Blythe v. Bell,
2013 NCBC 8.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
COUNTY OF CATAWBA 11 CVS 933
WILLIAM A. B. BLYTHE (individually )
and in his capacity as shareholder) and )
DRYMAX SPORTS, LLC, )
)
Plaintiffs, )
)
v. )
ORDER
)
ROBERT E. BELL III, VIRGINIA )
BELL, NISSAN JOSEPH and )
HICKORY BRANDS, INC., )
)
Defendants. )
)
{1} THIS MATTER is now before the court on Defendants’ Motion to
Exclude Testimony from William A. Barbee (“Barbee Motion”) and Defendants’
Motion to Strike or Preclude Expert Report of Charles M. Phillips (“Phillips
Motion”).
Moore & Van Allen, PLLC by James P. McLoughlin, Jr., Mark A. Nebrig,
Benjamin P. Fryer, Frank E. Schall, and Christopher D. Tomlinson for
Plaintiffs William A. B. Blythe and Drymax Sports, LLC.
Ellis & Winters LLP by Andrew S. Chamberlin and C. Scott Meyers, and
Young, Morphis, Bach & Taylor, LLP by Paul E. Culpepper for
Defendants Robert E. Bell III, Virginia Bell, Nissan Joseph, and Hickory
Brands, Inc.
Gale, Judge.
I. NATURE OF MATTER BEFORE THE COURT
{2} This litigation has spawned multiple motions upon which the court has
issued written orders, including most recently orders dated December 10, 2012 and
February 4, 2013 ruling upon three summary judgment motions. Each of those are
available at the court’s website at www.ncbusinesscourt.net, and are referenced for
facts and case history not repeated in this Order.
{3} Plaintiffs seek to have Drymax Sports, LLC (“Drymax”) recover profits
it contends it lost as a result of Defendants’ failures to abide by agreements and
honor their fiduciary duties, which would have afforded sales and opportunities that
were instead diverted to Hickory Brands, Inc. (“HBI”). Individual Plaintiff William
A.B. Blythe (“Blythe”), HBI, Nissan Joseph (“Joseph”) who is HBI’s former
president, and Robert E. Bell III (“Rob Bell”) and Virginia Bell are Drymax’s
members. The Bells have controlling ownership of HBI.
{4} Plaintiffs seek to prove and quantify those alleged lost profits through
the expert testimony of William A. Barbee (“Barbee”). Barbee prepared both an
Initial Report dated August 1, 2012 and a Rebuttal Report dated September 20,
2012, and Defendants deposed him on those reports on August 27, 2012, and
October 3, 2012. Defendants moved to exclude Barbee’s testimony on October 23,
2012. As a part of their challenge, Defendants submit reports from their own
experts, who contend that Barbee’s damage determination is based on marketing
opinions which Barbee is not qualified to make and which he reached based on an
unreliable methodology. Plaintiffs do not offer Barbee as a marketing expert, but
contend that his projected additional sales allow for the reasonable estimates he has
made, and making such estimates is a valid exercise by a qualified damages expert.
Plaintiffs designated Charles M. Phillips (“Phillips”) as a rebuttal expert solely to
provide testimony that the methodology Barbee used is proper. Phillips does not
himself intend to testify as to the amount of Plaintiffs’ damages. Defendants
challenge the designation of Phillips as late and further argue that it is improper
for Plaintiffs to have one expert vouch for another in this manner.
{5} Defendants ground their Barbee motion primarily on Howerton v. Arai
Helmet, Ltd., which charges the trial court with preliminary questions concerning
the qualifications of an expert or the admissibility of his testimony using a threepart test which inquires: “(1) Is the expert’s proffered method of proof sufficiently
reliable as an area for expert testimony? (2) Is the witness testifying at trial
qualified as an expert in that area of testimony? (3) Is the expert’s testimony
relevant?” 358 N.C. 440, 458,
597 S.E.2d 674, 686 (2004). This test embodies and
applies the requirements for expert testimony defined by North Carolina Rule of
Evidence 702(a). Defendants emphasize that Barbee is not a qualified marketing
expert and that without this expertise the method Barbee used is not sufficiently
reliable to pass the Howerton test. After careful examination, the court concludes
that the motions turn instead on whether Barbee has a sufficiently certain basis for
following the assumptions he utilized in the methods he adopted for his analysis.
