, the plaintiff said it did not think additional damages evidence was necessary (i.e., a revised expert report) considering the court’s findings that there was fraud regarding PayPal. According to the plaintiff, all of its fraud claims ultimately “built to the PayPal fraud,” which “was always the main issue. It’s also where we tracked the damages from. And when that was the fraud that was found, we thought we could move forward on that basis.” The court found the plaintiff’s argument problematic.
The plaintiff’s overriding damages theory was that the alleged breaches and wrongdoing by the various defendants lead to the diminution in the fair value of the plaintiff’s equity interest in Plimus.
The plaintiff’s damages expert found damages consisted of: (a) the difference between the $115 million sale price and the value of Plimus as determined by him on the merger date (the difference being about $90.3 million); (b) $31.5 million representing the additional investments the plaintiff had made in Plimus post-merger; and (c) about $212,300 in preclosing fines.
The expert noted the plaintiff had arrived at its $115 million sale price based on multiples of 2011 actual Q2 run rate EBITDA and 2011 estimated Q4 and yearly EBITDA. The expert thought it was appropriate to adhere to the same methodology. He used the 2011 Q4 EBITDA multiple of 10.1x, which, he said, was the valuation metric the plaintiff used for its valuation of Plimus.
The expert first calculated the 2011 Q4 EBITDA using Plimus’ actual 2011 Q4 EBITDA. He then significantly downward adjusted the actual Q4 EBITDA to arrive at what he considered “the full extent of the harm.” The projected Q4 EBITDA was about $11.4 million, which, based on a multiple of 10.1x, resulted in the $115 million merger price. In contrast, the actual Q4 EBITDA was about $5.1 million, which would have resulted in a fair value of about $51.3 million. Importantly, however, the plaintiff’s expert did not use the difference between those two figures as his damages figure.
Rather, he adjusted the actual Q4 2011 EBITDA by eliminating revenues from “transactions attributable to the lost volume to Plimus’ decision to terminate the relationship of customers with chargebacks in excess levels allowed by the payment processors or other risk concern.” He justified this adjustment by noting “the full effects of the fraud were not felt until 2012 and beyond … [t]hat is, the actual EBITDA results still included the benefit of profits from clients that were shortly lost or terminated as the fallout from the fraud continued.”
In essence, he backed out from the company’s actual Q4 2011 EBITDA revenue from any client (court’s emphasis) whom Plimus terminated a few days after the closing of the merger, in October 2011, and throughout June 2012. The expert maintained that making this adjustment resulted in a “conservative estimate of the harm” the plaintiff incurred. By the expert’s calculation, Plimus’ adjusted 2011 Q4 EBITDA was only $2.45 million. Applying the 10.1x multiple, the expert arrived at a fair value determination of about $24.7 million (rather than $51.3 million based on actual Q4 EBITDA). The difference between the price the buyer paid and the $24.7 million was the diminution in business value, the expert found.
He then added to this amount the $31.5 million he said the buyer had invested in Plimus in fall 2012 and December 2014 and the fines.
Limited scope of damages. The court found certain defendants were liable for certain chargeback fines, and Plimus’ CEO was liable for the $200,000 in fraud damages for the PayPal GoClickCash fine.
The more important issue was what damages were available to the plaintiff related to Plimus’ nondisclosure of PayPal’s termination threats where PayPal did terminate its relationship with Plimus immediately after the merger.
Damages could be based on tort or contract, but the damages resulting from this liability were identical, the court explained. “Both contract and tort law thus conceive of damages as the pecuniary consequences of the breach or tort. This requires an identification of the conduct for which a defendant is liable and an isolation of the harm occurring therefrom.”
The task here was to “separate the non-disclosure of PayPal’s termination threats—and the harm occurring therefrom—from all other fraud and breach allegations,” the court explained. It observed that damages must “represent the difference between what the Plaintiffs expected—Plimus with PayPal as a processor—and what they got—Plimus sans PayPal.”
