NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 977(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 977(b). This opinion has not been certified for publication or ordered published for purposes of rule 977.
Kairos Scientific Inc. (Kairos) filed a complaint for legal malpractice against the law firm of Fish & Richardson P.C. (Fish & Richardson) and John Land (collectively, F&R). Land was a partner at Fish & Richardson at the time of the incident giving rise to this malpractice lawsuit. F&R admitted a breach of the duty of care, but argued at a court trial that its failure to file a timely application for foreign patent rights for Kairos's invention was not the cause of any damages. The trial court rejected F&R's contention, and found its negligence resulted in approximately $30 million in damages and costs to Kairos. F&R appeals the court's rulings on causation and damages. We agree that the trial court should have deducted from the damage award the sums Kairos received from two of its non-exclusive license agreements entered into after F&R's acts of negligence. We are also remanding for the trial court to determine whether the net profits equal the gross profits and, if not, to deduct the costs from the award. We, however, otherwise reject F&R's arguments.
Kairos is a California corporation that conducts science research and development. Doctor Mary Yang founded the company in the early 1990s and is the company's president. Doctor Douglas Youvan is the company's chief executive and scientific officer.
Sometime prior to 1998, Kairos invented "KCAT," a technology used to "screen" enzymes. Enzymes are proteins that function as biological catalysis or as substances that accelerate reactions. Chemical engineers use enzymes to produce or improve numerous types of products, such as soft drinks, foods, laundry detergents, paints, pharmaceuticals, and paper. KCAT is intended to facilitate the "directed evolution of enzymes." "Directed evolution" is a methodology intended to develop improved enzymes for commercial use.
The methodology for "directed evolution" involves an eight-step process. First, the gene containing the DNA for a starting enzyme with properties close to the desired target enzyme is isolated. Second, the gene is cloned and then mutated by one of a variety of methods, such as ultraviolet light. Third, the gene variants produced are placed into bacterial cells, which are allowed to develop into colonies on petri dishes or well plates. Fourth, a "substrate" or test substance is added to each enzyme colony to test which colonies best accomplish the desired reaction. Fifth, the results are screened to identify the colonies that produce the best reaction. Sixth, the colonies that produce the best reactions are removed from the petri dish or well plate. Seventh, the process is repeated multiple times by re-isolating the DNA for the best enzymes to find more highly evolved enzymes. Eight, the evolved enzymes produced from repeated mutations are then tested to determine whether the laboratory results can be reproduced commercially.
KCAT technology includes instrumentation, methods, and computer algorithms that screen, image, and analyze microcolonies1 of solid state enzymes to determine the colonies that produce the best reaction. KCAT is different from other technology in its ability to screen very tiny colonies of bacteria in a solid state quickly, while prior technology required the colonies to be very large and/or to be contained in a liquid environment. KCAT leads to faster and more comprehensive screening in step five of the "directed evolution" process.
Kairos asked Land, a patent attorney at Fish & Richardson, to file patent applications for KCAT. On April 20, 1998, F&R filed a provisional patent application for KCAT with the United States Patent and Trademark Office (PTO). A provisional application, which is less formal than a regular utility application, allows the inventor to establish priority to an invention if the inventor is not ready to file the utility application. A provisional application lapses if not converted to a utility application within a year. Thus, Kairos had to file its utility application by April 20, 1999.
The same one-year deadline for claiming priority based on a provisional application also applies to foreign patents. Rather than file patent applications in each country, an applicant may file a single application under the Patent Cooperation Treaty (PCT). Kairos had to file its PCT application by April 20, 1999.
F&R filed the utility application for KCAT with the United States PTO on June 16, 1998. The patent issued approximately a year later in June 1999. The same month that the United States patent issued, F&R discovered that, due to an error in its calendaring system, it had failed to file the foreign PCT application by the April 20, 1999 deadline. F&R was able to obtain a Canadian patent, but it could not correct the error for any other foreign country; Kairos therefore lost the ability to seek patent protection in all foreign countries with the exception of Canada.
Kairos retained a new patent attorney who asked the PCT office to issue an "examiner's report" on the KCAT application. An examiner's report sets forth the requirements necessary before a patent will issue. In June 2001, the PCT examiner issued a written opinion that stated, among other things, that two articles written prior to the provisional application constituted preclusive prior art2 in that they rendered certain of KCAT's claims "obvious" or lacking an "inventive step."
Prior to the issuing of the United States patent, on October 9, 1998, Kairos entered into an 18-month, non-exclusive license with Hercules, a "specialty chemical company" that supplies chemicals for various industries, including the pulp and paper industry. Doctor Barry Lee Marrs,3 the director of corporate research at Hercules, negotiated this license on Hercules's behalf. Hercules was interested in using directed evolution to develop a faster, improved version of galactose oxidase, an enzyme used to make oxidized guar, a substance that adds temporary "wet strength" to toilet paper. Under the October 9, 1998 license, Hercules agreed to pay Kairos $360,000 a year to use KCAT for in-house research on enzymes and for instruction on how to use the instrument.
In June 1999, Youvan informed Marrs about the PCT filing error. Marrs replaced the October 9, 1998 license with a new, non-exclusive license, where Hercules agreed to pay $600,000 in license fees per year, milestone payments4 totaling $600,000 per year, and royalty payments based on net sales of improved enzymes developed with KCAT or net sales of products made with such enzymes. No royalties were ever paid.
In late 2000, Hercules began experiencing unrelated financial difficulties. In May 2001, Hercules terminated the January 2000 license and signed a one-year agreement for $96,000 a year with no royalty payments. Hercules terminated the May 2001 licensing agreement and entered into a licensing agreement with Maxygen, a company that had foreign patent protection.
Kairos also had been involved in negotiations with Dyadic for a non-exclusive license to use KCAT. Dyadic is an international company that discovers genes and makes proteins. Dyadic's president and chief executive officer, Mark Emalfarb, contacted Youvan at Kairos. Emalfarb believed KCAT could help Dyadic find additional proteins that could be brought to the market and could help Dyadic increase the protein productivity of one of its existing products. He also believed that it would help create additional value by bringing in new technology that would aid him in raising money with venture capitalists and investment bankers in moving towards an initial public offering.
