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Dore v. Sweports, Ltd.

Court of Chancery of Delaware

January 31, 2017

JOHN A. DORE, MICHAEL J. O'ROURKE, AND MICHAEL C. MOODY, Plaintiffs,
v.
SWEPORTS, LTD., Defendant.

          Submitted: November 15, 2016

          Bruce E. Jameson, John G. Day, PRICKETT, JONES & ELLIOT, P.A., Wilmington, Delaware; Robert E. Williams, O'ROURKE & MOODY, Chicago, IL; Counsel for John A. Dore, Michael J. O'Rourke, and Michael C. Moody.

          Paul D. Brown, Joseph B. Cicero, CHIPMAN BROWN CICERO & COLE, LLP, Wilmington, Delaware; Anthony S. Divincenzo, Robert W. Queeney, DIVINCENZO SCHOENFIELD AND SWARTZMAN, Chicago, Illinois; Counsel for Sweports, Ltd.

          MEMORANDUM OPINION

          LASTER, Vice Chancellor.

         Plaintiffs John Dore, Michael O'Rourke, and Michael Moody seek indemnification from defendant Sweports Ltd. for expenses[1] incurred in three proceedings that took place in Illinois. This post-trial decision awards them $241, 492.50 for the Illinois proceedings, plus 20% of the expenses they incurred enforcing their indemnification right through this proceeding.

         I. FACTUAL BACKGROUND

         Trial took place on March 16-17, 2016. The parties submitted over two hundred exhibits. Each of the plaintiffs testified live. The parties relied as well on the deposition testimony of the plaintiffs and four non-parties: George Clarke, who was a central figure in the underlying dispute; Andrew G. Chenelle, who participated with the plaintiffs in one of the transactions that led to the underlying dispute; Thomas Courtney, who served as an expert witness in the Illinois litigation; and Robert Queeney, an attorney for Sweports in the Illinois litigation who served as forwarding counsel in this case. The following facts were proven by a preponderance of the evidence.

         A. Sweports

         Sweports is a Delaware corporation with its principal office located in Skokie, Illinois. It is a holding company that owns intellectual property rights for cleaning products and a majority interest in UMF Corporation, an Illinois corporation. PTO ¶ 1.

         The businesses and internal affairs of Sweports and UMF are inextricably linked. UMF uses technology licensed from Sweports to manufacture anti-microbial cleaning products that are sold primarily in the healthcare and hospitality industries. Sweports also engages in capital-raising activities and provides funding for UMF.

         Clarke founded both Sweports and UMF. He is the majority stockholder and chief executive officer of Sweports, as well as a member of its board. Through these roles, Clarke controls Sweports. Through his control over Sweports, Clarke controls UMF. He also serves as UMF's chief executive officer and as a member of its board.

         B. The Initial Sandbox Deal

         In 2005, UMF needed capital. Clarke contacted Sandbox Industries, LLC, a venture capital firm. In November 2005, Sandbox agreed to provide UMF with strategic, financial, and managerial consulting services in return for warrants to purchase approximately 30% of UMF's equity. See JX 139 at 1.

         One of Sandbox's specific tasks was to help UMF raise up to $1 million in financing. Sandbox proved unable or unwilling to locate external financing for UMF. Instead, between December 9, 2005, and February 20, 2006, Sandbox loaned $1.7 million to UMF (the "Sandbox Loan"). The consideration for the Sandbox Loan included warrants to purchase an additional 17.2% of the equity in UMF. Sandbox also received the right to designate a member of the UMF board and the right to obtain board control in the event of default by expanding the board and filling the resulting vacancies. Id. at 1-2; JX 107 at 1.

         Joseph Feldman, a managing member of Sandbox, joined the UMF board. JX 139 at 2. At that time, the UMF board comprised Clarke, Feldman, and Barry White.

         C. Sandbox Introduces Clarke To The Law Firm.

         In July 2006, Clarke and Sandbox began discussing further investments by Sandbox. The discussions progressed sufficiently that Clarke needed counsel to render a tax opinion. Nick Rosa, a principal at Sandbox, suggested O'Rourke, a Chicago lawyer. Rosa was O'Rourke's "good friend and client." Tr. 141 (O'Rourke). Rosa reached out to O'Rourke and asked him to work with Clarke. Id.

