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Meyers v. Quiz-Dia LLC

Court of Chancery of Delaware

March 16, 2018

PATRICK E. MEYERS et al., Plaintiffs,
v.
QUIZ-DIA LLC et al., Defendants. QUIZ-DIA LLC et al., Third-Party Plaintiffs,
v.
ROCKFORD MANAGER LLC et al., Third-Party Defendants.

          Date Submitted: January 18, 2018

          John T. Dorsey, Richard J. Thomas, Emily V. Burton, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Bruce S. Bennett, Christopher Lovrien, JONES DAY, Los Angeles, CA; Attorneys for Plaintiffs.

          Blake Rohrbacher, Susan M. Hannigan, Elizabeth A. DeFelice, Brian F. Morris, RICHARDS, LAYTON & FINGER, P.A., Wilmington, DE; Attorneys for Defendants.

          MEMORANDUM OPINION

          LASTER, V.C.

         In an opinion dated June 6, 2017, [1] this court granted summary judgment in favor of Greg MacDonald and Dennis Smythe, holding that they were entitled to indemnification from defendants Quizmark LLC and QCE Gift Card LLC (together, the "Subs") for losses they incurred defending against claims filed against them in Colorado federal court (the "Colorado Federal Action"). The Entitlement Decision did not quantify the amount of the indemnification award. Instead, the decision instructed the parties to confer and stated that if they could not agree, then MacDonald and Smythe could make an application pursuant to Court of Chancery Rule 88.[2] The parties could not agree.

         MacDonald and Smythe filed the pending motion to quantify the amount of their indemnification award. They are not the only movants. To date, Consumer Capital Partners LLC ("Consumer Capital") has paid all of MacDonald and Smythe's expenses. Consumer Capital seeks to recover those amounts from the Subs, claiming it is entitled to assert, by way of subrogation, the indemnification rights held by MacDonald and Smythe.

         This decision holds that Consumer Capital can recover $145, 571.86 for the expenses it paid for the defense of the claims asserted in the Colorado Federal Action.[3] Pre- and post- judgment interest on the expenses shall accrue from August 21, 2015. This decision awards Consumer Capital $125, 000 in fees-on-fees for funding this enforcement action. Pre- and post-judgment interest on the fees-on-fees shall accrue from August 30, 2017.

         I. FACTUAL BACKGROUND

         The facts are drawn from the Entitlement Decision and the parties' submissions in connection with the Rule 88 application. The Entitlement Decision ruled on cross motions for summary judgment where the parties did not identify any material disputes of fact. The cross motions therefore were deemed "the equivalent of a stipulation for decision on the merits based on the record submitted with the motions."[4] Consequently, the facts recited in the Entitlement Decision represent factual findings for purposes of the case.

         A. The Parties

         At the time of the events giving rise to this decision, QCE LLC ("OpCo") was the primary operating entity for the Quiznos sandwich shop empire. The Subs were subsidiaries of OpCo. Quizmark was a Delaware limited liability company. QCE Gift Card was an Arizona limited liability company. Both Subs had operating agreements that granted their officers a right to mandatory indemnification.

         MacDonald was the Chief Executive Officer of OpCo. Smythe was the Chief Financial Officer of OpCo. MacDonald and Smythe were also officers of the Subs.

         Consumer Capital is a Delaware limited liability company controlled by Richard E. Schaden and Richard F. Schaden. Before the restructuring discussed in this decision, the Schadens beneficially owned a 51% interest in the Quiznos family of companies.

         B. The Threatened Claims

         In 2006, Quiznos engaged in a leveraged recapitalization. To fund the transaction, OpCo borrowed a total of $875 million. OpCo subsequently suffered financial reversals.

         By 2012, various funds affiliated with Avenue Capital Management II, L.P. and Fortress Investment Group LLC (the "Funds") had accumulated a substantial position in OpCo's debt. Their holdings gave them the power to declare a default under OpCo's loan agreements and pursue remedies as creditors. To neutralize that threat, Quiznos entered into a complex out-of-court restructuring with its creditors (the "Restructuring"). In practical terms, the Restructuring transferred ultimate ownership of Quiznos and its subsidiaries, including the Subs, to the Funds.