Youvan indicated that Kairos wanted a $1 million up-front payment and $100,000 to $150,000 per month as a maintenance fee to license KCAT to Dyadic. Emalfarb believed these numbers "were in the ballpark [of] what other people were paying for access fees and maintenance fees in [this] industry." However, he "would have liked to be able to get it for less." He was willing to pay "in the neighborhood of a million dollar access fee." However, he would have "negotiated the monthly fee down significantly" and he was prepared to pay "[i]n the neighborhood of $250,000 per year."
Emalfarb stopped negotiating the agreement with Youvan once he was told that Kairos no longer had foreign patent protection because he "could freely operate outside" of the patent without paying one million dollars and a maintenance fee. Dyadic could go to Europe, Japan, Israel, or several other countries "and actually practice the art."
On February 2, 2001, Kairos filed a lawsuit against F&R. On April 24, 2001, Kairos filed its first amended complaint (containing the same causes of action asserted in its original pleading) and alleged causes of action for legal malpractice, breach of contract, and restitution/unjust enrichment. F&R conceded it breached its duty to file the PCT application, and reimbursed Kairos $115,797 for out-of-pocket fees and costs. It disputed the question of whether its malpractice caused any damages and the case proceeded to trial on the issues of causation and damages. The parties waived a jury trial and Judge Carl W. Holm heard the case.
In July 2003, the trial court issued an 85-page tentative decision awarding Kairos $30 million in damages. The court considered further briefing and then issued its 86-page final statement of decision, which reduced the $30 million in damages by $1.53 million, the estimated cost to Kairos to obtain foreign national patents. The court also provided for prejudgment interest and called for evidence concerning present dollar value. Following further briefing and testimony concerning present value, the court on April 30, 2004, entered a judgment against F&R for $29,868,004. This sum represented $27,775,735 for present dollar value plus $2,092,269 prejudgment interest. F&R filed a timely notice of appeal from the judgment.
F&R moved for a new trial and to tax costs. On June 29, 2004, the court filed orders denying the motion for new trial and granting in part the motion to tax costs. The net cost award was $125,307.29. F&R filed a timely notice of appeal from the costs award. We consolidated the appeals.
The trial court found that F&R's failure to file a timely PCT application constituted legal malpractice. A cause of action for legal malpractice requires evidence of the following four elements: "(1) the duty of the attorney to use such skill, prudence, and diligence as members of his or her profession commonly possess and exercise; (2) a breach of that duty; (3) a proximate causal connection between the breach and the resulting injury; and (4) actual loss or damage resulting from the attorney's negligence." (Coscia v. McKenna & Cuneo (2001) 25 Cal.4th 1194, 1199-1200.)
In the present case, F&R admits it breached its duty of care, but it maintains that the trial court erred in finding the third element of causation. F&R also challenges the amount of damages awarded. We consider each of these contentions.
I. The Test for Causation
F&R contends that the trial court erred when it ruled that the loss of foreign patent rights caused damage to Kairos. F&R maintains that the court should have required Kairos to prove that KCAT had been replicated in Europe and that, "but for" the filing error, Kairos would have obtained the foreign patents and been entitled to infringement damages. Alternatively, F&R insists that Kairos had to establish, but for F&R's negligence, Kairos would have obtained foreign patent rights and the loss of these rights precluded it from entering into various license agreements.
We review the question of whether the court used the proper legal standard de novo. (See, e.g., Burden v. Snowden (1992) 2 Cal.4th 556, 562). Those findings of fact that support the trial court's ruling, we review for substantial evidence. (Scott v. Common Council (1996) 44 Cal.App.4th 684, 689.)
When malpractice occurs during the representation of a party in litigation, courts require the plaintiff to establish that the negligence caused actual financial harm or loss. "Unless a party suffers damage, i.e., appreciable and actual harm, as a consequence of his attorney's negligence, he cannot establish a cause of action for malpractice. Breach of duty causing only speculative harm is insufficient to create such a cause of action." (Thompson v. Halvonik, (1995) 36 Cal.App.4th 657, 661.) " `Damage to be subject to a proper award must be such as follows the act complained of as a legal certainty.' " (Marshak v. Ballesteros (1999) 72 Cal.App.4th 1514, 1518.)
Our Supreme Court in Viner v. Sweet (2003) 30 Cal.4th 1232 (Viner) considered the standard of proof necessary to establish the causation element when, as in the present case, the attorney's malpractice involves transactional work. The court in Viner explained that the "but for" test of causation in negligence cases remains the proper test and some of the confusion has resulted because this test has been subsumed by the "substantial factor" test articulated in section 432 of the Restatement Second of Torts (Restatement). (Viner, supra, at p. 1239, citing Mitchell v. Gonzales (1991) 54 Cal.3d 1041, 1052.) The substantial factor test applies when there are concurrent independent causes, which is not the situation here. The sole cause of Kairos's injury is F&R's failure to file the PCT application. Thus, the substantial factor test is inapplicable and we apply the "but for" test. (See Viner, supra, at p. 1240.)
Our Supreme Court in Viner explained the reasons for refusing to relax the standard for establishing causation in transactional malpractice claims: " `When a business transaction goes awry, a natural target of the disappointed principals is the attorneys who arranged or advised the deal. Clients predictably attempt to shift some part of the loss and disappointment of a deal that goes sour onto the shoulders of persons who were responsible for the underlying legal work. Before the loss can be shifted, however, the client has an initial hurdle to clear. It must be shown that the loss suffered was in fact caused by the alleged attorney malpractice. It is far too easy to make the legal advisor a scapegoat for a variety of business misjudgments unless the courts pay close attention to the cause in fact element, and deny recovery where the unfavorable outcome was likely to occur anyway, the client already knew the problems with the deal, or where the client's own misconduct or misjudgment caused the problems. It is the failure of the client to establish the causal link that explains decisions where the loss is termed remote or speculative. Courts are properly cautious about making attorneys guarantors of their clients' faulty business judgment.' " (Viner, supra, 30 Cal.4th at p. 1241.)
