Lost Profits Award for Breach of a License Agreement Cannot Rely on Comparison Between Recent Entrant and Market Behemoth
Originally published in the New York Law Journal, an ALM Media publication, on November 13, 2017.
By: Richard Raysman and Peter Brown
It is black-letter law that liability for breach of contract does not mean that the prevailing party is entitled to its requested damages award, much less any damages at all. In particular, New York law applies a higher standard relative to other damage categories when evaluating a prevailing party’s claim based on lost profits. To avoid losing on a damages request, or receiving only a nominal award, the prevailing party must show that lost profit damages can be proven with “reasonable certainty” and “were fairly within the contemplation of the parties to the contract at the time it was made.”
Past sales often furnish a persuasive rationale for estimating lost profits. Obviously this is largely inapplicable to start ups and other nascent enterprises, particularly when these entities have not executed agreements that specifically contemplate the dollar amount of compensation, and rely instead on equity offerings or percentages of prospective sales. An early stage trademark licensor encountered this problem when litigating the breach of a license by the licensee in 2005, when the licensee had been in business for only a handful of years. This column discusses the most recent opinions in the matter, which illustrate the difficulties in obtaining a lost profits award when premised on conjectural comparisons between the prevailing party and an established, if not leading presence in the relevant market.
Facts and Procedural Background
Plaintiffs Daryl Washington and Sunday Players, Inc. owned seven licensed marks for a “Sunday Players” brand utilized in selling “compression” apparel. Defendant Kellwood Company manufactures, advertises and distributes various types of apparel. In 2002, the parties discussed an arrangement wherein defendants would manufacture compression products bearing the “Sunday Players” marks. This proposed business arrangement soon progressed into a potential joint venture after Kellwood allegedly facilitated meetings with major players in the retail apparel market, in which such retailers “express considerable interest in selling products displaying [plaintiffs’] marks.”
Consequently, on Nov. 25, 2003, the parties entered into a license agreement (the “license”). The initial term of the license expired on Jan. 31, 2007. The license granted defendant an exclusive license to use the “Sunday Players” mark in conjunction with the “production, manufacture, advertising, merchandising, promotion, importation, distribution and sale” of various classes of apparel and accessories. The license obligated defendant to spend three percent of gross sales on marketing these products. Plaintiffs’ alleged that defendants, through subsequent “various oral and written agreements,” undertook additional obligations, including to spend additional funds on marketing products using the Sunday Players name.
According to the plaintiffs, the defendant failed to uphold its side of the bargain to use best efforts to generate profits under the license. Defendant countered by alleging that it in fact did dedicate its best efforts to selling products with the Sunday Players mark, but nonetheless could not make a single sale of such a product. Defendant claimed to have spent more than $220,000 in marketing the Sunday Players’ products, including pitches to “approximately eighteen large retailers.” Dissatisfied with the performance of the Sunday Players products, in or around April 2005, defendant terminated its arrangement with plaintiffs’, including the license.
That decision triggered the instant litigation, which has now been active for nearly 12 years. Plaintiffs alleged, inter alia, that defendant failed to give its best efforts to market and sell the Sunday Players products and breached the license by unilaterally terminating it prior to expiration. After considerable procedural wrangling and discovery, on summary judgment, the District Court held that defendant breached the license due to an unlawful premature termination and the failure to provide product samples to plaintiffs.
Trial was held to determine if defendant also breached the license in a third way: by failing to undertake reasonable marketing efforts prior to termination. On Feb. 11, 2016, a jury returned a verdict in the affirmative, awarding plaintiffs, in relevant part, $4,350,000 in lost profits. The jury heard the testimony of plaintiffs’ expert witness, which concluded that if reasonable marketing efforts had been made, “Sunday Players would have sold [products] at 50 percent [of a primary competitor] at a comparable stage of development.”
Legal Analyses and Conclusion
In September 2016, the parties cross-moved for various reasons, including defendant’s motion for a judgment as a matter of law alleging that plaintiffs’ provided no foundation for certain assumptions of plaintiff’s expert concerning the lost profits and loss value estimates. See Washington v. Kellwood Co., 2016 WL 3920348 (S.D.N.Y. July 15, 2016).
The District Court agreed. While finding for plaintiffs on liability grounds, the court held that plaintiffs lost business value broadly speaking as a result of the license breach, but did not prove that “its new and untested business would have achieved vast market success but for Kellwood’s breaches,” which was the foundation for the $4,350,000 verdict. Accordingly, since the jury’s lost value verdict relied on speculative evidence projections rooted in the future success of plaintiffs’ business (then in its nascent stages), the court vacated the verdict with respect to damages and remanded for a new trial to establish any “lost business value damages.”
Specifically, the District Court held that the lost profits award was based on insufficient evidence. First, the award did not have a foundation, i.e., Sunday Players’ lack of “track record” in the market, to prove with reasonable certainty the existence of lost profits. See Kenford Co., Inc. v. Cnty. of Erie, 67 N.Y.2d 257 (1986) (lost profits must be proven “with reasonable certainty” and be “fairly within the contemplation of the parties to the contract at the time it was made”). Rather, Sunday Players was a “start-up business with no capital or manufacturing capacity, no national advertising, and no long-term deals with retailers. It had no brand recognition and meager sales.”
Second, the court rejected the estimate of the plaintiffs’ expert that, had the license been fully performed, defendant would have then sold $82,000,000 of Sunday Players’ product. It noted that plaintiffs’ expert had no marketing expertise, so any prognostications about lost value are without basis. The court out-of-hand rejected the comparison by the plaintiffs’ expert of Sunday Players to Under Armour. The comparison “posited superficial similarities” to Under Armour, the “market’s dominating force.” His comparison, which entailed in part suggesting that Sunday Players and Under Armour were comparable because they used similar grassroots marketing strategies and television advertising, is “pitched at such a high level of generality as to be totally meaningless.” Moreover, of course plaintiffs would try to emulate Under Armour’s past strategies, given the successful results, irrespective of whether Under Armour was a comparable company for purposes of damages analysis.
In sum, for these reasons and a number of others, the court concluded that the comparison with Under Armour actually proved the opposite of the plaintiffs’ expert’s argument. As a result, the jury’s lost value award was also erroneous as a matter of law, since it was premised entirely on the same expert testimony that justified the lost profits analysis. Nonetheless, since plaintiffs proved liability based on defendant’s breach of the license, the court ordered a new trial with respect to lost profit damages.
Reviewing de novo, the Second Circuit agreed and held that the vacatur of the $4,350,000 verdict and the denial of a new damages trial was correct. See Washington v. Kellwood Co., — F. Appx. —-, 2017 WL 494467 (2d Cir. Nov. 2, 2017). The Second Circuit elaborated by stating that plaintiffs’ “failed to proffer evidence from which lost profits could be established with reasonable certainty.” To wit, during the relevant period Under Armour had annual sales between $49.5 million and $195 million, whereas Sunday Players had “no record of notable sales.” Accordingly, the plaintiffs’ expert’s contention that Sunday Players’ revenues were reasonably certain to increase from a six figures to approximately $80 million “was so unfounded that it failed to establish any legal basis for awarding lost-profits damages.”