Horizon Case Addresses “Causation Conundrum” in Departing-Employee Litigation

Horizon Case Addresses “Causation Conundrum” in Departing-Employee Litigation

Oral argument in Horizon Health v. Acadia Healthcare illustrates difficulties with proving lost profits damages when employment is at-will

Last week I wrote about a new Texas Supreme Court opinion that had to draw the line between sexual harassment and sexual assault. Just days later, the Texas Supreme Court confronted an even more difficult issue in oral argument in Horizon Health v. Acadia Healthcare: how to draw the line between reasonable assumption and speculation when an expert witness testifies about lost profits damages in a departing-employee case.

This is a difficult issue, because the typical departing-employee case involves at-will employment. Let’s assume a group of employees does all kinds of bad things before leaving to go to work for a competitor. And let’s assume the employer lost sales after the group left. Those facts are relatively easy for a jury to understand.

But this leaves out a critical issue that is harder for the average person to grasp: causation.  It’s not enough to prove the defendants did bad things and the plaintiffs were damaged. You have to prove that the bad things caused the damage. And you have to quantify the damage.

Let’s say the bad conduct is soliciting a key employee to join a competitor, and the damage is the loss of sales the key employee would have made for the company if she had not been solicited. The problem for the plaintiff is obvious: if the key employee is an at-will employee, she could have left the company at any time regardless of whether she was solicited. How do you quantify the amount of lost profits caused by the wrongful solicitation?

That, in simplified form, is the problem confronting the Texas Supreme Court in Horizon Health v. Acadia Healthcare. I call this the Causation Conundrum for departing-employee cases.

Facts of Horizon v. Acadia: the distilled version

Horizon was a somewhat complex case with multiple defendants, numerous causes of action, and a 55-page jury charge (see Court of Appeals opinion here). But the basic facts, in simplified form, follow a familiar pattern:

  • Horizon managed mental-health programs for hospitals.
  • Four of Horizon’s executives, the Saul group, began negotiating to join a Horizon competitor, Acadia, while they were still working for Horizon.
  • While still employed by Horizon, the Saul group solicited John Piechocki, a successful Horizon salesman, to work for the competitor.
  • The Saul group and Piechocki left Horizon to work for Acadia.
  • Before leaving Horizon, the Saul group said things in their emails that must have made their trial lawyers cringe later. Our departures will leave Horizon “dead,” they said, and our business strategy at Acadia will be “hurting Horizon early and often.”
  • The Saul group also did things that would not look good to the jury. Saul, for example, copied a massive amount of Horizon files from his work computer to an external hard drive before leaving Horizon.[1]

Given these facts, Horizon’s lawyers had a lot to work with on liability. But how could they prove the Saul group caused damage to Horizon by bringing Piechocki to the new company? And how could they quantify that damage?

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Emails about “hurting Horizon early and often” certainly didn’t help the defendants at trial

These challenges were compounded by a couple pesky facts. First, Horizon’s profits continued to go up after the employees departed, even exceeding Horizon’s own targets. Second, there was no evidence that any existing Horizon customer left and went to Acadia.

How could Horizon prove lost profits given all these difficulties? The answer is that Horizon tried to prove causation and damages the old-fashioned way: they hired an expert.

Horizon’s expert dares to pose hypotheticals and make assumptions

Horizon designated Jeff Balcombe, a qualified CPA, to testify on damages. Balcombe’s assignment was to quantify Horizon’s future lost profits resulting from the loss of Piechocki. In the words of the Court of Appeals:

Balcombe testified as to the “lost production” damages Horizon suffered as a result of the individual defendants’ wrongful actions. In doing so, he attempted to determine what would have happened but for the wrongful actions—as opposed to what actually happened—by considering (1) how long Piechocki would have remained an employee of Horizon but for the alleged wrongful conduct, (2) how many contracts Piechocki would have sold “but for being an employee of Horizon,” and (3) what the average profit for each of those contracts would have been had he remained with Horizon.[2]

The court’s interjection “as opposed to what actually happened” is dripping with skepticism. But in fairness to Horizon, let’s pause here to consider the nature of causation and damages in a lost profits case involving departing employees.