Barbee is well qualified in the field of business valuation and financial forensics,
and the methods he invoked are well recognized in those fields for quantifying
damages. However, those methods, as well as the North Carolina standards for
proof of lost profits, see, e.g., N.C.P.I. Civ. 517.20 and cases cited, require that
projected lost revenues must not be based on conjecture or speculation. The court
concludes that Barbee’s determination of loss based on actual sales and costs does
not require such assumptions, but his projection of additional lost revenues, either
past or present, does rest on conjecture and speculation and should therefore be
excluded. As such, the issue is more one of relevance than of examining the
reliability of the methods Barbee invokes. And, to the extent that Barbee’s
projections can be argued to have sufficient minimal indicia of certainty, the court
concludes that any probative value of his testimony would be outweighed by the
danger of unfair prejudice and unfair confusion of issues. Accordingly, his
testimony should be limited under North Carolina Rules of Evidence 402, 403 and
702 to his testimony regarding losses to date as based on actual sales made and
costs incurred. Accordingly, the Barbee Motion is GRANTED in part and DENIED
in part.
{6} Because the court finds that Barbee purported to base his
determinations on recognized methodologies but had an inadequate basis to do so, it
would be unnecessary and unfairly redundant for Plaintiffs to seek to bolster
Barbee through Phillips’ testimony. The court is not disputing that a damages
expert can rely on reasonable estimates of additional sales as long as there is an
adequate basis for such assumptions. Rather, the court concludes that there is no
such adequate basis. That is a gate keeper function properly exercised by the court
to which Phillips’ testimony would not contribute. Accordingly, the court’s ruling
effectively moots the Phillips Motion, but if a ruling is required, the Phillips Motion
is GRANTED. It may well be also that the court’s ruling will make certain
testimony from Defendants’ expert irrelevant as well.
II. DISCUSSION
{7} Barbee is Director of Litigation and Forensic Services for Greer &
Walker, LLP, of Charlotte, North Carolina. Defendants do not really challenge
Barbee as unqualified to testify as an expert in business valuation and the
quantification of financial losses. They rather contend that he has strayed beyond
his area of expertise into the marketing field, and he has created the marketing
assumptions critical to his opinions without having the expertise to do so.
{8} Barbee bases his testimony on the contested premise that the
Operational Agreement is an enforceable operative agreement controlling the sale
of socks using the Drymax Process. He assumes that the Operational Agreement
calls for Drymax to receive sales dollars rather than a royalty and Drymax would
then pay HBI the costs of goods plus a 20% markup. Barbee contends that had the
Operational Agreement been followed, revenues Drymax would have enjoyed would
have been adequate to repay the loan to HBI, and Drymax would have reasonably
invested additional funds in marketing necessary to develop the Drymax brand and
increase sales. He recaptures sales revenues from HBI and calculates the costs of
goods upon which HBI would have been paid by Drymax. In addition he then
projects what additional sales would have been made to date as well as additional
future sales that would be made with the additional revenue adequate to support
marketing. Barbee examined a range of the branded apparel industry and
evaluated Drymax sales representative testimony to support his conclusion that
there was abundant opportunity for such additional sales. Based on his overall
assessment of these various factors, rather than on a specific calculation, Barbee
opines as to a growth percentage Drymax would enjoy, and having stated that rate
of growth, he calculates additional sales and adjusts them for the expenses
necessary to generate them, including the marketing dollars he assumed would be
available and contributed to marketing efforts.
