Sunday Players v. Kellwood Co., 105 F. Supp. 3d 293 (2015)

This court case illustrates the importance of choosing the proper method to compute lost profits. Forensic accountants in “lost profits” civil cases commonly rely upon either the “yardstick” method or the “before and after” method.

The “yardstick” method estimates what revenues and profits of the affected business would have been, but for actions of the defendant, by comparing the affected business performance of the plaintiff (1) to business performance at a different business location of the plaintiff, (2) to the plaintiff’s past budgeted results, (3) to the actual experience of another similar business unaffected by the defendant’s actions or (4) to industry averages.

The “before and after” method compares the plaintiff’s revenues & profits before the action or event causing the loss of profits to the plaintiff’s revenues & profits after the action or event.

Additionally, with respect to businesses that are newly established, such as a start-up business, decisions of the courts have commonly applied a “new business rule” where claims for lost profits of a newly formed business are inherently speculative and are difficult, if not impossible, to recover. However, some courts have begun to be more reasonable in their consideration of the merits of a lost profits case by considering new business’s expertise, business experience, industry economy, barriers to entry and capital requirements.

In 2002, the owners of Sunday Players, Inc. developed several licensing trademarks for a line of sports apparel, also called “compression clothing.” Athletes and others often wear compression clothing with the intent of improving their performance capabilities, while others choose this type of apparel for medical reasons. A competitor, Under Armour, was already an established and successful compression sportswear market leader at the time that Sunday Players was formed. In order to begin to compete in this market, Sunday Players sought a business partner to promote its products and it selected the Kellwood Company, a major clothing producer for the retail market.

The owners of Sunday Players stated in their complaint against Kellwood that Kellwood had told them MTV was interested in partnering with Sunday Players in a sublicensing agreement. The MTV deal never materialized. In addition, although Kellwood spent $220,000 in representing the Sunday Players brand to many large retailers, no retailers signed on. In the same period, the Sunday Players sales organization made only a total of about $150,000 in sales.

Sunday Players blamed Kellwood for the lackluster launch of their new line of compression clothing and engaged a business valuator to determine the value of the lost profits and lost business value. Sunday Players’ valuator chose the “yardstick method” for the calculation of damages. In this case, the valuator compared the Sunday Players apparel line, a brand new product, to the Under Armour line which had successfully grown over a period of years to become the industry leader. The Under Armour line had grown partially as a result of a successful partnership with ESPN, so the valuator postulated that a similar growth in revenues and profits should have occurred with the unsuccessful sales pitch by Kellwood of Sunday Players’ apparel to MTV. When Kellwood failed to deliver on the MTV deal, Sunday Players lost business and potential profits, at least in the logic argued by the valuator, resulting in the damages calculated.

According to the case summary, “Plaintiffs allege that Kellwood failed to use reasonable efforts to market and sell Sunday Players products, breached the License Agreement before its expiration, and defrauded plaintiffs by various misrepresentations and omissions. The plaintiffs sought in excess of $50 million in damages.”

Although Kellwood challenged the logic of Sunday Players’ expert, the court allowed the testimony of plaintiff’s expert. In the final decision, the jury awarded damages to Sunday Players in the amount of $4.35 million in lost profits or $500,000 in lost business value.”

Appeals Court Reverses the Decision

Not surprisingly, Kellwood challenged the ruling of the lower court and appealed the decision. The appellate court went right at the heart of the matter – the value of the lost business and profits. The appellate court found that Sunday Players had failed to prove that their new business and product line would have experienced the growth their expert had projected using the yardstick method. While Sunday Players contended that their products compared favorably with the Under Armour line, the pre-existing sales levels of Sunday Players, as a start-up business, did not support that assertion. The court also said that the $220,000 Kellwood invested in representing the Sunday Players line more than met Kellwood’s financial obligations to Sunday Players. The court ruled that Sunday Players had optimistically projected growth and earnings that did not match market conditions and product performance. The appellate court ruled in favor of the plaintiff, but awarded only one dollar in damages.

What Can We Learn from This Case?

“The expert for the plaintiff (Sunday Players) erred in choosing to apply the yardstick method in calculating damages”, Denny Taylor said. “Although the court admitted the expert testimony of Sunday Players’ expert, the plaintiff’s arguments failed to prove that the yardstick method using Under Armour’s sales history was reliable. The appellate court opined that no relationship can be drawn between the hopeful sales of an upstart product line and one that had grown to be very successful over many years – the ‘new business’ rule was applied in reaching the court’s decision. In other words, it’s very difficult to successfully argue lost profits on a line that has never become established. While both parties used experienced valuators, the Sunday Players valuation lacked believability when compared to the facts of the case.”

At TD&T, we perform business valuations for cases of this nature. We bring many years of knowledge and experience to you in helping you craft a successful claim of lost profits. Please consider us when choosing a forensic accountant and business valuator.