Our Supreme Court further explained that "[i]n both litigation and transactional malpractice cases, the crucial causation inquiry is what would have happened if the defendant attorney had not been negligent." (Viner, supra, 30 Cal.4th at p. 1242.) The plaintiff can prove causation with circumstantial evidence that " ` "affords a reasonable basis for the conclusion that it is more likely than not that the conduct of the defendant was a cause in fact of the result." ' " (Id. at p. 1243.)
In the present case, the trial court stated in its statement of decision that "one must be careful to distinguish the fact of damage from the amount of those damages." It stated that there was uncertainty in the present case as to the amount of damage caused by F&R's wrongful act. The court explained that the error in this case was F&R's failure to file the PCT application. It therefore set forth the " `fundamental inquiry' " as being whether, "but for this error, [Kairos would] have obtained its foreign patent rights[.]" The court explained that the evidence at trial convinced it that Kairos would have overcome the initial PCT examiner's opinion and therefore Kairos had "proven causation, i.e., it has shown `a proximate causal connection between the breach [of the duty owed between defendants and plaintiff] and [a] resulting injury . . . .' "
F&R criticizes the trial court for failing to cite the Viner decision, but the question is whether the trial court used the proper standard, not what authority it specifically cited. F&R argues that the trial court found that the simple loss of a patent right, which is similar to the loss of a legal right, is sufficient to establish causation. However, the simple loss of a patent right, according to F&R, does not establish any financial loss. F&R argues that a patent right, similarly to the right to pursue a lawsuit, has no intrinsic financial value. A patent does not grant the inventor an affirmative right to practice the invention, nor does it guarantee the invention's financial success. A patent merely grants the inventor the right to exclude others from making, using, or selling the invention, which may have no financial value. (See Leatherman Tool Group v. Cooper Industries, Inc. (Fed.Cir. 1997) 131 F.3d 1011, 1014.) F&R cites to a New York case involving a legal malpractice based on the failure to file a foreign patent application where the court observed that a plaintiff "has sustained no injury unless there has been an infringement against which its patent would have afforded a right of recovery." (IGEN, Inc. v. White (1998) 250 A.D.2d 463, 465 [672 N.Y.S.2d 867].)
F&R asserts that Kairos could not prove any unauthorized use or copying of its invention, and therefore it claimed damages based on lost licenses. F&R claims that Kairos had to prove that it was more likely than not it would have entered into more favorable licenses "but for" the filing error. (See Viner, supra, 30 Cal.4th at p. 1244.) Instead, the trial court only required Kairos to prove that it would have successfully obtained the foreign patents, and F&R insists this constituted error.
We disagree with F&R that the trial court relaxed the standard of proof for establishing causation. The court did not simply require Kairos to prove that it lost its right to file a foreign patent, which would be similar to losing a right to a legal claim or to a trial in the litigation malpractice context. Instead the court required Kairos to establish that F&R's negligence caused it "to suffer some financial harm or loss." (Viner, supra, 30 Cal.4th at p. 1235.) Kairos had to establish that a more favorable result would have been obtained "but for the alleged negligence." (Id. at pp. 1238-1239, fn. omitted.) The trial court found that Kairos proved to its satisfaction that, had F&R properly filed for a foreign patent, Kairos would have been successful in overcoming the initial PCT examiner's opinion that KCAT was "obvious" or lacking an "inventive step." Thus, as in litigation cases where the plaintiff must not only establish the loss of a legal right but the likelihood that the client would have prevailed on this claim, in this transactional case, Kairos not only had to establish that F&R failed to make a timely application, but that such an application would have been successful.5
F&R is essentially asking this court to make the standard for transactional malpractice cases more difficult than the one for litigation malpractice cases. F&R argues that the loss of a patent right, in itself, has no financial value and therefore Kairos had to prove that it was more likely than not it would have entered into more favorable licenses "but for" the filing error. We are not aware of any California case that requires such a standard of causation, nor does the New York case cited by F&R set forth such a requirement. The New York case did not address the question of causation but held there were no actual damages when the plaintiff admitted no "actual harm had been sustained as of the date its action was commenced." (IGEN, Inc. v. White, supra, 250 A.D.2d at p. 466.) Thus, the New York determined the plaintiff had not established the fourth element of malpractice, actual damages. Indeed, in a legal malpractice case that involves the failure to litigate a patent infringement, in order to prove causation, the plaintiff only needs to establish that he or she would have prevailed on that claim. The question of whether any damages resulted from that injury relates to the element of actual damages.
The present case differs from the typical transactional case, such as Viner, where the malpractice relates to the drafting of the agreement. When the malpractice relates to the drafting of the agreement, the plaintiff must establish that the parties would have agreed to the contract that did not contain the alleged mistakes. The malpractice in the present case did not relate to the drafting of the licenses; rather it relates to the failure to apply in a timely fashion for the foreign patents.
In the present case, as already stressed, the trial court used the proper standard that required Kairos not simply to prove that F&R failed to file for a foreign patent. Rather, the court required Kairos to establish that, had the PCT application been timely filed, Kairos would have received foreign patent rights. It may well be that this injury did not result in any actual damages or that no consequential damages flowed from this injury, but that is a question of the amount of any damages, not the fact of damage or injury. The fact that the loss of foreign patent rights does not have any "intrinsic" monetary value, as F&R argues, is immaterial. Kairos lost a personal property right to exclude others from practicing its invention in foreign countries, which certainly constitutes an injury.
Although not expressly articulated, it appears that F&R also is arguing that substantial evidence did not support the court's finding of causation. The record, however, amply supports this finding. Several witnesses testified that the PCT application would have been granted because there was no disqualifying prior art. F&R's expert patent attorney testified at his deposition that the PCT examiner's examples of possible prior art were not invalidating prior art. Doctor Alexander M. Klibanov, a professor at M.I.T. who teaches courses in chemistry, biochemistry, and enzyme technology, testified there was no disqualifying prior art6 and the PCT application would have been granted. Accordingly, substantial evidence supported the finding that, but for F&R's failure to file a timely PCT application, Kairos would have received foreign patent rights.
