United States District Court, W.D. Kentucky, Owensboro Division
MEMORANDUM OPINION AND ORDER
JOSEPH H. McKINLEY, Jr., Chief District Judge.
Institutional Labor Advisors, LLC ("ILA") is a limited liability corporation that provides consulting, business, and compliance services to mining industry clients with respect to acquisitions and operational matters. On April 4, 2012, ILA filed this breach of contract action against Allied Resources, Inc. ("Allied"), alleging that Allied breached a Compensation Agreement that it had entered into with ILA. (Compl. [DN 1].) This matter is now before the Court on various motions filed by the parties concerning the Compensation Agreement's enforceability and meaning.
In specific, this matter is before the Court on ILA's Partial Summary Judgment Motion [DN 141] and Allied's Summary Judgment Motion [DN 149]. Also before the Court are motions to exclude certain expert testimony, including: (1) ILA's Motion to Exclude the Opinions of Peter Ostermiller, Esq. [DN 138]; (2) ILA's Motion to Exclude the Opinions of W. William Hodes, Esq. [DN 139]; (3) Allied's Motion to Exclude or Limit the Expert Testimony of William Fortune and Leslie Haley [DN 140]; (4) Allied's Motion to Exclude or Limit the Expert Testimony of W. Douglas Blackburn [DN 142]; (5) Allied's Motion to Exclude or Limit the Expert Testimony of Elizabeth Woodward [DN 145]; and (6) ILA's Motion to Exclude the Opinions of the Defendant's Damages Experts [DN 146]. ILA has also filed two Motions for Oral Argument [DNs 150, 167]. Fully briefed, the matter is ripe for decision.
During the relevant period, ILA was a labor law boutique firm that provided consulting, business, and compliance services to mining industry clients. Attorney David Smith ("Smith") was a co-founder of ILA. (Smith Dep. [DN 149-6] 8-11.) During the same period, Allied was a corporation that was owned by Chester Thomas ("Thomas"). Thomas wanted to acquire certain coal reserves located in western Kentucky, owned by the Pittsburg & Midway Coal Mining Co. ("P&M") and its parent company, Chevron Corp. ("Chevron"). The reserves were known as the Onton Reserves. P&M and Chevron, however, were not willing to sell the Onton Reserves without also selling the idled Sebree Mine and its labor liabilities. (Thomas Decl. [DN 149-8] ¶¶ 3-6; Smith Dep. [DN 144-4] 54-57.) As such, in the fall of 1999, Thomas retained his business lawyer, George "Skip" Stigger ("Stigger"), to begin negotiating with P&M and Chevron over the terms of a potential acquisition. To address the labor liabilities, Thomas engaged Smith and ILA. It is undisputed that ILA did not prepare a written engagement letter or fee agreement upon accepting the representation. Instead, Thomas and Smith orally agreed that the payment of a fee to ILA would be contingent on the transaction's successful closing. The parties disagree on whether the idea of a percentage fee was proposed by Thomas or Smith. (See Smith Dep. [DN 149-6] 184-85 (indicating that the percentage fee was Thomas' idea); Thomas Dep. [DN 149-9] 274-75 (stating that the percentage fee was Smith's idea).) They also disagree as to when they made their oral fee agreement. (See Smith Dep. [DN 149-6] 184-85 (indicating that it was made before ILA's engagement began in October 1999); Thomas Dep. [DN 149-9] 274-75 (indicating that it was made around January of 2000).) Regardless, the parties agree that under their oral fee agreement, ILA's entitlement to the fee depended upon the occurrence of the closing. (See Smith Dep. [DN 149-6] 236-38; 245-49.) Thomas and Smith made this agreement without any input or involvement by Stigger or any other attorney representing Thomas and his company. (See Stigger Dep. [DN 149-10] 133-34 (stating that he first learned that Thomas and Smith had agreed to a fee agreement involving a five percent interest during a conversation with Thomas).)
