The Use of Daubert and Its Progeny to Attack Lost-Profit Claims
Beginning with its landmark ruling in Daubert v. Merrell Dow Pharmaceuticals,1 and continuing through Kuhmo Tire Co. v. Carmichael,2 the U.S. Supreme Court greatly expanded the obligation of federal district judges to act as gatekeepers to exclude speculative, unreliable expert testimony. This trend culminated in the December 2000 amendments to Rules 701 and 702 of the Federal Rules of Evidence, which require trial judges to review rigorously an expert's opinions for reliability before admitting those opinions into evidence. These amendments promise to be a powerful tool for attacking expert opinions on lost profits in franchise disputes, since expert testimony is often critical to proving damages in a franchise case, and lost-profit projections typically involve a greater degree of speculation than do other forms of expert testimony. As the U.S. Supreme Court's recent decision in Weisgram v. Marley Co.3 makes clear, a successful Daubert challenge can have dramatic consequences—turning a plaintiff's verdict at trial into a defendant's judgment on appeal.
This article will (1) review the standards for admitting expert testimony under the U.S. Supreme Court's decisions in Daubert, General Electric Co. v. Joiner,4 Kuhmo, and Weisgram, and the codification of those standards in the recent amendments to Rules 701 and 702 of the Federal Rules of Evidence; (2) discuss the more notable federal and state court decisions applying Daubert (or a Daubert-like test) to expert testimony about lost future profits in a franchise, distributor, or dealer dispute; and (3) offer some practical suggestions on how and when to challenge expert testimony in a lost-profit case and how to cope with a Daubert challenge.
Daubert and Its Progeny
The original version of Rule 702 of the Federal Rules of Evidence, adopted in 1975, set the standard for admitting expert testimony in federal litigation by declaring that "[i]f scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise."5
Before Daubert, the admissibility of expert testimony was governed by the general acceptance test outlined in Frye v. United States.6 Under Frye, which was the dominant standard for seventy years,7 expert testimony was admissible if a trial judge concluded that the expert's methodology was "sufficiently established to have gained general acceptance in the particular field in which it belongs."8 In 1993, however, the U.S. Supreme Court held in Daubert that the adoption of Rule 702 superseded Frye, and that "[n]othing in the text of this Rule establishes ‘general acceptance' as an absolute prerequisite to admissibility."9 Instead, the Court concluded that the trial judge, in deciding whether to admit scientific expert testimony, must make a less formulaic "assessment of whether the reasoning or methodology underlying the testimony is scientifically valid and of whether that reasoning or methodology properly can be applied to the facts in issue."10
Although the Court held that satisfying the Frye general acceptance test was not a prerequisite for admissibility, it emphasized that it was not sanctioning "a ‘free-for-all' in which befuddled juries are confounded by absurd and irrational pseudoscientific assertions."11 Rather, the Court explained that the Federal Rules themselves required lower courts to play an active role in screening expert testimony. Accordingly, before admitting such testimony, the district court "must ensure that any and all scientific evidence is not only relevant but reliable."12 The Court also identified four factors for trial judges to consider:
• whether the "theory or technique . . . can be (and has been) tested"
• whether "the theory or technique has been subjected to peer review and publication"
• "the known or potential rate of error of the technique or theory"
• whether the theory or technique has "widespread acceptance" in the scientific community.13
The Court emphasized that this four-part analysis was "flexible," and that the overriding role of the trial judge was to ensure that the expert's opinion had a "reliable foundation" and was "relevant to the task at hand."14
General Electric Co. v. Joiner
Four years after Daubert, the U.S. Supreme Court held in General Electric Co. v. Joiner that district court judges were required to examine not only an expert's underlying methodology, but also the reasonableness of the expert's resulting conclusion:
[C]onclusion and methodology are not entirely distinct from one another. Trained experts commonly extrapolate from existing data. But nothing in either Daubert or the Federal Rules of Evidence requires a district court to admit opinion evidence which is connected to existing data only by the ipse dixit of the expert. A court may conclude that there is simply too great an analytical gap between the data and the opinion proffered.15
The Court also held that the trial judge's decision to admit or exclude scientific expert testimony was reviewable for an abuse of discretion,16 and that the Eleventh Circuit erred in reversing a trial court's decision to exclude expert testimony in the case at issue.17 In light of this deferential standard of review, if a trial judge sustains a Daubert challenge, that decision will often be outcome determinative.
Kuhmo Tire Co. v. Carmichael
In Kuhmo, the U.S. Supreme Court clarified that Daubert required trial judges to review not just scientific testimony, but "all expert testimony" for reliability:
We conclude that Daubert's general principles apply to the expert matters described in Rule 702. The Rule, in respect to all such matters, "establishes a standard of evidentiary reliability." 509 U.S., at 590. It "requires a valid . . . connection to the pertinent inquiry as a precondition to admissibility." Id. at 592. And where such testimony's factual basis, data, principles, methods, or their application are called sufficiently into question, . . . the trial judge must determine whether the testimony has "a reliable basis in the knowledge and experience of [the] discipline." Id.18
Consequently, before admitting any type of expert testimony, the trial judge is obligated "to make certain that an expert, whether basing testimony upon professional studies or personal experience, employs in the courtroom the same level of intellectual rigor that characterizes the practice of an expert in the relevant field."19 This holding has particular significance to franchising, since most expert testimony admitted under Rule 702 in franchise disputes, including testimony in support of lost-profit damage claims, is nonscientific.
