On November 26, 2012, in a matter involving a claim for breach of contract and lost profits, the California Supreme Court, in a major decision, reversed the judgment of the court of appeals, which had held the trial court erred in excluding expert testimony regarding plaintiff’s lost profits.  Sargon v. USC (Case No. S191550)  The Sargon decision will have significant implications in cases concerning the admissibility of expert witness testimony and contractual loss profit claims.

FACTS

In 1991, plaintiff Sargon Enterprises, Inc. (Sargon) patented a dental implant.  In 1996, Sargon contracted with defendant University of Southern California (USC) to conduct a five-year clinical study of the implant.  In May 1999, Sargon sued USC and faculty members of its dental school involved in the study, alleging breach of contract and other causes of action.  USC cross-claimed for breach of contract.  All of Sargon's claims except the breach of contract claim against USC were eliminated by demurrer or summary judgment.  In 2003, the contract action was tried before a jury.  Before trial, at an in limine hearing, the trial court excluded evidence of Sargon's lost profits on the ground USC could not have foreseen them.

The jury found that USC had breached the contract and awarded Sargon $433,000 in compensatory damages.  It also found in Sargon's favor on USC's cross-complaint for breach of contract.  Sargon appealed.  The court of appeals reversed the judgment, holding that the trial court had erred in excluding evidence of Sargon's lost profits on the ground of foreseeability.  It also stated, "Given that the in limine hearings focused on foreseeability and not the amount of lost profit damages, it is premature to determine whether such damages can be calculated with reasonable certainty." (Sargon Enterprises, Inc. v. University of Southern California (Feb. 25, 2005, B167519) [nonpub. opn.].)

On remand, the case proceeded to retrial on the breach of contract claim.  USC moved to exclude as speculative the proffered opinion testimony of one of Sargon's experts, James Skorheim.  The court presided over an eight-day evidentiary hearing at which Skorheim was the primary witness.  Following the evidentiary hearing, the court issued a 33-page written ruling on USC's motion to exclude Skorheim's testimony.  The court concluded "that Mr. Skorheim's opinions are not based upon matters upon which a reasonable expert would rely, and do not show the nature and occurrence of lost profits with evidence of reasonable reliability, because his opinion is not based on any historical data from Plaintiff or a comparison to similar businesses. The court also finds his 'market drivers' meaningless for comparison purposes. Additionally, his opinion rests on speculation and unreasonable assumptions."  Accordingly, it granted USC's motion to exclude Skorheim's testimony.

Sargon appealed once again.  The court of appeals reversed the exclusion of Dr. Skorheim’s testimony, stating, in part: "We acknowledge the difficulty in determining lost profits when an established business is built upon the sale of an innovative, revolutionary, or world-changing product.  The factor of innovation — what the trial court described as a 'beauty contest' — is not easily converted into dollars and cents.  But exactitude is not required... Skorheim's expert opinion was based on 'economic and financial data, market surveys and analyses, business records of similar enterprises, and the like.' (…)  He also considered Sargon's historical financial data. The trial court's ruling is tantamount to a flat prohibition on lost profits in any case involving a revolutionary breakthrough in an industry.”  The court of appeals reasoned that "[i]f USC had not sabotaged the clinical study of the Sargon implant, Sargon would have had a successful clinical trial to its credit and a prominent university using the implant at its dental school.  But it was denied.  Through its wrongful conduct, USC allegedly caused the loss of profits and has made the proof of lost profits all the more difficult, thereby rendering its evidentiary attack unconvincing. (…)  We have carefully reviewed the trial court's criticisms of Skorheim's proffered testimony and conclude they were better left for the jury's assessment."

The California Supreme Court granted USC's petition for review to decide whether the trial court erred in excluding Skorheim's testimony.