Between October of 1999 and May of 2000, Smith spent a substantial amount of time and effort providing Thomas with advice relating to the federal labor law aspects of the transaction. (Smith Dep. [DN 144-4] 388-90; George Oliver Dep. [DN 144-6] 43-44 (stating that spending 600 hours on a project is a significant time); Stigger Dep. [DN 144-5] 58 (noting that "if [the deal] were a baby, it would have been a breech birth, " as it was "a tough series of negotiations").) On May 12, 2000, two separate Asset Purchase Agreements were finalized and signed: under one, a newly formed corporation that Thomas owned and controlled called Cochise Coal Co. ("Cochise") acquired the idled Sebree Mine from P&M; under the second, Allied acquired the Onton Reserves from Chevron. (Asset Purchase Agreements [DNs 144-8, 144-9].) Thereafter, Smith and Thomas began the process of negotiating and drafting a written compensation agreement regarding the percentage fee that they had previously discussed.
Stigger represented Allied and Thomas in negotiating the terms of the written agreement. (Mem. in Supp. of ILA's Mot. for Partial Summ. J. ("ILA's Mem.") [DN 144] 6; Mem. in Supp. of Def.'s Mot. for Summ. J. ("Allied's Mem.") [DN 149-1] 8.) On July 17, 2000, Stigger sent a draft to ILA, entitled "Limited Net Profits Interest Agreement." He proposed that ILA would obtain an "ownership of and entitlement to a limited undivided five percent (5%) of the net profits realized by Allied... in the ownership, operation and/or sale of" the Onton Reserves. (Draft Agr. [DN 144-10].) Over the next seven months, Stigger negotiated the agreement's terms with Douglas McDonald ("McDonald"), who represented Smith and ILA. (Smith Dep. [DN 144-4] 234, 238; Thomas Dep. [DN 144-2] 354, 358.) Over the course of the negotiation, the parties shifted concepts-from "net profits" to "net operating income" to "distributions." On February 8, 2001, both ILA and Allied signed the Compensation Agreement.
The finalized and executed Compensation Agreement states, in pertinent part, as follows:
Payments. Allied shall pay to ILA an amount in cash equal to five percent (5%) of the value of any Distribution (as defined below) at such time as any such Distribution is paid....
As used herein, the term "Distribution" means any dividend, payment or distribution of cash, securities or other tangible or intangible property to any holder of capital stock of Allied ("Allied Stockholder") or to any Affiliate (defined below)... provided that in no event shall (i) a payment or distribution to any Allied Stockholder or any Affiliate in an arms-length transaction in which Allied receives fair market consideration for such payment or distribution, or (ii) any payment to Chester Thomas as reasonable salary for services provided to Allied be deemed to be a Distribution.
As used herein, the term "Affiliate" means any of (i) a director, officer, stockholder holding 5% or more of the capital stock (on a fully diluted basis) of Allied, (ii) the spouse, parent, lineal descendant or adopted children of a person who is an individual or a person who is an Affiliate of Allied by virtue of clause (i), or (iii) any other person that, directly or indirectly, through one or more intermediaries, controls or is controlled by, or is under common control with, Allied.
(Comp. Agr. [DN 144-1] 1-2 (emphasis in original).) The Compensation Agreement also states that both parties "agree that the compensation... is fair, reasonable, and adequate consideration for the services provided by ILA in connection with Allied's purchase of the Onton Reserves." (Id. at 1.) In the complaint filed in this action, ILA alleges that while certain Distributions were paid, Allied failed to compensate it. (Compl. [DN 1] ¶¶ 11, 13, 16-17.) The parties have now filed cross-summary judgment motions concerning the Compensation Agreement's enforceability and meaning. The parties have also filed motions to exclude or limit proffered expert testimony.
II. STANDARD OF REVIEW
Before the Court may grant a motion for summary judgment, it must find that there is no genuine dispute as to any material fact and that the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(a). The moving party bears the initial burden of specifying the basis for its motion and identifying that portion of the record that demonstrates the absence of a genuine issue of material fact. Celotex Corp. v. Catrett , 477 U.S. 317, 322 (1986). Once the moving party satisfies this burden, the non-moving party thereafter must produce specific facts demonstrating a genuine issue of fact for trial. Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 247-48 (1986).
