To what extent can an expert witness rely on the internal projections of an opposing party? Wouldn’t those numbers, made during the normal course of business and sometimes provided to third parties for financing purposes, reflect the best judgment of management? Would it not be fair to give more credibility to numbers developed for business purposes before the onset of litigation with all of its pressures and incentives? The Texas Court of Appeals for the 14th District in Houston addressed these questions in Citrin Holdings, LLC v. Minnis (14-11-00644-CV, May 9, 2013).
In 2002, when they first met, Jacob Citrin and Matthew Minnis were aspiring real estate investors. The following year they began negotiating a partnership. Together they would form entities to buy industrial properties near airports and seaports, lease the properties, and then sell them. They adapted a company Citrin owned for this purpose. The operating agreement for Cargo Ventures, LLC gave Citrin a 55% interest and made him the manager. Minnis received a 45% interest and became president. The financing for their properties would come from banks, and from an equity investor, Millennium Partners, a company owned by Citrin’s father-in-law.
Under the arrangement between Millennium and Cargo Ventures, Millennium would receive an 8% preferred return on its investment. After recouping the original investment, plus 8% per annum, Millennium and Cargo would share the profits at a ratio of 75% to 25% respectively.
The favorable terms given to Millennium seem to be a principal source of the eventual conflict. Minnis wanted a more equitable sharing of the profits. He wanted Citrin to look for other financing partners. Citrin seemed less inclined to cut Millennium out of the plan. Cargo Ventures did consider other partners, but eventually settled on a renegotiated arrangement with Millennium. Under the modified deal, Millennium received a 12% preferred return and split the profits 50/50. Whether Minnis was ever satisfied with the new arrangement or not, by the end of 2006 the partnership between Minnis and Citrin was over.
Minnis sued Citrin in December 2006. The case came to a jury trial in July 2010 with several causes of action, including fraud, breach of fiduciary duty, negligent misrepresentation, majority oppression, conspiracy, and a request for an accounting, among others. Minnis asked the jury for the value of the carried interests (in the entities/properties) as of March 2007.
To prove the value of these interests Minnis sought the expertise and testimony of a CPA, Accredited in Business Valuation (ABV) by the American Institute of Certified Public Accountants (AICPA), a Certified Valuation Analyst (CVA) and member of the National Association of Certified Valuation Analysts (NACVA). He had around 20 years of experience, and an 18-page curriculum vitae.
Citrin challenged the admission of this expert testimony at trial. He did not challenge the expert’s qualifications, the relevance of his testimony, or the reliability of the “direct capitalization” method chosen for his analysis. Citrin argued that the testimony was unreliable because (1) the expert used Cargo Ventures’ internal future projections as if they reflected March 2007 “stabilized values,” and (2) he arbitrarily stopped running the interest on Millennium’s preferred return at March 2007.
Citrin’s Daubert challenge was overruled by the trial court judge, and Minnis won a verdict from the jury in his favor. The trial court awarded him over $28 million in actual damages, the same amount presented by the expert witness in his testimony. He also won over $14 million in exemplary damages, over $10 million in prejudgment interest, and almost $2 million in attorney’s fees.
On appeal Citrin renewed his challenge to the admission of Minnis’ expert witness. Minnis argued that Citrin could not claim, after-the-fact, that the internal projections were an unreliable basis for the expert’s analysis. After all, he said, Cargo relied on these numbers to secure financing from Millennium and other lenders. Citing Del. Open MRI Radiology Assocs., P.A. v. Kessler, 898A.2d 290, 332 (Del. Ch. 2006), the Court agreed with Minnis that “an effort by [Citrin] to discredit or disclaim [his] own Cargo Ventures’ projections would lack credibility, if those projections were otherwise reliable.” However, “[t]hat they are Cargo Ventures’ internal figures is not, standing alone, evidence of reliability. There has been no showing that the stabilized values Cargo Ventures placed on the properties were anything more than its hopes for what the property would be worth in the future. Such hopes do not establish a reliable damages model… Cargo Ventures was entitled to ‘create speculative, optimistic, and conjectural projections and to rely on them in making business decisions.’”
