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Dietrichson v. Knott

Court of Chancery of Delaware

April 19, 2017

MARTIN G. KNOTT, and NXGENED, LLC, a Delaware limited liability company, Defendants.

          Date Submitted: January 20, 2017

          Robert W. Mallard and Alessandra Glorioso, DORSEY & WHITNEY LLP, Wilmington, Delaware; Attorneys for Plaintiff.

          David S. Eagle and Sally E. Veghte, KLEHR HARRISON HARVEY BRANZBURG LLP, Wilmington, Delaware; Attorneys for Defendants.


          MONTGOMERY-REEVES, Vice Chancellor.

         In this action, Aleksander Dietrichson, one member of a Delaware limited liability company, alleges that another member, Martin G. Knott, breached his fiduciary duties to the company and Dietrichson by improperly paying himself an unauthorized salary and misappropriating the proceeds of an asset sale. Plaintiff alleges that this behavior also deprived him of contractually-mandated distributions and wasted corporate assets.

         Defendants-Knott and the company-move to dismiss the complaint, arguing that all of plaintiff's claims are derivative and that plaintiff has failed to make demand or allege demand futility. Alternatively, defendants contend that plaintiff's fiduciary duty claims are barred by the contract claims; the complaint fails to state a claim for waste; and plaintiff's claims for unjust enrichment and breach of the implied covenant of good faith and fair dealing should be dismissed because the operating agreement's provisions address this issue.

         For the reasons discussed herein, I conclude that plaintiff's fiduciary duty claims are exclusively derivative, and, as plaintiff has not alleged demand futility or that demand was made and wrongfully refused, the claims are dismissed. I also conclude that plaintiff's claims for breach of contractual provisions relating to mandatory distributions are unripe, and because express contracts govern the right to distributions, there is no claim for unjust enrichment. Therefore, the complaint is dismissed in its entirety.

         I. BACKGROUND[1]

         All facts are taken from the verified complaint (the "Complaint") and the NxGenEd, LLC operating agreement (the "Operating Agreement").[2]

         A. Facts

         Plaintiff Aleksander Dietrichson and Defendant Martin G. Knott formed NxGenEd, LLC ("NxGenEd" or the "Company") on September 25, 2014, and each is a 50% member, director, and officer of the Company. Dietrichson and Knott formed the Company for the purpose of marketing intellectual property, including the X-Ray Analytics software platform. Dietrichson contributed the intellectual property to the Company. Knott allegedly would use his expertise and contacts in the field to gain investors and customers for the Company. Saint Bernard, Inc. ("Saint Bernard") and X-Ray Research SRL ("X-Ray Research") provided the services to develop the Company's intellectual property. Dietrichson is the director of Saint Bernard and owns a majority interest in X-Ray Research.

         Under a purported oral agreement, X-Ray Research further developed the X-Ray Analytics software for the Company and received $18, 500 per month for those services. Saint Bernard and the Company entered into a services agreement under which Saint Bernard would provide services as an independent contractor and all work product (and corresponding rights) created by Saint Bernard would be the property of the Company.

         Under the Operating Agreement, Dietrichson and Knott, as members, are entitled to certain distributions, but no salary. The Operating Agreement also requires the board of directors to approve any salary to a director.[3] In the event of a deadlock, "the vote upon such matter will be determined reasonably and in good faith by Knott."[4] The board of directors has never approved a salary for any director or employee, and Knott never requested a salary from the board. The board has never approved an operating budget for the Company.

         Around February 2015, the Company faced a liquidity shortage. It had only $1, 500 in cash on hand, no revenue, and "a total monthly cash burn of $45, 800."[5] During this time, the Company terminated its contract with Saint Bernard but continued to use X-Ray Research and the X-Ray Analytics software platform. Dietrichson allegedly offered to buy out Knott to regain ownership of the intellectual property of the Company, but Knott rejected that offer. Knott instead proposed terms for a sale of the Company's assets to Blackboard, Inc. ("Blackboard"). The Complaint alleges that, under the proposed deal terms for the sale (the "Deal Terms"), Blackboard would buy the Company's assets, and the proceeds from the sale would be distributed in the following order: (1) creditors; (2) members of the board other than Dietrichson and Knott; and (3) Dietrichson, receiving two-thirds, and Knott, receiving one-third. After these distributions, Knott would resign from the Company and cease all involvement.

