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Sargon Enterprises, Inc v. University of Southern

November 26, 2012

SARGON ENTERPRISES, INC., PLAINTIFF AND APPELLANT,
v.
UNIVERSITY OF SOUTHERN CALIFORNIA ET AL., DEFENDANTS AND APPELLANTS.



Ct.App. 2/1 B202789, B205034 Los Angeles County Super. Ct. No. BC209992

The opinion of the court was delivered by: Chin, J.

A small dental implant company that had net profits of $101,000 in 1998 has sued a university for breach of a contract for the university to clinically test a new implant the company had patented. The company seeks damages for lost profits beginning in 1998, ranging from $200 million to over $1 billion. It claims that, but for the university's breach of the contract, the company would have become a worldwide leader in the dental implant industry and made many millions of dollars a year in profit. Following an evidentiary hearing, the trial court excluded as speculative the proffered testimony of an expert to this effect. We must determine whether the court erred in doing so.

We conclude that the trial court has the duty to act as a "gatekeeper" to exclude speculative expert testimony. Lost profits need not be proven with mathematical precision, but they must also not be unduly speculative. Here, the court acted within its discretion when it excluded opinion testimony that the company would have become extraordinarily successful had the university completed the clinical testing.

We reverse the judgment of the Court of Appeal, which had held the trial court erred in excluding the testimony.

I. Factual and Procedural History

Because neither party petitioned the Court of Appeal for rehearing, much of this summary of the factual and procedural history is taken from that court's majority opinion. (See Richmond v. Shasta Community Services Dist. (2004) 32 Cal.4th 409, 415; Cal. Rules of Court, rule 8.500(c)(2).)

A. The Lawsuit and First Appeal

In 1991, plaintiff Sargon Enterprises, Inc. (Sargon) patented a dental implant that its president and chief executive officer, Dr. Sargon Lazarof, had developed. The United States Food and Drug Administration approved the implant, which meant it could be sold and used in the United States. As the Court of Appeal opinion described it, Sargon's implant "could be implanted immediately following an extraction and contained both the implant and full restoration. [¶] In the 1980's, the standard implant was the Branemark implant developed at the University of Gothenburg in Sweden. The Branemark implant required several steps. First, surgery would place the implant in a healed extraction socket in the patient's mouth; a second surgery would inspect the implant to see if it had properly integrated with the bone (a process known as 'osseointegration'); last, a crown would be placed on the implant. Sargon's implant was a one stage implant: it expanded immediately into the bone socket with an expanding screw; this mechanism permitted the implant to be 'loaded' with a crown the same day."

In 1996, Sargon contracted with defendant University of Southern California (USC) for the USC School of Dentistry to conduct a five-year clinical study of the implant. In May 1999, Sargon sued USC and faculty members of its dental school involved in the study, alleging breach of contract and other causes of action. USC cross-claimed for breach of contract. All of Sargon's claims except the breach of contract claim against USC were eliminated by demurrer or summary judgment. In 2003, the contract action was tried before a jury. Before trial, at an in limine hearing, the trial court excluded evidence of Sargon's lost profits on the ground USC could not have foreseen them.

The evidence presented at trial showed that after initial success in the clinical trials, USC failed to present proper reports as its contract with Sargon required. The jury found that USC had breached the contract and awarded Sargon $433,000 in compensatory damages. It also found in Sargon's favor on USC's cross-complaint for breach of contract.

Sargon appealed. The Court of Appeal reversed the judgment, holding that the trial court had erred in excluding evidence of Sargon's lost profits on the ground of foreseeability.*fn1 It also stated, "Given that the in limine hearings focused on foreseeability and not the amount of lost profit damages, it is premature to determine whether such damages can be calculated with reasonable certainty." (Sargon Enterprises, Inc. v. University of Southern California (Feb. 25, 2005, B167519) [nonpub. opn.].)

On remand, the case proceeded to retrial on the breach of contract claim. USC moved to exclude as speculative the proffered opinion testimony of one of Sargon's experts, James Skorheim. The court presided over an eight-day evidentiary hearing at which Skorheim was the primary witness.

B. The Evidentiary Hearing

Skorheim testified that he was a certified public accountant and an attorney. He had been an accountant for 25 years and "work[ed] as a business and industry analyst and forensic accountant." As the Court of Appeal summarized, he testified that Sargon's lost profits "ranged from $220 million to $1.18 billion. In preparing his opinion, Skorheim reviewed litigation materials (including deposition transcripts and reports of USC's damages experts), financial information from Sargon and its competitors (including annual reports), and market analyses of the global dental implant market prepared by Millennium Research Group . . ." (Millennium). Skorheim based his opinion on a "market share" approach, by which he determined what share of the worldwide dental implant market Sargon would have gained had USC completed a favorable clinical study, and he calculated future profits based on that market share. "Skorheim used the market share approach to lost profit damages because the methodology had been used in complicated patent cases, antitrust cases, and unfair competition cases."

