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Daugherty v. Highland Capital Management, L.P.

Court of Chancery of Delaware

June 29, 2018

PATRICK DAUGHERTY, Plaintiff,
v.
HIGHLAND CAPITAL MANAGEMENT, L.P., HIGHLAND EMPLOYEE RETENTION ASSETS LLC, HIGHLAND ERA MANAGEMENT LLC, and JAMES DONDERO, Defendants, and HIGHLAND EMPLOYEE RETENTION ASSETS LLC, Nominal Defendant.

          Date Submitted: March 14, 2018

          Thomas A. Uebler and Kerry Porter, of MCCOLLOM D'EMILIO SMITH UEBLER LLC, Wilmington, Delaware, Attorneys for Plaintiff.

          Michael F. Bonkowski and Nicholas J. Brannick, of COLE SCHOTZ P.C., Wilmington, Delaware; OF COUNSEL: Marc D. Katz and Crystal Woods, of DLA PIPER LLP (US), Philadelphia, Pennsylvania, Attorneys for Defendants.

          MEMORANDUM OPINION

          GLASSCOCK, VICE CHANCELLOR.

         This matter involves litigation concerning a Delaware LLC, Highland Employee Retention Assets ("HERA"). HERA was created as a holding company, to encourage certain employees of Highland Capital Management, L.P. ("Highland Capital") to remain with the partnership. HERA was owned by these employees, and held incentive payments from Highland Capital. The Plaintiff, Patrick Daugherty, is one such employee, and he became the largest unitholder in HERA. HERA is controlled by the Defendants. In the fall of 2011, Daugherty left Highland Capital's employ.

         Thereafter, the Defendants, including Highland Capital and its principal and affiliates, amended HERA's LLC Agreement in 2012, to include what amounts to an in terrorem clause. Any HERA unitholder who sued HERA or Highland Capital could be responsible for the entities' legal fees, and was subject to having contributions due him diverted from HERA and placed in escrow instead, until resolution of the dispute, and (presumably) satisfaction of the fees. The LLC Agreement was amended again in 2013, to remove a recitation that the purpose of HERA was to incentivize employment.

         Highland Capital and Daugherty engaged in cross-litigation in Texas, starting in 2012, involving, in part, the legitimacy of these amendments. The Texas court restricted the jury's consideration to the 2012 amendment: the jury found a breach by the Highland Capital defendants of the implied covenant of good faith and fair dealing in connection with the amendment, and awarded Daugherty $2.6 million against HERA, as a result; it also awarded Highland Capital $2.8 million from Daugherty for fees, however. That decision was affirmed on appeal. Meanwhile, Highland Capital bought out all of the unitholders in HERA, save Daugherty, leaving him the sole remaining individual equity holder. HERA's remaining assets were placed in escrow, but the agent resigned and paid the escrow fund, approximately $3.1 million, to Highland Capital, soon after the appellate court affirmed the judgment. Daugherty paid the Texas judgment; HERA has not.

         In 2017, Daugherty brought this action, with three sets of claims. First, he argues that the transfer of the funds from escrow to Highland Capital involves a fraudulent transfer, designed to prevent him from collecting on the Texas judgment. Next, he brings claims based on several theories arising out of the 2013 amendment to the LLC Agreement and contemporaneous actions of the Defendants. Finally, he seeks indemnification from Highland Capital for litigation expense in Texas (as well as fees on fees).

         The Defendants have moved to dismiss. I have already, by Letter Opinion, denied the motion with respect to the fraudulent conveyance claim. I address the balance of the motion below. I find claims based on the 2013 amendment barred by laches. The indemnification claim must proceed, however. My reasoning follows.

