2009 Caiola Family Trust v. PWA, LLC ( 2015 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
_________________________________
:
2009 CAIOLA FAMILY TRUST, :
a New Jersey trust, and LOUIS CORTESE, :
:
Plaintiffs, :
:
v. : C.A. No. 8028-VCP
:
PWA, LLC, a Kansas limited liability :
company, and WARD KATZ, :
:
Defendants, :
:
and :
:
DUNES POINT WEST ASSOCIATES, :
LLC, a Delaware limited liability :
company, :
:
Nominal Defendant. :
_________________________________ :
MEMORANDUM OPINION
Date Submitted: June 24, 2015
Date Decided: October 14, 2015
Kurt M. Heyman, Esq., Patricia L. Enerio, Esq., PROCTOR HEYMAN ENERIO LLP,
Wilmington, Delaware; Gary M. Fellner, Esq., Michael J. Naporano, Esq., PORZIO
BROMBERG & NEWMAN P.C., New York, New York; Attorneys for Plaintiffs.
Thomas E. Hanson, Jr., Esq., Patricia A. Winston, Esq., Albert J. Carroll, Esq., MORRIS
JAMES LLP, Wilmington, Delaware; Attorneys for Defendants.
PARSONS, Vice Chancellor.
This case involves a dispute between members of a limited liability company that
owns an apartment complex in Lenexa, Kansas. The plaintiffs include a trust, which
owns 90% of the membership interests in the company, and its trustee. The defendants
include another LLC, which owns 10% of the company‘s membership interests and is the
original managing member of the first LLC, and the managing member and 10% owner
of the second LLC. The plaintiffs are suing the defendants for breaching both the first
LLC‘s operating agreement and their fiduciary duties and are seeking a declaratory
judgment that the second LLC should be removed as the managing member of the
company and replaced by an affiliate of the plaintiffs. The plaintiffs also seek money
damages in favor of the first LLC. Both parties requested that the other side pay their
attorneys‘ fees under a fee-shifting provision in the operating agreement. I tried this
matter for three days in February 2015. For the reasons that follow, I conclude that: (1)
the plaintiffs are entitled to the declaratory judgment they seek; (2) the defendants owe
the company a relatively small fraction of the money damages sought; and (3) the
plaintiffs are entitled to recover one-half of their reasonable attorneys‘ fees.
Before delving into the myriad details relevant to this dispute, I note that it
provides an important object lesson: an alternative entity, like the LLC at the center of
this litigation, is not the same thing as a corporation. In particular, the 90% non-
managing member of an LLC generally does not get to call the shots. By the same token,
the managing member enjoys broad discretion in the management of the entity, but can
be removed for cause if it fails to pay attention to the requirements of the LLC‘s
1
operating agreement. It is critical to the successful and mutually beneficial operation of
an alternative entity that the members and their counsel not lose sight of these
fundamentals.
I. BACKGROUND1
A. The Parties
The plaintiffs are the 2009 Caiola Family Trust (―CFT‖), a Florida trust, and Louis
Cortese, CFT‘s trustee. I refer to CFT and Cortese, collectively, as ―Plaintiffs.‖ CFT is
the 90% owner and the Non-Managing Member of Dunes Point West Associates, LLC
(―DPW‖ or the ―Company‖). Cortese‘s uncle, Louis Caiola, is the settlor of CFT and
operated an investment banking boutique. Cortese, beginning in 1976, served as the
financial manager of Caiola‘s businesses.
Defendant PWA, LLC (―PWA‖), a Kansas limited liability company (―LLC‖),
owns 10% of the Company‘s membership interests and was its original Managing
Member. Whether PWA still remains the Managing Member is the primary issue in this
case. Defendant Ward Katz2 is PWA‘s managing member and owns 10% of its
membership interests. Katz has over thirty years of experience in developing and
1
Citations to testimony presented at trial are in the form ―Tr. # (X)‖ with ―X‖
representing the surname of the speaker, if not clear from the text. Exhibits are
cited as ―JX #,‖ and facts drawn from the parties‘ pre-trial Joint Stipulation are
cited as ―JS ¶ #.‖ Capitalized terms not defined herein have the meaning assigned
to them in the Company‘s Amended and Restated Operating Agreement, executed
as of November 28, 2006 (the ―Operating Agreement‖).
2
All references to ―Katz‖ throughout this Opinion should be understood to mean
Ward Katz. Any reference to Ward Katz‘s son, Peter Katz, will include his first
and last name.
2
managing multifamily properties and is also the President and CEO of Dunes Residential
Services, Inc. (―DRS‖), the former Property Manager of DPW. Together, I refer to PWA
and Katz as ―Defendants.‖ DPW is also a nominal defendant in this case. DPW is a
Delaware LLC that was formed in 2006 to acquire, own, operate, lease, or otherwise
dispose of approximately 12.67 acres of land upon which a 172-unit multifamily
apartment complex, known as the Dunes at City Center, sits in Lenexa, Kansas (the
―Property‖).
There are numerous relevant non-parties in this action. Along with PWA, NDC
Point West LLC (―NDC Point West‖) and Block Investment Group Point West, LLC
(―Block‖) were the Company‘s Members at formation. NDC Capital Partners, LLC
(―NDC Capital‖), an affiliate of NDC Point West and Block, was the Company‘s original
asset manager under the Operating Agreement (the ―Asset Manager‖) and a co-investor
with Katz in another property. Curo Enterprises, LLC (―Curo Enterprises‖), an affiliate
of Caiola, assumed NDC Capital‘s role as the Asset Manager in July 2012.3 DRS, a
Texas corporation and an affiliate of Defendants, was the Company‘s original Property
Manager under the Management Agreement between DRS and the Company, dated
August 14, 2006. DRS also managed several other properties in which Katz or NDC
Capital had invested. DRS resigned as the Property Manager in September 2013 and was
replaced by GREP South L.P. (―Greystar‖), a property manager that is not affiliated with
the parties but was selected for the Company by Plaintiffs. Curo Point West, LLC
3
JS ¶¶ 49, 54.
3
(―CPW‖), an affiliate of Caiola, was designated by Plaintiffs to replace PWA as the
Managing Member. NorthMarq Capital, Inc. (―NorthMarq‖) holds an $8.715 million
mortgage that encumbers the Property. The Ward A. Katz Revocable Trust, the Donna
Katz Revocable Trust, and DLKPWA, LLC are all entities associated with and controlled
by Katz to which Katz transferred his interest in PWA in 2007 or 2008, 2011, and 2013,
respectively.
B. Facts
1. Katz and NDC Capital plan their investment in the Property
Katz‘s initial investment strategy for the Property centered on the acquisition and
repositioning of the then-Point West Apartments to benefit from the City of Lenexa‘s
planned development of the Lenexa City Center (the ―City Center‖). The City Center
was expected to offer 4.5 million square feet of mixed-use development, including retail
and office space, on 200 acres and serve as a ―gathering place for shopping, recreation,
and employment.‖4 Katz monitored the progress of the City Center plan and attended
city council meetings where it was discussed and ultimately approved.5
After a local broker listed the Property for sale, Katz obtained and reviewed the
sales brochure and presented it to Eric Jones of NDC Capital. NDC Capital expressed an
interest, and Katz developed a business plan to purchase and rehabilitate the Property to
increase rents (the ―Rehab Program‖). As part of the repositioning effort, Katz planned
4
JX 7 at 5; JX 66 at 4-6.
5
Tr. 405 (Katz).
4
to rename the Property the Dunes at City Center to give it ―more of an urban flavor . . .
[and] brand.‖6
2. DPW is formed
DPW was formed on August 9, 2006. PWA (10%), NDC Point West (12%), and
Block (78%) were the Company‘s Members at formation, with PWA designated as the
Managing Member. The Company purchased the Property on November 28, 2006 from
Aimco Properties for $10.5 million. The $10.5 million purchase price was financed in
part by the investors‘ equity capital and in part by a secured, non-recourse loan from
NorthMarq, totaling $8.715 million.
The Operating Agreement provides that PWA is the Managing Member, vested
with ―sole and exclusive control over the Company,‖ and that all other parties are Non-
Managing Members.7 The Non-Managing Members are not to ―participate in making the
decisions of the Company‖ or have the power to ―manage or transact any Company
business.‖8 According to Katz, NDC Capital‘s role was limited to representing and
interfacing with investors: ―NDC [Capital] provided, really, the capital market‘s [sic]
expertise because they raised most of the equity in this case. And they were really much
more familiar with what the expectations of investors are, and that was their expertise.‖9
6
Id. at 412.
7
JX 16 [hereinafter Operating Agreement] Preamble, §§ 3.4, 6.1.
8
Id. § 3.8.
9
Tr. 410-11.
5
Consistent with these responsibilities, the Operating Agreement required PWA to
provide certain financial information to NDC Capital, which NDC Capital was then to
deliver to the Non-Managing Members.10 This structure is consistent with information
that Caiola acknowledged he received before investing.11 The Company‘s Confidential
Investment Brochure (the ―Investment Brochure‖) stated that ―Investors will be
extremely limited in the management of the Company, and investors will have no right to
control the affairs of the Company except as specifically provided in the [Operating
Agreement]. . . . Therefore, it will be very difficult to remove [the Managing Member].‖12
3. Plaintiffs invest in DPW
Caiola was introduced to the Company by NDC Capital, with whom he previously
had done business. On January 18, 2007, Block transferred its membership interests to
Cortese and Caiola, who transferred their interests to CFT on January 1, 2009 and April
14, 2014, respectively. In addition, on June 30, 2012, NDC Point West transferred its
membership interests in the Company to CFT. By mid-2014, therefore, PWA owned
10% of DPW and CFT owned 90%.13
10
Operating Agreement § 7.9.
11
Tr. 180-83 (Caiola).
12
JX 10 at 23.
13
As a result of the above described transfers, the terms ―Non-Managing Members,‖
―Investment Members,‖ ―NDC Investors,‖ and ―NDC‖ in the Operating
Agreement all now refer to CFT.
6
As part of their initial investment in DPW in 2007, Caiola and Cortese contributed
approximately $2.5 million to the Company. A portion of Caiola‘s and Cortese‘s
investment was placed into reserve accounts, including an account for the Rehab Program
designed to improve the Property and increase rents (the ―Rehab Reserve‖). Before
investing, Plaintiffs received the Investment Brochure from Defendants and NDC
Capital, which projected that each Member, in the first year, would receive distributions
amounting to a 7.5% annual return and projected a 10% return on investment in later
years.
4. DPW makes distributions to the Members
Each month during the period from January 1, 2007 through September 30, 2013,
Defendants and DRS prepared financial reports regarding the Property (the ―Investment
Updates‖). The Investment Updates, which were distributed to the other Members
through the Asset Manager, included an income statement, balance sheet, and monthly
commentary, among other financial documents. Further, toward the end of each year,
Defendants and NDC Capital distributed an annual business plan (the ―Business Plans‖)
to the Members for their approval. The Business Plans contained detailed narratives
regarding DPW‘s operations and finances as well as a proposed budget for the upcoming
year.
At the end of each quarter in 2007 and the first quarter of 2008, Defendants caused
DPW to make distributions to the Members. In the aggregate, these distributions totaled
$331,973, approximately $260,000 of which went to Plaintiffs. These distributions
ceased in 2008. In the Investment Updates and Business Plans, PWA and NDC Capital
7
characterized these distributions as ―returns on equity,‖ ―dividends,‖ ―annualized
returns,‖ and distributions from ―cash flow.‖ The Investment Updates and Business
Plans also indicated that Plaintiffs were receiving a 7.5% annualized return on their
investment, which matched the amount projected in the Investment Brochure. Further,
through 2012, the Investment Updates continued to refer to the 2007 and 2008
distributions as ―annualized returns‖ or ―dividends.‖
Caiola testified that, at the time, he believed that DPW was distributing returns on
Plaintiffs‘ equity rather than returns of their investment. DPW had not generated a profit
or positive cash flow from operations, however, from which to fund those distributions.
But, the Investment Updates disclosed on the first page the distributions paid to the
Members and the sources of those distributions. For the quarter ending December 31,
2007, for example, the Investment Update stated that the Members were paid
distributions in the amount of $62,330, while the total net income available for the
distribution was negative $10,963. The update further showed that the distribution had a
negative $73,293 effect on the Company‘s working capital.
5. PWA and DRS attempt to implement the Rehab Program
After acquiring the Property in 2006, the Company commenced implementation of
the Rehab Program, budgeted to cost $853,504. The Rehab Program focused on interior
upgrades and certain exterior improvements, and its goal was to position the Property ―to
compete with apartment projects which [were] ten years less in age translating to a 10%
8
to 15% increase in rents.‖14 As of June 1, 2008, the Company had completed the interior
renovation of 125 out of the 172 units. NDC Capital reported to Cortese that this was ―on
schedule with the Business Plan.‖15
There were some cost overruns during the Rehab Program, however, and, due to
the 2008 financial crisis, DPW could not achieve the projected post-rehabilitation rents
for certain apartment types. Further, because DPW previously had distributed its
Members‘ capital, the Rehab Reserve was exhausted and could not be relied on to fund
the remainder of the Rehab Program.16
As a result, it was projected that DPW would need an additional $160,000 to
complete the Rehab Program and a total of $225,000 to complete the revised Business
Plan for the Property. PWA offered to contribute $175,000 and NDC offered to
contribute $50,000 to cover this expense. Caiola rejected these contribution offers
because he considered them to be efforts to ―strip equity from the investors.‖17 The
parties instead agreed to a capital call for $175,000, with each Member contributing
based on their percentage ownership interest. On August 25, 2008, Defendants issued the
capital call to all the Members to replenish the depleted reserves, and Plaintiffs
contributed 78%—equal to their percentage ownership of DPW at the time—or
14
JX 14 at 3.
15
JX 46 at 2.
16
JX 48.
17
Tr. 201-02.
9
$136,600. The Company used these funds to continue performing the Rehab Program.
As of January 2011, 164 of the 172 units had been renovated.
6. Plaintiffs seek to take a more active role in managing the NDC Investments
Caiola originally was introduced to the Property in late 2006 by Anthony Niosi, an
executive at Citibank, N.A. who Caiola met approximately nine years earlier. Niosi also
managed NDC Capital, and the Property was one of seven similarly structured real estate
investments Caiola made through NDC Capital (the ―NDC Investments‖). During the
term of his investment, Caiola received the Investment Updates and had occasional
conversations with representatives of NDC Capital, but he had no contact with Katz
before July 2012.18
From 2000 to 2009, Caiola primarily resided in Europe. While overseas, Caiola
and Cortese primarily ―check[ed] [the monthly Investment Updates] for occupancy and
. . . read the narratives.‖19 Caiola and Cortese ―depended on NDC [Capital], who is the
conduit to the managing member, to provide [them] with accurate information.‖20
After returning from Europe, Caiola looked to devote more of his efforts to
managing his investments in the United States, including reviewing the Investment
Updates in more detail. In April 2011, Caiola formed Curo Enterprises for purposes of
acquiring a 40% equity interest in NDC Capital and taking a more ―hands-on‖ approach
18
Tr. 23, 170 (Caiola).
19
Id. at 192.
20
Id.
10
with the NDC Investments. Curo is Latin for ―cure,‖ and Caiola thought the name ―was
pretty appropriate because we had some assets that need[ed] to be cured within the
portfolio.‖21
After Caiola acquired a 40% equity stake in NDC Capital, he caused it to be
restructured as Dome Equities (―Dome‖) and tried to convince Dome to take a more
active role in managing the NDC Investments. Caiola left his position with Dome after
only six months, but retained his equity stake. Caiola then contacted one of his advisors,
Stephen Cox, and told him that ―he was unhappy with his investments that he made
through NDC.‖22 In advising Caiola, Cox divided the investments into two categories:
(1) those Caiola should sell right away; and (2) those Caiola should hold, reposition, and
sell later. The latter category included DPW.
Cortese acknowledged during his deposition that Plaintiffs‘ ―overall objective‖
with respect to the NDC Investments was to obtain ―total control of these properties.‖23
Cortese believed Plaintiffs could ―better direct a more satisfactory conclusion and
completion by having control.‖24 Indeed, Caiola stated in an email to the operator of
Fenwick Apartments Associates, L.P. (―Fenwick‖), another NDC Investment, that
―[f]rankly the NDC experience has convinced us to never again outsource our financial
21
Tr. 223.
22
Tr. 358 (Cox).
23
Cortese Dep. 103.
24
Id.
11
destiny to any [general partner]. Our current and future investments will only be directed
to those opportunities in which we control the outcome.‖25
Defendants point to Caiola‘s dealings with the operator of Fenwick as illustrative
of the means by which Plaintiffs sought to take control of the NDC Investments. Caiola
testified that he was satisfied with the performance of Fenwick, its operator, and his
equity investment.26 Nonetheless, by November 2013, Caiola began discussing a sale of
that property with the operator. In a letter dated January 15, 2014, Plaintiffs pressed the
operator to either purchase Plaintiffs‘ interests or sell its interests to Plaintiffs, and Caiola
stated that they would use ―whatever means necessary‖ to effectuate a consolidation of
the partnership interests, including removing the operator as Fenwick‘s general partner.27
Ultimately, on January 31, 2014, the parties signed a Purchase and Sale Agreement by
which the operator agreed to purchase Plaintiffs‘ interests in Fenwick. As Defendants
emphasize, the DPW Property is the only one of Plaintiffs‘ seven NDC Investments for
which Plaintiffs, to this point, have been unsuccessful in either gaining full control or
selling their interest.28
25
JX 223.
