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CMS Investment Holdings, LLC v. Castle

Court of Chancery of Delaware

June 23, 2015


Date Submitted: January 16, 2015

Lisa A. Schmidt, Esq., Catherine G. Dearlove, Esq., Robert L. Burns, Esq., Elizabeth A. DeFelice, Esq., RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Bruce A. Featherstone, Esq., FEATHERSTONE DeSISTO LLC, Denver, Colorado; Attorneys for Plaintiff CMS Investment Holdings, LLC.

Seth A. Niederman, Esq., Carl D. Neff, Esq., FOX ROTHSCHILD LLP, Wilmington, Delaware; Attorneys for Defendants Lawrence E. Castle, Caren J. Castle, The Castle Law Group, LLC, LEC Holdings, LLC, and Next Organization, LLC.

Samuel T. Hirzel, II, Esq., PROCTOR HEYMAN LLP, Wilmington, Delaware; Attorneys for Defendants Leo C. Stawiarski, Jr. and LCS Colorado Holdings, LLC.

David E. Wilks, Esq., WILKS, LUKOFF & BRACEGIRDLE, LLC, Wilmington, Delaware; Attorneys for Defendant Associates Management Services, LLC.

Robert A. Penza, Esq., Christopher M. Coggins, Esq., POLSINELLI PC, Wilmington, Delaware; Attorneys for Defendants Jennifer Wilson-Harvey, individually and as personal representative of Robert M. Wilson, Jr. and Wilson & Associates, PLLC.


PARSONS, Vice Chancellor.

The plaintiff in this action invested in a Delaware limited liability company ("LLC") whose business was providing non-legal administrative services to law firms and their mortgage lender clients in connection with mortgage foreclosures. That business was created by the principal defendants: five individuals who practiced law in Colorado and Arkansas. Seeking to monetize their non-legal services businesses, those individuals sold them to a Delaware LLC in 2007 in exchange for certain membership units. The plaintiff and others paid cash to acquire other membership units in that LLC. The defendants continued to run the services businesses, but now in the capacity of employees, officers, and managers of the LLC.

According to the plaintiff, the defendants, along with several of their affiliated entities, enjoyed a lucrative business. But, they failed to facilitate the LLC's collection of the administrative services fees owed to it by the law firms and clients, instead retaining the fees for themselves or paying them in improper distributions, placing the LLC in danger of defaulting on its debt obligations. The plaintiff further alleges that, instead of helping the LLC restructure and survive, the defendants purposely ushered it into insolvency. The LLC went into receivership in Colorado in 2012, and within a matter of weeks the services businesses-the main assets of the company-were sold. The buyers in the receivership sale were entities allegedly owned by the defendants.

The plaintiff charges the defendants with a litany of wrongs, including: breach of the LLC agreement, breach of the implied covenant of good faith and fair dealing, unjust enrichment, breach of fiduciary duty, aiding and abetting, civil conspiracy, and fraudulent transfer. The defendants, who divided into four groups, each moved to dismiss the complaint as it relates to them. In support of their motions, the defendants have raised numerous arguments in favor of dismissal, some of which overlap to a certain extent.

For the reasons set forth below, I largely deny the motions. I grant dismissal, however, of some of the claims as to certain of the eleven defendants. For example, not all of the defendants conceivably are bound by the LLC agreement, and not all owed fiduciary duties to the plaintiff. Therefore, where appropriate, I dismiss the claims for breach of contract and breach of fiduciary duty as to certain specific defendants.


A. The Parties

Plaintiff is CMS Investment Holdings, LLC ("CMS"), a Delaware LLC. The members of CMS are CMS Corporate Holdings, Inc., a Delaware corporation, and CalPERS Corporate Partners, LLC, a Delaware LLC. Plaintiff owns 99% of the Class A Preferred Units[2] of what I referred to above as the LLC, non-party RP Holdings Group, LLC ("RPH" or the "Company"), a Delaware LLC.