When responding to this same argument by F&R in its statement of decision, the lower court explained that F&R was attempting to require Kairos to prove causation twice. F&R was requiring Kairos to prove that it could be successful in the PCT process and, additionally, " `that a non-exclusive [or for that matter an exclusive] license was lost for lack of foreign patent protection . . . .' " The court correctly noted that the latter goes to the amount of damages, not the fact of damages. Further, the court noted: "Even if plaintiff is obligated to prove the second level of causation as well plaintiff has done that too. The injury to plaintiff in the form of losing an exclusive licensing agreement with Hercules as well as the effect on their relationship with Dyadic [a loss of license], establishes the second level of causation as well." The court heard evidence that the absence of foreign patents impacted Kairos's ability to sell exclusive licenses for KCAT because the licensees had no protection for anything discovered by using the KCAT invention outside the United States.7 Further, Klibanov testified that the worldwide market for enzymes is "at least twice the size of the U.S. market." In terms of patents, he expressed the opinion that it was "very important" to have a foreign patent as well as a United States patent because two of the largest enzyme producing companies in the world are European companies. Moreover, he noted that at least half, and probably more, of the market for the use of enzymes is outside of the United States. Klibanov opined that the loss of foreign patent rights would "basically" destroy the chances of Kairos getting an exclusive license for KCAT. Indeed, Marrs testified that Hercules no longer wanted an exclusive license with Kairos after learning about the foreign patent rights because "it no longer made sense from a strategic point of view because a lot of our competition is European and there would be no strategic advantage to having an exclusive license if we couldn't exclude the Europeans from practicing this art."
We therefore reject F&R's challenge to the trial court's ruling on causation.
II. The Award of Damages
A. The Trial Court's Award
In its statement of decision the trial court noted that Kairos had claimed that it had lost licensing revenue in the approximate amount of $39 million due to F&R's failure to file a timely PCT application. The court noted that Kairos lost its personal property right to exclude others from practicing its invention in foreign countries. This affected its ability to license the practicing of its invention in the United States due to the worldwide market for enzymes. When determining the damages award of almost $30 million, the court considered Kairos's claims concerning lost contracts with Dyadic and Hercules.8
The court noted that Emalfarb, on behalf of Dyadic, was negotiating with Kairos for an access fee as well as a monthly maintenance fee for a nonexclusive license for KCAT. Emalfarb was willing to pay " `somewhere in the neighborhood of a million dollars access fee[,]' " but he would have negotiated the monthly fee down to $250,000 a year. Based on testimony by another expert on the useful duration of patents and other evidence, the court determined that it would be reasonable to conclude that the licensing agreement would be for no more than seven years. The court found that the damages from the loss of this licensing agreement was $250,000 multiplied by six years plus the additional one million access fee for a sum of $2.5 million.
The court also pointed out that, prior to the loss of the foreign patent rights, Dyadic was considering the purchase of Kairos. Emalfarb estimated that having Kairos within his company would have been worth between $10 to $15 million added value to his company and that he would have paid Kairos between $2.5 to $7.5 million for the purchase. The court, however, concluded that Kairos would not have agreed to sell because it thought it could have lucrative licensing agreements with many companies.
Once Emalfarb learned that Kairos had lost its international patent rights, Emalfarb stopped negotiating. The court explained that Emalfarb "needed the international patent rights, in his opinion, since Dyadic was an international company that `sell[s] products on a worldwide basis.' Once he learned that [Kairos] had lost its international patent protection, he felt that he `could freely operate outside of [Kairos's] patent without paying a million dollars and $250,000 a year.' He had facilities in other countries where he could practice the art with `impunity.' "
The trial court cited testimony by Marrs, the director of corporate research at Hercules. He testified concerning the licensing agreement Hercules would have entered into with Kairos if it had obtained foreign patent protection for KCAT. Marrs stated that his interest in an exclusive licensing agreement evaporated once he learned of the loss of the foreign patent rights. The court found that the conservative estimate was that $5 million would have been paid at the beginning of the exclusive license in the year 2000 and the remainder over the effective life of the license for the next six years beginning in the year 2001 for an additional $5 million at $833,333 a year.
The court summarized the evidence concerning a royalty payment agreement, and disregarded any milestone payments in the calculation of damages because it found them to be uncertain. It found that 3.5 percent was a fair calculation of the royalty payment given the range from one to three percent in the second licensing agreement and the various opinions expressed by the experts at trial. The court rejected Marrs's and Youvan's testimony that they expected three marketable products per year and accepted the "conservative estimate" of another expert of one product a year. The court considered Hercules's studies that each product would net $50 million in sales for each year it existed during the seven years of the license, and the court concluded that "the total sum of $17.5 million in royalties would have been paid to [Kairos]. [F&R is] responsible for that loss of royalties as well."
In response to F&R's arguments, the court stated that it did not consider the operating expenses in servicing the Hercules and Dyadic license because F&R never met its burden of showing what these expenses were. The court also rejected F&R's contention that it should be given a " `credit for the payments contemplated by the second Hercules license, including an estimated royalty stream, as the second license would not have been reached if the foreign rights were obtained and Hercules actually entered into the limited exclusive which the court determined was lost because of the lack of foreign rights.' " (Fn. omitted.) The court stated that the award did not provide Kairos with " `double income' since there would not have been a second licensing agreement between Hercules and [Kairos] if the foreign patent rights were not lost. Furthermore, [Kairos] received no royalty income since the second licensing agreement was terminated partly as a result of Hercules's desire to access biodiversity and move into industrial BoCatalysis with a company that had foreign patent protection, such as Maxygen, and partly as a result of economic difficulty making it impossible to collaborate with both Maxygen and [Kairos] at the same time." (Fn. omitted.)
Finally, the court considered F&R's argument that it should be granted an offset for each license Kairos could not get if it gave an exclusive license to Hercules. The court found that F&R presented no evidence to justify such an offset.
The court did, however, offset the award of damages of $30 million to Kairos by $1.53 million. This latter figure represented the estimated cost of national filings in the 102 PCT countries during the applicable time period.
After an additional hearing on the present value of the damage award, the court rejected F&R's present value evidence that considered the time-value of money and the risk that the future profits would never have been realized. The court accepted Kairos's present value calculations and awarded Kairos $27,775,735 in damages, plus $2,092,269 in prejudgment interest, for a judgment total of $29,868,004.