{9} Barbee then separates his opinions of loss into three categories. First,
he determines the profits that would have been enjoyed by Drymax had revenue
from actual sales been booked at Drymax rather than at HBI. He opines that
Drymax has lost approximately $3.3 million in this regard from 2007 to May 31,
2012, and that the figure will be updated to the date of trial based on actual further
sales. He had sufficient records available to determine costs of goods as he
employed the term. As to this particular calculation, Defendants challenge Barbee’s
definition of “costs of goods,” just as they challenge the basic assumption that the
Operational Agreement applies to the sale of socks in the first instance. But
Defendants do not seriously challenge Barbee’s qualifications and methodology as to
this component of damages. Nevertheless, they say even this opinion should be
excluded because Barbee has become so enmeshed in advocating for the adoption of
Blythe’s position on disputed facts that he can no longer be said to be an objective
expert. Plaintiffs respond to this argument by attacking the in limine motion to
exclude as an improper disguised effort to secure summary judgment, a tactic
foreclosed by Howerton. As to this initial opinion Barbee offers, the court
concludes: (1) Barbee is clearly qualified to present expert testimony regarding
damage calculations so long as he does so using a recognized methodology; (2)
Barbee utilized a recognized methodology in this initial determination; (3) while the
facts upon which Barbee relies are clearly contested, they are based on the
evidentiary record and do not require speculation or conjecture, because they are
based on actual sales and actual or reasonably assumed additional costs; (4) these
facts and the manner in which Barbee applies them can be fairly and adequately
attacked by cross-examination; and (5) Barbee should not be foreclosed from
presenting his opinion because of improper or excessive bias. Accordingly, as to this
initial opinion, the Barbee Motion is DENIED.
{10} Barbee’s other two damage determinations include projecting lost
revenues from additional past or present socks sales, which Barbee contends would
have occurred “but for” Defendants’ wrongful acts. These projections are the
primary focus of the Barbee Motion, and Plaintiffs offer the testimony of rebuttal
expert Phillips to respond to Defendants’ challenge to Barbee’s methodology to
arrive at those projections.
{11} Barbee first projects an increase in Drymax’s past sales that would
have occurred had Drymax been afforded the revenue stream Barbee assumes was
improperly diverted to HBI. He assumes those revenues would have repaid HBI’s
loan and then some of the revenue would have been spent on marketing. He then
recalculates Drymax’s sales with additional sales revenue in 2009 and 2010, which
in turn leads to a recalculation of Drymax’s growth rate in sales. Barbee then
opines as to a future growth rate in sales that would result from additional
marketing using additional sales revenue. He does not actually calculate the
growth rate but estimates a growth rate based on his overall consideration of the
evidentiary record and his own review of the branded apparel industry. Once he
assumes a growth rate, he is able to calculate additional sales revenue and
determine overall lost profits, reduced to present value. He opines that the present
value of this loss is $7.4 million.
{12} Using the same assumed growth rate and additional revenues, Barbee
alternatively calculates Drymax’s loss in business valuation. He discounted future
lost profits based on a weighted average cost of capital and employed the Income
Approach of valuation, with a “build up” using opportunity cost and risk. He
calculated an overall loss of value of Drymax at $7.5 million. He then performed a
simple calculation to calculate the 40% of this loss Blythe personally suffered as a
minority owner, which is $2.9 million.
{13} In addition to challenging Barbee’s lack of expertise to estimate sales
revenue based on marketing opportunity, Defendants complain that they cannot be
expected to rely on any ability to cross-examine Barbee because he either refuses to
or cannot define the specific method or calculation demonstrating how he
established his assumed growth rate in Drymax sales, but rather simply forms an
opinion as to a fair growth rate based on his review of the entire record. Plaintiffs
counter that Barbee does not profess to be a marketing expert and that projecting
further growth rates based on past performance and general market trends is an
accepted reliable methodology and, in fact, one used regularly by Defendants’ own
experts. Plaintiffs also argue that Defendants unfairly and inaccurately assert that
Barbee attempted to tie specific additional sales to specific additional marketing
dollars, when, in fact, Barbee did no more than projecting a reasonable future
growth rate based on past performance. He looked to testimony from Drymax sales
representatives and industry data only to legitimate the clear opportunity for
sustained growth. Plaintiffs contend that thus projecting a future growth rate is
well within the realm of typical of accepted expert testimony in the field.
{14} The question then becomes whether Barbee has a basis for projecting
additional sales that allows them to be stated with reasonable certainty rather than
basing them on conjecture or speculation. As stated, the North Carolina Supreme
Court in Howerton stated three questions a trial court should examine: “(1) Is the
expert’s proffered method of proof sufficiently reliable as an area for expert
testimony? (2) Is the witness testifying at trial qualified as an expert in that area of
testimony? (3) Is the expert’s testimony relevant?” 358 N.C. at 458,
597 S.E.2d at
686.
{15} The court first examines the field in which Barbee claims expertise and
the methodology recognized in his field. Barbee is a CPA, member of the American
Institute of Certified Public Accountants (“AICPA”), and has been certified by the
AICPA in the field of business valuation and financial forensics. As indicated
above, the court concludes that Barbee is well qualified in the field of damages
calculations. The court further concludes that he has expertise as an expert
qualified to project lost revenues, provided, however, that he does so in accordance
with the standards and methodologies recognized as reliable in his field.