         In July 2012, MacDonald and Smythe left Quiznos. In summer 2013, the Funds asked MacDonald and Smythe to attend meetings with Fund representatives in New York City and Denver. Suspecting that the Funds were contemplating litigation, MacDonald and Smythe retained Jones Day to investigate potential claims that the Funds might pursue. At the meetings, the Funds interrogated MacDonald and Smythe about the Restructuring, expressed frustration with the Restructuring and Quiznos' post-transaction performance, and disclosed their intention to file a lawsuit.

         C. The OpCo Bankruptcy

         On March 14, 2014, OpCo and a number of its affiliates-but not the Subs-filed for bankruptcy. Their filings disclosed that "[t]he Reorganized Debtors [and the Funds] w[ould] enter into [a] Specified Litigation Agreement" to pursue "Specified Litigation Claims" against various individuals, including MacDonald and Smythe.[5] The plan of reorganization defined the term "Specified Litigation Claims" as encompassing "all claims and causes of action made, or which could be made, on behalf of the Debtors [or the Funds] against" the named individuals.[6] An exhibit to the plan stated that the Funds intended to pursue "any claims and rights they or their affiliates may have against former management and former owners of the Company relating to the [Restructuring] and any forecasts, projections, models, representations, or warranties made or provided in connection therewith . . . ."[7]

         As originally proposed, the plan sought to limit the ability of former officers like MacDonald and Smythe to defend against the litigation that the Funds had threatened by constraining their ability to assert counterclaims or setoffs. The plan sought to achieve this end by discharging and enjoining the former officers from asserting counterclaims based on pre-petition events or claiming setoffs for pre-petition amounts in any future litigation with the debtors.[8] The plan also sought to permanently enjoin former officers from asserting counterclaims or claiming setoffs in any litigation with former Quiznos entities or their equity holders and affiliates, including the Funds and Subs, which were included in the definition of "Released Party."[9] As originally drafted, the plan also included provisions that would broadly exculpate non-fiduciaries, including the Funds.[10]

         In addition, the plan originally sought to subordinate any claims by former officers like MacDonald and Smythe, including indemnity claims, to the rights of Quiznos' unsecured creditors.[11] Because the unsecured creditors were not paid in full under the plan, the plan proposed to discharge the subordinated claims and prohibit them from being asserted against both debtors and non-debtors, including the Funds.[12]

         If these provisions had remained in the plan, then they would have significantly prejudiced the ability of former officers like MacDonald and Smythe to respond to and defend themselves against litigation brought by the Funds, such as the threatened claims involving the Restructuring. The provisions would have prevented MacDonald and Smythe from asserting counterclaims or claiming setoffs against the Funds and functionally eliminated their indemnification rights.

         To protect their rights, MacDonald and Smythe had Jones Day filed proofs of claims in the bankruptcy proceeding. They also filed objections to the plan. The parties negotiated a revised plan that removed the subordination provision, preserved MacDonald and Smythe's indemnification rights against non-debtors, and made other changes favorable to MacDonald and Smythe.[13]

         D. Litigation Between The Parties

         On July 1, 2014, MacDonald, Smythe, and other former officers of Quiznos demanded advancement and indemnification from the Subs based on the imminent threat of suit by OpCo and the Funds.[14] The letter sought advancement and indemnification under what the parties have referred to as the "Assignment Agreement." The letter asked the Subs to "respond within 10 days."[15]

         On July 10, 2014, just before the ten-day period expired, MacDonald, Smythe, and other officers of Quiznos filed this lawsuit in which they sought to establish their rights to indemnification and advancement under the Assignment Agreement. The parties refer to the claims seeking indemnification and advancement under the Assignment Agreement as the "Assignment Agreement Claims."

