UTILISAVE, LLC, a Delaware limited liability company, and MHS Venture Management Corp., Plaintiffs, v. MIKHAIL KHENIN, Defendant.
C.A. No. 7796-ML
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
August 18, 2015
MASTER‘S REPORT (Post-Trial)
Oral Draft Report: January 12, 2015
Submitted on Exceptions: May 11, 2015
Mikhail Khenin, pro se Defendant.
LEGROW, Master
The background of this case and the parties’ interactions is described in greater detail in the final report on the plaintiffs’ motion for summary judgment (the “Final SJ Report“), issued simultaneously with this report. For the sake of clarity, I briefly will describe the parties’ relationship and various disputes, but I refer the reader to the Final SJ Report for a more complete description of the factual background. The factual recitation in this report largely focuses on my resolution of disputed factual issues as I find them after trial.
A. The Parties
Utilisave, LLC (“Utilisave“) is a Delaware limited liability company that audits utility bills in an effort to help its customers, typically large companies, find savings. MHS Venture Management Corporation (“MHS“) is wholly owned and managed by Michael Steifman (“Steifman“). Utilisave and MHS are the plaintiffs in this action. Steifman founded Utilisave in 1991 and hired the defendant, Mikhail Khenin (“Khenin“) in 1997. By 2003, Khenin was the CEO of Utilisave. Before 2012, Utilisave was owned by MHS, Khenin, and Donna Miele (“Miele“), who was the President of Utilisave. MHS owned a 50% interest in Utilisave, Khenin owned 40%, and Miele owned the remaining 10%. MHS and Khenin were the co-managing members of Utilisave.
In 2006, Steifman and Khenin entered into an Amended and Restated Limited Liability Company Agreement (the “Operating Agreement“) as well as employment agreements naming Khenin as CEO and Steifman as an executive charged with assisting Khenin, safekeeping funds, and maintaining the company‘s books and records. For his services, Khenin was to be paid a salary of $289,000, which would be increased annually by the change in the Consumer Price Index, plus benefits and other perquisites. By its express terms, Khenin‘s employment agreement expired on January 1, 2009, unless he was terminated for cause before that date.1
The Operating Agreement addressed several matters at issue in this case, including restrictions on taking certain actions without the approval of the managing members, requirements for safeguarding the company‘s confidential information, and rules regarding distributions to members. Under the Operating Agreement, “[t]he power to manage the affairs of the company and to act on behalf of the company [was] vested exclusively in the Managing Members, acting unanimously.” This meant that Khenin, even acting as CEO, could not take certain actions without approval from MHS, which was fully controlled by Steifman. A number of other corporate actions, including approving employee compensation or
Section 3.03 Distributions. All distributions will be made at the discretion of the majority of the Members. It will be presumed that cash in excess of required working capital will be distributed unless there is a compelling reason to accumulate additional cash reserves. Any distributions to the Members (other than a liquidation distribution upon the sale of all or substantially all of the Company, or any Special Distributions approved by all the Members) will be made to the Members in accordance with their relative Participating Percentages.
The method by which distributions could be approved became a source of disagreement between the parties as their relationship deteriorated.
Although the execution of the Operating Agreement and the employment agreements in 2006 suggests relative harmony between Utilisave‘s members, whatever harmony existed was short-lived. By 2007, the relationship between Steifman and Khenin rapidly was deteriorating and in March Khenin purported to fire Steifman and unilaterally assumed control over Utilisave‘s operations. Under Khenin‘s direction, Utilisave ceased paying Steifman his salary and ceased making distributions to MHS. Ostensibly, the dispute that led to this incident involved a disagreement between Steifman and Khenin regarding how to allocate for tax purposes certain payments made by Utilisave to Steifman.5 The parties’ animus, however, was much more deep-seated, and appears – from an outsider‘s perspective – largely to be driven by mutual distrust and perhaps a fair amount of resentment Khenin bore toward Steifman.