         Sweports formally retained O'Rourke Katten & Moody LLP[2] pursuant to an engagement letter dated July 12, 2006. See JX 93. Sweports also retained John Perkaus of the law firm of Perkaus & Farley, whom O'Rourke brought in to provide additional transactional expertise. Id. O'Rourke added his partner, Moody, to the engagement because Moody had the expertise to render a tax opinion. See JX 93; Tr. 27 (Moody).

         D. Clarke Ends The Sandbox Relationship.

         In September 2006, the negotiations over the Sandbox investment reached an impasse. Sandbox upped the ante by claiming that UMF had defaulted on the Sandbox Loan. Sandbox notified UMF that it was exercising its right to appoint a majority of the UMF board. If successful, Sandbox would have gained control over UMF. JX 139.

         Clarke enlisted the Law Firm to defend against the takeover attempt. In early November 2006, the Law Firm negotiated a settlement with Sandbox. JX 108.

         The settlement called for UMF to pay Sandbox the amounts due under the Sandbox Loan and to buy out Sandbox's equity interest in UMF. See Tr. 30 (Moody); Tr. 144-45 (O'Rourke). The terms contemplated UMF making three significant cash payments to Sandbox between November 2006 and May 2007. The parties appear to have agreed that Feldman would remain on the UMF board until the separation was complete.

         E. The Law Firm Becomes Enmeshed With Its Client.

         UMF needed capital to fund the settlement. Clarke hoped to obtain a credit line of $1.2 million. O'Rourke and Moody told Clarke that they could raise the funds he needed because they had wealthy friends and a relationship with American Chartered Bank (the "Bank"), which was a client of the Law Firm.

         The Bank declined to provide non-recourse financing to Sweports or UMF. The Bank agreed to extend a loan to Sweports if individuals of means guaranteed it. O'Rourke and Moody therefore structured a financing transaction in which (i) the Bank loaned $500, 000 to Sweports (the "Bank Loan") and (ii) the plaintiffs and non-parties Chenelle and Lee Abrams guaranteed the loan. Tr. 145 (O'Rourke); Clarke Dep. at 54; JX 97.

         Sweports and the guarantors memorialized their part of the financing transaction in two poorly drafted documents. One of the documents was a promissory note. JX 5.0022 (the "Note"). In it, Sweports committed to repay the Bank Loan and to treat any amounts that the guarantors had to pay the Bank as amounts due under the Note.

         The other document was a Loan Guaranty and Stock Purchase Agreement. JX 97 (the "Guarantee Agreement"). It provided the guarantors with consideration for guaranteeing the Bank Loan. Each guarantor received a 2% equity interest in Sweports from Clarke, plus an option to buy an additional 1% equity interest from Sweports for $100, 000. Each guarantor also received a preemptive right, styled as an option, to acquire a proportionate share of any additional equity that Sweports issued "for a period of 2 years on the same terms offered to any other person or entity." Id. at 2. The preemptive right protected the guarantors against dilution.

         O'Rourke and Moody also raised money from other investors. In total, they raised approximately $1.3 million for Sweports. UMF received over $1 million of the proceeds in the form of a loan from Sweports.

         In December 2006, each of the plaintiffs exercised the option to acquire another 1% of Sweports stock, raising their combined ownership stake to 9%. By this time, Sweports owed the Law Firm a substantial sum. Pursuant to an agreement dated December 31, 2006, Sweports and the Law Firm agreed to convert $107, 500 of its outstanding receivable into 1.25% of Sweports equity. JX 113; Tr. 56 (Moody). The Law Firm received the same two-year preemptive right to protect itself against dilution.

         During this period, Clarke added O'Rourke and Dore to the Sweports board, and Dore served as Sweports' Chief Operating Officer. They began acting in these capacities in November 2006. See Tr. 8 (Dore). Clarke did not formally appoint O'Rourke and Dore to their new positions until December 26, 2006, when he did so by written consent. JX 112.

