By Scott Waxman and Anthony L Yerry
In Jagodzinski v. Silicon Valley Innovation Company, LLC, Christian Jagodzinski, a unitholder in Silicon Valley Innovation Company, LLC (“SVIC”), fueled by personal disputes with Bram Portnoy, the receiver of SVIC, brought a motion to terminate the court-appointed receivership over SVIC or, alternatively, to reduce the receiver’s pay. Setting aside the personal disputes between Portnoy and Jagodzinski, the Delaware Court of Chancery ruled that Jagodzinski failed to make a sufficient showing to justify terminating the receivership but held that the 10% contingency portion of Portnoy’s fees are to be based off of the net, instead of the gross, recovery of the receivership.
In 2000, Jagodzinski invested $1 million in SVIC, which was an incubator for other startup technology companies. After about four years of allegedly successful investments, SVIC stopped sending reports to the equity holders. Jagodzinski unsuccessfully attempted to contact SVIC and investigate the state of the company’s affairs. Eventually on February 18, 2011, Jagodzinski initiated a books and records action against SVIC in the Delaware Court of Chancery. The then manager of SVIC refused to cooperate with the court, and the court appointed Portnoy as a limited receiver of SVIC with the specific task of collecting the books and records of the SVIC.
Portnoy was not unfamiliar with Jagodzinski. Sometime in the mid-to-late 2000s, Portnoy was hired by Desdemona Capital LLC, which managed Jagodzinski’s investments, including SVIC. Portnoy worked for Jagodzinski and acted as the SVIC receiver congruently until around January 2014.
As receiver, Portnoy reconstructed destroyed documents from SVIC’s present and former bankers, lawyers, and accountants and discovered that the previous advisors and managers of SVIC were engaging in widespread self-dealing and looting. Accordingly, Jagodzinski filed a new action with the court to have the court appoint Portnoy as a full-blown receiver to pursue claims against SVIC’s prior advisors and managers. The court granted the order in which Portnoy was to be paid $250 per hour as receiver.
Over the course of 2013 and early 2014, Portnoy caused sixteen separate lawsuits to be filed against former managers and advisors of SVIC. As the case developed, Portnoy and Jagodzinski realized that the magnitude of potential recovery in one of the cases could be in the range of $100 million. The court found that this potential recovery played a role in Jagodzinski’s effort to end the receivership or else reduce Portnoy’s compensation.
Overtime, Jagodzinski viewed Portnoy’s $250 per hour fee as unreasonable and in late January or early February 2013, Portnoy and Jagodzinski mutually agreed to modify Portnoy’s compensation, without a court order, such that Portnoy would bill no more than $14,000 a month, regardless of the number of hours he worked. Portnoy conducted a stockholder survey where stockholders were asked to approve salary of $14,000 a month and 10% contingency component for any money recovered. Jagodzinski and the other stockholder approved and Portnoy filed a proposed order to amend his compensation, which the court granted.
In January 2014, Portnoy stopped working for Desdemona Capital LLC, and less than three months later Jagodzinski filed the Motion to Terminate Receivership and Establish Procedures for Discharge of Receiver and Dismissal of the Case. At the hearing, the court recognized “the largely personal nature of this dispute between Jagodzinski and Portnoy.”
Ultimately, the court decided three primary questions: (1) should the receivership be terminated and power returned to the stockholders? (2) if not, should Portnoy be removed as Receiver and replaced with someone else? and, (3) if not, should Portnoy’s compensation structure be modified?
The court started its analysis by noting that “there are few statutory provisions regarding receivers for limited liability companies” compared to corporations and that very few cases have addressed the standard to be applied to terminate a receivership. Looking back to a Delaware Supreme Court decision from nearly a century ago, the court “held that the Court of Chancery could discharge a receiver and return a corporation to the stockholder if it ‘has attained a condition in which it can meet its obligations in the usual course of business, or that there is a reasonable prospect that its business can be successfully continued, notwithstanding any deficiency of assets.’”
Focusing on the general principal that courts should be reluctant to allow interested parties to attempt to terminate a receivership, “especially where they might be pursuing ulterior motives,” the court denied Jagodzinski’s motion to terminate or replace the receiver. The court found that Portnoy “appears to be doing a good job in his role as a receiver” and “has operated [SVIC] for over two years on roughly $625,000 to cover all of its costs and expenses.” As for Portnoy’s compensation, the dispute focused almost exclusively on the 10% contingency fee portion. The court held that the applicable standard is that “receivers are entitled only to reasonable compensation.” The court agreed with Jagodzinski that a 10% contingency fee on the gross recovery is unreasonable, especially considering that Portnoy and Jagodzinski previously operated on net contingency fees when Portnoy worked for Jagodzinski, but disagreed that the contingency fee should be based on a sliding scale.
The court reasoned that the goal in setting a receiver’s compensation is to align the receiver’s incentives with the stockholders to seek the best risk-adjusted recovery without granting him or her a windfall. The court found that a 10% contingency fee on recovery for the receiver accomplished just that, but that 10% figure is most appropriate, given the circumstances, if it is based off the receiver’s net recovery. The court held that “[t]his arrangement avoids a windfall for Portnoy and better comports with the sort of net contingency arrangements under which Portnoy and Jagodzinski operated with respect to Desdemona.”