Opinion
G054604
05-18-2018
KHYBER ZAFFARKHAN, Plaintiff, Cross-defendant, and Appellant, v. JUSTIN DOMESEK, Defendant, Cross-complainant, and Respondent, GREG CHERRY, Defendant and Respondent.
Fingal, Fahrney & Clark and Christopher R. Clark for Plaintiff, Cross-defendant and Appellant. Justin Domesek, in pro. per., for Defendant, Cross-complainant and Respondent. Greg Cherry, in pro. per., for Defendant and Respondent.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115. (Super. Ct. No. 30-2014-00755427) OPINION Appeal from a judgment of the Superior Court of Orange County, Robert J. Moss, Judge. Affirmed. Fingal, Fahrney & Clark and Christopher R. Clark for Plaintiff, Cross-defendant and Appellant. Justin Domesek, in pro. per., for Defendant, Cross-complainant and Respondent. Greg Cherry, in pro. per., for Defendant and Respondent.
* * *
Plaintiff Khyber Zaffarkhan appeals from the trial court's entry of judgment in favor of defendants Justin Domesek and Greg Cherry in the fallout from a failed software startup company that Zaffarkhan, Domesek, and another mutual acquaintance, Scott Martin, formed in June 2012 and dissolved in August 2013. Before forming the company, Martin and Domesek developed a prototype version of a software application aimed at helping doctors manage patient medications to prevent fraud and prescription drug abuse. They later brought Zaffarkhan aboard because, in addition to being a medical doctor like Martin, he had computer programming experience. The trio formed Prescription Diversion Solutions, Inc. (PDS), but within 14 months, Martin and Domesek decided not to continue working with Zaffarkhan, whom Domesek claimed misrepresented his programming ability and contributed little to the company.
In board resolutions, Martin and Domesek dissolved PDS over Zaffarkhan's contrary vote, and the pair also voted to sell PDS's assets—consisting primarily of the prototype software code—to a new company they formed. Zaffarkhan refused PDS's buyout offer of $110,000 for the work he put into PDS and his one-third ownership share in PDS. Instead, he sued Domesek and Cherry, a PDS shareholder who took minutes at PDS board meetings and purported to vote as a member of the board of directors in favor of dissolving PDS and selling its assets.
After a bench trial, the court concluded Cherry was only a minority shareholder and not a PDS director or board member and, therefore, neither owed nor breached a fiduciary duty in the sale of the company. In contrast, the court found that by participating as an interested director in the sale of PDS's assets to his new company, Domesek breached his fiduciary duty as a PDS board member and director, breached the shareholder agreement he and Zaffarkhan signed as directors in forming the company, and engaged in an unfair business practice. But the court also found Zaffarkhan "failed in his burden of establishing the amount of damages. At the time of the [board resolution authorizing the sale of assets,] the corporation had no physical assets, no product, no investors, and no customers. It was a start-up software company with an idea." The court similarly rejected Domesek's cross-complaint, finding he did not prove Zaffarkhan made misrepresentations and "also failed to establish the amount of damages suffered, if any."
On appeal, Zaffarkhan challenges the sufficiency of the evidence to support the trial court's defense judgment based on his failure to prove damages. As we explain, the court could not award damages that were speculative or "merely possible" (Piscitelli v. Friedenberg (2001) 87 Cal.App.4th 953, 989 (Piscitelli)); rather, it was Zaffarkhan's burden to prove damages with reasonable certainty. In particular, where the party challenging the judgment shouldered the burden of proof at trial, the standard of review on appeal is daunting, requiring the appellant to demonstrate judgment in its favor was required as a matter of law. But damages are a question of fact, and the court as the trier of fact reasonably could agree with Domesek's summation of the evidence showing "[t]his was a garage band startup with a few guys working part-time to try to solve one of the biggest epidemics in America today, a few guys that had never run a startup company before. We had high hopes of what could have been, but we never made it off the starting line. [¶] We never raised enough money to fund the project. We never finished the product. We never entered the marketplace period."
Because we find no merit to Zaffarkhan's damages challenge, we need not reach his additional claims that the trial court erred in declining to find Cherry owed and breached a fiduciary duty, that Cherry therefore engaged in an unfair business practice, and that Domesek also breached the covenant of good faith and fair dealing in his contractual relationship with Zaffarkhan. Without damages, none of these additional claims warrant consideration for reversal. As we discuss more thoroughly below, we therefore affirm the judgment.
