Chancery Court Dismisses Former LLC Member’s Claims for Alleged Amounts Owed and Breach by Former Co-Members
By: Scott E. Waxman and Michael C. Payant
In Terry L. Menacker v. Overture, L.L.C., et al., C.A. No. 2019-0762-JTL (Del. Ch. Aug. 4, 2020), the Delaware Court of Chancery (the “Court”) considered a motion to dismiss claims by a former member of Overture L.L.C. (the “Company”) concerning a dispute over a buyout payment allegedly due upon his withdrawal as a member, certain other alleged past-due amounts, and an alleged breach of fiduciary duty by former co-members of the Company. The Court dismissed all claims, holding that (i) the Court lacked subject matter jurisdiction over the buyout payment dispute because it was subject to arbitration; (ii) plaintiff’s allegations regarding other amounts owed failed to state claims upon which relief could be granted; and (iii) plaintiff’s claims for breach of duty were derivative claims for which plaintiff lacked standing.
For nearly 25 years, Terry L. Menacker (“Menacker”) was a member of the Company, as were entities controlled by each of John Iwanicki and John Fawthorp. Through the Company, the three men sold high-end home theater systems. Iwanicki and Fawthorp (together, the “Co-Members”) provided initial start-up capital to the Company but largely remained behind the scenes thereafter; Menacker served as Chief Executive Manager and oversaw the Company’s day-to-day operations. In November 2017, the Co-Members terminated Menacker. Shortly thereafter, Menacker signed a document memorializing his departure and Fawthorp and Iwanicki exercised their right to buy his interest.
The Company is governed by an Operating Agreement (the “Agreement”), which was originally entered into in 1993. In recognition of Menacker’s full-time work for the Company, the original Agreement made special provision for Menacker to receive a guaranteed minimum salary payment (the “Guaranteed Payment”). Other than Menacker’s guaranteed salary payment, the Agreement did not provide for mandatory payments or distributions to Members, but permitted discretionary interim distributions and provided for profit sharing among the three members. The original Agreement was ambiguous as to whether the Guaranteed Payment was an advance against Menacker’s share of net profits or a separate standalone liability of the Company.
For 20 years, the Company amended the Agreement roughly annually to clarify and confirm the profit-sharing arrangement, but several amendments in particular were central to the present case. In March 2009, the Members amended the Agreement to clarify that since 1995, the Guaranteed Payment had not been treated as a separate liability of the Company, but had instead been an advance against Menacker’s capital account (the “Net Profits Amendment”). In January 2010, the Members executed another amendment to govern transfers of Company interests by the Members, which by its terms superseded conflicting terms in the Agreement (the “Buy-Sell Amendment”). Importantly, the Buy-Sell Amendment contained an agreement by the Members to “arbitrate any claims or disputes arising out of or relating to the Buy-Sell Amendment, subject to an exception for equitable relief.” Finally, in 2014, the Members executed an amendment confirming that the Guaranteed Payment was indeed a draw against Menacker’s capital account, not a separate payment in addition to his distributions of net profits (the “Confirmatory Amendment”).
After his termination in 2017, Menacker filed suit in 2019 alleging he was owed a buy-out payment for his interests (the “Buy-Out Payment”) and certain other monetary amounts. Menacker also alleged a fiduciary breach by the Co-Members. The Co-Members filed a motion to dismiss all claims, and the Court addressed these claims in turn.
Addressing the Buy-Out Payment first, the Court determined the Buy-Sell Amendment applied to the dispute and required the issue be resolved in arbitration. Menacker contended he was owed a Buy-Out Payment of more than $800,000; the Co-Members refused to pay this amount and argued Menacker in fact owed more than $100,000. The substance of the dispute hinged on whether the Guaranteed Payment had been a draw on Menacker’s capital account (as posited by the Co-Members) or a separate amount due to Menacker (as argued by Menacker). The Court noted that by its terms, the Buy-Sell Amendment superseded any conflicting terms from the Agreement and required arbitration of any claims arising out of or relating to the Buy-Sell Amendment. Because the Buy-Out Payment claim concerned the price to be paid upon transfer of Menacker’s interests, the Court determined it “arose” under the Buy-Sell Amendment, such that the agreement to arbitrate was applicable. Accordingly, the Court dismissed Menacker’s Buy-out Payment claims under Rule 12(b)(1) for lack of subject matter jurisdiction. Notwithstanding the arbitration provision’s exception for equitable relief, the Court also denied Menacker’s request for a mandatory injunction with request to the Buy-Out Payment. This was because Menacker sought monetary relief, and a mandatory injunction was not available to compel payment of monetary damages.
The Court next dismissed Menacker’s allegations that he was owed Guaranteed Payments and certain other profit sharing amounts and distributions under Rule 12(b)(6) for failure to state a claim. The Agreement as originally drafted was ambiguous, but the Net Profits Amendment and Confirmatory Amendment unequivocally established the parties’ mutual agreement that the Guaranteed Payment was a draw on Menacker’s capital account, rather than a separate amount due to Menacker. As such, Menacker’s assertion he was entitled to a separate Guaranteed Payment failed to state a claim. Furthermore, because Menacker failed to bring the claim until 2019, the Court held it was also barred by laches, because Menacker had notice of this claim as early as the 2009 Net Profits Amendment, and in no case later than the 2014 Confirmatory Amendment. The Court also dismissed Menacker’s claims that he never received profit sharing payments. The Court noted Menacker had signed on to dozens of amendments through the years affirming he had in fact received profit sharing payments and he could not now contend he had not received them. Finally, the Court dismissed Menacker’s assertion he was entitled to certain un-made distributions. The Court noted that (i) the distribution language in the Agreement was discretionary, not mandatory; and (ii) Menacker did in fact receive distributions – the periodic profit sharing payments were distributions, and the Guaranteed Payments constituted an advance against eventual distributions of profits.
Finally, the Court dismissed Menacker’s claims that the Co-Members had breached fiduciary duties. Menacker argued the Co-Members had abused their combined 70% beneficial interest in the Company for more than 20 years to funnel contracts to themselves or affiliates at prices in excess of market value. Although Menacker couched his claim in terms of his own personal lost distributions and profit sharing, the Court determined the harm, if any, belonged to the Company and was borne by each of the other Members in proportion to their share of Company profits or losses. Accordingly, this was a derivative claim, and under Section 18-1001 of the Delaware LLC Act, the only persons with standing to bring such claims on behalf of a Delaware LLC are its members and assignees of its LLC interests. Menacker withdrew as a member of the Company in December 2017 and did not file this action until September 2019. Because he was no longer a member at the time of filing, Menacker lacked standing to assert a derivative claim on behalf of the Company. Accordingly, the Court dismissed the derivative claim based on lack of standing.
Terry L. Menacker v. Overture, L.L.C., et al., C.A. No. 2019-0762-JTL (Del. Ch. Aug. 4, 2020)