courtThe 5th Circuit Court of Appeals considered how to measure damages for a facility with no real market when it reviewed the district court’s $3.8 million award to the plaintiff related to a destroyed waste treatment plant.

The defendants owned and operated a Texas oil refinery that contained a third party’s waste treatment plant. After an explosion destroyed the plant, its owner filed an insurance claim with the plaintiff and received payment of $6.1 million. The insurance company sued the refinery’s owners to recover damages, and the latter stipulated to liability. At a bench trial, both parties agreed that damages should be the fair market value (FMV) of the plant before the explosion but disagreed over how to determine FMV.

The plaintiff argued that there was no market for the type of facility that existed before the accident that could provide a measure of value. Its expert stated that it would be “highly uncommon” to build a plant such as the one destroyed “completely out of used equipment.” Therefore, it sought the adjusted replacement cost.

The defendants claimed they were only liable for the cost of the plant’s components and that used versions of those were available from vendors.

Both sides presented damages experts. The plaintiff’s appraiser considered the remaining life of the original plant at the time of the explosion for his calculation. Without this adjustment to the replacement costs, he said, the plaintiff would receive a windfall. Since the original equipment was no longer available, he met with plant employees, explained depreciation and how to calculate it, and adopted their estimate. This, he stated, was the method he had used in the past. He was surprised by the employees’ “aggressive” and low estimate that the facility only had 65% of its remaining life but believed it was reliable. He also considered statements from an employee who identified nearly three-quarters of the equipment that was at the plant and tried to obtain price quotes from vendors.

The plaintiff’s industry expert spoke to the multiplier that should apply to the underlying cost figure to account for anticipated costs related to the construction. There are different ways to look at multipliers, he said: take either a percentage of value, “say a hundred percent of cost increase,” or two times the original amount. Also, multipliers , although not ideal, were appropriate because there was no better information available. He recommended a 2.5 multiplier. In the past, multipliers ranging from 1.8 to 3.2 when building the type of plant that was at issue applied. Based on their experts’ calculations, the plaintiff sought $6.1 million—or precisely the amount the plaintiffs had already paid out for lost value.

The defendant’s expert based his calculation on the cost of the plant’s component parts. He did not account for installation, on-site engineering, or startup. Rather, his damages figure covered equipment that was “sitting on the ground, not assembled.” He noted that experts generally disfavor the use of multipliers “for their inaccuracy” and that they were only appropriate “for broad cost estimates.” A multiplier was inappropriate in this case, he concluded. Total damages were no more than $878,000.

The district court found that, although there was a market for the components making up the plant, there wasn’t one for the company’s used waste treatment system. Since the market value of a fully operational plant was greater than the sum of the components, the measure of value was the adjusted replacement cost. It estimated that new equipment, including taxes and shipping, costs approximately $2.3 million. The court added 10% as a contingency. It then multiplied the combined amount by 2.25 and multiplied the result by 0.65 to account for the 35% depreciation the plaintiff’s expert had proposed, arriving at a total of $3.8 million in damages.

The defendants appealed on three grounds, stating the district court erred when it: (1) used replacement cost to determine the market value of the plant; (2) admitted the plaintiff’s expert testimony regarding the 35% depreciation; and (3) used a 2.25 multiplier that lacked a factual basis. The Court of Appeals considered the objections in turn.

1. Replacement cost. Prior case law stood for the proposition that “evidence of replacement cost is no evidence of market value damages,” the defendants claimed. The district court should have measured the plant’s market value by pricing the individual components that were likely present at the facility before the accident.

At the outset, the appellate court noted that the defendants read a much broader meaning into the cited case, which concerned a totaled car, than it supported and this was not sufficient evidence to prove damages. In this case, the Court of Appeals pointed out, the plaintiff offered much more proof when it “utilized the services of an appraiser to determine the value of [the facility].”

Also, the destroyed plant was not like a totaled car, whose market value emerges by looking at comparable sales in a specific geographic area. In this case, each facility had proprietary components, and the plant’s underlying process was patented. Further, in their appeal, the defendants failed to address the finding that no market exists, insisting instead that their ability to price out components precluded the use of replacement cost as a measure of damages. The district court had discretion to consider the countervailing arguments, and its decision duly considered the labor, layout, and installation of the plant. Replacement cost was the appropriate measure of damages, the Court of Appeals stated.

2. Inadmissible expert testimony. Beyond relying on the employees’ estimate as to how much life the plant had left before the explosion, the plaintiff’s expert did nothing to calculate the depreciation, the defendants claimed. This uncritical adoption made his testimony inadmissible under Rule 703 of the Federal Rules of Evidence, which requires an expert to bring his professional judgment to the use of data he receives from external sources. The plaintiff countered that the expert had explained how he had arrived at the factors he had used to determine the plant’s depreciated value.

The Court of Appeals agreed with the defendants that the depreciation aspect of the testimony was problematic. Although he “clearly articulated what depreciation means and how it is usually calculated,” he did not describe the particular experience he brought to the process. At the same time, there was no way to verify whether they acted in accordance with his instructions. That said, the court continued, “insofar as he educated and interviewed [the employees], [the expert] did more than just repeat information gleaned from external sources.” Also, he showed that he was familiar with appraising heavy industrial plants “broadly,” if not the type of plant at issue.

Finally, it was important to consider what was “feasible,” the court said. Although he could have developed a more accurate estimate “by inspecting records or the equipment itself,” neither was available. He consulted one of the few sources of information to which he had access: the employees. Under the circumstances, the district court was in the best position to assess the admissibility of his testimony.

3. Multiplier. There was no basis for the plaintiff’s proffered 2.5 multiplier and the district court’s 2.25 figure, the defendants claimed.

The appellate court disagreed. There were few records to estimate the cost of rebuilding the plants, a situation which “counsels in favor of using a multiplier,” it stated. The district court received two permissible views on multipliers and used one that was well within the range the experts proposed and that was consistent with experience as to those plants. For all these reasons, the Court of Appeals upheld the award.