Fiduciary and Contractual Claims Arising from LLC Management Dispute Survive a Motion to Dismiss
By Scott Waxman and Ryan Drzemiecki
In an ongoing dispute between the members of a Delaware limited liability company, Vice Chancellor Parsons was tasked with resolving pre-trial motions filed by both the managing member defendants and the non-managing member plaintiffs. Except for plaintiffs’ claim of waste, V.C. Parsons denied the defendants’ Rule 12(b)(6) motion to dismiss finding that, drawing all reasonable inferences in favor of plaintiffs, facts have been pleaded that make the defendants’ inappropriate at this stage of the litigation. In addition, V.C. Parsons denied plaintiffs motion of summary judgment, which sought to remove the defendant LLC from its position as managing member, finding that the plaintiffs have not yet produced evidence sufficient to meet their burden of showing that they are entitled to judgment as a matter of law.
This case involves an ongoing dispute between the managing member and non-managing members of Dunes Point West, LLC, a Delaware limited liability company (the “Company”). The Company was formed in 2006 to acquire and operate an apartment complex in in the State of Kansas (the “Apartment Complex”). Presently, Louis Cortese and the 2009 Caiola Family Trust (“Plaintiffs”) collectively hold 90% of the membership interests in the Company. Defendants include the Company’s managing member and holder of 10% of its membership interests, PWA, LLC, a Kansas limited liability company (“PWA”) and Ward Katz, the managing member of PWA.
In April of 2014, the Court issued a Memorandum Opinion in which it granted summary judgment in favor of Defendants’ interpretation of a provision in the Company’s operating agreement (the “Operating Agreement”), finding that the provision unambiguously does not provide Plaintiffs with the affirmative power to mandate significant actions by the Company. This decision was summarized here.
Plaintiffs’ filed a complaint in which they allege that, in in breach of the Operating Agreement and violation of their fiduciary duties, Defendants have taken various actions, which have damaged the Company and justify removal of PWA as the managing member of the Company. In response, Defendants moved to dismiss the complaint for failure to state a claim under Rule 12(b)(6). Additionally, Katz sought dismissal under the theory that he lacks sufficient minimum contacts with the State of Delaware upon which to be subject to the personal jurisdiction of the Delaware Chancery Court.
Turning first to Katz’s motion to dismiss for lack of personal jurisdiction, the Court denied his motion. The Court explained that because Katz voluntarily undertook to manage a Delaware limited liability company, has received benefits for so doing, and now has been accused of causing damage arising directly out of such management, it is reasonable and comports with due process to require Katz to answer for his alleged wrongful acts in the Delaware Chancery Court.
In determining the outcome of Defendants’ motion to dismiss, the Court explained that a motion to dismiss under Rule 12(b)(6) will only be granted if, accepting all well-pleaded factual allegations in the complaint as true and drawing all reasonable inferences in Plaintiffs’ favor, Plaintiffs could not recover under any reasonably conceivable set of circumstances susceptible to proof. The Court then applied this standard to each count in Plaintiffs’ complaint.
In Count I, Plaintiffs sought a declaratory judgment against PWA pursuant to 6 Del. C. § 18-110(a), which allows a member or manager of a limited liability company to apply for the Delaware Chancery Court to hear and determine the validity of any admission, election, appointment, removal or resignation of a manager of such limited liability company. Plaintiffs’ Count II claimed that Defendants breached the Operating Agreement by (1) paying asset management fees in violation of the Operating Agreement; (2) distributing inaccurate or misleading financial reports to Plaintiffs; (3) failing to provide information to Plaintiffs as required by the Operating Agreement; and (4) neglecting to maintain the Apartment Complex. Based on the foregoing, the Court denied Defendants’ motion to dismiss Counts I and II because Plaintiffs’ factual allegations could conceivably support a claim for breach of the Operating Agreement and removal of PWA as the Company’s managing member.
In Count III, Plaintiffs argued that Defendants breached their fiduciary duties as managing member of the Company. Under Delaware law, a limited liability company “may displace fiduciary duties altogether or tailor their application” by the terms of its operating agreement. In the absence of such contractual displacement or tailoring, the managing member of a Delaware limited liability company owes traditional fiduciary duties of loyalty and care. Defendants did not claim that the Operating Agreement reduced or eliminated their fiduciary duties; instead, they argued that their allegedly wrongful actions arose directly out of the Operating Agreement, and if proved to be true, would result only in breach of contract, not breach of fiduciary duty. The Court disagreed with Defendants and concluded that while some of the factual allegations supporting Plaintiffs’ breach of fiduciary duty claims overlap with those related to their breach of contract claim, the potential breaches of fiduciary duty are broader in scope than, and therefore not precluded by, the terms of the Operating Agreement. Thus, the Court dismissed Defendants’ motion dismiss Count III of the complaint.
In Count IV, Plaintiffs alleged that Defendants engaged in waste by (1) failing to maintain the Apartment Complex, (2) charging to little for rent and (3) allowing the Company’s profit margin to be impacted as a result. The Court explained that the standard for proving a corporate waste claim under Delaware law is “onerous, stringent, extremely high, and very rarely satisfied.” Applying such standard, the Court granted Defendants’ motion and dismissed Plaintiffs’ waste claim because they failed to allege sufficient facts demonstrating that Defendants’ actions were so one sided that no business person of ordinary, sound judgment could conclude that the Company has received adequate consideration.
Finally, the court turned to Plaintiffs’ motion for partial summary judgment and a declaratory order removing PWA as managing member of the Company. Plaintiffs alleged that Defendants, in the course of their duties as managing member of the Company, improperly commingled tenant security deposits with the Company’s operating funds in violation of Kansas law and their fiduciary duties. The Court denied Plaintiffs’ motion for summary judgment because (1) the relevant Kansas law applies only to mobile-home parks and (2) the way in which PWA maintained the Company’s tenant security deposits was not unreasonable and therefore did not represent a breach of the duty of care as a matter of law.