Lost profits calculations often require experts with specialized industry knowledge. A recent Daubert case involving a construction contract illustrates what happens when a client retains a relative novice to develop a damages model for an unfamiliar environment. It sends a note of caution about accepting work that is outside the expert’s area of expertise.

Unique industry, unique contract: The plaintiff, a minority and/or women-owned business, entered into a subcontract with the defendants for work on a major construction project, the “Indianapolis Project.” The price of the lump-sum contract was nearly $6.8 million. Ultimately, the plaintiff sued for breach of contract, claiming the defendants never intended to honor the contract but used the plaintiff to fulfill a city MBE/WBE requirement. The defendants counterclaimed.

The plaintiff’s damages expert was a CMA who had worked as a tax preparer and outside accountant for the plaintiff for 10 years. He determined that total damages amounted to over $1.7 million, most of it related to lost profits. The defendants moved to exclude him under Daubert, arguing the lost profits calculation was based on insufficient data and an unreliable methodology.

Many ‘shortcomings’. The defendants did not attack the expert’s qualifications, but the court found his lack of experience worth discussing. The expert testified that different industries calculated lost profits differently. His experience in determining lost profits in general was limited. He said that in a few instances he had calculated lost revenue to businesses that had to close after a fire or flooding, and he had done a business valuation in a marital dispute case. He admitted he had never developed a report “to [the] extent” of the one he prepared for the plaintiff. The court noted he “has not previously offered expert lost profit opinion in a construction industry case.” It also said that “generally speaking expert qualifications are liberally construed.” Considering this principle and the defendants’ decision not to challenge the expert’s qualifications, the expert’s testimony might be admissible “if qualifications were the only shortcoming,” the court said. However, here the problematic work product provided other reasons to exclude the entire opinion.

For example, for his calculation, the expert relied on data related to a past construction project on which the plaintiff had worked with the defendants. Unlike the Indianapolis Project, however, the earlier project did not involve a lump-sum contract but was based on time and materials spent. Although the expert acknowledged that a lump-sum contract came with the risk of not making any profit, which did not exist in a time and materials contract, he did not analyze this difference.

Using historical data was an acceptable approach for ascertaining lost profits with reasonable certainty, the court said. But for a meaningful calculation the expert must provide an analysis as to why and how the data can reliably project the future loss to the project at issue. Here, the expert did not show that the conditions of the past project were comparable to those in the Indianapolis Project in terms of the type of contract and the scope of work. Without this analysis, the court “was not convinced” that the historical data were credible comparable evidence.

The court also found the expert used an “ad hoc” method that did not lend itself to independent testing and, therefore, was unreliable.

The exclusion of the damages expert opinion left the plaintiff scrambling for ways to get into evidence facts about the company’s economic performance. It tried to qualify the expert as a fact witness, but the court was alert to the backdoor maneuver. “Surely [the expert] cannot offer expert testimony through the cloak of a lay witness,” the court said.

Takeaway: Economic damage calculations are industry and fact specific; no one damages calculation fits every case. To avoid exclusion at trial, and minimize the risk to a potential client’s case, experts need to know what they don’t know and call in an industry expert when necessary.

An extended discussion of RMS of Wisconsin, Inc. v. S-K JV, 2016 U.S. Dist. LEXIS 64224 (May 16, 2016), appears in the August issue of Business Valuation Update; the court’s opinion is available at BVLaw.