Proving lost profits damages necessarily requires entering a hypothetical world. To prove how the defendants caused your company to lose profits, you must ask the hypothetical question “what amount of profits would we have made but for the defendants’ wrongful conduct?” There is no other way to do it. So when Horizon’s expert tried to figure out what would have happened, he was doing his job.

The harder part for the damages expert is deciding what assumptions to make. Balcombe based his lost profits analysis on three assumptions:

  1. “Balcombe analyzed the average amount of time Horizon retained its higher-level employees and ‘conservatively elected to assume’ that Piechocki would have stayed at Horizon two or four more years but for the alleged wrongful conduct.”
  1. “Piechocki would have sold six contracts in each year he stayed, up to four years, but for the wrongful conduct because other Horizon salespeople sold four contracts per year.”
  1. “He concluded that $247,000 per year for each contract was ‘a conservative and reliable figure for a mature contract price.’”[3]

This is where the Court of Appeals thought the damages expert went wrong. “We conclude that Balcombe’s opinion was too speculative based on an analytical gap between the data and his opinion; thus, it was no evidence of lost profits suffered by Horizon.” For example, the assumption that Piechocki, an at-will employee, would have stayed employed by Horizon was “nothing more than speculation.” Experts are allowed to make assumptions, but the Court of Appeals found that Balcombe’s factual assumptions were “unsupported” and “not admitted into evidence.”[4]

Wait a minute. Does this mean lost profits damages are never recoverable in a case based on solicitation of an at-will employee? Is the Court of Appeals saying a damages expert is never allowed to make assumptions about how long an at-will employee would have stayed at a company? And does the plaintiff have to offer evidence during the trial to support every factual assumption made by the damages expert?

Surely the Court of Appeals did not mean to go that far. But where to draw the line? That is what the Texas Supreme Court will have to decide.

Fortunately I have the answers to these difficult questions

Does the fact that a wrongfully-solicited employee was also an at-will employee legally bar the company from obtaining lost profits damages? The answer has to be no. That the employee could have left at any time is certainly a relevant fact for the jury to consider, but it can’t mean that lost profits damages are never recoverable in such a case.

So, if lost profits damages are available in such cases, is it legally impermissible for a damages expert to make assumptions about how long a solicited employee would have stayed at the company?

Some might argue that making an assumption about how long an employee would have worked for the company is always speculative, and therefore impermissible. How can an expert know with absolute certainty how long an at-will employee would have stayed?

The answer, of course, is that he can’t. But absolute certainty is not required. The Texas Pattern Jury Charge asks the jury to decide the amount of lost profits “that, in reasonable probability, will be sustained in the future.” Reasonable probability is the standard.

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There is always some hypothetical element to the calculation of lost profits damages

So, even if the employment is at-will, a damages expert can make assumptions based on reasonable probability. That much is clear. But what assumptions?

Again, the question almost answers itself. The assumptions must be reasonable and must be supported by some evidence. No one would argue that an expert can base a damage calculation on unreasonable assumptions. And a damages expert should not be allowed to assume facts that have no evidence to support them.

A harder question is whether the facts assumed by the expert must be offered in evidence at trial. Texas Rule of Evidence 703, like the corresponding Federal Rule, allows an expert to reasonably rely on facts he has been made aware of, even if those facts are not admissible. But the Court of Appeals in Horizon was troubled by the fact Balcombe’s underlying information was not admitted into evidence.

The Texas Supreme Court also seemed troubled. In oral argument, one of the justices asked whether there was any evidence other than the expert testimony to support the amount of damages found by the jury. The Court of Appeals assumed the answer was no. But Horizon’s counsel argued to the Supreme Court that the answer was yes.

So perhaps the Texas Supreme Court will sidestep the entire expert testimony issue and find that there was other evidence sufficient to sustain the damages verdict.