26
Tr. 232.
27
JX 219, 223.
28
Tr. 231-32 (Caiola).
12
7. Plaintiffs become more closely involved with DPW and suspect Defendants
are mismanaging the Company
In 2012, as Caiola negotiated his purchase of NDC Point West‘s 12% membership
interest and explored his desired replacement of NDC Capital as the Asset Manager, he
inquired more closely about PWA‘s financial reporting. As a result of his increased
scrutiny, Caiola began to suspect that, in addition to making distributions to Members
that were returns of capital rather than returns on investment, as described above: (1)
Defendants repeatedly had misstated the Company‘s finances; (2) Defendants had paid
Asset Management Fees to NDC Capital in violation of the Operating Agreement; and
(3) DPW was incurring unreasonable expenses.
a. Plaintiffs suspect Defendants are misstating the Company’s finances
Plaintiffs‘ experts prepared a report identifying a number of inconsistencies and
errors in DPW‘s financial records and alleged that the financial statements in the
Investment Updates were not compliant with Generally Accepted Accounting Principles
(―GAAP‖). For example, the Company‘s balance sheets and accounts receivable aging
reports were inconsistent, as the balance sheets reflected a greater amount of accounts
receivable than the aging reports did.29 As a result, the assets on the balance sheets may
have been inflated because they included receivables that may have been either
uncollectible or nonexistent. Elisa Edwards, a DRS employee, acknowledged in an email
to Cortese dated November 12, 2012 that the accounts receivable balance on the balance
29
JX 280.
13
sheet did not agree with the aging reports because unpaid rents ―ha[d] not yet been
written off.‖ 30
Defendants also may have overstated net cash flows and liabilities by failing to
report DPW‘s mortgage principal payments and, correspondingly, to reduce DPW‘s
mortgage principal amount between 2010 and 2012.31
In addition, despite the fact that DPW never segregated security deposits from
other funds, the balance sheets indicated that those deposits were held in a separate
―security deposit account.‖ The April 2010 balance sheet specifically lists a separate line
item for ―Cash – Security Deposit Account‖ in the amount of $30,682.32 Jerry Gottlieb,
Defendants‘ expert witness and DPW‘s accountant, admitted that this line item was an
error. Gottlieb also admitted that when a company does not segregate tenant deposits,
―[i]f you showed a security deposit account with an amount of money, that would be
pulling the wool over the eyes of an investor or a reader of the financial statements.‖33
b. Plaintiffs suspect Defendants paid management fees to NDC Capital in
violation of the Operating Agreement
NDC Capital was entitled, as the Asset Manager, to receive asset management fees
under Section 8.3(c) of the Operating Agreement (―Asset Management Fees‖) for its
30
Id.
31
JX 280.
32
JX 62.
33
Gottlieb Dep. 90.
14
services. Those services included providing DPW‘s financial reporting and overseeing
PWA‘s management of DPW.
NDC Capital was to receive $6,563 in Asset Management Fees each quarter, but
only to the extent of the Company‘s Net Cash Flow from Operations (―NCFO‖) after the
payment of all of the Company‘s liabilities. If there was insufficient NCFO, the Asset
Management Fees were to accrue and be paid either: (1) when the Company had
sufficient NCFO to pay the fees; or (2) upon the sale of the Property or a refinancing. 34
From the time DPW was formed until mid-2012, when NDC Capital was replaced as the
Asset Manager, PWA paid the Asset Management Fees each quarter, totaling $146,755.35
As demonstrated by Edward Dratch, Plaintiffs‘ accounting expert, however, DPW never
had sufficient NCFO to support payment of these Asset Management Fees.
There was some dispute at trial as to how Defendants decided whether to pay the
Asset Management Fees. Katz testified that ―at the end of a quarter, [he] would make a
determination as to whether the asset management fee was payable [to NDC Capital]‖
and that he made these calculations ―in his mind.‖36 Edwards, on the other hand, stated
that the payments to NDC Capital were made automatically and were ―a given.‖37 And,
as Katz himself admitted, if he determined there was negative cash flow in a particular
34
Operating Agreement § 8.3(c).
35
JX 280.
36
Tr. 439.
37
Edwards Dep. 34.
15
quarter, he still would pay the Asset Management Fees from DPW‘s reserve accounts,
including the Rehab Reserve.38
On July 1, 2012, Curo Enterprises replaced NDC Capital as the Asset Manager,
and on July 23, it demanded that PWA reimburse DPW for the Asset Management Fees
paid to NDC Capital. PWA refused to reimburse those fees. In addition, at the end of the
next quarter, PWA sent Curo Enterprises the same quarterly fee it had been paying NDC
Capital. Curo Enterprises, however, refused to accept that payment.
c. Plaintiffs suspect DPW is incurring unreasonable expenses
Defendants‘ financial statements show that from January 2007 through September
2013, DPW‘s total revenue was $9,396,215.39 Under the Management Agreement, DRS
was entitled to 4% of that amount in Property Management Fees,40 which Plaintiffs
calculated to be $384,366. During that same period, however, DPW paid DRS
$1,945,766, which included both the Property Management Fees and expense
reimbursements.41 In addition, overall expenses, including payroll, increased over DRS‘s
term as Property Manager. According to Plaintiffs‘ real estate expert, Alan Feldman, as
compared to 2006—i.e., when the Property was under the prior owner‘s management—
38
Tr. 439.
39
JX 280.
40
Operating Agreement Ex. D [hereinafter Management Agreement] § 5.
41
JX 280.
16
the Property‘s average annual operating expenses under DRS‘s management were 31%
higher.42
Some of the payments to DRS were necessary to operate the Property: because all
of the Property‘s employees worked directly for DRS rather than DPW, DRS allocated
employee expenses among all the properties it managed. Plaintiffs dispute the validity of
other payments, as well. For instance, DRS charged the Company for auto and excess
liability insurance coverage. DPW also allocated all the health and medical insurance
costs for all DRS employees to DPW, including part-time employees, without regard to
the amount of time they spent at other DRS properties. In total, Plaintiffs‘ experts
concluded that DRS allocated $88,724 of expenses to the Company without appropriate
back up or authority under the Management Agreement.43
Defendants attribute the increase in DPW‘s operating expenses to the costs
associated with the Rehab Program and their replacement of the Property‘s administrative
staff. As described in the Company‘s 2008 Business Plan, PWA expected a 4.67%
increase in total payroll expense to complete the Rehab Program in an ―efficient manner.‖
PWA reported that it had ―replaced the entire administrative staff with a more
enthusiastic and upbeat leasing professional as well as a more customer oriented property
manager, which both required additional compensation than the original staff.‖44 PWA
42
JX 279 at 10.
43
Id.
44
JX 34.
17
also hired a ―groundskeeper/make-ready person for April through October rather than
contracting this work out.‖45 And, according to Joy Peters, Defendants‘ property
management expert, the Property was staffed appropriately.46
8. DRS is replaced by Greystar as the Property Manager
Caiola and Cox first met Katz in mid-July 2012 at the Property. Before that
meeting, Plaintiffs had decided, without viewing the Property, that DRS needed to be
replaced.47 At the July 2012 meeting, Caiola and Cox demanded that PWA replace DRS.
Katz ―vehemently disagreed‖ with their claim that DRS had not performed properly and
refused to replace DRS as the Property Manager.48 Shortly thereafter, Plaintiffs‘ counsel
sent a letter to Defendants purporting to remove DRS.49
Plaintiffs, using a strategy similar to what they used to gain control of the other
NDC Investments, sought to compel Katz‘s compliance with their requests. For instance,
on August 2, 2012, Plaintiffs formed CPW to replace PWA as the Managing Member.
Cox sent an email dated October 16, 2012 and a letter dated February 4, 2013 to
NorthMarq criticizing PWA and DRS‘s performance in managing the Property.50 When
45
Id.
46
Tr. 758-59.
47
Tr. 170-71 (Caiola).
48
Tr. 364 (Cox).
49
JX 92.
50
JX 117, 158.
18
PWA refused to replace DRS as the Property Manager, Plaintiffs purported to remove
PWA as the Managing Member and filed this action to validate that removal on
November 13, 2012.
Cortese also began sending emails to PWA questioning various items in the
Company‘s financial reports. PWA responded to those emails, but Plaintiffs considered
the responses unsatisfactory. On October 29, 2012, Cortese told Katz that he ―must take
action and remove DRS in favor of Greystar.‖51 Around the same time, Plaintiffs refused
to approve the 2013 Business Plan, which included the budget for that year. Without an
approved budget, PWA‘s ability to perform repairs and maintenance at the Property was
restricted because DRS was ―limited to basically following the budget from the previous
year as far as capital expenses.‖52
On February 22, 2013, Curo Enterprises notified Katz that it was terminating the
Management Agreement. Katz disputed Curo Enterprises‘s right to terminate that
agreement unilaterally, and DRS refused to step down as the Property Manager. In
March 2013, Curo Enterprises filed an action against DRS in Kansas state court seeking a
declaration that it had the right, as the Asset Manager, to terminate the Management
Agreement with DRS and replace it with a new Property Manager (the ―Kansas Action‖).
On September 7, 2013, just before the trial of the Kansas Action was set to begin, DRS
resigned as the Property Manager.
51
JX 123.
52
Pence Dep. 36. Elizabeth Pence is a DRS employee.
19
On September 17, 2013, NorthMarq approved Curo Enterprises‘s application to
appoint Greystar as the new Property Manager. In addition, on September 26, the Kansas
court entered an order directing the parties to effect the transition from DRS to Greystar.
Beginning October 1, 2013, Katz, on behalf of DRS, referred all Property Manager-
related inquiries to Greystar. Greystar and CPW, acting on DPW‘s behalf, entered into a
new management agreement dated September 30, 2013. Curo Enterprises then asserted
that, because it had prevailed in the Kansas Action, it was entitled to reimbursement from
DRS of its legal fees in that action under the Management Agreement. PWA disputed
that proposition. The trial court in the Kansas Action denied Curo Enterprises‘s
application for fees, but on January 2, 2015, the Kansas Court of Appeals agreed with
Curo Enterprises and reversed.53 DRS reportedly has appealed that decision.
Greystar took over as the Property Manager on October 1, 2013. According to
Vicki Hutchens, Greystar‘s property manager, the Property was in bad shape: ―concrete
was in severe disrepair‖; many of the handrails in the common areas ―had a lot of rust
and were compromised‖; and there were ―a lot of dead limbs, . . . which seemed kind of
hazardous.‖54 In addition, Hutchens testified that ―[t]he property was not in maintained
condition,‖ ―a lot of [the angle irons supporting stairs] [were] rusted and in disrepair . . .
[a]nd some of them were loose‖; there was erosion that ―was so bad that we had a
mudslide approaching the building [and p]eople couldn‘t even get to their front door
53
JX 278.
54
Hutchens Dep. 16-17.
20
without stepping in mud‖; and ―there was extensive damage‖ from wood rot.55 In 2013,
DPW received a city fire-code violation, under DRS‘s management, regarding the
wrought-iron steelwork on the stair treads. In 2014, before repairs could be made, a
resident fell through a step and suffered injuries when a rusted angle iron supporting the
step gave way.
Greystar conducted a comprehensive inspection of the Property when it took over.
It identified approximately $10,000 in ―life safety‖ repairs, $400,000 in ―required‖
repairs, and $200,000 in ―recommended‖ repairs. Many of the ―required‖ repairs
included the types of repairs Katz previously had deemed ―Emergency Expenditures‖
under the Operating Agreement. For example, on July 22, 2013, Katz informed Plaintiffs
that he had to spend ―$5,414 to replace stair treads and railings‖ and ―$8,300 to make
concrete repairs‖ as Emergency Expenditures.
Despite the conditions giving rise to these Emergency Expenditures and the
―required‖ and ―recommended‖ repairs identified by Greystar, PWA budgeted and spent
little for safety and repair expenditures before 2013. From 2010 to 2012, PWA budgeted
and spent nothing on sidewalk and wood rot repairs. In 2010 and 2011, PWA budgeted
$0 and $100, and spent $86 and $0, respectively, for parking lot asphalt repairs. In 2012,
PWA budgeted $7,125 for total repairs and $33,378 for total capital expenditures. PWA
submitted a proposed 2013 Business Plan with significantly more money budgeted for
repairs and capital expenditures—$75,307 and $66,680, respectively—but Plaintiffs
55
Id. at 26, 49, 134.
21
rejected that plan, forcing PWA to operate from the 2012 budget. Because PWA had not
completed the repairs for the Emergency Expenditures it had identified, Greystar flagged
those same items, among other things, as ―required‖ and ―recommended‖ repairs once it
took over as Property Manager on October 1, 2013.
Annually, NorthMarq sent an inspector to the Property for a routine property
inspection and issued a letter reporting the results of that inspection. On November 21,
2013, soon after Greystar took over as the Property Manager, Hutchens accompanied
NorthMarq‘s inspector during its annual inspection. The inspector identified multiple
repairs and discussed those with Hutchens. On December 9, 2013, NorthMarq sent a
letter to CPW seeking an update on the progress of those identified repairs. That letter
identified the repairs that ―need[ed] to be addressed.‖56 Some of those items also had
been identified in NorthMarq‘s 2012 inspection, but had not been addressed because, as
PWA acknowledged in its 2012 Business Plan, DPW lacked the necessary ―surplus
cash.‖57
9. Katz steps away from DPW’s operations
Katz conceded at trial that since DRS resigned as Property manager in September
2013, he has not ―been actively involved in managing‖ DPW.58 David Antebi, the non-
managing member of PWA, sent Caiola emails on October 3 and 8, 2013 stating that
56
JX 200.
57
JX 74 at 11.
58
Tr. 507-08. Katz further admitted that his son, Peter Katz, has not been involved
with the Property since 2007. Id. at 513-14.
22
Katz ―is out of the picture‖ and ―resign[ed] from all activities at PWA.‖59 Katz explained
that he has not done anything to oversee Greystar since October 2013 because DRS is no
longer the Property Manager. Katz did not respond to NorthMarq‘s requests for repairs
in its December 2013 inspection report and has not paid DPW‘s mortgage payments or
overseen the Property‘s insurance. Moreover, when DPW‘s tax return was due on
September 15, 2013, Katz refused to sign the return.60 Cox signed the 2013 tax return in
Katz‘s place and CPW caused it to be filed. Cox also testified that, after October 1, 2013,
he, rather than Katz, has been involved in every facet of DPW‘s management and the
Property‘s operations, including working with Greystar to prepare the financial reports,
dealing with insurance claims, overseeing repair work, and interfacing with NorthMarq in
all respects.61
Katz testified, however, that he ―visit[s] the [P]roperty several times a month‖ and
has visited Hutchens ―at least three times . . . since 2013.‖62 Through those meetings and
visits, as well as by reading the monthly operating reports, Katz claims he kept abreast of
the developments at the Property. Hutchens corroborated Katz‘s testimony, testifying
that she and Katz met multiple times to discuss the progress of the Rehab Program and
that they once walked through the Property. She also indicated that Katz ―appeared to
59
JX 184.
60
Tr. 119-20 (Caiola).
61
Tr. 309.
62
Tr. 502.
23
have an investor or someone that wanted to see the community‖ with him when he
visited.63 Hutchens further acknowledged being in contact with two other DRS
employees, Pence and Gina Johnson, more frequently to ask for assistance with resolving
various issues that arose in the management of the Property. 64
10. Plaintiffs issue two capital calls
When Greystar assumed the Property Manager‘s responsibilities, it notified
Plaintiffs that DPW lacked cash. Gottlieb acknowledged that DPW‘s working capital
was negative from 2010 through 2013 and that it had shrunk to approximately negative
$45,000 by November 2013. Indeed, according to Greystar, the Company was in danger
of defaulting on its debts. In addition, Greystar notified Curo Enterprises that it had
written off nearly $21,000 of tenant receivables from the Company‘s September 30, 2013
balance sheet as uncollectible bad debts, thereby further increasing the working capital
deficit.
In a December 11, 2013 Asset Management Report (the ―Asset Management
Report‖), Cortese wrote that ―Curo [Enterprises] is in discussion with management to
consider re-introducing the property (once approved capital improvements are complete)
to the market with a name change (The Pointe at City [C]enter) revision of all marketing
materials and signage.‖65 The Asset Management Report also listed a number of
63
Hutchens Dep. 95.
64
Id. at 125-26.
65
JX 206.
24
improvements as recommended for repositioning and reintroducing the Property. These
improvements appear to coincide with what Greystar identified as life safety, required,
and recommended repairs in its earlier assessment.
PWA‘s practice was to rely on security deposits to fund operations, and it
commingled those funds with operating cash. Because the tenant turnover rate was 60 to
70% per year, it appears that DPW repeatedly was required to return security deposits
throughout the year. Nevertheless, there is no evidence that DPW had any history of not
refunding security deposits when such payments were due.