The Complaint names eleven Defendants. Defendants Lawrence E. Castle, his wife, Caren J. Castle, and Leo C. Stawiarski, Jr. are individuals residing in the State of Colorado, where all three are licensed to practice law. Defendant LEC Holdings, LLC ("LEC") is a Colorado LLC affiliated with the Castles. LEC is a party to the RPH LLC Agreement and holds Class B Common Units in RPH. Another Colorado LLC, Defendant LCS Colorado Holdings, LLC ("LCS"), affiliated with Stawiarski, is also a party to the RPH LLC Agreement and a holder of RPH Class B units. Defendant The Castle Law Group, LLC ("Castle Law Group"), formerly known as Castle Meinhold & Stawiarski, LLC, is a law firm organized as a Colorado LLC, of which the Castles and Stawiarski are managers or affiliates. Defendant Next Organization, LLC ("Next Org") is a Colorado LLC affiliated with the Castles. Next Org, Castle Law Group, LEC, and the Castles are referred to as the "Castle Defendants." LCS and Stawiarski are the "Stawiarski Defendants."

Defendant Jennifer Wilson-Harvey is an individual residing in the State of Arkansas, where she is licensed to practice law. Defendant Robert M. Wilson, who died on August 3, 2012, also practiced law in Arkansas. Wilson-Harvey, as personal representative of the Estate of Robert M. Wilson, is named as a Defendant in Wilson's place.[3] Wilson-Harvey and Wilson (the "Wilsons, " and, together with the Castles and Stawiarski, the "Individual Defendants") held Class B units in RPH. At relevant times, the Wilsons were affiliated with Defendant Wilson & Associates ("W&A"), a law firm organized as a Tennessee LLC. I refer to Wilson-Harvey, Wilson, and W&A, collectively, as the "Wilson Defendants."

Defendant Associates Management Services, LLC ("AMS") is a Delaware LLC affiliated with Wilson-Harvey.

B. Facts

1. RPH's formation

The Castles, Stawiarski, and the Wilsons were attorneys who focused on providing legal services to mortgage lenders and mortgage servicing companies in connection with mortgage foreclosures and bankruptcies. The Castles and Stawiarski, primarily through Castle Law Group, operated in Colorado, New Mexico, Arizona, Nevada, Wyoming, and Utah; the Wilsons, through W&A, operated in Arkansas and Tennessee. The Individual Defendants also operated businesses related to, but formally separate from, their law firms (respectively, the "Castle Services Business" and the "Wilson Services Business, " and together, the "Services Businesses"). The Services Businesses provided non-legal support services to the law firms' clients in connection with mortgage defaults, foreclosure processing, and sales of lender-owned real estate.

In 2007, the Castles and Stawiarski sought to monetize their Services Business through an outside investment, and were introduced to FTV Capital, a private equity firm. FTV Capital formed Plaintiff, CMS, as the vehicle for its investment. The investment plan called for the Castle Services Business to operate as an independent entity, which would provide non-legal or administrative services, through Castle Law Group, to mortgage industry clients. If the project was successful, the independent business could offer its administrative services to other law firms and other clients. Consistent with that plan, the Castles and Stawiarski formed RPH, which acquired the Castle Services Business in exchange for certain membership units.

Plaintiff, the Castles, and Stawiarski devised an intricate structure that would enable the Castle Services Business, which would be owned by RPH, to continue servicing the law firms' clients while also protecting RPH from violating professional ethics obligations and prohibitions against the unauthorized practice of law. In that regard, RPH obtained a legal opinion from Professor Geoffrey Hazard (the "Hazard Opinion"), which stated that Castle Law Group's law practice must be separated from the Services Business. To effectuate that separation, Exclusive Services Agreements (the "Castle ESAs") were executed by Plaintiff, the Castles, Stawiarski, and Castle Law Group.[4] Pursuant to the Castle ESAs, RPH was to be the exclusive provider of the relevant non-legal services to Castle Law Group and its clients for a period of twenty-five years. This mechanism envisioned that RPH would provide non-legal services to Castle Law Group, which would bill its clients for the non-legal services provided and ultimately pass the invoiced payments through to RPH.

Effective August 27, 2007, Plaintiff, RPH, and the Castle Defendants entered into several agreements, including the Castle ESAs, pursuant to which Plaintiff invested in the RPH venture (the "2007 Transactions"). The RPH LLC Agreement was amended as part of the 2007 Transactions. As relevant here, Section 4.1 provides the holders of Class A Preferred Units, such as RPH, the right to receive preferred distributions in an amount equal to the principal value of the units plus an 8% annual preferred accrual, before any distributions could be made to holders of Class B or Class C units.[5] Section 6.8 requires RPH to obtain the consent of the Class A unitholders before, among other things: amending any provision of the LLC Agreement, making distributions to RPH members or equity holders of RPH subsidiaries, transferring substantially all of the assets of RPH or its subsidiaries, or materially changing the nature of RPH's business without Board approval.[6]

