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Trading Secrets A Law Blog on Trade Secrets, Non-Competes, and Computer Fraud

Virginia Federal Court Finds For Employer on Fidicuary Duty Claim Against Former Employee

Posted in Breach of Fiduciary Duty, Computer Fraud, Computer Fraud and Abuse Act, Practice & Procedure

By Michael Baniak

A Virginia federal court district court recently issued a significant decision awarding lost profits to an aggrieved employer for breach of fiduciary duty by a former employee. The Court found that the ex-employee was not able to deduct his services for the company as an expense against the damages award. Further, the Court found that the employer’s CFAA claim failed becuase there was not a sufficient showing of loss. Ritlabs, SRL v. Ritlabs, Inc., 2012 WL 6021328 (E.D. Va. 11/30/12).

Ritlabs SRL (“SRL”) sued its CEO and part owner Demcenko, for alleged self-dealing through another company he formed (co-defendant), Ritlabs, Inc. (“INC”). The host of counts included breach of fiduciary duty of loyalty, violation of the Computer Fraud and Abuse Act (CFAA), and tortious interference with contractual relations. In a nutshell, Demcenko, while still the director (essentially CEO) of SRL, allegedly formed a rival Internet technology and software company INC with his wife. He then entered into a license agreement between SRL and INC to exclusively sell SRL’s software in the US, with a non-exclusive worldwide. As the Court determined, Demcenko did not obtain approval from his SRL co-owners, nor advise them of his ownership interest in INC, or that he was cancelling a software distributorship agreement between SRL and another company, which he then entered into on behalf of INC.

Needless to say, his co-owners did not take kindly to Demcenko’s activities, and sued. Plaintiff ultimately moved for summary judgment as to all of its claims, which resulted in the Court’s grant of the same generally across the board, along with summary judgment against Defendants on all counterclaims. The Court imposed constructive trusts, issued restraining orders, and ordered an accounting and disgorgement proceeding. A bench trial ensued as to damages, and it is here that interesting tidbits reside.

The breach of fiduciary duty was the big-ticket item, based upon Demcenko’s diversion of corporate opportunities to himself (through INC). SRL went for INC’s gross revenue, without reduction for any expenses, as well as for some other smaller amounts. SRL also sought punitive damages in the way of costs and attorney’s fees.

Applying Virginia law, a plaintiff is entitled to what it would have received “but for” the breach of fiduciary duty, so as to “deny Defendants the fruits of their scheme.” Accordingly, the Court determined that damages should therefore be calculated on the basis that Demcenko was operating INC for the constructive benefit of SRL; ergo, SRL was entitled to only profits, not gross revenue. In what might be seen as a bit of chutzpah by some, the Defendants sought to deduct amounts received by Demcenko for his “services”. The Court was not buying it, however, and concluded that collecting a salary for breach of one’s duty of loyalty, and while he was still receiving a salary from SRL, was not appropriate as a deductible expense.

As for damages under the CFAA, the Court noted that civil liability, and responsibility for compensatory damages or other relief, requires a showing of CFAA qualifying “loss” aggregating at least $5000. 18 U.S.C. section 1030(g). The bar for loss is not terribly high, as any reasonable cost to the “victim,” including the cost of responding to the offense, damage assessment, restoration, revenue lost “or other consequential damages incurred because of interruption of service” will suffice. But here, the Court did not find the necessary nexus with damage incurred because of interruption of service for the bulk of what SRL was toting up on this count. That left an amount below $5000 total, which the Court noted was below the jurisdictional threshold, and divested the Court of jurisdiction. The previous judgment as to liability was thereby vacated for “lack of subject matter jurisdiction.”

As for costs and attorneys fees, the elimination of the CFAA count removed that as a basis for a fee award. And as for punitive damages, upon which SRL further predicated its costs and attorneys fees, “the Plaintiff did not include a prayer for punitive damages in its Complaint, and should not be considered now.” Nonetheless, the Court reviewed the evidence, and concluded that SRL did not meet its high burden for punitive damages. It was in this discussion that what might otherwise have seemed to be a fairly open and shut case revealed some nuances, such as his former partners having some favorable knowledge of Demcenko’s plans to open a US branch, and “that the affairs of SRL were at times accompanied by rather unorthodox self-driected transactions by each of the owners.”