The Court of Appeal summarized Skorheim's testimony about the dental implant industry: "Nobel Biocare's Branemark implant was the pioneer implant developed in the 1960's and 1970's and required two surgeries. Straumann developed the second generation implant, which was placed in the bone without being submerged in the gum. In the early 1990's, there was very little penetration into the potential dental implant market. Out of millions of potential patients, only about 1 percent of this potential market was receiving product, presenting an opportunity for tremendous growth. In the late 1990's, the market began to grow dramatically. Industry reports demonstrated the global market was expected to grow during the period 1998 to 2009 at an annualized rate of 18.5 percent. At the time, the market craved technological innovation aimed at shortening healing time, cost, and treatment time. [Millennium] predicted that sales of immediate load implants would grow at compound annual rates of 56.3 percent during 2002 to 2006, and 32.8 percent from 2005 to 2009. Further, [Millennium] reported in 2004, immediate loading implants represented only a 'niche' market because demand was limited by industry acceptance. By 2009, immediate load implants would account for 14.9 percent of the United States market, up from 0.4 percent in 2000.

"Sargon's innovation lay in the use of an 'immediate load implant,' the ' "holy grail of dental implantology," ' which was directed at the market's need for ease of use, shortened healing times, and overall cost. Given the state of the implant market at the time, in Skorheim's opinion an innovator such as Sargon would have rapidly commanded a significant market share; with the exception of Nobel Biocare, all of the other major implant makers are recent arrivals on the scene."

In Skorheim's opinion, three key "market drivers" operate in the dental implant industry: (1) innovation, (2) clinical studies, and (3) outreach to general practitioners. A company must have all three to be successful. Skorheim had testified, the Court of Appeal stated, that "[t]he value of a clinical study to an implant maker is two-fold: It establishes the efficacy of the device and permits entry into the universities where students can be taught to use the device, with the expectation that, upon graduation, they will use the product in their practices." He believed that clinical success of the Sargon implant would likely lead to commercial success. Skorheim also had testified that because virtually every dental implant company employed clinical studies and general practitioner outreach, innovation really determined market success and what market share a company would achieve. He had explained, "The greater the technological achievement in the product mix, the greater the likelihood for revenues." In Skorheim's opinion, innovation was a necessary prerequisite to achieving market success. "[F]irst and foremost, you have to have the technological innovation and the efficacy."

As the Court of Appeal observed, "Skorheim's 'market share' approach was based upon a comparison of Sargon to six other large, multinational dental implant companies that were the dominant market leaders in the industry, and which controlled in excess of 80 percent of global sales (Big Six): Nobel Biocare, Straumann, [Biomet 3i], Zimmer, Dentsply, and Astra Tech. Although there are approximately 96 companies worldwide that make dental implants, Skorheim believed the Big Six were the top innovators based upon his analysis of the [Millennium] report and market intelligence." Skorheim had described the smaller companies as "copycats" and "price cutters" that competed on the basis of price and were not innovative; he believed that "the top six are innovators and the rest are copycats." The Court of Appeal stated: "On cross-examination, Skorheim acknowledged that [Millennium's] report did not state the Big Six were the most innovative; rather, it was an inference he drew from reviewing the report and the size and success of the companies in comparison to other, smaller companies."

Skorheim had acknowledged that many of the smaller companies claimed to be innovative, but he believed in fact they were not. When the trial court noted that the Millennium report mentioned other companies that claimed to be innovative, Skorheim had responded, "And I would say that the proof is in the pudding. And the proof is their ability to track the market share and they haven't been able to do that." When asked whether he agreed "that the company with the largest market share is not necessarily the most innovative," Skorheim had answered, "I don't think I can agree with that. I mean, ultimately, the markets determine what's innovative and what's not innovative. These markets reward innovativeness. . . . And so the market really makes a determination of which of these companies is more innovative than not by the extent to which they reward them with purchasing their products, and so forth." Skorheim had acknowledged that the Millennium report did not specifically indicate that some of the smaller companies were not innovative, but explained that this was because "those companies are not big enough to be even addressed in the global market, so there's nothing specific."

