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Court Rejects Double-Dip Claim, Emphasizing Owner’s General Earning Capacity

Callahan v. Callahan, 157 Conn. App. 78 (May 5, 2015)

Double counting (often called “double dipping”) was one of the key issues the Connecticut appellate court discussed in this contentious divorce proceedings involving several financial consulting companies that the ex-spouses had established. The husband said the trial court’s order to pay the wife a significant sum of money in alimony per month was impermissible double dipping because the alimony was income from the very companies of which the court had awarded the wife a portion. The wife countered there was no double dipping as the alimony calculation was based on the husband’s general earning capacity. The appellate court agreed with the wife.

Husband’s earnings capacity. During the marriage, in 1995, the husband and wife created three related companies that provided financial and investment consulting. The companies were structured so that the wife owned 51% of each of the three companies and the husband the remaining 49%. Further, the husband owned 100% of a fourth related company. In 2009, the wife resigned formally from the positions she held at the companies and the spouses separated. The wife then filed for divorce.

Before the husband worked for the couple’s companies, he had held positions on Wall Street and had worked in London.

During the divorce proceedings, in the spring of 2012, the wife’s forensic valuation expert arrived at a combined value of the companies of not less than $11.7 million. The expert noted that comparable compensation for the husband, as a key person working on Wall Street, would be in the $1 million-to-$2 million range annually. The wife’s expert attributed 50% of the pretax profits to the husband. For 2010, the adjusted compensation was nearly $2 million. As of the completion of the second quarter of 2011, adjusted compensation attributable to the husband was nearly $685,000, the expert said. The husband did not offer contradicting evidence.

In its May 2012 memorandum of decision, the trial court called the valuation methodology of the wife’s expert, and the adjustments he made, “a sound and reasonable approach to valuation” and adopted the expert’s conclusions.

Both parties came to agree that the companies should be sold. The trial court ordered the wife to transfer to the husband the titles and all rights to the companies. And it ordered the husband to sign a promissory note for $6 million payable to the wife at $1 million per year for six years. If the husband were to sell the companies within six months, he was to pay the wife 55% of the sale proceeds; the wife was to receive no less than $4 million from the sale, the trial court ordered.

Further, the court awarded the wife $60,000 per month in alimony until the death of either party, the remarriage of the wife, “or as determined by the court.” The court said it based alimony on “earnings, including member distributions to the defendant up to $2,0000,000 per year.” The court particularly noted the statement from the wife’s expert regarding the husband’s ability to make at least $1 million to $2 million per year, operating as a key person on Wall Street. The court said: “Accordingly, finding earnings attributable to the defendant in the amount of $2,000,000 gross is conservative, the court adopts it as a finding of fact as to the present earning capacity of the defendant at [the companies].”

The husband subsequently filed various motions in which he asked the trial court to reopen the dissolution judgment and related financial orders. In November 2012, the trial court granted the husband’s motion and ordered an evidentiary hearing related to the husband’s claims that the wife had appropriated funds from the companies and engaged in conduct that negatively affected the value of the businesses. At an evidentiary hearing, the parties presented expert testimony as to the husband’s value-related claims.

The trial court concluded that the “deleterious conduct” of the wife undermined the husband’s ability to operate the companies and caused the value of the companies to drop from $11.7 million to $6.3 million. Finding a new trial was not necessary, the court issued substitute financial orders in which it reduced the amount the wife would receive for her interest in the companies from $4 million to $3 million.

Both parties appealed various aspects of the trial court’s findings.

Challenge to alimony. The husband claimed the trial court’s alimony determination was error because the court considered income generated by the companies while also awarding the wife a portion of the value of the companies. The trial court double dipped, the husband argued.

In a related argument, the husband contended the trial court did not make a finding as to the husband’s general earning capacity but only as to the husband’s earning capacity at the companies. Further, if the trial court had found the husband’s earning capacity was independent of the income he earned at the companies, the trial court erred because it did not have evidence that the husband had earnings from an independent source of $2 million per year. Nor did the court have evidence of the husband’s earning capacity. The husband’s argument was based on a claim that the trial court had stricken testimony from the wife’s expert as to potential earnings on Wall Street for procedural reasons.

