By Zach Wolfe
Horizon v. Acadia finds expert’s assumptions too speculative to support lost profits verdict
Mamas, don’t let your babies grow up to be damages experts in Texas.
That’s the refrain CPAs may feel like singing after the Texas Supreme Court recently raised the bar for proving lost profits damages in trade secrets lawsuits—again.
It started in 2016 with Southwest Energy v. Berry-Helfand, where the damages expert calculated lost profits for misappropriation of oilfield trade secrets by assuming a flat reasonable royalty rate of 3%, which was consistent with industry standards. As I reported here, the Texas Supreme Court said this opinion was faulty because the information available to the expert would have allowed for a more precise calculation.
More recently, the Texas Supreme Court addressed trade secrets damages again in Horizon Healthcare v. Acadia Healthcare. The court rejected the expert’s calculation of lost profits damages because it was based on assumptions about causation and profitability of contracts that were not supported by the evidence.
Horizon had somewhat complicated facts, but in essence it was a typical departing employee case where a management group left a company to work for a competitor:
- Horizon provided contract management services to healthcare providers
- Four Horizon executives, the “Saul group,” signed non-competes with Horizon.
- The Saul group began negotiating to join Acadia, a Horizon competitor.
- The Saul group solicited Piechocki, a successful Horizon salesman, to join them in moving to Acadia.
- Shortly before leaving, Saul secretly copied a “massive amount” Horizon documents to an external hard drive.
- The copied documents included contracts, financial models, and lists of Horizon’s sales leads.
- After leaving Horizon to join Acadia, the former Horizon employees began competing with Acadia and soliciting Acadia’s clients.
If you think these facts are bad, you should read some of the emails recounted in the Court of Appeals opinion. But bad facts don’t necessarily make a good damage model.
The facts concerning damages were a mixed bag. Here is what Horizon’s damages expert had to work with:
- After leaving Horizon, Piechocki used Horizon’s financial models to win a contract from Westlake.
- Westlake was on Horizon’s “lead list” but was not a Horizon client.
- Horizon did not lose any existing clients to Acadia.
- Piechocki was an at-will employee without a non-compete who could have left Horizon at any time.
- Piechocki was Horizon’s best salesperson.
So, if you represent Horizon, how do you work with your expert to construct a defensible damages theory?
Keep in mind that Texas law does not require lost profits damages to be “susceptible of exact calculation.” Lost profits must be calculated with “reasonable certainty.”
As I explained here when I reported on the oral argument in Horizon, calculating lost profits damages requires entering a hypothetical world. The question is how much profit the plaintiff would have earned if the defendant had not used the plaintiff’s trade secrets, breached the non-compete, etc. This necessarily requires making assumptions.
Assumptions made in Horizon v. Acadia – the Westlake contract
Take the Horizon case as an example. To calculate lost profits based on the Westlake contract, Horizon’s expert assumed that Westlake would have signed a similar contract with Horizon if it had not signed the contract with Acadia. Based on that assumption, the expert calculated lost profits of $898,000 on the Westlake contract, and the jury included that amount in its verdict.
Was it a mistake for the expert to assume Horizon would have won the Westlake contract? Not necessarily. To prove causation, Horizon had to show it would have obtained the contract but for the defendants’ wrongful conduct. It was an essential assumption.
But was it a reasonable assumption? The challenge for the plaintiff’s lawyer is that there must be evidence to support the assumption. The strategic question is how to support the assumption: with expert opinion or with some other evidence?
Often it will be better to prove the assumption with other evidence. Financial experts are good at crunching numbers, so it’s pretty easy for them to calculate the amount of profits that would have been made on a contract. But whether the plaintiff would have gotten a contract is another story. On that issue, a CPA doesn’t necessarily have any special insight that an ordinary jury member doesn’t have.
The problem for Horizon was not so much that the expert made the assumption, but that there was insufficient evidence to support the assumption. The Texas Supreme Court said it was “pure speculation” to assume Horizon would have won the Westlake contract if the defendants had not. This was especially true given the fact that there was no evidence that Horizon would have included a specific $150,000 incentive that Acadia included in its bid. Thus, “Horizon failed to establish the fact of damages relating to the Westlake contract with reasonable certainty.”
Assumptions made in Horizon v. Acadia – Piechocki’s future contracts
The Westlake contract was not the only one lost. Horizon’s loss of Piechocki, its top salesperson, also caused Horizon to lose the future contracts Piechocki would have obtained if he had stayed at Horizon.
To quantify the lost profits for these hypothetical contracts, Horizon’s expert had to make assumptions about three issues:
(1) how long Piechocki would have stayed at Horizon
(2) how many contracts Piechocki would have generated at Horizon
(3) the amount of profits Horizon would have made on those contracts
Based on ten years of Horizon’s retention data for employees in Piechocki’s position, the expert provided two alternatives: Piechocki would have stayed either two years or four years. This was only an assumption, because Piechocki was an at-will employee not bound by a non-compete or any employment agreement. The court found there was some evidence to support this assumption, including testimony by Piechocki himself that suggested he would have stayed at Horizon if not solicited to work for Acadia.
There was also some evidence to support the assumption that the loss of Piechocki caused Horizon to lose future sales. This included an email from one of the defendants saying “I cannot think of a bigger body blow relative to impacting future new sales for Horizon than to get Piechocki out of there.”
But the Texas Supreme Court said there was no evidence to support the third assumption: the profitability of contracts Piechocki sold or would have sold had he remained at Horizon. In the court’s view, the specific problem with the expert’s calculation of lost profits was that it was based on the historical profitability of Horizon contracts generally, rather than the historical profitability of Piechocki’s Horizon contracts. The court held that the absence of evidence showing the profit associated with Piechocki’s sales was “fatal” to Horizon’s lost profits claim.
A trend of nit-picking expert calculations of lost profits damages
I see the logic in the Horizon court’s criticism of the expert’s third assumption, but isn’t this getting a little nit-picky? The evidence of Horizon’s contract profitability generally seems like at least a scintilla of evidence of the profit Horizon would have made on Piechocki’s contracts. Remember that all it takes to uphold a jury verdict on appeal is some evidence (in theory).
But at least the Texas Supreme Court has been consistently nit-picky about lost profits damage theories lately. As mentioned earlier, the court did the same thing in Southwest Energy v. Berry-Helfand, finding that the reasonable royalty rate assumed by the expert was not precise enough.
So what practice pointers can prudent practitioners pry from this pair of persnickety opinions? First, if you represent the plaintiff in a lost profits case and you hire a damages expert, you need to work closely with the expert to identify the key assumptions underlying the expert’s calculations, and to evaluate whether the evidence will support those assumptions. If you don’t have the evidence, find another theory.
Second, the at-will status of departing employees is not necessarily fatal to proving causation. Yes, the Texas Supreme Court ultimately found there was insufficient evidence to support Horizon’s damage theory, but its opinion makes clear that an expert can make a reasonable assumption about how long an at-will employee would have stayed at the company, provided there is evidence to support the assumption.
That brings us to the third tip: Whatever assumptions the damages expert is going to make, the plaintiff’s lawyer must be prepared to offer evidence to support those assumptions.
Zach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands. He correctly predicted that the Texas Supreme Court would not like the lost profits award in Horizon.
These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.