ATA Airlines, Inc. v. Federal Express Corp. , 665 F.3d 882 ( 2011 )

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 11-1382, 11-1492
ATA A IRLINES, INC.,
Plaintiff-Appellee, Cross-Appellant,
v.
F EDERAL E XPRESS C ORPORATION,
Defendant-Appellant, Cross-Appellee.
Appeals from the United States District Court
for the Southern District of Indiana, Indianapolis Division.
No. 1:08-cv-00785-RLY-DML—Richard L. Young, Chief Judge.
A RGUED N OVEMBER 2, 2011—D ECIDED D ECEMBER 27, 2011
Before E ASTERBROOK, Chief Judge, and P OSNER and
W OOD , Circuit Judges.
P OSNER, Circuit Judge. ATA filed this diversity suit for
breach of contract against Federal Express (which the
parties call “FedEx,” as shall we, even though it’s actually
a subsidiary of FedEx Corporation), and obtained a jury
verdict in the exact amount it had asked for: $65,998,411.
FedEx has appealed. ATA has filed a cross-appeal that
is conditional on our reversing the judgment; the cross-
appeal challenges the district court’s refusal to let ATA
2 Nos. 11-1382, 11-1492
present evidence that it incurred $27,842,748 in unrecov-
erable costs in reliance on a promise by FedEx in the
alleged contract, and that it is entitled to recover these
costs as reliance damages, either as an alternative to the
expectation damages awarded by the jury or pursuant to
the doctrine of promissory estoppel. The parties agree
that the substantive issues are governed by the law of
Tennessee, FedEx’s principal place of business, except
that FedEx defends the district court’s ruling that ATA’s
promissory estoppel claim is preempted by the federal
Airline Deregulation Act. See American Airlines, Inc. v.
Wolens, 513 U.S. 219 (1995); Morales v. Trans World
Airlines, Inc., 504 U.S. 374 (1992).
We begin there, and can be brief: the ruling was incor-
rect. Although the Act forbids a state to “enact or enforce
a law, regulation, or other provision having the force and
effect of law related to a price, route, or service of an air
carrier,” 49 U.S.C. § 41713(b)(1), it does not “afford[]
relief to a party who claims and proves that an airline
dishonored a term the airline itself stipulated. This dis-
tinction between what the State dictates and what the
airline itself undertakes confines courts, in breach-of-
contract actions, to the parties’ bargain, with no enlarge-
ment or enhancement based on state laws or policies
external to the agreement.” American Airlines, Inc. v.
Wolens, supra, 513 U.S. at 232-33.
Promissory estoppel, as the word “promissory” implies,
furnishes a ground for enforcing a promise made by
a private party, rather than for implementing a state’s
regulatory policies. A garden-variety claim of promissory
estoppel—one that differs from a conventional breach of
Nos. 11-1382, 11-1492 3
contract claim only in basing the enforceability of the
defendant’s promise on reliance rather than on consider-
ation, In re Fort Wayne Telsat, Inc., No. 11-2112, 2011 WL
5924446, at *2 (7th Cir. Nov. 23, 2011); Garwood Packaging,
Inc. v. Allen & Co., 378 F.3d 698, 701-02 (7th Cir.
2004)—is therefore not preempted. “We do not read the
[Act’s] preemption clause . . . to shelter airlines from
suits alleging no violation of state-imposed obligations,
but seeking recovery solely for the airline’s alleged
breach of its own, self-imposed undertakings . . . . A
remedy confined to a contract’s terms” is not preempted.
American Airlines, Inc. v. Wolens, supra, 513 U.S. at 228-29.
Not so tort claims that override contract claims, see
United Airlines, Inc. v. Mesa Airlines, Inc., 219 F.3d 605 (7th
Cir. 2000), rather than just seeking a remedy “confined
to a contract’s terms.” But ATA is not alleging a tort; it
is trying to hold FedEx to a promise that it contends
FedEx made to it. We’ll see later that ATA’s promissory
claim fails, but not because of preemption.
We turn to the conventional contract issues, on which
ATA prevailed in the district court.
In the event of a national emergency, the Department
of Defense can use commercial aircraft drawn from
what’s called the “Civil Reserve Air Fleet” to augment
the Department’s own airlift capabilities. See Air Mobility
Command, “Factsheets: Civil Reserve Air Fleet,” www.
amc.af.mil/library.factsheets.factsheet.asp?id=234 (visited
Dec. 21, 2011). Composed of aircraft owned by commercial
air carriers but committed voluntarily to the Department
for use during emergencies, the Fleet is divided into
separate “teams” of airlines, each with a “team leader.”
4 Nos. 11-1382, 11-1492
The teams pledge portions of their fleets for use by
the Department during an emergency; the leader
assembles the team and submits the team’s bid to par-
ticipate in the Civil Reserve Air Fleet.