The wife contended the trial court based its decision on the husband’s general earning capacity. She argued the trial court referenced the husband’s educational background, experience, and qualification when finding earning capacity of at least $1 million to $2 million, “irrespective of his income from the companies.” Moreover, under case law, it was not improper for the trial court to use a spouse’s income derived from a closely held business as some evidence of the spouse’s general earning capacity, the wife said. This was what the trial court did here.

The state appellate court agreed with the wife. It first noted the general principle that “a court may not take an income producing asset into account in its property division and also award alimony based on that same income.”

The appellate court found the trial court here made fact findings as to the husband’s earning capacity “independent of his employment at the companies.” The trial court both determined that the husband’s “present [gross] earning capacity” at the companies was $2 million per year. But, according to the appellate court, there also was additional evidence that the trial court considered in fashioning its order for alimony. The reviewing court pointed to the trial court’s crediting the approach the wife’s expert used for the valuation and the expert’s comment as to the husband’s earning capacity on Wall Street. In addition, the appellate court said, the trial court had evidence regarding the husband’s educational background and his employment prior to working for the companies, “which included various positions on Wall Street and in London.”

Therefore, there was evidence to support the trial court’s finding as to the husband’s general earning capacity, “independent of his position [at the companies],” the appellate court said. It concluded the trial court did not engage in improper double dipping.

Improper post-judgment revaluation. The wife challenged the trial court’s decision to revisit the dissolution judgment and change its earlier financial orders based on the husband’s allegations of post-judgment misconduct by the wife.

The appellate court agreed with the wife that the trial court did not have the authority to undertake a do-over. In a nutshell, as the appellate court explained, under the controlling law, the circumstances in which a court may reopen or set aside a judgment are limited because of the important principle of achieving finality in judgments. Basically, a court may open a judgment if a motion is filed within four months following the judgment date and where there is “a good and compelling reason for its modification or vacation.”

The husband had filed the motion within four months of the judgment. But the wife contended, and the appellate court agreed, that a post-judgment change in the value of a marital asset was not a valid reason to revisit a judgment. Under case law, the trial court’s decision to reopen a judgment must relate to prejudgment conduct, the wife said.

The appellate court noted that the trial court improperly considered post-judgment withdrawals by the wife. “Neither party has identified precedent wherein the trial court opened a marital dissolution judgment to revalue an asset subject to equitable distribution on the basis of post-judgment conduct by one of the parties,” the court said. It went to on say that the applicable statutes did not “vest[] the trial court with authority to revisit a judgment dividing marital property where post-judgment conduct, conditions, or changes affect the value of a marital asset.”

The appellate court reversed the modified judgment of the trial court and reinstated the trial court’s original financial orders “in their entirety.”

Court Admits Unjust Enrichment Damages Based on Profit Projections

Grove US LLC v. Sany America Inc., 2019 U.S. Dist. LEXIS 32125 (Feb. 28, 2019)

This Daubert case, which arose out of the plaintiff’s claim that the defendant misappropriated the plaintiff’s trade secrets, includes an important discussion of unjust enrichment damages. A key issue was whether, in the context of misappropriation of a trade secret, the plaintiff’s damages expert may consider expected future income to the defendant from the offending product, as the plaintiff’s damages expert did. The defendant said only the actual profits to the defendant may be used and that the opposing expert’s calculation was based on speculation. The plaintiff argued that use of future profit projections may be appropriate to determine the market value of the trade secrets. The court found the testimony was admissible.

Prior ITC ruling against defendant. The parties had a history of litigation. The plaintiff is a leading crane manufacturer and initially sued the defendant (related companies), alleging patent infringement and misappropriation of trade secrets related to crane technology. The U.S. International Trade Commission (ITC) started its own proceedings against the defendant, alleging tortious interference with contract. The ITC found the defendant had violated the Tariff Act by misappropriating the plaintiff’s protectable trade secrets and infringing one patent. On appeal, the Federal Circuit affirmed the ITC’s ruling.

Meanwhile, in the instant case, the plaintiff amended its complaint by asserting only claims of state law misappropriation of trade secrets and tortious interference with contract. The defendant filed counterclaims. In its summary judgment motion, the plaintiff asked the court to adopt the ITC ruling. Although the court found the defendant liable for violating the plaintiff’s trade secrets under state law, the court allowed the defendant to asset certain counterclaims against the plaintiff.

At this stage in the proceedings, both parties filed Daubert motions asking the court to exclude the opposing expert damages testimony.