         I. BACKGROUND [1]

         A. The Parties and Relevant Non-Parties

         Plaintiff Patrick Daugherty was a partner and senior executive of Defendant Highland Capital and certain of its affiliates from 1998 until his resignation in 2011.[2]Daugherty resides in Dallas, Texas.[3]

         Defendant Highland Capital is a Delaware limited partnership with a principal place of business in Dallas, Texas.[4] Highland Capital claims to have nearly $15 billion of assets under management and is an SEC-registered investment advisor.[5]

         Defendant James Dondero is the president and co-founder of Highland Capital.[6] Dondero and co-founder Mark Okada, along with their affiliates and various personal and family trusts, control Highland Capital.[7]

         Defendant and Nominal Defendant HERA was formed on June 23, 2009 as a Delaware limited liability company.[8] According to its LLC Agreement, HERA was created as a holding company for incentive and retention payments to Highland Capital employees.[9] Pursuant to his previous employment at Highland Capital, Daugherty became a member of HERA and its largest unitholder.[10]

         Defendant Highland ERA Management LLC ("HERA Management") is a Delaware limited liability company.[11] Dondero is the president and sole member of HERA Management.[12] According to the Plaintiff, HERA Management is "a mere instrumentality and Dondero's alter ago."[13]

         B. Factual Overview

         1. Daugherty Leaves Highland Capital

         Highland Capital struggled during the 2008-09 financial crisis and created HERA "to curb employee resignations by offering employees a replacement of their previously received deferred compensation."[14] HERA granted employees "equitylike awards in certain funds" and then distributed the proceeds of those interests to its unitholders.[15] As an employee of Highland Capital, Daugherty became a director of HERA and the largest HERA unitholder.[16] Daugherty resigned from Highland Capital on September 28, 2011.[17]

         The other directors removed Daugherty as a director of HERA on February 16, 2012.[18] The new HERA board immediately executed a Second Amended and Restated Agreement (the "2012 Amendment"), which included a new Article XII.[19] Article XII states that "[i]n the event any Member or holder of units . . . commences litigation or . . . otherwise initiates any dispute or makes any claim" against HERA or any member of HERA, including Highland Capital,

that in any way does or could adversely impact any of the assets held by the Company, then with the consent of 75% of the Board, all pending and future distributions to the Disputing Party shall be immediately suspended and held in escrow by the Company (the "Dispute Escrow") until the final, non-appealable resolution of the Dispute.[20]

         The new Article XII further provides that the "full costs and expenses" from any dispute will be deducted from the interests of a HERA member that loses that dispute.[21] In addition, the HERA board retains "sole discretion" to retain escrow funds for "any diminution in value to the assets held by the Company resulting from or in connection with such Dispute" and reallocate those funds pro rata to the other unitholders, even if the disputing member prevails in the controversy.[22]

         2. The HERA Buyout

         After the adoption of the 2012 Amendment, Highland filed suit against Daugherty in Texas, and Daugherty responded with counterclaims (the "Texas Action").[23] During the Texas Action, according to the Plaintiff, Dondero "sought to gain control of Highland Employee Retention Assets by buying its units held by current and former employees of Highland Capital."[24] On January 18, 2013, Highland Capital offered to purchase all the HERA units for 100% of their cash interest value and 60% of their non-cash interest value―except for the units owned by Daugherty.[25] The HERA board transferred its powers to HERA Management on January 17-18, 2013.[26] On January 19, 2013, Highland Capital bought out the HERA board members, who then resigned and left HERA Management as the sole manager of HERA.[27] Highland Capital circulated a formal offer to purchase the units of HERA, except for those owned by Daugherty, on January 31, 2013 until its expiration on February 15, 2013.[28] HERA Management was formed under Delaware law on February 1, 2013.[29]

         HERA Management executed the Third Amended and Restated Agreement of HERA on February 1, 2013 (the "2013 Amendment").[30] The 2013 Amendment eliminated the employee-retention purposes, formerly stated in the LLC Agreement as a reason for HERA's existence and operation, [31] the requirement to make distributions to cover pass-through tax obligations, and members' indemnification rights.[32] That same day, Dondero caused Highland Capital and HERA Management to allocate 93.4% of Highland Capital's legal expenses in the Texas Action as of December 31, 2012, or $1, 142, 284, to HERA through an Expense Allocation Agreement.[33] On February 7, 2013, Highland Capital offered Daugherty $0 for his interests in HERA because the "costs, expenses, and diminution of the assets" exceeded the value of Daugherty's interests.[34] All other HERA unitholders had purportedly sold their units to Highland Capital, which according to the Plaintiff, used its own and HERA's funds to purchase the HERA units.[35]

