Date
Submitted: March 6, 2018
Philip
Trainer, Jr., Esquire Marie M. Degnan, Esquire Ashby &
Geddes.
Stephen P. Lamb, Esquire Meghan M. Dougherty, Esquire Paul,
Weiss, Rifkind, Wharton & Garrison LLP.
Elizabeth A. Sloan, Esquire Ballard Spahr LLP.
Dear
Counsel:
I
addressed the Defendants' Motions to Dismiss in my
Memorandum Opinion of November 30, 2017, granting the Motions
in part, denying in part, and reserving decision in
part.[1] The Plaintiff moved for reargument, in
part, of that Memorandum Opinion. This Letter Opinion denies
that Motion, and resolves the remaining issues regarding the
Motions to Dismiss. An adumbration of the pertinent facts,
and my reasoning, follows.
I.
BACKGROUND[2]
In this
case, Plaintiff RCS Creditor Trust alleges that Defendants
Nicholas S. Schorsch, Edward M. Weil, Jr., William M. Kahane,
Peter M. Budko, and Brian S. Block (collectively, the
"Control Defendants") breached the fiduciary duties
they owed to RCS Capital Corporation
("RCAP").[3] The Control Defendants were the sole
owners of Defendant AR Capital LLC, which created and
sponsored non-traded real estate investment trusts
("REITs").[4] The Control Defendants also controlled
RCAP, which marketed and distributed AR Capital's
investment products through a subsidiary known as Realty
Capital Services ("RCS").[5] After RCAP went public, the
Control Defendants retained only a 25% interest in the
company.[6] They maintained effective control,
however, through their collective ownership of a single share
of super-voting common stock.[7]
The
Complaint primarily challenges the Control Defendants'
use of their dual control of AR Capital and RCAP to enrich
themselves at the expense of RCAP's public
stockholders.[8] The Control Defendants allegedly hatched a
scheme in which RCAP and RCS would enter into off-market
wholesaling arrangements with AR Capital.[9] In those
arrangements, RCAP was responsible for marketing and selling
AR Capital's investment products.[10] If the
Control Defendants had been loyal RCAP fiduciaries, the
Plaintiff alleges, they would have bargained for RCAP to
receive advisory fees from AR Capital in exchange for
performing wholesaling services; instead, the Control
Defendants diverted those fees to wholly owned subsidiaries
of AR Capital.[11]
The
Complaint additionally challenges several other business
decisions the Control Defendants made for RCAP.[12] Specifically,
the Control Defendants caused RCAP to pursue three imprudent
acquisitions and maintain irrationally high staffing levels
at RCS.[13] The overstaffing purportedly benefited
AR Capital by enhancing RCS's ability to market and sell
AR Capital's investment products.[14] But the
Control Defendants' refusal to fire any RCS employees
harmed RCS, which was suffering "devastating losses that
ultimately drove [it] into bankruptcy."[15]
On
November 30, 2017, I upheld the core fiduciary duty claim in
this case- namely, the challenge to the self-dealing
transactions between AR Capital, in which the Control
Defendants held a 100% economic stake, and RCAP, which they
controlled but in which they held only a 25%
interest.[16] I described the core claim as a classic
example of self-dealing by corporate
fiduciaries.[17] Indeed, the Control Defendants stood on
both sides of the allegedly unfair wholesaling
arrangements.[18]Worse still, all of those arrangements
were negotiated and approved solely by the Control Defendants
and their affiliates.[19] The allegations about the core claim
thus invoked entire fairness review, which in turn precluded
dismissal on a Rule 12(b)(6) motion.[20]
I
reached a different conclusion as to the imprudent
acquisitions and the purportedly irrational staffing
decisions. Because the Control Defendants did not stand on
both sides of those transactions, they did not automatically
trigger entire fairness review.[21] Thus, to rebut the
presumptions of the business judgment rule, the Plaintiff had
to allege that the challenged transactions conferred material
benefits on the Control Defendants that were not shared with
RCAP's other stockholders.[22] I held that the Plaintiff had
failed to meet this pleading burden.[23] In my view, the
Plaintiff's allegations about the Control Defendants'
financial circumstances and the benefits conferred by the
challenged decisions failed to support a reasonable inference
that those benefits were material to them.[24] Turning to
the overstaffing allegations in particular, the pertinent
theory is that during a period when RCS was increasingly less
profitable, staffing levels were maintained; the Plaintiff
alleges they should have been reduced.[25] With respect
to that theory, I noted that the "Plaintiff provide[d]
no details that allow[ed] me to quantify any benefit to AR
Capital from having additional staff members at RCS push AR
Capital product."[26]Thus, I held that the allegations
relating to the imprudent acquisitions and the overstaffing
at RCS failed to state a claim for breach of the duty of
loyalty.[27] I reserved decision on the
Plaintiff's claims for unjust enrichment and aiding and
abetting breach of fiduciary duty pending supplemental
briefing on the viability of those claims in light of my
rulings on the fiduciary duty count.[28]
The
Plaintiff has moved for reargument on one narrow issue: the
dismissal of its claim that the Control Defendants breached
the duty of loyalty by causing RCS to maintain irrationally
high staffing levels. The parties have also submitted the
requested supplemental briefing on the unjust enrichment and
aiding and abetting claims. I address the Motion for Limited
Reargument first. I then turn to the balance of the Motions
to Dismiss.