Applicable law. Under Rule 702 of the Federal Rules of Evidence and Daubert, a witness who is qualified by knowledge, skill, experience, training, or education, may testify if: (1) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (2) the testimony is based on sufficient facts or data; (3) the testimony is the product of reliable principles and methods; and (4) the expert has reliably applied the principles and methods to the facts of the case. A district court functions as a gatekeeper and has broad discretion in determining the reliability and relevance of the proposed testimony. There is a preference for admissibility in case of doubts as to the usefulness of the expert testimony.

Recovering benefit to the defendant. The ITC, in its investigation, determined that the defendant used the plaintiff’s trade secrets to build a crane that allowed the defendant to enter the U.S. wind energy market. Without the plaintiff’s technology, the defendant did not have cranes that were suitable for this market and it would have had to adapt two of its own crane models and incur substantial development costs.

The plaintiff’s expert calculated unjust enrichment damages and actual damages.

Regarding unjust enrichment, the plaintiff claimed it had a right to recover the amount by which the defendant was unjustly enriched by misappropriating the plaintiff’s trade secrets. The plaintiff’s expert found unjust enrichment damages included research and development costs the defendant avoided by not having to adapt its own cranes; research and development costs the defendant saved by using the plaintiff’s trade secrets to build the violating crane; and the incremental profit the defendant anticipated it would generate at the time closest to the misappropriation.

For the incremental profit determination, the plaintiff’s expert relied on an analysis one of the defendant’s employees had done projecting future sales and profits to the defendant from the offending crane; this was called the “Economic Value Added” (EVA) analysis.

In total, unjust enrichment damages ranged from almost $74 million to $112 million, the plaintiff’s expert calculated.

The defendant attacked the plaintiff expert’s assessment of unjust enrichment, saying it was based in part on “hypothetical future profits” and was an “irrelevant, unreliable, and inappropriate measure of damages for unjust enrichment.” Unjust enrichment damages must not be based on estimated profits, the defendant claimed. It asked the court to preclude the opposing expert from testifying to or relying on the defendant’s EVA analysis.

The court explained that the issue here was one of substantive law rather than determining the merits of the plaintiff expert’s methodology. Two principles are at work. Under the applicable case law, “damages in an unjust enrichment claim are measured by the benefit conferred upon the defendant.” See Ramsey v. Ellis, 484 N.W.2d 331 (Wis. 1992).

For claims of misappropriation of trade secrets, courts look “to the time at which the misappropriation occurred to determine what the value of the misappropriated trade secret would be to a defendant who believes he can utilize it to his advantage, provided he does in fact put the idea to a commercial use.” See Univ. Computing Co. v. Lykes-Youngstown Corp., 504 F.2d 518 (5th Cir. 1974).

The plaintiff argued its expert used the defendant’s EVA analysis to determine the fair market value of the trade secrets at the time of the misappropriation. Parties may use future profit projections to determine the value of trade secrets, the plaintiff said. It went on to argue that the plaintiff could recover the value of trade secrets even if the defendant obtained no actual profit from the misappropriation, citing to the comments of section 51 of the Restatement (Third) of Restitution and Unjust Enrichment. Comment d, in particular, says that, “[s]o long as benefits wrongfully obtained have an ascertainable market value, that value is the minimum measure of the wrongdoing defendant’s unjust enrichment, even if the transaction produces no ascertainable injury to the claimant and no ascertainable injury to the defendant.”

The court concluded the plaintiff expert’s opinion on the value of the trade secrets, relying on the EVA analysis, was admissible. The defendant was free to challenge the expert’s valuation of the trade secrets by arguing the projections in the EVA analysis were speculative and unreliable and did not provide a reasonable measure of the fair market value of the trade secrets. Also, the defendant could point out that the actual profit it received from the use of the trade secrets was less than $2 million; moreover, the defendant could say that the value of the trade secrets was reduced because of the remedies the plaintiff had already obtained as a result of the ITC ruling. However, the court said, the defendant had not shown that it was improper or economically unsound for the plaintiff’s expert to consider the likely income from the use of the trade secrets.

