Using Appropriate Comparables in Estimating Lost Profits

Sargon Enterprises, Inc. v. University of Southern California, et al., 55 Cal. 4th 747
Supreme Court of California: Opinion Delivered November 26, 2012
Sargon Enterprises, Inc. (“Sargon”), a small dental implant company with net profits of $101,000 in 1998, sued the University of Southern California (“USC”) for breach of contract for USC’s failure to clinically test a new implant Sargon had patented. Sargon sought damages for lost profits beginning in 1998, ranging from $200 million to over $1 billion. Sargon claims that, but for USC’s breach, it would have become a worldwide leader in the dental implant industry and generated many millions of dollars a year in profits. The trial court excluded as speculative the proffered testimony of Sargon’s expert to this effect. The Court of Appeal held that the trial court erred in excluding the testimony. The California Supreme Court reversed that judgment.

In its opinion, the Supreme Court examined the speculative nature of the expert’s testimony on lost profits. The Court explained that while lost profits can be established with the aid of expert testimony, economic and financial data, market surveys and analysis, and business records of similar enterprises, “the underlying requirement for each is ‘a substantial similarity between the facts forming the basis of the profit projections and the business opportunity that was destroyed.’” Siding with the trial court, the Supreme Court found that Sargon’s expert relied on data that was not analogous to Sargon. Specifically, Sargon’s expert considered Sargon to be comparable to the “Big Six” dental implant companies, rather than smaller companies which the Supreme Court found Sargon to far more closely resemble. The expert admitted that by no objective business metric, such as sales or number of employees, was Sargon comparable to the “Big Six,” but instead based his comparison on his belief that Sargon, like the “Big Six” and unlike the rest, was innovative and that innovation was the prime market driver. The expert’s failure to base his comparison to the “Big Six” on any “relevant, objective business measure” culminated in the Court’s conclusion that his testimony was speculative.

Although the Court acknowledged that exactitude is not required in estimating lost profits, it crystalized the issue before it as: “Whether the actual [lost] profits could logically be estimated in the manner [the expert] claimed.” In addressing the Court of Appeal majority’s concern that “[t]he trial court’s ruling is tantamount to a flat prohibition on lost profits in any case involving a revolutionary breakthrough in an industry,” the Supreme Court disagreed concluding that other avenues besides “speculative projections of future spectacular success” must be employed, such as, for example, Sargon’s lost sales and canceled contracts due to USC’s failure to complete the study.

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