Greystar took a different approach; it established a segregated account of $46,105
for security deposits and funded the deposits on its own with Plaintiffs‘ support. On
November 14, 2013, Amy Stephens, the accounting manager at Greystar, emailed
Cortese and Cox, stating: ―I am not positive the property will cash flow enough to cover
its bills over time . . . I think it makes sense for a capital contribution to occur to fund the
security deposit liability in order for the property [sic] pay its vendors in a timely
manner.‖66 CFT then delivered to the Members, on November 25, 2013, a Notice of
Additional Capital Contribution (the ―First Capital Call Notice‖) under Section 4.3 of the
Operating Agreement.67
The First Capital Call Notice sought total contributions of $190,000 (the ―First
Capital Call‖) for the explicit purposes of: (1) replenishing $46,105 to fund DPW‘s
66
JX 191.
67
JX 192.
25
liability for security deposits; (2) funding $103,895 to balance the Company‘s negative
working capital to make payments to vendors and ensure compliance with the Mortgage‘s
obligations to pay operating expenses and insurance premiums; and (3) paying $40,000
for concrete and railing repairs. Plaintiffs contributed their proportionate share of the
First Capital Call—$171,000—but PWA opposed the Capital Call and refused to
contribute its share—$19,000. On December 6, 2013, CFT notified PWA that it had
funded both its and PWA‘s shares of the First Capital Call.68
Hutchens oversaw the repairs at the Property and, on January 6, 2014, delivered a
report to Cox so that he could update NorthMarq on the status of those repairs. During
the winter of 2014, the Property suffered additional damage when exposed pipes ruptured
and flooded several apartments. On January 6, 2014, a fire destroyed two apartments.
CPW handled the claims process with DPW‘s insurer. A deductible payment of $25,000
and additional funds were required to address those issues.
By July 2014, CFT claimed that additional capital was needed to finish the
ongoing repairs. As a result, on July 31, 2014, CFT delivered to the Members a second
Notice of Additional Capital Contribution (the ―Second Capital Call Notice‖) under
Section 4.3 of the Operating Agreement. The Second Capital Call Notice sought
contributions of $158,052 (the ―Second Capital Call‖) to: (1) fund partially $256,423 to
repair damaged or deteriorated concrete sidewalks, stoops and pads, breezeways, curbs,
asphalt and seal coating, siding and wood rot, filing metal stair rails, landscape erosion,
68
JX 199.
26
and flood damages, as well as subfloor repairs; and (2) fund $67,629 to balance the
Company‘s negative working capital to make payments to vendors and ensure
compliance with the Mortgage‘s obligations to pay operating expenses and insurance
premiums. Once again, Plaintiffs contributed both their proportionate share of the
Second Capital Call—$142,246.80—and PWA‘s—$15,805.20—after PWA refused to
participate. On August 14, 2014, CFT notified PWA that CFT had funded the entire
Second Capital Call. CFT also purported to convert its contributions under both Capital
Calls into Deficit Loans under Section 4.4 of the Operating Agreement and deemed PWA
a Forfeiting Member.
11. Katz attempts to sell the Property
Since DRS‘s removal as the Property Manager, Katz twice has attempted to secure
proposed buyers for the Property. The first was ELKCO Properties, Inc. (―ELKCO‖),
which Katz identified in connection with his effort to exercise the Buy-Sell provision of
the Operating Agreement69 on July 9, 2014. ELKCO made an offer of $10,655,402,
which was structured to avoid a pre-payment penalty under the Mortgage. A sale at that
price would have resulted in CFT receiving $2,271,950 and PWA $252,439.
ELKCO then asked Caiola to provide a good faith price for the purchase of CFT‘s
interest. Caiola submitted a price based on a valuation of the Property at $12,933,720.
This would have netted CFT $4,325,486, but nothing to PWA unless ELKCO accepted
CFT‘s counter and agreed to pay PWA a proportionate amount. ELKCO then made a
69
Operating Agreement § 15.1.
27
further offer of $11,200,000, which would have netted CFT $2,797,066 and PWA
$310,785. Caiola neither accepted nor countered this offer.
After the ELKCO deal fell through, Katz continued to market the Property. In
May 2015, the Mandel Group (―Mandel‖) issued a Letter of Intent offering to purchase
the Property for $13,500,000, free and clear of the Mortgage. After accounting for an
estimated $600,000 Mortgage prepayment penalty, the sale would have netted CFT
$4,419,482 and PWA $481,615. Plaintiffs rejected Mandel‘s offer.
C. Procedural History
This case has an extensive and relatively complex procedural history. Plaintiffs
filed their original complaint against PWA on November 13, 2012. The action then was
removed to the United States District Court for the District of Delaware and then later
remanded back to this Court in July 2013. I entered a status quo order on August 28,
2013 to keep PWA in place as the Managing Member and to prevent the consummation
of a sale of the Property.
In November 2013, both sides moved for summary judgment on the proper
interpretation of Section 8.4 of the Operating Agreement. Plaintiffs interpreted that
section as authorizing them to call for and execute a vote of the Non-Managing Members
for the purpose of removing DRS as the Property Manager. I held argument on those
cross-motions, as well as Plaintiffs‘ motion to amend their Complaint to add Katz as a
Defendant, on January 10, 2014. At argument, I granted Plaintiffs‘ motion to amend. By
Memorandum Opinion dated April 30, 2014, I granted summary judgment in favor of
Defendants‘ interpretation of Section 8.4, finding that it unambiguously does not provide
28
the Non-Managing Members with the affirmative power to mandate significant actions
by the Company. Instead, that Section gives the Non-Managing Members a negative
right to veto such actions under certain circumstances.70 Plaintiffs filed an amended
complaint on January 13, 2014 (the ―Complaint‖) adding, among other things, Katz as a
Defendant.
I presided over a trial of this matter from February 17 to February 19, 2015. The
parties filed their post-trial briefs in May and June 2015. On August 4, 2015, after
Defendants had taken preliminary steps toward another sale of the Property, Plaintiffs
moved to enforce the status quo order and for a temporary restraining order or a
preliminary injunction blocking the sale and filed a motion to expedite proceedings. I
heard argument on those motions on August 28, 2015 and issued an oral ruling denying
them in part and granting them in part. In summary, that ruling: (1) effectively granted
Plaintiffs‘ motion to expedite; (2) denied the motion to enforce the status quo order and
for a temporary restraining order or a preliminary injunction as they related to the
preliminary actions Defendants had taken to prepare for the possible sale of the Property;
and (3) granted that motion as to Plaintiffs‘ request for a stay of the thirty-day period
during which Plaintiffs have the option to purchase Defendants‘ membership interest, but
only to the extent that Plaintiffs shall have fifteen days from the date of my post-trial
opinion to exercise that option.
70
See 2009 Caiola Family Trust v. PWA, LLC, 2014 WL 1813174 (Del. Ch. Apr. 30,
2014).
29
This Memorandum Opinion reflects my post-trial findings of fact and conclusions
of law in this matter.
D. Parties’ Contentions
Four main issues were raised at trial: (1) whether Plaintiffs may remove PWA as
the Managing Member under the Operating Agreement; (2) whether the alleged breaches
of the Operating Agreement that Plaintiffs argue warrant PWA‘s removal based upon its
breaches of the Operating Agreement also establish a basis to award DPW money
damages against PWA; (3) whether those same facts also show a breach of Katz‘s
fiduciary duties owed to DPW and, if so, whether DPW is entitled to money damages
against Katz as well; and (4) whether either party is entitled to attorneys‘ fees from the
other party.71
Plaintiffs contend that the first three issues should be resolved in their favor on
two main bases. First, Defendants committed a number of acts that constitute either an
Egregious Act or an Impermissible Act, as defined in the Operating Agreement. In either
case, such Acts constitute grounds on which Plaintiffs can remove PWA as the Managing
Member and DPW can obtain damages from Defendants. Second, PWA improperly
71
In pursuing their allegations, Plaintiffs rely on two sections of the Delaware
Limited Liability Company Act. The first, Section 18-110, authorizes a member
of an LLC to test the validity of a purported removal of the LLC‘s manager,
among other things. See 6 Del. C. § 18-110. The second, Section 18-111,
authorizes a member of an LLC to have the Court of Chancery interpret, apply, or
enforce provisions of the LLC‘s operating agreement on the LLC‘s behalf. See 6
Del. C. § 18-111.
30
failed to participate in the First and Second Capital Calls, creating additional grounds for
its removal as the Managing Member.
Defendants assert, however, that each of Plaintiffs‘ claims is fatally flawed
because Plaintiffs either have failed to prove them at trial or they are barred by laches. In
addition, Defendants contend that the Complaint fails to plead a number of the bases
under which Plaintiffs argued at trial that they were entitled to relief. Defendants
therefore seek to preclude Plaintiffs from pursuing these claims because they failed to
provide adequate notice.
Regarding the fourth issue, attorneys‘ fees, the Operating Agreement provides for
fee-shifting in favor of the prevailing party in any action over its provisions. Because
both Plaintiffs and Defendants urge me to find in their favor, they both also contend that
they are entitled to recover their attorneys‘ fees.
II. ANALYSIS
A. Legal Standard
―Plaintiffs have the burden of proving each element, including damages, of each of
their causes of action against each Defendant by a preponderance of the evidence.‖72
―Proof by a preponderance of the evidence means proof that something is more likely
than not. It means that certain evidence, when compared to the evidence opposed to it,
has the more convincing force and makes you believe that something is more likely true
72
OptimisCorp v. Waite, 2015 WL 5147038, at *55 (Del. Ch. Aug. 26, 2015).
31
than not.‖73 ―By implication, the preponderance of the evidence standard also means that
if the evidence is in equipoise, Plaintiffs lose.‖74
B. Should PWA Be Removed as the Managing Member of the Company?
Plaintiffs advance a number of grounds on which they assert that PWA should be
removed as the Managing Member of DPW. I sort those various grounds into two
categories and analyze each category separately. First, I group together all of Plaintiffs‘
contentions that PWA engaged in conduct that constitutes an Egregious or Impermissible
Act under Section 6.4 of the Operating Agreement. Then, I analyze Plaintiffs‘ argument
that PWA improperly failed to participate in the First and Second Capital Calls and, as a
result, became a Forfeiting Partner under Sections 4.3 and 4.4 of the Operating
Agreement.
1. Egregious and Impermissible Acts under the Operating Agreement
Under Section 6.4(a) of the Operating Agreement, ―the Managing Member may be
removed at any time for ‗Cause‘ by a Majority Vote of the Non-Managing Members.‖75
As the 90% Non-Managing Member, therefore, CFT may remove PWA as the Managing
Member at any time, provided it has Cause. ―Cause‖ includes any ―Egregious Act‖ or
―Impermissible Act.‖ An Egregious Act is defined as:
73
Agilent Techs., Inc. v. Kirkland, 2010 WL 610725, at *13 (Del. Ch. Feb. 18,
2010) (quoting Del. Express Shuttle, Inc. v. Older, 2002 WL 31458243, at *17
(Del. Ch. Oct. 23, 2002)).
74
OptimisCorp, 2015 WL 5147038, at *55.
75
Operating Agreement § 6.4(a).
32
[A]ny of the following committed by the Managing Member
or any of its Affiliates in connection with the Company or the
[Property]: (i) Willful misconduct; (ii) The breach of any
fiduciary duty; (iii) Self-dealing . . . ; (iv) Fraud; (v)
Intentional misappropriation of Company funds or other
Company property; or (vi) Gross negligence.76
According to Plaintiffs, Defendants breached their fiduciary duties, thereby committing
an Egregious Act, by making improper distributions to the Members and improper
payments of Asset Management Fees to NDC Capital.
In addition, the Operating Agreement defines an Impermissible Act, in relevant
part, as:
[A]ny of the following: (i) . . . any transfer of any interest in
the Managing Member or any of its Affiliates that is not
permitted by this Agreement and is in contravention of the
Loan Documents . . . ; (ii) A material breach of [the
Operating] Agreement, the Management Agreement
(provided the Property Manager is an Affiliate of the
Managing Member) or any agreement between the Company
and the Managing Member or any of its Affiliates by the
Managing Member or any of its Affiliates; . . . (iv) Upon the
occurrence of any default or event of default under any of the
Loan Documents resulting from any action or inaction of the
Managing Member or any of its Affiliates . . . ; (v) To the
extent that the Loan Documents relating to the First Mortgage
Loan contain provisions limiting the recourse to the property
securing the First Mortgage Loan, the actions or inactions of
the Managing Member or an Affiliate that give rise to the
personal liability of the Company or any guarantor or
indemnitor under such Loan Documents or result in the
invalidation of such provisions in the Loan Documents
limiting the recourse under such Loan Documents to such
property; (vii) If none of the Key Persons is actively involved
in the operation of the Managing Member‘s business . . . ;
76
Id. § 6.4(c).
33
(viii) If none of the Key Persons is actively involved in the
operation of the Property Manager‘s business . . . .77
Plaintiffs assert that Defendants breached the provisions of Section 6.4(d) and
committed an Impermissible Act in at least eight different ways. The first two are: (1)
under Sections 6.4(d)(i), (iv), and (v), Katz transferred his interest in PWA in violation of
the Operating Agreement and the Loan Documents; and (2) under Sections 6.4(d)(vii)
and (viii), Ward and Peter Katz, who are included in the definition of ―Key Persons,‖ are
no longer actively involved in the operation of PWA or Greystar. The third through
eighth Impermissible Acts arise under Section 6.4(d)(ii) and allegedly involve material
breaches by PWA or its Affiliate DRS of the Operating Agreement, unless otherwise
noted, as follows: (3) PWA abdicated its Managing Member duties; (4) DRS improperly
allocated expenses to DPW in breach of the Management Agreement; (5) PWA caused
DPW to make improper distributions to the Members; (6) PWA improperly paid Asset
Management Fees to NDC Capital; (7) DRS refused to relinquish its role as Property
Manager as requested by Curo Enterprises in breach of the Management Agreement; and
(8) PWA maintained inaccurate and inconsistent financial records.78
77
Id. § 6.4(d).
78
Although Plaintiffs mention Defendants‘ fiduciary duties in general terms in their
briefs, they make no effort to identify the scope of PWA‘s duties, whether default
or contractual, or its alleged breaches thereof. Plaintiffs generally refer to
fiduciary duties more in terms of Defendant Katz. I address that aspect of
Plaintiffs‘ claim in Section II.B.1.d.iv infra.
In the case of PWA, regarding the specific actions that Plaintiffs allege constitute
Impermissible Acts, it appears that Plaintiffs consider those to be contractual
34
I address each of these specific arguments, as well as Defendants‘ responses
thereto, infra. As an initial matter, however, I discuss Defendants‘ contention that
Plaintiffs failed to follow the procedures governing removal of a Managing Member for
Cause in Section 6.4 of the Operating Agreement as to the first, second, third, fourth, and
fifth grounds enumerated above.
a. Plaintiffs’ compliance with procedures required for removal of the Managing
Member
Sections 6.4(a), (e), and (f) of the Operating Agreement govern the procedures
with which the Non-Managing Members must comply to remove the Managing Member
for Cause. Section 6.4(a) states that there must be a majority vote of the Non-Managing
Members.79 Section 6.4(e) requires that ―[w]ritten notice of the Managing Member‘s
removal . . . shall be served upon the Managing Member‖ and that the ―notice shall set
forth the reason(s) for removal‖ and provides for a transition period during which the
removed Managing Member may continue to transact business in the ordinary course as
necessary until the replacement Managing Member takes over.80 Section 6.4(f) gives the
violations of the terms of the Operating Agreement. Even assuming that PWA has
unlimited default fiduciary duties of care and loyalty, Plaintiffs have not shown
how the analysis would be different or pointed to a contractual expansion of
PWA‘s duties beyond the common law fiduciary duties. Therefore, I focus only
on whether PWA breached its affirmative obligations under the Operating
Agreement.
79
Operating Agreement § 6.4(a).
80
Id. § 6.4(e).
35
Managing Member thirty days to commence an action challenging the removal.81
Defendants concede that Plaintiffs followed the voting and notice requirements as to
three of their asserted grounds for removing PWA as the Managing Member,82 but argue
that Plaintiffs failed to comply with Sections 6.4(a), (e), and (f) as to the other five
grounds. Defendants, therefore, contend that Plaintiffs are barred from relying on any of
those five grounds as a basis to remove PWA in this action.
Plaintiffs provided the initial notice of removal to Defendants in a letter dated
November 8, 201283 and then initiated this action on November 13, 2012. Because the
Complaint sought a declaratory judgment as to the validity of Plaintiffs‘ removal of PWA
as the Managing Member, the requirement in Section 6.4(f) that PWA bring an action
within thirty days of receipt of the removal notice was mooted, as its defense of this case
serves as such an action. Similarly, although Plaintiffs raised additional grounds for
PWA‘s removal after delivering the removal notice, I conclude for the reasons stated
81
Id. § 6.4(f).
82
See JX 127 (―[CFT and Cortese voted to] remove[] PWA for ‗Cause‘ under
Sections 6.4(c) and (d) of the Operating Agreement by reason of PWA‘s failure to
carry out and implement the decision duly voted on and approved by [CFT and
Cortese] to replace the existing property manager of the Company, and by reason
of PWA‘s willful misconduct, breaches of the Operating Agreement and breaches
of its fiduciary duties by improperly distributing Company funds to the asset
manager, distributing inaccurate financial and operational reports . . . , and
refusing to replace its affiliate as property manager.‖).
83
Id.