Specifically, the plaintiff had a right to damages “consequent to the loss of the PayPal relationship which meant the inability to use PayPal’s services, and the resulting reputational damage.” At the same time, the court cautioned that the plaintiff was not entitled to damages going back to the underlying reasons as to why PayPal terminated its relationship with Plimus, such as Plimus’ excessive chargebacks, lack of risk monitoring, and illegitimate vendors. The record showed the buyer knew of these problems at the time of the merger, the court explained.
The plaintiff had to prove damages related to the PayPal termination with “reasonable certainty,” the court noted.
The court found the plaintiff’s expert offered a damages calculation that was not sufficiently linked to the harm to the plaintiff from the nondisclosure of PayPal’s termination threats. Rather, the calculation managed to “throw everything in the hopper: all amounts by which Plimus missed [the plaintiff’s] projections for Q4 2011 EBIDA, all revenue and volume from vendors terminated in the 9 month period after the Merger, and all amounts [the plaintiff] invested in Plimus in the years after the Merger.”
In his testimony, the expert himself said his calculations failed to filter out damages from the wrongdoing the plaintiff was able to prove at trial, which, the court noted, “are a rather small subset of its allegation.” Notwithstanding the court’s liability findings, the plaintiff “elected to stand” on its expert report, submitted before the court’s liability findings were made, the court noted.
It said the plaintiff’s expert offered no mechanism to segregate out the decrease in Q4 2011 EBITDA attributable to the loss of PayPal. Also, in terms of the claimed post-merger investment, the plaintiff failed to segregate what portion of the investment was necessary because of the loss of PayPal. Further, the plaintiff did not show how the latter damages were not already covered in the plaintiff’s fair value estimate, the court noted.
Based on the record, the court said it was unable to assign damages caused by the loss of PayPal as a payment processor. Doing so would be “mere speculation or conjecture because the Plaintiffs failed to tie any portion of their damages estimate to the loss of the PayPal as a processing service provider.”
Accordingly, even though the court found the plaintiff suffered harm from the loss of the PayPal relationship, the court declared itself unable to award fraud or contract damages related to the misrepresentations regarding the PayPal termination threats. The plaintiff was entitled to recover about $212,300 related to fines only.
Plaintiff Fails Panduit Test Where Lost Profits Analysis Includes ‘Far More’ Than Value of Patents
Sunoco Partnership Mktg. & Terminals L.P. v. U.S. Venture, Inc., 2020 U.S. Dist. LEXIS 14994; 2020 WL 469383 (Jan. 29, 2020)
In this patent infringement case, which featured a protected system for blending butane and gasoline, the plaintiff claimed over $30 million in lost profit damages resulting from the defendant’s misconduct. The court rejected the claim, noting the plaintiff failed to satisfy the four-factor Panduit test, and instead awarded a significantly lesser amount in reasonable royalty. The court found the plaintiff expert’s damages analysis was flawed in that it did not capture the value of the patented invention only. The court also observed that the same expert earlier had been excluded under Daubert in a different suit involving the same plaintiff for offering a similarly problematic analysis. One takeaway for experts is that courts and the opposing party keep track of an expert’s testifying history, including Daubert exclusions.
Backstory. The plaintiff owned five patents related to an automated system for blending butane into gasoline at the last point of distribution, i.e., before tanker trucks move the gas to retail gas stations. Butane is more volatile than gasoline and blending it into gasoline allows cars to start up consistently in colder weather. Because butane is lower in price than gasoline, commercial sellers have an incentive to blend as much of it into gas as possible. However, gas with higher volatility contributes to smog, causing the Environmental Protection Agency (EPA) to impose limits on the level of volatility allowed in gasoline. The plaintiff’s patented system was able to blend to the permitted degree by way of an automated system that did not require human involvement.