I
FACTUAL AND PROCEDURAL BACKGROUND
Consistent with the deferential standard of review concerning evidentiary matters, we briefly set out "in the light most favorable to the judgment" (Delgado v. Trax Bar & Grill (2005) 36 Cal.4th 224, 229) the background facts pertinent to the dispositive issue of PDS's value. In 2011, while working full-time as a medical supply company salesman specializing in spine products, Domesek met Martin, a doctor who consulted for the same medical supply company in addition to running his own practice. Domesek shared with Martin his interest in creating a software solution to help doctors manage their patients' medications to "prevent prescription fraud and abuse," and they hired a computer programmer who created for them a prototype application. Toward the end of the year, the programmer took a full-time job elsewhere and was no longer available to further develop the software.
Domesek either knew Zaffarkhan independently as a customer of the medical supply company, or Martin introduced them. In either event, Domesek believed Zaffarkhan's experience as a physician and computer programmer would be an asset to his plans with Martin to move their existing software beyond the prototype stage. The record is not clear concerning the precise nature or functionality of the software in its prototype phase.
At trial, Domesek described his initial efforts predating Zaffarkhan's involvement in general terms, as "a project regarding prescription diversions," apparently to prevent diversion of a patient's prescribed medicine to illicit use either by someone pretending to be the patient or by the actual patient.
Domesek and Martin described their initial software application and unspecified further plans to Zaffarkhan and another doctor at a dinner in April or May 2012. According to Domesek, "after the dinner, Dr. Zaffarkhan . . . told me that he was very excited about the opportunity and the concept. And he said that he used to be a computer programmer. And he told me that he could build the application." Domesek sent Zaffarkhan an email stating "[c]heck out what we have already built from another project last year," and attached "live links" to a sample "profile_patient_personal" page and "other developed pages." At trial, Domesek claimed in his opening statement that Zaffarkhan "told us that he used to be a computer programmer, kn[ew] the space well and could build the application we were trying to create. . . . Then a couple months after [forming PDS] we realized he couldn't do any of the things that he said he could do. He didn't have the time, he didn't have the knowledge and he didn't have the experience that he said he had in order to build the application."
But back in June 2012, prospects looked brighter for the collaboration between Domesek, Martin, and Zaffarkhan. The trio agreed to form PDS to enhance the prototype software Martin and Domesek had developed and to bring it to market. An attorney friend of Zaffarkhan's drew up the necessary documents to incorporate PDS with 1,000 shares at the outset, with each of the three founding members owning a 30 percent interest in the company. As reflected in the founders' shareholder agreement, each of the three filled the company's officer and director positions, and together comprised PDS's board of directors. Cherry, another acquaintance, was not a founder but instead purchased the remaining 100 shares, or 10 percent of the company. As he explained at trial, "I did not sign the shareholders agreement, . . . did not sign any contract . . . that would establish [Zaffarkhan's later] fiduciary claim. . . . I was not an officer in the company. I was not a founder in the company. I was not a director or [on the] board of director[s], and I was not a majority shareholder. I was a part-time consultant."
In fact, the three principals also limited their commitment to PDS. Domesek stayed full-time at his medical sales position, while Martin and Zaffarkhan maintained their active medical practices in addition to ongoing consulting positions in other endeavors. According to Domesek, between PDS's founding in June 2012 and dissolution in August 2013, Zaffarkhan did little to help PDS succeed, adding only a secure printing function to the prototype software when his anticipated role, as Zaffarkhan acknowledged at trial, was to scale the software up to "enterprise" level for access by thousands of patients and doctors at a time. Domesek apparently believed Zaffarkhan had the ability to complete such programming himself, while Zaffarkhan envisioned hiring others to do the work, which he would oversee.
Zaffarkhan explained at trial that Domesek had no real grasp of the "costs to take the system to the next level," erroneously believing technical support personnel would cost "10 to 12 dollars an hour," whereas "actual costs would [require] senior programmers at $100,000 a year, junior programmers at 80, network administrators, database administrators, information security officers, and a technical lead, all [at] salaries . . . between . . . 80,000 and $100,000 a year, not inclusive of benefits."