THE CALIFORNIA SUPREME COURT’S DECISION

The California Supreme Court reiterated the trial court’s gatekeeping function under California Evidence Code section 801 and 802, stating “We construe this to mean that the matter relied upon must provide a reasonable basis for the particular opinion offered, and that an expert opinion based on speculation and conjecture is inadmissible.”  Lockheed Litigation Cases (2004) 115 Cal.App.4th 558, 564.  The court, citing to Evidence Code section 802, also noted that “the [trial] court may also inquire into the expert’s reasons for his opinion.”  But the court went further, extending the application of Section 802 to constitutional, statutory, and decisional law. 

Thus, the court held, “under Evidence Code sections 801, subdivision (b), and 802, the trial court acts as a gatekeeper to exclude expert opinion testimony that is (1) based on matter of a type on which an expert may not reasonably rely, (2) based on reasons unsupported by the material on which the expert relies, or (3) speculative.  Other provisions of law, including decisional law, may also provide reasons for excluding expert opinion testimony." 

Taking it a further step, the California Supreme Court emphasized the fact that under existing law, irrelevant and speculative matters are not proper basis for an expert opinion.  Thus, under Evidence Code section 801, the trial court acts as a gatekeeper to exclude speculative or irrelevant expert opinion.  The court stated:

As we recently explained, the expert‘s opinion may not be based on assumptions of fact without evidentiary support [citation], or on speculative or conjectural factors . . . . [¶] Exclusion of expert opinions that rest on guess, surmise or conjecture [citation] is an inherent corollary to the foundational predicate for admission of the expert testimony: will the testimony assist the trier of fact to evaluate the issues it must decide?”(Jennings v. Palomar Pomerado Health Systems, Inc. (2003) 114 Cal.App.4th 1108, 1117.)‖ (People v. Richardson (2008) 43 Cal.4th 959, 1008; accord, People v. Moore (2011) 51 Cal.4th 386, 405.)

After an extensive discussion of Skorheim’s methodology, the California Supreme Court reversed, finding no error with the exclusion of his testimony.  It agreed that Skorheim’s methodology was too speculative to be admissible.  Specifically, it noted that Skorheim’s market share approach was not based on any market share that Sargon had “ever actually achieved.  Instead, the opinion that Sargon’s market share would have increased spectacularly over time to levels far above anything it had ever reached.”  The California Supreme Court also questioned Skorheim’s assumption that Sargon’s product (and its lost profits) was comparable to the other Big Six dental implant companies stating that “he based his comparison solely on his belief that Sargon, like the Big Six, and unlike the rest, was innovative, and that innovation was the prime market driver.”  The California Supreme Court found that reasoning circular under Evidence Code Section 802 and, therefore, inadmissible.  Finally, it concluded:

An accountant might be able to determine with reasonable precision what Sargon's profits would have been if it had achieved a market share comparable to one of the Big Six.  The problem here, however, is that the expert's testimony provided no logical basis to infer that Sargon would have achieved that market share. The lack of sound methodology in the expert's testimony for determining what the future would have brought supported the trial court's ruling. [¶] The Court of Appeal majority was concerned 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.’  We disagree.  Other avenues might exist to show lost profits.  An expert could use a company's actual profits, a comparison to the profits of similar companies, or other objective evidence to project lost profits.  Sargon itself argues that the record in this case contains evidence of specific lost sales and canceled contracts due to USC's failure to complete the study.  Evidence of this kind might support reasonably certain lost profit estimates.  The trial court's ruling merely meant Sargon could not obtain a massive verdict based on speculative projections of future spectacular success. [¶] The trial court properly acted as a gatekeeper to exclude speculative expert testimony.  Its ruling came within its discretion.  The majority in the Court of Appeal erred in concluding otherwise.

TAKEAWAY

This clarification of existing case law – the interaction between Evidence Code Sections 801 and 802 – brings California one step closer to the federal Daubert admissibility standard.  This decision provides further ammunition for challenging expert testimony – not just on methodology, but also on the reasoning and foundation for the expert’s opinion.  Finally, the opinion provides good language when facing speculative lost profit claims, especially as it pertains to prospective profits.