The inventors first assigned the patents to a company called Texon in early 2000. In 2010, the plaintiff in this suit, Sunoco Partnership Marketing & Terminals LP (Sunoco), bought Texon’s butane blending business for $140 million.
The defendant owned gasoline terminals in various states that stored and shipped gasoline and diesel. In 2008, the defendant began research on the development of an automated blending process. When it learned of the Texon system, the defendant negotiated with Texon to provide blending services to one of the defendant’s facilities. However, the parties were not able to reach a deal. The defendant then continued to explore alternatives and recruited a different company, Technics (no longer a party to the litigation), to design and install a blending system. By the defendant’s own admission, the goal always was to develop an automated way of blending butane into gasoline. Automation was a key feature in the plaintiff’s patented system.
During the infringement period (April 2012 to April 2017), the defendant used its infringing system in seven of its terminals. Notably, in 2015, after the plaintiff filed suit in federal court alleging infringements of four patents related to the blending system, the defendant extended the use of its automated blending system from three facilities to seven. The plaintiff later successfully argued to the court that the defendant’s conduct showed the infringement was willful and that the plaintiff was entitled to treble damages.
In April 2017, the defendant modified its system in a way that required a human operator to assist with the blending. The merit of the modified system in relation to the plaintiff’s protected system also was an issue in the litigation, especially regarding the calculation of damages.
Much of the trial centered on the validity of certain patent claims, the question of whether there was infringement, and the extent and nature of damages available to the plaintiff.
Lost profits. The plaintiff sought lost profit damages based on expert testimony that professed to calculate the profit the plaintiff would have made had the defendant not infringed its patents. The expert claimed the total amount of lost profits was about $31.6 million.
This figure was based on the premise that the plaintiff would have signed a butane supply agreement with the defendant and the two sides would have split the profits made from the sale of gas blended with butane. The expert explained that the profit margin was the difference between the price of the extra gasoline that could be sold because it was blended with butane and the cost related to buying, transporting, and blending the butane.
The defendant’s expert criticized the plaintiff’s analysis, noting that the plaintiff’s butane supply agreements did not reflect the value of the patent.
Applicable law. Under the applicable law, a plaintiff seeking lost profit damages must satisfy the four-factor Panduit test. Specifically, the plaintiff must show: (1) demand for the patented product; (2) an “absence of acceptable noninfringing alternatives”; (3) “manufacturing and marketing capability to exploit the demand”; and (4) “the amount of profit it would have made.” See Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978).
The Federal Circuit has noted that it is difficult to prove damages under Panduit and that the second factor “often proves the most difficult for patent holders.” See Mentor Graphics v. EVE-USA, Inc.,851 F.3d 1275 (Fed. Cir. 2017).
In this case, the parties’ disagreement in fact centered on Factor 2, specifically on the issue of whether the defendant’s modified blending system (requiring a human operator) represented a noninfringing alternative to the plaintiff’s automated system. The defendant argued it did, but the court found this argument “not a compelling one.” The court noted that automation was a critical aspect of the plaintiff’s protected system and a feature the defendant had, for years, tried to replicate in its own infringing system. The court noted that the defendant’s own damages expert stated the modified system cost the defendant 10% more than the automated system; moreover, the modified system required human intervention, which increased the risk of error related to blending. There was testimony that the defendant’s human operators asked the company to “scrap” the modified system for the automated one.
The court found automation was the “particular feature available only from the patented product,” which meant the modified system was not “acceptable.” Accordingly, the plaintiff was able to show that there was no acceptable noninfringing alternative to its patented system.
However, the court noted the plaintiff was not able to meet Factor 4 of the Panduit test, i.e., establish the amount of profit it would have made but for the infringement. The court agreed with the defendant’s expert that the plaintiff expert’s calculation based on butane supply agreements failed to separate out the value of the patented system. “But the problem with this analysis is that neither butane nor blended gasoline is the patented invention,” the court said. It also noted that neither butane nor blended gasoline constituted a “functional unit,” such that the plaintiff would be entitled to the entire market value of the patented and unpatented parts. And the court noted that, under the agreements Sunoco made, it did not require blending partners to use the butane Sunoco provided.
