Lost profits are almost always a difficult element of damages to prove. Expert testimony is essential, but courts that employ the Daubert test will not admit an expert’s opinion about lost profits unless it is based on a reliable methodology. A recent decision from the United States Court of Appeals for the Sixth Circuit, however, illustrates that even “shaky” testimony might be admissible in a trial judge’s discretion.
Wayne State’s Relationship with CDG
Wayne State University had a long business relationship with Contract Design Group (CDG), a company that sells and installs floor coverings. Wayne State’s 2008 contract with CDG required CDG to bill on a time and materials basis and to pay Michigan’s prevailing wage to its employees. Wayne State severed its relationship with CDG after it became concerned that CDG was not in compliance with Michigan’s prevailing wage law. It also withheld contract payments, arguing that CDG had breached its contract by failing to provide evidence that its employees were paid the prevailing wage.
Notwithstanding the terms of the blanket contract (which included no specifications for any particular project), a facilities manager at Wayne State typically accepted lump sum estimates for assigned projects. The practice of entering into lump sum contracts began before, and continued after, Wayne State entered into time and materials contracts with vendors. Pursuant to CDG’s agreement with the manager, Wayne State paid CDG lump sums for specific projects without demanding that CDG adhere to the blanket time and materials contract. The manager who entered into those lump sum agreements was later fired.
Representatives of Wayne State and CDG met several times after Wayne State alleged that CDG was not withholding FICA from payments it made to its subcontractors. At Wayne State’s request, CDG submitted wage records purporting to demonstrate its compliance with Michigan’s prevailing wage law. Wayne State alleged that those records were falsified.
CDG denied falsifying any records. Some of the information upon which Wayne State relied apparently came from individuals who hoped to benefit if contracts with CDG were diverted to their own business. When Wayne State began debarment proceedings that would disqualify CDG from being awarded future contracts, Wayne State refused to disclose the evidence upon which it relied in deciding that CDG had falsified its certified payrolls.
Wayne State reluctantly held a debarment hearing after making clear that it did not intend to change its debarment decision. Debarment proceedings continued even after Michigan’s Wage & Hour Division declined to accept jurisdiction over a complaint that CDG violated the prevailing wage law. The Wage & Hour Division concluded that the complaint concerned subcontractors to whom the law did not apply.
CDG sued Wayne State in federal district court on a variety of theories, including breach of contract, intentional interference with business relations, violation of CDG’s right to due process, and defamation. At trial, the jury determined that Wayne State failed to pay CDG’s account for services rendered, breached its contract with CDG, and violated CDG’s right to due process. Wayne State was required to pay CDG’s attorney’s fees on the federal due process claim. The court entered a total judgment against Wayne State for about $1.3 million.
On appeal, the Court of Appeals for the Sixth Circuit determined that the jury awarded duplicate amounts on payments that were owed to CDG for the services it rendered, and remanded the case with instructions to reduce the award by eliminating the duplicated damages. The other significant issue raised on appeal concerned Wayne State’s argument that the trial court improperly admitted expert testimony on its claim for lost profits.
CDG claimed damages for lost profits as the result of Wayne State’s cancellation of its contract. It employed Ted Funke to prepare a report and to testify about the profits that CDG lost as a result of Wayne State’s actions.
Federal courts are often skeptical about lost profit claims. They take care to exclude expert testimony about lost profits when that testimony is “overly speculative,” particularly when the testimony depends upon predictions of future demand for a new product or service.
The federal Daubert standard for expert opinion admissibility considers whether an expert’s opinion is based on a valid methodology. Courts are more likely to admit expert opinions about lost profits when they are grounded in historical trends and typical industry profit margins. Methodologies that ignore factors that might cause a business to fail or to suffer reduced profits tend to fail the Daubert test, as do opinions that make questionable comparisons (such as comparing the anticipated profit margin of a startup business to profit margins earned by industry leaders).
Wayne State made a pretrial Daubert objection to Funke’s prediction of lost profits. Its challenge contended that Funke was unqualified, that his opinions were not based on adequate data or a reliable methodology, and that he did not reliably apply the methodology to the facts. The trial judge decided that CDG made a preliminary showing of reliability and that Wayne’s State’s challenge went to the weight of Funke’s testimony rather than its admissibility.
Funke calculated CDG’s lost profits by examining CDG’s historical monthly sales to Wayne State over a period of 18 months prior to its debarment. He multiplied the monthly average by 41 to estimate lost income for 41 months after debarment.
A key question on appeal was whether Funke should have been allowed to testify about the loss of gross profits rather than net profits. The Court of Appeals agreed that basing a lost profit calculation on gross rather than net profits is usually inappropriate. Funke testified, however, that there was no net profit on the lost jobs and that gross profit was the correct measure of the loss. That testimony was challenged on cross-examination and by Wayne State’s own expert. The trial judge acknowledged that Funke’s testimony was “shaky,” but decided that the testimony presented a factual dispute that the jury was capable of resolving.
On appeal, Wayne State argued that Funke relied upon financial information provided by CDG that was not independently verified, that Funke did not take a potential economic downturn into account, and that he had no basis for assuming that CDG would continue to win contracts for 41 months. While acknowledging that Funke’s calculation was “not a model of precision” and that the admissibility of Funke’s testimony presented a “close call,” the Court of Appeals noted that Funke based his opinions on historical data, that he limited his projection of lost profits to a reasonable time period, and that he explained his reasons for believing that gross rather than net profit was the correct measure of loss. Funke’s analysis might have been imperfect but it generally followed a reliable methodology. The jury had the opportunity to consider the countervailing testimony of Wayne State’s expert and was entitled to decide how much weight it should give to the opinions rendered by each expert. Under the circumstances, the Court of Appeals decided that the trial court did not abuse its discretion by allowing the jury to consider Funke’s opinions.