36
below that they were not required to deliver an additional removal notice to Defendants
to pursue those grounds.
Plaintiffs only sought to remove PWA as the Managing Member once. As Section
6.4(f) states, ―[i]f the court in any Action finally determines that the Removal Notice
delivered to the Managing Member was not valid because one of the events constituting
Cause has not occurred, then the Managing Member that was removed shall be reinstated
as the Managing Member under this Agreement.‖84 This appears to contemplate a system
whereby the Managing Member is ―removed‖ upon the receipt of a removal notice and
reinstated only upon the conclusion of the relevant action. Because this action still was
pending when Plaintiffs raised the additional grounds for PWA‘s removal—and, thus,
PWA was still ―removed‖ under the Operating Agreement—requiring a second vote by
the Non-Managing Members and delivery of an additional removal notice simply would
elevate form over substance. And, to the extent the removal notice requirement of
Section 6.4 was intended to protect the Managing Member and preserve its ability to seek
judicial determination of the validity of the Non-Managing Members‘ purported removal,
that purpose is being served by this action. As a result, I consider Plaintiffs‘ additional
grounds for PWA‘s removal essentially to have been added by amendment to the initial
removal notice dated November 8, 2012 and reject Defendants‘ suggestion that they
would have to deliver an additional removal notice including those five grounds to have
them considered.
84
Operating Agreement § 6.4(f).
37
b. Katz’s transfers of his interest in PWA
Plaintiffs argue that Katz‘s transfers of his interest in PWA to the Ward A. Katz
Revocable Trust, the Donna Katz Revocable Trust, and DLKPWA, LLC in 2007 or 2008,
2011, and 2013, respectively, were made without Plaintiffs‘ or NorthMarq‘s consent.
Section 10.4 of the Operating Agreement and Sections 21(e)(iv)(B) and 21(e)(viii) of the
Mortgage appear to prohibit the transfer of an interest in the Managing Member 85 and
provide that such a transfer constitutes an Event of Default under the Mortgage. 86 And,
because Katz‘s transfers allegedly triggered an Event of Default under the Mortgage,
Plaintiffs contend that Section 9(f)(ii) of the Note underlying the Mortgage invalidates
the provisions of the Note that limit NorthMarq‘s recourse to the Property. 87 Thus,
Plaintiffs argue that Defendants committed Impermissible Acts under Sections 6.4(d)(i),
(iv), and (v) of the Operating Agreement and that Cause therefore exists to remove PWA
as the Managing Member.
85
Id. § 10.4(a) (―The Managing Member shall not . . . approve or consent to, or
permit or acquiesce in, any Transfer of any beneficial interest in the Managing
Member other than as permitted by this Agreement.‖).
86
JX 1 [hereinafter Mortgage] §§ 21(e)(iv)(B), 21(e)(viii) (―The occurrence of any
of the following Transfers shall constitute an Event of Default under this
Instrument: . . . (iv) . . . (B) a Transfer of any membership or other interest of a
manager in Borrower that results in a change of manager . . . (viii) a transfer of
any interest in a Controlling Entity which, if such Controlling Entity were
Borrower, would result in an event of Default . . . .‖).
87
JX 4 [hereinafter Note] § 9(f)(ii) (―Borrower shall become personally liable to
Lender for the repayment of all of the Indebtedness upon the occurrence of any of
the following Events of Default: . . . (ii) a Transfer . . . that is an Event of Default
under Section 21 of the [Mortgage] . . . .‖).
38
Defendants admit that Katz has made more than one transfer of his interest in
PWA to entities he controls, but deny that Plaintiffs have demonstrated that these
transfers constitute grounds for PWA‘s removal as the Managing Member. Under
Section 6.4(d)(i), PWA was entitled to thirty days notice that Katz‘s transfers violated the
Operating Agreement and the Mortgage, as well as an opportunity to cure those
violations.88 Such notice was provided to Defendants on February 11, 2015, 89 and
Defendants cured the alleged violation by causing the 10% interest in PWA to be
transferred back to Katz on March 2, 2015. As a result, I find that neither Defendant
committed an Impermissible Act under Section 6.4(d)(i).
Defendants also argue that Sections 6.4(d)(iv) and (v) of the Operating Agreement
were not triggered because Katz‘s transfers constituted ―Preapproved Transfers.‖ Under
Section 21(c)(vii) of the Mortgage, certain transfers constitute Preapproved Transfers, the
execution of which do not constitute an Event of Default under the Mortgage or the
Note.90 Because Preapproved Transfers include ―a sale or transfer to an entity owned and
controlled by the transferor or the transferor‘s immediate family members,‖ and because
the Ward A. Katz Revocable Trust, the Donna Katz Revocable Trust, and DLKPWA,
LLC were all controlled by Katz or his immediate family members, Defendants contend
that Katz‘s transfers did not constitute Events of Default. As Plaintiffs point out,
88
Operating Agreement § 6.4(d)(i).
89
Trans. Aff. of Thomas E. Hanson, Ex. 9.
90
Mortgage § 21(c).
39
however, Exhibit B to the Mortgage modifies that document by deleting Section
21(c)(vii) from it in its entirety.91 Defendants‘ reliance on that provision, therefore, is
unfounded.
Defendants also argue that both Sections 21(e)(iv) and (e)(viii) of the Mortgage
require a transfer that results in a change of DPW‘s or PWA‘s manager for an Event of
Default to occur92 and that none of Katz‘s transfers had that effect. Although Plaintiffs
cannot show definitively that a change of DPW‘s Managing Member occurred, as that is
the subject of this action, they assert that a change in PWA‘s manager occurred, citing to
Section 5.2 of PWA‘s operating agreement. That provision states that ―[Katz] shall serve
as Manager until such time as [Katz] transfers his entire interest in [PWA] or resigns his
position as Manager.‖93 Because Katz initially transferred his interest in PWA in 2007 or
2008, Plaintiffs claim, his tenure as PWA‘s manager ended and an Event of Default
occurred under the Mortgage.
The final sentence of Section 5.2 of PWA‘s operating agreement, however, states
that upon Katz‘s term as manager ending, ―a Majority in Interest shall elect a successor
Manager.‖94 Plaintiffs failed to demonstrate that a different manager succeeded Katz.
Because Katz initially transferred his interest in PWA in 2007 or 2008, Section 5.2 of
91
Id. Ex. B §1.
92
Id. §§ 21(e)(iv)(B), 21(e)(viii).
93
JX 5 § 5.2.
94
Id.
40
PWA‘s operating agreement, if triggered at all, was triggered at that point. The record
indicates, however, that Katz continued acting as PWA‘s manager for years after that,
and Plaintiffs, in arguing that Katz eventually abandoned his position with PWA in 2013,
do not claim differently. Although Katz transferred his interest in PWA, it appears that
he continued to act as its manager and, consequently, that no ―change‖ in DPW‘s or
PWA‘s manager accompanied that transfer. Thus, I conclude that no Event of Default
occurred under the Mortgage or the Note and no Impermissible Act occurred under the
Operating Agreement as a result of Katz‘s transfers of his interest in PWA.
c. Ward and Peter Katz’s participation in PWA and Greystar’s businesses
Sections 6.4(d)(vii) and (viii) of the Operating Agreement state that the failures of
the Key Persons to be ―actively involved in the operation of the Managing Member‘s
business‖ or ―the Property Manager‘s business,‖ respectively, constitute Impermissible
Acts.95 ―Key Persons‖ is defined to include only Ward and Peter Katz.96 Plaintiffs claim
that Ward and Peter Katz were not actively involved in the operation of either PWA or
Greystar, after October 1, 2013. As to Peter Katz, Defendants conceded at trial that he
has not been involved with the Property at all since 2007. 97 Thus, the crux of this dispute
centers on Ward Katz‘s involvement in the operations of PWA and Greystar during the
relevant period.
95
Operating Agreement §§ 6.4(d)(vii), 6.4(d)(viii).
96
Id. Ex. B.
97
Tr. 513-14 (Katz).
41
i. Katz’s involvement in the Property Manager’s business
Regarding Katz‘s involvement in the business of the Property Manager, the parties
agree that he was actively involved in DRS‘s business when it served as the Property
Manager. Accepting that as true, however, does not preclude the possibility of an
Impermissible Act under the Operating Agreement. Although ―[t]he Managing Member
or an Affiliate thereof‖—i.e., DRS—is defined initially as the ―Property Manager,‖98 the
expanded definition also includes ―any other property manager approved pursuant to the
provisions of [the Operating Agreement],‖99 which would encompass Greystar.
Plaintiffs claim that when Greystar replaced DRS as the Property Manager on
October 1, 2013, Katz ceased his active involvement in the operation of the Property
Manager‘s business. To support this argument, Plaintiffs point to Katz‘s admission at
trial that he has ―not done anything to oversee Greystar.‖100 Defendants counter by
arguing that Katz‘s and Hutchens‘s testimony that they met together two or three times to
discuss the Rehab Program and once took a walk through the Property rebuts Plaintiffs‘
argument. Defendants also highlight the interactions between Greystar and other DRS
staff members as evidence of Katz‘s continued active involvement as a Key Person in the
Property Manager‘s business.
98
Operating Agreement § 8.3(e).
99
Id. Ex. B.
100
Tr. 502.
42
Although the record indicates that Katz had some involvement with Greystar, the
question is whether he was ―actively involved in the operation of [Greystar‘s] business.‖
The difficulty in answering this question lies in determining what level of involvement
constitutes ―active‖ involvement. The Operating Agreement does not define the term
―actively involved.‖ The Preamble to Greystar‘s management agreement with the
Company describes Greystar‘s duties as to ―manage, operate, maintain and service the
[Property], and supervise the leasing and renting operations of the same . . . .‖ 101 Thus,
active involvement includes, at a minimum, some participation in, or conscious oversight
of, these day-to-day operational activities. Based on the record presented at trial, I
conclude that Plaintiffs have proven by a preponderance of the evidence that Katz has not
been actively involved in the operation of the Property Manager‘s business since Greystar
supplanted DRS in October 2013.
Defendants failed to cite any persuasive evidence that indicates that Katz was
involved in Greystar‘s management, operation, maintenance, or servicing of the Property,
or that he was involved in supervising the Property‘s leasing and renting operations.
Katz‘s admission that he has not done anything to oversee Greystar is damning, and the
few visits he had with Hutchens do not constitute active involvement. Even if Katz and
Hutchens discussed the status of the Rehab Program and took a tour of the Property,
Katz‘s visits with Hutchens appear to have been more in the nature of a Member
checking in on his investment than active involvement in the Property Manager‘s
101
JX 182 Preamble.
43
operations. This conclusion is bolstered by Hutchens‘s testimony that Katz ―appeared to
have an investor or someone that wanted to see the community‖ with him. 102 And,
although two of DRS‘s employees may have communicated with Hutchens on a more
regular basis regarding operational issues at the Property, the Operating Agreement
requires that either Ward or Peter Katz—i.e., one of the ―Key Persons‖—be actively
involved in the Property Manager‘s business, not DRS or its employees.
Defendants also contend that the prevention doctrine103 precludes a finding that
Katz failed to satisfy the Key Person-involvement requirement. Defendants fail to point
to any evidence, however, that indicates Plaintiffs prevented Katz from being actively
involved in the operation of Greystar‘s business. While Defendants emphasize Plaintiffs‘
efforts to remove DRS as the Property Manager and PWA as the Managing Member,
none of their arguments address Katz‘s involvement with Greystar, which appears to be
an independent, third-party property management company. Thus, as a result of Katz‘s
failure to be actively involved in the operation of Greystar‘s business, I find that an
Impermissible Act has occurred under Section 6.4(d)(viii) of the Operating Agreement.
102
Hutchens Dep. 95.
103
See, e.g., T.B. Cartmell Paint & Glass Co. v. Cartmell, 186 A. 897, 903 (Del.
Super. 1936) (―It is a sound principle that he who prevents a thing being done shall
not avail himself of the non-performance he has occasioned.‖); W & G Seaford
Assocs., L.P. v. E. Shore Markets, Inc., 714 F. Supp. 1336, 1341 (D. Del. 1989)
(―Delaware courts follow the principle that a party who wrongfully prevents a
thing from being done cannot avail itself of the nonperformance it has
occasioned.‖).
44
Plaintiff CFT, therefore, as the Non-Managing Member, did have Cause to remove PWA
as the Managing Member.
ii. Katz’s involvement in the Managing Member’s business
Regarding Katz‘s involvement in PWA‘s business, Plaintiffs point to evidence that
they contend indicates Katz ceased his active involvement with PWA upon DRS‘s
removal as Property Manager. Specifically, they direct my attention to October 2013
emails from PWA‘s non-managing member stating that Katz ―is out of the picture‖ and
―resign[ed] from all activities at PWA.‖104 Notably, however, Plaintiffs have not adduced
any evidence of actions taken by PWA without Katz‘s involvement. In fact, Katz
credibly testified that he has ―continue[d] to act as the [M]anaging [M]ember of
PWA,‖105 and Defendants have pointed to his attempts to sell the Property as evidence
thereof.
Katz‘s involvement with the Company and its day-to-day operations decreased
when Greystar replaced DRS. But, that is to be expected, given the fact that Katz owned
and managed DRS and therefore was the lead employee of the Property Manager while
DRS held that post. The responsibilities of the Property Manager and the Managing
Member, however, are separate and distinct from one another. Although I concluded
above that Katz has not remained actively involved in the operation of the Property
104
JX 184.
105
Tr. 472.
45
Manager‘s business, whether he remained actively involved in PWA’s business is a
separate inquiry.
On this issue, I agree with Defendants and conclude that Plaintiffs have failed to
prove by a preponderance of the evidence that Katz has not remained actively involved in
the operation of the Managing Member, PWA‘s, business. PWA‘s sole business is the
management of DPW.106 In attempting to market the Property under the Buy-Sell
Provisions in the Operating Agreement,107 Katz was acting as the purported Managing
Member of the Company. And, although Plaintiffs contend that Katz resigned from
PWA in October 2013,108 they challenged his authority in July 2014 to attempt to market
the Property under the Buy-Sell Provisions because they no longer recognize PWA as the
Managing Member.109 As a result, Plaintiffs implicitly have admitted that, in his capacity
as PWA‘s managing member, Katz was attempting, in or around July 2014, to utilize the
powers allocated to the Managing Member in the Operating Agreement.
106
Operating Agreement § 3.1.
107
Id. Art. 15.
108
The evidence Plaintiffs rely on for this proposition consists of the emails from
PWA‘s non-managing member described above. See supra note 104 and
accompanying text. Having considered all of the relevant evidence, I credit
Plaintiffs‘ evidence to the extent that it suggests that Katz reduced his time
commitment to PWA in or around October 2013, but I do not find persuasive the
suggestion that Katz resigned from or had no further involvement with PWA.
109
JX 245 (―[P]laintiffs dispute that PWA even has the right to issue a marketing
notice under Section 15.1, because PWA is no longer the [M]anaging [M]ember of
[DPW].‖).
46
Plaintiffs attempt to refute Defendants‘ argument by recasting Katz‘s marketing
efforts as activities of the ―Offering Group‖ under Section 15.1 of the Operating
Agreement rather than the Managing Member under Section 8.1. This contention cannot
be squared with the terms of the Operating Agreement. Under Section 15.1, the Offering
Group is defined as either the Managing Member or the NDC Investors. 110 Plaintiffs
admit that any reference in the Operating Agreement to the NDC Investors is a reference
to CFT.111 Because the Offering Group can consist of either the Managing Member or
CFT, and Katz obviously was not acting for CFT, he only could have acted on behalf of
PWA as the Managing Member in performing the Offering Group‘s activities under
Section 15.1. As a result, Katz‘s efforts to market the Property entailed active
involvement in the operation of PWA‘s business. Thus, I conclude that Plaintiffs have
not proven that any Impermissible Act occurred under Section 6.4(d)(vii) of the
Operating Agreement.
d. Plaintiffs’ claims that PWA materially breached the Operating Agreement
As I described supra, Plaintiffs assert a number of grounds on which PWA
allegedly committed an Impermissible Act under Section 6.4(d)(ii) of the Operating
Agreement. Preliminarily, I note that in order for a breach of the Operating ―Agreement,
the Management Agreement . . . or any other agreement between the Company and the
110
Operating Agreement § 15.1 (―The Managing Member on one hand or all of the
NDC Investors, based on a Majority Vote of the NDC Investors, on the other hand
(in this regard, the ‗Offering Group‘) . . . .‖).
111
Pls.‘ Opening Br. 7 n.1.
47
Managing Member or any of its affiliates by the Managing Member or any of its
Affiliates‖ to constitute an Impermissible Act, that breach must be material.112 ―A
‗material breach‘ is a failure to do something that is so fundamental to a contract that the
failure to perform that obligation defeats the essential purpose of the contract or makes it
impossible for the other party to perform under the contract.‖113 To be material, the
breach ―must ‗go to the root‘ or ‗essence‘ of the agreement between the parties, or be
‗one which touches the fundamental purpose of the contract and defeats the object of the
parties in entering into the contract.‘‖114 In addition, the Restatement (Second) of
Contracts identifies a number of relevant factors for ―determining whether a failure to
render or to offer performance is material,‖115 including:
(a) [T]he extent to which the injured party will be deprived of
the benefit which he reasonably expected; (b) the extent to
which the injured party can be adequately compensated for
the part of that benefit of which he will be deprived; (c) the
extent to which the party failing to perform or to offer to
perform will suffer forfeiture; (d) the likelihood that the party
failing to perform or to offer to perform will cure his failure,
taking account of all the circumstances including any
reasonable assurances; and (e) the extent to which the
112
Operating Agreement § 6.4(d)(ii).