After Khenin assumed de facto control over Utilisave, Steifman and MHS brought an action against Khenin and Utilisave in New York (the “New York Action“). In that action, Steifman and MHS brought claims for breach of contract, breach of fiduciary duty, wrongful termination, and indemnification, among other things. Utilisave and Khenin brought counterclaims against Steifman and MHS for breach of fiduciary duty, tortious interference, indemnification, and fraud. The
D. Khenin unilaterally extends his employment agreement
The New York Action between the parties continued through 2008. Toward the end of that year, with his employment agreement set to expire on January 1, 2009, Khenin had a document prepared that purported to renew his employment agreement. At some point, Khenin and Miele executed a document that they dated January 7, 2009. The New York Court held that the document was not actually executed on that date, but at some later time.6 More specifically, the New York Court concluded that Khenin‘s trial testimony regarding the date that document was executed was “duplicitous” and that the signatures of Khenin and Miele were backdated.7
Nevertheless, Khenin continued to manage Utilisave as its de facto CEO and paid himself the salary and benefits established by the 2006 employment agreement, including annual raises he awarded himself. In 2009, Khenin increased his salary from $323,770.00 to $333,483.00. In 2010, Khenin increased his salary to $343,487.00. Khenin‘s salary remained the same in 2011, until he was removed
E. Khenin makes distributions without the approval of MHS
After assuming sole control over Utilisave, Khenin unilaterally declared six distributions to Utilisave‘s members: (1) a $100,000 distribution in April 1, 2008, (2) a $250,000 distribution on March 27, 2009, (3) a $350,000 distribution on April 19, 2010, (4) a $200,000 distribution on July 23, 2010, (5) a $150,000 distribution in February 2011, and (6) a $200,000 distribution on June 23, 2011, two hours after the New York court issued its post-trial decision. The first three distributions were the subject of claims by MHS in the New York Action, because Khenin withheld all or a portion of those distributions from MHS for reasons the New York court concluded were invalid.10 MHS challenged in this action the distributions in July 2010, February 2011, and June 2011, arguing that Khenin
F. Khenin copies Utilisave‘s software and customer databases
In 2009, Khenin formed a wholly-owned limited liability company, which he called Venergex LLC.11 Khenin opened a bank account for Venergex, obtained a credit card in Venergex‘s name, and testified that he intended to use Venergex for a “side business,” although he had not decided what the business would entail.12 At some point in February or March 2011, Khenin asked one of Utilisave‘s employees, Max Smelyansky, to purchase a server and desktop computer using Venergex‘s credit card.13 The computers were shipped to Venergex at Khenin‘s home address.14 Smelyansky also established a domain for Venergex at Khenin‘s request.15 The facts admitted into evidence at trial support the conclusion that the server and desktop were owned by Venergex, as they were purchased with Venergex funds and were linked to the Venergex domain Smelyansky created.16
At some point in the late winter or early spring of 2011, Khenin asked Smelyansky and another Utilisave employee, Dmitri Wittal, to transfer Utilisave‘s
Notwithstanding this new argument, Khenin effectively conceded at trial that the software and client list was transferred to the Venergex computers, although he steadfastly contended that he made the transfer for purposes of maintaining a back-up for Utilisave to use in the event of an emergency. For example, Khenin responded affirmatively when asked by plaintiffs’ counsel whether “[t]he Utilisave information you had transferred to your personal computers or Venergex computers kept at your home included the following categories of information: utility provider information ... client information ... billing information ... utility usage information...?”18 Similarly, Khenin acknowledged that Utilisave‘s source code “was transferred from Utilisave onto [his] personal computers kept in [his] home, purchased by a Utilisave employee,
Although the timing of when the download occurred is not clearly established in the record, the best evidence indicates it was done in or around March 2011. Although the trustee believed that the download was made at some point after the New York court issued its post-trial decision and before Khenin was
Khenin also maintained that the download was made as an emergency back-up and testified that he had retained copies of Utilisave‘s database, including its software, source code, and client information since at least 2005. According to Khenin, he first kept copies of the database on a back-up tape, which was updated monthly.25 Khenin concedes those back-up tapes could not be used on computer equipment he maintained at home.26 Khenin further testified that beginning in 2009 he asked Utilisave employees to copy the database to one of two computers Khenin maintained at his home. This copying purportedly occurred two to three