II.
ANALYSIS
A.
Motion for Limited Reargument
Court
of Chancery Rule 59(f) allows a party to move for reargument
within five days after the filing of the Court's
opinion.[29] The standard governing motions for
reargument is settled. This Court will deny reargument unless
it "overlooked a decision or principle of law that would
have controlling effect or . . . misapprehended the facts or
the law so the outcome of the decision would be
different."[30] "Where the motion merely rehashes
arguments already made by the parties and considered by the
Court when reaching the decision from which reargument is
sought, the motion must be denied."[31] Nor is
reargument warranted simply because a party disagrees with
the Court's decision.[32] Thus, if the ruling on which
reargument is sought was a close call, or one on which
reasonable minds could differ, reargument will be
denied.[33] In my view, the Plaintiff has failed to
meet its "heavy burden" of showing that I
misapprehended the law or the facts in an
outcome-determinative fashion.[34]
First,
the Plaintiff argues that, "in a very real sense, "
the Control Defendants stood on both sides of "the macro
business decision to maintain extremely high staffing"
at RCS.[35] The Plaintiff points out that each RCS
wholesaler was hired primarily to sell AR Capital products.
Thus, the Plaintiff reasons, maintaining unreasonably high
staffing levels at RCS served AR Capital's interests in a
particularly direct way. While the Plaintiff does not
explicitly so argue, the implication appears to be that
entire fairness automatically applies to the decision to
overstaff RCS. I disagree.
Delaware
law is clear: "Entire fairness review ordinarily applies
in cases where a fiduciary either literally stands
on both sides of the challenged transaction or where the
fiduciary 'expects to derive personal financial benefit
from the [challenged] transaction in the sense of
self-dealing, as opposed to a benefit which devolves upon the
corporation or all stockholders
generally.'"[36] And if the fiduciary does not stand
on both sides of the challenged transaction, a plaintiff
seeking to rebut the business judgment rule must plead that
any non-pro rata benefit the fiduciary received was material
to her.[37] Here, the Plaintiff acknowledges that
"the hiring of individual wholesalers is not technically
a contract between RCS and AR
Capital."[38]I am aware of no authority supporting the
position that, even when a fiduciary does not stand on both
sides of a transaction, entire fairness automatically applies
if the transaction "directly implicates" her
interests, regardless of materiality to her.[39] To the extent
the Plaintiff is arguing for such a rule, I decline to adopt
it.
Next,
the Plaintiff claims it has adequately alleged that the
decision to maintain irrationally high staffing levels at RCS
was material to the Control Defendants. A benefit is material
if it is so significant, "in the context of the
[fiduciary]'s economic circumstances, as to have made it
improbable that [she] could perform her fiduciary duties to
the . . . shareholders without being influenced by her
overriding personal interest."[40] The Court must apply
"a subjective 'actual person' standard to
determine whether a particular director's
interest is material and debilitating."[41]
The
Plaintiff points out that the Complaint describes each
Control Defendant's equity stake in AR Capital. For
example, Block held a 3.03% interest in AR Capital, which the
Plaintiff says was worth "tens of millions of
dollars."[42]The Plaintiff then argues that these
valuable equity stakes demonstrate that the Control
Defendants had "a strong motivation to further AR
Capital's interests."[43]That is true, but beside the
point. The question is not whether the Control Defendants
generally had an interest in benefiting AR Capital at
RCAP's expense; I have already recognized the
"perverse incentives" created by the misalignment
of equity and control at these two companies.[44] Instead, the
question is whether the Control Defendants received material
benefits from maintaining RCS's existing staffing levels
as opposed to firing some (undisclosed) appropriate number of
employees. The Complaint itself is silent as to how many
superfluous employees RCS kept on, or how much additional
profit for AR Capital those unnecessary employees helped
generate. That is why I held the Complaint did not
"allow me to quantify any benefit to AR Capital from
having additional staff members at RCS push AR Capital
product."[45]
According
to the Plaintiff, it has alleged enough facts to quantify
such benefits. It states that "during the period when
RCS lost more than $62 million . . ., it raised more than $13
billion in capital - providing AR Capital with an income
stream in perpetuity of approximately $130 million per
year."[46] Again, however, these allegations do not
address the core of the materiality inquiry here: what
portion of these benefits was attributable to the superfluous
RCS employees? Absent well-pled facts answering that
question, I cannot evaluate whether the purported
overstaffing at RCS conferred material benefits on the
Control Defendants.