B. F&R's Claim that the Award Is Speculative, Excessive, and Unreasonable
1. Standard of Review
F&R contends that the award of almost $30,000,000 is speculative, excessive, and unreasonable as a matter of law. However, the proper standard of review is substantial evidence. Only the determination of whether the plaintiff is entitled to a particular measure of damages is a question of law subject to de novo review. (Kajima/Ray Wilson v. Los Angeles County Metropolitan Transportation Authority (2000) 23 Cal.4th 305, 315.) The amount of damages is a question of fact and will not be disturbed if it is supported by substantial evidence. (Westphal v. Wal-Mart Stores, Inc. (1998) 68 Cal.App.4th 1071, 1078.)
The evidence is insufficient to support a damage award only when no reasonable interpretation of the record would support the amount awarded. (San Diego Metropolitan Transit Development Bd. v. Cushman (1997) 53 Cal.App.4th 918, 931.) " `When a finding of fact is attacked on the ground that there is no substantial evidence to sustain it, the power of an appellate court begins and ends with the determination as to whether there is any substantial evidence, contradicted or uncontradicted, which will support the finding of fact. [Citations.] [¶] When two or more inferences can reasonably be deduced from the facts, a reviewing court is without power to substitute its deductions for those of the trial court.' [Citation.]" (Scott v. Common Council, supra, 44 Cal.App.4th at p. 689, quoting Green Trees Enterprises, Inc. v. Palm Springs Alpine Estates, Inc. (1967) 66 Cal.2d 782, 784-785.) The testimony of a single credible witness may constitute substantial evidence. (In re Marriage of Mix (1975) 14 Cal.3d 604, 614.)
2. F&R's Assertions of Unreasonableness
F&R maintains that the lost profits award violates Civil Code section 33599 because it is unreasonable, unconscionable, and grossly oppressive. (See Postal Instant Press, Inc. v. Sealy (1996) 43 Cal.App.4th 1704, 1714-1716.) It protests that such an award makes the attorney the virtual guarantors of insurers of their clients' success even where, as here, the market is inherently unpredictable and the invention one of unproven commercial value.
Although F&R attempts to argue that the court erred as a matter of law, as already explained, we apply the substantial evidence test. Accordingly, we do not reweigh the evidence but merely look to see if the record contains evidence to support the court's award of damages. As the trial court noted, it is impossible to determine with certainty the damages in this case, but the award will be affirmed as long as the court used a reasonable approximate estimate of the damages, and " `the defendant whose wrongful act gave rise to the injury will not be heard to complain that the amount thereof cannot be determined with mathematical precision.' " (DuBarry Internat., Inc. v. Southwest Forest Industries, Inc. (1991) 231 Cal.App.3d 552, 562; see also Toscano v. Greene Music (2004) 124 Cal.App.4th 685, 691.) Indeed, the Viner court reiterated the principle that the court will take a more flexible approach in transactional legal malpractice cases when considering the proof of consequential damages. (Viner, supra, 30 Cal.4th at pp. 1243-1244.)
The trial court's statement of decision was carefully thought out and the court at times rejected, and at other times deemed credible, evidence from both parties. The court considered the testimony of Marrs that Hercules had been interested in an exclusive licensing agreement for KCAT until it learned about the loss of the foreign patent rights. When considering the damages for the lost license with Hercules, the court assessed the testimony of Marrs, Youvan, and experts as well as the non-exclusive licenses between Kairos and Hercules. The numbers the court derived from this evidence were neither unreasonable nor unconscionable.
Similarly, with regard to the damages based on the lost licenses between Dyadic and Kairos, the court thoroughly considered the evidence presented at trial. Emalfarb testified that he ceased pursuing a licensing agreement for KCAT after he learned that Kairos did not have foreign patent protection, because he knew he could freely operate outside of the patent in Europe, Japan, Israel, or several other countries without paying any money. When arriving at the sum of $2.5 million, the court used the specific numbers Dyadic had discussed with Kairos and considered Emalfarb's testimony about what he would have agreed to pay had F&R's error not caused Dyadic to withdraw from the ongoing negotiations. Further, the court did not simply accept Emalfarb's numbers, but reduced them after considering expert testimony about the useful duration of such licensing agreements. Thus, the court's determination was neither speculative nor excessive.
We therefore reject F&R's argument that the award was unreasonable and unconscionable. Simply because the damages were estimates due to the nature of the injury, does not mean that F&R can escape the consequences of its negligence. " `[I]f the business is a new one or if it is a speculative one . . . , damages may be established with reasonable certainty with the aid of expert testimony, economic and financial data, market surveys and analyses, business records of similar enterprises, and the like.' " (Kids' Universe v. In2Labs (2002) 95 Cal.App.4th 870, 884.)
In addition to its general objections to the damages award, F&R makes the following specific challenges: there can be no damages award when KCAT failed to produce any commercial enzyme; the trial court's estimate that the licenses would be for seven years is speculative and not based on the evidence in the record; and the record does not support any award of royalties or the court's determination of the royalty rate. We consider each of these criticisms.
a. Lack of Past Commercial Success
F&R argues that Kairos suffered no damages and the award was speculative because KCAT never proved its usefulness by producing a commercialized enzyme. The trial court expressly rejected that contention. There is some evidence in the record that the failure to develop new commercial products was Hercules's fault. More significantly, the record establishes that KCAT's function was not to produce marketable enzymes, but to provide an accelerated rate of screening, which reduces the cost per assay10 or per test and conserves compounds that are either expensive or difficult to synthesize and purify. Klibanov testified that the KCAT invention "allows a fast and comprehensive screening of very large libraries." He considered it fast because it can screen up to 50,000 "variants" at a time whereas using the conventional "96 well plate . . . you can roughly do a hundred variants per plate." He believed that KCAT was an innovative technology that could be extremely helpful in identifying promising enzyme candidates. When asked whether the fact that KCAT had not resulted in an enzyme that was put into a commercial product was a fair way to determine the usefulness of KCAT as a tool, Klibanov gave a lengthy explanation as to why he believed that was "the wrong way to look at it." He stated that the mission of KCAT technology "is to facilitate and improve directed evolution" and "there are companies that all they do is directed evolution, and they are worth hundreds of millions of dollars." In response to the court's question, he clarified that these companies involved in directed evolution that are worth millions of dollars "cannot produce an industrially used enzyme." He commented that the criticism of KCAT related to its failure to produce a commercial enzyme was "the wrong criterion to use to evaluate the virtues and the worth of KCAT. KCAT is a technology to identify promising enzyme candidates. That's all. It's not a technology for commercializing enzymes."
