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TRADE SECRETS Expert Witnesses

An Indiana software company brought an action against its former employees and new employer alleging violations of non-compete covenants and interference with their business by divulging confidential information and trade secrets.

The plaintiff company, in an interlocutory appeal, asked the Indiana Court of Appeals to review the trial court’s ruling to exclude the testimony of its expert witness on economics and business valuation.

A computer-related business (“Company T”) employed the defendants (“the former employees”) in 2001.  It had a company policy that required most, if not all, employees to sign employment agreements containing a covenant not to compete.  From April 2001 to April 2002, all of the former employees left the company.  With the exception of one individual, all of the former employees went directly to a company (“Company C”) that was in a similar business. Company C was told of the covenant not to compete by some of the former employees, but others believed they hadn’t signed one when they were hired by Company T.

The superior court granted a temporary restraining order finding that the plaintiff had a protectable interest in its goodwill (which included customer information and relationships and its employees) and reputation.  The plaintiff, however, failed to pursue injunctive relief, and in August 2004, the former employees moved to dismiss the case for a lack of prosecution. That motion was denied and discovery continued until November 2009. The former employees then filed a motion for summary judgment challenging Company T’s claims. After an evidentiary hearing in March 2010, the trial court granted the motion for summary judgment for the defendants on all of the claims raised by plaintiff in its first amended complaint.  As a result, the trial court concluded that the covenant not to compete was overbroad, unenforceable, and could not be reformed. The court also concluded that the information alleged to have been misappropriated by the former employees did not constitute a “trade secret” as defined in the Indiana Trade Secret Act. Company T’s other claims didn’t apply to the fact situation of the case.

The Court of Appeals in its first review of this dispute (Plaintiff I) held that the trial court erred in granting summary judgment because the covenant not to compete was overbroad. It also held that the court erred in granting summary judgment on the propriety of the confidentiality clause, as there were genuine issues of material fact that needed to be determined. Further, the appellate court said that the trial court erred in granting summary judgment on the tortious interference with a contract issue, but did not err in granting summary judgment on any of the remaining issues.  The Court of Appeals affirmed in part, reversed in part and remanded the case.

On the second appeal, Senior Judge John T. Sharpnack of the Court of Appeals, writing for the court, said that the same issue still existed as to the claim for misappropriation of trade secrets.  In the course of the Plaintiff I opinion, it noted that Company T had submitted a report by its economics expert, BSW.  In an apparent attempt to create a genuine issue of material fact pertaining to customers in addition to those referred, Company T pointed to a report prepared by its expert that listed the customers that the company lost in the years following the former employees’ departure to Company C.  Judge Sharpnack said that the report concluded that even though plaintiff lost almost all of its key employees, and it normally lost a percentage each year, plaintiff only guessed that some of the lost customers must have been attributable to the defendants’ actions.  Mere speculation, the judge said, could not create genuine issues of material fact to defeat summary judgment.

While the appeal was pending, BSW produced a second report that examined sales information that Company C provided.  Then, after the court of appeals decided Think Plaintiff I, BSW issued a third report.  Company C moved the court to exclude BSW’s testimony from trial.  The trial court granted the motion, and Company T filed this interlocutory appeal.

Company T argued that nothing in the appellate court’s decision in Plaintiff I made BSW’s testimony inadmissible.  Company C responded that BSW’s testimony did not comply with the requirements for expert opinion evidence under Indiana’s Evidence Rule 702. The court of appeals stated the context of the expert’s report in Plaintiff  I was whether it established causation for the loss of some of Company T’s customers.  The appellate court concluded that the report did not give rise to a dispute of material fact on that point.

In BSW’s third report, rather than address the loss customers as he did in his first and second reports, the expert’s third report focused on damages sustained due to the loss of four specific customers identified in Plaintiff I, in addition to general profit erosion caused by the defection of the former employees to Company C. As a result, BSW’s third report and his proposed testimony at trial addressed questions not conclusively decided in the earlier appeal. Judge Sharpnack held that the doctrine of law of the case didn’t bar the admission of the expert’s testimony at trial.