113
eCommerce Indus., Inc. v. MWA Intelligence, Inc., 2013 WL 5621678, at *13
(Del. Ch. Oct. 4, 2013) (quoting Shore Invs., Inc. v. Bhole, Inc., 2011 WL
5967253, at *5 (Del. Super. Nov. 28, 2011)).
114
Id.115
RESTATEMENT (SECOND) OF CONTRACTS § 241 (1981).
48
behavior of the party failing to perform or to offer to perform
comports with standards of good faith and fair dealing.116
I next analyze each contractual breach alleged by Plaintiffs to determine whether
any such breach is material under the above standard, as is required to constitute an
Impermissible Act under Section 6.4(d)(ii).
i. PWA’s obligations as the Managing Member
Plaintiffs‘ first argument under Section 6.4(d)(ii) is that PWA breached its
obligations under the Operating Agreement by ―totally abdicat[ing] its role as Managing
Member.‖117 PWA‘s responsibilities under the Operating Agreement are set forth in
Section 8.1, which states, in relevant part:
The Managing Member shall devote such care, time and
attention to the affairs of the Company as may be necessary in
order to accomplish the performance standards set forth in an
Annual Business Plan. The Managing Member shall . . .
perform the following duties and obligations on behalf of the
Company: (a) Use all commercially reasonable efforts . . . to
maximize the amounts distributable to the Members . . . , to
preserve and enhance the value of the [Property], and to
protect the interests of the Members in the [Property]; (b) . . .
timely pay all taxes . . . ; (c) . . . timely pay all debts . . . ; (d)
. . . use all reasonable efforts to cause the Company . . . at all
times to perform and comply with, and to enforce the
Company‘s rights pursuant to, the provisions of any loan
commitment . . . ; (e) . . . keep and maintain in full force and
effect . . . insurance coverages . . . ; (h) Notify the Non-
Managing Members promptly upon the receipt of any offer
from a third party to purchase the [Property] . . . ; (j) Deliver
to the Non-Managing Members all reports required pursuant
116
Id.; eCommerce Indus., Inc., 2013 WL 5621678, at *13; Preferred Inv. Servs., Inc.
v. T&H Bail Bonds, Inc., 2013 WL 3934992, at *11 (Del. Ch. July 24, 2013).
117
Pls.‘ Opening Br. 38.
49
to [the Operating Agreement]; and (k) Make
recommendations on sales and refinancings.118
According to Plaintiffs, PWA stopped performing its Managing Member duties
under Section 8.1 in October 2013, when Greystar replaced DRS as the Property
Manager. In support of their position, Plaintiffs rely on several allegations. First,
regarding Sections 8.1(a) and (d), Plaintiffs assert that PWA has not interfaced with
NorthMarq to ensure that all the repairs NorthMarq requested were made. Second,
regarding Sections 8.1(c) and (e), Plaintiffs argue that PWA has not made DPW‘s
mortgage payments or overseen the maintenance of the Property‘s insurance. 119 Third,
regarding Section 8.1(b), Plaintiffs contend that Katz and PWA failed to sign DPW‘s
2013 tax return and cause it to be filed. Plaintiffs further aver that CPW, through Cox,
has acted as the de facto Managing Member since October 2013, without any objection
from PWA, by: (1) handling all communications with NorthMarq; (2) preparing and
distributing all financial statements; (3) dealing with insurance claims and other coverage
issues; and (4) signing DPW‘s 2013 tax return and causing it to be filed.120
Defendants respond by disputing Plaintiffs‘ claim that PWA abdicated its
Managing Member duties. Specifically, Defendants argue that PWA satisfied its duty
under Section 8.1(b) by causing DPW‘s accountant, Gottlieb, to prepare the Company‘s
tax returns despite Curo Enterprises‘s and CPW‘s attempts to file them. In addition,
118
Operating Agreement § 8.1.
119
Katz Dep. 117.
120
Tr. 119-20 (Caiola); Tr. 309, 316 (Cox).
50
Defendants highlight Katz‘s efforts, on PWA‘s behalf, to market and sell the Property
and argue that such actions constitute compliance with the Managing Member‘s
responsibilities under Sections 8.1(a), (h), and (k). Finally, Defendants contend that
PWA satisfied its Managing Member obligations by opposing Plaintiffs‘ Capital Calls
because they allegedly failed to meet the requirements for a capital call under the
Operating Agreement and ―involved the depletion of the Company‘s operating funds
through the formation of a separate account for security deposits.‖121
Even assuming that I found PWA breached its obligations under Section 8.1 of the
Operating Agreement, Plaintiffs have not proven that such breaches were material.
PWA‘s failure to perform certain actions arguably required by Section 8.1 did not defeat
the ―essential purpose of the [Operating Agreement] or make[] it impossible for
[Plaintiffs] to perform.‖122 This is largely due to the fact that, based on the record,
Greystar and CPW appear willingly to have assumed, during this period of uncertainty as
to the proper Managing Member, many of the responsibilities otherwise allocated to
PWA in the Operating Agreement.123
The record does not show that PWA simply stopped performing and that, had
Greystar and CPW not intervened, the activities described in Section 8.1 would have
been neglected. The Court also cannot ignore the context in which these alleged breaches
121
Defs.‘ Answering Br. 35.
122
eCommerce Indus., Inc., 2013 WL 5621678, at *13.
123
Tr. 487-88 (Katz).
51
occurred: the parties and their agents, including PWA and CPW, were and are in a
dispute over which of those entities is the Managing Member of DPW. Greystar
presumably is attempting to perform its obligations as the Property Manager, but
otherwise remain neutral, although it was selected by Plaintiffs or their affiliates, who
brought about the resignation of the previous Property Manager, DRS. In this context, I
find that the division of labor between PWA, Greystar, and CPW evolved organically and
fairly logically, with Greystar and CPW managing more of the day-to-day issues at the
Property and PWA taking a higher level approach, including attempting to consummate a
sale of the Property.124 Plaintiffs, therefore, were not ―deprived of the benefit which
[they] reasonably expected,‖125 as the actions required under Section 8.1 were completed
with PWA‘s assistance. Thus, Plaintiffs have failed to prove that PWA materially
breached the Operating Agreement by abdicating its Managing Member duties.
ii. DRS’s reimbursements from DPW
Plaintiffs‘ second argument under Section 6.4(d)(ii) is that DRS, as an Affiliate of
PWA, breached the Management Agreement by improperly allocating its expenses to
DPW. DRS and PWA are Affiliates, as that term is defined in the Operating Agreement,
124
Id. (―[M]ost of the activity at PWA was really executed by DRS, in terms of
managing the property, reporting, and so forth. So now that . . . Greystar is
fulfilling those responsibilities, we're conducting the other business of the
managing member, which includes, for example, assuring that the annual tax
return for the venture is completed, filed.‖); see also supra Section I.B.11.
125
RESTATEMENT (SECOND) OF CONTRACTS § 241 (1981).
52
because both were ―Controlled‖ by Katz.126 And, as stated in Section 6.4(d)(ii),
Impermissible Acts consist not only of PWA‘s material breaches of the Operating
Agreement, but also PWA‘s Affiliates‘ material breaches of any agreement with the
Company, including the Management Agreement.127
The Management Agreement specifies the reimbursements and compensation to
which the Property Manager is entitled. Under Section 5, DPW is obligated to pay the
Property Manager a management fee of 4% of the Operating Income collected monthly
and the Property Manager is entitled to reimbursement of any Operating Expense that is
―directly associated with the [Property].‖128 Furthermore, Sections 4 and 5 both state that
the Property Manager‘s general overhead and administrative expenses are not to be
charged to the Company because the 4% management fee is meant to cover them.
According to Plaintiffs, DRS arbitrarily allocated $88,724 in expenses to DPW
during the period from 2007 to 2013 that were not associated directly with the
Property.129 Plaintiffs argue, in reliance on their expert‘s report, that those expenses
constituted non-reimbursable overhead and administrative expenses for which DPW
should not have been charged. As Defendants point out, however, the $88,724 identified
126
Operating Agreement Ex. B (―‗Affiliate‘ means, when used with reference to a
specified Person . . . any person who . . . is under common Control with the
specified Person . . . .‖).
127
Id. § 6.4(d)(ii).
128
Management Agreement §§ 2(f), 5(a)(2).
129
JX 280 at 33-34. The total amount of uncontested payments from DPW to DRS
during that period was $1,857,042. Id. at 32.
53
by Plaintiffs‘ expert appears to include some expenses that are reimbursable under the
Management Agreement, including ―Advertising Materials,‖ ―Computer[s],‖ ―Property
Software,‖ and ―Employee Expense Reimbursements.‖130 This raises doubt as to what
portion, if any, of the $88,724 in disputed reimbursements over a seven-year period
actually violated the Management Agreement. I conclude, therefore, that Plaintiffs have
failed to prove that DRS materially breached the Management Agreement by
misallocating general overhead and administrative expenses to the Company.
iii. DPW’s distributions to the Members
Plaintiffs‘ third argument under Section 6.4(d)(ii) is that PWA breached the
Operating Agreement and that both PWA and Katz breached their fiduciary duties by
making distributions of capital to the Members in 2007 and 2008. Although Plaintiffs do
not raise the issue in their briefs, if such behavior constitutes a breach of fiduciary duty
by either PWA or Katz, as an Affiliate of PWA, then that would amount to an Egregious
Act under Section 6.4(c)(ii), providing Cause for the Non-Managing Member to remove
PWA as the Managing Member.
Plaintiffs‘ argument hinges on their interpretation of the Operating Agreement as
prohibiting the Managing Member, PWA, from making distributions of capital to the
Members in the circumstances that it did. Section 5.2 of the Operating Agreement (the
―Waterfall Provision‖) governs DPW‘s distributions to the Members. According to
Plaintiffs, the Waterfall Provision requires that Members receive a ―Preferred Return I‖
130
Compare Management Agreement §§ 2(f), 5(a)(2), with JX 280 Ex. 6A.
54
on their capital before they receive a return of their capital.131 And, because ―Preferred
Return I‖ is defined to ―include only a return on, and not a return of, capital,‖132 Plaintiffs
contend that the Operating Agreement prohibits a distribution of capital before a
distribution of Preferred Return I.
Before venturing too deeply into the substance of Plaintiffs‘ argument, I note that
Defendants raised a laches defense regarding the challenged distributions. Because it is
an affirmative defense, Defendants bear the burdens of proof and persuasion on the issue
of laches.133 ―Laches is an affirmative defense that the plaintiff unreasonably delayed in
bringing suit after the plaintiff knew of an infringement of his rights, thereby resulting in
material prejudice to the defendant.‖134 In applying the doctrine of laches, ―[a]bsent
some unusual circumstances, a court of equity will deny a plaintiff relief when suit is
131
See Operating Agreement §§ 5.2(c)-(d) (―Net Cash Flow from Operations and Net
Capital Event Proceeds shall be applied and distributed . . . in the following order
of priority: . . . (c) To the Members in proportion to their Percentage Interests until
such time as each of the Members has received aggregate distributions under this
subsection (c) equal to the amount of the Preferred Return I; (d) To the Members
in proportion to their Additional Capital Contribution Accounts, until the
aggregate amount received by each Member under this subsection (d) equals the
total Additional Capital Contributions made by such Member . . . .‖).
132
Id. Ex. B.
133
See Ct. Ch. R. 8(c); Penn Mart Supermarkets, Inc. v. New Castle Shopping
LLC, 2005 WL 3502054, at *5 n.40 (Del. Ch. Dec. 15, 2005) (citing Warwick
Park Owners Ass'n, Inc. v. Sahutsky, 2005 WL 2335485, at *4 (Del. Ch. Sept. 20,
2005)).
134
U.S. Cellular Inv. Co. v. Bell Atl. Mobile Sys., Inc., 677 A.2d 497, 502 (Del. 1996)
(citations omitted).
55
brought after the analogous statutory period.‖135 In this case, Plaintiffs have brought
breach of contract and breach of fiduciary duty claims. The analogous statutory period
for those claims is three years.136 ―[T]he general law in Delaware is that the statute of
limitations begins to run, i.e., the cause of action accrues, at the time of the alleged
wrongful act, even if the plaintiff is ignorant of the cause of action.‖137 In other words,
―the limitations period begins to run when the plaintiff is objectively aware of the facts
giving rise to the wrong, i.e., on inquiry notice.‖138
Plaintiffs sued on November 13, 2012. As a result, only claims based on
Defendants‘ alleged breaches that occurred before November 13, 2009 arguably would be
subject to the laches defense. DPW‘s distributions of capital to the Members fall into that
category, as they occurred in 2007 and 2008. ―Absent some unusual circumstances,‖139
therefore, the claims presumably are barred. Plaintiffs argue, however, that such unusual
circumstances do exist in this case and aver that the doctrine of equitable tolling should
135
Id.136
See, e.g., 10 Del. C. § 8106(a); Charney v. Am. Apparel, Inc., 2015 WL 5313769,
at *11 (Del. Ch. Oct. 5, 2015); Smith v. Mattia, 2010 WL 412030, at *3 (Del. Ch.
Feb. 1, 2010).
137
In re Dean Witter P’ship Litig., 1998 WL 442456, at *4 (Del. Ch. July 17, 1998),
aff’d, 725 A.2d 441 (Del. 1999).
138
Id. at *6 (emphasis in original); see also SmithKline Beecham Pharm. Co. v.
Merck & Co., 766 A.2d 442, 450 (Del. 2000).
139
U.S. Cellular Inv. Co., 677 A.2d at 502.
56
apply to ―stop[] the statute from running while [Plaintiffs] reasonably relied upon the
competence and good faith of a fiduciary.‖140
Plaintiffs deny that their claims regarding the distributions are time-barred and
accuse Defendants of having mischaracterized those distributions as ―returns on equity,‖
―dividends,‖ ―annualized returns,‖ and distributions from ―cash flow.‖ Further, Plaintiffs
assert that it was not obvious from DPW‘s financial statements that there were no profits
or cash flows to support the distributions and that they were misled as to the true nature
of the distributions. Rather, Plaintiffs claim they had no reason to suspect wrongdoing by
Defendants and were not on inquiry notice as to the existence of the claims they now
assert until after November 2009.
I disagree with Plaintiffs and conclude that they were, in fact, on inquiry notice as
to the nature of the distributions by the end of 2008, if not earlier. In so concluding, I
rely on the fact that each of the Investment Updates distributed during the five quarters in
2007 and 2008 in which the distributions were made, beginning in March 2007 and
ending in March 2008, plainly disclosed the amount of Net Income earned by the
Company and the amount of the quarterly Distribution to Partners on the first page.141 In
addition, with the exception of March 2007, each of those Investment Updates described
the Net Income as ―Total Net Income Available for Distribution‖ and also included a line
140
Forsythe v. ESC Fund Mgmt. Co., 2007 WL 2982247, at *15 (Del. Ch. Oct. 9,
2007) (citation omitted).
141
JX 21-28, 30-31, 36-37, 39.
57
item for ―Addition/(Subtraction) to Working Capital,‖ which was calculated by
subtracting the amount of the distribution from the amount of Net Income.
The Addition/(Subtraction) to Working Capital was negative on every one of those
Investment Updates because the distributions exceeded Net Income, which at least
suggested that they were being funded by the Members‘ capital. In addition, Plaintiffs
admitted that they received and read the monthly Investment Updates during 2007 and
2008.142 Thus, I find that Plaintiffs were on inquiry notice as to the true nature of the
distributions. As this Court stated in Dean Witter, ―[i]t is not too much to ask investors to
read beyond the first page of an annual report, to read past the rosy forecasts and actually
look at the cold, hard figures provided to them.‖143 ―Inquiry notice does not require
actual discovery of the reason for the injury. . . . Rather, the statute of limitations begins
to run when plaintiffs should have discovered [the facts giving rise to their claims].‖144 In
this case, Plaintiffs only needed to look at the first page of the Investment Updates to
either detect the true nature of the distributions or realize that the results were
142
Tr. 192 (Caiola).
143
1998 WL 442456, at *8. The facts of Dean Witter are eerily similar to those here.
In that case, the plaintiffs argued that they were misled as to the fact that a
distribution from a partnership was a return of capital rather than a return on
investment because, in the annual report, the distribution was characterized as ―an
annualized return on investment of 7.5%.‖ Id. But, the court pointed out that the
same annual report contained ―a chart showing clearly that the partners‘ capital
had declined from the previous year. . . . [T]he fact that the distributions are
consistently greater than the Partnership income should have alerted plaintiffs to
the fact that something was amiss.‖ Id. (emphasis in original).
144
Id. at *7 (emphasis in original).