In addition to clarifying that Daubert applied to all types of expert testimony, the Kuhmo Court reiterated that trial judges have broad discretion in screening the testimony. The Court explained that the four factors identified in Daubert were "meant to be helpful[,] not definitive," and that these factors "may or may not be pertinent in assessing reliability, depending on the nature of the issue, the expert's particular expertise, and the subject of his testimony."20 The Court also emphasized that the "trial court must have the same kind of latitude in deciding how to test an expert's reliability . . . as it enjoys when it decides whether that expert's relevant testimony is reliable."21 As a result, trial judges are not only entitled to substantial deference concerning the substance of their rulings, but also may employ a wide array of procedural alternatives (e.g., motions in limine, affidavits, minitrials) for resolving a Daubert challenge.
Weisgram v. Marley Co.
The U.S. Supreme Court's decision in Weisgram v. Marley Co., handed down last year, illustrates what can happen if expert testimony admitted at trial flunks the Daubert test on appeal. In Weisgram, the Court held that if an appeals court concludes that expert testimony was improperly admitted at trial, and that the plaintiff could not satisfy his or her burden of proof without the testimony, the appellate court may enter judgment for the defendant. Writing for a unanimous court, Justice Ginsburg reasoned that, in the wake of Daubert, Joiner, and Kuhmo, "parties relying on expert evidence have had notice of the exacting standards of reliability such evidence must meet . . . . It is implausible to suggest, post-Daubert, that parties will initially present less than their best expert evidence in the expectation of a second chance should their first try fail."22
Accordingly, under Weisgram a plaintiff may establish liability at trial, convince the district court judge that a highly accredited expert's testimony on lost-profit damages satisfies the Daubert test, win a large verdict based on the expert's testimony, and still lose the case if the appeals court concludes that the expert's underlying methodology or conclusions were flawed.
Recent Amendments to the Federal Rules of Evidence
Effective December 1, 2000, the Federal Rules of Evidence were amended to codify the standards set forth in Daubert and later U.S. Supreme Court decisions governing the admission of expert testimony. The purpose of the amendments was to require "a more rigorous and structured approach" to Daubert questions "than some courts are currently employing."23 The amended version of Rule 702 (with the amendments shown in italics) now provides:
Rule 702. Testimony of Experts
If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.
In order to "eliminate the risk that the reliability requirements set forth in Rule 702 will be evaded through the simple expedient of proffering an expert in lay witnesses clothing,"24 Congress also enacted the following changes to Rule 701:
Rule 701. Opinion Testimony by Lay Witnesses
If the witness is not testifying as an expert, the witness's testimony in the form of opinions or inferences is limited to those opinions or inferences which are (a) rationally based on the perception of the witness, (b) helpful to a clear understanding of the witness's testimony or the determination of a fact in issue, and (c) not based on scientific, technical, or other specialized knowledge within the scope of Rule 702.
Despite the plain language and stated purpose of the amendment, the Advisory Committee expressly left the door open for a party to introduce lay opinion (e.g., from the owner or operator of the subject business) in support of a lost-profit damage claim:
[M]ost courts have permitted the owner or officer of a business to testify to the value or projected profits of the business, without the necessity of qualifying the witness as an accountant, appraiser, or similar expert. See, e.g., Lightning Lube, Inc. v. Witco Corp., 4 F.3d 1153 (3d Cir. 1993) (no abuse of discretion in permitting the plaintiff's owner to give lay opinion testimony as to damages as it was based on his knowledge and participation in the day-to-day affairs of the business). Such opinion testimony is admitted not because of experience, training or specialized knowledge within the realm of an expert, but because of the particularized knowledge that the witness has by virtue of his or her position in the business. The amendment does not purport to change this analysis.25
This loophole has practical limitations. For starters, a damage analysis offered by an officer or principal of a brand new business might not be admissible under Rule 701, since the testimony would not be predicated on the witness's "particularized knowledge" of any claimed losses "by virtue of his or her position in the business." Moreover, even if an officer or employee is allowed to testify in support of a lost-profit damage claim, the plaintiff may still need additional testimony from an expert to sustain its burden on damages.26 These factors, coupled with the obvious risk that the trier of fact will disregard projections coming from witnesses with a vested interest in the outcome, typically make the successful introduction of expert testimony a critical part of a lost-profit damages case, and therefore limit the opportunities for a plaintiff to use Rule 701 as a way to evade the more stringent requirements on expert testimony set forth in the amended version of Rule 702.
