Submitted Date October 1, 2013.
Defendant's Motion to Dismiss and Plaintiffs Motion for Summary Judgment.
Stephen E. Jenkins, Esquire and Marie M. Degnan, Esquire of ASHBY & GEDDES, Wilmington, Delaware; OF COUNSEL: Phillip S. McKinney, Esquire and John K. Larkins III, Esquire of ROGERS & HARDIN LLP, Atlanta, Georgia; Attorneys for Plaintiff
William M. Lafferty, Esquire and John P. DiTomo, Esquire of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; OF COUNSEL: Michael W. Johnston, Esquire, Samuel M. Matchett, Esquire and Darrick L. McDuffie, Esquire of KING & SPALDING LLP, Atlanta, Georgia; Attorneys for Defendant.
Abigail M. LeGrow,
Master in Chancery
This dispute is standard fare in the world of indemnification and advancement. The plaintiff, Karl Fillip ("Fillip"), is a member, manager, and the former CEO of defendant Centerstone Linen Services, LLC ("Centerstone" or the "Company"). In 2012, Fillip resigned his position as CEO and then filed a lawsuit in Georgia when Centerstone refused to pay Fillip the severance to which he believed he was entitled. Centerstone quickly alleged counterclaims and affirmative defenses against Fillip in the Georgia case, alleging he breached his fiduciary duties and certain contractual obligations by manipulating the Company's earnings and revenues, paying kickbacks, modifying the terms of a note obligation between the Company and Fillip's holding company, and attempting to sell Centerstone without the board of managers' authorization. When Fillip demanded Centerstone advance his attorneys' fees and expenses related to the affirmative defenses and counterclaims, Centerstone sought to avoid its advancement obligations by filing amended counterclaims omitting the counts alleging Fillip breached his fiduciary duties. Centerstone argued Fillip was not entitled to advancement for the remaining counts because those claims were personal to Fillip and did not involve actions he took in the performance of his duties as CEO. This lawsuit soon followed.
Centerstone is not the first company to experience the uncomfortable remorse of having granted advancement rights to an official the company now believes engaged in grievous misconduct, nor is it the first to attempt to evade its contractual advancement obligations by offering an awkward or illogical interpretation of the advancement obligation or the underlying litigation. Those arguments rarely succeed, and they meet no different fate in this case. The only reasonable reading of the language at issue leads to the conclusion that Fillip is entitled to advancement for at least two of the three counterclaims asserted by Centerstone, as well as the dismissed counterclaims and the affirmative defenses that relate to his alleged wrongdoing as CEO.
The background facts largely are undisputed. Not surprisingly, the parties vigorously dispute the facts underlying the claims pending in Georgia, but those disputes are not relevant to the resolution of Fillip's advancement rights. The parties agree this case can be resolved on the record currently before the Court.
A. The parties and the formation of Centerstone
Centerstone is a Delaware limited liability company with its principal place of business in Georgia. Centerstone provides healthcare linen services through its wholly owned subsidiaries, Alliance Laundry and Textile Services ("Alliance") and Atlas Healthcare Linen Services. Fillip and his business partner founded Alliance in 1999, and Fillip served as Alliance's President and CEO until 2008, when Fillip and his partner sold Alliance to Centerstone. In connection with that sale, Fillip received a 10.47% Class A preferred membership interest in Centerstone, which he holds through KF Equity Holdings, LLC, a Georgia LLC of which Fillip is the sole member. When it acquired the equity stake in Centerstone, KF Equity Holdings executed a $1 million promissory note in favor of Centerstone (the "Promissory Note.")
In addition to his membership interest, Fillip became a manager of Centerstone and served as its CEO. On May 15, 2008, Fillip executed a Member Service Agreement (the "Employment Agreement") governing the terms of his employment. The Employment Agreement set Fillip's annual salary and the bonus he was eligible to earn, which amounted to 5% of Centerstone's normalized EBITDA for the applicable calendar year. The Employment Agreement also provided that if Fillip resigned his position as CEO for "Good Reason, " or was terminated without cause, he was entitled to certain severance payments, along with a continuation of his benefits.
B. Problems begin to develop between Fillip and the board of managers
The honeymoon was not long lived. By 2010, problems had arisen between Fillip and Centerstone's six-member board of managers (of which Fillip was one). The cause of those tensions is disputed and not relevant to this case, but appears to have centered around the search for a CFO for Centerstone, Fillip's concerns regarding the company's financial operations and direction, and the question of whether the company should be sold. Centerstone contends Fillip hired a CFO and covertly solicited offers to buy Centerstone, both without the knowledge or requisite approval of the board of managers. Fillip contends the board of managers failed to obtain sufficient capital to support the company's operations and hired a CFO without consulting Fillip, which materially decreased Fillip's responsibilities as CEO.
