Texas law is well-settled that lost profits can be recovered only when the amount can be proven with “reasonable certainty.” A recent Supreme Court of Texas case has made clear that this requirement cannot be circumvented by seeking the lost “market value” of a venture that is determined based on lost profits. Instead, litigants should look to actual valuations made by participants in the marketplace to demonstrate a reasonably certain measure of damages in cases seeking lost market value.

The Dispute

In Phillips v. Carlton Energy Group LLC, No. 12-0255 (Tex. May 8, 2015), Carlton brought suit against entrepreneur Gene Phillips and other Phillips-related entities. In October 2000, Bulgaria granted CBM Energy Limited a three-year concession to explore for coalbed methane in a field in the Dobroudja Coal Basin. The concession required CBM to drill one exploratory well, and if successful, two additional wells would be authorized.

CBM could not fund the project itself and inquired whether Carlton would be interested in partnering with it to help find investors. Carlton agreed and paid $8 million for a 48 percent interest in the Bulgaria project. Carlton then offered Phillips, a Dallas businessman who expressed interest in the project, a 10 percent interest in the project for $8.5 million (which would leave Carlton with a 38 percent interest). The contract between Carlton and Phillips included a provision allowing Phillips a 30-day period to review all documentation and granting Phillips the right to withdraw from the agreement. Shortly after signing, Phillips wrote Carlton withdrawing from the project. Phillips later moved to supplant Carlton on the project by reaching out to CBM directly. Eventually, the project was shut down after the participants failed to convince the Bulgarian government that commercial production had been achieved.

Expert’s Valuations

Carlton ultimately brought suit against Phillips and other entities for breach of the Carlton-Phillips contract and tortious interference with the CBM-Carlton contract. Rather than seeking lost profits as damages in the case, Carlton sought the lost “market value” of its interests, using expert testimony to establish the fair market value of the investment. Its expert relied heavily on the project’s supposed lost profits to offer three damages models, ranging from approximately $12.5 million to as high as $11.3 billion.

First, Carlton’s expert testified that the value of the interest could be derived from the value of the gas in the ground (as forecast by a second expert) leading to a value as high as $11.3 billion. Second, the expert estimated the value of the interest by determining the total net income for a limited group of wells and applying a discount factor, leading to a range of values from $12.5 million to $38 million. Finally, the expert put forth a model that assumed that Phillips' agreement to pay Carlton $8.5 million for a 10 percent interest in the prospect showed that the value of the entire prospect was $82 million ($85 million minus $3 million to drill the required wells). Thus, the extrapolated value of Carlton’s 38 percent interest would be $31.16 million.

Trial Court’s Award

The jury found Phillips liable and awarded $66.5 million in actual damages (an amount that Carlton had not specifically sought) and $8.5 million in exemplary damages. After remittitur, the trial court entered judgment for $31.16 million in actual damages, the amount Carlton’s counsel argued was appropriate to the jury in closing argument based on the expert’s third valuation model. The trial court also entered judgment on the $8.5 million exemplary damages award.

Court of Appeals Rejects Reasonable Certainty Requirement

On appeal, the First District Court of Appeals in Houston reversed the trial court’s judgment in part and rendered judgment on the verdict, awarding Carlton the full $66.5 million in actual damages, as well as the exemplary damages. The court of appeals concluded that Carlton had presented sufficient expert testimony and documentary evidence to support a broad range of values for the jury to consider in determining the fair market value of Carlton’s interest. It thus held that Carlton was not required to prove any “lost profits” to recover actual damages. The court of appeals concluded that “it was the jury’s job, as fact finder ... to determine the fair market value of Carlton's interest[.]” Phillips petitioned the Supreme Court of Texas for review.

Supreme Court of Texas Holds Reasonable Certainty Is Required

The Supreme Court of Texas disagreed and unanimously reversed the damages award as impermissibly speculative because there was no evidence that the amount awarded was “based on objective facts, figures, or data from which the amount of lost profits [could] be ascertained.” The state high court noted that “[w]hile we have never spoken to whether this requirement of reasonable certainty of proof should apply when lost profits are not sought as damages themselves but are used to determine the market value of property for which recovery is sought, it clearly must.” Thus, the court made clear that the “reasonable certainty” standard applies, and may not be avoided simply by seeking market value damages derived from lost profits, rather than seeking lost profits damages themselves.

The Supreme Court of Texas, however, did not categorically reject the prospect of recovery for lost market value in this situation. It concluded that “when evidence of potential profits is used to prove the market value of an income-producing asset, the law should not require greater certainty in projecting those profits than the market itself would.” The reasonable certainty requirement thus “should not be used to deny a claimant damages equal to the value the market would have placed on the property.”

While the Supreme Court of Texas rejected the Carlton expert’s first two models as impermissibly speculative, the state high court concluded that the expert’s third market-based damages model — which included an offer made by Phillips to Carlton — would constitute legally sufficient evidence of damages. The Supreme Court of Texas, however, remanded the case to the court of appeals to determine the factual sufficiency of the evidence surrounding that amount and other issues.

Phillips reminds us that Texas law is “skeptical of claims of lost profits from untested ventures or in unpredictable circumstances, which in reality are little more than wishful thinking.” It also establishes that actual valuations made by the parties themselves can be used as a “reasonably certain” measure of damages in cases seeking lost market value. It remains to be seen, however, to what extent other types of market-based evidence may also be legally sufficient in cases seeking recovery for lost market-value in unproven ventures.

Originally appeared in Law360 on June 17, 2015.