Exclusion of Lost Future Profit Claims
Daubert has already spawned successful challenges to the admission of expert testimony on lost future profit damages in several franchise, distributor, and dealer cases. For example, in David Otis v. Doctor's Associates, Inc.,27 a federal judge granted a motion in limine on the eve of trial precluding a damage expert from testifying in support of a multimillion-dollar lost future profit claim. The plaintiff, David Otis, was a former sales agent for Cajun Joe's, a bankrupt franchisor of chicken restaurants. He sued the franchisor's owners and affiliates for allegedly duping him into a development agent agreement with Cajun Joe's. According to Mr. Otis, the defendants falsely represented that Cajun Joe's was a "fully developed" franchise concept, and he contended that the defendants' failure to deliver on that promise cost him more than $8 million in lost future profits.28
In support of the claim, Mr. Otis relied entirely on the testimony of a business valuation expert. Although the expert was a certified public accountant (CPA) and had testified as a damage expert in numerous other cases, he had simply relied on the quotas in the twenty-year development agent contract to project the alleged lost profits.29 The contract set requirements both for the number of Cajun Joe's outlets in the territory and for the minimum average sales for those stores, and provided that Mr. Otis would receive commissions based primarily on a percentage of the royalties paid by franchisees in his territory. The expert opined that the inclusion of unit and sales-volume quotas in the contract was definitive evidence that the targets were reachable, and calculated damages based on the amount of royalties that Mr. Otis would have earned had the unit and sales-volume requirements been met over the twenty-year term of the agreement.
The district court precluded the testimony under Daubert.30 Judge Ann Williams of the U.S. District Court for the Northern District of Illinois held that the expert's failure "to perform any independent market analysis" to verify the reasonableness of the contract quotas against the actual number of units and average unit sales for other fast-food chicken chains was fatal to the admissibility of the CPA's testimony.31 Judge Williams emphasized that the expert's theory had not been subject to any peer review process, that the plaintiff had not presented evidence of any known or potential rate of error, and that there was no evidence that the expert's lost-profits theory had been generally accepted by other experts in the field.32 The court concluded that the plaintiff "has shown no evidence indicating that the methodology [the expert] used is anything more than an exercise in arithmetic based on inherently unreliable values," and consequently threw out the plaintiff's $8 million damage claim.33
The plaintiff's damage expert in Lithuanian Commerce Corp. v. Sara Lee Hosiery34 was also excluded from testifying on the eve of trial. A foreign pantyhose distributor claimed that a manufacturer, Sara Lee, had wrongfully saturated the Lithuanian, Latvian, and Estonian markets with pantyhose at artificially low prices. After extensive negotiations, Sara Lee agreed to provide the distributor with free pantyhose manufactured in Mexico, warranting that they were of the same quality as the American product. According to the distributor, however, the Mexican pantyhose were defective, and the distributor sued in the U.S. District Court for the District of New Jersey seeking lost profits. The distributor retained a CPA with "several advanced degrees," who projected future lost profits for periods ranging from fifteen to twenty-two years, based on the distributor's lost sales in each of the three countries.35
After a two-day Daubert hearing and extensive briefing, the magistrate judge deemed the expert's testimony "shaky" but nonetheless admissible.36 The magistrate emphasized that he "was confident that any perceived defects in [the expert's] analysis, underlying data and assumptions, and conclusions are capable of being adequately addressed" by Sara Lee, and that Sara Lee's ability to rebut the testimony compelled him to "err on the side of caution" by not excluding the testimony.37 District Judge Orlofsky disagreed. He concluded that many of the expert's assumptions either had "no apparent basis" in the record or were "far too speculative" to credit.38 Among these assumptions were that: (1) the distributorship's relationship with Sara Lee would have lasted twenty additional years; (2) the distributor would outperform other Sara Lee distributors; (3) the distributor controlled 10 percent of the relevant markets and would increase its market penetration at a rate of 1 percent per year; and (4) future sales in the relevant foreign markets could be projected based on Sara Lee's sales in the United States.39 Judge Orlofsky emphasized that "the Third Circuit has not shied away from excluding expert economic testimony on reliability grounds,"40 and concluded that the expert's assumptions about the future duration of the distributorship, market share, and Baltic consumption patterns were too unreliable to be credited.
Another case illustrating that an accounting degree, standing alone, is not enough to ensure admissibility of a damage analysis is JMJ Enterprises v. VIA Veneto Italian Ice, Inc.,41 which involved a dispute over an Italian ice distributorship. The plaintiff's expert, Leon LaRosa, Jr., an accountant with a bachelor's degree in business administration and a master's degree in taxation, opined that the plaintiff distributor had suffered more than $4.5 million in damages as a result of the manufacturer's breach of an oral agreement to ship ice water.42 Mr. LaRosa reviewed records showing that the plaintiff sold approximately 6,000 containers of ice water in 1995 and 6,000 containers in the first half of 1996. Based on this six-month "trend" of doubling sales, the expert concluded that, absent the breach, the distributor would have doubled sales in 1997 and again in 1998 and that the distributor would have maintained those sales through the year 2006.43 Mr. LaRosa did not verify the sales data on which he based his assumptions, and completely ignored the distributor's tax returns, which showed that the business had lost more than $150,000 in its first two years of existence.44 In addition, he knew little about the industry, failed to perform or review any market surveys, and failed to account for the increased operating costs that would have resulted if his sales projections had been accurate.45
Judge James Kelly of the U.S. District Court for the Eastern District of Louisiana concluded that the plaintiff was simply presenting its "unrealistic hopes through the mouth of an expert":
When examining reliability, the court asks whether the methods applied by an expert produce reasonably consistent results. See Daubert, 509 U.S. 579, at 590–91 n.9. A reasonable accountant does not report certain expenses, and choose to omit other, like expenses. Such accounting practices do not produce consistent results. Further, an expert must be able to point to methods that he applied. An expert cannot simply base his conclusions on his "thirty-one years of experience."