It’s hard to predict what this Texas Supreme Court will do in a departing-employee lawsuit. This is a court that likes defendants and doesn’t like big speculative damage awards (see Southwestern Energy for example). But this is also a court that likes employers and non-competes.

If I had to predict, I would bet that the court’s aversion to speculative damage awards will outweigh its warm fuzzy feelings for employers, meaning a win for the defendants on the lost profits damages issue.

But it is a conundrum.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. He can’t remember the last time he wrote a post with as many rhetorical questions as this one.

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.

[1] Acadia Healthcare Co. v. Horizon Health Corp., 472 S.W.3d 74, 79-82 (Tex. App.—Fort Worth 2015, pet. filed).

[2] Id. at 88.

[3] Id. at 88-89.

[4] Id. at 89-90 (emphasis added).

Is That Your Final Answer? Lost Profits Damages in “Fiduciary Duty Lite” Cases

Is That Your Final Answer? Lost Profits Damages in “Fiduciary Duty Lite” Cases

Recent Case from Beaumont Court of Appeals Provides Opportunity to Test Your Knowledge of Texas Lost Profits Damages Law

This week I’m doing something a little different on Five Minute Law: a contest! Here are the official rules:

  1. Read the fact pattern and multiple-choice question below.
  1. You have one week to send me your answer and your explanation. You can do this in the Comments section, by email (zwolfe@fleckman.com), on the Twitter (@zachwolfelaw), on LinkedIn . . . you get the idea.
  1. For the next week you are not allowed to read Rhymes v. Filter Resources, Inc., 2016 WL 5395548 (Tex. App.—Beaumont Sept. 22, 2016). We are on the honor system!
  1. The Five Minute Law follower who gives the best answer will win a fabulous prize.*
  1. Non-lawyers get extra credit.

But first, the background. Last month, the Beaumont Court of Appeals issued a revised opinion on lost profits damages in Rhymes v. Filter Resources, a typical Fiduciary Duty Lite case.

Fiduciary Duty Lite? As I wrote here, that is the flavor of fiduciary duty that an employee owes to an employer under Texas law. As I explained, it doesn’t really make sense to call it “fiduciary” duty, but that’s the label Texas courts have used so we’re probably stuck with it.

Winneconne WI - 17 Feb 2016: Six pack of Miller Lite in cans.
“Fiduciary Duty Lite” allows an employee to make plans to compete

Essentially, Fiduciary Duty Lite says that an employee can prepare to compete with his employer while still employed but cannot actually start competing until after leaving the employer. If you suspect that maintaining this distinction is easier in theory than in practice, you may have a bright future in Fiduciary Duty Lite litigation.

But first you have to pass this quiz. Here are the facts of Rhymes in simplified form:

  1. Employee signs agreement with Company that says Employee will not solicit the Customers for one year after leaving Company.
  1. Employee speaks to attorney who provides formal legal opinion that non-solicitation clause is “not worth a s**t.”
  1. Employee gets access to Company’s double super-secret information, such as “products, prices, contracts, and financial, vendor, and customer information” (i.e. the same kind of information every sales employee gets).
  1. Employee, while employed by Company, prepares to compete with Company, including forming Competitor and communicating with Customers about Employee’s plans.
  1. But Employee testifies he did not actually “solicit” Customers before leaving Company (whatever that means).
  1. After leaving Company and joining Competitor, Employee quickly begins selling to his old Customers from Company.
  1. Company sues Employee and Competitor. Law firm partner who represents Company buys new Lexus. At trial, Company’s damages expert presents these numbers for Year 1:

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  1. Company’s expert also testifies that Company’s lost profits for a five-year period would be $622,800, using Year 1 as a base line and assuming a gradual decrease over Years 2-5 to account for risk and customer attrition.
  1. Employee and Competitor present no contrary expert testimony.
  1. Jury finds that Employee breached his Fiduciary Duty Lite and finds damages of $620,000 for Year 1 and zero dollars for Years 2-5.

Got it? Now, here is the multiple choice question.