         On July 22, 2014, the Funds filed the Colorado Federal Action in the United States District Court for the District of Colorado (the "Colorado Federal Court"). The complaint alleged that MacDonald, Smythe, and other former officers of Quiznos had induced the Funds to participate in the Restructuring by creating financial projections that "made it appear that the debt burden and capital structure that would remain in place post-[Restructuring] would be sustainable and appropriate."[16] The complaint also alleged that the projections were false or misleading. The Funds asserted claims for violations of the federal securities laws and common law fraud. Although the complaint in the Colorado Federal Action named multiple defendants, it focused primarily on MacDonald and Smythe. It asserted claims for secondary liability against the other defendants.

         The defendants in the Colorado Federal Action moved to dismiss the lawsuit on various grounds. Meanwhile, in this action, I denied the Subs' motion to dismiss the plaintiffs' claims.[17] The parties proceeded with discovery. During that process, the plaintiffs obtained copies of the Subs' operating agreements and determined that those documents provided MacDonald and Smythe with advancement and indemnification rights.

         In letters dated August 21, 2015, MacDonald and Smythe demanded advancement and indemnification under the Subs' operating agreements. In September 2015, the plaintiffs amended their complaint to add claims under the Subs' operating agreements.[18]The parties refer to the claims seeking indemnification and advancement under the Subs' operating agreements as the "Operating Agreement Claims."

         On September 17, 2015, the Colorado Federal Court dismissed the Colorado Federal Action. The court did not dismiss the action on the merits, but rather held that federal jurisdiction did not exist because the claims did not fall within the scope of the Securities Exchange Act of 1934. The Funds appealed the ruling to the United States Court of Appeals for the Tenth Circuit.

         Consumer Capital had been paying the expenses that MacDonald, Smythe, and the other defendants were incurring in the Colorado Federal Action. In December 2015, the plaintiffs in this action amended their complaint for a second time.[19] In this pleading, Consumer Capital joined as an additional plaintiff and asserted claims for subrogation. In May 2016, the plaintiffs amended their complaint for a third time. This amendment dropped certain claims and added counts seeking indemnification and advancement under MacDonald and Smythe's employment agreements. Consistent with other labels, this decision calls these counts the "Employment Agreement Claims."

         In July 2016, the parties in this action cross-moved for summary judgment. After briefing and argument, I issued a ruling dated November 30, 2016, that dismissed the plaintiffs' claims for indemnification as premature pending the final disposition of the Colorado Federal Action.[20] I issued a ruling dated December 2, 2016, that stayed the Employment Agreement Claims in favor of arbitration.[21] In a ruling dated January 9, 2017, I granted summary judgment in favor of the defendants on the Assignment Agreement Claims.[22] As a result of these rulings, the only claims remaining in this action were the Operating Agreement Claims asserted by MacDonald and Smythe.

         Meanwhile, on December 13, 2016, the United States Court of Appeals for the Tenth Circuit affirmed the Colorado Federal Court's order dismissing the Colorado Federal Action. The plaintiffs moved to vacate my order that dismissed their claims for indemnification as premature, arguing that the appellate decision constituted a final disposition. The defendants argued that it was still possible for them to seek certiorari. Whether a pending opportunity to seek certiorari rendered a decision non-final for purposes of indemnification presented an interesting legal issue, but because there was only a short time remaining before the deadline for seeking certiorari would pass, I stayed further proceedings on the Operating Agreement Claims until it was known whether or not the Funds had sought certiorari.[23]

         In March 2017, the deadline passed without the Funds seeking certiorari. As a result, the dismissal of the Colorado Federal Action became indisputably final.[24] This development meant that the claims for advancement under the Operating Agreements were moot while the claims for indemnification were now ripe. The parties agreed to provide supplemental briefing on the indemnification issues.[25]

         On July 7, 2017, I issued the Entitlement Decision, which held that MacDonald and Smythe were entitled to mandatory indemnification from the Subs "for the amounts they incurred preparing for and defending the Colorado [Federal] Action."[26] The Entitlement Decision did not address Consumer Capital's subrogation claim or the specific amount of indemnification to which MacDonald and Smythe were entitled.

