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Base Optics Inc. v. Liu

Court of Chancery of Delaware

May 29, 2015

BASE OPTICS INC., Plaintiff,
v.
YAPING LIU, individually and on behalf of ARGUS INTERNATIONAL LTD., and ARGUS INTERNATIONAL INC., Defendants.

Submitted: February 20, 2015

Joanne P. Pinckney and Seton C. Mangine, of PINCKNEY, WEIDINGER, URBAN & JOYCE LLC, Wilmington, Delaware, Attorneys for Plaintiff.

John G. Harris and David Anthony, of BERGER HARRIS LLP, Wilmington, Delaware, Attorneys for Defendants.

MEMORANDUM OPINION

GLASSCOCK, Vice Chancellor

As of 2013, Defendant Yaping Liu was a one-third owner of the equity in, and CFO and a director of, Base Optics, Inc. ("Base Optics"), a Delaware corporation involved in optics design and sales. She was also the sole owner of Defendant Argus International LTD ("Argus"), another optics sales company incorporated in the state of Washington. Argus was a small operation with an established customer base and large outstanding debt. Liu found herself overwhelmed attempting to service Argus's customers. She reached a deal with the two other principals and owners of equity in Base Optics, John Myrick and Lars Sandstrom, wherein Base Optics would acquire Argus's customer list and the right to do business with those customers "as Argus, " and Argus would retain its debt and the right to receive a royalty of 50% of profits on sales by Base Optics doing business as Argus ("Base DBA Argus") arising from the customer list. The principals did not obtain the assistance of counsel in drafting this agreement, and none seemed concerned about potential conflicts of fiduciary duty concerning Liu's dual role as director of Base Optics and sole owner of its competitor/contractual partner, Argus. In practical terms, Liu retained the Argus debt, Base Optics took over operation of the Argus business, and Liu received two-thirds of the profits, half from the royalty agreement and her residual one-third of the remainder as an owner of Base Optics equity.

Unfortunately, Liu quickly fell out with Myrick and Sandstrom over the appropriate distribution of profits between Base Optics and Argus. Within weeks, Liu proposed, and Base Optics accepted, an amendment to the parties' agreement. In the amended agreement, Argus waived its right to royalties, Base Optics received the entire right to do business as Argus with the existing Argus customer list, with a single exception, and Base Optics was entitled to retain all profits from sales to those customers. The exception involved one of Argus's largest customers, Synergy International Optronics LLC ("Synergy"); that account was returned to Argus, which would henceforth service the Synergy account itself and retain all Synergy-generated profits. Like the original agreement, the amended agreement was drafted without the assistance of counsel and is rudimentary in its language. To again restate in practical terms, Liu went from the sole owner of an entity, Argus, with a valuable customer base, which she was unable to service on her own, and substantial debt, to the sole owner of an Argus with the same debt and a single customer, Synergy; at the same time, Liu was a one-third owner of Base Optics, which had acquired the right to the bulk of Argus's business, including the right to all profits therefrom.

It was not long after the amendment that Liu began to experience seller's remorse. Her relationship with Myrick and Sandstrom became adversarial, and they removed her from Base Optics' board of directors. Liu began to take the actions described in detail below, purportedly in breach of her contractual, statutory, and fiduciary duties to Base Optics. Base Optics has sued for injunctive relief and damages on numerous theories, and the matter came before me on a two-day trial. This is my post-trial Memorandum Opinion.

I. BACKGROUND FACTS[1]

The following are the facts as I find them after trial, by the preponderance of the evidence

A. The Parties

Plaintiff Base Optics is a Delaware corporation created in 2012 by Myrick, Sandstrom, and Liu. In the early 2000s, Myrick and Sandstrom met Liu through their common involvement in the photonics industry.[2] At the time, Sandstrom and Myrick worked for one of the leading U.S. designers and manufacturers of optical equipment, Thorlabs, Inc. ("Thorlabs"). Liu was then the proprietor of Y&M Technologies, Inc. ("Y&M"), a Delaware corporation that acted as a sourcing intermediary between Chinese optics parts manufacturers and U.S. consumers, including Thorlabs. In 2011, Myrick and Sandstrom struck out on their own to form Base Optics-"a catalog photonics company" that also "does custom design as well as custom manufacture of optical components and photonics equipment."[3] The following year, they reincorporated Base Optics, originally a Maryland limited liability company, in Delaware, at which time they also brought in Liu to gain access to the network of suppliers, manufacturers, and customers she had cultivated after years as a broker in the photonics industry. All three were issued equal shares of Base Optics stock and named directors; in addition, Myrick became Base Optics' Chief Executive Officer and President, Sandstrom became its Chief Technology Officer, and Liu became its Chief Financial Officer.

Shortly after forming Base Optics in Delaware, Myrick and Sandstrom learned that Liu was a partial owner of another optics company incorporated in Washington and headquartered in Delaware, Defendant Argus (together with Liu, the "Defendants"), [4] which was experiencing financial troubles. Liu engaged Myrick and Sandstrom to advise Argus on its business, during which they found that Argus owed hundreds of thousands of dollars to its vendors, including a large portion to Liu's own companies, Y&M and a company the parties refer to as "Accina." The parties also believed that Argus was being bled by Liu's co-owner, non-party Brian Morrisey, who had purportedly been diverting Argus's cash and customers for personal gain. In May 2013, Liu bought Morrisey out of Argus, becoming its President, Chief Executive Officer, and sole owner.