Emalfarb testified that the value of KCAT to Dyadic was not based on commercial success in assisting a company in the production of an enzyme. Part of the technology's value was that it could screen variants and find them. The technology, itself, was part of the value of KCAT to Dyadic because Emalfarb "could get a lot more value on Wall Street for that by having access to everything and tying it all up so nobody else could use it . . . . So not only would I be able to charge access fees and royalties and milestones, I may actually have new business units forming on the basis of this technology." Emalfarb estimated that KCAT would have added value to his company in the amount of $10 to $15 million.
The record therefore provides sufficient support for the trial court's determination that the lack of prior commercial success with KCAT would not have significantly impacted Kairos's ability to negotiate licenses with Hercules and Dyadic for this use of this invention.
b. Award Based on License of Seven Years
F&R argues that no evidence in the record establishes that Dyadic would have paid Kairos the full license and maintenance fees over a seven-year period. It points out that Emalfarb testified that he would license KCAT only "as long as [he] could derive usefulness out of it." F&R maintains that KCAT never proved its usefulness by producing a commercialized enzyme. (See Toscano v. Greene Music, supra, 124 Cal.App.4th at p. 696 [award of future lost earnings based on what plaintiff would have earned until retirement were too speculative where employer could have terminated plaintiff at any time and no evidence plaintiff would have enjoyed continued employment].)
Substantial evidence supported the court's determination that the license with Dyadic would be for seven years. When negotiating with Kairos, Emalfarb was asked whether he had "in mind the duration of that agreement." He responded: "I believe the life of the patent is 17 or 20 years. So as long as we could derive usefulness out of it, we would have continued on." The court then heard expert testimony regarding the general length of these contracts in the industry and limited the agreement to seven years.
F&R makes essentially the same complaint with regard to the court's determination that Kairos is entitled to damages based on a seven-year license with Hercules. F&R states that the record establishes that none of the three actual licenses that Hercules entered into with Kairos lasted for more than one and one-half years, and Hercules consistently invoked the early termination clause in its licenses. F&R asserts that given Hercules's history of early termination and the financial difficulties it was experiencing in 2000 to 2001, no evidence supported the trial court's finding that Hercules would have remained in the license for seven years and paid the full $10 million in license fees.
When assessing the lost licenses with Hercules, the court considered Marrs's testimony that Hercules was no longer interested in an exclusive license for KCAT because it "no longer made sense from a strategic point of view because a lot of our competition is European and there would be no strategic advantage to having an exclusive license if we couldn't exclude the Europeans from practicing this art." F&R's argument that Hercules would not have agreed to a license for seven years because of its financial problems is not supported by the record. Hercules entered into an agreement with Maxygen to pay $8 million for an exclusive license for a somewhat similar technology.
F&R's argument regarding the nonexclusive license agreements between Kairos and Hercules is somewhat irrelevant, because such agreements are not similar and have different objectives. The three actual licenses between Kairos and Hercules, to which F&R refers, were for unrelated, nonexclusive use of KCAT for Hercules's internal purposes, and were exclusive licenses for use in screening enzymes for commercial product development. The lost exclusive agreement was not the same as the nonexclusive agreement because the former would have given Hercules a license to use KCAT in its efforts to develop marketable enzyme products. With the nonexclusive license, Hercules could pursue individual products one at a time and make money, but without an exclusive license that excluded the Europeans from practicing this art, it lost the ability for a " `strategic play which was a much bigger play.' "
Accordingly, we conclude that substantial evidence in the record supported the trial court's determination that the licenses would have been for seven years.
F&R argues that as a matter of law, Kairos is not entitled to royalties for yet-to-be-discovered enzymes. It maintains that such damages are too speculative. (See Sanchez-Corea v. Bank of America (1985) 38 Cal.3d 892, 907 ["evidence of lost profits must be unspeculative and in order to support a lost profits award the evidence must show `with reasonable certainty both their occurrence and the extent thereof' "]; S.C. Anderson, Inc. v. Bank of America (1994) 24 Cal.App.4th 529, 535-536 [failed to present evidence to jury of a reasonable probability that profits would have been earned except for the defendant's conduct].) F&R argues that the January 2000 agreement, which contained a royalty provision for enzyme products developed with KCAT, used a complicated schedule ranging from zero to eight percent depending on the type of product and the amount of sales. The court's decision to use a 3.5 percent royalty rate was therefore, according to F&R, arbitrary and speculative. Further, F&R repeats its argument that Hercules's failure to produce a single commercialized enzyme should have resulted in the court not awarding any damages based on a royalty. (See Kids' Universe v. In2Labs, supra, 95 Cal.App.4th at pp. 887-888 [lost profits for new business were too speculative].) Kairos failed to present any evidence of profits or royalties from comparable enzyme-selling businesses. The absence of such evidence, F&R argues, requires reversal. (See Resort Video, Ltd. v. Laser Video, Inc. (1995) 35 Cal.App.4th 1679, 1699 [no evidence of operating history of this venture or of operating histories of comparable business and therefore award for lost anticipated profits of new business was too speculative]; Gerwin v. Southeastern Cal. Assn. of Seventh Day Adventists (1971) 14 Cal.App.3d 209, 222 [same].)
As to the $175 million award for royalties from Hercules, Hercules discussed a three to four percent royalty rate with Kairos based on its market studies that estimated three marketable products per year with annual sales of $50 million each, over a span of seven years. Thus, the court's determination of 3.5 percent had some basis in the record.