The $31.6 million figure, which the plaintiff said represented lost profits, included much more than just the damage to the plaintiff from the defendant’s infringement, the court noted.
It went on to say that “[t]his court is not the first to identify such problems with [the plaintiff expert’s] analysis.” According to the court, a magistrate judge presiding over another suit Sunoco brought and featuring testimony by the same damages expert granted the defendant’s Daubert motion to exclude the same expert’s testimony for failure “to apportion the value of the patented system in comparison to the value of the butane supply agreements.”
The court in the instant case concluded the plaintiff was not entitled to lost profits because it did not meet all the requirements under Panduit.
Reasonable royalty. Under the applicable statute and case law, if a plaintiff proves infringement, it is entitled to no less than a reasonable royalty. See 35 U.S.C. § 284; Panduit.
The court here looked to the common method for determining a reasonable royalty, which is premised on a “hypothetical negotiation” between the parties prior to infringement to achieve an agreed-upon royalty. This approach looks to the Georgia-Pacific factors for calculating the reasonable royalty.
The plaintiff’s expert determined a reasonable royalty was between $17.1 million and $25.7 million. He estimated that, at the time of infringement, the defendant could expect to make a profit of between .40 to .60 per gallon of blended butane. Because the plaintiff typically negotiated a 50-50 profit share agreement, these numbers would be half, the expert assumed. He multiplied them by the 85.7 million gallons of butane the defendant blended during the five years in which it infringed to arrive at the proposed total numbers.
In contrast, the defendant’s expert proposed royalty damages in the amount of $2 million only. He came to this figure by finding that, using the modified system, the defendant would blend about 10% less butane than if it used the plaintiff’s protected system. Moreover, the modified system required a human operator to whom the expert assigned a $200,000 annual salary. During the five-year infringement period, the defendant would have lost about $4.6 million and would have had to pay a total salary of about $1 million to the extra operator, the defense expert calculated. He proposed that $5.6 million was the highest amount the defendant would pay to use the plaintiff’s patented system. According to the expert, the parties would have agreed to a $2 million license for the plaintiff’s system.
The plaintiff countered that this figure was too low considering the plaintiff bought the patented system for $140 million in 2010, two years before the infringement began.
The court rejected the plaintiff’s reasonable royalty for a number of reasons. It said the expert’s calculation was based on the same flawed analysis as the expert’s lost profits analysis—relying on the plaintiff’s butane supply agreements, where these agreements covered much more than the value of the patents. Similarly, the court found the $140 million price the plaintiff paid for the butane blending business, included the patents and the existing butane blending contracts, according to testimony from one of the inventors of the patented system.
Because the butane supply contracts included “far more than just patent licenses,” the court said it was “difficult to identify how much of that $140 million actually concerned the patents as opposed to Texon’s profit sharing agreements.”
Finally, the court noted that, when the plaintiff acquired the patents and the rest of Texon’s blending business, Texon retained a contract with one terminal. The plaintiff then granted Texon a license for the “Blending Patents” for use in Texon’s ongoing relationship with the terminal. Texon paid the plaintiff .02 per gallon of each gallon it blended for the terminal. Using the .02-per-gallon amount with the 87.5 million gallons of butane the defendant blended during the infringement period results in $1.7 million, the court noted. It suggested this figure was close to the reasonable royalty the defense expert proposed.
The court said it was more persuaded by the defense expert’s analysis and awarded the plaintiff $2 million in reasonable royalty.
Enhanced damages appropriate. In addition, the court found enhanced damages were justified because there was sufficient evidence that the defendant willfully infringed the plaintiff’s patented system. Under the applicable statute, if a court finds there was infringement, it “may increase the damages up to three times the amount found or assessed.” Accordingly, here, the plaintiff was entitled to $6 million plus prejudgment interest, the court said.