Through a Securities Purchase Agreement (the "2007 SPA"), Plaintiff paid $26.9 million in cash to acquire a majority of RPH's Class A Preferred Units. The "Sellers" in the 2007 SPA included the Castles, Stawiarski, and various affiliates. Plaintiff also arranged for Freeport Financial LLC ("Freeport Financial") to make a secured loan of approximately $20 million to RPH (the "Freeport Credit Agreement"). Plaintiff alleges that the Castles and Stawiarski personally received a substantial portion of the proceeds from Plaintiff's $26.9 million equity investment and Freeport Financial's $20 million loan.

2. RPH's initial operation and the Wilson acquisition

RPH began operating according to the structure set up in the 2007 Transactions. Shortly thereafter, at the Castles' suggestion, RPH initiated discussions with the Wilsons about acquiring their services business, which, like the Castle's, provided non-legal mortgage-related administrative services to the Wilsons' law firm clients. On April 1, 2008, RPH acquired the Wilson Services Business (the "2008 Transactions"), pursuant to a series of agreements substantially similar to those involved in the 2007 Transactions. Specifically, RPH executed another Securities Purchase Agreement to acquire more Class A Preferred units and other interests (the "2008 SPA"), and entered into an Exclusive Services Agreement with the Wilsons' law firm, W&A (the "Wilson ESA"). To finance the Wilson acquisition, Plaintiff injected another $18 million of cash into RPH, and helped arrange a $3 million increase in the Freeport Credit Agreement. Allegedly, a substantial portion of the proceeds of those investments went to the Wilsons.

Plaintiff, as Majority Holder of the Class A series units, had the right to appoint three of the five members of RPH's Board of Managers. The Class B unitholders had the right to fill the other two Board seats, and initially appointed Mr. Castle and Stawiarski. Importantly, however, the parties also agreed in connection with the 2007 Transactions to form an "Operating Board" for RPH, initially consisting of the Castles, Stawiarski, and another individual.[7] After the 2008 Transactions, Wilson and Wilson-Harvey were added to the Operating Board. The members of the Operating Board agreed to provide services to and consult for RPH as independent contractors. According to the Complaint, the Operating Board "was not initially expected to act in any managerial capacity on behalf of RPH." According to Plaintiff, however, the Individual Defendants used their positions, including as members of the Operating Board, "to take effective control of RPH and to limit the information provided to Plaintiff and its designees to the Board of Managers."[8]

In this regard, it also is relevant that Mr. Castle was the CEO of RPH from 2007 through July 2009, at which time he became CEO of RPH's "West Region." He also was Chairman of the Board of Managers until July 2011, and a member of the Board until October 2012. Mrs. Castle co-managed the West Region. In July 2009, Wilson-Harvey became RPH's CEO, as well as the CEO of the "South Region."[9]

3. RPH struggles and Plaintiff intervenes

Shortly after the 2008 Transactions, the United States housing market declined precipitously, sending the economy into recession and causing a meltdown in U.S. and global financial markets. What was a nightmare scenario for many, however, was a golden opportunity for RPH: as the number of residential mortgage foreclosures skyrocketed, so did the demand for the mortgage-related administrative services that RPH was designed to offer. Consistent with that increase in foreclosure activity, RPH's business appeared to grow, at least as measured by the volume of services it was rendering to the relevant law firms and their clients. On paper, based on its use of the accrual method of accounting, RPH's profits grew too. The Complaint alleges that RPH's management, led by Castle and Wilson-Harvey, represented to Plaintiff and Plaintiff's appointed Board members that RPH was performing well, but that the structural transition to the separate-entity model, in which RPH invoiced the law firms for non-legal services, and the law firms, in turn, billed the clients, was taking time to implement and fine-tune.

According to the Complaint, the Individual Defendants in fact had been invoicing and collecting fees from the law firm clients, but diverting those funds from passing through to RPH as they should have. Castle, for example, specifically is alleged to have directed his law firm, Castle Law Group, not to pay RPH the amount prescribed by the ESAs and instead to remit some portion of the firm's profits.[10] The Wilsons allegedly took payments from clients of their law firm, W&A, that were intended to remunerate RPH for its non-legal services, and used the money to pay W&A's bills or make distributions to the Wilsons themselves, for personal expenses and perquisites.