In a footnote (fn.17), the Court of Appeals expressed particular interest in one of the properties, Bronstein, calling it “the most telling example of [the expert’s] reliance on unreliable internal projections.” This property was purchased in January 2007 for approximately $38 million. Applying his methodology to the $113 million “stabilized” value provided by Cargo Ventures’ internal projections, the expert subtracted $30 million in improvement costs and lost rent to reach an adjusted “stabilized” value of $83 million at March 2007. The Court saw an $83 million value in March, compared with a $38 million value in January. What could account for such a significant gap? No one was arguing that there was a flaw in the methodology. It must have been an unreliably optimistic internal projection.
This was not just “the most telling example” of incongruity between internal projections and a real-world value. It was the only positive evidence the Court used to show that the internal projections were “unreliable.” Everything else it said on the matter went to the failure by Minnis to meet his burden to prove that projections were reliable.
The Court in this case certainly believed that “stabilized value” should approximate market value. The Court’s assumption may be correct, but could it be that “stabilized value” is not supposed to resemble what a willing buyer would pay a willing seller in an open and competitive market? At trial it is the job of an expert witness to serve as an educator on questions, like this, related to his field of expertise. On appeal, where experts rarely, if ever, make an appearance before the court, this function may be missed.
The Dissenting Opinion
Justice Sharon McCally wrote the majority opinion in this case. Justice Margaret Garner Mirabel wrote a dissent. She believed that the majority did not strictly adhere to the abuse of discretion standard required for review of a trial court’s evidentiary rulings.
When you properly distinguish between the evidence before the court at the Daubert hearing, and the evidence it had at the time of the verdict, did the trial court abuse its discretion by ruling in favor of Minnis and his expert witness? Justice Mirabel said, no. The issues that ultimately decided this case in Citrin’s favor were not before the court at the time of the Daubert hearing. Therefore, no matter what one may think of the expert’s analysis or the jury’s prudence, the judge did not abuse her discretion by allowing the expert to testify.
Don’t assume that internal projections from the other side are automatically reliable. While they may be given “great weight… because they usually reflect the best judgment of management, unbiased by litigation incentives,” management also has the freedom to speculate. It could be said that business projections are only as good as the people who make them.
Don’t assume that it is the job of the expert witness alone to carry the argument for the reliability of any projections he uses. There may be other witnesses able to do more to establish the credibility of those documents, based on their familiarity with the people making the projections, the circumstances of their development, and the track record of the organization developing such numbers.
It is always important for an expert witness to consider how his work is going to look when measured against the proverbial “smell test.” Common sense says that a building worth $38 million in January will not be worth $83 million in March, but common sense might be the wrong standard. If so, the “how” and “why” of the distinction between two different measures of value needs to be made very clear on direct-examination in the record of the trial. There won’t be another opportunity to do this at the appellate level.
When reading the Court’s opinion, we cannot see what was written in pre-hearing briefs, and we do not know what was said in oral arguments. We can observe that the majority opinion did not mention the “abuse of discretion” standard until the very end of its recitation of precedents. The dissenting opinion began with that standard, and kept it in view throughout. This is enough to make one wonder whether anything could have been done to persuade the Court to give greater attention to that critical standard. Perhaps not, but it is something to consider before taking this kind of case to an appellate court.
Table of Citations
 “Stabilized” value, as explained by the Court in its opinion, is the value of the property obtained by applying a “capitalization rate” to the “stabilized income” of the property. The “capitalization rate,” or “cap rate,” is a ratio representing the relationship of a property’s net operating income to its value. “Stabilized income” is the income a property is expected to produce at full occupancy.
Disclaimer: The views and opinions expressed on The Daubert Files belong to Eric Matthaei, and do not necessarily reflect those of Janik PC.