Court Decides Daubert Exclusion of Expert Testimony for Failure to Apportion Is Premature
Pawelko v. Hasbro, Inc., 2020 U.S. Dist. LEXIS 738; 2020 WL 42451 (Jan. 3, 2020)
An inventor of a Play-Doh-like substance brought suit against Hasbro, the toy company, for misappropriation of a trade secret and breach of contract. The company unsuccessfully sought to exclude both of the plaintiff’s damages experts under Daubert. Two observations by the court stand out. The court found an expert’s reasonable royalty was not fatally flawed simply because the expert did not analyze every Georgia-Pacific factor, where the expert used an accepted industry standard royalty. Further, the court found a damages determination was not automatically inadmissible where the expert did not apportion. Rather, the court said, it was for the jury to hear all the evidence and damages theories and then determine the experts’ credibility as to the reasonable royalty in this case.
Backstory. The plaintiff created “Liquid Mosaic,” an “arts and craft play system … that made it easy and fun for children to create art projects and decorate by using a unique craft gun. ” She signed a nondisclosure agreement with the defendant, Hasbro, a multinational conglomerate that owned toy, board games, and media assets, and made a presentation to generate interest for her product. Hasbro was not interested in a deal but later came out with two product lines, Play-Doh Plus and DohVinci, which, the plaintiff claimed, incorporated components of her “Liquid Mosaic.”
The plaintiff claimed Hasbro misappropriated the plaintiff’s confidential information and breached the nondisclosure agreement. Hasbro countered that there was no legally protectable trade secret and sought summary judgment on this issue. The court rejected Hasbro’s summary judgment motion, finding these were fact-intensive issues that had to be presented to the trier of fact. In other words, the issue should go to trial.
In pretrial motions, including a motion under Federal Rule of Civil Procedure 720 and Daubert, the defendant argued that the plaintiff’s two damages experts should be precluded from testifying.
Court looks to industry standard. The plaintiff’s Expert 1 presented two opinions. In one opinion, she essentially testified that the plaintiff’s invention qualified as a trade secret even if elements were already known to the public (and Hasbro) before the plaintiff’s meeting with Hasbro if those components in a new form gave the final product a competitive advantage.
In determining the applicable royalty rate, Expert 1 said the general industry standard royalty rate in the toy industry is 5%. That rate drops to 3% for co-branded products. Initially, in her report, the expert said the applicable rate was 5% for Play-Doh Plus. But, at her deposition, the expert changed the rate to 3% after finding out this product was a co-branded product.
Hasbro claimed this testimony was inadmissible because it was not based on an acceptable methodology and was speculative in that the expert did not follow the Georgia-Pacific 15-factor framework.
The court disagreed. It explained that, under Rule 702, an expert may testify if his or her “scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue.”
Under Daubert, a court must determine whether the testimony represents specialized knowledge and whether this knowledge is relevant such that it will help the jury make factual determinations. Daubert also provides a list of factors to determine the reliability and relevance of the expert’s specialized knowledge, including whether the expert’s theory can be tested, has been subject to peer review, and has been generally accepted within the relevant community.
In the instant case, the court found the expert based her opinions as to the applicable royalty rate on standards that were generally acceptable in the toy industry. Therefore, the opinions “pass muster under Rule 702.”
Hasbro further argued the testimony was unreliable because the expert did not “expound on every Georgia-Pacific factor in her report.” The court said this failure did not “doom” the expert’s opinion. “Because there is an established toy industry standard royalty rate, the Court finds that the fact that [Expert 1] did not focus specifically on Georgia-Pacific factors to render her opinions does not make those opinions inadmissible.” The court added that cross-examination by Hasbro and the presentation of opposing evidence were the traditional methods for attacking “shaky but admissible evidence.”