. . . .
According to LaRosa, a company that actually sold 6,000 units in 1995, and 6,000 units in the first half of 1996, would sell 57,000 units in 1997 and 115,000 units per year from 1998 through 2006. At the same time, the company's supplier would repay its initial investment and the company's operating expenses would either remain constant or disappear. That is how a company that lost $159,000 in two years of business can earn $4.7 million in the next ten years.
Success stories, such as the one described above, do happen. The court cannot, however, allow a jury to find that [the plaintiff] would have been such a remarkable success just because an "expert" says it is so. LaRosa did not point to reliable evidence that would bridge the gap between the facts and his conclusion. Without evidence, LaRosa's success story is pure speculation.46
Although it was not a franchise, distributor, or dealer case, the Seventh Circuit's decision in Target Market Publishing, Inc. v. Advo, Inc.47 also illustrates the pitfalls of relying on unsupported, rosy sales projections to calculate future lost profits. Target Market Publishing sued Advo for breach of a one-year joint venture agreement to produce and market a direct mail advertising publication. The venture had little success—the parties sold the publication in just one market during the first six months of the venture, and Target's profit from that effort amounted to only $1,300.48 Nonetheless, plaintiff's damage expert projected that, but for Advo's breach of the agreement, Target would have earned $1.4 million for the one-year contract term. The expert assumed that if Advo had continued to perform under the contract, the parties would have penetrated forty-nine sales markets, that each market would generate fourteen advertisers per month per issue and that virtually all those advertisers would pay the full price for their ads.49 As in Otis, the expert's assumptions were based largely on sales projections that the defendant had prepared.
On these facts, the Seventh Circuit affirmed the trial court's decision to grant summary judgment for the defendant.50 The plaintiff's expert possessed strong credentials, and his calculations were consistent with some of the defendant's own sales forecasts, but the Seventh Circuit concluded that the expert's analysis was far too divorced from reality to be admissible.51 The court found that actual performance of the business venture was the critical factor in evaluating the expert's computations and that an expert's reliance on the defendant's unsupported sales projections was insufficient to pass the Daubert test.
Although the Connecticut Supreme Court did not expressly decide Beverly Hills Concepts, Inc. v. Schatz and Schatz, Ribicoff and Kotkin52 under Daubert, it did apply a Daubert-like test to reverse a multimillion-dollar legal malpractice judgment in favor of a failed health club franchisor. Beverly Hills Concepts, a start-up franchisor of fitness clubs that had been operating for about one year, sued its former law firm, alleging that the defendants' malpractice had caused the business to fail. After a bench trial, the court ruled that the firm had committed malpractice. Based on an expert's projections of future lost profits for a twelve-year period, the court then awarded nearly $16 million in damages. The Connecticut Supreme Court affirmed the trial court's conclusions on liability but reversed on damages and entered judgment for the lawyers.
Writing for the majority, Justice Katz recognized that the court was "constrained to accord substantial deference to the fact finder on the issue of damages," and that it would not reverse unless the trial judge's findings were "clearly erroneous."53 The court also concluded that the expert was qualified to testify.54 However, the majority found numerous problems with the damage claim. Among other things, the expert, an accountant with no experience in or knowledge of the health club industry, had assumed that the franchisor would have sold twenty franchises per year for the first five years and would have continued to expand until it was selling forty franchises per year by year twelve.55 In fact, the plaintiff had opened just one model unit (which failed), had never sold a single franchise, and had never turned a profit. The plaintiff owed approximately $80,000 in unpaid payroll taxes, was insolvent according to its own financial statements, and had been unable to obtain financing from the Small Business Administration and a number of other financial institutions.56
Because of all these problems, the Connecticut Supreme Court held that the damage analysis was unreasonable and entered judgment for the defendants. The court concluded that there was no basis in the record to support the expert's projections, especially in light of the franchisor's dismal performance and the expert's admission that the franchisor was a "poor credit risk." Moreover, the majority held that it was improper "to award damages over such a long time span when there is no evidence that the plaintiff would have survived for twelve years, let alone that it would have remained profitable."57 As Justice Katz acknowledged, "our decision that the plaintiff failed to prove damages means that the defendants, whose malpractice caused the plaintiff's harm, escape virtually unscathed."58 However, consistent with the U.S. Supreme Court's later decision in Weisgram, the Schatz majority viewed this result as warranted, because it was a product of the plaintiff's conscious "choice of evidence" and resulting failure to prove an essential element of its malpractice claim.59
A Delaware trial court, citing Schatz with approval, also refused to credit a hefty lost-profit claim. In Pfizer, Inc. v. Advanced Monobloc Corp.,60 the plaintiff's expert, a marketing professor, asserted that the defendant's errors in manufacturing spray cans caused the failure of a new line of women's hair salon products, which he concluded would have earned in excess of $20 million over the course of two decades absent the problems. The trial judge, applying Daubert under the Delaware rules of evidence (which track the Federal Rules ), held that the expert had made an impermissible "quantum leap" from the data to his conclusions.61 Among other things, the court found that the expert could not reasonably rely on the manufacturer's success in selling one line of men's shaving cream to project sales for women's hair care products, that he did not meaningfully evaluate the manufacturer's marketing plan, and that he did not adequately link the manufacturing problems to the failure of the product.62 Thus, the trial court excluded the testimony and denied Pfizer's motion for an interlocutory appeal.