F&R complains that an award that included royalties was too speculative because of the earlier lack of success in developing a commercial product and the complete lack of any evidence that there ever would be any commercial product. The evidence, however, was that KCAT worked as expected but Hercules had not conducted the tests properly. Marrs explained: "We got what we asked from KCAT, but it didn't work, in fact, but that's because we didn't ask the right question from KCAT. It's a mantra in this field that you get what you screen for. We got what we screened for. We screened under dilute conditions, and we got an enzyme that really worked faster under dilute conditions. When we put it into commercial conditions which are highly concentrated, we didn't see the improvement that we predicted, but that wasn't KCAT's fault. That was our fault, our lack of understanding, I would say."
The trial court's statement of decision establishes that the court carefully considered the evidence. The court rejected Marrs's and Youvan's expectation of three marketable products per year; instead, it accepted a conservative estimate by an expert of one product a year. William Scott Mowrey, Jr., a certified public accountant who does forensic accounting, looked at information regarding Kairos to evaluate the damages it suffered in terms of lost profits and the lost value of the business as a whole relative to the loss of its foreign patent rights. He provided a conservative estimate of one product a year based on a model he created by analyzing the second nonexclusive license agreement between Kairos and Hercules and information that he had received regarding Maxygen. The court properly considered the industry's customary range as satisfactory proof (Sanchez-Corea v. Bank of America, supra, 38 Cal.3d at p. 908) and the testimony of an expert.
We therefore conclude that the award of royalties was not speculative, excessive, or unreasonable.
C. Gross or Net Profits
F&R contends that where, as here, " `loss of anticipated profits is an element of damages, it means net and not gross profits.' " (Resort Video, Ltd. v. Laser Video, Inc., supra, 35 Cal.App.4th at p. 1700.) The trial court, according to F&R, awarded damages based on gross profits, not net profits, because it did not take into account the costs Kairos would incur in servicing the licenses. F&R maintains that plaintiff had the burden of proving the costs incurred in producing the profit. (S.C. Anderson, Inc. v. Bank of America, supra, 24 Cal.App.4th at pp. 535-537.)
In addition, F&R argues that the court erred when it ruled that costs and expenses were matters of mitigation that it had to prove. F&R asserts that because it was Kairos's burden to prove net and not gross profits, "the award should be reversed with directions to enter judgment [in] F&R's favor." Even if the burden was on Kairos to prove net rather than gross profits, this would not result in reversal of the judgment but a remand to consider relevant evidence and for a recalculation.
It is fundamental that in awarding damages for the loss of profits, net profits, not gross profits, are the proper measure of recovery, and the plaintiff has the burden of proof. (General Advertising Agency, Inc. v. Komer (1967) 251 Cal.App.2d 805, 811; Carrey v. Boyes Hot Springs Resort, Inc. (1966) 245 Cal.App.2d 618, 622-623.) Although Kairos did not argue that its gross profits equaled its net profits at trial, it did raise this issue in its brief submitted to the court after the trial and after the court had issued its tentative decision. Kairos asserted that the exclusive license was for use of the patent and for royalties, neither of which would have required Kairos to incur any costs or expenses in addition to those it was otherwise incurring in the absence of the licenses.
In its final statement of decision, the trial court stated that "in the context of this case, it was defendants' burden to show what these expenses were. Since they haven't shown this, their request [to have the costs deducted from the gross profits] is denied." In a footnote, the court cites inapplicable cases.
As noted ante, Kairos had the burden of establishing that its gross profits equal the net profits and it is not clear from this record that the trial court concluded there were no expenses that should be deducted. Accordingly, we remand for the court to determine whether the gross profits equal the net profits and, if expenses should be deducted, to so modify the damages award.
D. Offset for Sums Received for Licenses with Hercules
F&R challenges the trial court's refusal to provide an offset for the amount Kairos recovered in mitigation of its damages. In particular, F&R contends that the court should have deducted sums from the damages awarded when it found that, but for the filing error, Hercules would have entered into a seven-year exclusive license with Kairos beginning in 2000. F&R argues that the court should have deducted from the measure of damages the $600,000 in license fees and the $600,000 in milestone payments under the January 2000 license and the $96,000 in licensing fees under the May 2001 license. F&R asserts that the court did not deduct these fees because "there would not have been a [January 2000] agreement between Hercules and [Kairos] if the foreign patent rights were not lost." However, F&R insists the fact there would not have been a January 2000 license is precisely the reason why the payments for that license should have been deducted to avoid a double recovery.
"The measure of damages in a case predicated on legal malpractice `is the difference between what was recovered and what would have been recovered but for the attorney's wrongful act or omission.' " (Mosier v. Southern Cal. Physicians Ins. Exchange (1998) 63 Cal.App.4th 1022, 1049-1050.)
With regard to the first license dated October 9, 1998, the income from this license was unrelated to the damages award. Indeed, the testimony by Marrs was that he wanted to establish that KCAT worked so that he could demonstrate to others within Hercules its desirability. Accordingly, the trial court properly did not deduct the sum received by Kairos for the first license with Hercules.
Kairos also insists that there should be no offset for the sums received for the second and third license agreements, which occurred after it became clear Kairos had lost its foreign patent rights. Kairos argues that the $600,000 milestone payments under the nonexclusive agreements could not operate as mitigation of damages since the court refused to award Kairos any damages for milestone payments under the lost exclusive licensing agreement. Further, under the second nonexclusive agreement, Kairos was obligated to provide up to 360 hours of "consultation services at no additional charge." These services would not have been included in any exclusive licensing agreement. Since the license fees for the second and third nonexclusive agreements were for different uses by Hercules, Kairos asserts the court correctly found that F&R failed to meet its burden of proving the amount of any mitigating recovery.
The trial court, however, expressly found that there would not have been a second non-exclusive licensing agreement between Hercules and Kairos if the foreign patent rights had not been lost. Since there would have been no second or third contract had Kairos and Hercules entered into the seven-year exclusive license and since Kairos received damages based on this seven-year exclusive license, the court should have deducted from the damage award the sums received for the second and third non-exclusive licenses. It does not matter that the objectives for these agreements were not identical; the non-exclusive licenses resulted because the more lucrative exclusive agreements were abandoned once the foreign patent rights to KCAT were lost. Accordingly, Kairos should not receive the benefits of both the non-exclusive as well as the exclusive license agreements.