G. The New York Decision
The New York court issued its post-trial decision on June 23, 2011. In that decision, the Court held that: (1) MHS was entitled to a judgment against Utilisave for distributions that were declared, but never paid to MHS, in April 2008, March
H. The sale of Utilisave
The disputes between the parties also led to various actions that were filed in this Court, including a Petition for Dissolution of Utilisave, which MHS filed in March 2009. The dissolution action was stayed pending resolution of the New York Action. After the New York court issued its decision and the stay was lifted,
The Trustee‘s efforts and the hurdles he confronted are described in greater detail in the Final SJ Report. Of the issues the Trustee confronted, one is particularly notable for purposes of this report: Khenin‘s copying of Utilisave‘s database onto the Venergex computers. On November 1, 2011, Steifman and Miele informed the Trustee that Utilisave employees were reporting that Khenin maintained a copy of Utilisave‘s database on a computer in his home. The Trustee interviewed Steifman, Miele, and several Utilisave employees.31 Through these interviews, the Trustee discovered the existence of Venergex, the Venergex computers, and the copying of Utilisave‘s proprietary database onto those computers.32 Up to that point, Khenin had claimed that the only Utilisave information he maintained outside the office was an outdated computer.33 During a meeting on November 14, 2011 between the Trustee and Khenin, Mr. Khenin described the “back-ups” of Utilisave‘s information he purportedly had maintained in his home since 2005. The Trustee found this explanation implausible for a number of reasons.34 The Trustee retained a technology company, Synthesis Technology Group (“Synthesis“), to review the “Venergex computers” and delete
Once issues were resolved regarding preserving Utilisave‘s confidential information and trade secrets, the Trustee turned to the task of selling the company. As described in the Final SJ Report, the Trustee performed a market check at Khenin‘s insistence and invited several third parties to bid on Utilisave, in addition to MHS and Khenin. MHS was the only party who submitted a bid and the Trustee recommended the sale of Utilisave as a going concern to MHS. Over Khenin‘s objection, then-Chancellor Strine approved the proposed sale, under which MHS purchased all the assets and liabilities of Utilisave in exchange for waiving its priority claim to proceeds of the sale of the company, as well as any legal claims or judgments MHS or Steifman had against Utilisave. The Chancellor granted the Trustee‘s motion to approve the transaction and dismissed the dissolution action on July 9, 2012. The transaction closed the same day.
Less than two months later, Utilisave and MHS filed this action against Khenin. In their amended complaint, Utilisave and MHS brought six primary claims against Khenin: (1) breach of the fiduciary duty of loyalty (Count I), (2) breach of the Operating Agreement relating to Khenin‘s “unauthorized” salary payments between 2009 and 2011 (Count II), (3) breach of the Operating Agreement for Khenin‘s alleged use of Utilisave funds to pay legal expenses for the counterclaims he personally brought in the New York Action (Count III), (4) breach of the Operating Agreement for the distributions Khenin made in 2010 and 2011 (Count IV), (5) breach of the Operating Agreement relating to Khenin‘s alleged misuse of Utilisave‘s confidential information (Count V), and (6) misappropriation of trade secrets (Count IX). The plaintiffs also brought three claims against Khenin for unjust enrichment, conversion, and waste, but those claims were not pursued by the plaintiffs at trial or in their motion for summary judgment. For his part, Khenin asserted two counterclaims against the plaintiffs: (1) breach of contract based on Khenin‘s claim that distributions should have been made to him under Sections 3.03 and 6.04 of the Operating Agreement, and (2) breach of contract based on Khenin‘s claim that distributions should have been made to him under Section 6.05 of the Operating Agreement.37
A three day trial was held on February 17-19, 2014. At the conclusion of trial, both parties submitted post-trial briefs. By the time briefing was complete, the plaintiffs had abandoned Count I of their complaint alleging Khenin breached his fiduciary duty of loyalty. Counts VI, VII, and VIII – alleging claims for unjust
Both parties filed exceptions to the Draft Bench Report, but Utilisave later withdrew its exceptions. This final report therefore addresses Khenin‘s exceptions to the Draft Bench Report.41 Khenin also took exceptions to my draft report on the motion for partial summary judgment. Those exceptions are addressed in the Final SJ Report.