Skorheim believed that Sargon was innovative, like the Big Six, and not a copycat or price cutter, like the other small companies. He acknowledged that Sargon was a very small company whose annual profits peaked in 1998 at around $101,000 and, unlike the big companies, it had no meaningful marketing or research and development organization and no parent company to assist it. But he believed these factors were merely "incidental" to innovation and played little role in achieving market share. Accordingly, and because innovation is the key factor driving market success, Skorheim had compared Sargon to the "Big Six" rather than to the smaller companies in computing lost profits. He considered the Big Six and Sargon to be "comparable companies."

Skorheim had testified that "assuming the jury finds [the new implant] was a superior innovative revolutionary product and based upon everything else I see in the materials here, I think that Sargon had a very good chance of becoming the market leader over a period of time. I estimated maybe a 10-year period of time." Indeed, he believed to a "reasonable certainty" that within 10 years or so Sargon would have become a market leader. He also believed it likely that one of the Big Six would have dropped out of the leadership, and that Sargon would have replaced that company as a world leader.

When the trial court asked whether it mattered that some of the big companies had many different products, Skorheim had responded that Sargon "would have to remain competitive by investing significant amounts of money in [research and development] like . . . the other major manufacturers. Each of them are investing tens of millions of dollars a year into research and development to remain strong and technologically sound." He was confident that a company like Sargon would have been able to expend the necessary resources to "develop other products over time, that they would be able to use their patented expandable root process with other types of coatings, let's say, or shapes or sizes." He thought Sargon's ability to do so distinguished it from the other small companies.

The Court of Appeal stated: "Skorheim outlined similarities and differences between the Big Six and Sargon: First, they all manufactured titanium implants, and the implants were one-stage, two-stage, or immediate load (Sargon only); second, all used clinical studies; third, all used outreach to general practitioners; fourth, pricing was substantially the same; fifth, their qualitative and quantitative cost structures were the same; and the implants were manufactured either in-house or pursuant to a contract with a third party. Qualitative cost structure consisted of cost of goods sold, research and development costs (R & D), sales and marketing costs, and general administrative costs. Sargon did not have a meaningful R & D organization or a sales and marketing department. In all other respects, Sargon's costs were similar to the Big Six." Skorheim had acknowledged, however, that he could not think of any objective "business metric" -- "whether it's sales, number of employees, number of distributers, anything" -- by which Sargon was comparable to, for example, Astra Tech, the member of the Big Six with the smallest market share.

The Court of Appeal opinion provided a chart summarizing Skorheim's testimony regarding Sargon and its competitors for the "relevant time period, approximately 1998." We reproduce it here:

Sargon (1998) AstraZeneca (1999) Dentsply (1998) Biomet 3i (2000) Nobel[*fn2 ] (1998) Employees { 20 } 55,000 } 6,000 } 4,000 } 1,000 R&D $46,000 $2,923,000,000 $18,200,000 $40,208,000 $8,741,808 Net Sales $1,748,612 $18,445,000,000 $795,122,000 $920,582,000 $164,747,305 Net Profits $101,113 $1,143,000,000 $34,825,000 $173,771,000 $5,868,080 Assets $544,977 $19,816,000,000 $895,322,000 $1,218,448,000 $243,621,260 Market Share (2007)[*fn3 ] N/A 4.8% 7% 17% 22-23%

The dental implant business was only part of AstraZeneca's company. Skorheim testified that Astra Tech, its dental implant division, had sales in 1999 of $111 million.

For the reasons he gave, Skorheim believed that Sargon, unlike any of the other smaller companies, would, over time, have become a market leader, one of the Big Six. In calculating Sargon's lost profits, he had not considered profits Sargon had ever actually realized, but instead considered the market leaders' profits. He believed that Sargon's profits would have increased over time until they reached the level of one of the market leaders. He testified, however, that in one respect he had taken into account Sargon's actual income.*fn4 He had started with Sargon's gross revenues (not net income) in 1998, the year USC should have produced an interim report, which were around $1.7 million to $1.8 million and constituted approximately one half of 1 percent of the total global market. He then doubled that number based on his belief that, had the initial report from the clinical study been favorable and had other potentially favorable publicity followed, Sargon would have sold approximately 20 implants each to approximately 200 additional dentists. This would have brought Sargon's market share for that year to about 1 percent. Skorheim believed that beginning in 1998, Sargon's market share would have "ramp[ed] up" over the years from this 1 percent to a share that a comparable member of the Big Six enjoyed. He had calculated the lost profits based on sales in 1998 of over $3 million and a subsequent increase each year until Sargon reached the level of one of the Big Six.