58
questionable and deserved further inquiry. As a result, I conclude that the doctrine of
equitable tolling does not apply here and that Plaintiffs‘ claims as to DPW‘s distributions
to the Members in 2007 and 2008 are barred by laches.
iv. PWA’s payment of Asset Management Fees to NDC Capital
Plaintiffs‘ fourth argument under Section 6.4(d)(ii) is that PWA breached the
Operating Agreement by improperly causing DPW to pay Asset Management Fees to
NDC Capital. Plaintiffs also argue that Katz breached his fiduciary duties in this regard,
which, as I noted supra, would constitute an Egregious Act under Section 6.4(c)(ii).
Section 8.3(c) of the Operating Agreement governs the payment of the Asset
Management Fees. Under that Section, the Asset Management Fee ―of one-quarter
percent (.25%) of the Project Purchase Price shall be paid annually by the Company . . .
to NDC Capital Partners. The Asset Management fee shall be due and payable in equal
quarterly installments . . . .‖145 Because the Project Purchase Price is defined as the total
amount DPW paid for the Property, or $10,500,000,146 the amount of the quarterly
payments due to NDC Capital was $6,563. PWA made these payments every quarter
from the Company‘s inception in 2006 until Curo Enterprises replaced NDC Capital as
the Asset Manager in July 2012.147
145
Operating Agreement § 8.3(c).
146
Id. § 2.8.
147
As noted in Section I.B.7.b supra, PWA tendered the same quarterly Asset
Management Fees to Curo Enterprises when it replaced NDC Capital as the Asset
Manager, but Curo Enterprises refused to accept the payment.
59
Section 8.3(c), however, limits the payment of Asset Management Fees ―to the
extent of available Net Cash Flow from Operations and Net Capital Event Proceeds, after
payment of all outstanding third party debts and liabilities of the Company then due and
payable, in accordance with . . . the priorities established in‖ the Waterfall Provision.148
According to Plaintiffs, NDC Capital should not have been paid an Asset Management
Fee in any quarter because DPW‘s cash flow, as calculated by Plaintiffs‘ expert witness,
was negative in each quarter. Plaintiffs claim that Defendants knew that there was
insufficient cash to pay the Asset Management Fee, but that Katz decided to pay it
anyway because he wanted to benefit his relationship with NDC Capital149 and
concluded, without any documentary support, that the fees were payable. Plaintiffs
challenge a total of $146,755 in payments to NDC Capital. Based on those payments,
Plaintiffs argue that PWA diverted funds from the Company that were otherwise
necessary to complete the Rehab Program and to make repairs to the Property, including
those requested by NorthMarq in late 2012.
(a) Asset Management Fees subject to Defendants’ laches defense
Because the payment of the Asset Management Fees extended from 2006 until
2012, Defendants argue that Plaintiffs‘ claims are barred, at least partially, by laches.
But, because Plaintiffs brought their suit on November 13, 2012, only the Asset
148
Id. § 8.3(c).
149
As detailed supra, Katz‘s business relationship with NDC Capital extended
beyond DPW, as they invested in another property together and DRS managed
other properties for NDC Capital.
60
Management Fees paid up until November 13, 2009 are potentially subject to the laches
defense.150 This includes all of the fees paid in 2007 and 2008151 as well as the first three
quarters in 2009, or $74,562 of the total $146,755 paid to NDC Capital.152
The standard for evaluating a laches defense is set forth supra in the context of my
evaluation of Plaintiffs‘ claims regarding DPW‘s distributions to the Members.153
Determining whether Plaintiffs were on inquiry notice as to the Asset Management Fees,
however, is not as straightforward as it was for the Member distributions. There, the
Investment Updates conspicuously showed that distributions were being made from
Members‘ capital. Here, the Investment Updates indisputably showed that the Asset
Management Fees were being paid. What is at issue is whether Plaintiffs were on inquiry
notice as to the fact that there may not have been sufficient NCFO to support those fees.
Under Section 8.3(c), each quarterly Asset Management Fee is only payable to the
extent of available NCFO for that quarter.154 The monthly Investment Updates show the
150
See supra notes 133-138 and accompanying text.
151
No Asset Management Fees were paid in 2006, as the Property was not acquired
until November 28, 2006. The Fees paid in 2007 appear to have been increased
slightly to include the period from November 28 until December 31, 2006. See JX
280 Ex. 9.
152
See id.
153
See supra notes 133-138 and accompanying text.
154
Operating Agreement § 8.3(c). Section 8.3(c) also states that Net Capital Event
Proceeds can fund the Asset Management Fees. Net Capital Event Proceeds,
however, are generated by events such as sales of Members‘ interests in the
Company, a sale of the Property, and loan refinancing, none of which occurred
during the relevant period. Id. Ex. B. As a result, only NCFO could have funded
61
Asset Management Fees paid and the Net Cash Flow generated for both that month and
the fiscal year-to-date. A cursory review of the Investment Updates from December
2007, 2008, and 2009155 reveals that the Asset Management Fees exceeded Net Cash
Flow in all three years.156
As both Plaintiffs‘ and Defendants‘ experts agree, however, the Net Cash Flow
displayed on the Investment Updates is not the same as NCFO, as defined in the
Operating Agreement. The Net Cash Flow number reported in the Investment Updates
must be adjusted by, at a minimum, adding back the Asset Management Fees and the
the Asset Management Fees. It is unclear from the text of Section 8.3(c) and the
definition of NCFO what the measurement period should be for determining
whether there is sufficient NCFO—i.e., whether NCFO should be calculated only
for the three months in the quarter for which the Asset Management Fee is being
paid, for the fiscal year-to-date, or for the period since the Company‘s inception,
etc. Because Plaintiffs‘ expert used the quarterly NCFO as the relevant metric, see
JX 280 at 16, and because Defendants‘ expert appears to have agreed with this
methodology, see JX 282 at 2, I use each quarter as the appropriate measurement
period.
155
Although, arguably, only the Asset Management Fees paid through September 30,
2009 are relevant for purposes of Defendants‘ laches defense, I reviewed the
December 2009 Investment Update rather than the September 2009 Investment
Update because the latter was not included in the record.
156
See JX 32, 54, 60. It appears, from examining both the April and December 2009
Investment Updates, that Asset Management Fees were only paid in the first
quarter of 2009. Compare JX 50, with JX 60. While this does not impact my
laches analysis, I note that it does not comport with Plaintiffs‘ claim, or their
expert‘s calculation, as to the amount of Asset Management Fees improperly paid
by Defendants. Because Defendants did not dispute the amount of Asset
Management Fees Plaintiffs claim were paid, however, I consider this issue
waived by Defendants.
62
distributions DPW made to its Members to get NCFO.157 Plaintiffs‘ expert independently
calculated NCFO to determine whether the Operating Agreement permitted payment of
the Asset Management Fees. Relying solely on the DPW financial information contained
in the Investment Updates, he concluded that there was insufficient NCFO to pay the
Asset Management Fees in each quarter from 2006 until 2012.158 That is, Plaintiffs base
their claims on the same information they were provided at the time the Asset
Management Fees were paid in 2007, 2008 and 2009. Thus, the claims arising from
those payments could have been brought at that time.
Plaintiffs assert that under the objective standard of inquiry notice, a reasonable
investor could not have been expected to perform the analysis their expert did to
determine whether the Asset Management Fees were paid improperly. This argument
was also addressed by the court in Dean Witter:
Although plaintiffs suggest that their claims were
―unknowable‖ because it required an expert to uncover
defendants‘ alleged wrongdoing, that argument is without
merit. It may in fact have taken an expert to unravel the entire
scheme alleged by plaintiffs. But having all of the facts
necessary to articulate the wrong is not required. Rather,
―[o]nce a plaintiff is in possession of facts sufficient to make
him suspicious, or that ought to make him suspicious, he is
deemed to be on inquiry notice.‖159
157
Operating Agreement Ex. B.
158
JX 280 at 15.
159
Dean Witter, 1998 WL 442456, at *7 n.49 (emphasis in original) (quoting Harner
v. Prudential Secs. Inc., 785 F. Supp. 626, 633 (E.D. Mich. 1992) (citations
omitted), aff’d, 35 F.3d 565 (6th Cir. 1994).
63
The same facts that gave rise to Plaintiffs‘ suspicion as to the Asset Management Fees in
2012 existed when they were paid in 2007, 2008, and 2009. Hence, I find that Plaintiffs
were on inquiry notice as to the Asset Management Fees paid before November 13,
2009.160 Plaintiffs‘ claims as to those fees, therefore, are barred by laches.
(b) Asset Management Fees not subject to Defendants’ laches defense
As to the remaining $72,193 in Asset Management Fees paid to NDC Capital after
November 13, 2009, Plaintiffs‘ and Defendants‘ experts disagree as to how NCFO should
be calculated under the Operating Agreement. Plaintiffs‘ expert concluded that Asset
Management Fees should not have been paid to NDC Capital in any quarter, and
Defendants‘ expert concluded the opposite.161 The crux of the disagreement centers on
the experts‘ differing interpretations of the clause in Section 8.3(c) that states that the
Asset Management Fee only may be paid ―after payment of all outstanding third party
160
In arguing that equitable tolling should apply here, Plaintiffs cite to Forsythe, 2007
WL 2982247, and aver that ―[t]here also was insufficient information in PWA‘s
reports to determine whether asset management fees were properly paid.‖ Pls.‘
Reply Br. 30. That contention is contradicted by Plaintiffs‘ expert‘s sole reliance
on the Investment Updates in determining that the Asset Management Fees were
paid improperly. JX 280 at 15. Further, Plaintiffs‘ reliance on Forstythe is
misplaced here because the court in that case found that the plaintiffs did not
possess the information necessary to bring their claim until after the statutory
period expired. Forsythe, 2007 WL 2982247, at *15. Here, because Plaintiffs had
all of the information they needed to put them on inquiry notice before November
2009 and failed to adduce any evidence that they could not have obtained any
additional information they needed during the same time period, I do not consider
this to be an appropriate case for the application of equitable tolling.
161
JX 280, 282.
64
debts and liabilities of the Company then due and payable.‖162 According to Plaintiffs,
this means that all liabilities that had accrued by the end of the quarter in question,
including Accounts Payable and Taxes Payable, should be subtracted from NCFO to
determine whether the Asset Management Fees should be paid. Defendants, on the other
hand, contend that only past-due invoices should be subtracted from NCFO.163
I find Plaintiffs‘ interpretation to be correct for three main reasons. First,
Plaintiffs‘ interpretation of Section 8.3(c) more closely comports with the text of that
section, which states that the Asset Management Fee may only be paid after ―payment of
all outstanding third party debts and liabilities.‖164 Nowhere does Section 8.3(c) limit
those debts and liabilities to invoiced amounts only or to invoices that are past due.
According to the plain language of Section 8.3(c), all accrued liabilities and debts should
be subtracted from NCFO before paying the Asset Management Fees. Second, I credit
the testimony of Edwards and Katz that PWA treated the payment of the Asset
Management Fees as essentially ―a given‖ and that Katz would pay them even if net cash
flow was negative.165 Third, I consider it relevant that Plaintiffs‘ expert is independent,
while Defendants‘ expert, Gottlieb, has worked with Katz for the past twelve years,
162
Operating Agreement § 8.3(c) (emphasis added).
163
Tr. 779-80 (Gottlieb).
164
Operating Agreement § 8.3(c) (emphasis added).
165
Edwards Dep. 34; Tr. 439 (Katz).
65
performing accounting services for six different properties, including the Property. 166 For
these reasons, I give the testimony and calculations of Plaintiffs‘ expert more weight on
this issue.
Because I accept Plaintiffs‘ expert‘s calculations regarding the amount of NCFO
available to be paid as Asset Management Fees, I conclude that the $72,193 in Asset
Management Fees paid to NDC Capital after November 13, 2009 was made in breach of
Section 8.3(c) of the Operating Agreement. In addition, considering the cash-starved
nature of DPW‘s business, I also find that this breach was material and constituted an
Impermissible Act under Section 6.4(d)(ii) of the Operating Agreement. The Rehab
Program was implemented as part of the Company‘s investment strategy to reposition the
Property and increase rents. Because PWA paid the Asset Management Fee without
regard to the Operating Agreement‘s prescribed procedures, it improperly diverted funds
away from DPW that were otherwise necessary for capital expenditures and to perform
repairs on the Property. These items were budgeted for in each Business Plan, the
preparation and implementation of which were PWA‘s responsibility under the Operating
Agreement.167 Because the Rehab Program and the Business Plans represent DPW and
Plaintiffs‘ expectations with respect to PWA‘s performance, I find that actions taken in
breach of the Operating Agreement that inhibit their implementation go to the root of the
Operating Agreement, touch on its fundamental purpose, and deprive Plaintiffs of the
166
Gottlieb Dep. 16-19.
167
Operating Agreement § 7.11.
66
benefit of their bargain. Moreover, although $72,193 is not a large amount in comparison
to the Property‘s purchase price of $10.5 million, its importance is magnified when
viewed in the context of the Company‘s negative net cash flow and working capital.
(c) Katz’s fiduciary duties to the Company and its Members
As to whether Katz breached any fiduciary duties, Plaintiffs claim that Katz paid
the Asset Management Fees to benefit his relationship with NDC Capital, which
extended to other properties, and that he therefore breached his duty of loyalty. In the
circumstances of In re USACafes, L.P. Litigation, Chancellor Allen held that the directors
of a corporate general partner in a limited partnership owe a fiduciary duty to the limited
partnership and the limited partners in addition to the stockholders of the corporate
general partner.168 While the court in USACafes did not ―delineate what the scope of a
director‘s fiduciary duty might be . . . [it] did . . . conclude that any duty owed included
the duty not to use control over [the limited partnership‘s] property to the advantage of a
director at the expense of [the limited partnership].‖169 ―This court has
followed USACafes consistently, holding that the individuals and entities who control the
general partner owe to the limited partners at a minimum the duty of loyalty identified in
168
600 A.2d 43 (Del. Ch. 1991).
169
MARTIN I. LUBAROFF & PAUL M. ALTMAN, DELAWARE LIMITED PARTNERSHIPS
§ 11.2.11 at 11-34 (2015).
67
USACafes.‖170 USACafes also has been extended to business entities acting as the
managing member in the LLC context.171
Katz is a 10% owner and the managing member of PWA, the Company‘s
Managing Member. As a result, under the USACafes line of cases, Katz would owe a
duty of loyalty to DPW in at least certain circumstances. Based on the evidence
presented at trial, however, I find that Plaintiffs have not shown that Katz‘s actions
implicate a breach of the duty of loyalty. Plaintiffs do assert that Katz acted in his own
self-interest and to DPW‘s detriment by improperly paying the Asset Management Fees
to benefit his relationship with NDC Capital. Plaintiffs ignore, however, the fact that if
NDC Capital‘s Asset Management Fees were not paid, they would have accrued172 and
do not allege that NDC Capital had any specific need for immediate payment of those
fees during the relevant time period. Further, although Plaintiffs point to the fact that
Katz and NDC Capital were co-investors in another property and that DRS—Katz‘s
property management company—managed other properties in which NDC Capital had
170
Feeley v. NHAOCG, LLC, 62 A.3d 649, 670-71 (Del. Ch. 2012) (collecting
authorities). The duty of loyalty identified in USACafes related to a sale of
substantially all of the assets of the subject limited partnership in which the
directors of the corporate general partner received substantial side payments in
connection with the sale. USACafes, 600 A.2d at 46.
171
See, e.g., Bay Ctr. Apartments Owner, LLC v. Emery Bay PKI, LLC, 2009 WL
1124451, at *8-9 (Del. Ch. Apr. 20, 2009); Paige Capital Mgmt., LLC v. Lerner
Master Fund, LLC, 2011 WL 3505355, at *30 (Del. Ch. Aug. 8, 2011).
172
See Operating Agreement § 8.3(c). Because of the accrual feature of the Asset
Management Fees, DPW presumably would have paid those fees to NDC Capital
eventually.
68
invested, they did not present any evidence as to whether the business relationship with
NDC Capital was material to Katz.
Plaintiffs barely even raised the issue of Katz‘s fiduciary duty to DPW and its
Members in their briefs. Indeed, Plaintiffs failed to cite USACafes or its progeny or any
other case for the proposition that Katz owes a fiduciary duty to DPW and its Members
regarding the relatively routine payments at issue in this case. Rather, Plaintiffs asserted,
in conclusory fashion, that ―Katz‘s participation and approval of such payments also
constitutes a breach of fiduciary duty by Katz to DPW because he approved the fees to
benefit his relationship with NDC Capital‖173 and that ―NDC Capital gave substantial
business to Katz.‖174 Notably, PWA attempted to make the same Asset Management Fee
payment to Curo Enterprises when it replaced NDC Capital. Based on that fact and the
relatively automatic way in which Katz caused DPW to pay that fee each quarter, I
consider it equally likely that any breach of fiduciary duty in that regard would be one of
care. But, under Feeley, although Katz could be sued by Plaintiffs ―for breach of
fiduciary duty in his capacity as the party who controls [PWA], he cannot be sued in that
capacity of breach of the duty of care.‖175
In sum, the record in support of Plaintiffs‘ claim against Katz for breach of
fiduciary duty is not developed adequately. As the Delaware Supreme Court stated in
173
Pls.‘ Opening Br. 49.
174
Pls.‘ Reply Br. 21.
175
Feeley, 62 A.3d at 667.
