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
...