The team members are not compensated directly for
their commitment, but are compensated indirectly
because in exchange for a team member’s commitment
the Department awards the member “mobilization value
points” in proportion to the scale of the commitment. The
more points a member has, the more non-emergency air
transportation for the Department the member can bid
on. The points are transferrable within teams. Smaller
carriers value providing non-emergency service to the
Department (for which of course they are compensated)
more than the bigger ones (such as FedEx) do. So they
want the larger carriers’ points and are willing to pay
for them, and as a result end up doing most of the non-
emergency flying. The team leader—invariably a large
carrier that therefore has a large number of mobilization
value points because of its commitment to provide
copious emergency service if needed—transfers points
to the members of its team in exchange for a com-
mission on their non-emergency military flights. The
commission rate is the price term in the contractual
arrangements between the team leader and each of the
team’s smaller carriers. (This case concerns the con-
tractual relations among the members of one team rather
than the contracts between the teams and the Department.)
FedEx is the leader of one of the teams, which before
the alleged breach of contract included ATA and Omni Air
International—small passenger and charter airlines that
Nos. 11-1382, 11-1492 5
split between them the team’s allotment of non-emergency
military passenger service (as distinct from cargo ser-
vice). The FedEx team’s annual revenues from the provi-
sion of non-emergency services to the Department
amount to about $600 million.
Relations among members of FedEx’s team are defined
in three separate contracts, each with a one-year term.
One contract fixes both the allocation of military
business among the team members and the commission
rate for the team leader. This contract is negotiated sepa-
rately between the leader and each team member (so
actually it’s more than one contract, but we can ignore
that detail). A second contract identifies the team
members and the aircraft they will commit to the
military if the team’s bid is accepted. A third defines the
liability and insurance obligations of the team mem-
bers. There are additional provisions in these contracts,
but we can disregard them. We’ll call the three con-
tracts as a group the “tripartite contract.”
The tripartite contract has as we said only a one-year
term. (The year is the federal fiscal year, which runs
from October 1 of the previous calendar year to Septem-
ber 30, so that the 2002 fiscal year, for example, began
in October 2001. All our year references are to fiscal
years.) But it was the team’s practice to enter into a sepa-
rate three-year agreement concerning the distribution
of business among the team’s members. Implementation
of the agreement depended on the Defense Depart-
ment’s accepting the team’s bid; otherwise there would
be no business to divide among the team’s members. And
6 Nos. 11-1382, 11-1492
if the Department decided it wanted more or less service
from the team than had been bid, this might affect the
division of business, since a particular team member
might have insufficient capacity to provide its allotted
share of service if the service requirement increased, or
alternatively might be badly hurt by a reduction in that
requirement if its share were unchanged—there might
for example be limited demand for or profit in a par-
ticipant’s nonmilitary business. The agreement also
assumed that the parties would all end up on the FedEx
team, though there was no contractual stipulation to
that effect.
With so many contingencies, especially ones dependent
on decisions entirely within the power and rights of
each party, the agreement was a planning document
rather than an enforceable contract. We have pointed out
that “if any sign of agreement on any issue exposed the
parties to a risk that a judge would deem the first-resolved
items to be stand-alone contracts, the process of negotia-
tion would be more cumbersome (the parties would have
to hedge every sentence with cautionary legalese), and
these extra negotiating expenses would raise the effective
price.” PFT Roberson, Inc. v. Volvo Trucks North America, Inc.,
420 F.3d 728, 731 (7th Cir. 2005). Contract law “permits
parties to conserve these costs by reaching agreement
in stages without taking the risk that courts will enforce
a partial bargain that one side or the other would have
rejected as incomplete.” Id.; see EnGenius Entertainment,
Inc. v. Herenton, 971 S.W.2d 12, 17-18 (Tenn. App. 1997);
Restatement (Second) of Contracts § 27, comments b, c (1981).
Nos. 11-1382, 11-1492 7
ATA’s suit is based on one of these three-year “con-
tracts,” signed in 2006, in which ATA and (maybe) Omni
agreed with FedEx that during the following three years
(2007 through 2009) the team’s passenger business would
be divided equally between those two carriers. The
“contract” is in the form of a letter from FedEx to them
that reads as follows:
The letter will serve as the agreement for the distribu-
tion between ATA and Omni of both fixed and expan-
sion for both wide and narrow body passenger busi-
ness in the AMC Long Range International Contract
for FY07-FY09.
It is agreed that the distribution for the above passen-
ger segments will be fifty-fifty (50%-50%) respectively
for both wide and narrow body and for both fixed
and expansion.
Please indicate your concurrence by signing as indi-
cated below and returning to the undersigned.