         3.The Escrow

         Dondero, acting for Highland Capital, entered an Assignment Agreement with HERA on April 30, 2013. The Agreement stated that Highland Capital held "the sole economic interest in HERA," and that Highland Capital and HERA "have each determined that it is in their respective best interest" to distribute substantially all the HERA assets, then valued at approximately $9, 700, 000, to Highland Capital "as an in-kind distribution."[36]

         In December 2013, Highland Capital placed Daugherty's HERA interests, valued at $3.1 million, into escrow with the law firm Abrams & Bayliss LLP as escrow agent (the "Escrow").[37] Under the escrow agreement, transfer was only authorized to Daugherty if he prevailed in the Texas Action, and to Highland Capital if his action was dismissed.[38]

         4.The Texas Action

         Dondero testified in the Texas Action regarding the Escrow:

Question: Okay. So -- so if, if Mr. Daugherty somehow prevails in his lawsuit against Patrick Boyce and Lane Britain and [HERA], what happens to Mr. Daugherty's interest that's being escrowed right now with a third-party escrow agent?
Answer: They go to him.
Question: I'm sorry?
Answer: They go to him via to [sic] [HERA] and then to him.[39]

         Dondero also testified that Highland Capital's buyout of the other unitholders in HERA eliminated the retention purpose of HERA.[40]

         After a three-week jury trial in the Texas Action, the jury found that Daugherty used Highland Capital's confidential, proprietary, and/or privileged information, and Daugherty was ordered to cease and desist from using that information.[41] The jury also found that Daugherty should pay $2, 800, 000 in attorneys' fees.[42] Daugherty avers that he later paid that judgment.[43] The jury was instructed to "not consider any actions taken by HERA after February 16, 2012, when the [2012 Amendment] was adopted when determining if HERA failed to comply with the HERA Agreement."[44] The jury found that HERA breached the implied covenant of good faith and fair dealing and awarded $2, 600, 000 to Daugherty from HERA.[45] The judge then struck a provision of what appears to have been a form of order supplied by Highland Capital regarding Daugherty's interest in HERA[46]:

(Image Omitted.)

         All parties appealed.[47] HERA represented to the Texas court in September 2014 that "[p]er the Escrow Agreement, if a final, non-appealable judgment against [HERA] is reached, Abrams & Bayliss, LLP, as Escrow Agent, will transfer the Deposit Assets to [HERA]."[48] HERA stated that it owed Highland Capital $7, 459, 658 for legal expenses but that "$4, 904, 497 of that liability have been written off by [Highland Capital] as of December 31, 2013, assuming a lack of collectability from [HERA]," leaving a $2, 555, 071 liability in the net worth calculation and balance sheet.[49] HERA was purportedly insolvent with a negative net worth of $2, 447, 709 as of August 31, 2014.[50] However, this did not include the Escrow, as mentioned in a footnote on HERA's August 31, 2014 balance sheet:

On July 14, 2014, a court entered a final judgment against HERA, which is currently subject to appeal. The amount specified to compensate Daugherty for these damages was $2, 600, 000 plus interest. Per the Escrow Agreement dated December 13, 2013 between HCMLP and Abrams & Bayliss, LLP, if a final, non-appealable judgment against HERA is reached, Abrams & Bayliss, LLP as Escrow Agent, will transfer the HERA Deposit Assets to HERA. As such, for bookkeeping purposes, the Deposit Assets as well as the damage award of $2, 600, 000 plus interest are contingent assets and liabilities, due to the inherent uncertain outcome of a final, non-appealable judgment. Accordingly, neither the asset or [sic] liability is recorded on the balance sheet. In the event of a final, non-appealable judgment against HERA, the Deposit Assets would be recognized by HERA as an asset as would the $2, 600, 000 liability to Daugherty (or different amount in the event that the final, non-appealable judgment were to differ from the original jury finding).[51]

