Since it filed for bankruptcy nearly two months ago, Roanoke-based Luna Innovations Inc. has seen its business rapidly deteriorate as contracts have been lost and employees have fled, according to court testimony Friday morning.

During a hearing held before the U.S. Bankruptcy Court for the Western District of Virginia in Roanoke, Scott Graeff, Luna's chief operating officer, testified that the technology company has lost eight government contracts valued at $4.2 million since filing for Chapter 11 protection July 17.

Additionally, 10 engineers have left the company, seven of whom held doctorates and represented a significant loss to Luna's ability to secure contracts and continue to reach the company's research and development goals, Graeff testified.

"We will quickly be shifting from cracking to crumbling if this continues on," he said.

With locations in Roanoke, Blacksburg, Charlottesville and Danville, Luna develops and manufactures products for the health care, telecommunications, energy and defense markets. As of Aug. 17, Luna reported in a filing with the bankruptcy court that it had 199 employees.

Graeff said that while Luna executives anticipated they would see a dip in product sales, they did not think they would see such an impact on contracts and employee retention. Government contracts represent between 75 percent and 80 percent of Luna's revenues.

Luna, once hailed as a rising star for Roanoke's future economic development around high-tech biomedical companies, has been caught in a downward spiral since a California jury ordered it to pay Hansen Medical Inc. $36.3 million in damages for breach of contract and misappropriation of trade secrets.

Since the jury verdict was announced in April, Luna had sought to have it thrown out, while Hansen has asked that the damages be increased to as much as $62 million. But instead of continuing to fight the verdict in California, Luna opted to ask a federal bankruptcy judge in Virginia to determine what it owes Hansen, suggesting that $1.3 million would be a better amount.

"The claim itself is large potentially and it is anyone's guess where that number will end up," said Kristin Myles, a partner at San Francisco-based Munger, Tolles & Olson who is representing Luna.

Luna has repeatedly argued that determining the amount it owes Hansen is key to Luna's ability to emerge from bankruptcy as a viable company.

Judge William Stone, who is presiding over the bankruptcy proceedings, questioned if Luna would be able to pay Hansen more than the $1.3 million. Without giving a specific sum, Luna suggested it could pay slightly more.

Hansen, whose attorneys were in Roanoke for Friday's bankruptcy proceedings, has asked the bankruptcy court to send the case back to California to let a judge there determine the ultimate amount Luna owes. The California verdict has never been officially entered into judgment, leaving the case in limbo. A bankruptcy filing halts all other court proceedings.

Hansen's lawyers argued Friday that Luna was improperly attempting to retry the California case in bankruptcy court and pay all of its other creditors while not paying Hansen a fair sum.

"They are trying to cram down Hansen so they can pay all their other creditors in full and pay Hansen just 3 percent on the dollar," said Benjamin Ackerly, a Richmond-based bankruptcy lawyer at Hunton & Williams hired to represent Hansen. "The case smells of bad faith, and the court should take that into consideration."

Hansen, which is based in California, also argued that the California court is best equipped to determine if the jury verdict should stand because that judge is much more familiar with the complexities of the situation.

Shares of Luna closed at 68 cents Friday, up 9 cents.