Daubert and lost-profits testimony: when lost profits are an issue, both parties' experts will face the judicial 'gatekeeper.' Study the case law to understand who will be admitted - and who will be stranded outside.

The issue of lost profits can arise in a wide range of contract and tort cases. When the law allows for such recovery, the plaintiff must prove something that never came to be: the profits the plaintiff would have earned but for the defendant's breach or wrongful conduct. Unless the plaintiff's expert has the right expertise and applies an appropriate methodology to estimate lost profits, his or her opinion is subject to attack as unfounded, irrelevant, or unreliable, based on Daubert v. Merrell Dow Pharmaceuticals, Inc., (1) and its progeny.

In the 12 years since the Daubert decision, a sufficient body of case law has developed to provide precedent for admission and exclusion of lost-profits expert testimony and to expose traps for the unwary.

Under Daubert and its progeny (most notably General Electric Co. v. Joiner (2) and Kumho Tire Co. v. Carmichael (3)), expert testimony is admissible if the expert is qualified to testify on the topic at issue, the testimony will assist the trier of fact, and the expert's methodology is sufficiently reliable. To ensure a proper foundation, the trial court acts as a "gatekeeper," screening expert testimony to determine if it is relevant and reliable. Expert testimony must be excluded if the reasoning or methodology underlying the opinion is scientifically invalid, or if the methodology cannot be properly applied to the facts.

As Justice Stephen Breyer pointed out in his concurring opinion in Joiner, this gatekeeper function sometimes requires judges to make "subtle and sophisticated determinations about scientific methodology and its relation to the conclusions an expert witness seeks to offer ... Yet ... judges are not scientists and do not have scientific training that can facilitate the making of such decisions." (4)

In contract cases, the plaintiff has the burden of proving that the profits lost were contemplated by the parties when they entered into their contract. In tort cases, the plaintiff's burden is to show that the loss of the profits was foreseeable from the defendant's wrongful conduct and that the defendant's actions caused the profits to be lost.

Lost profits must be proven with reasonable certainty and cannot be too speculative or remote to be computed reliably. The amount of profits lost need not be proven with mathematical precision; rather, evidence is sufficient if it enables the fact-finder to make a fair and reasonable finding of the amount.

Whether the plaintiff sustains this burden is crucial, especially since the standard of review of the district court's decision to admit or exclude expert scientific evidence is abuse of discretion, an issue addressed in Joiner but not Daubert. In Joiner, the Supreme Court rejected the plaintiff's argument that because the granted summary judgment against him was "outcome determinative" it should have been subjected to a more searching standard of review. The Court held that the admissibility of expert testimony is not an issue of fact and that the Eleventh Circuit had failed to give the trial court enough deference. (5)

Insufficient expertise

Applying Daubert, courts have excluded testimony of seemingly highly credentialed experts, including some with doctorates in economics, on the issue of lost profits. Courts have rejected witnesses' testimony for lack of expertise based on

* lack of familiarity with the methods and reasons underlying profit projections. (6)

* lack of familiarity, knowledge, or experience with damages analysis. (7)

* inability to explain the damages model. (8)

* inability to explain design and execution of a marketing survey that the expert conducted to determine the market for the plaintiff's product in estimating lost profits. (9)

* lack of experience in the business that is the subject of the lost-profits analysis, and therefore inability to provide a reasonable basis for the estimate of lost profits. (10)

An expert should be able to explain the validity of the method used to estimate damages. As one judge pointed out with regard to a common analytical method: "Since multiple regression analysis is subject to misuse, courts cannot be expected to accept at face value conclusions derived from such a model absent expert testimony concerning the validity of the model itself." (11)

Furthermore, to avoid a successful attack on a damages expert's qualifications, the plaintiff sometimes needs to use more than one expert--one in the same field as the plaintiff's business to testify about the industry and its market conditions during the relevant time, and another to combine the plaintiff's profit history with the business expert's testimony to derive a lost-profit figure.

