Proof of Lost Profits

Although lost profits are recoverable in an action for a tort or breach of contract, extra care must be taken to ensure that a jury is not misled or confused. Both bench officers and attorneys handling these types of cases must be cognizant of the basic rules that govern admissibility of expert opinions on lost profits.

The objective of this article and self-study test is to explain the cases and statutes that discuss evidence of lost profits in civil cases. Readers will learn about expert opinions regarding old and newly established enterprises, how to take competition into account, and the qualifications needed to provide expert testimony in this field.

Writing more than 30 years before Daubert v. Merrill Dow Pharmaceuticals Inc., 509 US 579 (1993), as well as before analogous California authority, Judge Henry J. Friendly, in upholding the exclusion of the plaintiff’s expert testimony with regard to lost profits, noted that it was especially important to protect juries against expert testimony containing “an array of figures conveying a delusive impression of exactness in an area where a jury’s common sense is less available than usual to protect it.” Herman Schwabe Inc. v. United Shoe Mach. Corp., 297 F2d 906 (1962).

What are the matters upon which an expert may rely in rendering an opinion? What assumptions have been held to be improper?

In all cases, the proponent of the expert’s testimony must comply with Evidence Code Section 801(b), which sets forth three separate but related tests that a matter must meet to serve as a proper basis for an expert’s opinion. First, the information used must come from the witness’ personal observation, the witness’ personal knowledge, or an assumption of facts finding support in the evidence. Second, the matter on which the opinion is based must be of a type on which the expert may reasonably rely. Third, an expert may not base his opinion on any matter held to be improper as the basis of expert opinion by constitutional, statutory, or decisional law. Pacific Gas & Elect. Co. v. Zuckerman, 189 CA3d 1113 (1987); In re Marriage of Hewitson, 142 CA3d, 874 (1983). Proof of lost profits implicates all three Evidence Code Section 801(b) prongs.

When the operation of an established business is prevented or interrupted, such as by a tort or breach of contract or warranty, damages for the loss of prospective profits that otherwise might have been made from its operation are generally recoverable. The profits’ occurrence and extent may be ascertained with reasonable certainty from the past volume of business and other provable data relevant to the probable future sales. Grupe v. Glick, 26 C2d 680 (1945). “Lost profits to an established business may be recovered if their extent and occurrence can be ascertained with reasonable certainty; once their existence has been so established, recovery will not be denied because the amount cannot be shown with mathematical precision.” Berge v. International Harvester Co., 142 CA3d 152 (1983).

“[T]he determination of lost profits of a new business presents problems of proof. It has been frequently stated that if a business is new, it is improper to award damages for loss of profits because absence of income and expense experience renders anticipated profits too speculative to meet the legal standard of reasonable certainty.” Shade Foods Inc. v. Innovative Prods. Sales and Mktg. Inc., 78 CA4th 847 (2000). If the business is new or speculative, damages may be established with reasonable certainty with the aid of expert testimony, economic and financial data, market surveys and analyses, business records of similar enterprises, and the like. When a tortfeaser has prevented the beginning of a new business, all factors relevant to the likelihood of the success or lack of success of the business or transaction that are reasonably provable are to be considered, including general business conditions and the degree of success of similar enterprises. Kids’ Universe v. In2Labs, 95 CA4th 870 (2002). The underlying requirement for each of these types of evidence is a substantial similarity between the facts forming the basis of the profit projections and the business opportunity that was destroyed.

In rendering an opinion on lost profits of a new enterprise, “[a] plaintiff’s prior experience in the same business has been held to be probative; as has a plaintiff’s experience in the same enterprise subsequent to the interference…. [T]he experience of the plaintiff and that of third parties in a similar business have been admitted to prove lost profits. In addition, the average experience of participants in the same line of business as the injured party has been approved as a method of proving lost profits. Similarly, pre-litigation projections, particularly when prepared by the defendant, have also been approved. The underlying requirement for each of these types of evidence is a substantial similarity between the facts forming the basis of the profit projections and the business opportunity that was destroyed.” Kids’ Universe, quoting Beverly Hills Concepts v. Schatz & Schatz, 717 A2d 724 (Conn 1998).

California courts have allowed lost profit evidence when there is some basis between historical income and expenses or a comparison to comparable businesses. For example, in Shade Foods Inc. v. Innovative Prods. Inc., an expert was properly allowed to calculate lost profits by using plaintiff’s historical income and expenses at a 10 percent growth rate. In Heiner v. Kmart Corp., 84 CA4th 335 (2000), the expert was allowed to testify about lost profits from a dental practice based on the practice’s financial history and assumed certain growth rate. In Sanchez-Corea v. Bank of America, 38 C3d 892 (1985), while the plaintiff’s small company was compared to the earnings of much larger ones, lost profits were allowed because the damage award was based on plaintiff’s historical growth and prelitigation profit projections.