69
Brinckerhoff v. Enbridge Energy Co., ―[t]his type of ‗throwaway argument‘ is not
sufficient to gain any traction.‖176 Hence, I conclude that Plaintiffs have not met their
burden to prove as a matter of fact and of law that Katz breached his fiduciary duty to
DPW or Plaintiffs as a result of the Company‘s payment of Asset Management Fees to
NDC Capital.
v. Curo Enterprises’s replacement of DRS with Greystar
Plaintiffs‘ fourth argument under Section 6.4(d)(ii) is that DRS breached the
Management Agreement by resisting Curo Enterprises‘s attempts to replace DRS with
Greystar as the Property Manager. Similar to their claim regarding DRS‘s expense
reimbursements,177 Plaintiffs argue that an Impermissible Act has occurred under Section
6.4(d)(ii) because DRS, a PWA affiliate, has materially breached the Management
Agreement.178 According to Plaintiffs, Curo Enterprises, which became the Asset
Manager in July 2012, had the right under the Management Agreement‘s termination
provisions179 to terminate that agreement between DPW and DRS on DPW‘s behalf.
Plaintiffs further assert that by refusing to step down as the Property Manager after that
termination, DRS materially breached the Management Agreement.
176
67 A.3d 369, 372 n.11 (Del. 2013).
177
See supra Section II.B.1.d.ii.
178
Operating Agreement § 6.4(d)(ii).
179
Management Agreement § 6.
70
In support of their claim that Curo Enterprises was authorized to terminate the
Management Agreement on DPW‘s behalf, Plaintiffs rely on the ruling in the Kansas
Action by the Kansas Court of Appeals.180 In that case, the Kansas Court of Appeals
reversed the trial court, holding, in relevant part: (1) that Curo Enterprises had the right to
enforce the Management Agreement on DPW‘s behalf under Section 14 of that
agreement as the Asset Manager and the Company‘s agent; and (2) that Curo Enterprises
was the ―Prevailing Party‖ in the Kansas Action and, therefore, was entitled to its
attorneys‘ fees under Section 21 of the Management Agreement.181 While the decision
by the Kansas Court of Appeals as to those two issues presumably is entitled to collateral
estoppel effect,182 the Kansas court did not address whether DRS breached, materially or
otherwise, the Management Agreement by resisting Curo Enterprises‘s attempts to
terminate that agreement. Thus, I do not consider any party to this action to be precluded
from litigating that issue.
180
Curo Enters., LLC v. Dunes Residential Servs., Inc., 342 P.3d 948 (Kan. Ct. App.
2015).
181
Id. at 954, 958. Defendants claim to have appealed the judgment of the Kansas
Court of Appeals, but the record in this case does not indicate the status of that
appeal.
182
―Collateral estoppel, also known as issue preclusion, prevents a party who litigated
an issue in one forum from later relitigating that issue in another forum.‖ Yucaipa
Am. Alliance Fund I, LP v. SBDRE LLC, 2014 WL 5509787, at *11 (Del. Ch. Oct.
31, 2014). ―Collateral estoppel applies if: (1) the same issue is presented in both
actions; (2) the issue was litigated and decided in the first action; and (3) the
determination was essential to the prior judgment.‖ Zutrau v. Jansing, 2014 WL
3772859, at *41 (Del. Ch. July 31, 2014), aff’d, __ WL __ (Del. Aug. 26, 2015).
71
Although DRS arguably may have breached the Management Agreement by
resisting Curo Enterprises‘s attempts to terminate that agreement, I find that Plaintiffs
have failed to prove DRS‘s actions constitute a material breach. DRS appears to have
resisted Curo Enterprises‘s termination attempts in good faith, and Plaintiffs have not
adduced probative evidence to the contrary. Admittedly, the Kansas Court of Appeals
eventually adopted Curo Enterprises‘s interpretation of Section 14 of the Management
Agreement, but the fact remains that the trial court in the Kansas Action agreed with DRS
that Curo Enterprises did not have the power to terminate that agreement.183 This leads
me to conclude that DRS‘s resistance was made in good faith and on a reasonable basis.
In arguing that DRS‘s breach was material, Plaintiffs state that ―[n]o provisions in
the Management Agreement could be more material than the provisions granting Curo
Enterprises the right to terminate its very existence.‖ 184 This argument is unpersuasive.
In terms of whether the breach was ―material,‖ Plaintiffs have not presented any specific
evidence as to any harm they or DPW suffered as a result of DRS‘s alleged breach, the
parties‘ expectations in negotiating the Management Agreement, or whether the alleged
breach defeated the purpose of entering into that agreement in the first place. On the
contrary, it appears that Plaintiffs did receive the benefit of the bargain its predecessor,
NDC Capital, expected when it entered into the Management Agreement. Curo
Enterprises purported to terminate that agreement on DPW‘s behalf under Sections 6 and
183
Curo Enters., LLC, 342 P.3d at 82.
184
Pls.‘ Opening Br. 50.
72
14, and DRS resigned, albeit not as promptly as Plaintiffs desired. Curo Enterprises then
moved for attorneys‘ fees against DRS under Section 21 of the agreement and ultimately
prevailed. I conclude that in such a situation—where DRS resisted Curo Enterprises‘s
termination attempts in a manner that comports with standards of good faith and fair
dealing and where Curo Enterprises eventually received the benefit it expected under the
Management Agreement, including attorneys‘ fees—no material breach has occurred. I
hold, therefore, that DRS‘s resistance to Curo Enterprises‘s attempts to terminate the
Management Agreement did not constitute an Impermissible Act.
vi. PWA’s maintenance of DPW’s financial records
Finally, Plaintiffs argue under Section 6.4(d)(ii) that PWA breached its obligations
under the Operating Agreement to maintain accurate and consistent books and records of
the Company.185 Sections 7.1 and 7.2 of the Operating Agreement impose these
obligations on PWA, stating that ―[t]he books and records of the Company shall be kept
by the Managing Member in accordance with GAAP or the method of accounting
determined appropriate by the accountants for the Company . . . with the approval of
185
Although they did not raise the issue in their Opening Brief, Plaintiffs assert, in
their Reply Brief, that Katz breached his duty of care because, as PWA‘s
managing member, he was in charge of all of DPW‘s finances and had ultimate
authority for the financial statements. Because I concluded supra that, at most,
Katz owed DPW and its Members only a duty of loyalty, I reject this argument.
See supra notes 168-171 and accompanying text.
73
NDC Capital Partners, applied on a consistent basis‖186 and that those books and records
should ―fully and accurately [reflect] all transactions of the Company.‖187
Plaintiffs‘ expert lists a number of ways in which PWA breached Sections 7.1 and
7.2. These alleged deficiencies include: (1) inconsistencies between the Investment
Updates, tax returns, and general ledgers; (2) use of accrual basis cash flow statements;
(3) misleading Investment Updates; (4) unexplained retained earnings adjustments; (5)
inconsistencies between the balance sheets and income statements; and (6) conflicts
between the balance sheets‘ accounts receivables figures and the accounts receivables
aging reports.188
From the first time Caiola met with PWA and Katz, it has been Plaintiffs‘
objective to replace PWA as the Managing Member of DPW, preferably with an affiliate
of Plaintiffs. In general, therefore, I am skeptical as to the materiality of PWA‘s alleged
breaches of Sections 7.1 and 7.2. That skepticism is increased by Plaintiffs‘ heavy
reliance on DPW‘s financial statements in bringing, and in prosecuting, this action. If the
unreliability of DPW‘s financial statements rose to such a level as to constitute a material
breach of the Operating Agreement, then Plaintiffs‘ other claims—including those
regarding the distributions to Members, the Asset Management Fees, and the
reimbursements to DRS, as well as their general allegations regarding DPW‘s poor
186
Operating Agreement § 7.1.
187
Id. § 7.2.
188
JX 280 at 23-28.
74
financial condition under PWA and DRS‘s management—would be largely dependent on
other, internal information obtained through discovery. In addition, if Plaintiffs were
dissatisfied with the manner in which PWA kept DPW‘s books and records, they could
have raised that complaint much earlier and given PWA an opportunity to cure the
alleged deficiencies. Plaintiffs‘ delay in doing so has prejudiced PWA by creating a
potential pretext for its removal as the Managing Member. Thus, because Plaintiffs
essentially have undermined any claim regarding the completeness, accuracy, and
consistency of DPW‘s financial statements by using the information in those statements
to form the bases of their contentions that PWA and Katz breached the Operating
Agreement and their fiduciary duties, and because Plaintiffs appear to have made their
claims that DPW‘s financial records are inadequate for self-interested, pretextual reasons,
I find that the breaches they allege are not material. Accordingly, I conclude that no
Impermissible Act has occurred in conjunction with the preparation of DPW‘s financial
statements.
2. The First and Second Capital Calls
In addition to their claims under Section 6.4(d) of the Operating Agreement,
Plaintiffs assert that PWA should be removed as the Managing Member because it failed
to contribute to the First and Second Capital Calls under Sections 4.3, 4.4, and 6.4(e).
Section 4.3 establishes the grounds on which ―each Member shall have the right, but not
the obligation, to make additional capital contributions to the Company (the ‗Additional
Capital Contributions‘) as the Managing Member or [CFT] . . . shall determine are
75
required by the Company . . . .‖189 Those grounds include a need for funds required ―to
pay emergency expenditures that are necessary to protect against injury to persons or
damage to property (‗Emergency Expenditures‘)‖ and ―to satisfy any obligation under the
First Mortgage Loan . . . .‖190 Section 4.4(a) provides that ―[i]f any Member fails to fund
its Proportionate share of any Additional Capital Contribution,‖ that Member will be
designated a ―Non-Contributing Member.‖191 Under Section 4.4(c), any Member that
―fails to make two (2) consecutive Additional Capital Contributions‖ will be a ―Forfeiting
Member,‖ and if ―the Forfeiting Member is the Managing Member, then, in that event,
[CFT] shall also have the right, in the exercise of their sole discretion, to remove the
Managing Member as the Managing Member of the Company pursuant to Section
6.4(e).‖192 Finally, Section 6.4(e) provides the procedure by which the Managing
Member may be removed and replaced and the effect of such removal.193
Plaintiffs assert two grounds under which the First and Second Capital Calls were
authorized under Section 4.3(a). First, Plaintiffs claim that the Capital Calls were needed
to fund Emergency Expenditures, as defined in the Operating Agreement. Second,
Plaintiffs argue that the Capital Calls were necessary to meet the Company‘s obligations
189
Operating Agreement § 4.3(a).
190
Id.
191
Id. § 4.4(a).
192
Id. § 4.4(c) (underlining omitted).
193
Id. § 6.4(e).
76
under the Mortgage. Defendants deny that either of these grounds provides a valid basis
for making a Capital Call under Section 4.3(a) and argue that they should not be
considered a Forfeiting Member under Section 4.4(c) or be removed as the Managing
Member pursuant to Section 6.4(e).
a. Making Emergency Expenditures
Emergency Expenditures are defined as ―expenditures that are necessary to protect
against injury to persons or damage to property.‖194 Plaintiffs contend that the funds
from the First and Second Capital Calls were used to address repairs that ―were critical to
tenant and visitor safety and to prevent further damage or deterioration to‖ the
Property.195 To support their argument, Plaintiffs‘ point to: (1) Hutchens‘s testimony that
the repairs completed with the funds from the Capital Calls ―address either issues to
protect against injury to person or property;‖196 and (2) the fact that a tenant was injured
on a stairway in 2014 when a rusted angle iron supporting the step collapsed.197
Defendants respond, in part, by citing to a dictionary definition of ―emergency‖ to
show that the funds from the Capital Calls were not necessary. But, their reliance on that
definition is misplaced because Emergency Expenditures is defined in the Operating
194
Id. § 4.3(a)(ii).
195
Pls.‘ Opening Br. 47.
196
Hutchens Dep. 155-57.
197
Id. at 30.
77
Agreement.198 Based on that definition, the crucial issue is whether the funds from the
Capital Calls were truly ―necessary‖ to protect against injury to tenants and visitors and
damage to the Property. For this determination, I consider it relevant that many of the
repairs identified by Greystar as either ―life safety‖ or ―required‖ repairs are similar to
items that Katz himself previously characterized as ―Emergency Expenditures.‖199
The parties‘ course of performance is instructive not only in identifying items that
constitute ―Emergency Expenditures,‖200 but also in evaluating the amount of additional
capital being sought for those expenditures. In the two instances in which Katz stated
that he needed to make Emergency Expenditures, the amounts totaled approximately
$25,000 and $13,000, respectively. The two Capital Calls, on the other hand, sought
roughly $300,000 for repairs. Moreover, to the extent that more Emergency
Expenditures were needed in 2013 than in prior years, it is likely that Plaintiffs
themselves contributed to that necessity by refusing, without a reasonable justification,201
198
Operating Agreement § 4.3(a).
199
JX 164, 170.
200
See, e.g., Sun-Times Media Gp., Inc. v. Black, 954 A.2d 380, 398 (Del. Ch. 2008)
(―When the terms of an agreement are ambiguous, ‗any course of performance
accepted or acquiesced in without objection is given great weight in the
interpretation of the agreement.‘‖ (quoting RESTATEMENT (SECOND) OF
CONTRACTS § 202)); RESTATEMENT (SECOND) OF CONTRACTS § 202 cmt. g (―The
parties to an agreement know best what they meant, and their action under it is
often the strongest evidence of their meaning.‖).
201
Defendants submitted the 2013 Business Plan to Plaintiffs with two versions of the
budget, the second of which was premised on improved metrics. Under both
versions, the budgeted amount for repairs was $75,307 and the budgeted amount
78
to approve PWA‘s proposed budget for repairs and capital expenditures for 2013.
Defendants further raise doubt as to the necessity of the Capital Calls by pointing to the
Asset Management Report, issued by Curo Enterprises in December 2013, which
recommended a number of improvements for the purpose of repositioning and
reintroducing the Property—i.e., for making it more marketable and obtaining higher
rents—that Greystar had identified as life safety, required, and recommended repairs in
its property condition assessment, issued in October 2013.202
Given the timing of these reports in relation to the First and Second Capital Calls,
which were issued in November 2013 and August 2014, respectively, I find it more likely
than not that a majority of the repairs to be performed with the funds from the Capital
Calls were not justified under Section 4.3(a) as Emergency Expenditures. I also note that
Plaintiffs still were performing some of those repairs and improvements on the Property
at the time of trial, over a year and a half after the First Capital Call. Thus, although a
portion of the funds raised from the Capital Calls may have been valid Emergency
Expenditures, I find that much of it was not. I also do not read Section 4.3(a) as
contemplating a system whereby Members initially can issue partially valid Capital Calls;
for capital expenditures was $66,680. By comparison, the budgeted amounts for
repairs and capital expenditures in 2012 were $7,125 and $33,378, respectively.
When Cox was asked at trial why Plaintiffs did not approve the 2013 Business
Plan, he responded, ―Is it budget 1 or is it budget 2? So how about no budget? And
you can operate per the 2012 budget. That was our decision.‖ Tr. 333. Cox‘s
cavalier approach to that budget-related decision further supports my finding that
Plaintiffs‘ primary focus here was on ousting PWA as the Managing Member.
202
JX 187.
79
rather, either the full amount is warranted, or none of it is. As to the First and Second
Capital Calls, therefore, I find that neither was justified under Section 4.3(a).
b. Satisfying obligations under the Mortgage
Similarly, I do not agree with Plaintiffs‘ contention that the Capital Calls were
necessary under Section 4.3(a)(v) to satisfy the Company‘s Mortgage obligations.
Contrary to Plaintiffs‘ assertion, DPW‘s commingling of tenant security deposits and
operating funds does not create a breach of Section 10 of the Mortgage203 because Kansas
law does not require the maintenance of segregated security deposit accounts.204 In
addition, as to Section 17 of the Mortgage,205 I agree with Defendants that the record does
not support Plaintiffs‘ claim that almost $350,000 was necessary to meet repair
203
Mortgage § 10 (―Borrower . . . shall comply with all applicable laws that pertain to
the maintenance and disposition of tenant security deposits.‖).
204
Plaintiffs concede that no applicable statute mandates security deposits at a multi-
family complex be segregated from operating funds, but argue that the case law
demonstrates that commingling funds entrusted to a fiduciary is a breach of the
duty of care in Kansas. For this proposition, Plaintiffs cite In re Bryant Manor,
LLC, 422 B.R. 278 (Bankr. D. Kan. 2010). The court‘s decision in Bryant,
however, does not indicate that commingling security deposits violates a fiduciary
duty or any other law. Id. at 291-92. At most, the court expressed its view that
such commingling constitutes mismanagement by a property manager. Id. Thus,
although Plaintiffs probably are correct that commingling tenant security deposits
and operating funds is contrary to best practices, Bryant does not hold that such
commingling constitutes a violation of a fiduciary duty, and Plaintiffs‘ citation of
it for that proposition is misplaced.
205
Mortgage § 17 (―(a) Borrower shall not commit waste or permit impairment or
deterioration of the [Property]. . . . (c) Borrower shall restore or repair promptly, in
a good and workmanlike manner, any damaged part of the [Property] to the
equivalent of its original condition . . . (d) Borrower shall keep the [Property] in
good repair . . . .‖).