We look forward to a continued successful relation-
ship over this period.
There is a space below the writer’s signature for signa-
tures by representatives of ATA and Omni. Although
only ATA’s representative signed, the evidence indicates
that Omni concurred, and if so the omission of a signa-
ture by a representative of Omni is immaterial.
The tripartite contracts for 2007 and 2008 incorporated
the 50/50 division—but with a change in the 2008 contract:
ATA’s allotment was reduced by 10 flights per month
to enable them to be allotted instead to Northwest Air-
8 Nos. 11-1382, 11-1492
lines, a much bigger carrier, which wanted to start
flying for the Civil Reserve Air Fleet. Northwest was
already a participant in the FedEx team, but like FedEx
(though without FedEx’s responsibilities as team leader)
had heretofore been a guarantor of emergency service
to the military and thus a seller of points to the smaller
airlines; 2008 would be the first time it would be a
flying member of the team.
The change turned out to be pregnant with menace
for ATA. For later that year FedEx decided to drop ATA
from the team and, beginning in 2009, give the mobiliza-
tion value points that would have gone to ATA to Delta,
which had acquired Northwest shortly after the signing of
the 2008 tripartite contract. FedEx’s decision to replace
ATA in 2009 caused ATA to withdraw from the team
prematurely, in the middle of 2008 (we’re not sure why).
The withdrawal precipitated it into bankruptcy because
it had very little nonmilitary business to fall back on.
ATA’s breach of contract claim should never have
been permitted to go to trial. Courts interpret and enforce
contracts; they don’t make contracts. A contract is
unenforceable if it is “indefinite” in the sense of missing
vital terms, such as price, that can’t be readily supplied
by a court, for example by reference to a price formula
agreed on by the parties. Doe v. HCA Health Services of
Tennessee, Inc., 46 S.W.3d 191, 196-97 (Tenn. 2001); Four
Eights, LLC v. Salem, 194 S.W.3d 484, 486-87 (Tenn. App.
2005); Restatement (Second) of Contracts § 33 (1981); 1 E.
Allan Farnsworth, Farnsworth on Contracts § 3.27, pp. 417-20
(3d ed. 2004). If the price or other vital missing term can’t
Nos. 11-1382, 11-1492 9
be reconstructed in that way, the “contract” shouldn’t be
called a contract at all, but an attempted contract; its
indefiniteness renders it unenforceable.
We’ve already seen that a great deal was missing from
the so-called contract to allocate the FedEx team’s passen-
ger business for 2007-2009 between ATA and Omni. True,
“the fact that a contract is incomplete, presents interpre-
tive questions, bristles with unresolved contingencies,
and in short has as many holes as a Swiss cheese does
not make it unenforceable for indefiniteness. Otherwise
there would be few enforceable contracts. Complete con-
tingent contracts are impossible. The future, over which
contractual performance evolves, is too uncertain.” Haslund
v. Simon Property Group, Inc., 378 F.3d 653, 655 (7th Cir.
2004). But “a contract is rightly deemed unenforceable
for indefiniteness when it leaves out (1) a crucial term
that (2) a court cannot reasonably be asked to supply in
the name of interpretation.” Id.
The proper division of responsibility between the
contracting parties, on the one hand, and a court asked to
enforce a purported contract, on the other, requires the
parties to decide on the key terms of the contract (or at
least on a methodology that generates the key terms
more or less mechanically), such as price, and leaves
the court to resolve only issues that, being unlikely to arise,
the parties should not be required to have foreseen
and provided for. To require parties to negotiate every
contingency that might arise during performance would
be impossible, because as we said not every contingency
can feasibly be foreseen and provided for—the future is
10 Nos. 11-1382, 11-1492
too uncertain. Contract law supplies a set of standard
terms that the parties can change if they wish but that if
they don’t change supply a substitute for negotiation. But
there is no standard price term, and no agreed-upon
formula for calculating the price, for the service provided
by the leader of a team of the Civil Reserve Air Fleet.
The doctrine of indefiniteness that makes a contract
unenforceable when it omits a crucial term that cannot
be supplied by interpretation has particular force when
the contract is one between sophisticated commercial
entities and involves a great deal of money. PFT Roberson,
Inc. v. Volvo Trucks North America, Inc., supra, 420 F.3d at
730; Skycom Corp. v. Telstar Corp., 813 F.2d 810, 815 (7th
Cir. 1987); Farnsworth, supra, § 3.8, pp. 224-26. That
describes the letter agreement; ATA’s share of the
revenues that the tripartite contract generated each year
was, at its peak, $406 million, and in 2007 its profits
from the contract exceeded $90 million. Even if we as-
sumed—unrealistically—that all the other holes that
we mentioned in the team structure for 2007-2009 could
be filled by a court from industry standards, course
of dealing, trade usage, or some other objective source of
guidance that enables judicial completion of an incom-
plete contract, the price term—FedEx’s compensation
for providing team leadership and transferring mobiliza-
tion value points to team members—could not be
supplied from any such source. That compensation was
the result of ad hoc negotiations and thus was deter-
mined by the parties’ circumstances each year at the time
of contracting. It had usually been 7 percent but one year
had plunged to 4.5 percent.