         5. The 2016 Escrow Transfer

         Nearly three years later, on December 1, 2016, the Texas appellate court affirmed the trial court judgment.[52] Thus, the judgments against Daugherty for $2.8 million (plus interest) in favor of Highland Capital, and against HERA for $2.6 million (plus interest) in favor of Daugherty, became final.[53]

         On December 2, 2016, Highland Capital filed for and received a writ of execution for the attorneys' fee award.[54] Abrams & Bayliss resigned as escrow agent that same day but continued to serve as counsel for Highland Capital and its affiliates.[55]

         On December 5, 2016, Abrams & Bayliss transferred approximately $3.1 million in Escrow assets to Highland Capital.[56] That same day, Highland Capital filed a judgment lien on Daugherty's home, which is purportedly still in place.[57]

         The mandate of the Texas appellate court was filed with the trial court in the Texas Action, finalizing the judgment on December 8, 2016.[58] Also on December 8, 2016, Highland Capital sought a writ of garnishment in the Texas Action to seize HERA assets owed to Daugherty because, according to an affidavit filed by Highland Capital's general counsel, Daugherty had no other way to pay Highland Capital's attorneys' fees.[59] The writ of execution returned unexercised because Daugherty was in New York on business.[60]

         On December 9, 2016, Highland Capital requested and received a second writ of execution.[61] Also on December 9, 2016, Highland Capital filed an application of turnover to transfer Daugherty's interest in NexBank Capital, Inc. and Trussway Holdings, Inc. to Highland Capital.[62] Both entities are involved in other actions pending in this Court and are controlled by Dondero, Okada, and Highland Capital.[63]

         Daugherty wired approximately $3.2 million in cash to Highland Capital on December 14, 2016 to satisfy the award of attorneys' fees in the Texas Action.[64] Daugherty then contacted Abrams & Bayliss regarding the Escrow.[65] Abrams & Bayliss responded on February 16, 2017:

By letter dated December 2, 2016, Abrams & Bayliss notified Highland that it was resigning as Escrow Agent pursuant to Paragraph 5 of the Escrow Agreement. By letter dated December 2, 2016, Highland informed Abrams & Bayliss that it was (i) accepting Abrams & Bayliss' resignation as Escrow Agent, (ii) waiving the ten-day notice period under Paragraph 5 of the Escrow Agreement, and (iii) directing Abrams & Bayliss to return the Deposit Assets to Highland in accordance with the instructions provided in the letter.
On December 3, 2016, Abrams & Bayliss informed Highland in writing that it agreed to the waiver of the notice period, such that Abrams & Bayliss' resignation was effective immediately. On December 5, 2016, Abrams & Bayliss returned the Deposit Assets to Highland in accordance with the December 2, 2016 instructions. Accordingly, Abrams & Bayliss no longer serves as Escrow Agent or holds Deposit Assets.[66] HERA now claims to be insolvent and Daugherty seeks to collect his judgment against HERA.[67]

         C. Procedural History

         The Plaintiff filed the Complaint on July 6, 2017. The Defendants filed a Motion to Dismiss on August 23, 2017, and I heard oral argument on that Motion on December 14, 2017. The parties then submitted supplemental briefing regarding the Texas Action.

         The Complaint contains seven counts. Count One alleges that the Defendants caused a fraudulent transfer to allow HERA to evade Daugherty's judgment in the Texas Action.[68] Count Two seeks judicial dissolution of HERA and distribution of the HERA assets to Daugherty, because HERA can "no longer fulfill its original limited purpose, the retention of Highland Capital employees."[69] Count Three alleges breach of fiduciary duties against Dondero and HERA Management, both directly and derivatively on behalf of HERA, in the adoption of the 2013 Amendment, the Expense Allocation Agreement, and the Assignment Agreement.[70]Count Four alleges, directly and derivatively, that Highland Capital aided and abetted breaches of fiduciary duty by Dondero and HERA Management in the drafting of the 2013 Amendment and the receipt by Highland Capital of the Escrow assets under that Amendment.[71] Count Five alleges a breach of the implied covenant of good faith and faith dealing against HERA Management and Dondero in adopting the 2013 Amendment and entering into the Expense Allocation Agreement and the Assignment Agreement.[72] Counts Six and Seven are claims for indemnification (and fees on fees) against Highland Capital.[73]