Skorheim claimed no expertise regarding how innovative Sargon's dental implant was, although he had testified that "the immediate loading of implants is kind of the so-called holy grail of dental implantology." He said the jury would have to "wrestle" with the question of how innovative Sargon was. Because of this lack of expertise, Skorheim could not give a single sum of lost profits. Rather, in Skorheim's opinion, the amount would depend on how innovative the jury found Sargon to be, compared to the market leaders.

As the Court of Appeal explained, "Skorheim's damages model created four alternative damage scenarios based upon the jury's determination of the innovativeness of the implant. As a predicate, Skorheim had ranked the innovativeness of the comparator companies and established a hierarchy. If the jury concluded Sargon's level of innovation was equal to the least innovative of the benchmark companies, Astra Tech, Sargon would have attained a 3.75 percent share; if the jury concluded Sargon's level of innovation was equal to one of the lesser innovators of the benchmark companies, like Dentsply, Sargon would have attained a 5 percent market share; if the jury concluded Sargon's level of innovation was equal to a middle-level innovator, like [Biomet 3i], Sargon would have attained a 10 percent share; and if the jury concluded Sargon's level of innovation was that of the most innovative companies, Nobel Biocare and Straumann, Sargon would have attained a 20 percent market share." In establishing this hierarchy, Skorheim had assumed that the higher the market share a company had obtained, the more innovative it was. He also agreed, however, that it was possible, for example, that Astra Tech, with its smaller market share, was more innovative than Biomet 3i, which had a greater market share.

For each of these four scenarios, Skorheim had calculated lost profits from 1998 to 2009, then added what he calculated to be post-2009 lost profits. Skorheim believed that Sargon's net profits, which in actuality peaked at $101,000 in 1998, would have grown to $26 million per year in 2009 under the least profitable of the scenarios, and to $142 million per year in 2009 under the most profitable of the scenarios.

The Court of Appeal opinion provided a chart summarizing Skorheim's lost profits calculations. We reproduce it here:

Market Share 3.75% (Astra Tech) 5% (Dentsply) 10% (Biomet 3i) 20% (Nobel/Strau.) Lost Profits 1998-2009 $120,011,000 $181,020,949 $335,940,541 $640,232,628 Value Post 2009 100,473,347 134,343,563 269,824,425 540,786,150 TOTAL: $220,484,347 $315,364,512 $605,764,968 $1,181,018,778

Thus, Skorheim had projected total lost profits of $220 million if the jury found Sargon's innovation was comparable to that of the least innovative market leaders, making what he described as a "meaningful contribution to innovation"; of $315 million if the jury found Sargon's innovation was somewhat greater; of $600 million if the jury found Sargon's innovation was somewhat greater yet; and of $1.2 billion if the jury found Sargon's innovation was comparable to that of the market leaders, making what he described as "revolutionary industry changing technology."

The Court of Appeal summarized the testimony of the other witnesses at the evidentiary hearing. "Dr. Lazarof confirmed Skorheim's conclusion that innovation coupled with clinical studies was the driver of market share. Sargon also presented the testimony of Steven Hanson, president from 1992 to 2004 of Calcitek, a successful implant company, who testified Sargon could have commanded a 15 to 20 percent share of the market if the USC study had been completed, although he had not done a market study or considered the probability of all of the other steps necessary to get Sargon a 15 to 20 percent market share. Robert Pendry was at Straumann from 1992 to 2001 and at Thommen Medical from 2002 to 2006, and testified that in his opinion the Sargon implant was 'absolutely revolutionary' and 'world changing' when introduced in 1997 to 1998. In Pendry's words, the Sargon implant 'was the most exciting thing I'd heard in the implant business ever.' "

C. The Trial Court's Ruling

Following the evidentiary hearing, the court issued a 33-page written ruling on USC's motion to exclude Skorheim's testimony.

The court began by quoting an opinion by Judge Friendly of the Second Circuit Court of Appeals stressing the need to protect juries from "an array of figures conveying a delusive impression of exactness in an area where a jury's common sense is less available than usual to protect it." (Herman Schwabe, Inc. v. United Shoe Machinery Corp. (2d Cir. 1962) 297 F.2d 906, 912.) The court found it unreasonable for Skorheim, "or any such expert, to rely on much of the data which forms the basis of his opinions, because no data bears any resemblance to Plaintiff's historical profits or to those of any similar business." "Mr. Skorheim's opinion leaves the determination of up to a billion dollars of lost profit damages to pure speculation."

The court assumed for purposes of its ruling "that a 'market share' analysis is appropriate and warranted under California law," but it found that Skorheim's "market share opinion is not based on any actual historical financial results or comparisons to similar companies and, therefore, is not based on matter of a type [on which] an expert may reasonably rely." "The fatal flaw in Mr. Skorheim's reasoning is that it starts off assuming, without foundation, its conclusion. The fatal flaw in his analysis is that he relies on data that in no way is analogous to Plaintiff. Mr. Skorheim deems Plaintiff's historical data, such as past business volume, 'not relevant' to his lost profits projections." (Fn. omitted.)