Actual damages. The plaintiff’s expert broke the actual damages to the plaintiff down into three categories. First, he calculated incremental “Performance Improvement Programs” (PIPS) expenses. The argument was that, once the defendant introduced its offending crane into the market, the plaintiff had to accelerate the development of its two new cranes, which increased PIPS expenses due to work necessary to correct design flaws and other mistakes that were not caught during the accelerated product development, before the cranes were delivered to customers.

The plaintiff relied on a document that one of the plaintiff’s employees had created, tracking expenses related to the new cranes in comparison to two older crane models. Working with these numbers, the plaintiff’s expert found incremental PIPS expenses for the two cranes amounted to $4.5 million.

The expert also prepared an itemized summary of legal expenses related to the earlier ITC action, which he said were recoverable as money spent to mitigate damages. The total of these expenses was nearly $7.4 million. Further, the plaintiff’s expert calculated incremental security expenses, related to what the plaintiff claimed were additional security improvements it had to make because of the defendant’s misappropriation. Expenses in this category amounted to over $1 million.

The defendant first claimed this testimony was inadmissible because the plaintiff’s expert merely served as a mouthpiece for the plaintiff. He did not do an independent analysis of the accuracy and reliability of the data the plaintiff’s employees provided to the expert.

The court noted that the defendant did not challenge the opposing expert’s qualifications and said the expert brought more to the case than simple repetition of the plaintiff’s calculations. Given the expert’s background in valuation and financial consulting, he would be able to explain to the jury the effect of the misappropriation on the plaintiff’s business and the value of the misappropriation to the defendant. “A general knowledge of how businesses operate, i.e., the importance of trade secrets, the way businesses conduct research and development into new products, the costs of such research and development, performance improvement plans, and similar topics will help the jury understand the nature and basis of the damage claims [the plaintiff] is asserting,” the court said.

It also noted that questions as to the sources of an expert’s testimony went to the weight of the opinion, rather than admissibility, and should be left for the jury to decide. However, the court excluded the expert’s testimony as to irreparable harm resulting from the defendant’s misconduct. It said it would suspend its determination regarding equitable relief until after the jury resolved the issue of damages.

In sum, the court found the plaintiff expert’s testimony as to actual damages and unjust enrichment damages was admissible.

No legal conclusions. The defendant’s expert provided rebuttal testimony and his own assessment of damages related to the misappropriation of trade secrets.

In trying to exclude this testimony, the plaintiff first contended the expert, at various points, improperly offered an opinion as to what legal standard the jury should use. For example, the defendant’s expert said, “[T]he ‘anticipated’ economic profits based on forecasts that never materialized is not proper, and are not a measure of unjust enrichment.”

The defendant countered its expert did no more than explain his understanding of the applicable law.

The court disagreed with the defendant, finding the defense expert expressed an opinion on a legal question, that is, which factors or evidence the jury could consider in determining unjust enrichment. As such, the expert’s opinion “encroach[ed] on the court’s authority to instruct the jury on the law to be applied to the facts of the case.” Merely telling the jury what result to reach is not helpful to the jury, the court noted, striking this legal conclusion from the expert’s report.

At the same time, the court noted the defense expert was allowed to point out that the anticipated profits did not materialize and he was able to challenge the opposing expert’s opinion on the fair market value of the misappropriated trade secrets on the grounds that the relied-upon EVA analysis was “speculative, unreliable, and not a true measure of the value of the trade secrets.”

The plaintiff also claimed the defense expert improperly offered an opinion on causation. For example, in critiquing the plaintiff expert’s testimony on accelerated development of two cranes and increased PIPS expenses, the defense expert claimed the opposing expert did not independently analyze the premise of causation. He simply assumed that the defendant’s conduct was the only cause for the accelerated development of the two cranes, rather than also take into account market conditions, competition, staffing, and business management factors.

The court found this was proper rebuttal evidence. Simply because the defense expert used different assumptions and methods to calculate the various expenses did not justify the exclusion of his testimony.

Moreover, the plaintiff argued the defense expert was not permitted to offer an opinion that contradicted the findings of the ITC investigation. For example, the ITC found that, without the plaintiff’s trade secrets to build the defendant’s offending crane, the defendant would have had to adjust two other models for the U.S. market. By misappropriating the trade secrets, the defendants avoided “what likely would have been a developmental dead end.”