{16} The court then has critically examined the methodologies which
Barbee employed. Barbee is certified by the AICPA and can be expected to adhere
to its standards. While those standards may be somewhat different and perhaps
more relaxed for forensic testimony compared to attestation opinions, the AICPA
recognizes limitations that must be imposed on methods used to estimate lost
revenues. It has published a guideline on how to do so. Exhibits offered in
connection with the Motions include Richard A. Pollack, et al., American Institute of
Certified Public Accountants, Calculating Lost Profits (2006). This guideline
discusses accepted methodologies and recognizes that
damages for lost profits are recoverable only if the plaintiff can prove
the damages related to lost profits are reasonable and that they have
been calculated using reliable factors without undue speculation . . .
The calculation of lost profits does not require precision, and an
estimate of damages can be made. However, the loss cannot be based
on speculation.
Id. at Ch. 8 ¶¶ 52–53. As discussed below, this is similar to restrictions
imposed by the North Carolina evidentiary standard for recovering lost
profits.
{17} The AICPA publication further describes four accepted methods
normally used to calculate lost revenues. They are: (1) the “Before and After”
method, which examines the plaintiff’s prior experience and its experience after the
defendant’s acts to make a calculation in the nature of a “but for” determination; (2)
the “Yardstick” or “Benchmark” method which may look, among other things, at the
experience of similar companies or industry averages, provided that the plaintiff is
sufficiently comparable to the “yardstick,” and which inquiry may also include
determinations based on pre-litigation projections; (3) a calculation based on an
underlying contract which defines the method for doing so; and (4) and an
accounting of defendant’s profits. Id. at Ch. 10 ¶¶ 61–71.
{18} Here, Barbee combines a Before and After approach and a Yardstick
approach. As such, he invoked methods which are well recognized and accepted as
reliable. The issue is whether he has applied them properly, and particularly
whether he used estimates with the degree of reliability that methodologies
demand. The court concludes that he does not have a sufficiently adequate basis to
project additional sales, even if he has an adequate basis to define a baseline from
past performance. The court also concludes that he has not done sufficient analysis
to compare Drymax to the branded general apparel industry, including adjusting for
market variables. Barbee may have an adequate basis to conclude that there was
substantial upside potential that has been lost, based on testimony from Drymax
sales representatives, but he strays into conjecture and speculation when he
attempts to quantify those opportunities. In short, the court concludes that Barbee
has invoked well recognized methodologies but he does not have a sufficient
evidentiary basis upon which to utilize them. A similar conclusion arises when
applying established North Carolina case precedent dealing with proof of lost
profits.
{19} North Carolina allows a corporation to recover lost profits occasioned
by a defendant’s wrongful conduct so long as they can be proven with reasonable
certainty. Olivetti Corp. v. Ames Bus. Sys., Inc., 319 N.C. 534,
356 S.E.2d 578
(1987). But in order to be admitted, evidence of such loss must qualify as
reasonably certain. Parris v. H. G. Fischer & Co.,
221 N.C. 110, 112,
19 S.E.2d 128,
129 (1942). While the courts do not demand mathematical certitude in calculating
lost profits, they do not countenance conjecture or speculation, and conjecture or
speculation does not become admissible simply because it is presented by an expert.
Castle McCulloch v. Freedman,
169 N.C. App. 497, 501-03,
610 S.E.2d 416, 420-21,
aff’d per curiam
360 N.C. 57,
620 S.E.2d 674 (2005).
{20} The admissibility of testimony of lost profits and the determination of
whether the testimony passes from conjecture to reasonable certainty is determined
from case to case and the evidentiary standard does not evolve into a rigid formula.
Iron Steamer, Ltd. v. Trinity Rest. Inc., 110 N.C. App. 843, 848, 431 S.Ed.2d 767,
770 (1993). While the amount of damages is generally reserved for the jury, the
court determines as a matter of law whether the evidence would allow a jury to
calculate lost profits with reasonable certainty.