Unsound methodology

Daubert held that, faced with a proffer of expert scientific testimony under Federal Rule of Evidence 702, the trial judge must make a preliminary determination whether the testimony's underlying reasoning or methodology is scientifically valid and can be applied properly to the facts at issue: Can the theory or technique be tested, and has it been subjected to peer review and publication? What is its known or potential error rate? Are there standards controlling its operation? Has it attracted widespread acceptance within the relevant scientific community?

The inquiry is flexible, focusing on principles and methodology rather than the conclusions they generate. But as the Supreme Court made explicit in Joiner, nothing in Daubert or the Federal Rules of Evidence requires a district court to admit opinion evidence connected to existing data only by the expert's statement--a court may conclude that there is simply too great an analytical gap between the data and the opinion proffered to be acceptable.

To estimate lost profits, economists employ a variety of methods in addition to regression analysis, such as concept surveys, growth rate extrapolations, and various econometric and statistical methodologies. (12) Courts have rejected testimony for inappropriate or misapplied methodology, such as

* the use of before-and-after modeling to support conclusions about the causes of market fluctuation. (13)

* the use of gross rather than net sales figures in calculating lost profits. (14)

* reliance on a defective survey to determine the market for the plaintiff's product; that survey failed to comply with accepted standards (an accurate, complete, and unbiased description of the product; a random selection of qualified respondents; a sufficient response to be statistically significant; and a uniform format to record responses). (15)

* reliance on growth rates of other products in estimating lost profits without demonstrating a valid scientific connection to the potential growth rate for the subject product. (16)

* reliance on statistics regarding promotions in another market in estimating lost profits, without establishing that those promotions are analogous to the subject promotion. (17)

* failure to perform a market survey or send questionnaires to potential customers in estimating lost profits. (18)

* failure to consider all the relevant facts in the relevant market when performing a market-share analysis. (19)

* reliance on information in tax returns without independent verification or an independent market survey or study. (20)

* novel methodology not subjected to empirical research or tested, without potential error rate, and published only by the proffered expert without any peer review. (21)

* failure to include a "before" component in a before-and-after model, and unsound selection of a normative period. (22)

* failure to separate damages caused by the alleged conduct from decreased profits resulting from a powerful competitor's entry into the marketplace. (23)

* failure to perform any market analysis to verify the reasonableness or accuracy of projections, and use of a methodology not subjected to peer review or publication. (24)

Unfounded assumptions

A damages expert's opinion is only as valid as the assumptions underlying it. Lost profits can arise from a variety of circumstances, including changes in the market and the economy at the relevant time, increases in costs for raw materials or labor, increased competition, changes in government controls, and interest rate fluctuations. Sometimes, experts assume that all lost profits are the result of the defendant's conduct alone, without considering independent variables, and courts reject their testimony. (25)

Courts have rejected lost-profits expert testimony where experts have made other unfounded assumptions:

* that the plaintiff would enter into a certain number of contracts, without empirical evidence providing the requisite foundation (26)

* that the plaintiff would have a long-term contractual relationship with the defendant, without considering competition and the actual term of the subject contract (27)

* that the plaintiff would receive future profits from contract renewals and new customers (28)

* that all the plaintiff's claims as set forth in the original complaint were still viable, when some were precluded by the defendant's successful motion for summary judgment (29)

* that market share would remain unchanged (30)

* that potential annual earnings would be more than actual annual earnings. (31)

Challenges

You must be aware of defense tactics designed to thwart your expert's presentation of the lost-profits analysis, and you can use those same tactics to keep out or at least undermine the testimony of the defendant's expert.

A party seeking to exclude expert lost-profits testimony has an arsenal of procedural devices to draw from before, during, and after trial. Use these devices to attack the opposing expert's testimony and ask the court to reject it as speculative. Immunize your expert from such attacks by carefully assessing whether he or she has the requisite expertise and whether his or her methodology will pass muster under Daubert.