The defendant’s expert disputed these findings, saying the record was clear that the defendant would have rejected, and did reject, the idea of adapting the two cranes and, therefore, any development costs related to the two cranes were irrelevant to measuring unjust enrichment, i.e., measuring the benefit to the defendant. The defense expert found the only additional development costs the defendant avoided because of the misappropriation ranged from $1.3 million to $1.5 million.

The court said the defendant was not allowed to use an expert to contradict the ITC’s factual findings. The expert was precluded from making statements that were inconsistent with the ITC’s findings because this opinion would not be helpful to the jury but would cause jury confusion.

The plaintiff objected to the defense expert critique that there was no reliable basis for the plaintiff expert’s actual damages calculation because the plaintiff didn’t show lost sales resulting from the misappropriation. According to the defense expert, many factors could have played a role in the plaintiff’s failure to meet sales projections as to one of the cranes it developed in response to the defendant’s offending crane. The defense expert suggested the opposing expert should have considered the boom-bust cycle of the wind power market, oil prices varying between the time the plaintiff forecast sales for its crane and the sales date of the crane, flaws in the crane’s design, and poor forecasting on the part of the plaintiff’s employees.

The court found these statements by the defense expert were admissible testimony. The plaintiff would be able to challenge the correctness of the defense expert’s conclusion in cross-examination or by introducing contrary evidence.

In sum, the court precluded the defense expert from presenting legal conclusions and making statements that contradicted the findings of the earlier ITC proceeding (in favor of the plaintiff). Other defense expert opinions as to the causal link between the misconduct and the plaintiff’s claimed damages and claimed lost sales were admissible, the court concluded.

In Florida Divorce, Expert’s ‘With-and-Without’ Valuation Withstands Appeal

Muszynski v. Muszynski, Case No. 2013-DR-18828-O, Final Judgment of Dissolution of Marriage, Circuit Court of the Ninth Circuit, Orange County, Fla. (Oct. 4, 2017), Bob Leblanc (Circuit Judge), aff’d per curiam Muszynski v. Muszynski, 2019 Fla. App. LEXIS 9913 (June 25, 2019)

In a nasty Florida divorce case, an appellate court recently upheld the trial court’s valuation findings concerning the husband’s 50% interest in a successful company that operates in the waste disposal industry. The trial court adopted the valuation of the wife’s expert, which included the value of certain intangibles belonging to the company but excluded the value of the husband’s personal goodwill. In Florida, enterprise goodwill is a marital asset, but personal goodwill is not.

Separating out personal goodwill: During the marriage, the husband set up a business, soon selling a 50% ownership interest to a third party. The husband had sole ownership over the remaining 50%. The company facilitated waste removal in that it had relationships with companies that generated waste and those that hauled it away. Apparently, the company did not, itself, remove the waste.

A few years before filing for divorce, the husband sold a 45% interest (nonvoting stock) to a trust but retained a 5% interest that represented 50% of the total voting rights in the company. Ostensibly, he did so for estate planning purposes. But the trial court noted that, at that time, the parties’ marriage was breaking down and that the wife was not properly informed of the sale and its implications.

The trial court first determined that the totality of circumstances suggested the sale “did not serve a valid marital purpose and was unconscionable.” The transaction was the husband’s “unilateral decision” and did not change the classification of the husband’s interest from a marital asset to a nonmarital asset. The value, for purposes of equitable distribution, was the full 50% of the company’s stock (not the retained 5% interest), the trial court decided.

The parties’ experts prepared fair market value determinations but disagreed on how to value the husband’s interest. The husband’s expert proposed a net asset valuation, noting, however, that the company had no significant assets as it didn’t produce anything or own much. According to this expert, all intangible value was linked to the husband’s (and his business partner’s) client relationships and therefore was not a marital asset. This value represented nothing more than the husband’s future earning capacity, which must not be considered in dividing marital property in a divorce proceeding, the expert said.

The wife’s expert valued the company’s assets and teased out the value of all identifiable intangibles which, he explained, belonged to the enterprise (including workforce, trade name, employees’ noncompetes, and customer relations). Proceeding from the premise that a buyer would not buy the company without having a noncompete for the husband in place, which evidences personal goodwill, he used the with-and-without method to determine the value of the husband’s noncompete and subtracted this value from the overall valuation.

In crediting this expert’s testimony, the court emphasized that the valuation did not include any personal goodwill of the husband. The court said it accepted the wife’s expert’s “methodologies for separating out any value related to Husband’s personal goodwill.” A state court of appeal recently affirmed the trial court’s decision per curiam, without issuing an opinion.

