Kids' Universe v. IN2LABS

• Decision Date: 30 January 2002
• Docket Number: B147455.
• Citation: 95 Cal.App.4th 870,116 Cal.Rptr.2d 158
• Court: California Court of Appeals Court of Appeals
• Parties: KIDS' UNIVERSE et al., Plaintiffs and Appellants, v. IN2LABS et al., Defendants and Respondents.

116 Cal.Rptr.2d 158

95 Cal.App.4th 870

KIDS' UNIVERSE et al., Plaintiffs and Appellants, v. IN2LABS et al., Defendants and Respondents.

B147455.

Court of Appeal, Second District, Division 5.

January 30, 2002.

Law Offices of Edward A. Hoffman, Edward A. Hoffman, Los Angeles; Law Offices of Bernie Bernheim, Bernie Bernheim, North Hollywood, and David C. Parisi, Los Angeles, for Plaintiffs and Appellants.

Sedgwick, Detert, Moran & Arnold, Irvine, and Robert F. Helfing, Los Angeles, for Defendants and Respondents.

TURNER, P.J.

I. INTRODUCTION

Plaintiffs, Kids' Universe, and Lew and Howard Rudzki,¹ appeal from a summary judgment in favor of defendants, In2Labs and Conrad Salindong. Plaintiffs sought lost profits on the theory defendants negligently caused a flood in the Kids' Universe retail store and prevented them from launching an internet Web site for the sale of toys. The trial court found plaintiffs could not establish with the requisite certainty that profits would have been made from the operation of the online business. We conclude defendants met their summary judgment burden as to the entire damage element of plaintiffs' cause of action which sought only lost profits. Further, because of the speculative nature of their evidence, we conclude plaintiffs failed to raise a triable issue of material fact as to their ability to prove lost profits. Accordingly, we affirm the summary judgment.

II. FACTS

The material facts are undisputed.² Two brothers, the Rudzkis, founded Kids' Universe in 1992. Kids' Universe is a retailer of toys, educational products, and computer training services for children. Kids' Universe operates a retail store in Beverly Hills.

Defendants leased office space directly above the Kids' Universe store. On November 18, 1997, one of defendants' employees left water running in a sink overnight, causing a flood in plaintiffs' store. The store remained closed due to flood damage for two weeks. When the store reopened, many of its shelves were empty. Further, computer classes, an important factor in the store's profitability, could not be resumed until January 1998. The store was not operating at its previous level until April 1998. Defendants, through their insurer, paid plaintiffs $200,000 for damage to the retail store.

Defendants presented evidence Kids' Universe had no line of credit available to it during 1997 and 1998. Kids' Universe had never attracted any investors. At the time of the flood, Kids' Universe had five employees, only one of whom had a sales position.

Kids' Universe had started a Web site in the spring of 1995. Howard described the Web site as a "test" site; a way to learn about the internet and e-commerce; to experiment with Web designs and to "debug" the internet Web page. Howard stated the on-line business originally was not intended to be profitable. In fact, the online business generated less than $500 per year with the exception of one order for approximately $17,000. Between 1995 and 1997, Kids' Universe repeatedly revised its Web site.

Plaintiffs presented evidence that by November 1997, when the flood occurred, the Rudzkis had developed a sophisticated Web site. As described by Lew, the new Web site "had one of the first online `shopping carts' on the [W]eb (this was the beginning of `e-commerce'), a state of the art navigational system, and was a full functioning site." Plaintiffs had incurred significant time and expense in drafting the programming code for and designing their "state of the art" Web site. They had hired a Web site design company and a development programmer. The new Kids' Universe Web site was "very similar" to the eToys site. The new Web site was scheduled to go online on Thanksgiving Day 1997, the start of the holiday shopping season and the most profitable time of year in the toy business.

In addition, prior to the flood, plaintiffs had signed a one-year contract with MindSpring, described as one of the "fastest growing" internet service providers with "a relatively wealthy base of subscribers." Plaintiffs presented evidence of an agreement between MindSpring and Kids' Universe. The agreement was signed by Howard only and not by any MindSpring representative. Under the terms of the agreement, MindSpring's 200,000 subscribers would have direct, one-click access from its homepage to three toy Web sites—eToys, F.A.O. Schwartz, and Kids' Universe. According to Howard: "This was a key place to be because Kids' Universe would be highly visible to people who entered the site. Just as location has always been critical for a retail business, the same holds true for the [I]nternet." Further, Kids' Universe would not have been required to make any up-front payment to MindSpring. Instead, Kids' Universe would have paid commissions to MindSpring "based on a percentage of sales made from the MindSpring placement."

