Shaky expert testimony topples $18 million damage award

Courts serve as gatekeepers to ensure that expert evidence is relevant and reliable. Expert opinions based on speculative assumptions are likely to be rejected. This article summarizes a recent federal appellate court case in which a valuation expert’s testimony was excluded as both irrelevant and unreliable, leaving the plaintiff without sufficient evidence to prove any amount of damages.

Endless River Tech. LLC v. TransUnion, LLC, No. 23-3087 (6th Cir., January 17, 2025).

In Endless River Technologies LLC v. TransUnion, LLC, the U.S. Court of Appeals for the Sixth Circuit affirmed the U.S. District Court’s order overturning an $18 million jury award, albeit on different grounds. The district court found that the awarded damages constituted lost profits, which were a form of consequential damages barred under the parties’ contract.

The appellate court didn’t address the issue of whether the damages were consequential. Instead, it focused on the lower court’s denial of the defendant’s motion to exclude the plaintiff’s damages expert, which it found dispositive. The appellate court held that the expert’s testimony should have been excluded as both irrelevant and unreliable. This left the plaintiff with “insufficient evidence to prove any amount of damages above the zero dollars awarded by the district court.”

Background

The plaintiff was a start-up company formed to develop and market a platform called “Quote Exchange.” The platform served as an online marketplace where insurance companies buy and sell insurance leads. In late 2012, the company created a “pre-development profit projection model” that estimated no revenue in the initial development year, $16.7 million in revenue during the first year on the market and approximately $213 million by year four.

On March 31, 2014, the plaintiff entered into a contract with the defendant. Under the terms of the contract, the defendant would fund the development of Quote Exchange, and the plaintiff would act as product designer and technical consultant.

From 2014 to 2017, the parties worked to bring the platform to market, but they were dissatisfied with the platform’s performance. It generated only $240,000 in revenue between 2016 and 2018. The defendant terminated the contract on April 2, 2018. After the termination, the plaintiff continued to believe that the platform had revenue-generating potential. A battle ensued over whether the defendant was required to return the platform’s source code to the plaintiff, resulting in this lawsuit. According to the plaintiff, the defendant’s refusal to return the source code violated the contract and deprived the plaintiff of the ability to market and monetize the platform. It also claimed that the window for doing so had closed, rendering the source code worthless.

Venture capital approach

The plaintiff hired a valuation expert who applied the venture capital approach to estimate damages. This technique calculates a start-up’s value based on its expected future revenue. The starting point for the expert’s analysis was the plaintiff’s estimated revenue from 2014 to 2018 ($213 million). Then he:

• Applied a multiple of 1.1 times revenue, based on comparable transactions, to arrive at an “enterprise value” of roughly $234 million in 2018,
• Adjusted the 2018 enterprise value, using a 70% discount rate to reflect perceived market risk, to arrive at an adjusted enterprise value of approximately $18.9 million on March 31, 2014 (the date when the parties signed the contract), and
• Applied a “revenue growth rate,” based on comparable transactions, to arrive at a value of $59 million on December 1, 2021 (the date of the expert’s report).

The expert concluded that the plaintiff’s damages equaled what the platform’s value would have been on December 1, 2021, but for the defendant’s alleged breach of the contract. Later, he revised his damages conclusion to approximately $55 million as of September 12, 2022 (the trial date).

Expert testimony rejected

The appellate court described the expert’s testimony as “riddled with defects.” It concluded that the district court should have excluded the expert’s testimony under Federal Rule of Evidence 702 as both irrelevant and unreliable.

The court said that the testimony lacked relevance because the expert valued the platform as of March 2014 and September 2022. But the appropriate measure of damages was the platform’s value on April 2, 2018 (the date the contract was breached). Although the expert testified during the Daubert hearing on his testimony’s admissibility that he measured damages as of April 2, 2018, the court found that this testimony contradicted his reports and his prior sworn statements.

The court also found the expert’s testimony unreliable because 1) he relied on the plaintiff’s projections without independently vetting the data, and 2) the projections were speculative. It highlighted the “stark gap” between the plaintiff’s revenue projections and the platform’s real-world performance.

A tough lesson

The court in Endless River sent a clear message: Even if a plaintiff may arguably be entitled to some damages, it can end up with nothing if its expert’s testimony is speculative or fails to align with the relevant measure of damages. In this case, the plaintiff learned that lesson the hard way.

Projection vs. forecast

The court in Endless River (see main article) excluded a valuation expert’s damages conclusion as speculative, because it was based on the plaintiff’s revenue projections, which varied significantly from the start-up’s actual results. But is it ever appropriate for valuators to rely on projections? And what’s the difference between a projection and a forecast?

In most valuation contexts, forecasts are more appropriate. Forecasts estimate expected future performance based on historical data, current trends and existing management plans. In contrast, projections predict future performance based on hypothetical what-if scenarios. Projections may be used in connection with strategic planning, internal decision-making and merger negotiations. But most other valuation purposes call for forecasts, which reflect reasonable expectations regarding a company’s future cash flows or other financial results.

The terms are often used interchangeably. So, when evaluating management’s predictions about future financial performance, it’s important to assess whether they’re forecasts or projections, regardless of how they’re labeled.