         The Law Firm drafted the written consent that Clarke executed. In addition to the appointments, the consent adopted a set of amended and restated bylaws for Sweports. JX 112 (the "Amended Bylaws"). The Amended Bylaws introduced a number of new provisions, including the following:

• Article II, Section 9(c) added a supermajority voting provision that required the affirmative vote of not less than 75% of all outstanding shares entitled to vote for a list of actions that included "the removal from office of a duly elected and qualified Director prior to the expiration of his term." JX 112 at 3. At the time, Clarke owned 73% of Sweports equity. See JX 8 at 10.
• Article IV, Section 3 provided that "[a]ny officer may be removed only for cause, " defined narrowly as the conviction of a felony, a crime involving dishonesty or theft, reckless or intentional misconduct, or breach of fiduciary duty. JX 112 at 7.
• Article VII added mandatory indemnification rights "to the full extent permitted by the Delaware General Corporation Law" for any person "who at any time is or was a director, officer, employee, or agent." Id. at 13-14. This is the provision at issue in this litigation.

         There is reason to believe that when Clarke executed the written consent that adopted the Amended Bylaws, he did not perceive the importance of these provisions. He instead trusted his lawyers and their representation that the changes made by the Amended Bylaws were non-substantive clean-up items. See JX 8 at 33-34; JX 139 at 2, 8-9.

         F. Another Potential Sandbox Deal

         Shortly after O'Rourke and Dore began functioning as directors of Sweports, O'Rourke started discussing a new deal with Sandbox. The concept involved forming an entity to market consumer products that used Sweports' technology. Sandbox would fund the entity and receive in return a supermajority of its equity (the initial proposal was 85%; it ended up at 80%). Sweports would contribute its technology, and UMF would contribute its operating assets. They would receive in return a minority stake (the initial proposal was 15%; it ended up at 20%). Sandbox and O'Rourke hoped to prevent Clarke from having any involvement in the post-transaction entity. They discussed "that a deal won't happen if George [Clarke] is involved." JX 110.

         On January 8, 2007, the Sweports board held a regular meeting. The members at the time were Clarke, O'Rourke, and Dore. The minutes recite that the directors, including Clarke, "unanimously agree[d] to consider and evaluate a joint venture with Sandbox for exploitation of the consumer market." JX 114. At the time, Clarke does not appear to have known important details such as the plan to cut him out of the new venture or the fact that the entities he controlled (Sweports and UMF) would own a minority stake.

         At the same meeting, the directors caused Sweports to add Dore to the UMF board. Dore filled a vacancy created by the death of White, who had been a member of the board. As a result, the members of the UMF board were Clarke, Dore, and Feldman.

         After the meeting, O'Rourke moved forward with new Sandbox deal. Moody handled the negotiations with Sandbox, performed the legal work, and began drafting the implementing documents. Tr. 37 (Moody).

         During a meeting of the Sweports board on February 20, 2007, Dore suggested that O'Rourke replace him on the UMF board. O'Rourke and Dore voted to cause Sweports to act by written consent to appoint O'Rourke to the UMF board. Clarke abstained. Dore subsequently executed a written consent on behalf of Sweports. JX 116.

         Clarke had to leave halfway through the February 20 meeting. After his departure, O'Rourke and Dore resolved that Dore, O'Rourke, Moody, and two other individuals would loan Sweports a total of $125, 000, "secured by the intellectual property and other assets of the Company" and "convertible into common stock of the Company at an agreed upon conversion rate." JX 115 at 3; cf. JX 117. They also doubled Dore's salary to $100, 000 a year, something Clarke opposed, and made the increase retroactive to February 1. Compare JX 115 at 4 with JX 139 at 10.

         G. The Schism Between Clarke And The Law Firm

         After the meeting of the Sweports board on February 20, 2007, Clarke became suspicious. He seems to have gotten the sense that the plaintiffs were plotting with Sandbox against him. Matters came to a head in early March, when Moody and Sandbox reached agreement on the terms of the Sandbox deal. Clarke viewed it as "a takeover of UMF and Sweports by Sandbox." Clarke Interrog. at 4. The record supports his view. See JX 118.

         O'Rourke tried to schedule a joint meeting of the Sweports and the UMF boards to approve the Sandbox deal. He noticed a meeting for March 12, 2007, but Clarke refused to attend. Clarke said he was exploring a competing opportunity with a German company and expected to hear back on March 14. See JX 121; Tr. 151 (O'Rourke).

