Damages Opinion Based on “Nascent Company’s” Business Plan Excluded Where Expert Didn’t Know Who Prepared Plan or Its Assumptions — That Plan Was Admitted at Trial Does Not Preclude Exclusion of Opinion under Rule 702, Even If Rule 703 Satisfiied

ZF Meritor, LLC v. Eaton Corp., 2012 U.S. App. LEXIS 20342 (3d Cir. Sept. 28, 2012):

2. Expert Testimony on Damages

In their cross-appeal, Plaintiffs argue that the District Court erred in excluding DeRamus's testimony on the issue of damages. The core of DeRamus's damages analysis was one page (titled "Five Year Product Line Profit and Loss") of ZF Meritor's Revised Strategic Business Plan ("SBP") for fiscal years 2002 through 2005, which was presented to ZF Meritor's Board of Directors in November 2000. The District Court determined that, although DeRamus used methodologies regularly employed by economists, his opinion nevertheless failed the reliability requirements of Daubert and the Federal Rules of Evidence because the underlying data was not sufficiently reliable. The District Court acknowledged that experts often rely on business plans in forming damages estimates, but concluded that DeRamus's reliance on the SBP in this case was improper because he did not know either the qualifications of the individuals who prepared the SBP estimates or the assumptions upon which the estimates were based. ***

i. DeRamus's original damages calculations

First, we will consider Plaintiffs' contention that the District Court erred in determining that DeRamus's damages opinion was not sufficiently reliable. Federal Rule of Evidence 702, as amended in 2000 to incorporate the standards set forth in Daubert, imposes an obligation upon a district court to ensure that expert testimony is not only relevant, but reliable. Fed. R. Evid. 702; Paoli II, 35 F.3d at 744. As we have made clear, "the reliability analysis [required by Daubert] applies to all aspects of an expert's testimony: the methodology, the facts underlying the expert's opinion, [and] the link between the facts and the conclusion." Heller v. Shaw Indus., Inc., 167 F.3d 146, 155 (3d Cir. 1999); see also id. ("Not only must each stage of the expert's testimony be reliable, but each stage must be evaluated practically and flexibly without bright-line exclusionary (or inclusionary) rules."). As we explain below, the District Court did not abuse its discretion by finding that DeRamus's damages estimate, which was based heavily on the SPB projections, bore insufficient indicia of reliability to be submitted to a jury.

To determine the damages suffered by Plaintiffs as a result of Eaton's anticompetitive conduct, DeRamus conducted a two-part analysis. He computed Plaintiffs' lost profits for the period between 2000 and 2009, as well as the lost enterprise value of Plaintiffs' HD transmissions business. To calculate Plaintiffs' lost profits, DeRamus first estimated the incremental revenues that Plaintiffs would have earned "but for" Eaton's anticompetitive conduct, and then subtracted from that figure the incremental cost that Plaintiffs would have had to incur to achieve such incremental sales.

Ordinarily, such an approach would be appropriate because "an expert may construct a reasonable offense-free world as a yardstick for measuring what, hypothetically, would have happened 'but for' the defendant's unlawful activities." LePage's, 324 F.3d at 165 (citations omitted). However, the District Court's primary criticism of DeRamus's report was that he did not construct an offense-free world based on actual financial data, but instead relied on a one-page set of profit and volume projections without knowing the circumstances under which such projections were created or the assumptions on which they were based. In some circumstances, an expert might be able to rely on the estimates of others in constructing a hypothetical reality, but to do so, the expert must explain why he relied on such estimates and must demonstrate why he believed the estimates were reliable. See Fed. R. Evid. 702; Daubert, 509 U.S. at 592-95; Paoli II, 35 F.3d at 748 n.18 ("Arguably, [third-party estimates] that an expert relies on are not his underlying data, but rather the data that went into the [third-party estimates] in the first place are his underlying data.").

Plaintiffs contend that DeRamus's reliance on the SBP estimates was appropriate because a company's internal financial projections, like those in the SBP, are regularly and reasonably relied upon by economists in formulating opinions regarding a company's performance in an offense-free world. Plaintiffs are certainly correct that "internal projections for future growth" often serve as legitimate bases for expert opinions. See LePage's, 324 F.3d at 165; Auto west, Inc. v. Peugeot, Inc., 434 F.2d 556, 566 (2d Cir. 1970) (holding that damages testimony was admissible because the financial projections on which the testimony was based "were the product of deliberation by experienced businessmen charting their future course"). Businesses are generally well-informed about the industries in which they operate, and have incentives to develop accurate projections. As such, experts frequently use a plaintiff's business plan to estimate the plaintiff's expected profits in the absence of the defendant's misconduct. See Litigation Services Handbook: The Role of the Financial Expert 24:13 (4th ed. 2007). Vvvvvv However, there is no per se rule of inclusion where an expert relies on a business plan; district courts must perform a case-by-case inquiry to determine whether the expert's reliance on the business plan in a given case is reasonable. See Heller, 167 F.3d at 155.

Here, the District Court concluded that the SBP could not serve as a reliable basis for DeRamus's opinion because he was unaware of the qualifications of the individuals who prepared the document, or the assumptions on which the estimates were based. Plaintiffs argue that these factual findings are contradicted by the record. Admittedly, the record indicates that DeRamus did not, as the District Court suggested, blindly accept the SBP estimates without question. DeRamus was aware that the SBP had been presented to ZF Meritor's Board of Directors, and that it was revised several times to "address and resolve queries management had about the reasonableness of the assumptions, projections, [and] forecasts." He also knew that the Board had relied on the SBP in making business decisions. Moreover, ZF Meritor's former president testified that he "did not submit SBPs to management for review unless [he] believed the projections, forecasts, and assumptions therein to be reliable."