In Misappropriation Case, Expert’s ‘Head Start’ Damages Calculation Survives Appeal

Sabre GLBL, Inc. v. Shan, 2019 U.S. App. LEXIS 19983 (July 3, 2019)

This damages case, which centered on an employee’s breach of fiduciary duties and other misconduct toward her former employer, and which went to arbitration, includes an informative discussion of the difference between head start damages and saved development costs. Both the federal district court and 3rd Circuit Court of Appeals found the head start award was based on a valid damages theory and methodology for calculating the benefit to the wrongdoer as a result of her misconduct.

Background. The employee worked for nearly two decades for Sabre in the United States and China. Sabre was a technology provider to the travel and tourism industry. In 2013, the employee became a consultant for the company and entered into an employee intellectual property and confidentiality agreement (EIPC agreement). The contract forbade her to disclose or use the company’s confidential information for her own benefit or the benefit of a third party.

The EIPC agreement also included a noncompete clause and restricted the employee’s ability to interfere with the company’s relationships with customers, employees, and contractors for a period of time, both during and after her employment with the company.

In violation of the agreement, the employee, while still employed, started a competing Chinese company and also began to recruit Sabre employees and to solicit Sabre customers. The employee ultimately owned a 68% stake in the company, through a holding company she had formed to acquire shares in the Chinese competitor. The employee then resigned from Sabre and returned to China to work for the Chinese competitor.

More than a year later, Sabre sued the employee in New Jersey (where she had worked as a contractor) for breach of the EIPC agreement and breach of her fiduciary duties to Sabre. The employee was able to remove the lawsuit to federal court and compel arbitration. An arbitrator ultimately found for the company on a number of claims and awarded the employer two types of damages. The employee was required to disgorge $200,000, representing the salary she had received from Sabre during the period in which she had been disloyal to the company. Under the “head start” measure of damages, the arbitrator awarded the company nearly $1.2 million in damages. In a nutshell, this award represented the benefit to the employee derived from her misconduct based on her equity interest in the Chinese competitor.

However, the arbitrator rejected recovery under another category of damages for saved development costs, finding the evidence Sabre provided was too speculative.

The arbitrator also found the employee liable for breach of contract and other violations but did not award any additional damages related to the additional claims. The district court confirmed the arbitration award.

The employee then appealed the district court’s confirmation of the arbitration award with the 3rd Circuit Court of Appeals, arguing, in essence, that the arbitrator “manifestly disregarded” various aspects of the applicable Texas law when it awarded the damages. The 3rd Circuit disagreed.

Calculation of head start damages. The flashpoint was the head start damages award. The arbitrator accepted the calculations of the company’s damages expert, which were premised on the theory that the employee’s breach of fiduciary duty to Sabre (acquiring and using the company’s confidential information and trade secrets and, improperly, recruiting its personnel), gave the Chinese competitor a two-year head start, which that company would not have had but for the employee’s misconduct. In other words, the head start damages quantified the benefit to the Chinese company and to the employee who held an equity stake in it as a result of the employee’s misconduct.

The expert first computed the incremental value of the head start to the Chinese company by valuing the company with and without the head start and determining the difference between the two valuations. He then multiplied this figure by 68%, representing the employee’s ownership in the Chinese competitor.

For his valuation of the company with the head start, the expert relied on a transaction in which an actual outside investor was willing to buy a 20% interest in the company for a certain amount. The expert then discounted the resulting valuation to calculate the value of the company without the head start, showing that, but for the employee’s misconduct, the company would not have achieved this valuation for an additional two years.

The expert determined that the incremental value to the Chinese company was over $1.7 million, whereas the incremental value to the employee was about $1.2 million. The arbitrator, in adopting the expert’s damages determination, found this was “an accepted and credible approach” with which to calculate the benefit to the employee from the misconduct.

Among the numerous arguments the employee made to contest the damages, she claimed the head start damages calculation was flawed because it was based on Sabre’s erroneous assumption that head start damages and saved development costs are “the same thing.” The employee then contended the arbitrator mistakenly allowed Sabre to recover saved development costs, without there being any evidence of those costs.

