Delaware Chancery Court Addresses Alleged Breaches of LLC Agreement

By Scott Waxman and Sophia Lee Shin Internet Holdings, Inc. v. Entertainment Benefits Group, LLC, et al., involves a dispute between the two owners, each with a 50% interest, of Entertainment Group, LLC (“NYEG” or the “Company”). The plaintiff alleged that the Company’s board (the “Board”) was deadlocked because it had been excluded from all decision-making and sought dissolution, and the defendant counterclaimed for various breaches by the plaintiff of the Company’s operating agreement; the plaintiff then moved to strike the defendant’s counterclaim or dismiss it in its entirety. In this opinion, the court granted in part and denied in part the plaintiff’s motion to strike, and denied in its entirety the plaintiff’s motion to dismiss.

The plaintiff and defendant in this case were the two owners of NYEG. The principals of the plaintiff, Internet Holdings, Inc. (“NYIH”), were the original registrants of the domain name, a website that sells and markets travel and entertainment tickets in New York. The defendant, Entertainment Benefits Group, LLC (“EBG”), is in the business of selling and marketing travel and entertainment tickets.

In January 2012, NYIH and EBG entered into an asset purchase agreement, pursuant to which they formed NYEG. NYEG acquired 100% of In connection with this transaction, NYIH and EBG also entered into an LLC agreement (the “Operating Agreement”), pursuant to which each entity owned 50% of the Company, and the Board was comprised of Tom Stafford of NYIH (“Stafford”) and Brett Reizen of EBG (“Reizen”). The Operating Agreement gave EBG the exclusive authority to manage the day-to-day operations of the Company, but NYIH argued that the Board was authorized to participate in making a number of larger decisions for the Company. The Operating Agreement also listed eight “Triggering Events” that, if NYIH were to commit any such event, NYIH must offer its interest in the Company to EBG. Two of the Triggering Events were relevant to the court’s decision: (1) if NYIH or Stafford engages in any activities, events, or conduct that, in EBG’s reasonable opinion, reflects unfavorably on the good name, goodwill, or reputation of the Company or EBG (a “Reputation Triggering Event”); and (2) if NYIH breaches any of its obligations under the Operating Agreement (a “Breach Triggering Event”).

In October 2012, EBG relaunched the website and significantly improved website traffic and revenues. In contrast, NYIH argued that despite this improvement, the Company’s operating costs far exceeded revenues and resulted in the ultimate loss of millions of dollars. Accordingly, NYIH requested the Company’s books and records on two occasions, but EBG denied both demands despite the Operating Agreement’s express provision of this right to NYIH. Based on these denials, NYIH believed that EBG could be engaged in financial improprieties. In addition, NYIH claimed that EBG excluded NYIH from all decision-making for the Company, again, despite the Operating Agreement, and cited the fact that there have been no Board meetings since EBG’s involvement in the Company. Given its preclusion from decision-making for the Company, NYIH argued that the Board was dysfunctional and deadlocked. In response, EBG argued that Stafford or NYIH committed a Reputation Triggering Event and Breach Triggering Event.

The parties participated in an unsuccessful mediation session in July 2014, and on October 7, 2015, NYIH initiated this litigation. EBG subsequently filed its Answer and Verified Counterclaim (the “Counterclaim”), seeking a declaratory judgment that NYIH or Stafford triggered a Reputation Triggering Event, and seeking relief for breaches of the Operating Agreement.

First, the court addressed the plaintiff’s motion to strike certain portions of the Counterclaim. NYIH sought to strike portions of the Counterclaim that described Stafford’s offensive conduct during the mediation, arguing that it disclosed confidential information regarding the mediation. EBG claimed that the paragraph showed an injurious act triggering a Reputation Triggering Event. The court held that Stafford’s conduct may have reflected poorly on him, but did not reflect poorly on the Company or EBG. Furthermore, the mediation agreement indicated that neither party was to reveal information provided during the mediation. Given the public policy favoring confidentiality in mediation proceedings, the court granted NYIH’s motion to strike those portions.

NYIH also sought to strike portions of the Counterclaim that described information about prior to EBG’s involvement, claiming that this background information served no useful purpose other than to undermine the perception of NYIH. The court held that these portions were neither egregious nor materially prejudicial, and that they did provide relevant background information. As such, the court denied NYIH’s motion to strike those portions.

The court then turned to the plaintiff’s motion to dismiss the Counterclaim in its entirety. First, EBG claimed that Stafford or NYIH triggered a Reputation Triggering Event by (1) making abusive comments to a third-party vendor, (2) yelling loudly and refusing to speak to Reizen or shake his hand at a meeting in the Company’s office, (3) disclosing to a former employee of the Company details of the dispute between the parties and requesting that such employee give Stafford information about the Company’s operations, and (4) sending a retired basketball player to the Company’s office pretending to be an investor in to ask to inspect the books and records of the Company. NYIH responded to this claim by arguing that the alleged actions were all de minimis. The court held that, regardless of the arguably picayune nature of EBG’s complaints, the court could not eliminate at this stage of the litigation the possibility that, together, the various actions could support a Reputation Triggering Event.

Second, the Counterclaim also argued that NYIH breached the Operating Agreement by (1) failing to recognize EBG’s exclusive authority to manage the operations of the Company, (2) disclosing confidential information to the former employee of the Company, and (3) failing to notify EBG of the occurrence of Triggering Events. The court denied the motion to dismiss issue (1) because the language of the contract was somewhat ambiguous, rendering this an issue that could not be dismissed under Rule 12(b)(6). The court also denied the motion to dismiss issue (3) because the need for notice hinges on whether a Triggering Event occurred, which is a factual dispute and thus not one that could be dismissed at this stage. The court then turned to issue (2) regarding confidentiality. NYIH argued that this particular claim became moot when the lawsuit began, but the court disagreed, stating that this information likely did not become public until after Stafford disclosed the confidential information to the former employee in July 2014, as the complaint was not filed until October 2014. NYIH also argued that Stafford contacted the former employee in his effort to monitor NYIH’s investment in the Company, which the Operating Agreement expressly allowed as a permitted use of confidential information. The court held that this argument was actually a defense against the Counterclaim, and whether it had merit was an issue that could not be determined via a motion to dismiss. Thus, the court denied this motion to dismiss as well.

Despite the holdings in this opinion, however, the court went to some lengths to note that it did not foresee that EBG would likely be successful on the merits at future stages of litigation. Internet Holdings, Inc. v. Entertainment Benefits Group, LLC, et. al, C.A. No. 10206-VCP (Del. Ch. July 8, 2015) (Parsons, V.C.)

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