II. ANALYSIS
A. The plaintiffs are entitled to $59,697.01 as damages for Khenin‘s breach of Section 2.03 of the Operating Agreement.
I concluded in the Final SJ Report that Khenin breached Section 2.03 of the Operating Agreement by paying himself a salary and benefits after his employment agreement expired and without the authorization of a majority of Utilisave‘s members. I also explained, as had the New York court, that it was possible that Khenin could establish that he provided services to Utilisave during his tenure as acting CEO and that the amount he received as compensation for those services was reasonable. For that reason, the issue of damages was reserved for trial.
For those reasons, I concluded that the services Khenin provided the company between 2009 and 2011 were approximately equal to the salary he was receiving at the time his employment agreement expired. Khenin did not show, however, that the raises he awarded himself between 2009 and 2011 were justified or reasonable. Although I believe the 2008 salary is a fair approximation of the
I also recommended in the draft report that the Court disgorge one month of Khenin‘s salary for his acts of disloyalty in connection with establishing Venergex and downloading Utilisave‘s confidential information onto the Venergex computers. I based that recommendation on the faithless servant doctrine under New York law. Although Khenin‘s exceptions dispute as a factual matter the reasons for the download and whether it was made to Venergex computers, I explain in Section C, below, why I am denying those exceptions. Khenin does not dispute my application of the faithless servant doctrine to those facts. Because Khenin has not taken exception to my legal conclusions, and because I have denied his exceptions to my factual conclusions, I recommend that the Court order Khenin to disgorge one month of his 2011 salary, which amounts to $28,623.92.
In the Final SJ Report, I concluded that the plaintiffs had submitted undisputed evidence that Keane & Beane, P.C., the firm that represented both Khenin and Utilisave in certain matters in the New York Action, had billed Utilisave for at least some of the attorneys’ fees incurred in prosecuting Khenin‘s personal counterclaim against Steifman in that action. I therefore recommended that the Court grant the plaintiffs’ motion as to Khenin‘s liability to repay such amounts, but reserved for trial the issue of damages.
At trial, the plaintiffs introduced all of Keane & Beane‘s bills and questioned Khenin regarding the bills Utilisave and Khenin received from Keane & Beane. Khenin took the position during trial that Keane & Beane separately billed him for services relating to his personal counterclaim against Steifman, pointing particularly to a letter from Keane & Beane to the Trustee stating that the firm had billed Utilisave separately for services provided the company after the New York Court‘s decision in June 2011, while billing Khenin individually for services associated with his counterclaim against Steifman.42 Khenin acknowledged at trial,
The plaintiffs took the position after trial that there were six invoices in which the billing descriptions for various entries indicated Keane & Beane had billed Utilisave for work performed on Khenin‘s personal counterclaim or did not
For example, invoices dated November 5, 2010 and December 10, 2010 contain several references to an amended answer and counterclaim.50 According to Khenin, those entries relate to a counterclaim Utilisave ultimately brought against Steifman and MHS after those parties improperly removed approximately $650,000 from Utilisave‘s accounts in late October 2010. The New York court ultimately concluded that Steifman breached his fiduciary duty to the company by making that withdraw and ordered Steifman to pay $10,000 in damages for that
In contrast, three other invoices contain charges that appear to relate to Khenin‘s personal claim against Steifman or do not clearly indicated which counterclaim was addressed in that work. Invoices dated September 11, 2009, July 6, 2010, and March 7, 2011 contain references to work Keane & Beane performed on one or more counterclaims, as well as additional discovery requests likely related to those counterclaims. Some of the entries directly reference Khenin‘s counterclaim,52 while others are not as explicit but refer to counterclaims that more
Khenin also argued in his exceptions to the draft report that it is not logical to assume that Keane & Beane improperly charged Utilisave for such a small sum because the firm also gave Utilisave “courtesy discounts” on several bills and those discounts exceeded the amount the plaintiffs claim was improperly billed to Utilisave. This argument is a non sequitur. It is entirely possible, if not likely, that Keane & Beane unintentionally included in Utilisave‘s bills certain services
C. Khenin misappropriated Utilisave‘s trade secrets and required the company to undertake costs to remedy that misappropriation.