80
obligations to NorthMarq.206 To the extent Plaintiffs rely on NorthMarq‘s December 11,
2013 letter identifying requested repairs to the Property, I note that the letter was sent
after the First Capital Call, and, as Defendants‘ property management expert, Peters,
testified, NorthMarq frequently sent similar letters at other properties and the letter sent
to DPW was ―not out of the ordinary.‖207 Rather, I find that although NorthMarq‘s
December 11, 2013 letter might support some of the requested repairs in the First and
Second Capital Calls, it is insufficient to prove that much of the amount requested was
necessary to satisfy DPW‘s Mortgage obligations.
Finally, Plaintiffs‘ reliance on Greystar‘s assessment of the Property‘s condition
when it took over in October 2013 misses the mark. The standard for measuring DPW‘s
compliance with Section 17 is a relative rather than an absolute one. To illustrate,
Section 17(a) prohibits the ―deterioration of the [Property];‖ Section 17(c) requires DPW
to restore or repair the Property ―to the equivalent of its original condition;‖ and Section
17(d) obligates DPW to ―keep the [Property] in good repair.‖208 Each of these phrases
indicates that DPW‘s compliance with Section 17 is measured in relation to the
Property‘s condition at the time the Mortgage was executed. Although Greystar
subjectively may have disapproved of the condition of the Property when it took over as
the Property Manager, Greystar‘s assessment is not dispositive as to whether DPW risked
206
Defs.‘ Answer Br. 40.
207
Tr. 761.
208
Mortgage §§ 17(a), (c)-(d) (emphasis added).
81
breaching Section 17. As a result, I conclude that Plaintiffs also have failed to prove that
Section 4.3(a)(v) provided a valid basis for the First and Second Capital Calls.
c. Legal effect of the two Capital Calls
As I concluded above, neither Capital Call was justified under Section 4.3(a).
Taking into account all of the facts of record, I find it likely that, at least in part, Plaintiffs
issued the two Capital Calls to force Defendants‘ hand in an attempt to create a situation
in which PWA could be designated as a Forfeiting Member under Section 4.4(c) of the
Operating Agreement or induced to sell its interest in DPW or buy Plaintiffs‘ interest.
This determination is reinforced by Plaintiffs‘ implementation of similar strategies to
gain control of the other NDC Investments.209 For these reasons, I decline to give the
Capital Calls effect as Additional Capital Contributions under the DPW Operating
Agreement and hold that PWA cannot be considered either a Non-Contributing Member
under Section 4.4(a) or a Forfeiting Member under Section 4.4(c) of the agreement.
It is undisputed, however, that CFT actually did contribute $348,052 to DPW via
the First and Second Capital Calls and that, for the most part, those funds were used for
the purposes stated in the First and Second Capital Calls, including for making a number
of repairs and improvements. There arguably could be a windfall to PWA, therefore,
which owns 10% of the Company‘s membership interests and likely would benefit from
Plaintiffs‘ contributions and the use of those funds to repair and improve the Property, if
CFT is given no ―credit‖ for its infusion of $348,052 to DPW, either in terms of
209
See supra notes 23-28 and accompanying text.
82
additional equity or having the payments treated as some form of a loan. In evaluating
this possibility, I look first to the Operating Agreement for guidance.
The agreement does not address this precise situation. It does discuss, however,
the somewhat analogous situation of a Managing Member making the equivalent of a
defective capital call. Specifically, Section 4.3(b) provides, in relevant part:
Notwithstanding anything set forth herein to the contrary,
without the approval in writing in each instance by NDC and
a Majority Vote of the Investment Members [i.e., CFT], the
Managing Member shall not have any right to use Company
assets to pay for, nor any right to call for, and the Members
shall not have the right or obligation to make, any Additional
Capital Contributions for the purpose of funding any cost,
expense or liability: . . . (ii) that is in excess of available
amounts (A) set forth in the then applicable Annual Business
Plan (other than Emergency Expenditures and Additional
Permitted Expenditures), or (B) necessary to satisfy the
Company‘s Permissible Indemnity Obligations to the
Managing Member or (C) necessary to satisfy any obligation
under the First Mortgage Loan (to the extent not otherwise
provided in any applicable Annual Business Plan). Amounts
paid, from time to time, by the Managing Member (or any
Affiliate thereof) on account of any cost, expense or liability
with respect to which a capital call is prohibited by the
preceding sentence without the prior written approval of
[CFT] shall be paid from the Managing Member‘s assets and
shall not be treated as Capital Contributions or a loan to the
Company for the purposes of this Agreement. The Managing
Member shall not be entitled to reimbursement from the
Company or from any Member for such expenses. The
parties to this Agreement intend that each Additional Capital
Contribution be treated as a Capital Contribution only if all
Members make such Additional Capital Contribution, and
that if any Member fails to make such contribution, all such
83
amounts contributed by the Contributing Members shall be
treated as a loan as provided in Section 4.4.210
Thus, if the Managing Member contributed funds to DPW to pay certain expenses as part
of a defective capital call, it would ―not be entitled to reimbursement from the Company
or from any Member for such expenses.‖
In the circumstances of this case, I conclude that the most equitable way to handle
Plaintiff CFT‘s payment of a total of $348,052 pursuant to purported capital calls for
amounts in excess of what was authorized under the Operating Agreement is to treat them
as comparable to unauthorized payments of expenses by the Managing Member. That is,
Plaintiffs would not be entitled to reimbursement from the Company or PWA for such
payments. I reach this conclusion because, during the interim period from October 1,
2013, when Plaintiffs‘ affiliate Curo Enterprises, as the Asset Manager of DPW, caused
DRS to be replaced by Greystar as the Property Manager, until the Second Capital Call
on July 31, 2014, the uncertainty engendered by this litigation effectively created a
vacuum as to the position of Managing Member. In the context of that vacuum and the
day-to-day control of DPW‘s operations by CPW and Greystar, Plaintiffs caused the First
and Second Capital Calls to be made. Plaintiffs, therefore, should bear the responsibility
for those capital calls being deficient, just as the Managing Member would under the
portion of Section 4.3(b) quoted above. In addition, the money contributed by Plaintiffs
presumably benefited DPW, of which CFT owns a 90% interest. Finally, by virtue of this
210
Operating Agreement § 4.3(b) (underlining omitted).
84
Memorandum Opinion, the validity of PWA‘s removal as the Managing Member of
DPW has been confirmed, and Plaintiffs now will be able to control the appointment of
the new Managing Member and, thus, presumably the future direction of DPW.
C. Is DPW Entitled to Money Damages From PWA or Katz?
Plaintiffs assert two alternate means of computing the damages that they claim
PWA and Katz owe to DPW.
1. Plaintiffs’ request for direct damages
First, under Plaintiffs‘ direct method of calculating damages, they argue that
Defendants owe a total of $567,453, which is the sum of: (1) the $331,974 that DPW
distributed to the Members in 2007 and 2008; (2) the $146,755 in Asset Management
Fees that DPW paid to NDC Capital; and (3) the $88,724 that Plaintiffs claim DRS
improperly took as reimbursements. Plaintiffs then argue that because those damages
occurred from 2007 to 2013, DPW is entitled to pre-judgment interest. As a result, with
the inclusion of pre-judgment interest at the statutory rate under Delaware law, Plaintiffs
claim that Defendants owe a total of $918,000 to DPW in damages.
As to the three claimed categories of damages, I determined supra that Plaintiffs‘
claims regarding the distributions to DPW‘s Members in 2007 and 2008 were barred by
laches.211 I also determined that $74,562 of the total $146,755 in Asset Management
Fees paid to NDC Capital was barred by laches.212 Regarding the $88,724 that Plaintiffs
211
See supra Section II.B.1.d.iii.
212
See supra Section II.B.1.d.iv.
85
claim DRS improperly took as reimbursements, I found that Plaintiffs did not prove that
any such breach was material. Hence, PWA is exculpated under Section 6.3 for this
aspect of the claimed damages because the alleged breach did not constitute Cause under
Section 6.4(b). The only caveat is that Plaintiffs‘ claim might fall within one of the
exceptions to Section 6.3. That section provides, in relevant part:
Unless for an action constituting ―Cause (as defined in
Section 6.4(b)), the Managing Member shall not be liable or
obligated to the Members for any mistake of fact or judgment
made by the Managing Member in operating the business of
the Company that results in any loss to the Company or its
Members. . . . [T]he Managing Member shall not be
responsible to the Members because of a loss of that
Member‘s investment or a loss in operations, provided,
however, that the foregoing shall not limit the Managing
Member‘s liability in connection with any loss that has been
occasioned by fraud, self-dealing (in contravention of this
Agreement), willful misconduct, gross negligence, a wrongful
misappropriation or taking by the Managing Member, or any
other act by the Managing Member that constitutes ―Cause‖
as defined in Section 6.4(b) (but without regard to the notice
and/or cure periods provided therein).213
Plaintiffs have not shown that any of the exceptions to exculpation stated in Section 6.3
would apply to the damages claim based on DRS‘s reimbursement. Thus, PWA is not
liable on that claim. In addition, I note that, in their briefs, Plaintiffs do not contend that
PWA breached the Operating Agreement as to DRS‘s reimbursements. Plaintiffs only
argue that DRS breached the Management Agreement, and DRS is not a named
defendant in this action.
213
Operating Agreement § 6.3 (underlining omitted).
86
I conclude, therefore, that the only damages that Plaintiffs can claim Defendant
PWA owes to DPW are the $72,193 in Asset Management Fees that are not barred by
laches. DPW also is entitled to pre-judgment interest on that amount of $21,323.214
Further, because I held that Katz did not breach any fiduciary duties owed to DPW,215 I
dismiss any claims against him for damages owed to the Company or Plaintiffs. In
summary, therefore, based on Plaintiffs‘ request for direct damages, PWA owes DPW a
total of $93,516.
2. Plaintiffs’ request for alternative damages
Second, Plaintiffs set forth an alternative method for calculating DPW‘s ―damages
based on comparable industry data had PWA and Katz operated the Company without
breaching their fiduciary duties.‖216 I reject this method of calculating damages for a
214
Aveta Inc. v. Bengoa, 2010 WL 3221823, at *2 (Del. Ch. Aug. 13, 2010) (―When a
party has a right, contractual or otherwise, to a monetary amount, the party ‗is
entitled to prejudgment interest running from the date the payment is due.‘
. . . The right to pre-judgment interest demonstrates that the duty to pay arises out
of the underlying obligation, not the judicial order enforcing it.‖ (quoting
Hercules, Inc. v. AIU Ins. Co., 784 A.2d 481, 508 (Del. 2001))).
To calculate pre-judgment interest, I noted the amount of the Asset Management
Fees paid to NDC Capital by DPW in each quarter from the fourth quarter in 2009
until the second quarter in 2012 per Plaintiffs‘ expert‘s report. See JX 280 Ex. 2A.
For each of those quarterly payments, I calculated the amount of interest that
would have been earned had that payment instead been invested at the legal rate of
interest under Delaware law, 6 Del. C. § 2301(a), from the time of the payment
until the date of this Opinion, compounded quarterly. I then summed the interest
that would have been earned on each of the Asset Management Fees to get the
total pre-judgment interest of $21,323.
215
See supra Sections II.B.1.d.iv & II.B.1.d.vi.
216
Pls.‘ Opening Br. 55.
87
number of reasons. First, I concluded supra that neither PWA nor Katz breached any
fiduciary duties to the Company or its Members. Second, Plaintiffs‘ rationale for using
this alternative method of calculating damages is largely rooted in their claim that PWA
breached the Operating Agreement by keeping inaccurate, incomplete, and inconsistent
financial statements. As I previously held, however, Plaintiffs failed to prove that any
such breach was material. I am not persuaded, therefore, that those alleged breaches
warrant jettisoning DPW‘s financial records and resorting to an entirely hypothetical
damages model. Finally, ―[u]nder Delaware law, a plaintiff can only recover those
damages which can be proven with reasonable certainty. Moreover, ‗[n]o recovery can be
had for loss of profits which are determined to be uncertain, contingent, conjectural or
speculative.‘‖217 I find Plaintiffs‘ alternative method based on comparable industry data
to be too speculative to sustain their requested damages award.
D. Is Either Party Entitled to Attorneys’ Fees Under the Operating Agreement?
Both parties seek attorneys‘ fees under Section 16.14 of the Operating Agreement,
which contains a fee-shifting provision in favor of the ―prevailing party‖ in ―any action or
proceeding to enforce this Agreement or any provision hereof.‖218 Under Delaware law,
―to be declared the prevailing party, a litigant must achieve ‗predominance in the
217
Pharmathene, Inc. v. SIGA Techs., Inc., 2010 WL 4813553, at *11 (Del. Ch. Nov.
23, 2010) (quoting Callahan v. Rafail, 2001 WL 283012, at *1 (Del. Super. Mar.
16, 2001)).
218
Operating Agreement § 16.14.
88
litigation.‘‖219 To achieve predominance, a litigant should prevail on the case‘s ―chief
issue.‖220
In this case, the chief issue by any metric was whether CFT had Cause under the
Operating Agreement to remove PWA as the Managing Member. Because I concluded
that CFT did have Cause under Sections 6.4(d)(ii) and (viii) of the Operating Agreement
to remove PWA as the Managing Member, I conclude that they are the prevailing party
and can recover their attorneys‘ fees against Defendants under Section 16.14 of the
Operating Agreement.
I hold, however, that Plaintiffs are entitled to recover from Defendants 50% of the
fees they reasonably incurred in this action rather than the full amount of their fees. I
base this conclusion on the fact that Plaintiffs employed somewhat of a ―kitchen sink‖
approach in this action, asserting nine bases on which they purportedly had the right to
remove PWA as the Managing Member and prevailing on only two of those bases.
Plaintiffs also sought between $918,000 and $1,590,000 in total damages, but ultimately
were awarded less than $100,000. Although Plaintiffs were the prevailing party, this
Court has held that ―[w]here the plaintiff‘s success is not entire, the [Court] has discretion
219
Vianix Del. LLC v. Nuance Commc’ns, Inc., 2010 WL 3221898, at *28 (Del. Ch.
Aug. 13, 2010) (citation omitted) (quoting Brandin v. Gottlieb, 2000 WL 1005954,
at *28 (Del. Ch. July 13, 2000)).
220
W. Willow-Bay Court, LLC v. Robino-Bay Court Plaza, LLC, 2009 WL 458779, at
*9 (Del. Ch. Feb. 23, 2009).
89
to adjust the award by . . . reducing the award to account for the limited success.‖221
Because Plaintiffs were only partially successful in this case, I award them 50% of their
fees under Section 16.14 of the Operating Agreement.
I further hold that Defendants are jointly and severally liable for Plaintiffs‘
attorneys‘ fees. Although Katz was not a party to the Operating Agreement in his
individual capacity and only executed the agreement in his capacity as PWA‘s managing
member, he is liable to Plaintiffs in this regard because Section 16.14 of the Operating
Agreement states that in any action by a Member to enforce the Operating Agreement,
―the prevailing party shall recover from the non-prevailing party its attorneys‘ fees
. . . .‖222 Here, CFT, the Non-Managing Member, brought suit to enforce the Operating
Agreement, and Plaintiffs, as the prevailing parties, are entitled to their attorneys‘ fees
against Defendants, as the non-prevailing parties, even though neither Cortese nor Katz
are Members of DPW. In so concluding, I also take note that Defendants, in their brief
and in the pre-trial Joint Stipulation, sought attorneys‘ fees in favor of ―Defendants,‖
plural, against ―Plaintiffs,‖ plural. Defendants, therefore, have implicitly conceded that
even non-Member parties to an action to enforce the Operating Agreement are bound by
the fee-shifting provision in Section 16.14.
221
Elite Cleaning Co. v. Capel, 2006 WL 4782274, at *5 (Del. Ch. Nov. 20, 2006)
(quoting Jefferson v. City of Camden, 2006 U.S. Dist. LEXIS 46654, at *9 (D.N.J.
June 30, 2006)).
222
Operating Agreement § 16.14.
90
III. CONCLUSION
For the foregoing reasons, Plaintiffs are entitled to partial relief. Plaintiffs proved
that PWA materially breached the Operating Agreement and committed an Impermissible
Act under Section 6.4(d)(ii) by improperly paying Asset Management Fees to NDC
Capital. Plaintiffs also proved that PWA committed an Impermissible Act under Section
6.4(d)(viii) because the Key Persons, Ward and Peter Katz, did not remain actively
involved in the operation of the Property Manager‘s business after October 2013.223 As a
result, CFT had Cause to remove PWA as the Managing Member of the Company, and
PWA, therefore, validly has been removed as the Managing Member.
As to the Asset Management Fees, Plaintiffs proved that PWA owes DPW
$93,516 in damages, inclusive of pre-judgment interest. And, Plaintiffs proved that they
are entitled to recover 50% of their reasonable attorneys‘ fees and expenses from
Defendants under Section 16.14 of the Operating Agreement. Plaintiffs promptly shall
file appropriate papers documenting their claimed attorneys‘ fees and expenses. Within
fourteen days of the filing of those papers, Defendants shall file any objections they have
to the requested fees and expenses. In all other respects, Plaintiffs‘ claims for relief
against PWA will be dismissed with prejudice. All of Plaintiffs‘ claims against
Defendant Katz, except for the claim for attorneys‘ fees, will be dismissed with prejudice.
An implementing order accompanies this Opinion.
223
I reject all of the other grounds advanced by Plaintiffs for the removal of PWA as
the Managing Member.
91