         O'Rourke did not want to wait. He emailed Dore, Moody, and Perkaus that Clarke had "gone postal." JX 124. Perkaus responded:

Guys -
He [Clarke] doesn't have the power to cancel the meetings[.] I suggest we move forward on Tuesday as planned[.]
From now on no more email[.] I'll call later.

Id.

         O'Rourke re-noticed meetings of the Sweports and UMF boards for Tuesday, March 20, 2007. Clarke tried to cancel the meetings, but O'Rourke, Dore, and Feldman told him they were going forward. During the Sweports meeting, O'Rourke and Dore voted in favor of the Sandbox deal. Clarke voted against. During the UMF meeting, O'Rourke and Feldman voted in favor of the Sandbox deal. Clarke voted against. The UMF board also made O'Rourke general counsel of UMF.

         Promptly after the meetings, Clarke wrote a letter in which he raised numerous objections to the Sandbox deal and to O'Rourke serving as general counsel for UMF. O'Rourke responded with an email in which he berated and belittled Clarke:

Mr. Clarke--With respect to your letter and your restated objections to the actions of the UMF and Sweports Board [sic] on March 20, 2007, including my appointment as general counsel (by the way, the correct spelling for counsel is "counsel" not "council" which means an appointed group or tribunal, the lesson being if you intend to make a strong statement, it would behoove you to know how to spell), I have nothing but astonishment and disappointment in the childish and self-centered way you have behaved. To say you have behaved like a spoiled brat would be an unfair slap to the spoiled brats of this world. Try growing up. As for our actions, the actions we have taken have been entirely lawful. They have been entirely prudent. They have been taken in the best interests of the companies. They have reflected the financial realities of those companies, in contrast to your habit of dealing with our financial realities by setting off on another one your fantasy flights into Never Never [sic] land. Your objections are nonsensical. Thus, I can assure you that wherever you are, the Boards of these companies will continue to press forward to direct these companies in a professional and businesslike fashion. I can also assure you that wherever you are the Boards of Sweports and UMF will continue to work to put these companies on a sound financial footing. Finally[, ] I can assure you that wherever you are, the Boards of these companies will not wait to deal with your obstructionism. Wherever you are, we are going to deal with you now.

JX 130.

         On March 26, 2007, Clarke refused to sign letters announcing the Sandbox deal. In response, O'Rourke noticed a special meeting of the UMF board for April 2, 2007. The agenda included a discussion of the "performance of George Clarke as chief executive officer." JX 132. Clarke believed that O'Rourke and Feldman were going to fire him at the meeting.

         H. Clarke Retakes Control.

         Before the board meeting could take place, Clarke reasserted control over Sweports and UMF. He executed and circulated a document titled "Informal Action in Lieu of a Special Meeting of the Shareholders of UMF Corporation." JX 136 (the "UMF Informal Action"). It is not precisely clear when the UMF Informal Action was prepared, executed, or circulated. The definitive version is dated April 5, 2007, but the record suggests that Clarke signed an earlier version on March 30 and circulated it by email on March 31. See JX 133; JX 139 at 13.

         In the UMF Informal Action, Clark acted in his capacities as CEO and Chairman of the Board of Sweports to cause Sweports to vote its shares of UMF stock in favor of the following actions at UMF:

• A declaration that O'Rourke never had been validly appointed as a director of UMF;
• A declaration that because O'Rourke had never validly been appointed as a director, the approval of the Sandbox deal by a vote of 2-1 was invalid and ineffective; and
• The removal of Feldman as a director of UMF.

JX 136 at 3-4.

         The UMF Informal Action also contained recitals and resolutions directed at the Law Firm. It stated:

• "[T]he Law Firm has also provided legal services and advice to Sweports concerning inter alia, the Alleged Sandbox Deal, the appointment of Michael J. O'Rourke and John A. Dore to the Sweports' Board of Directors, the Sweports Corporation's By-laws, and the provisions of Sweport's stock purchase agreements to the principals of the Law Firm . . . and . . . to the Law Firm."
• "[T]he Law Firm has demanded payment for alleged legal services . . . that were negligently performed, not performed in the best interests of [UMF] or its shareholders, and in breach of the Law Firm's fiduciary duties to the corporation and its shareholders."
• "None of the monies sought by the Law Firm from [UMF] are in fact owed, due or payable, and upon information and belief, the Law Firm is in material part responsible for damages due to the Corporation from its acts and omissions, including without limitation, damage from the Alleged Sandbox Deal."