Nos. 11-1382, 11-1492 11
And so the letter agreement was not an enforceable
contract. But it did contain a promise to divide the
military passenger service to be provided by FedEx’s
team equally between ATA and Omni. The doctrine of
promissory estoppel makes a promise enforceable even
though it is not supported by consideration or other-
wise enforceable under conventional principles of con-
tract law, provided that the promisee reasonably incurred
a cost in reliance on the promisor’s fulfilling the promise
and that the promisor should reasonably have anticipated
that the promisee would rely in that way and might
therefore be hurt if the promisor reneged. Calabro v.
Calabro, 15 S.W.3d 873, 878-79 (Tenn. App. 1999); Amacher
v. Brown-Forman Corp., 826 S.W.2d 480, 482 (Tenn. App.
1991); Restatement (Second) of Contracts § 90 (1981);
Farnsworth, supra, § 2.19, pp. 176-78.
One function of the doctrine of promissory estoppel, as
we noted at the outset of this opinion, is to allow reason-
able reliance to be substituted for consideration. The
underlying idea is that a reasonable promisee wouldn’t
incur an unrecoverable cost in reliance on the promise’s
being fulfilled unless there really had been a promise,
and so reasonable reliance is as good a basis for inferring
the existence of a promise as consideration is. Garwood
Packaging, Inc. v. Allen & Co., supra, 378 F.3d at 702. In this
case, however, there is no question that there was a
promise—the promise to share business 50/50 between
ATA and Omni is in writing, in the letter agreement. The
question is whether the promise was (or could reasonably
have been understood to be) intended to induce, and could
reasonably induce, reliance to the tune of $28 million.
12 Nos. 11-1382, 11-1492
If someone tells you “I promise you X, but don’t hold
me to it,” the promisor is making clear that he is not
inviting reliance and the promisee cannot, by ignoring
the warning and relying on the promise to his detriment,
make the promise enforceable. Such a “promise” may
create an expectation but does not create a commitment,
and so the promisee relies at his risk. Risk taking is ubiqui-
tous in business and is perfectly reasonable because
the expected benefits of a risky undertaking will often
exceed the expected costs. It may have been reasonable
for ATA to reckon that it had a good enough chance of
getting half the passenger business of the FedEx team in
the 2007-2009 period to justify its going ahead and ac-
quiring the aircraft it would need to provide the service
because its existing fleet was inadequate; it is the $28
million in allegedly unrecoverable expenses relating to that
acquisition that ATA seeks to recoup by invoking promis-
sory estoppel. But ATA could not reasonably have
believed that FedEx intended to commit itself to split the
passenger business equally between ATA and Omni
during that period when so much was left to be agreed
upon, and so FedEx cannot have been expected to antici-
pate that ATA would rely on the promise. ATA’s lawyer
acknowledged at the oral argument that his client may
have been “imprudent” in failing to recognize the possi-
bility that Northwest would want more of the team’s
business; and Northwest was (and Delta, which swallowed
Northwest, even more so, is) to ATA as the Dreamliner
is to the DC-3. Acting on a hope is not reasonable reliance.
Classic Cheesecake Co. v. JPMorgan Chase Bank, N.A., 546
F.3d 839, 845-46 (7th Cir. 2008); Garwood Packaging, Inc. v.
Nos. 11-1382, 11-1492 13
Allen & Co., supra, 378 F.3d at 703-04; Wood v. Mid-Valley
Inc., 942 F.2d 425, 428 (7th Cir. 1991).
So ATA loses. But we do not want to ignore the jury’s
award of damages, which presents important questions
that have been fully briefed and are bound to arise in
future cases.
The award was based entirely on a regression analysis
presented by an expert witness, a forensic accountant
named Lawrence D. Morriss. FedEx objected to the ad-
missibility of the analysis, citing Rule 702(2), (3) of the
Federal Rules of Evidence, which when this case was
tried conditioned the admissibility of expert evidence
on the expert’s having applied “reliable principles and
methods . . . reliably to the facts of the case.” The rule
has been reworded slightly, effective December 1 of this
year, but the Committee Notes state correctly that the
changes are purely stylistic.