The court noted that at the evidentiary hearing, Skorheim had "offered a new opinion that would have been grounded in some historical performance." It explained that it had sustained USC's objection to this new opinion "on grounds it was never disclosed in discovery. This court notes that this new methodology is directly inconsistent with Mr. Skorheim's declaration, depositions testimony and the position Plaintiff has taken throughout this litigation. . . . Regardless, the methodology of the new opinion is unreasonable." Later in the evidentiary hearing, "Plaintiff again attempted to show some historical grounding for the damage projections. Mr. Skorheim testified that his damage projections started with Sargon's gross revenues of $1,700,000 in 1997. Mr. Skorheim then doubled those revenues in 1998 . . . . To accomplish this, Mr. Skorheim assumed a favorable USC study and resultant publicity would cause 200 more dentists to buy at least 20 more implants each. The Court can find no factual basis for this assumption. [¶] . . . [¶] This Court specifically finds that Sargon's historical performance played no role in determining Mr. Skorheim's market projections, except to the extent that Sargon's data showed it had some sales."

The court found that Skorheim's "projections are wildly beyond, by degrees of magnitude, anything Sargon had ever experienced in the past. Under the 20% market share scenario, for example, Plaintiff would see its profits climb by 534.4% the first year, and by over 157,000% by 2009." Instead, the court found, Skorheim "starts his analysis with a comparison to industry leaders, all multi-million or multi-billion international corporations, or subsidiaries of such. This, of course, is unavoidable if one only looks to industry 'drivers' to ascertain who most successfully employs those 'drivers.' [¶] The only thing these established companies have in common with Plaintiff is that they all sell or make dental implants. In all other respects, in areas the [Millennium] report deems relevant, such as size, history, product line, sales force, access to financing, among others, they are worlds apart from Sargon." (Fn. omitted.)

The court noted that Skorheim had testified "that of all the 98 dental implant manufacturers, he could not identify one that did not pursue clinical studies or target general practitioners, rendering these two 'drivers' meaningless for comparison purposes. [¶] Moreover, many implant companies who touted 'innovative' products, yet had smaller revenues, were omitted for comparison purposes." In his testimony, "Mr. Skorheim grouped the companies that he deemed had 'innovative' products. He omitted certain smaller companies who, according to the [Millennium] report, also claimed to have innovations. When asked in court to explain this omission, he testified, 'The proof is in the pudding.' The small market share of these companies showed the market disagreed. Apparently, a product is 'innovative' if the market embraces it and it sells. [¶] The summary exclusion of other companies from his analysis, along with the fact that it should not be a startling revelation that biotechnology companies that have innovative products, all other things being equal, do better than those who do not, render this 'driver' equally meaningless for comparison purposes." The court found this argument to be "entirely circular."

The court continued: "At the hearing, Plaintiff changed its theory and attempted to show that it was similar to the industry leaders in ways other than possession of the three 'drivers.' The characteristics that Mr. Skorheim contended made Plaintiff 'similar' to the industry leaders, however, were characteristics common to most, if not all, implant companies. Obviously, if most share these 'common traits,' the traits are meaningless for comparison purposes. If, based upon these common characteristics, the very smallest is considered 'similar' to the very biggest, all cases that have required objective similarity would be effectively overruled, and the rule requiring 'similarity' would cease to exist. This Court finds that Sargon is not similar to the industry leaders by any relevant, objective business measure."

The court found that the dissimilarity between Sargon and the industry leaders "is sufficient, itself, to grant Defendant's motion" to exclude Skorheim's testimony, but "this court has other problems with Mr. Skorheim's opinion that give further grounds, by themselves, to grant Defendant's motion." It found that "[c]omparing 'degrees of innovation' with other products fails to give the jury standards from which it can make a rational decision, is inherently speculative and subjective, and thus fails to assist the jury in its fact-finding function. [ΒΆ] The relevance of Mr. Skorheim's testimony, if any, is that it provides the jury with an evidentiary basis to make market share choices and thus assess damages. The jury can choose from four market shares ranging from 3.75% to 20%, depending upon its finding of relative 'innovativeness.' The highest rating gets Nobel Biocare's share, with the lesser market share percentages awarded depending upon whether the innovativeness of the Plaintiff's implant is more on a par with products from Zimmer, 3i, and Straumann. The lowest ...


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