Reliance (blind?) on another expert’s work can cost a damages expert dearly, as a recent 4th Circuit Court of Appeals decision illustrates. This case has sparked a spirited discussion among members of LinkedIn’s Forensic Accounting group.

Here’s the story. A startup company (plaintiff) launched a prepaid consumer gas program and used the defendants’ payment network. As soon as the company publicly announced it, thousands of people signed up for membership. Then, the defendants publicly distanced themselves from the program, claiming they had no relationship at all with the plaintiff. A deluge of negative publicity followed. The program stopped accepting new members and issued some refunds to existing members. The defendants authorized a retraction to the remarks they had made, but the program subsequently failed.

The plaintiff sued on a number of legal theories, including defamation. To show damages, it presented two experts whose testimony the defendants unsuccessfully tried to exclude in a Daubert challenge. The first expert was a professor of marketing who taught courses in advertising, marketing research, digital marketing, and consumer behavior but admitted she had no sales forecasting expertise. She used a “funnel approach” to project the plaintiff’s future membership and profits from the number of persons aware of the company’s brand, traffic to its website, actual sign-ups, and a projected growth rate and attrition. She also benchmarked the plaintiff’s growth against some of the most successful companies in the industry, including Apple, Costco, and Netflix, but not startups. Over a three-year period, the plaintiff could have signed up about 3.3 million members, she concluded. The damages expert was a CPA. He used the first expert’s membership projections to determine that the plaintiff had suffered $208 million in lost profits.

Giant blunder. The jury awarded $4 million, without specifying whether damages were general or special. The Court of Appeals agreed with the defendants that the award was excessive and based on inadmissible testimony. The first expert used only “industry giants” as benchmarks for the plaintiff’s growth without considering whether the company had the resources or experience necessary to ensure that degree of growth or “indeed, even as necessary to carry out its own business plan.” In a “puzzling omission,” she failed to consider what would happen if gas prices dropped, the court said. Her projections “ignored business realities” and were “sheer speculation.” Because the second expert’s lost profits calculation hinged on the excludable testimony, it, too, was speculative and inadmissible. The appellate court struck down the award and remanded for a new damages trial.

Can an expert guard against this situation? What do you think? Find an extended discussion of MyGallons LLC v. U.S. Bankcorp, 2013 U.S. App. LEXIS 11004 (May 31, 2013) in the August Business Valuation Update and at BVLaw.

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