Finally,
the Plaintiff suggests it can satisfy the materiality
requirement simply by alleging that the Control
Defendants' refusal to fire any RCS employees was
irrational from RCS's perspective, but made perfect sense
for AR Capital.[47] To my mind, that amounts to an
allegation that the Control Defendants acted in bad faith by
refusing to cut staff when RCS was experiencing financial
difficulties. "[A] plaintiff may show a lack of good
faith by establishing that a [corporate fiduciary's]
decision was 'so far beyond the bounds of reasonable
judgment that it seems essentially inexplicable on any ground
other than bad faith.'"[48] "This is a high
pleading standard, as Delaware courts typically frame a lack
of good faith in terms of 'intentional'
misconduct."[49] The Complaint does not satisfy this
exacting standard. As just noted, the Plaintiff alleges that
RCS should have been firing people when the business was
cratering. Maybe so. But I cannot say that the Control
Defendants' decision to keep on RCS employees in the face
of serious financial troubles "lacks any rationally
conceivable basis."[50] Indeed, the Complaint itself
acknowledges that "more salespeople [at RCS] spending
more money produced more sales, albeit at a dramatically
slower pace [in light of RCS's financial
difficulties]."[51] The Plaintiff's bad-faith theory
does not rebut the presumptions of the business judgment
rule.
Having
determined, on examination of the core claim, that the
Complaint sufficiently pleads that the Control Defendants
looted the Peter of RCAP to benefit their Paul-AR Capital-it
is, I acknowledge, tempting to follow the Plaintiff's
suggestion to its conclusion and subject all
business decisions at RCAP, including staffing decisions, to
entire fairness review. The core claim, which I have upheld,
involves the purportedly off-market nature of the wholesaling
arrangements between RCAP and AR Capital. The costs of
running RCAP, including RCS's labor costs, are part of
the entire fairness analysis that I must ultimately
undertake. Stand-alone claims concerning certain business
decisions at RCAP-including acquisitions and staffing
levels-are, to my mind, however, insufficiently pled to
survive independent of the core claim. Thus, because the
Plaintiff has failed to show that I "misapprehended the
law or the facts so that the outcome of the decision would be
affected, " I deny the Motion for Limited
Reargument.[52]
B.
The Remainder of the Motions to Dismiss
As
noted above, in my November 30 Memorandum Opinion, I reserved
decision on the Plaintiff's claims for unjust enrichment
and aiding and abetting breach of fiduciary duty pending
supplemental briefing.[53] The unjust enrichment claim is
brought against AR Capital, AR Global LLC (the successor to
AR Capital), [54] and several wholly owned AR Capital
subsidiaries (the "Advisor Defendants") that
provide "management services" to AR Capital's
investment vehicles.[55] The Advisor Defendants allegedly
received the management fees that would have gone to RCAP (or
a wholly owned RCAP subsidiary) if the wholesaling
arrangements between RCAP and AR Capital had been negotiated
at arm's length.[56] The aiding and abetting claim is brought
against the Control Defendants, Quarto, and RCAP Holdings LLC
("Holdings").[57] Holdings' primary asset was the
single share of super-voting RCAP common stock used by the
Control Defendants to control RCAP.[58]
The
Defendants have moved to dismiss the aiding and abetting and
unjust enrichment claims under Court of Chancery Rule
12(b)(6). When reviewing a Rule 12(b)(6) motion,
(i) all well-pleaded factual allegations are accepted as
true; (ii) even vague allegations are well-pleaded if they
give the opposing party notice of the claim; (iii) the Court
must draw all reasonable inferences in favor of the
non-moving party; and (iv) dismissal is inappropriate unless
the plaintiff would not be entitled to recover under any
reasonably conceivable set of circumstances susceptible of
proof.[59]
I need
not, however, "accept conclusory allegations unsupported
by specific facts or . . . draw unreasonable inferences in
favor of the non-moving party."[60]
1.