         On June 25, 2015, Blackboard and the Company executed an asset purchase agreement (the "Asset Purchase Agreement") in which Blackboard purchased substantially all of the Company's assets for $250, 000, excluding the assumption of liabilities. The payment would be composed of a $175, 000 up-front payment and a "Holdback Amount" of $75, 000 that Blackboard would pay within 30 days after the first anniversary of the closing date (the up-front payment and the Holdback Amount, collectively, the "Sales Proceeds").

         On August 10, 2015, Dietrichson sent a letter requesting copies of bank statements, explanations of payments, and confirmation that Knott had not paid Company funds to himself, his family, or any affiliates (the "August 10 Letter"). None of the financial information requested in the August 10 Letter was provided. On September 14, 2015, counsel for the Company, Mark A. Saudek from the firm Gallagher Evelius & Jones LLP ("Gallagher"), replied stating Knott had not made distributions to himself, his family, or affiliates but had paid himself a salary in compliance with Maryland and federal law.

         On October 12, 2015, Dietrichson made a demand on the Company under Section 18-305(a) of the Delaware Limited Liability Company Act and Section 8.1 of the Operating Agreement to inspect the Company's books and records.

         On November 12, 2015, Dietrichson filed a Verified Complaint for Inspection of Business Records in this Court (the "Books and Records Action"). In response to the demand, Knott sent Dietrichson copies of the Company's bank statements with annotations from Knott. The statements show $137, 398.91 in payments to Knott dating back to January 2015. The statements also show transfers of $28, 488.18 to Gallagher in July and October 2015, after the sale to Blackboard, (the "Gallagher Transfers"). The balance of the Company's account as of October 29, 2015, was $3, 009.71. Knott allegedly has not provided and denies the existence of any engagement agreement between the Company or Knott and Gallagher. Knott has not provided billing statements from Gallagher to show whether these services were for Knott in his individual capacity or "were paid as Knott's portion of the Operating Agreement's related legal fees for which he already received a credit."[6]

         Knott's response also contained an assertion that both he and Dietrichson approved the Company's budgets and that Dietrichson has copies of those budgets. Dietrichson allegedly possesses only a pro forma budget developed before the Company was formed, which Knott used as a marketing tool during demonstrations to potential investors. The board never approved that budget. It was not an operating budget, and it was based on the assumption the Company would engage in revenue-earning operations through 2017. It does not include expenses such as payments for services to Saint Bernard or X-Ray Research. Further, the Company never relied on any budget because it never generated revenue.

         B. Procedural History

         On February 5, 2016, Dietrichson filed the Complaint in this Court against Knott and the Company. On March 30, 2016, Defendants filed the motion to dismiss. Following briefing by the parties, on September 16, 2016, this Court held oral argument on the motion to dismiss. The parties submitted supplemental briefing on January 20, 2016.

         II. ANALYSIS

         A. Legal Standard

         When considering a motion to dismiss under Rule 12(b)(6), this Court must "accept as true all of the well-pleaded allegations of fact and draw reasonable inferences in the plaintiff's favor."[7] While the Court must draw all reasonable inferences in the plaintiff's favor, it is not "required to accept as true conclusory allegations 'without specific supporting factual allegations.'"[8] "[D]ismissal is inappropriate unless the 'plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof."[9]

         When analyzing whether a claim is direct or derivative, "[t]he Court will independently examine the nature of the wrong alleged and any potential relief to make its own determination of the suit's classification. This determination is for the Court to make based upon the body of the complaint; plaintiffs' designation of the suit is not binding."[10] In order to determine whether a claim is direct or derivative, the Delaware Supreme Court held in Tooley v. Donaldson, Lufkin & Jenrette, Inc. that the Court must apply a two-part test: "(1) who suffered the alleged harm (the company or the suing stockholder, individually); and (2) who would receive the benefit of any recovery or other remedy (the company or the stockholder, individually)."[11]

         With respect to derivative actions, Court of Chancery Rule 23.1 requires that the complaint "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort."[12] The Delaware Limited Liability Company Act provides that:

A member or an assignee of a limited liability company interest may bring an action in the Court of Chancery in the right of a limited liability company to recover a judgment in its favor if managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed.[13]

         Thus, a complaint must "set forth with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort."[14] In other words, a plaintiff member or assignee of a limited liability company attempting to bring a derivative action must allege with particularity either that she made demand and it was wrongfully refused or why such demand would be futile.

         B.Dietrichson's Fiduciary Duty and Waste Claims Are ...

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