Cases Admitting Expert Testimony
There are, of course, many franchise, distributor, and dealer cases in which a claim for lost future profits has survived judicial scrutiny. For example, in an unpublished decision in Drews Distributing, Inc. v. Leisure Time Technology, Inc.,63 the Fourth Circuit affirmed a judgment for more than $3 million in a case involving the breach of an exclusive agreement for the sale of video gambling games. The court held that the trial court had not abused its discretion in ruling that the damage expert, an economist, had a reasonable basis upon which to calculate damages. Rather than rely simply on unsupported projections, the expert reviewed the actual sales data of the product in the area where the distributor was to have exclusive rights as well as a "careful study of government revenue reports" supporting the sales data.64
Similarly, in In re Elder-Beerman Stores Corp.,65 a bankruptcy case, Judge William A. Clark of the U.S. District Court for the Southern District of Ohio admitted the testimony of the debtor's expert to quantify the damages caused by a furniture manufacturer's breach of a distributorship agreement in violation of the automatic stay provisions of the Bankruptcy Code. The court denied a Daubert challenge, even though it concluded that the expert's prediction that sales would have risen unchecked in the absence of the violation was speculative, and that this erroneous assumption forced the court to engage "in the difficult task of substituting its predictions for plaintiff's expert's predictions."66 Judge Clark emphasized that, although he disagreed with some of the expert's projections, the damage analysis was predicated on generally acceptable statistical methods that the court itself employed in awarding damages.67 Accordingly, the court permitted the testimony and simply substituted its own factual assumptions for those supplied by the plaintiff's expert to arrive at a lower damage figure.
The Seventh Circuit was even more forgiving in To-Am Equipment Co., Inc. v. Mitsubishi Caterpillar,68 in which it affirmed a jury award of $1,525,000 for Mitsubishi's wrongful termination of a forklift dealership. There are two remarkable things about this case: (1) it does not appear either from the district court decision of Judge Easterbrook69 (the trial judge sitting by designation) or from the Seventh Circuit's affirmance that Mitsubishi ever filed a Daubert motion; and (2) Judge Easterbrook refused to set aside the verdict even though he obviously believed that many of the opinions of the plaintiff's expert were unsustainable.
At trial, the plaintiff's expert, Fred Lieber, calculated damages of between $2.2 and $2.6 million, whereas the defendant's expert picked a range of only $0 to $36,000.70 The plaintiff's expert projected profits for To-Am "far in excess of those it had previously achieved," assuming a period of 50 percent growth per year for five years before reaching a plateau. Judge Easterbrook was not convinced:
What makes Lieber's work look fishy to [Mitsubishi] (and to me) is that Lieber projected a period of spectacular growth for To-Am, some 50% per year, compounded for five years before the dealership reached its new steady state in 1998. How likely is that? For To-Am to grow this fast, everything would have had to fall in its favor. Some dealerships reach the size [the expert] projected . . . . But do they grow so fast? Has any dealer ever grown so fast?71
The expert's failure to support this growth projection was just the tip of the iceberg as far as Judge Easterbrook was concerned. Observing that the expert's assumption about To-Am's price earnings ratios "strikes me as fantastic" and that the expert's estimates about To-Am's future operating costs defied logic, Judge Easterbrook openly ridiculed the expert's analysis:
[Lieber's] analysis imputes to To-Am a price earnings ratio of 249 at the end of December 1993! . . . How did that come about? Although Lieber projects growth of approximately 50% per year, compounded for four years, with more modest increases thereafter, he predicts a reduction in To-Am's costs of doing business (other than its costs of goods sold). A business grows at a startling rate without new capital?!? Yet Lieber projects To-Am's costs of capital as steadily declining . . . . A business quintuples its size in a few years, and repairs what it sells (repairs are a vital profit center for a forklift dealer) yet needs fewer man-hours in the service department?!? Again, this is what Lieber's projected pro forma balance sheets show. . . . Lieber's projected balance sheets impute to To-Am profit-to-revenue rations exceeding 10%, compared with an industry median of less than 2%. Has any forklift dealer in the history of the United States achieved such a profit ratio?72
However, Judge Easterbrook saved his harshest rebuke for Mitsubishi and its experts, concluding that "the only thing more farfetched than Lieber's projected balance sheets is the fact that [Mitsubishi] simply ignored their details."73 According to the judge, neither Mitsubishi's expert nor its lawyers ever raised Lieber's unrealistic cost estimates at trial or in the post-trial motions, even though these assumptions were primarily responsible for inflating the damage claim.74 In addition, it appears that neither Judge Easterbrook nor trial counsel ever considered whether the expert's testimony passed the Daubert test. Instead, Judge Easterbrook believed that Mitsubishi's lawyers had opted for "a risky strategy" of ignoring many of the deficiencies in the plaintiff's damage claim in favor of offering a similarly flawed, unsupported analysis.75 He held that "[i]t is not the proper function of the court to cut down the victor's damages because of beliefs about whether another strategy was available," and that the verdict must stand because Mitsubishi chose to ignore the fundamental problems with To-Am's lost-profit projections during the trial.76