There were, as we’re about to see, grave questions
concerning the reliability of Morriss’s application of
regression analysis to the facts. Yet in deciding that
the analysis was admissible, all the district judge said
was that FedEx’s objections “that there is no objective
test performed, and that [Morriss] used a subjective
test, and [gave] no explanation why he didn’t consider
objective criteria,” presented issues to be explored on
cross-examination at trial, and that “regression analysis
is accepted, so this is not ‘junk science.’ [Morriss] ap-
pears to have applied it. Although defendants disagree,
he has applied it and come up with a result, which ap-
parently is acceptable in some areas under some mod-
els. Simple regression analysis is an accepted model.”
14 Nos. 11-1382, 11-1492
This cursory, and none too clear, response to FedEx’s
objections to Morriss’s regression analysis did not dis-
charge the duty of a district judge to evaluate in advance
of trial a challenge to the admissibility of an expert’s
proposed testimony. The evaluation of such a challenge
may not be easy; the “principles and methods” used
by expert witnesses will often be difficult for a judge to
understand. But difficult is not impossible. The judge can
require the lawyer who wants to offer the expert’s testi-
mony to explain to the judge in plain English what the
basis and logic of the proposed testimony are, and the
judge can likewise require the opposing counsel to
explain his objections in plain English.
This might not have worked in the present case;
neither party’s lawyers, judging from the trial transcript
and the transcript of the Rule 702 hearing and the briefs
and oral argument in this court, understand regression
analysis; or if they do understand it they are unable
to communicate their understanding in plain English.
But a judge can always appoint his own expert to assist
him in understanding and evaluating the proposed testi-
mony of a party’s expert. Fed. R. Evid. 706; General Electric
Co. v. Joiner, 522 U.S. 136, 149-50 (1997) (concurring opin-
ion). If he worries that the expert he appoints may not be
truly neutral, he can ask the parties’ experts to agree on a
neutral expert for him to appoint, as we suggested in
DeKoven v. Plaza Associates, 599 F.3d 578, 583 (7th Cir. 2010),
and In re High Fructose Corn Syrup Antitrust Litigation, 295
F.3d 651, 665 (7th Cir. 2002); see also Daniel L. Rubinfeld,
“Econometrics in the Courtroom,” 85 Colum. L. Rev. 1048,
1096 (1985). Also, the Federal Judicial Center has published
Nos. 11-1382, 11-1492 15
a nontechnical “Reference Guide on Multiple Regression”
written by Professor Rubinfeld, published in Reference
Manual on Scientific Evidence 303 (3d ed. 2011). Had the
district judge read the relevant portions of Rubinfeld’s
guide, he would have realized that Morriss’s regression
analysis was fatally flawed. Another good introduction
to the use of statistical analysis in litigation is David
Cope, Fundamentals of Statistical Analysis (2005).
The judge would have discovered in these or other
sources that he might have consulted that a linear regres-
sion is an equation for the straight line that provides
the best fit for the data being analyzed. The “best fit” is
the line that minimizes the sum of the squares of the
vertical distance between each data point and the line.
(Why the squares rather than the simple distances is
difficult to explain, and the jury can be asked to take
it on faith.) A simple linear regression (that is, one in-
volving only two variables—one the dependent vari-
able, the variable to be explained, and the other the inde-
pendent variable, the variable believed to explain the
dependent variable) is easily visualized by plotting the
data points on a graph. The regression line is a straight
line that minimizes the aggregate of the squared vertical
distances from the points to the line. The equation that
generates that line can be written as Y = a + bX + u, where
Y is the dependent variable, a the intercept (explained
below), X the independent variable, b the coefficient of
the independent variable (that is, the number that
indicates how changes in the independent variable pro-
duce changes in the dependent variable), and u the regres-
sion residual—the part of the dependent variable that
16 Nos. 11-1382, 11-1492
is not explained or predicted by the independent variable
and the intercept, or in other words is “left over,” like
the change you receive after paying for a 99-cent item
with a $1 bill.
To illustrate below we graph a regression of salary
(the dependent variable, on the vertical axis) on job
experience (the independent variable, on the horizontal
axis) for a hypothetical company. Each dot represents the
salary and job experience of a particular employee. The
intercept is the point at which the regression line
crosses the vertical axis on the left side of the graph; it is
thus the salary received by an employee who has no job
experience at all. (Because a is 26.9, the model predicts
that the starting wage of a new hire with no experience
would be $26,900.) The slope of the regression line is the
coefficient of the independent variable: it is a positive
number because the more job experience a worker has, the
higher his salary is likely to be. For example, b equals 2.2 in
the graph, so the regression model predicts that a 1-year
increase in job experience generates a $2200 increase in
salary.
The relation between salary and job experience,
although positive, varies from employee to employee.
That is why not all the data points lie on the regression
line, the straight line that fits the data best; the best fit
is rarely a perfect fit. The variation in salary that the
regression line does not explain is the regression
residual, u in our equation.