Discovery. Make sure opposing counsel complies fully with the mandatory disclosure requirements for expert witnesses, as provided in Federal Rule of Civil Procedure 26(e). Read the articles the expert has disclosed and obtain transcripts of his or her testimony from previous trials. Use interrogatories, document requests, and your own Web research to learn everything you can about the expert's background, knowledge and experience, as well as the methodology used in the analysis. Consult with your own expert before deposing your opponent's witness. An effective deposition will give you fodder for an effective cross-examination in a Daubert hearing and, if necessary, at trial. Reviewing the opposing expert's report with your own expert will arm you with insights to help expose vulnerabilities in the witness's analysis. Ask the expert to identify authoritative texts and articles on the subject of his or her lost-profits analysis. Then read those sources to determine, with your own expert's advice, whether the witness is vulnerable.

In the deposition, inquire about the expert's knowledge of the subject business and market, all facts and documents the expert considered (whether or not he or she relied on them), all assumptions the expert made, all variables that could affect the plaintiff's claimed lost profits, and all factors the expert considered when extrapolating from existing data.

Ask the expert to explain his or her methodology. Can the witness, for example, explain the basis for the theory of multiple regression analysis if he or she relies on it? Frame your questions to encompass the four methodology factors that Daubert requires the trial court to consider: whether the theory can be objectively proven, whether the methodology has been subject to peer review, the potential error rate, and whether the expert's work has been generally accepted in the scientific community.

Pretrial pleading. A motion in limine to preclude expert testimony for failure to comply with Daubert can provide the basis for a pretrial Daubert hearing. A full hearing, however, is not required in every case. (32) The trial court enjoys considerable latitude to decide how to test an expert's reliability and whether or when special briefing or other proceedings are needed.

The court may reject as untimely a Daubert objection not raised before trial. However, because the court has broad discretion in its gatekeeper function, nothing prohibits it from hearing such a motion during trial. Indeed, the court may hold a Daubert hearing on an objection during trial or on a posttrial motion. (33) As the Supreme Court held in Kumho, the trial judge must have considerable leeway when determining whether expert testimony is reliable. (34)

Usually, though, if you seek to preclude opposing counsel's lost-profits expert, it is preferable to file a pretrial motion. At the pretrial hearing, cross-examine the witness on requisite expertise, his or her methodology, and the analytical connection between the data and the expert's opinion. Be prepared to put your own expert on the stand to attack the opposing expert's methodology.

Trial and posttrial procedures. Attack the opposing lost-profits expert with as many appropriate and persuasive Daubert challenges as possible. Know the judge's educational background and any other information about him or her that will help you determine how best to present the challenge, ff the presentation is arcane or confusing, the judge will probably determine that you have not met your burden of proof to knock out the opposing expert. Work with your expert to develop analogies and understandable terms to explain your challenge.

If the court did not already address the admissibility of lost-profits testimony before trial, then challenge whether the expert is qualified to give an opinion. During voir dire of the expert during trial, seek to raise sufficient doubt about the expert's methodology to preclude any testimony on his or her opinions. If the court refuses to exclude the testimony, consider an appeal, but remember that the standard of review is abuse of discretion.

Whether your objective is to slam the Daubert gate shut on a lost-profits expert or swing it open wide, you must persuade the judge on many, sometimes difficult, Daubert issues. Retain an expert--and, where appropriate, more than one expert-meeting Daubert's expertise requirements, and make sure each expert uses a methodology that will pass muster.

Before trial, learn everything relevant to the Daubert inquiry about the opposing witness's expertise and methodology, and file motions to knock out his or her testimony. At trial, challenge the opposing expert in a way the judge will understand, through voir dire and cross-examination on expertise and methodology. Renew your objections as appropriate, and make a good record for appeal. Throughout this process, let your own expert guide you in what can be a bewildering trip through the complex maze of lost-profits projections.

Notes

(1.) 509 U.S. 579 (1993).

(2.) 522 U.S. 136 (1997).

(3.) 526 U.S. 137 (1999).

(4.) Joiner, 522 U.S. 136, 147-48 (Breyer, J., concurring).

(5.) Id. at 142-43.

(6.) Chemipal Ltd. v. Slim-Fast Nutritional Foods Int'l, 350 F. Supp. 2d 582, 592 (D. Del. 2004).