The plaintiff also offered testimony from a second damages expert (Expert 2) who said the royalty base here was made up of the total net sales of all of Hasbro’s products in the DohVinci subbrand and the total net sales of all products sold with the Play-Doh compound. According to this expert, net sales were the gross earnings Hasbro made from the sale of each product line minus returns or discounts. Expert 2 calculated damages to the plaintiff of about $255 million. This calculation included profits from some 25 products that Hasbro sold with Play-Doh as well as all products sold under the DohVinci subbrand earned or to be earned from 2014 through 2023.
The products included elements that Hasbro, not the plaintiff, had invented. According to Hasbro’s damages expert, damages to the plaintiff were at most $261,000.
Entire market value claim. Hasbro also contended that the failure by both of the opposing experts to apportion to the invented product made the testimony inadmissible.
The plaintiff argued that both of Hasbro’s offending product lines derived from the plaintiff’s invention. The invention was the basis for customer demand. Therefore, under the applicable law, the entire market rule exception to apportionment applied. “For the entire market value rule to apply, the patentee must prove that ‘the patent-related feature is the basis for the customer demand.’” See Lucent Techs. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009).
The court noted that “apportionment in trade misrepresentation cases is a potentially important tool that the parties can give the jury if the jury finds liability and determines that the plaintiff suffered damages.” Citing to Ericsson, Inc. v. D-Link Sys., Inc., the court acknowledged that “the ultimate reasonable royalty award must be based on the incremental value that the patented invention adds to the end product.” See 773 F.3d 1201 (Fed. Cir. 2014) (available at BVLaw).
But the court went on to say that “this is a determination that a jury must make after hearing all the documentary and testimonial evidence.” The court said it could not, at this early stage in the litigation, determine that the decision of the plaintiff’s experts not to apportion was fatal for admissibility of their testimony. There was an assumption that the jury would hear evidence to support the plaintiff’s claim that the entire market value rule exception applied, the court said. Also, the experts might explain how they selected their royalty rate and royalty base to support their damages opinions, the court said. The parties must “equip the jury with reliable and tangible evidence to decide which numbers are more consistent with that evidence and which experts are more credible,” the court said.
The court rejected the defendant’s motion to exclude the plaintiff’s damages experts under Daubert and Rule 702.
Court Affirms Plaintiff’s Showing of Loss of Income Pursuant to Business Interruption Policy
Binghamton Precast & Supply Corp. v Liberty Mutual Fire Insurance Co., 2020 NY Slip Op 02214 (April 9, 2020)
Filing a business interruption claim has become one of the first remedies businesses suffering from the economic consequences of COVID-19 look to in an attempt to mitigate the damage to their operations. But the process is hardly trouble free, as this pre-COVID-19 case illustrates. Insurers often deny claims, and the case winds up in court, often going to appeal, as happened here. The instant case is helpful in explaining the applicable legal principles underlying the theory of business interruption and making it clear that the success of a claim depends entirely on the individual policy. The issue in litigation often becomes how to interpret the policy. Here, the business owner was able to show a loss of income pursuant to the terms of the policy, the court found.
Backstory. The plaintiff made precast concrete products for the construction industry. Sales were based on custom orders for specific products, not from inventory. Once orders came in, the plaintiff manufactured them based on a tight production schedule subject to contractual deadlines and limited capacity.
The plaintiff had a policy with the defendant insurance company for equipment breakdown. In June 2015, one of the plaintiff’s concrete mixers broke down and caused an interruption in production until the mixer was repaired and was able to resume operation two days later.
In the event of an equipment breakdown, the plaintiff’s policy provided coverage for “actual loss of Business Income during the Period of Restoration” and extra expenses incurred by operating the business during the restoration period. The parties agreed that the restoration period began with the breakdown of the concrete mixer and ended 30 days after repairs were complete.