Nos. 11-1382, 11-1492 17
Regression analysis is used to test hypotheses, in our
example the hypothesis that more experienced workers
get paid more (and how much more) depending on the
amount of their experience. But it is also used to pre-
dict—for example that when a new employee accrues
10 years of experience he will be paid $22,000 more than
his starting wage.
There is much more to regression analysis, even in
the simple case in which there is only one independent
variable; but we’ve now explained (and the judge could
readily have understood from the FJC guide) enough to
enable us to show why Morriss’s regression analysis
should never have been allowed to be put before a jury.
He used regression analysis to predict what ATA’s
military profits would have been had it not been dropped
from FedEx’s team. In a graph that he prepared which
18 Nos. 11-1382, 11-1492
we reproduce below, the dependent variable is ATA’s
annual costs of participating in the Civil Reserve Air Fleet
as a member of the FedEx team and the independent
variable is ATA’s total annual revenues from that partici-
pation. There are 10 data points, each representing ATA’s
costs and revenues for one year from 1998 through 2007.
As in our illustrative graph, the regression line in
Morriss’s graph slopes upward—when revenues rise,
costs rise. Notice that the data points are closer to the
regression line than the data points in our illustrative
graph. This means that the regression line in his graph
fits his data better than the regression line in our illustra-
tive graph fits the data in that graph.
To calculate ATA’s damages, Morriss needed to
estimate its military revenues and costs for the second half
Nos. 11-1382, 11-1492 19
of 2008 (after ATA withdrew from the team), and all of
2009, on the counterfactual assumption that the airline
would have continued to belong to FedEx’s team for the
entirety of those two years rather than for just the first
six months of the period. Morriss estimated that ATA’s
revenues for 2008 would have been $286.5 million, a
figure he arrived at by multiplying the FedEx team’s
2008 military passenger revenue of roughly $600 million
by ATA’s historical share of the team’s annual
passenger revenue. Plugging his revenue estimate into
his linear regression (which, remember, treats costs as
a function of revenues), Morriss came up with a cost
figure of $253.8 million; and subtracting that from the
estimated revenues yielded an estimated net profit for
ATA in 2008 of $32.7 million.
Since FedEx was willing to keep ATA on the team
throughout 2008, it is doubtful that the loss of
profits that ATA experienced in the last half of 2008 by
reason of its premature withdrawal can be blamed on
FedEx. Yet Morriss believed that his inflated estimate of
ATA’s lost profits underestimated the loss in 2008
because the figure for costs that he used (and profits are
revenue minus costs, so the higher the costs the lower the
profits) included interest, taxes, depreciation, and amorti-
zation costs that he estimated amounted to $11.4 million in
2008. He thought these costs would not have been affected
by the company’s flying as part of the Civil Reserve Air
Fleet that year, and so should not be deducted from
revenues. There is some truth to this. Some of those costs
may have been fixed, and if so were properly subtracted
from the cost figure used to compute ATA’s lost profits.
20 Nos. 11-1382, 11-1492
Imagine that a firm has a fixed rental expense of $1 million
a year, and unexpectedly lands a very profitable con-
tract. Because the rental would have to be paid even if
the firm had failed to obtain the contract, the rental
expense would not be a cost allocable to the contract and
so should not be subtracted in calculating the contract’s
profitability. Yet we’ll see that elsewhere in his analysis
he treated capital expenditures as current expenses, a
treatment that fails to match costs and revenues, just as
subtracting a fixed cost from the revenue generated by
the contract in our example would fail to match costs
and revenues.
Expunging the $11.4 million figure from Morriss’s cost
estimate increased his annual estimate of ATA’s lost
profits to $44 million for all of 2008. Last he assumed
that ATA’s profits would be identical in 2009, so he
multiplied $44 million by 1.5 (to calculate lost
profits for the period encompassing the latter half of
2008 and all of 2009) to yield a total lost profits estimate
of $66 million. As we said, the estimate was excessive
because it included ATA’s profits in second half
of 2008—the consequence of what appears to have
been a self-inflicted wound.
But these were the least of Morriss’s errors. His most
glaring error was to use costs as his dependent variable
and revenues as his independent variable. The dependent
variable as we know is a number sought to be explained
by the independent variable, as in any equation. In the
equation Y = bX, the effect of X on Y is quantified by
its coefficient, b; so, for example, if b is 3, then Y is three
times larger than X.
Nos. 11-1382, 11-1492 21
But revenue does not influence cost directly; nor is
it clear that it is closely correlated with unmeasured
variables that do influence costs. An increase in revenue
may be correlated with an increase in cost—and indeed
is likely to be if the increased revenue is the result of
increased sales, but not if it is the result of selling the same
output at a higher price. Increases in total costs are
driven by increases in component costs—labor, materials,
and so forth—not by revenues. What is true is that if
revenues plummet, the firm will try to cut its costs in
order to minimize the losses caused by the drop in reve-
nues. But to the extent that those costs are fixed, it may
not be able to cut them in time to avoid bankruptcy—
which is what happened to ATA in 2008.