Id.,431 S.E.2d at 771; see also Old
Well Water v. Collegiate Distrib., 2002 Lexis 1939, at *10 (N.C. Ct. App). An expert
may use market analysis, business records of similar enterprises, Iron
Steamer,
supra, and sales figures from businesses of a similar size, location and type of
product, McNamara v. Wilmington Mall Realty Corp.,
121 N.C. App. 400, 411, 466
S.Ed.2d 324, 331 (1996), but the testimony must still “pass the realm of conjecture,
speculation, or opinion not founded on facts, and must consist of actual facts from
which a reasonably accurate conclusion regarding the cause and the amount of the
loss can be logically and rationally drawn.” Overnite Transp. Co. v. Int’l
Brotherhood of Teamsters,
257 N.C. 18, 30,
125 S.E.2d 277, 286 (1962).
{21} After having thoroughly studied the record and the respective briefs
and arguments in detail, the court concludes that Barbee’s calculation of additional
lost revenues has not “passed the realm of conjecture or speculation.” Proving that
there were additional sales opportunities does not necessarily provide a basis for
then opining as to the extent of additional sales that would come from those
opportunities. Barbee identified the testimony of certain sales personnel which he
believed demonstrated that Drymax socks in particular presented an opportunity
for wide market acceptance with marketing support, and large upside potential
sales numbers. (Barbee Rebuttal Report 4–8, attached to Br. in Supp. of Defs.’ Mot.
to Exclude Test. of William A. Barbee.) However, this testimony does not provide
an anchor for the sales revenues Barbee projects. One of them, Michael Isaacson,
indicated he had sold something in the range of $12,000–15,000 of Drymax socks to
two dealers, but in his opinion, with a full marketing effort he could have sold more
than $500,000. Another, Brett Richardson, testified he thought a reasonable 5 year
plan would call for sales of $5 million. Several salesmen testified to the unique
qualities of the Drymax socks which should lead to a large market acceptance. The
court concludes that this testimony is, at best, only slightly less speculative than
the testimony refused by the North Carolina Court of Appeals in Old Well Water v.
Collegiate Distrib., supra.
{22} Barbee may have properly looked to trends within his branded apparel
industry segment in his effort to do a market based analysis. However, he did not
further demonstrate an adequate basis to conclude that companies within that
segment were fairly comparable to Drymax, either as product lines or otherwise..
It was speculative to assume that Drymax could be expected to perform within that
industry as large, multi-product line companies such as VF Corporation (Northface),
Columbia Sportswear, Deckers Outdoor Corp. (Teva), and Adidas.. Likewise,
Barbee engages in speculation when opining that Drymax could establish additional
sales outlets that would each achieve sales comparable to Drymax’s largest and best
customer.
{23} In sum, the court concludes that Barbee invoked methodologies that
are themselves reliable, but he failed to satisfy the prerequites they demand, and
he testimony fails to satisfy evidentiary standards for proof of lost profits. The
court then concludes that Barbee’s testimony as to additional sales revenues does
not have a sufficient basis to be considered probative evidence, and he should not be
permitted to testify as to losses other than those he determined on the basis of
actual sales to the date of trial. The court’s determination is made both in the
exercise of its discretion and on its understanding and application of the standards
expressed by the North Carolina Supreme Court in Howerton, which are, in turn,
reflected in the provisions and Rules 104, 402, and 702 of the North Carolina Rules
of Evidence.
{24} Because the court does not base its determination on Mr. Barbee’s
choice of methodology but rather the lack of reasonable certainty in the
assumptions used to employ his methods, any testimony from Phillips would not be
appropriate or necessary as rebuttal testimony. As a result, the court need not
further determine whether Plaintiffs timely designated Phillips pursuant to the
case management deadlines for designating experts or the nature of their
testimony.
{25} The court further concludes that the probative value, if any, of
testimony from Barbee as to additional lost sales would be outweighed by unfair
prejudice and unfair confusion, and any testimony from Phillips would be
unnecessary and unduly cumulative. Accordingly, even if otherwise admissible,
which the court believes it is not, the court in its discretion concludes that such
expert testimony should be excluded pursuant to North Carolina Rule of Evidence
403.
III. CONCLUSION
{26} For the reasons expressed above, the Barbee Motion is GRANTED in
part and DENIED in part and the Phillips Motion is deemed to have become
MOOT, or if not moot is GRANTED.
IT IS SO ORDERED this 4th day of February, 2013.