Counts V and IX of the plaintiffs’ complaint alleged that Khenin breached the Operating Agreement and Delaware law when he downloaded a copy of Utilisave‘s database, including billing and client information, onto the Venergex computers. In the draft post-trial report, I concluded that the plaintiffs had established that Khenin misappropriated trade secrets under the
- The existence of a trade secret as defined by the statute;
- Communication of the trade secret by the plaintiff to the defendant;
The communication was pursuant to an express or implied understanding that the secrecy of the matter would be respected; and - The secret information has been improperly ... used or disclosed by the defendant to the injury of the plaintiff.56
Khenin effectively conceded that the information he downloaded from Utilisave was a trade secret to which he had access by virtue of his position as CEO. The plaintiffs also proved the third element of their claim by reference to the Operating Agreement, in which the members agreed to maintain the confidentiality of Utilisave‘s information. I recommended that the Court deny summary judgment on this claim because there were disputed issues of fact regarding whether Khenin either used or disclosed the trade secrets. After trial, however, I concluded that Khenin disclosed Utilisave‘s trade secrets by downloading them onto a computer owned by Venergex. I reasoned that, even if Venergex was a shell company, as Khenin argued, the act of downloading the information to a Venergex computer was a disclosure, as Venergex constituted a “person” within the meaning of the DUTSA.57 I therefore recommended that the Court award the plaintiffs actual damages plus their attorneys’ fees in pursuing this claim.58
I also believe that Khenin‘s misappropriation of Utilisave‘s trade secrets was willful and done with the intent to compete with Utilisave, justifying an award of attorneys’ fees. I reach that conclusion for a variety of reasons and with an understanding that “[m]isappropriation of trade secrets may be proven by
In my draft report, I calculated the plaintiffs’ actual damages from the misappropriation as $19,399.64. That calculation consisted of the costs Utilisave and the Trustee incurred in remediating the misappropriation and ensuring that the trade secrets were removed from Khenin‘s possession. The damages included: (i) $3,150 billed by Synthesis, the forensic IT specialist the Trustee retained to delete information from the Venergex computers and see if any copies were made, (ii) $3,964.64 in hardware and data support services incurred by the Trustee relating to the misappropriation; and (iii) $12,285 billed by the Trustee for his services relating to the misappropriation. In his exceptions brief, Khenin argues that the Synthesis bill was not paid by Utilisave directly and instead was paid by the Trustee and then included in the Trustee‘s bill to Utilisave as “hardware and data support services” incurred by the Trustee. In other words, Khenin established that the $3,150 awarded for Synthesis was duplicative of the amount awarded for hardware and date support services. I therefore alter my recommendation to reduce the damages by $3,150. Khenin‘s other criticisms, however, are make-weight. He criticizes the Trustee‘s bills as vague because they utilize “block billing,” but any uncertainty associated with the Trustee‘s bills should be borne by
CONCLUSION
For the foregoing reasons, I recommend that the Court enter judgment against Khenin in the amount of $83,917.65, plus pre-judgment and post-judgment simple interest at the legal rate.63 This is my final report and exceptions may be taken in accordance with Rule 144.
Respectfully submitted,
/s/ Abigail M. LeGrow
Master in Chancery