QUESTION: Assuming there was sufficient evidence that Employee breached his Fiduciary Duty Lite, what is the right amount of damages to award to Company based on the jury verdict?

A. $620,000. This is the amount found by the jury, and there is some evidence to support it because Employee earned revenue of over $638,000 in Year 1.

B. $206,767. Lost profits damages must be based on net profits, not gross revenues, so there is insufficient evidence to award $620,000 for Year 1 but sufficient evidence to award $206,767 for Year 1.

C. $622,800. Company’s damages expert testified to this amount of net profits for Years 1-5 without contradiction.

D. Zero dollars. There is legally insufficient evidence to support the amount of damages found by the jury.

E. None of the above. A new trial should be ordered. (I added this choice strictly for my appellate ninjas.)

If you’re struggling, don’t feel bad. It took the Beaumont Court of Appeals two tries to come up with its final answer.

Now, may the odds be ever in your favor.

*Selection of the best answer will be in Five Minute Law’s sole discretion. “Fabulous” as used herein shall mean having a cash value of greater than $5.00. 

UPDATE – Answers and Explanations:

Here’s one important clarification: you are allowed to suggest a “remittitur,” which means giving the winning party the choice of a lower amount of damages or a new trial. With that clarification, the best answer–and the answer ultimately chosen by the Beaumont Court of Appeals in this revised opinion–is B. But you could make a plausible case for each of these answers.

A. $620,000. To support this answer you could cite the principle that the jury’s answer must be upheld as long as there is some evidence to support it. In fact, this was the answer the Beaumont Court of Appeals chose in its original opinion, reasoning that this amount was within the range of evidence presented at trial. But the problem with this answer is that the jury’s answer on damages was specifically broken down by time period, and there was no evidence that the Company would have made net profits of $620,ooo during Year 1.

B. $206,767. There was evidence that this was the amount of net profits for Year 1. For this reason, this was the answer ultimately chosen by the Beaumont Court of Appeals (in a revised opinion), suggesting a remittitur of this amount.

C. $622,800. There was some evidence to support this amount–testimony from the Company’s damages expert–but the problem with this answer is that the jury is free to reject even un-contradicted expert testimony.

D. Zero dollars. It is true that there  was legally insufficient evidence to support the amount of damages found by the jury. But when there is evidence of some amount of damages, the Court of Appeals typically will not reverse and render judgment for the defendant, but will reverse and remand for a new trial. Which leads to . . .

E. None of the above – order a new trial. The Court of Appeals could have chosen this answer, because there was insufficient evidence to support the amount of damages awarded by the jury. But this is why the remittitur procedure exists, to give the Court of Appeals the more efficient option of awarding a smaller amount of damages rather than subjecting the parties to the time and expense of a new trial.

Thank you for playing!

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Zach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn has offices in Austin, Houston, and The Woodlands. He made up the part about the Lexus.

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.

Southwestern Energy: Texas Supreme Court “Clarifies” Lost Profits Damages in Oil and Gas Trade Secrets Case

Southwestern Energy: Texas Supreme Court “Clarifies” Lost Profits Damages in Oil and Gas Trade Secrets Case

Proving damages in a trade secrets lawsuit—or any kind of business litigation—often involves having an expert witness calculate an amount of lost profits. The expert does not have to calculate the lost profits with exact certainty. Only “reasonable certainty” is required, and the expert often has to make reasonable estimates or approximations.

Let’s say the expert estimates that profits would have averaged 3% of revenues, but there was information available from which the expert could have calculated a more precise percentage—maybe 2.79%. If the jury awards damages that equal 3% of revenue, will the verdict stand? This, in simplified terms, was the situation the Texas Supreme Court recently addressed in Southwestern Energy v. Berry-Helfand.[1]

The trade secret in Southwestern Energy was a confidential map of potentially profitable oil and gas “sweet spots” that an engineer painstakingly constructed from years of research. The jury found that the past profits from use of the trade secret were $11,455,000. This number happened to equal exactly 3% of the defendant’s revenue from drilling the successful wells. The Texas Supreme Court ruled that there was sufficient evidence to support some amount of lost profits damages, but insufficient evidence to support the 3% figure. The court therefore sent the case back for a new trial.