On appeal, the Seventh Circuit affirmed the district court's decision, concluding that with two competing damage claims, the jury was entitled to split the difference between the parties' positions without invalidating the damage award. Without ever discussing whether the expert's testimony would have survived a challenge under Daubert, the Seventh Circuit reasoned that "[e]ven if we shared the district court's skepticism about Lieber's rosy predictions, we cannot say that the court abused its discretion in finding the valuation not overly speculative."77
Practical Tips for Asserting and Defending Against a Daubert Challenge
As To-Am illustrates, a party's failure to make a timely, well-supported Daubert challenge can have devastating consequences. In light of his scathing criticism of the plaintiff's damage expert, it is hard to imagine that Judge Easterbrook would have denied a Daubert motion in limine to exclude that expert from testifying. But because the defendant never filed a Daubert motion either before or during the trial, or challenged at trial some of the damage expert's more egregious assumptions, it lost the ability effectively to contest the jury's verdict on appeal.
That is why a Daubert challenge should be asserted before trial, either through a motion for summary judgment or in a motion in limine, and should be reasserted before the expert testifies. In light of the substantial discretion that trial judges enjoy under Joiner and Kuhmo, how the motion will get resolved will vary from court to court. Some district judges have excluded expert testimony on the papers, others have conducted special minitrials before permitting an expert to testify, and still others defer a decision on admissibility until trial.
Although the grounds of the motion will obviously turn on the facts of each individual case, the current post-Daubert decisions suggest that there are three general grounds on which to challenge proposed expert testimony:
The Expert's Qualifications
This is usually the easiest hurdle for a damage expert to clear. For example, although their opinions were ultimately excluded, even the experts in Schatz and JMJ Enterprises were held to be qualified to testify for the purpose of projecting lost future profits. But if a plaintiff proffers a CPA as its expert, and the witness has no knowledge or information about the relevant industry, it is still worth contesting his or her qualifications. As one leading commentator has observed, "[a]n accounting degree alone should not qualify a witness to testify that a given volume of sales, for example, will continue in the future."78 At a minimum, mounting this type of challenge will raise questions with the trial judge about whether the supposed expert really knows what he or she is talking about, and will probably cause the judge to take a harder look at the expert's underlying methodology and conclusions.
The Expert's Methodology
The decisions to date suggest that courts will consider the following factors in evaluating whether an expert's methodology passes muster under Daubert and its progeny:
• Did the expert rely on the available sales data of the subject business in making projections?
• Did the expert perform or review any market surveys?
• Did the expert review comparable sales data for similarly situated businesses, industrywide averages, or both?
• Did the expert review existing data concerning the expenses or profit margin of the business?
• Is the methodology employed something endorsed by other experts in the field?
• In those cases where the expert projects future revenue increases, is there a comparable projected change to the business's cost structure, in a manner consistent with accepted accounting practices?
This is obviously not an exhaustive list of the factors that determine a court's assessment of a damage expert's methodology. But if the answer to a significant number of the above questions is "no," a party seeking to introduce expert testimony is running a significant risk that the testimony will be excluded.
The Expert's Conclusions
As the U.S. Supreme Court observed in Kuhmo, "[c]onclusion and methodology are not entirely distinct from one another," so the factors used to analyze an expert's methodology will obviously influence the trial court's decision about the reliability of the expert's conclusions. But with respect to the conclusions themselves, trial courts will typically look at these factors:
• Did the expert take reasonable steps to ensure the accuracy of the information on which the conclusions are based?
• Were the expert's sales and profit projections reasonably based on the data supposedly relied upon, or simply a function of "subjective belief or unsupported speculation"?79
• Did the expert project lost-profit damages for an unreasonably long time into the future?
• Is the expert's analysis consistent with all of the available existing data, or did the expert intentionally ignore relevant information in an attempt to inflate the alleged damages?