Aiding and Abetting Breach of Fiduciary Duty
The
Plaintiff's aiding and abetting claim is pled in the
alternative to its fiduciary duty claim.[61] Specifically,
the Plaintiff alleges that, even if the Control Defendants
(and Quarto[62]) "are determined not to have owed
direct fiduciary duties of care and loyalty to RCAP and/or
any of its subsidiaries at any relevant time, each of these
defendants knowingly participated in breaches of fiduciary
duty by other defendants and thus is liable for aiding and
abetting such breaches."[63] The Defendants argue that the
aiding and abetting claim must be dismissed because the
Complaint lacks facts suggesting that the Control Defendants
knowingly participated in a breach of fiduciary duty.
Alternatively, the Defendants ask me to dismiss the aiding
and abetting count to the extent it relies on alleged
breaches of fiduciary duty dismissed in my November 30
Memorandum Opinion.
To
plead a claim for aiding and abetting breach of fiduciary
duty, a plaintiff must allege "(i) the existence of a
fiduciary relationship, (ii) a breach of the fiduciary's
duty, (iii) knowing participation in that breach by the
defendants, and (iv) damages proximately caused by the
breach."[64] "An adequate pleading of
'knowing participation' requires a pleading of
scienter."[65] "To establish scienter, the
plaintiff must demonstrate that the aider and abettor had
'actual or constructive knowledge that their conduct was
legally improper.'"[66]
At the
outset, the Plaintiff does not dispute that its aiding and
abetting claim must be dismissed to the extent it is premised
on already dismissed allegations of breach of fiduciary duty.
As noted above, I have dismissed any claim for breach of
fiduciary duty based on the purportedly imprudent
acquisitions, the overstaffing at RCS, and the supposed
efforts to facilitate proxy fraud. Thus, I dismiss the
Plaintiff's claim for aiding and abetting breach of
fiduciary duty to the extent it relies on those purported
breaches.[67]
The
aiding and abetting claim survives, however, to the extent it
rests on the core claim in this case: that the "Control
Defendants engineered a series of transactions between RCAP
and AR Capital that allegedly siphoned value away from RCAP
and to AR Capital."[68] The Plaintiff brings its aiding and
abetting count to address the possibility that any of the
Control Defendants may later be found not to have owed
fiduciary duties to RCAP. The Complaint pleads that the
Control Defendants were either officers or directors of RCAP
at all relevant times.[69] The Complaint also supports a
reasonable inference that the Control Defendants acted as a
control group with regard to RCAP.[70] Thus, at the pleading
stage, I may infer that the Control Defendants owed fiduciary
duties to RCAP.[71] But what is pled may turn out not to be
true, and it is possible that some of the Control Defendants
did not stand in a fiduciary relation to RCAP at any given
time. This Court has allowed plaintiffs to plead aiding and
abetting claims in the alternative to account for this
possibility.[72]
The
Defendants' only response is that the Plaintiff has
failed to adequately allege that any of the Control
Defendants knowingly participated in a breach of fiduciary
duty. The Defendants are wrong. I have already held that the
Complaint states a claim against the Control Defendants for
breach of the duty of loyalty. That claim rests on
allegations about a self-dealing scheme hatched by the
Control Defendants themselves. Specifically, "by forcing
RCAP to bear all the costs of wholesaling AR Capital's
investment vehicles, the Control Defendants enriched AR
Capital, in which they (together with Schorsch's wife)
held a 100% economic stake, to the detriment of RCAP, in
which they held only a 25% economic
interest."[73] This scheme allegedly involved blatantly
off-market arrangements between AR Capital and
RCAP.[74] It is reasonably conceivable that each
of the Control Defendants understood that his assistance in
looting RCAP for AR Capital's benefit contributed to a
breach of fiduciary duty.[75] Thus, if Schorsch (or any of
the other Control Defendants) happened not to owe fiduciary
duties to RCAP during one part of the scheme, he still could
be held liable under an aiding and abetting theory for his
deliberate participation in any self-dealing transactions
that took place during that time. I decline to dismiss the
aiding and abetting count.
2.