Although the Court must review the evidence in the light most favorable to the non-moving party, the non-moving party must do more than merely show that there is some "metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp. , 475 U.S. 574, 586 (1986). The Federal Rules of Civil Procedure require the non-moving party to present specific facts showing that a genuine factual issue exists by "citing to particular parts of materials in the record" or by "showing that the materials cited do not establish the absence... of a genuine dispute[.]" Fed.R.Civ.P. 56(c)(1). "The mere existence of a scintilla of evidence in support of the [non-moving party's] position will be insufficient; there must be evidence on which the jury could reasonably find for the [non-moving party]." Anderson , 477 U.S. at 252.
In considering a summary judgment motion, the Court must remain cognizant of the role that expert testimony plays. In this regard, Federal Rule of Evidence 702 provides:
A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if: (a) the expert's scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.
Fed. R. Evid. 702. Under Rule 702, the judge acts as a gatekeeper to ensure that expert testimony is reliable and relevant. Mike's Train House, Inc. v. Lionel, L.L.C. , 472 F.3d 398, 407 (6th Cir. 2006) (citing Kumho Tire Co. v. Carmichael , 526 U.S. 137 (1999)). In deciding whether testimony is reliable, a court's focus "must be solely on principles and methodology, not on the conclusions that they generate." Daubert v. Merrell Dow Pharms., Inc. , 509 U.S. 579, 595 (1993).
In Daubert, the Supreme Court identified a non-exhaustive list of factors that may assist a court in assessing the reliability of a proposed expert's opinion. The factors include: (1) whether a theory or technique can be or has been tested; (2) whether the theory has been subjected to peer review and publication; (3) whether the technique has a known or potential rate of error; and (4) whether the theory or technique enjoys "general acceptance" in a "relevant scientific community." 509 U.S. at 592-94. This gatekeeping role is not limited to expert testimony based on scientific knowledge, but instead extends to "all scientific, ' technical, ' or other specialized' matters" within the scope of Rule 702. Kumho Tire , 526 U.S. at 147. Whether a court applies the Daubert factors to assess the reliability of an expert's testimony "depend[s] on the nature of the issue, the expert's particular expertise, and the subject of his testimony." Kumho Tire , 526 U.S. at 150. Any weakness in the underlying factual basis bears on the weight, as opposed to the admissibility, of the evidence. In re Scrap Metal Antitrust Litigation, 527 F.3d 517, 530 (6th Cir. 2008).
In its summary judgment motion, ILA first argues that the record in this case shows that the Compensation Agreement is valid and enforceable. (ILA's Mem. [DN 144] 16-25.) ILA also argues that as a matter of law, it is entitled to a judgment that: (1) Allied is liable for breaching the Compensation Agreement; (2) Allied owes ILA 5% of, at least, $45, 130, 515 in Distributions (i.e. $2, 256, 525), plus interest compounded annually at the statutory rate of 8%; and (3) Allied cannot offset its liability to ILA through a malpractice claim. (See id. at 25-40; see also ILA's Mot. for Partial Summ. J. [DN 141] 1.) In its summary judgment motion, by contrast, Allied argues that the record shows that the Compensation Agreement is invalid and unenforceable. (See Allied's Mem. [DN 149-1] 13-37.) The Court will consider each of the parties' arguments, in turn.
A. COMPENSATION AGREEMENT'S VALIDITY AND ENFORCEABILITY
The parties' dispute regarding the Compensation Agreement's validity and enforceability concerns whether or not "ILA's claim is barred because the Letter Agreement was entered into in violation of the Rules of Professional Conduct in effect in the time..., and the public policy of the Commonwealth of Kentucky, thus rendering the Letter Agreement void and unenforceable." (1st Am. Ans., Aff. Defenses & Countercl. [DN 62] ¶ 22.) Whether a contract is enforceable is a question of law for the Court. Likewise, an attorney's obligations under the Rules of Professional Conduct raise questions of law. See Bertelsen v. Harris , 537 F.3d 1047, 1056 (9th Cir. 2008) (noting that "[w]hether an attorney's conduct violates a rule of professional conduct is a question of law"); Ky. Bar Ass'n v. Thornton , 392 S.W.3d 399, 407 (Ky. 2013) (noting that the Board of Governors' fact findings are "advisory only, " and further noting that Kentucky's Supreme Court will conduct a "de novo consideration of pleadings and trial review").
