Business ChartsThe defendants in a recent case were hit with numerous discovery sanctions by the district court, which led to a $413M default judgment based on an expert’s damages calculation.  Here’s how it happened:

KBP was a Polish company that was going to develop a business park in Poland. The plaintiffs were shareholders in KBP, and the defendants were all current or former shareholders. The plaintiffs filed suit and alleged a fraudulent scheme to plunder the company. They sought relief under RICO’s civil provisions, as well as several other state claims. The plaintiffs claimed that the defendants schemed to steal cash and property, and have KBP to pay millions to them for services never performed. The defendants put funds back into KBP as “capital contributions” in exchange for newly-issued stock to Defendant A, which diluted the plaintiffs’ ownership shares and made Defendant A the majority shareholder. The defendants also allegedly sabotaged the sale of KBP’s shares to a real estate firm [Corp. A] and then tried to squeeze out the plaintiffs.

To calculate damages, the plaintiffs proposed a three-step method and offered expert testimony. The expert measured the portion of KBP ownership lost as a result of the dilution of the plaintiffs’ stake and termed this amount the plaintiffs’ “adjusted KBP ownership percentage”—i.e., what share of the company they would have owned absent the defendants’ actions. The expert then multiplied this figure by the price that Corp. A had offered to purchase all of KBP’s shares to yield the plaintiffs’ gross damages. Finally, the expert witness subtracted the actual value of the plaintiffs’ KBP shares to calculate their net damages.

The fixing KBP’s present value (from which the plaintiffs’ share value was derived) was problematic as the defendants failed to produce certain relevant company documents. Consequently, the plaintiffs’ expert relied on an earlier offer of another company [Corp. B] to buy all of KBP’s shares.

When the plaintiffs objected to the magistrate’s lenient rulings, the district judge imposed more severe ones—including contempt and an order barring the defendants from using certain evidence. The plaintiffs moved for default judgment because the defendants didn’t produce the required documents of the contempt order, which they said was impossible. The district judge was not convinced by the excuse and granted default judgment with damages. Since the default judgment established liability under RICO, the damages were trebled, for a total of roughly $413M.

The defendants didn’t object to the use of “adjusted ownership percentages” as a baseline to measure economic damages, nor did they have any issue with the qualifications of the plaintiffs’ expert witness. Instead, they objected to the use of the Corp. B offer to determine KBP’s present value and to the certainty of their claimed losses from the Corp. A deal. The defendants didn’t offer a damages expert or theory of their own, but moved for an evidentiary hearing to establish damages, which was denied. The district judge acknowledged that the plaintiffs’ theory was somewhat speculative; however, the trial judge adopted it nonetheless—the defendants’ put forth no alternative and she found it was their own obstruction that created the issue of obtaining the business records. The defendants appealed, inter alia, the district judge’s calculation of the damages.

Circuit Judge Joel M. Flaum of the United States Court of Appeals, Seventh Circuit wrote the appellate opinion and explained that the case was examined for an abuse of discretion on the damages award. Such an award accompanying a default judgment will not be disturbed on appeal unless it’s plainly excessive. Judge Flaum recognized that while a default judgment conclusively establishes liability, the prevailing party was still required to prove its damages. Any allegations in the complaint relating to liability are considered true, but allegations going to damages are not, Flaum wrote. However, the Seventh Circuit’s prior decisions allowed “broad latitude” in quantifying damages, “especially when the defendant’s own conduct impedes quantification … [—e]ven speculation has its place in estimating damages.” As in any damages calculation, the amount sought must “naturally flow from the injuries pleaded,” the judge held quoting precedent.

Judge Flaum said the defendants’ claims “really boil down to this: the damages were not sufficiently certain for the district court to calculate them without holding a hearing.” The defendants challenged the certainty of the “adjusted ownership percentages,” the accuracy and certainty of the Corp. A offer used to calculate the gross loss amount, and the reliability of using the Corp. B offer to calculate the company’s present value. Because the defendants didn’t challenge the plaintiffs’ computations in the district court, they forfeited the right to do so on appeal.

The defendants also claimed that because the Corp. A deal wasn’t final, it wasn’t definite enough to support the damages award, and that Corp. A could have backed out, leaving the plaintiffs unharmed by the defendants’ conduct. Not true, said Judge Flaum, who held that this ignored the testimony of a Corp. A official who said that the deal would have gone forward as planned if the defendants hadn’t thwarted it—in other words, through the default judgment, the plaintiffs established that the deal would have gone off without a hitch but for the defendants. Thus, the plaintiffs properly proved their gross losses from the Corp. A deal.

As for Corp. B’s offer, the plaintiffs admitted that it wasn’t the best way to value the company, as it was four years old, non-binding, and subject to numerous conditions. The plaintiffs’ expert also acknowledged that a discounted cash-flow analysis would have been the preferred manner to ascertain then-present value. Unfortunately, Judge Flaum wrote, the documents needed to perform the preferred analysis were unavailable—”thanks to the defendants.” As a result, the expert witness thought that the Corp. B offer was a sensible alternative, and the district judge agreed, especially since the defendants withheld documents that might have aided in a more accurate valuation. There was no abuse of discretion in adopting the plaintiffs’ damages calculation formula.

The defendants didn’t submit a damages expert or an alternative damages theory of their own, and the district court had figures in hand. In these circumstances it wasn’t an abuse of discretion to decline to hold a damages hearing. Judge Flaum concluded that the district court was within its discretion to impose harsh sanctions, to grant a default judgment against the defendants, to calculate the damages as it did, and to decline to hold a damages hearing.

Domanus v. Lewicki, — F.3d —-, 2014 WL 408723 (C.A.7 (Ill.) Feb. 4, 2014.)

By Kurt Mattson, J.D., LLM