Because of the heightened scrutiny given to all expert testimony after Daubert, plaintiffs' counsel are well advised to be somewhat conservative when offering expert testimony on damages. For example, an expert who blesses a gargantuan damage claim for a failing or unestablished business had better have more than optimistic projections to support it. To ensure that the damage claim survives judicial review, the expert should analyze the track record of the relevant industry, the performance of comparable businesses within that industry, and the plaintiff's prior experience in similar enterprises. Also, as Otis and Target Marketing illustrate, an expert who relies on contractual sales quotas or prelitigation sales projections is unlikely to convince the judge that the testimony will be beneficial to the jury, absent some analysis supporting the reasonableness of the projections. Moreover, although an expert who makes one or two obvious errors may survive a Daubert challenge (e.g., failure to reduce future damages to a present value, failure to account adequately for rising incremental costs, failure to consider available sales or industry data), someone who makes a series of sloppy mistakes will appear to the trial judge as an advocate rather than an impartial expert whose testimony is worth crediting.
Plaintiffs' counsel who rely on an accountant or economist to quantify damages should attempt to supplement that testimony with the testimony of the principal, an officer of the subject business, or someone else with knowledge of the relevant industry. As noted above, the commentary to Rule 701 of the Federal Rules of Evidence makes clear that the owner of a business or someone else with knowledge of the business's operations may project lost profits of an established business without having to qualify as an expert under Rule 702. Thus, even if the damage expert gets disqualified, the testimony of the nonexperts may be enough to sustain some award of damages. In those cases where the business is not established, the testimony of someone familiar with the industry may be even more critical to a lost-profit claim, since a damage expert who tries to predict future lost profits without the benefit of someone familiar with the industry may appear to be pulling numbers out of thin air.
Defense counsel, on the other hand, should take full advantage of Daubert and its progeny in attacking unsupported claims for lost future profits. There is a natural and understandable belief among many defense lawyers that devoting substantial time at trial to attacking a plaintiff's damage claim can often backfire. Not only does this focus a jury on the wrong subject, but the effort is often ineffective, since jurors who find for the plaintiff on liability are unlikely to apply exacting standards in awarding damages. However, a Daubert motion gives a defendant a golden opportunity to go after a shaky damage expert before trial, without any risk of hurting its defense on liability. If the motion is granted, the defendant will likely have eliminated considerable exposure, with the promise of deferential appellate review; if the challenge fails, the defendant still has maximum flexibility in deciding how much time to spend attacking the damage element of the plaintiff's case before the jury.
Even if a pretrial Daubert motion is denied, however, the defendant should seriously consider pressing the attack on the damage expert at trial in order to preserve its position for appeal. As To-Am and Schatz each illustrate, a defendant that does not aggressively contest at trial the testimony of the plaintiff's damage expert is forfeiting a potentially winning issue on appeal.
As one federal district court recently observed, "[t]he objective of Daubert, Kuhmo and their progeny—at least in major part—was to eliminate the playground-like banter between experts, who each proclaim, without the benefit of a factual showing, that his opinions are correct, while those of the other expert are wrong."80 The codification in the recent amendments to the Federal Rules of Evidence of the standards set forth in Daubert and later U.S. Supreme Court decisions has important implications for both sides to a lost-profit case. For a plaintiff, in order to ensure that a damage expert passes muster under Daubert, it is not enough to proffer someone with impressive credentials. The expert's projections must also be supported by a disciplined analysis of the available information. Counsel representing defendants need to recognize that a timely, well-reasoned Daubert motion can transform defeat into victory, even where the trier of fact has concluded that the defendant was guilty of misconduct. The growing body of post-Daubert decisions that shows, for lawyers on both sides, the "risky strategy" of ignoring glaring defects in an expert's damage analysis can prove to be a painful multimillion-dollar mistake.
1. 509 U.S. 579 (1993).
2. 526 U.S. 137 (1999).
3. 120 S. Ct. 1011 (2000).
4. 522 U.S. 136 (1997).
5. Fed. R. Evid. 5 (1975).
6. 289 F. 1013, 1014 (D.C. Cir. 1923).
7. Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579, 585 (1993).
8. Frye, 289 F. at 1014.
9. Daubert, 509 U.S. at 587, 588.
10. Id. at 592–93.
11. Id. at 595–96.
12. Id. at 598.
13. Id. at 593–94.
14. Id. at 594, 597.
15. General Electric Co. v. Joiner, 522 U.S. 136, 146 (1997).
16. In two recent decisions, the Seventh Circuit emphasized that the "abuse of discretion" standard affords trial judges great latitude in deciding Daubert questions. According to the Seventh Circuit, "we will not reverse unless the record contains no evidence on which the district court rationally could have based [its] decision, or where the supposed facts found are clearly erroneous." United States v. Crotteau, 218 F.3d 826, 832 (7th Cir. 2000) (quoting United States v. Walton, 217 F.3d 443, 449 (7th Cir. 2000)).
17. Joiner, 522 U.S. at 143.
18. Kuhmo Tire Co. v. Carmichael, 526 U.S. 137, 149 (1999).
19. Id. at 152.
20. Id. at 150.
21. Id. at 152 (emphasis in original).
22. Weisgram v. Marley Co., 120 S. Ct. 1011, 1021 (2000).
23. See Report of Advisory Committee on Evidence to Proposed Amendment to Rule 702 of the Federal Rules of Evidence, May 1, 1999.