The appeals court rejected the argument. It noted that, in his report, Sabre’s expert made clear that head start damages and saved development costs were separate damages theories that sought recovery for two different benefits the wrongdoer received as a result of the misconduct. Head start damages, the appeals court said, reflected the benefit to the employee from the increase in the Chinese company’s value “as a result of the company’s being two years further along than it otherwise would have been in developing and commercializing its products and services.”

Saved development costs, on the other hand, capture the benefit to the employee from the Chinese competitor’s ability to avoid certain research and development costs by misappropriating Sabre’s trade secrets and confidential information. In other words, the Chinese competitor did not have to develop this knowledge and information on its own.

The 3rd Circuit noted that, in the instant case, the arbitrator found that Sabre failed to prove saved development costs and, instead, awarded head start damages based on Sabre’s expert’s damages calculation.

The argument that the expert’s valuation was precluded under Texas case law also had no traction with the 3rd Circuit. Rather, the reviewing court found there was no ruling “that shareholder equity is categorically an impermissible method of establishing the value of a company.”

Moreover, the court dismissed the employee’s claim that Sabre’s expert wrongly assumed that all or most of the Chinese company’s value as of the valuation date was attributable to products that were traceable to the employee’s misconduct. The employee claimed that other products unrelated to her misconduct also were in development as of the valuation date. However, the 3rd Circuit found the employee did not provide a basis for concluding the expert’s assumption was incorrect.

The 3rd Circuit Court of Appeals concluded that, despite many assertions of legal error, the employee failed to identify a governing legal principle in Texas law that the arbitrator knew of but chose to ignore when it awarded the former employer head start damages. There was no evidence to conclude the damages “were awarded in manifest disregard of the law,” the 3rd Circuit said. It confirmed the head start damages award.

High Court Approves of Trial Court’s Rejection of Discounts in Fair Value Determination

Puklich v. Puklich, 2019 ND 154; 2019 N.D. LEXIS 153; 2019 WL 2641017 (June 27, 2019)

A buyout dispute between siblings who owned several businesses generated a noteworthy decision from the North Dakota Supreme Court on the use of valuation discounts. Reviewing the applicable case law, the high court found the trial court, in determining the fair value of one sibling’s minority share in a closely held corporation, did not err in refusing to apply a minority discount. The trial court was authorized to use the value finding to account for the majority shareholder’s wrongful conduct, the high court found. Also, case law from other states supported the decision not to apply a minority discount under the circumstances, the state Supreme Court found. It also concluded the trial court’s decision not to use discounts in the context of the dissolution of a partnership also was not clear error.

Background. Two siblings held ownership interests in three businesses. One company was a closely held corporation that operated an automobile dealership. The other was a limited partnership that owned the real estate on which the dealership was located and leased it to the dealership. A third company, also a closely held business, operated a reinsurance business that was related to the dealership.

The siblings’ relationship broke down, leading the sister to ask the court to dissolve the partnership. In response, the brother, who was the minority shareholder in the dealership, asserted various breaches of fiduciary duty by the sister and ultimately asked the court to order the sister to buy out his interest in the dealership and award damages for the breaches.

The trial court dissolved the partnership and ordered the sister to pay $2.9 million to the brother for the value of his partnership interest. Further, the court compelled the sister to buy the brother’s 19% minority interest in the automobile dealership for $2.6 million.

As to the partnership, the court found the sister had breached her duty in winding up the partnership without notifying the brother, who was the co-owner. As to the dealership, the court found the sister had breached her duties of good faith and fair dealing by trying to oppress the brother as a minority shareholder in an attempt to buy his shares at below fair market value. The trial court found the sister limited the funds flowing to the brother and did not provide him with timely information about the business.

Liquidation of partnership assets. At trial, the parties presented expert testimony as to the value of the partnership and the automobile dealership. The trial court adopted the valuations of the brother’s expert.

On appeal to the state Supreme Court, the sister claimed the trial court’s valuation findings were erroneous. She particularly challenged the trial court’s rejection of the use of valuation discounts as to both entities.

Regarding the partnership, which owned the real estate, the sister claimed one of the brother’s experts mistakenly valued the real estate as a fee simple estate rather than a leased fee estate. She contended the expert ignored the leases that allowed the dealership to use the property. She also claimed that the brother’s other expert used the allegedly wrong real estate value when valuing the partnership.

