Proof of damages in restrictive covenant matters can be complicated. In Rhymes v. Filter Resources, Inc., the Ninth Court of Appeals in Beaumont reminded parties that revenue and sales are not the same as lost profits, and expenses must be considered when developing a damage model.
George Rhymes (“Rhymes”) was employed by Filter Resources (“Filter”) as a Branch Manager. In this role, he received confidential and proprietary information regarding customers, pricing, and margins, among other financial data. Rhymes executed an employment agreement containing a twelve month customer non-solicitation covenant. Rhymes resigned from Filter and started a competing company called Rhymes Industrial. The evidence at trial showed that Rhymes Industrial was a direct competitor of Filter, and that all the customers of Rhymes Industrial were former customers of Filter that Rhymes serviced while employed by Filter. Filter presented evidence that Filter’s annual revenue decreased over $1,000,000 since Rhymes left, and Filter offered expert testimony from a Certified Public Accountant claiming that Filter’s lost profits were $622,800. Based on this record, a jury rendered a verdict finding that Rhymes breached his employment agreement and awarded Filter $620,000 in damages.
On appeal, the Beaumont Court of Appeals explained that to support a lost profit theory of recovery, the plaintiff bears the burden to demonstrate by competent evidence the amount of lost profits with “reasonable certainty.” Exact calculation is not necessary, but the plaintiff must present evidence based on “facts, figures, or data” to reflect lost revenue as well as expenses. The evidence presented at trial (expert and otherwise) reflected that Rhymes Industrial had between $638,000 and $732,000 in sales during the non-solicitation period. However, this figure failed to account for expenses, such as payroll, the cost of goods sold, and related overhead. The court explained that lost profit is not synonymous with lost sales, and lost profit evidence must demonstrate the lost net income to the plaintiff by accounting for expenses. By failing to present evidence of net income, as opposed to simply lost sales, the plaintiff did not present evidence to support lost profits of $620,000 with reasonable certainty. However, the court concluded there was evidence that Rhymes Industrial had expenses of approximately $403,000, and Filter avoided salary expenses of $28,000. Based on $638,000 in lost revenue, and accounting for $431,000 in expenses, Filter suffered lost profits (or lost net revenue) of $207,000. Accordingly, the court issued a remittitur of $207,000.
The lesson to remember is that when litigating a restrictive covenant matter, lost revenue is only half the calculation. Parties must also develop and present evidence to reflect expenses (and avoided expenses) credibly to prove lost profits (or lost net income) with reasonable certainty. Depending on margins, lost profits may only be a fraction of lost sales, but to sustain a verdict, parties must account for both revenue and expenses. Alternatively, in some circumstances, an employer may choose to include a liquidated damages provision, which of course carry with them another set of issues – a topic for another conversation.