So what does Southwestern Energy mean for lawyers, clients, and expert witnesses in trade secrets litigation, oil and gas litigation, or any kind of litigation involving claims of lost profits?

The opinion is so detailed that it is tempting to dismiss it as too fact-intensive to provide any general guidance. But that would be a mistake. Putting aside the complexity of the case, the Texas Supreme Court’s message is this: an expert’s calculation of lost profits damages doesn’t have to be exact, but more precision is required if the available information makes more precision possible.

The key piece of data in the Southwestern Energy case was the “Petrohawk agreement.” Plaintiff first provided the confidential “sweet spot” information to Defendant pursuant to a non-compete and confidentiality agreement. After Defendant passed on the opportunity (or so Plaintiff thought), Plaintiff signed an agreement to provide the map to another company, Petrohawk, in exchange for a share of revenue.  The Petrohawk agreement had a complicated formula for calculating Plaintiff’s compensation; a 3% overriding royalty interest was just one component of the formula.

Using this third-party agreement as a benchmark for lost profits damages was fine, but if Plaintiff was going to rely on this methodology, she had to use actual—not oversimplified—numbers.  The court said:

In trade-secret cases, a measure of uncertainty is tolerated, and to an extent, unavoidable. However, when there is objective evidence from which more certainty can be gleaned, it is incumbent on the plaintiff to produce that evidence. An estimate or an average based on a small sample may be sufficient in some cases, but not in this case. Because the actual overriding royalty interest on the disputed wells could have been determined under the methodology of the exemplary transaction, applying 3% across the board paints an incomplete and misleading picture about the royalty terms a willing buyer and seller would negotiate.

Thus, the fact that the expert could have used the formula in the Petrohawk agreement to perform a more precise calculation made it improper for the expert—or the jury—to calculate damages based on an oversimplified 3% formula.

To explain why the evidence did not support the jury’s 3% calculation, the court used this example:

To illustrate, if Helfand [the engineer] owned a trade secret vital to the making of widgets and XYZ widget company misappropriated the information to make 3,000 widgets, a prior licensing agreement with a third party involving a licensing fee of $2 per widget would be strongly probative of a $2 reasonable royalty. But if Helfand previously negotiated a licensing fee of $1 on the sale of small widgets, $2 for medium widgets, and $3 for large widgets, an average of $2 under that deal would be inadequate to establish the value of a reasonable royalty for 3,000 widgets of varying sizes. What if XYZ only made small widgets? Depending on consideration of the other factors bearing on a reasonably royalty, the $2 average could vastly overstate the royalty a willing buyer and seller would negotiate.

True, an average can overstate (or understate) the actual amount. But financial experts often use averages or approximations in their calculations, especially when calculating hypothetical lost profits. As a practical matter it can be difficult for lawyers and experts to know just how detailed a lost profits calculation has to be. A lost profits calculation can always be attacked on the ground that it could have been a little more detailed.

In the wake of Southwestern Energy, expect more arguments in lost profits cases about whether a damages expert properly took into account all the available information. If you represent the defendant in a lost profits case, look for information available to the plaintiff’s expert that may have been ignored or oversimplified, and get the expert to admit she could have used the information to refine the calculation but did not do so.

If you represent the plaintiff, you have to strike a difficult balance. You want to simplify without over-simplifying. The lost profits calculation needs to be simple enough that you can make it compelling and understandable to the jury, but not so simple that it ignores available information that could have been used to perform a more precise calculation. This—in simplified form—is the lesson of Southwestern Energy.

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cropped-head-shot-photo-of-zach-wolfe.jpg

Zach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn has offices in Austin, Houston, and The Woodlands.

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.

[1] Sw. Energy Prod. Co. v. Berry-Helfand, No. 13-0986, 2016 WL 3212999 (Tex. June 10, 2016).