The policy also provided that the insurer would “consider the experience of your business before the ‘Breakdown’ and the probable experience you would have had without the ‘Breakdown’ in determining the amount of our payment.” According to the policy, “business income” meant “Net income (Net Profit or Loss before income taxes) that would have been earned or incurred” and normal operating expenses.
The plaintiff filed a claim with the defendant insurer for lost profits resulting from the two days of lost production. The plaintiff explained that, because construction work was seasonal, the plaintiff had to operate its plant close to full capacity in summer. Having the breakdown occur in June meant the plaintiff lost two days of production that it could not make up in summer, resulting in lost profits.
The plaintiff provided the insurer with evidence of the lost production and an explanation of how it calculated lost profits.
The insurer denied the claim, arguing the plaintiff failed to show specific lost sales resulting from the breakdown during the short period following the breakdown.
The plaintiff sued in the New York Supreme Court (trial court) for breach of contract. Both parties then filed summary judgment motions. The court granted the plaintiff’s motion, finding the plaintiff established actual loss of business within the meaning of the policy.
‘Reasonable expectation of the parties.’ The insurance company appealed the ruling to the New York Supreme Court’s appellate division, reviving its argument about the need to show specific sales lost as a consequence of the concrete mixer’s breakdown.
The court’s appellate division disagreed with this interpretation of the policy at issue. Under case law, “[a]n insurance policy must be interpreted to give clear and unambiguous provisions their plain and ordinary meaning.” The appellate division found the policy expressly included profits and losses in its broad definition of business income. However, said the court, neither term (“profits” or “losses”) referred to specific sales or showed an intent to limit coverage under the policy in the way the insurance company argued. The court added that the policy also did not refer to specific sales in setting out the methodology for determining the amount of the insurance holder’s lost business income.
The court noted that, in calculating lost profits, the plaintiff followed the methodology the policy prescribed, i.e., demonstrating production before, during, and after the equipment breakdown and applying its profit margin during the relevant period to the lost production.
In addition, the court noted that, under New York law, the touchstone in interpreting a business interruption policy is the “reasonable expectation of the parties.” The court found the policy “cannot reasonably be interpreted as the defendant argues.”
To impose a requirement that an insured cannot recover for lost business income under defendant’s policy unless it can demonstrate that an equipment breakdown caused a loss of specific sales during the relatively brief restoration period immediately after the breakdown would, in effect, prevent recovery under the policy by an insured whose business—like plaintiff’s—consists of fulfilling contracts after they have been made, rather than upon sales following production.
The court also rejected the defendant’s late objection that the plaintiff’s claim was not covered under a policy exclusion, noting the defendant had not ever advised the plaintiff this exclusion affected coverage or made this argument in front of the trial court. Rather, the record showed the defendant never argued denial of coverage but, instead, argued the plaintiff had failed to show actual loss of business income.
Moreover, the court dismissed the defendant’s argument that the plaintiff suffered no loss of profits because it was able to reschedule any lost production in the next few working days. The court noted the plaintiff showed that rescheduling work meant displacing work the plaintiff would otherwise have performed on those days and having to fit that work into a schedule that was tight due to contractual deadlines, limited capacity, and the short duration of the summer season.
However, the court found the trial court erred in granting summary judgment to the plaintiff on the issue of the amount of damages. Whether the plaintiff mitigated its losses as required in the policy was an issue for trial, the court found. It added that mitigation requirements in business interruption policies also were controlled by and enforceable under the terms of the individual policy.
Business Interruption Claim Raises Triable Issue as to Viability of New Business, Court Finds
Optical Works & Logistics, LLC v. Sentinel Ins. Co., 2020 U.S. Dist. LEXIS 53987 (March 26, 2020)
As the impact of the COVID-19 crisis on business activity has come into relief, business owners struggling to keep companies operating have turned to business interruption insurance to stay afloat. The instant pre-COVID-19 case shows what happens when the insurer denies the claim and the case proceeds to court. This case also points to opportunities business interruption disputes present for damages and valuation professionals, particularly on the plaintiff’s side. Ideally, financial experts become involved in the early stages of a case, where they can provide analysis in support of a damages claim and increase the chance of keeping the claim alive.