As a general rule, "[c]ourts may void contracts that violate law or public policy." Martello v. Santana , 713 F.3d 309, 313 (6th Cir. 2013) (citing Smith v. The Ferncliff , 306 U.S. 444, 450 (1939)). ILA argues that Kentucky law is unclear as to "whether the Rules of Professional Conduct governing lawyers provide a basis to discern public policy' for [the] purposes of determining the enforceability of contracts." (ILA's Mem. [DN 144] 18.) ILA cites a Maryland state-court case, Post v. Bregman , 707 A.2d 806 (Md. 1998), for the proposition that there is a significant split of authority regarding this issue. The Court finds, however, that the Rules of Professional Conduct do provide a basis to discern public policy. In Bregman, the court made such a holding. Also, in Martello v. Santana , the Sixth Circuit held that the "Kentucky Rules of Professional Conduct are public policy set by the Kentucky Supreme Court." 713 F.3d at 313.
In Martello, the Sixth Circuit recognized that the Rules of Professional Conduct "are not created only for the private benefit of the legal community, " but are also meant "to ensure [that attorneys] properly represent their clients, the public." Id. at 313-14 (internal quotation marks and citations omitted). Therefore, the Court finds that courts applying Kentucky law will not enforce an attorney's fee agreement that violates the Rules of Professional Conduct. See id. (affirming Martello v. Santana , 874 F.Supp.2d 658 (E.D. Ky. 2012), which voided a fee-sharing agreement barred by the Rules of Professional Conduct); Ky. Bar Ass'n v. Womack , 269 S.W.3d 409, 410-11 (Ky. 2008) (treating an unwritten contingency fee agreement as a nullity). Courts in other states have similarly refused to enforce contracts that violate their Rules of Professional Conduct. See Petit-Clair v. Nelson , 782 A.2d 960, 962-63 (N.J. 2001) (invalidating a mortgage because of an attorney's failure to comply with Rule 1.8); McLaughlin v. Amirsaleh , 844 N.E.2d 1105, 1111 (Mass. App. 2006) (refusing to recognize a mortgage obtained in violation of the ethical rules).
ILA argues that this analysis is incorrect, as the Kentucky Court of Appeals has cautioned that the Rules of Professional Conduct "are not designed to be a basis for civil liability." Rose v. Winters, Yonker & Rousselle, P.S.C. , 391 S.W.3d 871, 874 (Ky. Ct. App. 2012). In Rose, the Court declined to recognize a new cause of action against an attorney based on an alleged violation of the ethical rules restricting attorney advertising. In so doing, the Court noted that "the purpose of the Rules can be subverted when they are invoked by opposing parties as procedural weapons. The fact that a Rule is a just basis for a lawyer's self-assessment, or for sanctioning a lawyer under the administration of a disciplinary authority, does not imply that an antagonist in a collateral proceeding or transaction has standing to seek enforcement of the Rule." Id . (internal citation omitted). The Court finds, however, that Rose is off-point. It did nothing to overturn the principle that courts will not enforce contracts that violate public policy. Also, it did nothing to question that the Rules of Professional Conduct may reflect Kentucky's public policy in proper circumstances. Thus, this Court concludes that contracts that violate the Rules of Professional Conduct are unenforceable.
In this case, the Rule of Professional Conduct at issue is Rule 1.8(a), which applies when an attorney acquires an ownership interest in a client's business. Ky. Sup.Ct. Rule 3.130(1.8)(a). Allied argues that the undisputed record shows that ILA entered into the Compensation Agreement in violation of Rule 1.8(a). ILA, by contrast, argues that the undisputed record shows that it satisfied the requirements of Rule 1.8(a). During the relevant time period, Rule 1.8(a) stated:
(a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless:
(1) The transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client;
(2) The client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and
(3) The client consents in writing thereto.
Ky. Sup.Ct. Rule 3.130(1.8)(a). Thus, Rule 1.8(a) imposes three distinct requirements on an attorney who acquires an ownership interest in a client's business. The Court considers each in turn.