California courts have uniformly rejected attempts to award lost profits by comparisons to dissimilar business. “A plaintiff can rely on data from other enterprises only if [he or] she shows they operate under similar conditions, such as in the same area and with the same equipment.” Berge v. International Harvester Co. In Berge, “the 16 [percent] profit margin achieved as a national average had no relation whatsoever to Berge’s operation. For this reason, the net profit figure calculated was entirely speculative.” In Parlour Enters. Inc. v. Kirin Group, 152 CA4th 281 (2007), the plaintiff’s expert compared the plaintiff’s small ice cream parlor to several other ice cream parlors, including a publically traded chain business with about 300 restaurants, because they had a “similar concept.” The appellate court held that this was not sufficient evidence of comparability. See also Gerwin v. Southeastern Cal. Ass’n of Seventh Day Adventists, 14 CA3d 209 (1971) (“operating history” not similar); Resort Video Ltd. v. Laser Video Inc., 35 CA4th 1679 (1995) (plaintiff did not introduce any evidence of “operating histories of comparable businesses”).

Failure to consider the effects of competition has been grounds by itself to exclude expert opinions on lost profits. Children’s Broadcasting Corp. v. Walt Disney Co., 245 F3d 1008 (8th Cir 2001), for example, upheld the grant of a new trial when the expert failed to consider potential competition. Heary Bros. Lightning Protection Co. v. Lightning Protection Inst., 287 F Supp 2d 1038 (D Ariz 2003), excluded expert testimony because it was based on the assumption that there were no potential competitors.

Additionally, some courts have excluded expert opinions regarding lost profits when the expert relied solely on data from the plaintiff. In ID Sec. Sys. Canada Inc. v. Checkpoint Sys. Inc., 249 F Supp 2d 622 (ED Penn 2003), the trial court excluded the expert’s testimony when the expert relied on sales projections made by his client’s president, because the information needed to be viewed as reliable by some independent witness. In accord, in Chemipal Ltd. v. Slim-Fast Nutritional Foods Int’l Inc., 350 F Supp 2d 582 (D Del 2004), the plaintiff’s expert improperly did not verify and accepted without question, marketing information provided by plaintiff’s agent. As stated by United Phosphorous Ltd. v. Midland Fumigant Inc., 173 F.R.D. 675 (D. Kan. 1997), “It is not acceptable methodology for an economist to rely on deposition testimony of an interested party where objective evidence existed.”

This analysis applies to traditional tort and breach of contract cases, and care should be taken before any court in these types of cases that rely on antitrust opinions. In antitrust cases, it is proper to base evidence of lost profits on projections of market share, as distinguished from historical profits of the plaintiff’s or similar businesses. Antitrust statutes embody a different set of policy determinations than one would expect in an ordinary breach of contract case. See LePage’s Inc. v. 3M, 324 F3d 141 (3d Cir 2003).

Antitrust plaintiffs can measure damages in this manner because those cases involve anti-competitive actions by a competitor defendant that have taken a share of the market away from plaintiffs. In this context, comparison of market share of the defendant is required in order to determine plaintiff’s lost profits because, were it not for that competitor’s illegal actions, the plaintiff would have retained that market share. See Inter Med. Supplies Ltd. v. EBI Med. Sys. Inc., 181 F3d 446 (3d Cir 1999).

Who may be an expert to establish lost profits? While an expert may be competent to render opinions on some topics, he may not be competent to do so in related areas.

As one appellate court noted, “the Supreme Court of Connecticut reversed a lost profits damage award in favor of an unestablished business where a certified public accountant based his projections on speculative assumptions and unreasonable comparisons…. [T]he certified public accountant who testified on the plaintiff’s behalf had no experience in the industry in question, and based his projections on informal interviews and articles in the lay press about the industry.” Kids’ Universe, citing Beverly Hills Concepts. See also Maatuk v. Guttman, 173 CA4th 1191 (2009) (a CPA did not have expertise in the relevant market).

When projected revenues and expenses are already in evidence and the expert merely needs to calculate profits so as to come up with a number that is comprehensible to the jury, an accountant with no experience in the industry in question would be perfectly capable of rendering an opinion as to the amount of profits the plaintiff has lost.

When, however, the expert is going to project the sales and market share growth that the plaintiff would have achieved absent the defendant’s conduct, the expert will need specialized knowledge, and a generalist just will not qualify. “[I]t must be recognized that a witness’ justifiable patina, which may be conferred by his or her status as an expert in some acknowledged field of expertise, poses a special danger that the trier of fact may extend a comparable credence to the witness’ opinions that fall outside of that area of expertise.” Kay v. First Continental Trading Inc., 976 F Supp 772 (ND Ill 1997).

If a plaintiff can make a colorable showing that any projection of lost profits is based upon historical performance of the company or a comparison to the profits of companies similar in terms of size, locality, sales, products, number of employees, and other relevant factors, the question goes to the jury.

Most of the trial courts in the cases cited herein, however, heeded Judge Friendly’s warning and excluded the opinions at pretrial hearings. See also Westrec Marina Mgmt. Inc. v. Jardine Ins. Brokers Orange County Inc., 85 CA4th 1042 (2000). As Maatuk stated, “A trial court enjoys broad discretion in ruling on foundational matters on which expert testimony is to be based.”