As to whether BSW’s expert testimony was admissible under Indiana Evidence Rule 702, Company C argued that Company T was barred from addressing Rule 702 in this appeal because it didn’t discuss the rule in its initial appellate brief. The court of appeals disagreed. Company C made the argument in its Appellees’ Brief, and the plaintiff responded to that argument in its Reply Brief. Further, the parties extensively briefed the applicability of Evidence Rule 702 during the trial court proceedings, so the appellate court was indeed considering an issue that was presented to the trial court.

Both BSW’s qualifications as an expert and the reliability of the scientific principles upon which his testimony based were in dispute.

Company C argued that BSW was not qualified to render an opinion on causation. Judge Sharpnack explained that before an expert may testify about a subject, the proponent of the expert must show that the expert is competent in that subject. In addition, the proponent of expert testimony must show that the subject matter is distinctly related to some scientific field, business, or profession beyond that of the average layperson.

BSW had a Ph.D. in “Managerial Economics and Decision Science,” and more than 15 years of professional experience, including work as a professor of finance, an economist, and as a professional expert in business valuation, statistics, and financial damages. BSW also published articles on economic and business matters and presented to federal agencies, universities, and professional organizations on business valuation and other economic issues. His knowledge of economics and business valuation was beyond the knowledge of the average layperson. Therefore, BSW’s extensive education, training, and experience qualified him as an expert witness with respect in this area.

The parties also disagreed about whether BSW’s expert opinions were based on reliable scientific principles pursuant to Evidence Rule 702(b).  Judge Sharpnack said that “the court must make a preliminary assessment of whether the reasoning or methodology underlying an expert’s testimony is scientifically valid and whether that reasoning or methodology can be applied to the facts in issue.”  As part of this process, he said, Rule 702(b) directs the trial court to consider the underlying reliability of the general principles involved in the subject matter of the testimony, but “it does not require the court to reevaluate and micromanage each subsidiary element of an expert’s testimony within the subject.” The proponent of expert testimony must establish the reliability of the scientific principles upon which the testimony is based.

There is no specific test for determining whether expert scientific testimony satisfies Rule 702(b), Judge Sharpnack wrote. Federal courts have adopted the standard of Daubert, however, Indiana courts are not bound by it when analyzing evidence under their own state’s Evidence Rule 702(b). Nonetheless, the judge admitted that the Daubert principles were helpful. In determining whether evidence is admissible under Rule 702(b), the court will consider:

(i) whether the theory or technique can be and has been tested;
(ii) whether the theory has been subjected to peer review and publication;
(iii) whether there is a known or potential error rate; and
(iv) whether the theory has been generally accepted within the relevant field of study.

Judge Sharpnack commented further that the focus of the admissibility test was on the methodology of the theory or technique, rather than the conclusions generated. In addition, the Indiana Supreme Court’s adoption of Rule 702 reflected an intent to liberalize, rather than to constrict, the admission of reliable scientific evidence.

In this case, one of BSW’s reports reviewed numerous documents provided by Company T and Company C, and he spoke with Company T’s president and counsel in the course of preparing his report. In the report, BSW calculated plaintiff’s damages in two categories: (1) lost sales to four specific customers; and (2) general profit erosion caused by the defection of the former employees. The expert explained the basis for his calculations, identified the assumptions underlying those results, and the reasons why he compared certain data. He also took into account other potential causes for Company T’s losses.  He indicated that his overall methodology was based on “the benchmark method” as described in a publication from the American Institute of Certified Public Accountants.

In addition, BSW used this well accepted “yardstick approach” to calculate general profit erosion.  BSW’s conclusions were based on scientifically valid, reliable theories within the field of economics. To the extent that the trial court’s ruling relied on Indiana Evidence Rule 702(b), the court of appeals concluded that the trial court “overstepped its gatekeeper role” and abused its discretion by excluding the expert’s testimony.

Many of Company C’s objections to BSW’s opinions in his rebuttal report were claims that BSW failed to express an opinion on causation.  However, the judge explained, Company T was not obligated to prove every element of its claims through expert opinion.

The trial court’s ruling that BSW’s expert testimony was inadmissible at trial was reversed.

Source: Think Tank Software Development Corp. v. Chester, Inc., 988 N.E.2d 1169
(Ind.App. May 7, 2013).

By: Kurt Mattson, J.D., L.L.M.