Rule 1.8(a)(1). Rule 1.8(a)(1) states that the "transaction and terms on which the lawyer acquires the interest" must be "fair and reasonable to the client, " "fully disclosed, " and "transmitted in writing to the client in a manner which can be reasonably understood by the client." Id . The parties dispute whether Smith "fully disclosed" the transaction and terms on which he acquired the interest. The parties also dispute whether the transaction and terms are "fair and reasonable."
Full Disclosure. In its summary judgment motion, ILA argues that there is no genuine dispute that the Compensation Agreement's terms were not only fully disclosed and transmitted in writing, but also were extensively negotiated over a seven-month period between July of 2000 and February of 2001. (ILA's Mem. [DN 144] 20.) In this respect, ILA notes that the executed Compensation Agreement was reached only after multiple drafts had been exchanged between its counsel and Allied's counsel. These drafts allowed the parties to resolve the mechanism that they would use to calculate the 5% fee. (See ILA's Opp. to Allied's Mot. for Summ. J. [DN 159] 12.)
Allied argues that Rule 1.8(a)(1)'s "full disclosure" requirement calls for more than a written fee agreement. Allied states that instead, Rule 1.8(a)(1) requires an acquiring lawyer to disclose all the material risks and disadvantages of a proposed contract, as well as any reasonable alternatives thereto. (Allied's Mem. [DN 149-1] 24-30.) Allied cites the ABA's Formal Ethics Opinion 00-418 (July 7, 2000) in support of its position. That opinion states that a "good faith effort to explain in understandable language the important features of the particular arrangement and its material consequences as far as reasonably can be ascertained at the time of the [contract] should satisfy the full disclosure requirements of Rule 1.8(a)." ABA Formal Ethics Op. 00-418, 7 (July 7, 2000). Allied also cites cases from other jurisdictions that have discussed the disclosure requirement. See, e.g., People v. Barbieri , 61 P.3d 488, 491 (Co. 2000) ("Full disclosure... requires a clear explanation of the differing interests of the lawyer and client, the advantages of seeking independent advice, and a detailed explanation of the risks and disadvantages to the client entailed in the business agreement."). Further, Allied relies on Comment 2 of the current version of Rule 1.8(a) for the proposition that "full disclosure requires discussion of [the] risks of [the] transaction, including risks presented by [the] lawyer's involvement and reasonable alternatives to the transaction." (Allied's Mem. [DN 149-1] 17.) Allied states that ILA and Smith simply did not make the requisite disclosures. According to Allied, Smith had an obligation to disclose to Thomas that no binding oral agreement existed, that the circumstances surrounding the transaction had materially changed, and that the written agreement would create a conflict with regard to Smith's future representation of Allied. (Id. at 25-27.)
Rule 1.8(a)(1)'s unambiguous terms state only that "[t]he transaction and terms on which the lawyer acquires the interest" must be fully disclosed. In this case, the Court agrees with ILA that there is no genuine dispute as to whether ILA complied with this requirement. As ILA notes, the Compensation Agreement's terms are in writing and were extensively negotiated by the parties' counsel between July of 2000 and February of 2001. Moreover, the final, executed Compensation Agreement was reached only after multiple drafts had been exchanged. The Court finds that under the facts of this case, ILA and Smith's disclosures were sufficient.
To be sure, the ABA's Formal Ethics Opinion 00-418 indicates that an attorney must do more than simply have a written agreement. Instead, it indicates that Rule 1.8(a)(1) requires a "good faith effort to explain in understandable language the important features of the particular arrangement and its material consequences as far as reasonably can be ascertained at the time of the [contract]...." ABA Formal Ethics Op. 00-418, 7 (July 7, 2000). In this case, however, the Court finds that the undisputed facts show that Smith made such a "good faith effort." Even when the facts are construed in the light most favorable Allied, the non-moving party, there can be no doubt that the agreement's terms (and the material consequences of them) were conveyed to Thomas. In this respect, it simply cannot be overlooked that Thomas had retained Stigger as counsel, and Stigger was advocating for Thomas and Allied, negotiating favorable terms on their behalf. The Court does not believe that the Rule required ILA and Smith to reiterate the details of the contract's terms, and the material consequences of those terms, to Thomas and Allied in ...