Unjust Enrichment
The
Plaintiff alleges that AR Capital, AR Global (AR
Capital's successor), and the Advisor Defendants were
unjustly enriched "because each received the benefits of
income flowing from sales made and supported by RCAP without
entering into customary arrangements to share advisory and
management business with RCAP on terms consistent with . . .
arm's-length market transactions."[76] In
particular, the Advisor Defendants, which were wholly owned
AR Capital subsidiaries, received management fees that would
have gone to RCAP (or an RCAP subsidiary) but for the Control
Defendants' disloyal conduct. And, under the wholesaling
arrangements between AR Capital and RCAP, AR Capital received
equity in each of the Advisor Defendants, equity that again
would have gone to RCAP had those arrangements been
negotiated at arm's length.[77] Assuming, as I must at
the pleading stage, that these allegations are true, the
Complaint states a claim for unjust enrichment.
"Unjust
enrichment is 'the unjust retention of a benefit to the
loss of another, or the retention of money or property of
another against the fundamental principles of justice or
equity and good conscience.'"[78] "The
elements of unjust enrichment are: (1) an enrichment, (2) an
impoverishment, (3) a relation between the enrichment and
impoverishment, (4) the absence of justification, and (5) the
absence of a remedy provided by law."[79] In evaluating
an unjust enrichment claim, I must first determine
"whether a contract already governs the relevant
relationship between the parties."[80]"If a
contract comprehensively governs the parties'
relationship, then it alone must provide the measure of the
plaintiff's rights and any claim of unjust enrichment
will be denied."[81] But when a plaintiff alleges that
"it is the [contract], itself, that is the unjust
enrichment, " the existence of the contract does not bar
the unjust enrichment claim.[82] In other words, "[t]he
contract itself is not necessarily the measure of [the]
plaintiff's right where the claim is premised on an
allegation that the contract arose from wrongdoing (such as
breach of fiduciary duty or fraud) or mistake and the
[defendant] has been unjustly enriched by the benefits
flowing from the contract."[83]
The
Defendants first argue that the unjust enrichment claim fails
because the conduct at issue was governed by the contracts
between the Advisor Defendants, AR Capital, and RCS. It is
true that the Advisor Defendants received management fees
from AR Capital pursuant to a series of advisory agreements.
But the core claim in this case is premised in large part on
the allegation that the Control Defendants breached their
fiduciary duties by causing the Advisor Defendants, rather
than RCAP, to receive those management fees. Faithful
fiduciaries, the Plaintiff asserts, would have bargained for
RCAP to receive a portion of the "management
economics."[84] Indeed, according to the Plaintiff, that
is how wholesalers in the REIT industry typically make most
of their profits. Thus, the Complaint supports a reasonable
inference that the advisory agreements (and the benefits they
conferred on the Advisor Defendants) resulted from the
Control Defendants' breaches of fiduciary duty. The
unjust enrichment claim is therefore not barred by the
existence of binding contracts between AR Capital, RCS, and
the Advisor Defendants.[85]
Next,
the Defendants argue that unjust enrichment cannot be invoked
against the Advisor Defendants because they earned the
advisory fees they received for work performed under the
advisory agreements. Thus, the Advisor Defendants supposedly
did not receive any benefits to which they were not entitled.
Relatedly, the Defendants point out that the Complaint does
not allege the Advisor Defendants themselves engaged in
wrongful conduct. These arguments do not defeat the
Plaintiff's unjust enrichment claim.
For
starters, it is irrelevant that the Advisor Defendants
performed actual work in exchange for receiving advisory fees
from AR Capital. The Plaintiff does not seek to disgorge the
gross fees received by the Advisor Defendants; instead, it
seeks only the profits that would have gone to RCAP or an
RCAP subsidiary if the Control Defendants had been faithful
fiduciaries.[86] Indeed, this is the heart of the
Plaintiff's core claim: that the Control Defendants
breached their fiduciary duties by diverting the lucrative
advisory fees from RCAP to AR Capital subsidiaries. The
Complaint supports a reasonable inference that the Advisor
Defendants were not entitled to the profits realized from
those fees. And, contrary to the Defendants' suggestion,
the Plaintiff need not allege that the Advisor Defendants
themselves engaged in wrongdoing in order to invoke unjust
enrichment against them.[87] It is sufficient to plead, as the
Plaintiff has here, that the defendant received
"benefits that in equity and good conscience he ought
not to keep, even though he may have received those benefits
honestly in the first instance."[88]
Finally,
the Defendants ask me to dismiss the Plaintiff's
"claim" for imposition of a constructive trust. A
constructive trust is not itself a cause of action, however;
instead, it is an equitable remedy designed to "correct
the unlawful vesting, or assertion of, legal
title."[89] It is premature, at this stage of the
litigation, ...