Specific Language of Operating Agreements Key in Chancery Court Dismissal of “Laundry List” of Claims Against LLC Managers

By: Scott Waxman and Rich Minice

In 77 Charters, Inc. v. Gould et al.., C.A. No. 2019-0127-JRS (Del. Ch. May 18, 2020), 77 Charters, Inc. (“Plaintiff”) brought suit against defendants Jonathan Gould (“Gould”), Stonemar MM Cookeville, LLC (“Stonemar MM”), Cookeville Corridor, LLC (the “Preferred Purchaser”) and Eightfold Cookeville Investor, LLC (the “New Investor” and together with Gould, Stonemar MM and the Preferred Purchaser, the “Named Defendants”) for a series of alleged “wrongful acts” in connection with the management and sale of a shopping mall (the “Property”), which also implicated Stonemar Cookeville Partners, LLC (“Cookeville Partners”) and Cookeville Retail Holdings, LLC (“Cookeville Retail”). In delivering its opinion, which centered on the nature of Delaware limited liability companies as creatures of contract, and thus, the controlling nature of the applicable operating agreements and contracts into which the parties had entered, the Delaware Court of Chancery (the “Court”) ruled that only Plaintiff’s claims which could be connected to an alleged wrongful amendment of the operating agreement of Cookeville Retail could survive Defendants’ Motion to Dismiss (the “Motion”).

In 2007, Plaintiff, Gould and non-party Kimco Preferred Investor LXXIII, Inc. (“Kimco”), purchased the Property and formed Cookeville Retail and Cookeville Partners. The principal agreements governing the relationship between the parties were the operating agreement of Cookeville Retail (“Cookeville Retail LLC Agreement”) and the operating agreement of Cookeville Partners (“Cookeville Partners LLC Agreement”). Plaintiff and Gould held non-preferred interests in Cookeville Retail, while Kimco’s preferred interest entitled it to receive a 9% annual rate of return up to its investment amount before Plaintiff and Gould would receive any distributions. In 2013, Kimco, Gould and the New Investor negotiated a three-step transaction by which Kimco sold its interest in the Property. First, Gould acquired Kimco’s entire preferred interest for $1,995,283 (which gave Gould sole control of Cookeville Retail). Second, Gould amended the Cookeville Retail LLC Agreement to increase the rate of return for preferred interest-holders (himself) to 12.5%. Finally, Gould sold part of the preferred interest to the New Investor for the same price he had paid for the entire interest just eight days earlier ($1,994,283), but retained a significant interest for himself. Plaintiff had no notice of any of the sale transaction steps. Without Plaintiff’s knowledge or consent, Defendants sold the Property to a third party on June 27, 2018 (the “Final Sale”), and Gould authorized the sale on behalf of Stonemar MM, Preferred Purchaser and Stonemar Cookeville Partners, LLC (“Partners”), a special purpose entity which sat on top of Cookeville Retail in order to obtain and distribute distributions from operation of the Property. Shortly after the Final Sale, Plaintiff brought suit based on a variety of claims, including: (i) breach of contract; (ii) direct and derivative claims for breach of fiduciary duty based on a variety of theories; (iii) aiding and abetting breach of fiduciary duty; (iv) civil conspiracy; (v) unjust enrichment; (vi) tortious interference with business relations; and (vii) a claim seeking judgment declaring the amendment to the Cookeville Retail LLC Agreement void.

Plaintiff alleged Gould, Stonemar MM and Stonemar Cookeville, breached their fiduciary duties by engaging in self-dealing. The Court dismissed the claims against Stonemar Cookeville outright because Plaintiff attempted to bring claims both on behalf of and against Stonemar Cookeville in the same action. Noting the Cookeville Partners LLC Agreement and Cookeville Retail LLC Agreement unambiguously waived the corporate opportunity doctrine, but left other parts of the duty of loyalty intact the Court held Stonemar MM, as the managing member of Cookeville Partners, was subject to those remaining fiduciary duties even though the Cookeville Partners LLC Agreement disclaimed member liability. Gould, for his part, was not the manager of Cookeville Partners or Cookeville Retail, but nevertheless, under Delaware law, Gould was a second-tier controller who “exert[ed] control over the assets of [Cookeville Partners and Cookeville Retail],” and thus could be a fiduciary. Notwithstanding this recognition, the Court held the second-tier controller duties cannot apply where there the controller is subject to conflicting and irreconcilable fiduciary duties due to its contractual duties to other parties. Had the Preferred Purchaser’s acquisition of Kimco’s interest been the final act, this would have ended the inquiry in favor of Gould. However, Gould used his newfound interest through the Preferred Purchaser to amend the Cookeville Retail LLC Agreement, allegedly to the detriment of Plaintiff. Based on this act alone, the Court held that this self-dealing claim against Gould and Stonemar MM must survive the Motion.

Plaintiff advanced other theories of breach of fiduciary duty without success, including that the Final Sale was a breach because it resulted in a price which left nothing for Plaintiff. In dismissing this claim, the Court restated the maxim that “those who manage an enterprise do not become a guarantor of success.” In addition, under the Cookeville Partners LLC Agreement, Stonemar MM had exclusive authority to sell the Property without agreement of the minority members. The Court refused to apply an entire fairness standard in place of its ordinary deference to the business judgment of Stonemar MM.

An issue of timing and operative language determined the breach of contract claims against the Preferred Purchaser and the New Investor. As new purchasers of Kimco’s preferred interest, neither was initially party to the Cookeville Partners LLC Agreement or Cookeville Retail LLC Agreement. Concurrent with their preferred interest purchases, the Preferred Purchaser and the New Investor each executed Joinders to the Cookeville Partners LLC Agreement and Cookeville Retail LLC Agreement. However, the Court held that the Preferred Purchaser and the New Investor, by virtue of the language of the agreements at issue, did not become members when the joinder was executed, but were only admitted as members when the Cookeville Partners LLC Agreement and Cookeville Retail LLC Agreement were amended. As the acts on which the allegations were based occurred before the two defendants were admitted by amending the agreements, the breach of contract claims must be dismissed.

The remaining allegations were characterized by the Court as a “punch list of grievances” rather than proper legal complaints. Plaintiff wrongfully pursued several breach of contract claims as fiduciary breach, and the Court held it was too late to amend the complaint. Plaintiff’s unjust enrichment theory was also misplayed because the Court would not apply unjust enrichment as a remedy where there is an enforceable contract that sets out the rights of the parties, as the Cookeville Partners LLC Agreement and Cookeville Retail LLC Agreement do here. In addition, aiding and abetting claims were not supported by any allegations or evidence that the New Investor or Preferred Purchaser acted as anything other than at arms’ length when purchasing Kimco’s preferred interest. Finally, Plaintiff’s allegations of tortious interference were also dismissed because they relied on a theory of usurpation of a business opportunity to purchase Kimco’s preferred interest, which, as previously discussed, the Cookeville Partners LLC Agreement and Cookeville Retail LLC Agreement unambiguously waived.

As for Plaintiff’s civil conspiracy claims, such actions require an underlying actionable wrong. Given the Court dismissed all claims except those arising out of Gould and Stonemar MM’s amendment to the Cookeville Retail LLC Agreement in a self-dealing transaction, only the civil conspiracy claims related thereto could survive dismissal. The Court noted that “nothing in Delaware law bars a claim that a corporate parent conspired with a wholly-owned subsidiary to commit a wrongful act.” Therefore, the Court held the civil conspiracy claim against Cookeville Corridor (wholly owned and managed by Gould) would move forward along with the self-dealing claims against Stonemar MM and Gould.