(7.) Lifewise Master Funding v. Telebank, 374 F.3d 917, 928 (10th Cir. 2004); First Sav. Bank, F.S.B. v. U.S. Bancorp, 117 F. Supp. 2d 1078, 1083 (D. Kan. 2000).

(8.) "Whether a witness can parrot the results of a model does not mean that he is qualified to explain how the model works or to opine on the statistical validity or interpretation of the results." Lifewise Master Funding, 374 F.3d 917, 928.

(9.) Albert v. Warner-Lambert Co., 234 F. Supp. 2d 101, 104 (D. Mass. 2002).

(10.) Real Estate Value Co. v. US Air, Inc., 979 F. Supp. 731,743 (N.D. Ill. 1997).

(11.) Lifewise Master Funding, 374 F.3d 917, 928 (quoting Wilkins v. Univ. of Houston, 162 F.2d 1156, 1157 (5th Cir. 1981)).

(12.) PATRICKA. GAUGHAN, MEASURING BUSINESS INTERRUPTION LOSSES & OTHER COMMERCIAL DAMAGES (2004); ROBERT L. DUNN, RECOVERY OF DAMAGES FOR LOST PROFITS (5th ed. 1998).

(13.) Blue Dane Simmental v. Am. Simmental, 178 F.3d 1035, 1041 (8th Cir. 1999).

(14.) Club Car v. Club Car (Quebec) Import, 362 F.3d 775, 780 (11th Cir. 2004).

(15.) Albert, 234 F. Supp. 2d 101, 105.

(16.) Chemipal Ltd., 350 F. Supp. 2d 582, 592-93.

(17.) Real Estate Value Co., 979 F. Supp. 731, 744.

(18.) Meterlogic, Inc. v. KLT, Inc., 368 F.3d 1017, 1019 (8th Cir. 2004).

(19.) Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039, 1056 (8th Cir. 2000).

(20.) JMJ Enter. v. Via Veneto Italian Ice, No. Civ. A. 97-CV-0652, 1998 WL 175888, at *7-8 (E.D. Pa. Apr. 15, 1998).

(21.) Cochrane v. Schneider Nat'l Carriers, 980 F. Supp. 374, 379-80 (D. Kan. 1997).

(22.) In re Aluminum Phosphide Antitrust Litig., 893 F. Supp. 1497, 1502-03 (D. Kan. 1995).

(23.) Schiller & Schmidt, Inc. v. Nordisco Corp., 969 F.2d 410, 415-16 (7th Cir. 1992).

(24.) Otis v. Doctor's Assoc., Inc., No. 94 C 4227, 1998 WL 673595, at *4 (N.D. Ill. Sept. 14, 1998); First Sav. Bank, F.S.B., 117 F. Supp. 2d 1078, 1085.

(25.) Blue Dane Simmental, 178 F.3d 1035, 1040-41; Gannett Co. v. Kanaga, 750 A.2d 1174, 1186 (Del. 2000).

(26.) Real Estate Value Co., 979 F. Supp. 713, 744.

(27.) Children's Broad. Corp. v. Walt Disney Co., 245 F.3d 1008, 1015 (8th Cir. 2001).

(28.) Target Mktg. Publ'g v. Advo, Inc., 136 F.3d 1139, 1144 (7th Cir. 1998).

(29.) Children's Broad. Corp., 245 F.3d 1008,1018.

(30.) Total Containment, Inc. v. Dayco Prod., Inc., No. Civ. A. 1997-CV-6013, 2001 WL 1167506, at *5 (E.D. Pa. Sept. 6, 2001).

(31.) Elcock v. Kmart Corp., 233 F.3d 734, 755-56 (3d Cir. 2000); Boucher v. U.S. Suzuki Motor Corp., 73 F.3d 18, 21-22 (2d Cir. 1996).

(32.) Target Mktg. Publ'g, 136 F.3d 1139, 1143 n.3.

(33.) Club Car, 362 F.3d 775, 780.

(34.) Kumho, 526 U.S. 137, 152.

STEWART I. EDELSTEIN practices law with Cohen & Wolf in Bridgeport, Connecticut.