C. Fillip's resignation and the severance dispute
Fillip resigned his position as CEO of Centerstone on October 5, 2012. He contends he resigned for "Good Reason" under the terms of the Employment Agreement and therefore is entitled to a substantial severance payment. Centerstone disagrees that Fillip resigned for "Good Reason" and has refused to pay the severance he demanded. On December 4, 2012, Fillip filed a lawsuit in Georgia (the "Georgia Action"). In that lawsuit, Fillip argued that Centerstone had breached the Employment Agreement by failing to remit the severance payment. Fillip also sought to enjoin enforcement of the restrictive covenants in the Employment Agreement.
For a short time, it appeared that Fillip and Centerstone would resolve their disputes quickly. On January 14, 2013, the parties engaged in settlement negotiations and executed a term sheet. A month later, however, Centerstone refused to proceed with settlement on the basis that it had "discovered facts suggesting that Fillip had engaged in practices designed to manipulate Centerstone's revenue." In response to Fillip's motion to enforce the settlement agreement, Centerstone argued Fillip had a fiduciary duty to Centerstone to disclose during settlement discussions that he had "manipulated" revenue, and that his failure to do so "fraudulently induced" Centerstone to enter into the settlement agreement. The Georgia court ultimately refused to enforce the settlement agreement.
D. Centerstone's responds to the Georgia complaint
Centerstone then answered Fillip's complaint and filed a series of counterclaims against Fillip (the "Original Counterclaims"). The Original Counterclaims alleged Fillip had manipulated Centerstone's revenues and EBIDTA "in an effort to obtain larger annual bonuses for himself, " modified the terms of repayment of the Promissory Note without authorization, and attempted to covertly sell the company. Centerstone alleged that these actions amounted to breaches of Fillip's fiduciary duties and his Employment Agreement.
E. Fillip seeks advancement and Centerstone amends its counterclaims
Fillip quickly demanded that Centerstone advance Fillip's attorneys' fees and expenses for defending the Original Counterclaims, asserting that Article 3.7 of Centerstone's Limited Liability Company Agreement (the "LLC Agreement") provided advancement rights to Fillip. The language at issue provides:
3.7. INDEMNIFICATION. The Company shall indemnify, defend and hold harmless each Manager and Officer for all costs, losses, liabilities, and damages whatsoever paid or incurred by such Manager or Officer in the performance of his duties in such capacity, including, without limitation, reasonable attorney's fees, expert witness and court costs, to the fullest extent provided or permitted by the [Delaware Limited Liability Company] Act or other applicable laws. Further, in the event fraud or bad faith claims are asserted against such Manager or Officer, the Company shall nonetheless bear all of the aforesaid expenses subject to the obligation of such Manager or Officer to repay all such expenses if they are finally determined to have committed such fraud or bad faith acts.
Centerstone quickly rejected Fillip's advancement demand, but also indicated it would dismiss without prejudice those counterclaims that alleged Fillip had breached his fiduciary duties (the "Dismissed Counterclaims"). Centerstone indicated it would continue to pursue its counterclaims for breach of contract and for a declaratory judgment that the LLC Agreement barred Fillip from competing with Centerstone. Centerstone then filed an amended answer and counterclaim (the "Amended Counterclaims"). Although the factual allegations supporting those Amended Counterclaims did not change substantially, Centerstone withdrew certain counts against Fillip and "clarified" the basis for other counts. There are now three counterclaims pending against Fillip in the Georgia Action.
The Amended Counterclaims continue to allege that Fillip (1) engaged in deceptive practices related to the company's revenues, (2) manipulated Centerstone's EBITDA to obtain larger bonuses for himself, (3) engaged in deceptive practices by modifying the terms of repayment of his note obligation to Centerstone without authorization, and (4) attempted to sell the Company without authorization from the other owners. The Amended Counterclaims more specifically allege that Fillip engaged in a scheme to "„put his digital foot on the scale' and improperly inflate the Company's revenues, " and that Fillip used subordinates to make "unjustified and improper adjustments to Centerstone's EBITDA in order to overstate his bonus" from 2008 to 2012. With respect to the Promissory Note, Centerstone alleges that: "[p]ursuant to the terms of the note, Fillip was obligated to pay $1 million to Centerstone … . Rather than pay this amount to Centerstone as required by the note, Centerstone purported to apply part of his bonus to satisfy his note obligation." Those allegations, among others, form the basis for the three counts that remain in the Amended Counterclaims.
Count One alleges Fillip breached the Employment Agreement "by causing his annual bonus for the period 2008 through 2012 to be significantly overstated." Count Two alleges Fillip breached the Promissory Note by modifying its terms without authorization. Count Three seeks a declaratory judgment that Article 14.13 of the LLC Agreement prohibits Fillip from entering into business opportunities that create a conflict of interest with Centerstone, including but not limited to soliciting customers and employees from Centerstone. Centerstone also asserted a number of affirmative defenses to Fillip's claims in the Georgia Action, including that Fillip's claims ...