At the time of the flood, Kids' Universe was also negotiating an arrangement with WeatherChannel.com to establish a link similar to the MindSpring link. Weather-Channel.com was then one of the "highest trafficked sites" on the internet. Howard opined, "For Kids' Universe to have placement on the WeatherChannel site would assuredly guarantee a very high number of visitors to the Kids' Universe [Web site]."

Kids' Universe also intended to market its Web site through contacts at magazines as well as radio and television stations. Kids' Universe was prepared to fill orders placed over the internet. It had "drop shipment" agreements with numerous suppliers, i.e., the manufacturers agreed to ship products directly to Kids' Universe's customers. In addition, Kids' Universe was prepared to ship products directly from the retail store.

However, the flood caused extensive damage to the retail store. The Rudzkis were forced to devote their time to rebuilding and restocking the store. For a variety of reasons, they were unable to both rebuild the store and launch the Web site. Unable to launch their new Web site, plaintiffs withdrew their contract with MindSpring and did not follow through on the WeatherChannel agreement.

Prior to the flood, plaintiffs were able to obtain revenue sharing agreements with Web site portals such as MindSpring without paying money up-front. According to Lew, this was because "the [Web site] portals had not yet recognized their value." In March 1998, the Kids' Universe retail store was reestablished and plaintiffs once again set their sights on e-commerce. By that time, however, revenue sharing Web portal arrangements were no longer available. Following the success of e-commerce retailers like eToys and Amazon, large amounts of cash up-front were demanded in return for access to Web site portals. The fees often exceeded $1 million. Plaintiffs were financially unable to proceed; the Web portal costs were "exorbitant." Without links on popular Web site portals, plaintiffs were unable to attract customers to the Kids' Universe Web site.

Lew, who had a bachelor of arts degree in finance and five years' experience in the toy business, described investment opportunities in the industry during 1997 as follows: "In 1997, as an industry standard, there was not a traditional profit structure, but a valuation structure that created the ability to go out and receive capital to expand the business on favorable terms. In other words, profits were generated by a compan[y's] valuation and the company's] value was based on its ability to attract customers to the site. Once Kids' Universe's value was established, i.e., we proved that we could significantly attract customers and had a viable on[-]line business, we would be able to obtain significant venture capital."

In March 1999, Richard X. Hanson, a forensic economist, prepared at plaintiffs' request a "preliminary analysis of losses suffered by [Kids' Universe] as a result of the flooding incident. . . ." It is apparent the analysis was prepared for settlement purposes. Dr. Hanson opined in pertinent part: "At the present time, eToys is far and away the industry leader. This is due to its early positioning that would have been identical to Kids' Universe . . . . [¶] eToys recently filed for an Initial Public Offering (IPO) expected to draw $115 million [citation]. This implies that the market predicts long term annual profit in the $15 million per year range. This is a reasonable forecast for a firm with annual revenue currently at just under $30 million that is expected to double or triple every year for the next three to five years [citation]. [¶] Assuming that eToys and Kids' Universe would have been roughly equal competitors, the capital value of Kids' Universe could have been in excess of $50 million. This is therefore an estimate of the present value of lost profits to Kids' Universe from the possibility that the market will have grown sufficiently to foreclose effective market presentation." Dr. Hanson concluded if no settlement was reached between the parties to this action "by the time Toys `R' Us or Mattel makes the expected entry into [e-]commerce," Kids' Universe's loss would probably be valued at $50 million. Dr. Hanson cautioned: "This latter estimate is preliminary, however. If the market continues to astound, market valuations may argue for even larger damages in the near future." Dr. Hanson relied on news articles as the source of his information about eToys.

Two years after the flood, plaintiffs brought this action against defendants to recover profits lost not from the operation of the retail store, but because of the inability to launch the Web site at an optimal time. Plaintiffs alleged one cause of action for negligence. Defendants moved for summary judgment on the ground plaintiffs could not establish the damage element. The trial court granted the motion. The court concluded in part as follows: "In opposition to the motion for summary judgment, plaintiffs submitted, inter alia, the declaration of a forensic economist who projected a healthy profit...