24. See Fed. R. Evid. 701 advisory committee's note (2000).
25. Id. (emphasis added).
26. See 2 R. Dunn, Recovery of Damages for Lost Profits § 9.3, at 743 (5th ed. 1998) (observing that the testimony of professional economists, financial experts, cost accountants, and/or marketing analysts is often essential to proving a lost-profit case, since these experts are typically best equipped to determine causation and damage issues).
27. No. 94 C 4227, 1998 U.S. Dist. LEXIS 15414 (N.D. Ill. 1998). The author represented the defendants in Otis.
28. 1998 U.S. Dist. LEXIS 15414, at 2, Bus. Franchise Guide (CCH) ¶ 11,489 (N.D. Ill. Sept. 10, 1998).
29. Id. at 3.
32. Id. at 3–4.
33. The court also excluded any other evidence of future lost profits because the Cajun Joe's system was a new venture, and under Illinois law, "a new business generally has no right to recover lost profits." Id. at 5 (quoting Stuart Park Assocs. Ltd. Partnership v. Ameritech Pension Trust, 51 F.3d 1319, 1328 (7th Cir. 1995). Although the franchisor's reliance on the "new business" rule was successful in Otis, the rule is not followed in most jurisdictions. See Dunn, supra note 26, § 4.3, at 345 ("Most recent cases reject the once generally accepted rule that lost profits damages for a new business are not recoverable."). See also Beverly Hills Concepts, Inc. v. Schatz and Schatz, Ribicoff and Kotkin, 717 A.2d 724 (Conn. 1998) (holding that lost profits could be awarded for the destruction of a new enterprise).
34. 179 F.R.D. 450 (D.N.J. 1998).
35. Lithuanian Commerce Corp., 179 F.R.D. at 458.
38. Id. at 460–61.
40. Id. at 459–60.
41. No. 97-CV-0652, 1998 U.S. Dist. LEXIS 5098 (E.D. La. Apr. 15, 1998).
42. JMJ Enter., 1998 U.S. Dist. LEXIS 5098, at 15, 23.
43. Id. at 18–19.
44. Id. at 19–21.
46. Id. at 26–28. JMJ Enterprises also illustrates that in the real world, a trial judge's rulings on whether to exclude expert testimony can be affected by the expert's performance on the stand. According to Judge Kelly, the damage expert "was not objective," and "argued with defense counsel and made gratuitous remarks" during the Daubert hearing, behavior that reinforced the judge's view that the expert "was acting as an advocate, and not as an objective evaluator of evidence." Id. at 27–28.
47. 136 F.3d 1139, 1142 (7th Cir. 1998).
48. Target Market Pub., 136 F.3d at 1144.
49. Id. at 1144–45.
50. As a threshold matter, the Seventh Circuit addressed whether the trial judge dismissed the case on Daubert grounds or for some other reason, because the basis of the lower court's ruling was unclear. Id. at 1142–43. However, for purposes of appeal, the Seventh Circuit assumed that the trial court granted summary judgment because the trial judge had concluded that the damage expert's report was inadmissible under Daubert. Id.
51. Id. at 1144–45.
52. 717 A.2d 724 (Conn. 1998). The author's firm represented the defendants in Schatz.
53. Schatz, 717 A.2d at 735–36.
54. Id. at 732–33.
55. Id. at 737.
56. Id. at 734.
57. Id. at 739.
59. Id. at 740. Another member of the court was not so sanguine about this outcome. In a forceful dissent, former Chief Justice Ellen Peters asserted that the majority "denigrate[d] the fact finding function of the trial court" and that it "reach[ed] out to reverse a trial court judgment on grounds that are far from compelling." Id. at 741, 747. But what bothered her most was that the defendant law firm went unpunished. In her view, "we condone professional misconduct if we discharge these defendants of all liability to a plaintiff who has tried, as best it could, to quantify the loss that the defendants' misconduct caused it to suffer." Id. at 747.
60. 1999 LEXIS 509 (Del. Super. Sept. 22, 1999).
61. Pfizer, 1999 LEXIS 509, at 2–3.
62. Id. at 2–3, 8–14.
63. 1999 U.S. App. LEXIS 6121 (4th Cir. Apr. 5, 1999).
64. Drews Distrib., 1999 U.S. App. LEXIS 6121, at 26.
65. 206 B.R. 143 (S.D. Ohio 1997).
66. In re Elder-Beerman Stores Corp., 206 B.R. at 161.
68. 152 F.3d 658 (7th Cir. 1998).
69. 953 F. Supp. 987 (N.D. Ill. 1997).
70. To-Am Equip., 953 F. Supp. at 995.
71. Id. at 996 (emphasis in original).
72. Id. at 996–97 (emphasis in original).
73. Id. at 997.
77. To-Am Equipment Co., Inc. v. Mitsubishi Caterpillar, 152 F.3d 658, 665 (7th Cir. 1998).
78. Dunn, supra note 26, § 7.5, at 541.
79. Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579, 590 (1993).
80. Kemp v. Tyson Seafood Group, Inc., Civ. No. 5-96-173 (JRT/RLE), 2000 U.S. Dist. LEXIS 10258 (D. Minn. July 19, 2000).