Claim denied. The plaintiff was a fledgling Rhode Island optical media company that made replicas of DVDs and CDs for the education and healthcare markets. The company had invested in expensive, specialized machinery and ultrasensitive equipment by setting up a special room (“clean room”) in a building the company rented. There were unpaid construction bills and rent payments as the company tried to make a go of it. The company had an all-risk property and business interruption policy with the defendant insurer.
The company began operations in July 2011 and August 2011. One month later, Hurricane Irene as well as Tropical Storm Lee hit the area, resulting in roof damage and water leakage into the company’s clean room. The water damaged equipment and documents. The company tried to mitigate the damage and hired a company to fix the roof. Ultimately, the business owners decided they had to move the equipment off-site. In the end, the company concluded it could not stay in the building and moved operations.
The plaintiff claimed it had notified the business interruption insurer almost immediately, but the insurer disputed this, arguing it received late notice. The insurer only sent an adjuster in October 2011 who informed the company by letter that the insurer was investigating various coverage issues, including the cause of the water damage and whether conditions were sufficiently bad for the company to leave the property. The insurer sent three consultants to determine the cause of the loss to the building, the clean room, the equipment, and documents. Ultimately, the insurer denied the claim.
The plaintiff filed suit for breach of contract and bad faith on the insurer’s part. The defendant filed for summary judgment. The plaintiff contended that, while losses could have been limited to between $50,000 and $75,000 had the insurance company provided prompt coverage, damages rose to over $4 million and ultimately resulted in the company’s insolvency.
The insurer in essence claimed there was no breach of contract because the company did not suffer the kind of damage covered under its business interruption policy. The insurer also argued the company did not make a proper claim as required under the terms of the policy.
Question as to normal operating expenses. The court found summary judgment in favor of the defendant was inappropriate because the case raised too many issues of material fact that “are better left for a trier-of-fact to decide.”
“The purpose of business interruption coverage is to ensure that a business has the financial support necessary to sustain its business operation in the event disaster occurred,” the court said, citing case law. (internal citation omitted)
The court then looked at the plaintiff’s individual policy to determine the coverage the company had. Coverage included “continuing normal operating expenses incurred” after and because of the event causing the loss; physical damage to the property; extra business expenses incurred as a result of the loss; and damage to valuable papers, computers, and media.
The court noted the policy provided coverage during the restoration period, i.e., from the date of the direct physical loss or physical damage until the date when the property should be repaired or replaced with reasonable speed and similar quality or when business was resumed at a new permanent location.
The court said there was a factual dispute between the parties as to whether the post-storm investigation the insurance company performed was proper.
As to the continuing normal operating expenses the company claimed, the court noted the insurer made various assertions that the company was new and was not a viable business even before the storm. There was no evidence of expenses incurred before the storm, the insurer said, and, therefore, the company was not entitled to coverage of continuing operating expenses.
In contrast, the plaintiff maintained its consulting expert projected what expenses it would have incurred had the insurer paid the benefit under the policy and the company been able to successfully continue its operations. Because the insurer denied the claim, the company had to shut down its business, the plaintiff claimed.
According to the court, determining when and whether the company could have resumed normal business operations raised “the type of murky factual question” that was best resolved by a trier of fact.
There were other disputed issues, the court said, including some related to expert witnesses. For example, there were questions as to what operating expenses such as rent and utilities and what extra expenses the plaintiff had incurred. The court noted the plaintiff had submitted financial evidence from its expert as to how much money it would need to replace business property, equipment and machinery, and documents.
The court concluded that cross-examination was the best way to vet the disputed facts and opinions and that the trier of fact should decide which testimony was most credible and supported by facts. “The Court is sufficiently convinced that a trier-of-fact should decide the outcome of this case.”
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