Morriss tried to justify his explaining cost by revenue,
rather than by more plausible variables such as fuel,
maintenance, and labor costs, on the ground that such
information was unavailable. It is hard to believe this,
because the information must have been recorded by
ATA’s accountants—how else could they have prepared
a balance sheet and income statement for the company?
In any event a plaintiff’s failure to maintain adequate
records is not a justification for an irrational damages
theory.
Even if we assumed that Morriss’s model were built
on a rational foundation, we would have to reject its
results because the model was improperly implemented.
In 2007, the last full year in which ATA participated in
the Civil Reserve Air Fleet, its profits were a minuscule
$2.1 million. If it would have had the same profits in
22 Nos. 11-1382, 11-1492
2008 and 2009 had it not been dropped from FedEx’s team,
its total damages would have been only $3.15 million
during the 18 months remaining in 2008 and 2009, rather
than the $66 million that ATA asked for and the jury
awarded (to the dollar). $2.1 million is only 6.4 percent
of the $32.7 million profit that Morriss’s regression
analysis predicted that ATA would have earned the
following year (as well as the year after that) had ATA not
been dropped from the team. (The $32.7 million is the
profit before the adjustment for the so-called fixed costs of
$11.4 million. The adjustment was not carried into the
calculation of ATA’s 2007 profits, which is why we are
expressing those profits as a percentage of the predicted
profit for 2008 and 2009.)
The following graph, based on one prepared by Morriss
and admitted into evidence, exhibits the fallacy of his
prediction. (We are not clear why his graph was truncated
at 2002, since ATA had joined the FedEx team earlier
and the record provides sufficient data to extend the
graph to 1998, as we have done.) The top line is ATA’s
annual military revenues; the lower line is its annual
costs; the vertical distance between the two lines measures
the company’s profits from its military business. We see
that revenues rose sharply from 2002 to 2005, then plum-
meted in 2006 and 2007. Costs rose more gently, and fell
more gently, over the 2002-2007 period, and in 2007, the
last year for which there are data, the two lines almost
intersect—it was because revenues were so close to costs
that profits were so meager that year.
Nos. 11-1382, 11-1492 23
Morriss predicted that ATA’s military revenues would
have risen in 2008 and 2009 while its costs would have
continued to fall. The difference between his estimated
revenues and his estimated costs is the $66 million in
(imagined) lost profits. Remember that Morriss’s regres-
sion model, which is based on historical data (2002-
2007), found a positive relation between revenues and
costs: when revenues rise, costs rise, and when revenues
fall, costs fall. Remember too that he used the model to
predict that ATA’s costs would have continued to fall in
2008 and 2009 (the lower dashed line), even as revenues
rose. It’s this divergence in directions that turns a
modest predicted growth in revenues into a large
growth in profits.
What produced this odd result—costs falling as
revenues rise—is that ATA’s costs had increased much
more slowly than its revenues between 2002 and 2005,
24 Nos. 11-1382, 11-1492
resulting in big profit margins. To predict a comparable
(though somewhat smaller) profit margin in 2008 and
2009 (and thus produce a big lost-profits estimate), when
the uptick in revenues was expected to be much smaller
than it had been between 2002 and 2005, Morriss had
to make costs in those years fall. But for ATA’s costs to
fall as its revenues rose would make no economic sense,
as well as being inconsistent with Morriss’s underlying
assumption that costs are a positive function of reve-
nues—that if revenues rise costs rise and if revenues fall
costs fall. That costs rise more slowly than revenues does
not imply that costs drop when revenues increase slowly.
No mechanism for such a reversal is suggested, and
revenues and costs had never moved in opposite direc-
tions during the preceding decade in which ATA had
actually been operating.
Morriss tried to explain away the embarrassingly mi-
nuscule profits that ATA earned on its military business
in 2007 as a fluke: the carrier, he said, had experienced
“nonrecurring” costs that year. The costs in question were
the costs of acquiring new aircraft. They were indeed
nonrecurring costs, but they were not 2007 costs; they
were capital expenditures, which is to say expenditures
expected to increase revenues or reduce costs over a
period of more than a year, and thus beyond the year
in which the expenditures were made. If a business buys
a piece of equipment in year 1 for $1 million that will
be usable for 10 years and will then be scrapped, to treat
this as a $1 million cost in year 1 and a zero cost in each
of the nine subsequent years would create a misleading
picture of the firm’s profits through time. Costs should
Nos. 11-1382, 11-1492 25
be matched with revenues to provide an accurate year-to-
year picture of profitability. This is done by amortizing
(spreading) a capital expenditure over its useful life. In
the case of our hypothetical $1 million asset, this would
require assigning costs of $100,000 per year to each year
of the asset’s useful life. If that were done here, Morriss’s
estimate of lost profits in 2008 and 2009 would have
been lower than it was, because some of the nonrecurring
costs incurred in 2007 would have been reallocated to
those years.