The Individual Defendants allegedly told Plaintiff repeatedly that operational efficiency issues, combined with the turmoil in the mortgage and housing sectors, were preventing RPH from realizing positive net cash flow. Instead, RPH accumulated significant accounts receivable or "A/R" balances. Plaintiff and Plaintiff's Board appointees questioned these developments, but they allegedly were reassured repeatedly that the payors-i.e., the Individual Defendants and their affiliated law firms-would make good on the A/R. Plaintiff allegedly relied on those representations, finding them plausible in light of the circumstances, especially based on the Individual Defendants' superior on-the-ground understanding of the business and their involvement in the daily management of RPH.

In April 2011, the situation had not improved, and Plaintiff's Board representatives caused RPH to engage the accounting firm of Crowe Horwath, LLP ("Crowe") to investigate and make recommendations regarding RPH's operational efficiency issues, and in particular the A/R collection processes. Due to poor record-keeping, Crowe encountered difficulties in determining how funds were being transferred in and out of RPH. Plaintiff further asserts that, as the investigation progressed, Defendants failed to cooperate fully.

In September 2011, Crowe issued a report containing its findings (the "Crowe Report"). The Crowe Report found that the Individual Defendants and their affiliated law firms had been invoicing and collecting from their clients for the cost of the services provided by RPH, but had been retaining all or part of those payments rather than paying them to RPH in accordance with the "agreed-upon schedules."[11] Crowe also discovered that Castle had tampered with a management representation letter prepared for the accountants in connection with the 2010 year-end audit. Specifically, Castle deleted a representation that he previously had made to the auditors and to Plaintiff and its Board designees that the A/R would be paid.

According to Plaintiff, the Crowe Report revealed extensive wrongdoing on the part of the Individual Defendants, as well as "extensive and long-lasting efforts to conceal the true facts from Plaintiff and its representatives on the Board of Managers." [12]As an example of the affirmative actions Defendants took to misrepresent the state of RPH's affairs, Plaintiff avers that Defendants had fired RPH employees who attempted loyally to carry out the separation of the Services Businesses within the RPH entity structure, but hired and retained employees who were loyal to the Individual Defendants and assisted in their malfeasance.

4. Plaintiff tries unsuccessfully to save RPH

Plaintiff further alleges that the machinations of the Individual Defendants, and in particular Mr. Castle and the Wilsons, placed RPH in danger of engaging in the improper legal services "fee-splitting" against which the Hazard Opinion had counseled them. Equally troubling for RPH, though, was its increasing lack of liquidity. Because Defendants allegedly starved RPH of cash, RPH not only failed to make the preferred distributions as required by the RPH LLC Agreement, but also was doomed to default on its loan obligations. In January 2012, RPH failed to make an interest payment to Freeport Financial. RPH then owed a total of approximately $22 million on the Freeport Credit Agreement, which was secured by the Services Businesses as collateral. RPH also owed $39 million in subordinated notes, mostly held by Defendants. Most vexing was a $20 million balloon payment on the Freeport Credit Agreement that was coming due in August 2012.

In late 2011, Castle was removed as Chairman of the Board of Managers, and an outsider, Michael Bruder, was appointed CEO. Castle was directed to remove himself from RPH's offices, but he refused. Plaintiff's Board appointees and Bruder developed a proposal to restructure RPH, whereby Plaintiff and Freeport Financial each would make a $2.5 million loan, and Freeport Financial would forbear on RPH's recent loan defaults and extend the looming balloon payment. That plan would have subordinated obligations RPH owed to the Castles and the Wilsons to the new loans. Perhaps unsurprisingly, therefore, they rejected it. In March 2012, Plaintiff's Board appointees resigned from their positions in frustration. Two new Board representatives were appointed, but they quickly resigned. No restructuring plan was implemented, and by the summer of 2012, RPH's break-up "was inevitable."[13]

5. RPH's assets are sold in foreclosure-to the Castles and Wilson-Harvey

RPH defaulted on the Freeport Credit Agreement in August 2012, giving Freeport Financial the right to foreclose on its collateral, including RPH's Services Businesses. Plaintiff alleges that, rather than attempt in good faith to restructure RPH's debt and save the Company, the Castles and Wilson-Harvey initiated secret negotiations with Freeport Financial, in which they sought to acquire RPH's assets in an eventual foreclosure sale. According to Plaintiff, Defendants' motivation in this regard was clear: because they had ...

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