E. Striking Evidence of Present Value
F&R contends that the trial court "erroneously" struck relevant testimony by economist Michael Dansky regarding the award's present value. We apply the abuse of discretion standard of review to any ruling by a trial court on the admissibility of evidence. (People v. Waidla (2000) 22 Cal.4th 690, 725.)
At the evidentiary hearing to determine the "present value" of the damage award, F&R presented testimony from Dansky that the concept of "present value" included both the "time-value" of money and the "risk" that the future income stream may never be realized. Due to the risks involved in intellectual property licensing, he opined that a 35 percent present value discount rate should be used. Dansky determined that the present value of the award based on a 35 percent discount rate and discounted back to October 1999, the date the filing error became public, was $8.6 million.
The trial court granted Kairos's motion to strike Dansky's testimony. The court stated that the hearing was only to consider the " `time value of money.' " It stressed that the hearing was not intended to "revisit the issue of the amount of damages and the likelihood of receiving it, issues that have already been considered in this court's decision. As a result [Kairos's] motion to strike Mr. Dansky's testimony at the hearing on March 19, 2004, that went beyond the issue of the amount of the award in `present dollars,' or the `time value' of that money is granted as being irrelevant. Furthermore, [F&R has] waived any such presentation since [it] had [its] chance to present such evidence during the trial but decided to take an all or nothing approach."
The court ruled that Kairos was to receive $27,775,735 in damages in present dollars as well as prejudgment interest in the sum of $2,092,269 for a sum of $29,868,004. The court used the discount rate of 2.3 percent based on the testimony of Kairos's expert.
F&R argues that the risk of a future income stream should be considered when determining an appropriate discount rate. A discounted cash flow accounts for the time value of money and it adjusts the value of the cash flow stream to account for risk. (Energy Capital Corp. v. U.S. (Fed.Cir. 2002) 302 F.3d 1314, 1333.) This is particularly important, F&R argues, because Hercules had a history of prematurely terminating its licenses and Emalfarb, Dyadic's president, testified that he would stay in a license with Kairos only for as long as KCAT proved useful. Further, F&R maintains that Kairos's experts used high discount rates of 25 and 20 percent that expressly took into account the risk that the future income stream would not be realized, but the court's damage award did not take into account this risk analysis because it derived its own calculations rather than relying on the experts' calculations. F&R maintains that it had its first opportunity to present this evidence at the hearing on present value.
F&R concludes that the exclusion of Dansky's testimony was prejudicial. It asserts, with little evidence or argument to support this argument, that it is reasonably probable that the court would have lowered the damage award had it considered this evidence.
When Dansky testified that there was a 35 percent chance that the licensing agreement would be terminated, the court replied: "Yes. I understand all of that concept [sic]. But . . . all of that evidence about it would have been presented in the case in chief. Not now when I'm trying to figure out the mathematical amount of the award. . . ." The trial court expressly stated that it had already considered the risk factors when it determined the amount of damages. Indeed, it discussed Dansky's testimony extensively in its statement of decision and it explained the reasons it was not persuaded by his testimony regarding fair market value of KCAT. The court therefore did not abuse its discretion in excluding this testimony in the subsequent hearing after considering it during the trial. Moreover, F&R has failed to establish that the exclusion of this evidence would have resulted in a different award particularly given the court's earlier statement that it found Dansky's testimony unpersuasive and that it had already considered the risk factors when determining the amount of damages.
We remand for the trial court to determine whether any costs should be deducted from the award of gross profits. In addition, the damage award is reduced by $1,296,000 (offsets for the $600,000 in license fees and the $600,000 in milestone payments under the January 2000 license and the $96,000 in licensing fees under the May 2001). As modified, the judgment is affirmed. F&R is to pay the costs of appeal.
We concur: Kline, P.J., Haerle, J.
1. Microcolony means a "small number of bacteria."
2. Prior art is the body of work in a related area that has already been done.
3. Marrs had known Youvan before these negotiations. When Marrs was a professor, Youvan was in the audience and Youvan and his thesis adviser spoke to Marrs after the talk. Marrs collaborated with them on some research and Youvan did some post-doctorate work with Marrs. Later, when Marrs went to Exxon, he recommended that Youvan be hired and they worked together.
4. Milestone payments were payments for achieving specific goals or parts of the goal in independent projects.
5. In addition, Land acknowledged that Kairos could have received up to nine years of interim protection from competitors from the date of filing a timely PCT application until the time that it might eventually be denied.
6. Klibanov explained the term "prior art" as follows: "Well, science, of course, didn't start yesterday or a week ago. Science has been going on for several centuries. So whatever work one does, there is always something that had been done in a related area previously. And that body of work that had been done previously that is relevant to the given work is called prior art." Invalidating prior is the following: "When it comes to patents, specifically, then if the prior art was of such a nature that one of average skill in the art would consider this prior art and, having done so, would fully anticipate what the present invention is, then that will be invalidated."
7. F&R argues that we should also reverse on the court's alternative finding of causation because substantial evidence did not support its finding that, but for the loss of the foreign patents, Kairos would have entered into more favorable license agreements. In particular, it argues that there is no evidence that Kairos would ever have agreed to the terms proposed by Emalfarb. As discussed ante, this argument would have effect if the malpractice related to the drafting of the licenses. (See Viner, supra, 117 Cal.App.4th at pp. 1228-1231 [plaintiff must show a meeting of the minds on all essential terms of contract when asserting legal malpractice in the drafting of that contract].) In any event, we need not address this argument because we are affirming on the basis that the trial court used the proper test for causation when it determined that Kairos would have prevailed in the PCT process and, but for F&R's error, Kairos would have had foreign patent rights.
8. The court noted that there was evidence that others were also interested in the KCAT process, but it also noted that Yang and Youvan did not have a good marketing plan. It therefore did not base its damage award on this evidence, which it deemed unreliable or speculative.
9. Civil Code section 3359 provides: "Damages must, in all cases, be reasonable, and where an obligation of any kind appears to create a right to unconscionable and grossly oppressive damages, contrary to substantial justice, no more than reasonable damages can be recovered."
10. According to Klibanov, "Assay is a procedure whereby an enzyme is tested against a given substrate." It is essentially a test.