Another mistake Morriss made was to model the relation
between cost and revenue as a straight line, as if, for
example, ATA’s costs were always exactly 75 percent of
its revenue (producing the linear regression equation c =
.75r), in which event the company would turn a 25
percent profit every year. Yet its actual profit margins,
as shown in the next graph, fluctuated between 0 and
25 percent of total revenue.
26 Nos. 11-1382, 11-1492
Still another mistake was Morriss’s basing a prediction
of what ATA’s costs would have been in 2008 and 2009
(had it remained a member of FedEx’s team) on a tiny
sample—10 observations, each consisting of ATA’s costs
in one of the 10 years on which the regression analysis
was based. Small samples are less representative of the
population being sampled than large ones. The popula-
tion here would be the entire cost experience of ATA
and similar air carriers.
Confidence intervals (familiar as the “margins of
error” reported in predictions of election outcomes) are
statistical estimates of the range within which there can
be reasonable confidence that a correlation or prediction
is not the result of chance variability in the sample on
which the correlation or prediction was based; 95 percent
confidence is the standard criterion of reasonable confi-
dence used by statisticians. Consider our hypothetical
regression of wages on experience. A regression based on
a sample of 10 workers would yield a less precise predic-
tion of what the average relation of wages to experience
was for the workers in a plant that had 1000 workers than
a regression based on a sample of 50 or 100 of the workers.
The 95 percent confidence interval for Morriss’s predic-
tion of ATA’s 2008 costs was correctly calculated in the
report of FedEx’s expert to be $90 million. This means
that Morriss’s estimate that ATA would have costs of
$254 million was the midpoint of a range from $299 million
at the top ($254 million + $90/2 million) to $209 million
at the bottom ($254 million - $90/2 million)—and if its costs
were at the top of the range the result would have been
Nos. 11-1382, 11-1492 27
a $12.5 million annual net loss for ATA rather than
Morriss’s predicted $32.7 million profit (before the ad-
justment for fixed costs). All else aside, the confidence
interval is so wide that there can be no reasonable confi-
dence in the jury’s damages award.
All this is not to say that it would be a surprise if ATA
had lost profits as a result of its expulsion from the
FedEx team, although its nonmilitary business was col-
lapsing and it is doubtful that it could have survived
purely on its military business. But the only quantification
of damages presented at the trial was based on Morriss’s
regression, and as a result there was a failure of proof
of damages. It is not enough to prove injury in a
damages suit; the plaintiff must prove an amount
of damages and ATA failed to do that.
This is not nitpicking. Morriss’s regression had as
many bloody wounds as Julius Caesar when he was
stabbed 23 times by the Roman Senators led by Brutus.
We have gone on at such length about the deficiencies
of the regression analysis in order to remind district
judges that, painful as it may be, it is their responsibility
to screen expert testimony, however technical; we have
suggested aids to the discharge of that responsibility. The
responsibility is especially great in a jury trial, since
jurors on average have an even lower comfort level with
technical evidence than judges. The examination and cross-
examination of Morriss were perfunctory and must
have struck most, maybe all, of the jurors as gibberish.
It became apparent at the oral argument of the appeal
that even ATA’s lawyer did not understand Morriss’s
28 Nos. 11-1382, 11-1492
analysis; he could not answer our questions about it
but could only refer us to Morriss’s testimony. And like
ATA’s lawyer, FedEx’s lawyer, both at the trial and in
his appellate briefs and at argument, could only parrot
his expert. FedEx’s expert did not testify; as is common
in damages cases, the defendant offered no alternative
measure of damages, doubtless fearing that the jury
would take that as a signal to split the difference—finding
liability but awarding the plaintiff less than the plain-
tiff asked for—rather than struggle to understand an
incomprehensible case. Both because FedEx tendered no
estimate of damages and because neither Morriss nor the
lawyers nor the judge presented an intelligible damages
analysis to the jury, it is no surprise that, having decided
that ATA should win, the jury simply awarded the exact
figure that ATA had asked for in damages.
If a party’s lawyer cannot understand the testimony
of the party’s own expert, the testimony should be with-
held from the jury. Evidence unintelligible to the trier
or triers of fact has no place in a trial. See Fed. R. Evid.
403, 702.
The judgment is reversed with instructions to dismiss
the suit with prejudice.
R EVERSED.
12-27-11