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The prospect of riches beyond the dreams of avarice tantalizes inventors and innovators, often just out of their reach and ever receding like a mirage in the desert.  And when the would-be entrepreneur’s progress is stymied by a breach of contract that prevents commercialization of the idea, damages are now frequently sought for the loss of what might have been – a successful company rising from nothing to a proud position among the industry leaders.  But there’s the rub – “from nothing.”

In Sargon Enterprises, Inc. v. University of Southern California (2012) 55 Cal.4th 747,  ____ P.2d ____, the California Supreme Court dealt with a trial judge’s decision to bar expert testimony by a lawyer/accountant that Sargon’s damages were measured by the profits Sargon would have made if it had become a market leader but for USC’s breach of contract to conduct a clinical trial and report upon a revolutionary dental implant.  The damages claimed by the expert were not entirely certain and ranged from $220 million to $1.18 billion.  In 1998, however, the year before the breach of contract, Sargon had earned a profit of about $101,000.  The huge dental implant market is dominated by six major players; in addition scores of minor ones share about 20% of the market.  The expert proposed to testify that if the Sargon implant was truly innovative, Sargon could have been expected to become one of the Big Six, displacing one of the current members.  This was so because innovativeness was the sole variable determinant of success in the market place; those companies that were not in the Big Six were, by definition, not innovative.  The expert’s tag line was, “The proof is in the pudding.”

After an eight-day hearing on the admissibility of this testimony, the trial judge wrote a long opinion focusing on the circularity of the expert’s reasoning (that the companies were successful because they were innovative, and the only proof of the other companies’ lack of innovativeness was their lack of success), on the dissimilarity between Sargon and the Big Six, and on the lack of a rational basis on which the jury was supposed to measure the amount of damages.

The Court of Appeal reversed in a 2-1, unpublished decision, and the Supreme Court unanimously reversed the Court of Appeal, upholding the trial judge’s exercise of discretion.  The Supreme Court relied heavily on the trial judge’s logical analysis and made a number of important legal points.

First, the competing policies of the right to a civil jury trial and the need to forestall the jury’s reliance on specious expert testimony require that the judge’s discretionary power to bar expert testimony be exercised with substantial restraint, but be exercised nevertheless when appropriate.

Second, Evidence Code Section 801, which provides that an expert’s testimony must be based on matters “that reasonably may be relied upon by an expert,” is not the sole limitation on an expert’s testimony.  Section 802 of the Evidence Code authorizes the trial court to scrutinize the experts’ reasoning and bar testimony which is speculative.

Third, the Court restated what is often called “the new business rule.”  While no longer a total bar to recovery, the new business rule provides that damages for lost profits must ordinarily be based upon the operating history and profits of the plaintiff.  There are, however, cases where losses of profits in a new business may be recovered, but the propriety of such recovery is completely dependent upon evidence that the new business actually is comparable to the businesses on which the lost profits are based.

Based on this application of fairly well settled principles of California law, it will be extremely difficult to persuade a trial court to ignore a history of small profits and permit damages claims based on an opinion of the likely transformation of a small start-up into a giant market leader.  On the other hand, this case says nothing about recoveries of misappropriated profits when the wrongdoer is a competitor and the wrongful conduct involves misappropriation of intellectual property or other conduct so that the resulting damages can be measured by the wrongdoer’s income or profits.