         By Letter Opinion of January 16, 2018, I denied the Motion to Dismiss Count One because I found that "there is a factual issue about whether HERA had a cognizable interest in the amount in escrow."[74] I noted that "it is reasonably conceivable that HERA owned the amount in escrow once the Plaintiff's judgment against HERA became final; and that Highland caused HERA's escrowed asset to be transferred to Highland without value, leaving HERA insolvent, to defeat the Plaintiff as a creditor of HERA."[75] However, I granted the Motion to Dismiss Count One for Dondero because, even if I assume that HERA Management is the alter ego of Dondero, nothing in Count One indicates that HERA Management "took any act with respect to removing the escrowed amount from HERA."[76] What follows is my decision regarding the Motion to Dismiss the balance of the Complaint.

         II. ANALYSIS

         The Defendants have moved to dismiss the Complaint under Court of Chancery Rule 12(b)(6). When reviewing such a 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.[77]

         I need not, however, "accept conclusory allegations unsupported by specific facts or . . . draw unreasonable inferences in favor of the non-moving party."[78]

         In briefing, and at oral argument, the parties hotly contested the application of issue and claim preclusion, arising from the Texas Action, to the Complaint here. This appeared to me to be the most pertinent of the issues on the Motion to Dismiss. Accordingly, I suggested, in the rather imperious way judges have of suggesting, supplemental briefing on the precise nature of the issues raised in the Lone Star state. The parties complied with vigor and exactitude. As Burns observed, however, the best laid schemes gang aft a-gley. On review, I find that I need not reach issue or claim preclusion, because those portions of the Complaint arising from the 2013 Amendment and contemporaneous actions are barred by laches.

         A. Laches

         The Motion to Dismiss Counts Two through Five on grounds of laches is granted.

         Laches is an equitable defense designed to ensure that equity aids the vigilant, and not the dilatory.[79] The purpose for employing laches is partially similar to the purpose for respecting a limitations period at law: memories grow stale with time, evidence becomes lost, and individuals and entities are entitled to defend against claims in a reasonable amount of time, or not at all. Unlike a statute of limitations, which provides a time bar set out in a legal code, laches is a creature of equity. It is more flexible than a statute of limitations or repose, and focuses on a balancing of equities as well as the passage of time. Its application rests on the reasonableness of the delay, and any resulting prejudice. Nonetheless, where, as here, a claim is brought in Chancery that would be barred by a statutory limitation if brought at law, the same claim will be barred here by analogy to the statute, absent "extraordinary circumstances."[80] "The Court does not need to engage in a traditional laches analysis for a presumptively late complaint."[81] For claims sounding in contract, an action "must be brought within three years from the date that the cause of action accrued."[82] "It is well-settled under Delaware law that a three-year statute of limitations applies to claims for breach of fiduciary duty."[83]

         There are exceptions. First, "if unusual conditions or extraordinary circumstances make it inequitable" to bar a suit by laches, the court "will not be bound by the statute, but will determine the extraordinary case in accordance with the equities which condition it."[84] While "[t]here is no precise definition of what constitutes unusual conditions or extraordinary circumstances," the court "must exercise its discretion, after considering all relevant facts," including:

(1) whether the plaintiff had been pursuing his claim, through litigation or otherwise, before the statute of limitations expired; (2) whether the delay in filing suit was attributable to a material and unforeseeable change in the parties' personal or financial circumstances; (3) whether the delay in filing suit was attributable to a legal determination in another jurisdiction; (4) the extent to which the defendant was aware of, or participated in, any prior proceedings; and (5) whether, at the time this litigation was filed, there was a bona fide dispute as to the validity of the claim.[85]

         The Supreme Court interprets a "bona fide dispute" to mean that the claim would survive a motion to dismiss or, in ...


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