The founding trio had ambitious plans for enhancing the prototype software to aggregate a patient's prescription data. Zaffarkhan acknowledged the existence of another "system out there" at the time "provid[ing] that [functionality] to doctors," "but only on a state level," while he, Domesek, and Martin "were . . . envisioning" "[t]hat this application was going to be nationwide." Neither Zaffarkhan nor any other witness addressed whether there might be regulatory hurdles to their projected national rollout. More fundamentally, Zaffarkhan acknowledged PDS never developed "a completed software application" and that nothing in the record demonstrated "that the PDS software had the ability to receive outside data." He also admitted he did not have the technological know-how to program the necessary "API" protocols to "communicate with other databases, third party databases."
Evidence presented at trial demonstrated that PDS's software never emerged from the "beta" stage of software development. As Zaffarkhan explained, "A beta system indicates that a system is—has some functionality to it but is not ready for the real world." Zaffarkhan testified that, as of PDS's dissolution date in August 2013, "the enterprise level software had not been completed yet. We didn't have the resources, the dollars, all the things I outlined in the technical budget had not been apportioned for yet. We couldn't buil[d] it yet, so it wasn't built. All we did have in place was a concept under beta."
While Domesek pinned PDS's product failure on Zaffarkhan, as PDS's chief executive officer and ostensible leader, Domesek acknowledged under cross-examination that he "had never been an officer or a director of a company," nor had he "run a startup company," "raised capital from investors," or "valued a company before." Cherry characterized PDS at trial as "a very Mickey Mouse operation." Noting "startup companies are hard work" and claiming "nine out of ten startups fail," Cherry observed that nevertheless "every founder wants to believe that they have the next Microsoft. They don't want to come in and say this is a company that is ultimately going to fail but you should invest in us, no. Every founder comes in and says this is a company that is worth billions of dollars as soon as we get that first investment in." But according to Cherry, PDS's "Mickey Mouse" attributes were evident in "poor documentation, poor record keeping, poor legal counsel, and naive team members. We were a technology company with a tech product that could barely support two [beta] baby users, let alone 10,000 users."
PDS's revenue models and projections reflected its disarray. PDS's own financial projection in late 2012 for its 2013 net revenue was a candid "zero." PDS never settled on a revenue model. As a result of shifting revenue models, Zaffarkhan complained at trial that "the product was ever evolving, ever changing. Every time we took a meeting with someone, they wanted to see something else[,] . . . wanted a different functionality, so it's hard to define the product requirements when the product itself is changing and the people who want to see data from the product constantly changes. It's hard to define that when it's constantly in flux."
In PDS's brief lifespan of 14 months, Domesek explained it "had no product, no customers, no sales, didn't make a single dollar, [and] had no investors, or investment offers." Nor were there "any hard assets like furniture or phones or pictures, [or] art," but rather, as Zaffarkhan testified, "I think we had business cards and that was about it."
As Domesek explained at trial: "After more than a year of working in this toxic environment, without a product, without any customers, without any revenue, without any investors and the fact that all the shareholders . . . already lost tens of thousands of dollars, we decided to shut that business down." At a PDS board meeting in August 2013, Domesek and Martin voted to dissolve PDS, over Zaffarkhan's contrary vote. Cherry also purported to vote to dissolve the company, though he was not a board member.
Meanwhile, Domesek and Martin wanted to continue pursuing their efforts to develop prescription antidiversion software. Together with Cherry, they thereafter formed a new company, ScriptGuard, and the three men comprised ScriptGuard's officers and board of directors. In September 2013, Martin and Domesek attempted to settle their differences with Zaffarkhan by buying out his shares in PDS at a sum they considered a premium because, as their attorney wrote to Zaffarkhan, "The current company was not viable and the best alternative is to sell the assets."
They offered Zaffarkhan $110,000, which consisted of: returning his $35,000 investment in PDS; $15,000 in compensation for the part-time hours he had put into PDS; and $60,000 as his 30 percent share of PDS if valued at $200,000. Domesek complained that the $15,000 in compensation was three times the amount they paid for another PDS programmer's time. Cherry noted that PDS's self-assessed value by its founders in their incorporating documents a year earlier in June 2012 was $20 a share for 1,000 shares, or just $20,000. In his view, nothing supported any of the various values assigned to PDS.
Domesek claimed at trial that in refusing the $110,000, Zaffarkhan "was actually offered more than the fair market value [for his share of PDS], but chose not to accept it, twice." Instead, after Zaffarkhan received a voicemail months later from Martin apologizing for his role in shunting Zaffarkhan aside, Zaffarkhan eventually filed the lawsuit.
At trial, Zaffarkhan's expert testified PDS had a minimum value of $1.5 million, "a maximum value of eight million dollars, and a most likely value of six million dollars" based on documentation and deposition testimony he reviewed. The expert started from the premise that "ScriptGuard is the reorganized entity of PDS." He determined $1.5 million was ScriptGuard's floor value based on convertible promissory notes issued to its initial investors, under which they had the option to convert each $15,000 they invested in notes into a one percent ownership share of the company. The expert reasoned that 100 percent of the company therefore would be worth $1.5 million (i.e., 100 x $15,000).
The expert based his higher valuations on Cherry's deposition testimony assessing ScriptGuard's nominal value at four dollars a share. Multiplying that figure by ScriptGuard's formation with 1.5 million shares of common stock yielded the expert's $6 million valuation, and adding ScriptGuard's 500,000 shares of preferred stock at the same par value yielded the expert's high estimate of $8 million. The expert did not explain why he viewed $6 million as ScriptGuard's "most likely" value, essentially excluding the preferred stock from his valuation.
To support his maximum $8 million valuation, the expert also cited an email Cherry had sent in 2013 while at PDS "that said that the company was looking for a two million dollar investment from a single investor or investor group, and it was Mr. Cherry's testimony that that two million dollars was in exchange for 25 percent of the company." Zaffarkhan in his testimony at trial similarly recalled that in April 2013 he had proposed that Domesek meet with an investor group, and Domesek responded in an email, "Please make sure they have at least $2 million in their fund to dedicate to this project before we go to this meeting. Otherwise, it's just a waste of time." Zaffarkhan testified he was informed an investment of that sum would garner a one-quarter interest in PDS, supporting its valuation at $8 million, and his expert similarly believed "putting [that] value on what one would consider the initial tranche of funding . . . would be attractive to a potential investor . . . ." For reasons not explained in the record, however, the potential investor balked at the $2 million sum and did not invest in PDS.
Zaffarkhan's expert was unaware that Cherry "was not involved in any financial or investment discussions for PDS." Addressing ScriptGuard's lack of revenue, the expert observed, "There are many historical instances where nonrevenue generating companies, especially web-based companies, have sold for millions and millions of dollars on the expectation that they would begin to generate revenue and net profits related to the business." The expert believed ScriptGuard had run a pilot program testing its software in "a large medical group with three offices in Southern Orange County[,] comprised of 12 physicians, two physician assistants . . . and responsible for more than 35,000 covered lives," and that "there were testimonials as to the product as to how well it worked." He did not know that, in fact, "no pilot had ever taken place," as Domesek explained. The expert had never been "part of a software company before" and had never "valued a software company startup."
Domesek and Cherry, who had legal representation earlier in the proceedings, but were self-represented at trial, did not offer expert testimony. Domesek characterized Zaffarkhan's "entire case" as "based around [a] make-believe valuation," and lamented in his closing argument, "How did a part-time side project that never had a completed product, never had any customers, never had any revenue, and never had any investors turn into a multi-million-dollar lawsuit?" According to Domesek at trial, Zaffarkhan "maliciously and improperly claim[ed] valuation that never existed and frankly would make no sense." Citing a post-dissolution letter he received from Zaffarkhan's attorney demanding a "premium" for Zaffarkhan's interest in PDS, Domesek grumbled that offering Zaffarkhan anything amounted to "giving him a premium for the shares which were virtually worthless." Domesek complained that for the limited time Zaffarkhan put into PDS, and unlike any of the other PDS investors, "We offered him more than three times his original investment back, even though the company had no value and no money."
As noted at the outset, the trial court concluded Domesek had breached his fiduciary duty by participating as an interested director in the sale of PDS's assets to his new company, ScriptGuard. But the trial court concluded Zaffarkhan failed to meet his burden to prove damages with reasonable certainty. The court therefore entered a judgment for the defense, and Zaffarkhan now appeals.
II
DISCUSSION
Zaffarkhan challenges the sufficiency of the evidence to support the trial court's conclusion PDS had no ascertainable value at the time of its dissolution. As he phrased it below in resisting defendants' arguments, "[T]here is really no evidence that it had zero value in the record." But Zaffarkhan misperceives the burden of proof, and the standard of review on appeal magnifies his error.
Below, it was not the defendants' burden to prove PDS had negligible value, but rather Zaffarkhan's burden to prove his damages. "The burden of proof is on the plaintiff to prove his damages with reasonable certainty. [Citations.] The extent of such damage must be proved as a fact." (Fields v. Riley (1969) 1 Cal.App.3d 308, 313.) "'[D]amages which are speculative, remote, imaginary, contingent, or merely possible cannot serve as a legal basis for recovery.'" (Piscitelli, supra, 87 Cal.App.4th at p. 989.)
In contesting the trier of fact's conclusion he or she failed to prove damages, a plaintiff faces a heavy burden on appeal: the question for the reviewing court is whether the evidence required a verdict for the appellant as a matter of law. (Roesch v. De Mota (1944) 24 Cal.2d 563, 570-571; Caron v. Andrew (1955) 133 Cal.App.2d 402, 409.) It is not enough that reasonable minds may disagree; when two or more inferences reasonably can be deduced from the evidence, the appellate court may not substitute its judgment for that of the trier of fact. (Western States Petroleum Assn. v. Superior Court (1995) 9 Cal.4th 559, 571.) The reviewing court has "'"no power to judge of the effect or value of the evidence, to weigh the evidence, to consider the credibility of the witnesses, or to resolve conflicts in the evidence or in the reasonable inferences that may be drawn therefrom." [Citation.]' [Citation.]" (People v. Orange County Charitable Services (1999) 73 Cal.App.4th 1054, 1072, original italics.)
The fact that Zaffarkhan presented the only expert witness does not aid him. Relying on Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal.App.3d 278 (Huber), Zaffarkhan asserts "the uncontradicted expert testimony on a matter solely within the knowledge of the expert is conclusive and cannot be disregarded." (Zaffarkhan's italics.) But Huber involved expert testimony concerning an architect's professional negligence. Howard v. Owens Corning (1999) 72 Cal.App.4th 621 (Howard) explains the importance of a professional duty of care. On appeal in Howard, citing Huber, the plaintiffs "strenuously maintained that the jury was required to accept [their] experts' diagnosis of asbestosis . . . ." (Howard, at p. 631, original italics.)
The Howard court rejected the contention, explaining: "Appellants have seriously misstated the law. A careful examination of the cases they cite reveals that the stated principle—uncontroverted expert opinion testimony may be 'conclusive' on the jury—is actually the 'single exception' to the general rule that 'expert testimony, like any other, may be rejected by the trier of fact, so long as the rejection is not arbitrary.' . . . The exceptional principle requiring a fact finder to accept uncontradicted expert testimony as conclusive applies only in professional negligence cases where the standard of care must be established by expert testimony." (Howard, supra, 72 Cal.App.4th at pp. 632, original italics.) "Because the instant case does not present any issues of professional negligence or medical malpractice, there was no reason to require the trier of fact to accept as 'conclusive' the uncontradicted testimony of appellants' experts. Instead the general rule applies." (Id. at pp. 632-633.)
The same is true here. Valuing a company does not involve a professional standard of care. Accordingly, the general rule applies in which it was the trier of fact's exclusive province to assess witness credibility and weigh the evidence. The trial court reasonably could find on several grounds that Zaffarkhan's expert lacked credibility, from the fact that he had never valued a technology or software company—startup or otherwise—to his misapprehension of basic facts, including his incorrect assumption that PDS had conducted a successful pilot project of its software in a medical practice with 35,000 patients. To the contrary, PDS never conducted testing with more than two beta users and never demonstrated any capability to perform what Zaffarkhan described as its true value proposition in the marketplace: an ability to interact with third party prescription databases to guard against fraud and drug abuse.
Additionally, the trial court reasonably could put little stock in Zaffarkhan's and his expert's approach to valuation based on what the court described as "speculation and wishful thinking on the part of [both] the plaintiff and the defendants" in their self-interested assessments of PDS's value at various times. To avoid speculation, damages in new business cases are usually evaluated based on lost anticipated profits, rather than generalizations about a company's prospective market value. "'[I]f a business is new, it [may be] improper to award damages for loss of profits because absence of income and expense experience renders anticipated profits too speculative to meet the legal standard of reasonable certainty necessary to support an award of such damage. [Citations.]'" (Resort Video, Ltd. v. Laser Video, Inc. (1995) 35 Cal.App.4th 1679, 1698.)
"But although generally objectionable for the reason that their estimation is conjectural and speculative, anticipated profits dependent upon future events are allowed where their nature and occurrence can be shown by evidence of reasonable reliability. [Citations.] . . . [D]amages for the loss of prospective profits are recoverable where the evidence makes reasonably certain their occurrence and extent." (Grupe v. Glick (1945) 26 Cal.2d 680, 693; accord, S. C. Anderson, Inc. v. Bank of America (1994) 24 Cal.App.4th 529, 535.)
Lost profits are "'"the gains made from sales 'after deducting the value of the labor, materials, rents, and all expenses, together with the interest of the capital employed.' [Citation.]"' [Citations.]" (Kids' Universe v. In2Labs (2002) 95 Cal.App.4th 870, 884 (Kids' Universe).) Zaffarkhan made no effort to account for any of these factors.
Apart from expert testimony, Zaffarkhan made little use of the yardsticks commonly employed to value new businesses. "When the operation of an unestablished business is prevented, as here, prospective profits may be shown in various ways. The Restatement Second of Contracts, section 352, comment b, at page 146 provides, '[I]f the business is a new one or if it is a speculative one . . . , damages may be established with reasonable certainty with the aid of expert testimony, economic and financial data, market surveys and analyses, business records of similar enterprises, and the like.' Similarly, the Restatement Second of Torts, section 912, comment d at page 483 states, 'When the tortfeasor has prevented the beginning of a new business . . . all factors relevant to the likelihood of the success or lack of success of the business or transaction that are reasonably provable are to be considered, including general business conditions and the degree of success of similar enterprises.'" (Kids' Universe, supra, 95 Cal.App.4th at p. 884.)
Zaffarkhan may have avoided providing or relying on these indicia of value precisely because PDS never settled on a revenue model; therefore, it was difficult, if not impossible, to provide relevant economic and financial data, market surveys and analyses, or business records showing the degree of success of similar enterprises. The dearth of such evidence supports rather than undermines the trial court's judgment. (Kids' Universe, supra, 95 Cal.App.4th at p. 886 [reviewing court must "view the evidence in the light most favorable to" the prevailing party]; see S. Jon Kreedman & Co. v. Meyers Bros. Parking-Western Corp. (1976) 58 Cal.App.3d 173, 185 ["The trial court could have believed [appellant's] version of profitability; it chose not to do so"].)
In sum, we agree with the trial court's observations in rejecting Zaffarkhan's motions for a new trial and to vacate the judgment. At the hearing on the motions, the court found there was no merit to Zaffarkhan's argument a nonzero damages award was necessary because the defendants admitted Zaffarkhan's interest in PDS was at least the $110,000 they offered him. The court aptly explained, "That was the amount of money they offered him to make him go away." Zaffarkhan also argued "the best evidence" of PDS's value "were the agreements that the defendants . . . entered into to raise $220,000" for ScriptGuard, reflecting an asserted value by note-to-stock conversion "equat[ing] to . . . $1.5 million." But the court observed, "Those were people making bets that the business would succeed. [I]t says nothing about the intrinsic value of the business." Rather, "[i]t was speculation about what might happen in the future. . . . And that wasn't sufficient evidence . . . to find a value of that business. [¶] I know there's all kinds of sales talk and puffing that went on, but I don't see that as evidence of true value." We find no basis to second-guess the court's ruling.
III
DISPOSITION
The judgment is affirmed. Respondents are entitled to their appellate costs.
GOETHALS, J. WE CONCUR: BEDSWORTH, ACTING P. J. IKOLA, J.