Under the law, valuation is a question of fact, the state Supreme Court noted. The trial court’s valuation findings are only reversed if they are clearly erroneous. Moreover, the trial court’s valuations are presumed to be correct, “and a valuation within the range of evidence presented to the court is not clearly erroneous.”

The state’s high court observed that the trial court here was aware that the real estate appraiser had not considered the leases allowing the dealership to use the property. However, the high court said, there was evidence that the leases were not arm’s-length leases and that the rent payable under the leases could be increased. The brother’s expert considered the amount of rent that a lease reflecting market value could generate. This expert testified that, “if the leases reflected market value, the leased fee estate and fee simple estate would be equal.” Given this evidence, the trial court’s valuation of the real estate owned by the partnership was not clearly erroneous, the high court found.

The sister also claimed that the trial court erred in not applying a minority discount and a lack of marketability discount (DLOM) when valuing the partnership interest.

The high court, referencing a tax court decision, first noted that the two discounts were “conceptually distinct.” It explained that the minority discount deals with the interest owner’s inability to force liquidation and realize the owner’s respective portion of the net asset value. On the other hand, the marketability discount reflects the lack of a ready market for the ownership interest. See Estate of Fleming v. Commissioner, 74 T.C.M. (CCH) 1049 (T.C. 1997). Questions regarding the use of discounts and their rates are questions of fact, the high court noted.

It pointed out that the applicable state statute for winding up a partnership’s business (N.D.C.C. § 45-2-07) called for the liquidation of the business’s assets. Doing so required liquidating the assets of the business, paying its debts, and distributing the remaining funds to partners based on their ownership interests. Considering that the dissolution of the partnership here resulted in the liquidation of its assets, it was not clear error for the trial court to reject the use of discounts, the state Supreme Court found. It affirmed the trial court’s valuation of the partnership.

However, the high court struck down a damages award of $300,000 to compensate the brother for the sister’s breach of fiduciary duties with respect to the partnership, finding the trial court offered no explanation as to how it arrived at this sum.

Minority interest in auto dealership. The sister also challenged the valuation of the auto dealership, arguing the trial court improperly used the valuation of the brother’s expert to penalize her for the breach of fiduciary duty. She also claimed the court improperly rejected the use of valuation discounts.

The state’s high court disagreed. It first noted that the trial court had found the sister had taken “calculated steps to force the brother to sell his interest to her and reduce any funds owing to [the brother] from the business.” The trial court went on to say it would not discount the brother’s interest, as the sister’s expert had recommended.

The state Supreme Court noted that the reviewing court gives great deference to a trial court’s credibility determinations. According to the Supreme Court, the trial court here was not only making a credibility determination between the rivalling experts or deciding how much weight to give to each expert’s testimony. Rather, the trial court “adjusted its finding on the value of [the dealership] to account for [the sister’s] breach of fiduciary duty with respect to [the dealership].” Instead of awarding damages for the breach of fiduciary duty, the trial court decided to adopt the valuation of the brother’s expert, which did not apply discounts, the state Supreme Court noted.

It went on to explain that, in circumstances in which persons in control of a closely held corporation have acted in a wrongful manner toward the company’s shareholders, the trial court is authorized either to dissolve the corporation or “grant any equitable relief it deems just and reasonable under certain specified conditions.” The purchase price must be the fair value of the shares, unless there exists a controlling shareholder agreement. See N.D.C.C. § 10-19, 1-115(4)(a).

The state Supreme Court noted that the trial court here acted in accordance with the statute. The trial court used a value that favored the brother, “as an equitable remedy for [the sister’s] breach of fiduciary duty.” What’s more, the trial court selected a value for the company that was within the range of evidence. The trial court’s ruling did not reflect an erroneous view of the law, the high court found and upheld the valuation of the auto dealership.

In discussing the appropriateness of valuation discounts, the high court cited decisions from other state courts that have rejected the application of discounts when valuing a minority interest in the context of a corporate dissolution, where the buyer is the corporation or its controlling shareholder, as well in dissenting shareholder cases requiring a determination of the fair value of the dissenter’s interest.

“We agree a trial court ascertaining ‘fair value’ of minority shares under the Business Corporation Act should not automatically discount their value,” the state Supreme Court said. It concluded that the trial court’s rejection of discounts “was consistent with our case law.”


Jay Cunningham Director, Litigation & Dispute Services

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