Id. at 4-5. The UMF Informal Action then resolved that "the value of any invoices or demands for payment . . . by the Law Firm is zero; that no claims for services by the Law Firm has or could be deemed to constitute any consideration for any of [UMF's] stock; and that [UMF] including any of its Directors and Officers shall not tender, sell or exchange any of [UMF's] stock in consideration of any such demand or claim by the Law Firm." Id.

         At some point, Clarke executed a similar document relating to Sweports. Based on a later document he executed on June 23, 2007, in which he described himself as "the sole director" of Sweports, he must have acted previously by written consent to remove O'Rourke and Dore as directors of Sweports. There are references to such a document in the record. See JX 133; JX 139 at 11-12.

         In addition to taking legal control, Clarke asserted physical control over the companies' offices and their property. He changed the locks and refused to let Dore onto the premises. Tr. 35 (Moody). He also took control of the companies' books and records.

         On April 10, 2007, Clarke met with representatives of Sandbox. In return for a substantial payment from UMF, Sandbox agreed that there were no effective agreements among Sandbox, UMF, and Sweports. Feldman resigned from the UMF board. See JX 138.

         In June 2007, Clarke executed a document titled "Informal Action in Lieu of a Special Meeting of the Directors of Sweports Ltd." JX 139 (the "Sweports Informal Action"). The document's detailed recitals spanned fourteen pages and recounted the history of the transactions and interactions among Sweports, UMF, the Law Firm, Sandbox, and their principals. The document adopted the following resolutions:

1. . . . [A]ll of the above described agreements and actions . . . are part of one integrated and indivisible transaction and scheme committed and furthered by Sandbox, [the Law Firm], . . . Messrs. O'Rourke, Moody, . . ., Dore, [and others].
2. Those business transactions by and between Sweports and Counsel and Mr. Dore . . . resulted from the self-dealing of Counsel and Dore, are unfair to, and never knowingly or properly approved by Sweports . . . and were effected as a direct result of the negligent, reckless and/or intentional breaches of the fiduciary duties owned by Counsel as attorneys, Messrs. O'Rourke, Moody and Dore as financial brokers and agents, and Messrs. O'Rourke [and] Dore . . . as Directors and/or Officers of Sweports and UMF, as set forth above and accordingly, Sweports rescinds all such agreements and actions, including all stock rights and certifications granted and/or issued to [the Law Firm] and Messrs. O'Rourke, Moody, . . . Dore, [and others].
3. Their various relationships with Sweports and UMF benefited Messrs. O'Rourke, Moody and Dore . . . Sweports and UMF received nothing of value in connection with the legal services and advice provided by [the Law Firm] or the work purportedly performed by Mr. Dore and, in contrast, suffered significant economic injury as a result of same . . .; accordingly, and because the rescission of these agreements and related agreements shall be addressed by some court of equity, Sweports has no obligation to return any such alleged consideration as part of this rescission of the above described documents and certificates, including specifically, the $100, 000 paid to Sweports by Messrs. O'Rourke, Moody and Dore in connection with their respective purchases of 1% of Sweports common stock . . ., although Sweports will tender any such legitimate repayment, if any, when and to the extent that by final court order it is required to do so.
4. All of those other 2006 agreements purportedly entered into by UMF and/or Sweports . . . were effected as a direct result of this same . . . self-dealing, negligent, reckless and/or intentional breaches of the fiduciary duties owed by Counsel and Mr. Dore to Sweports and UMF . . . and, accordingly, to the extent that Sweports was a party to and/or it approved any such agreement or transactions, Sweports hereby rescinds all such transactions and agreements . . . .
. . . .
7.. Sweports hereby rescinds all retention agreements, if any, by and between it and [the Law Firm] . . . and all of their individual lawyers in their entirety.
8. Because of the above described acts and omissions of Counsel and Dore, Sweports hereby resolve, determines, and declares that it owes no monies whatsoever to any of these entities or individuals other than any amount found due and owing by a Court sitting in equity.
9. Sweports hereby resolves, determines and declares that the [Amended Bylaws] were null and void at the time of their purported approval and to the extent that one or more of the terms of these By-Laws might be construed as valid, Sweports hereby revokes, ...

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