B. The DBA Arrangement

With Morrisey gone, Liu required more help from Myrick and Sandstrom to service Argus's clients. By the summer of 2013, Myrick and Sandstrom were working so much on Argus's business that they feared Base Optics' growth would be stunted. However, Myrick and Sandstrom saw potential in Argus's healthy client base, so, rather than pull away from Argus, they began negotiating with Liu as to potential arrangements between Base Optics and Argus that would benefit both companies. Rather than a merger, the parties eventually settled on a "doing business as" (or "DBA") arrangement they hoped would allow Base Optics to service Argus's then-current customer base, ideally generating profit for both companies but without requiring Base Optics to assume Argus's debt.[5] Base Optics' ability to do business as Argus-in other words, to represent itself as Argus to customers-was paramount to its ability to service Argus's customer base in this arrangement, because only Argus, not Base Optics, was qualified to sell to a "vast majority" of Argus's customers, particularly defense contractors and government bodies, under those customers' strict vendor-qualifying processes.[6]

On June 11, 2013, Base Optics and Argus, via Myrick and Liu, executed a I rudimentary written agreement memorializing their collaboration, using a form contract Myrick had downloaded from the Internet and altered to reflect the parties' negotiated terms (the "Original Agreement"). As to Base Optics' obligations in the DBA arrangement, the Original Agreement provided that Base Optics would:

(a) address Argus current customer-base as "Argus International" by registering Doing Business As (DBA) "Argus International"[;]
(b) pay a royalty of 50% of the net profit from "Argus Customer Sales" (net profit = Sales - (Raw Materials Shipping)) for 10 years to Argus[;]
(c) attain the proper registration to support Argus'[s] current type of business[;]
(d) set up Base Optics ERP [accounting] system to be able to separate "Argus Customer Sales"[;]
(e) pay a minimum of $600/week to Yaping, John, and Lars using the funds deposit by Argus[; and]
(f) support Argus with business advice to maximize the royalty.[7]

As to Argus's obligations, the Original Agreement provided that Argus would:

(a) pay $18, 000 to Base Optics to be used to cover interim salaries for the first 10 weeks[;]
(b) transfer its customer-base to Base Optics from this point going forward Base Optics owns the customer-base[;]
(c) transfer all open sales orders and new orders in Argus Quick Books to Base Optics[;]
(d) ensure that Brian Morrisey does not contact or in any other way solicit business from the transferred customer-base or damage the customer relation (including legal action)[; and]
(e) allow Base Optics to use all Argus trademarks, service marks and trade names.[8]

The term "Argus Quick Books" in the Original Agreement referred to the accounting software QuickBooks, which Argus used to manage the entirety of its business, including for bookkeeping and for storing its customers' information and history.[9] The term "customer-base" refers to those customers with which Argus had previously done business at the time of the transaction (the "DBA Customers"), [10] a list of which Argus stored in QuickBooks.[11] In the weeks leading up to the Original Agreement, Liu had granted Sandstrom access to Argus's QuickBooks account in his role as a consultant, and Sandstrom maintained that access following the execution of the Original Agreement, using QuickBooks alongside Liu to manage Argus's business.[12]

C. The Amendment-It Becomes All About the Base . . .[[1]]

The ink on the Original Agreement had hardly dried when the parties began having issues with their arrangement. On July 13, Liu emailed Myrick and Sandstrom explaining that she was overwhelmed by customer orders and the complexity of the payment and royalties scheme.[14] Liu proposed a change to the parties' arrangement whereby the parties would abandon the royalties system, allow Argus to solely service and retain all the profits from one of the historically larger DBA Customers, Synergy, and allow Base DBA Argus to service and retain all of the profits from all of the other DBA Customers.[15] Myrick and Sandstrom were amenable to the change, but were concerned that Argus owed Base Optics money under the terms of the Original Agreement. Following the parties' execution of the Original Agreement, a number of the DBA Customers had continued to send payments to Argus rather than Base Optics, which payments Myrick and Sandstrom argue the Defendants failed to remit to Base Optics.[16]Thus, although the Original Agreement contemplated a system where royalties would flow from Base Optics to Argus, no such royalties were ever paid; rather, by October 2013, Sandstrom calculated that Liu had deposited so many payments from DBA Customers directly into Argus's bank account that Argus actually owed Base Optics approximately $18, 000.[17] When confronted by Myrick with this figure at the time, Liu denied that Argus owed that much money to Base Optics.[18] She testified at trial that she did not believe then, and she still does not believe to this day, that Base Optics' calculation of Argus' back payments under the Original Agreement was correct.[19]

After a series of video conferences between Myrick, Sandstrom, and Liu, the parties entered into a written agreement amending the Original Agreement to reflect Liu's proposal on November 11, 2013 (the "Amended Agreement"). As its purpose, the Amended Agreement provided:

The purpose of this amendment is to alter the division of customers in the [Original Agreement] to allow for simpler bookkeeping and the development [of] the clear delineation between customers that Base Optics services and . . . Argus International Ltd continues to serve. This change is at the request of Yaping Liu (the sole owner of Argus International Ltd) with the intent of freeing Argus to service top customer Synergy International Optronics[, ] moving all other customers to Base Optics as compensation for maintaining Argus quickbooks, website, email and providing customer service, sales and technical support to these customers.[20]

The Amended Agreement entirely replaced Base Optics' obligations under the Original Agreement with the requirements that Base Optics would:

(a) address Argus current customer-base as "Argus International" by registering Doing Business As (DBA) "Argus International' [;]
(b) attain the proper registration to support Argus'[s] current type of business[;]
(c) Pay the rent for [] Argus'[s] Scotts Valley office up to May 2014 ($1350/month)[; and]
(d) pay the Argus Bank of America line of Credit (approx. $17000)[.][21]

Further, the Amended Agreement entirely replaced Argus's obligations under the Original Agreement with the ...


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