         The Entitlement Decision instructed the parties to confer on the amount of indemnification. The parties could not agree, and Consumer Capital, MacDonald, and Smythe moved pursuant to Court of Chancery Rule 88 to quantify the amount of the award.

         II. LEGAL ANALYSIS

         In their Rule 88 application, Consumer Capital, MacDonald, and Smythe seek indemnification for expenses totaling $1, 373, 164.41. Of this amount, $552, 417.87 relates to the defense of the Colorado Federal Action. Included in this amount is $203, 470.44 incurred in connection with the OpCo bankruptcy. The remaining $820, 746.54 is for fees-on-fees incurred pursuing this litigation through July 31, 2017.

         The Subs have not challenged the reasonableness of any individual expenses. Rather, they have advanced arguments designed to cut away broad swathes of the total amount. If all of their arguments succeeded, then they would owe nothing to MacDonald and Smythe and only $31, 000 to Consumer Capital.

         A. Consumer Capital's Right To Subrogation

         In what is potentially their most significant argument, the Subs focus on the fact that Consumer Capital has paid all of the expenses that MacDonald and Smythe otherwise would have incurred to date in the Colorado Federal Action and in this proceeding. The Subs correctly observe that because of this fact, MacDonald and Smythe cannot recover any amounts in their own right. Instead, Consumer Capital must proceed by way of subrogation. The Subs believe that Consumer Capital cannot meet the requirements for subrogation for any of Smythe's fees or for the vast majority of MacDonald's fees. In my view, Consumer Capital is entitled to seek subrogation for all of the amounts that it paid on behalf of MacDonald and Smythe.

         "When a purported indemnitee has all of his indemnifiable expenses paid in full and cannot show an out-of-pocket loss, he has no claim for indemnification under section 145."[27] This is because Section 145 represents "a statutory embodiment of the common law of indemnification, " under which the party bringing the claim must have sustained an out-of-pocket loss.[28] As a result, when an indemnitee's expenses have been paid by another party, "the indemnitee lacks standing to assert an indemnification claim against the other indemnitor in the indemnitee's own right."[29] Under this rule, MacDonald and Smythe cannot recover any amounts in their own right.

         When another party has paid expenses on behalf of an indemnitee, that party can seek to enforce the indemnitee's rights by way of subrogation.[30] Under this doctrine, the payor "stand[s] in [the indemnitee's] shoes and may demand full payment from another party primarily responsible for the loss."[31] The payor succeeds to the right of payment held by the indemnitee and can enforce that right to the same extent (and subject to the same defenses) as the indemnitee.[32] To succeed, the party asserting a claim for subrogation (the "subrogee") must show that the defendant is primarily obligated for the loss, that the subrogee is secondarily responsible for the loss, and that by paying the loss, the subrogee satisfied the defendant's liability for the loss.[33] "One who pays the debt of another at his direct or indirect request is, therefore, usually entitled to subrogation."[34] "Ultimately, each subrogation claim turns on its specific facts and must therefore be decided on a case-by-case basis."[35]

         1. Primary Versus Secondary Responsibility

         The Subs claim that Consumer Capital cannot proceed by way of subrogation because it was not secondarily liable for the loss. Absent a contractually established hierarchy of obligations, Delaware law treats indemnitors as having equal responsibility for a loss and does not imply any primary-versus-secondary distinction.[36] Parties must establish the secondary nature of an obligation by contract. No particular magic words are required; the agreement need only contemplate that the indemnification obligation it establishes is secondary to another obligation.[37]

         MacDonald entered into an agreement with Consumer Capital dated June 19, 2014, which makes Consumer Capital's indemnification obligation secondary to the indemnification provided by the Subs. Sections 14(a) and (b) of the agreement state:

(a) The rights to payment of Indemnifiable Amounts and advancement of Indemnifiable Expenses provided by this Agreement are supplemental and secondary to, and not exclusive of, any rights which Indemnitee may otherwise have against QCE Finance LLC, [OpCo] or any of their subsidiaries ...

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