However, contrary to Plaintiffs' assertions, these excerpts from the record do not contradict the District Court's ultimate findings. The record amply supports the District Court's concern that, although DeRamus was generally aware of the circumstances under which the SBP was created and the purposes for which it was used, he lacked critical information that would be necessary for Eaton to effectively cross-examine him. An expert's "lack of familiarity with the methods and the reasons underlying [someone else's] projections virtually preclude[s] any assessment of the validity of the projections through cross-examination." TK-7 Corp. v. Estate of Barbouti, 993 F.2d 722, 732 (10th Cir. 1993); compare Auto west, 434 F.2d at 566 (holding that projections of company officials were admissible where such officials "set out at length the bases from which they derived their figures, and consequently, [the opposing party] was able to cross-examine them vigorously"). Here, DeRamus knew that the SBP was presented to the Board by experienced management professionals, but he did not know who initially calculated the SBP figures. He did not know whether the SBP projections were calculated by ZF Meritor management, lower level employees at ZF Meritor, or came from some outside source. Nor did DeRamus know the methodology used to create the SBP or the assumptions on which the SBP's price and volume estimates were based.

Footnote 24. As the District Court noted, it is especially important for an expert to identify and justify the assumptions underlying financial projections when dealing with a new company. Here, although Meritor had been in the HD transmissions industry for over a decade, ZF Meritor was offering a brand new line of transmissions that had never before been sold in the North American market.

Under the deferential abuse of discretion standard, we will not disturb a district court's decision to exclude testimony unless we are left with "a definite and firm conviction that the court below committed a clear error of judgment." In re TMI Litig., 193 F.3d 613, 666 (3d Cir. 1999) (citation omitted). Plaintiffs cannot clear that high hurdle. Accordingly, we conclude that the District Court acted within its discretion in determining that one page of financial projections for a nascent company, the assumptions underlying which were relatively unknown, did not provide "good grounds," Paoli II, 35 F.3d at 742 (quoting Daubert, 509 U.S. at 590), for DeRamus to generate his damages estimate. Compare LePage's, 324 F.3d at 165 (noting that plaintiff's expert considered the defendant's internal projections for growth, but also closely examined the market conditions, including the past performance of competitors).

*** Plaintiffs [also] contend that because the SBP was admitted into evidence at trial, Rule 703 does not provide a basis for exclusion. However, this argument is based on the flawed assumption that the District Court excluded DeRamus's testimony under Rule 703, rather than Rule 702. Plaintiffs assume that because the District Court stated that "DeRamus manipulated the SBP using methodologies employed by economists," ZF Meritor, 646 F. Supp. 2d at 667, the District Court necessarily concluded that Rule 702, which focuses on methodologies, was satisfied. However, the District Court explicitly stated that "the fundamental query" was "whether the [SBP] estimates pass[ed] the reliability requirements of Rules 104, 702, and 703. " Id. ***[W]e conclude that DeRamus's opinion was properly excluded because it failed the reliability requirements of Rule 702.

Footnote 25. We base our affirmance of the District Court's decision entirely on the fact that DeRamus's opinion failed Rule 702, and do not decide whether Rule 703 provides an additional basis for exclusion. We note, however, that Plaintiffs' argument that Rule 703 somehow constrains a district court's ability to conduct an assessment of reliability under Rule 702 is misplaced. After all, a piece of evidence may be relevant for one purpose, and thus admissible at trial, but not be the type of information that can form the basis of a reliable expert opinion. As the District Court stated, "the fact that [a piece of evidence] [i]s part of [the] plaintiffs' 'story' does not mean, ipso facto," that an expert opinion relying on such evidence is admissible. ZF Meritor LLC v. Eaton Corp., 800 F. Supp. 2d 633, 637 (D. Del. 2011).

Plaintiffs' suggestion that the reasonableness of an expert's reliance on facts or data to form his opinion is somehow an inappropriate inquiry under Rule 702 results from an unduly myopic interpretation of Rule 702 and ignores the mandate of Daubert that the district court must act as a gatekeeper. See Daubert, 509 U.S. at 589; Heller, 167 F.3d at 153 ("While 'the focus, of course, must be solely on principles and methodology, not on the conclusions that they generate,' a district court must examine the expert's conclusions in order to determine whether they could reliably flow from the facts known to the expert and the methodology used.") (emphasis added) (quoting Daubert, 509 U.S. at 595). Where proffered expert 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 relevant discipline.'" Kumho Tire Co. v. Carmichael, 526 U.S. 137, 149 (1999) (quoting Daubert, 509 U.S. at 592). A district court's inquiry under Rule 702 is "a flexible one" and must be guided by the facts of the case. Daubert, 509 U.S. at 591, 594. Here, the District Court's analysis fell squarely within its flexible gatekeeping function under Daubert and Rule 702. See Kumho Tire Co. 526 U.S. at 149; Paoli II, 35 F.3d at 748 n.18; see also Elcock, 233 F.3d at 754 (explaining that an expert's testimony regarding damages must be based on a sufficient factual foundation); [*98] Tyger Constr. Co. v. Pensacola Constr. Co., 29 F.3d 137, 142 (4th Cir. 1994) ("An expert's opinion should be excluded when it is based on assumptions which are speculative and not supported by the record.").

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