In a breach of contract case that took more than a decade to make its way through the court system, a financial expert's analysis was ultimately given no weight in determining the plaintiffs' damages. Here's why a U.S. Court of Appeals upheld the district court decision to award the plaintiff only nominal damages. (Washington v. Kellwood Co., 2017 U.S. App., Second Cir., Nos. 16-3413-cv, 16-3664-cv, November 2, 2017.)
In 2002, the plaintiffs created a brand of compression sportswear called "Sunday Players" and developed several licensing marks. The defendant told the plaintiffs that television network MTV wanted to partner with them and would help promote their brand. The plaintiffs believed that this partnership could potentially lead to hundreds of millions of dollars in product sales. Shortly thereafter, the plaintiffs entered an exclusive licensing agreement with the defendant to use the plaintiffs' marks on various types of apparel and accessories.
The MTV deal was never finalized, and the defendant terminated its arrangements with the plaintiffs in 2005. The plaintiffs sued the defendant under several theories, including breach of contract, seeking damages in excess of $50 million.
The defendant challenged the admissibility of the yardstick analysis by the plaintiff's expert, arguing that the guideline company used as a comparable (or yardstick) must be as "nearly identical" to the subject business as possible. The expert had used Under Armour, a well-established market leader in the compression sportswear industry, as the yardstick.
The court found that the expert's yardstick methodology satisfied the general minimum reliability standards and admitted this testimony. But the court left it to the defendant and its expert's "robust efforts at trial" to call into question the weight that should be given to that testimony.
Under New York law, a plaintiff deprived of its entire stake in a business by a breach of contract has two remedies:
1. Lost future profits, or
2. Lost business value on the date of breach.
Initially, a jury awarded the plaintiffs $4.35 million in lost profits or, alternatively, $532,000 in lost business value. However, that ruling was subsequently struck down by a district court judge, who decided that the award lacked a sound basis. Instead, the court awarded the plaintiffs $1 in damages. The case was appealed to the Second Circuit Court of Appeals.
Courts require lost profits to be measured using reliable factors and without undue speculation. Both the existence and amount of damages must be proven with "reasonable certainty." This standard can be especially hard to meet for start-up ventures with a limited earnings history.
In this case, the appellate court agreed that the plaintiff failed to meet this standard. At the time of the contractual breach, Under Armour controlled approximately 80% of the market share for compression sportswear and reported annual sales between $49.5 million and $195 million. In contrast, the plaintiff was a small start-up that sold less in $200,000 throughout its existence.
The court ruled that the expert's "purely hypothetical" assumption that the plaintiff could generate sales of $80 million in two years was "so unfounded that it failed to establish any legal basis for awarding lost-profits damages." Moreover, the plaintiff's capacity to produce compression wear wasn't necessarily relevant in establishing lost profits; what really mattered was whether consumers would want to purchase the plaintiff's products over those of competitors.
As a result, the appellate court, agreeing with the district court, gave the expert's yardstick analysis no weight when awarding damages to the plaintiff. The court concluded that the plaintiff's expert's "optimistic projections and valuations by reference to name-brand companies failed to establish damages with reasonable certainty." The court also refused the plaintiff's request for a retrial to present alternative damages evidence.
This case underscores the importance of choosing yardstick comparables that have more in common with the subject company than just the nature of its products. Other relevant criteria when selecting comparables may include market share, historical performance and geographic location.
Courts may allow testimony from experts who conduct detailed research and use proven methods to calculate damages. But courts ultimately may give experts' conclusions little or no weight when awarding damages if they fail to prove damages with reasonable certainty.
LOUIS J. CERCONE, JR., CPA, CFE, CFF, ABV, ASA, CVA
Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters.