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Kleinberg v. Aharon

Court of Chancery of Delaware

February 13, 2017

DANIEL KLEINBERG, TOMER HERZOG, SATURN PARTNERS LIMITED PARTNERSHIP II, and RAKIA INFRASTRUCTURES LTD., Plaintiffs,
v.
REFAEL AHARON, BOAZ COHEN, and BARUCH DILL, Defendants, and APPLIED CLEANTECH, INC., a Delaware Corporation, Nominal Defendant.

          Date Submitted: January 27, 2017

          Ryan P. Newell, Lauren P. DeLuca, CONNOLLY GALLAGHER LLP, Wilmington, Delaware; Amnon Shiboleth, Charles B. Manuel, Jr., Daniel S. Goldstein, Daniel J. Friedman, SHIBOLETH LLP, New York, New York. Counsel for Plaintiffs Daniel Kleinberg, Tomer Herzog, Saturn Partners Limited Partnership II, and Rakia Infrastructures Ltd.

          Refeal Aharon, pro se.

          Boaz Cohen, pro se.

          Baruch Dill, pro se.

          MEMORANDUM OPINION

          LASTER, Vice Chancellor

          A voting agreement binds the stockholders of Applied Cleantech, Inc. (the "Company"). The stockholders committed to a board of directors with six seats. The agreement gives defendant Refael Aharon, who is the founder and CEO of the Company, the practical ability to fill three seats.

         Historically, Aharon only filled two seats. In summer 2016, Aharon feared that a 3-2 majority had formed against him, so he filled his third seat with his brother-in-law. During a meeting on August 22, 2016, the board split 3-3 on a series of critical issues.

         The plaintiffs sought a custodian to break the board-level deadlock. This post-trial decision grants their request.

         I. FACTUAL BACKGROUND

         Trial took place on January 26-27, 2017. Aharon and two other witnesses testified live. Aharon proceeded pro se, and he frequently attempted to make affirmative statements when questioning other witnesses. The defendants agreed to treat Aharon's affirmative statements as part of his testimony. They also agreed that the record encompassed both the exhibits presented at trial and materials Aharon previously filed with the court. The following facts were proven by a preponderance of the evidence.

         A. The Company's Origins

         Aharon is a brilliant scientist and inventor who holds a doctorate from the Weizmann Institute of Science in Rehovot, Israel. Approximately a decade ago, Aharon perceived that urban sewage contained harvestable resources, ranging from cellulose that could be used in recycled paper products to particles of precious metals like gold, silver, and bronze. See Dkt. 9, App. 1; Tr. 10-11 (Lafferty); Tr. 261-62 (Aharon). Aharon raised start-up capital from angel investors, including defendant Baruch Dill, and formed an Israeli company called SePage Ltd. He registered patents on his sewage-processing technology and developed a prototype for a machine that extracted cellulose from sewage. See Dkt. 9 at 2; Tr. 261 (Aharon).

         In 2007, Aharon turned to Saturn Partners, a venture capital firm based in Boston, Massachusetts. Saturn liked the sewage-processing technology and agreed to invest $2.5 million. In May 2007, to facilitate the investment, the parties formed the Company as a Delaware corporation. They caused the Company to formed a wholly owned Israeli subsidiary, called Applied Cleantech (Israel) Ltd., to serve as the operating entity. To avoid confusion, this decision refers to the Israeli company as the "Subsidiary."

         In return for its investment, Saturn received shares of Series A preferred stock in the Company. The shares originally represented approximately 25% of the equity, but they carried additional preferences that included anti-dilution adjustments and the right to vote on an as-converted basis. Because of problems with the Company's books and records, it is not clear how much of the equity or voting power Saturn holds today.

         The parties also entered into an initial version of the voting agreement that contemplated a five-member board. It gave Aharon the right to appoint one director, the investors in SePage the right to appoint two directors, and Saturn the right to appoint two directors. As a practical matter, Aharon appointed the two SePage directors. PTO ¶ 3. He made himself a director and filled another seat with Dill. The third seat remained vacant.

         Saturn filed its seats with two of its partners: Jeff McCormick and Ed Lafferty. McCormick had sponsored the investment within Saturn. Lafferty joined in a secondary, monitoring role. Tr. 9 (Lafferty).

         B. The Company's Efforts At Commercialization

         After the Saturn investment, the Company tried to commercialize its sewer-processing technology. By all accounts, the technology was revolutionary, and it regularly attracted the interest of potential partners. Media accounts praised the technology and hailed Aharon as an international expert on water issues. See, e.g., Dkt. 9, Apps. 1-3.

         Unfortunately, Aharon's success as an inventor did not translate into success as a businessman. Although the trial did not focus in detail on the Company's early efforts, it appears that by 2010, the Company had used up the capital it obtained from Saturn. Around this time, Lafferty told Aharon that Saturn had written off its investment in the Company. Tr. 79 (Lafferty). He also told Aharon that Saturn was likely to be less involved in the Company's affairs going forward. See Dkt. 9 at 27.

         To keep the Company alive, Aharon raised approximately $1.5 million from family and friends. See id. at 5; Tr. 269 (Aharon). The funds kept the Company going until 2013, when Aharon needed more capital. In March, Aharon and his wife sold their home and invested the proceeds in the Company. Dkt. 9 at 27; Tr. 269 (Aharon).

         In May 2013, the Company gained a new lease on life when plaintiffs Daniel Kleinberg and Tomer Herzog invested approximately $2.5 million in the Company. Tr. 269 (Aharon). Kleinberg and Herzog had founded a technology company in 2002, which they sold for $115 million in 2011. Tr. 169-70 (Kleinberg). That transaction is the subject of unrelated litigation in this court. See Tr. 251-57 (Aharon & Kleinberg); Dkt. 9, App. 25.

         In return for their investment, Kleinberg and Herzog received Series B preferred stock representing approximately 35% of the Company's equity. The voting agreement was amended to provide for a board with six seats. See PX 22 (the "Voting Agreement"). Kleinberg and Herzog each received the right to fill a seat, and they appointed themselves. Aharon retained the right to fill a seat, and he continued to serve. The investors in SePage continued to have the right to fill two seats, and Aharon continued to have the practical ability to fill them. PTO ¶ 3; Tr. 16 (Lafferty). Dill continued to serve, and the other seat remained vacant. Saturn's appointment rights were reduced from two directors to one, and Lafferty continued as Saturn's lone representative. See PX 22; Tr. 80 (Lafferty).

         With the proceeds from Kleinberg and Herzog's investment, Aharon ramped up the Company's efforts to commercialize its products. For working capital, he secured a revolving line of credit from Bank Mizrahi, one of the largest banks in Israel. The Subsidiary was the borrower, and Aharon personally guaranteed the line. Tr. 270 (Aharon).

         During 2014, the Company appeared to be on the verge of success. It pursued pilot projects with an impressive list of potential partners, including Waterschap Aa en Maas, a government-sponsored utility in Holland; Scottish Water, a government-sponsored utility in Scotland; and Veolia, a major international water company headquartered in France. See Tr. 270, 277-79 (Aharon).

         But the Company needed additional funds to pursue these projects. In February 2014, the Subsidiary obtained a loan of approximately $800, 000 from Bank Mizrahi. The Subsidiary only received the loan because Aharon, Kleinberg, Herzog, and non-party Assaf Morag (who appears to be a friend of Herzog's) provided personal guarantees.

         In April 2014, the Company entered into an agreement to sell one of its sewage-processing machines, but the deal required seller financing. Aharon shopped for a loan at an interest rate of 15%, but no bank would lend to the Company at that rate. Kleinberg agreed to fund the loan at the rate Aharon wanted. See Tr. 203-04 (Kleinberg).

         In October 2014, the Company needed still more cash. With further support from Kleinberg and Herzog, the Company raised approximately $2.5 million.

         Unfortunately, none of the pilot projects led to a long-term contract. The parties disagree vehemently about the reasons for the Company's lack of success. Aharon blames external factors, such as the conservative nature of decision makers in the water industry, their resistance to new technology, and their preferences for local businesses. Tr. 264-65, 267 (Aharon). The plaintiffs blame Aharon's lack of business acumen, combative nature, and poor interpersonal skills. See Tr. 163-67 (Aharon & Lafferty).

         C. Kleinberg And Herzog Lose Confidence In Aharon.

         When Kleinberg and Herzog initially invested in the Company, they discussed with Aharon the need to bring in an experienced CEO who could take the Company to the next level. Aharon appeared supportive as long as the timing was right. Tr. 171, 207 (Kleinberg).

         The Company's difficulties during 2014 caused Kleinberg and Herzog to believe that the time had come to bring in a new CEO. During 2015, Kleinberg and Herzog introduced potential candidates to the Company. Aharon resisted their efforts. Tr. 171-73, 208-14 (Kleinberg). For his part, Aharon felt betrayed. He believed that Kleinberg and Herzog were attacking him personally and that they had become obsessed with replacing him. See Dkt. 9 at 7; Tr. 80-81 (Aharon & Lafferty); Tr. 271-72 (Aharon).

         In late 2015, with the Company running out of money and no new sources of financing available, Aharon terminated all of the employees except himself. Using money that he borrowed personally and his own retirement savings, he paid the severance obligations that he believed the Company owed its employees. See Dkt. 9 at 7; Tr. 272 (Aharon).

         D. The Bioform Opportunity

         With the Company on the brink of failure, an opportunity emerged that had real promise. Two years earlier, in 2013, representatives of a Canadian entity known as Canadian Sewage Mining Corporation had visited Aharon in Israel. The discussions led to a pilot project in Canada. Towards the end of 2015, Aharon and Gary McLoed, who was serving as the lead representative for Canadian Sewage Mining, worked out the terms of a joint venture to manufacture and distribute sewage-processing machines in North America. Tr. 273, 301 (Aharon).

         The basic idea was for the two companies to form a new entity called BioForm Manufacturing Inc. The Company would license its technology to the new entity, which would manufacture the Company's sewage-processing machines. In return, the Company would receive 10% of the equity in the new entity. Canadian Sewage Mining would rename itself as Bioform Sewage Mining and enter into a sales and distribution agreement with the manufacturing entity and the Company. Under the distribution agreement, the Company would receive royalties when its machines were sold. The distinction between the manufacturing entity and the selling entity are not critical to this decision, which refers to both collectively as "Bioform."

         Aharon asked Lafferty to help him on the Bioform deal. With the prospect of a solution to the Company's problems on the horizon, Lafferty became more involved. He conducted due diligence on the Canadian firm and its proposal, and he concluded that both were legitimate. He supported Aharon in working with Bioform's principals, primarily McLoed, and he tried to mollify Kleinberg and Herzog, who continued to press for a new CEO. See Tr. 77-78, 80 (Lafferty).

         In December 2015, Aharon presented the board with a Non-Binding Memorandum of Understanding for the Bioform deal. Dkt. 9, App. 16 (the "Non-Binding MOU"). It outlined the terms of the partnership and established a timetable for drafting definitive documents. The Non-Binding MOU contemplated that Aharon would relocate to Canada in March 2016 and would devote 85% of his time to working with Bioform for a period of two years. It also contemplated that Aharon's family would follow him to Canada later in 2016. Aharon told the board that Bioform wanted him in Canada to help with transitioning the technology and starting up the manufacturing process. Tr. 20 (Lafferty). During a meeting in December 2015, the five-member board voted unanimously to approve the Non-Binding MOU. See DX 2.

         Initially, Aharon was the Company's sole negotiator for purposes of preparing the definitive documents. By February 2016, after two trips to Canada and extensive discussions, Aharon had what he believed was an executable set of agreements. He emailed the Company's other directors a package of documents and asked them to respond by email with their approval.

         Kleinberg and Herzog did not believe they knew enough about the Bioform deal to approve the agreements. They felt they had not received any meaningful information about the transaction since December 2015, and they refused to approve the agreements without a board meeting. Tr. 215-17 (Kleinberg). They also continued to believe that the Company needed a new CEO. Tr. 206-07 (Kleinberg). Lafferty disagreed. He was convinced that the Company needed to focus on the Bioform deal, and he believed that Aharon was critical to making that transaction work. He also believed that once the deal was in place, Aharon naturally would assume a greater role with Bioform, making it easier to bring in a new CEO for the Company. See Dkt. 9, Apps. 10 & 20; Tr. 61 (Lafferty); Tr. 219-21 (Kleinberg).

         On February 22, 2016, the board met to consider the Bioform agreements. Herzog was not present. He tried to deputize Morag in his place, and Morag purported to act as a director at the meeting. Tr. 65 (Lafferty). As a matter of Delaware law, a director cannot act by proxy. In re Acadia Dairies, Inc., 135 A. 846, 847 (Del. Ch. 1927) (Wolcott, C.). This decision therefore ignores Morag's participation.

         When the Bioform transaction initially was presented, Kleinberg opposed it. After discussion, Kleinberg agreed to abstain. Lafferty, Dill, and Aharon voted in favor. The minutes recounted these events. See PX 5.

         After the February 2016 meeting, Aharon sent a copy of the minutes to Bioform to satisfy the Company's representation that the transaction was duly authorized. Tr. 67 (Lafferty). But Bioform was concerned about the lack of a unanimous vote. Two other Bioform representatives, Sean Ross and Jean Navert, reached out to Lafferty. They raised a host of concerns and sought improved terms in light of what they perceived to be greater uncertainty about the deal. See Tr. 74-76 (Lafferty); Tr. 274 ...


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