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CapStack Nashville 3 LLC v. MACC Venture Partners

Court of Chancery of Delaware

August 16, 2018

CapStack Nashville 3 LLC et al.
MACC Venture Partners et al.,

          Date Submitted: August 15, 2018

          Thad J. Bracegirdle, Esquire Julie M. O'Dell, Esquire Wilks, Lukoff & Bracegirdle, LLC.

          Philip Trainer, Jr., Esquire Randall J. Teti, Esquire Ashby & Geddes.

         Dear Counsel:

         The road to a temporary restraining order ("TRO") is well-worn; it typically requires only that a movant show a non-frivolous claim of wrongdoing, and resulting threatened imminent irreparable harm, to trigger equity's solicitude. If a weighing of the equites then demonstrates that injunctive relief to maintain the status quo pending a final hearing is appropriate, Chancery will, typically, enter a TRO, limiting the freedom of action of the responding party.

         Preventing harm is a public good, but it is not the only public good. In certain cases, other values trump maintenance of the status quo. In the Anglo-American judicial system, freedom of speech is a jealously guarded right. Historically, equity denied itself jurisdiction over restraints on speech, [1] leaving determinations of the actionability of potentially slanderous speech to a jury of the speaker's peers at an action at law. Both the Delaware and Federal Constitutions have enshrined the right to speak, casting further doubt on the ability of Chancery to place prior restraints on speech, particularly before a determination of whether the speech is entitled to constitutional protection following a hearing on the merits.[2]

         This TRO request illustrates this tension. Essentially, the movants contend that the respondents, the movants' business partners, have made false statements about the movants' conduct of the business, and threaten to make further such statements to investors and regulatory authorities, in an attempt to extort a business advantage. The respondents assert that the statements, and pending statements, are true. The movants' claims are colorable. For a number of reasons, however, I must decline to employ equity in prior restraint of the respondents' speech. I explain below.

         I. BACKGROUND

         The following facts are those alleged in the Complaint and in the Motion for a Temporary Restraining Order. This case stems from a joint venture to invest in and manage three apartment complexes in Nashville, Tennessee.[3] The joint venture has a rather baroque organizational structure. Nominal Defendant CSP Nashville 3 LLC ("CSP"), a Delaware limited liability company, is the entity that owns the properties.[4] Nominal Defendant CapStack MACC LLC ("CSM"), another Delaware limited liability company, serves as CSP's managing member.[5] CSM, for its part, has two 50% members: Plaintiff CapStack Nashville 3 LLC ("CapStack") and Defendant MACC Venture Partners LLC ("MACC").[6] Like CSP and CSM, CapStack and MACC are Delaware limited liability companies.[7] CSM has two managers: Plaintiff David Blatt (appointed by CapStack) and Defendant S. Anthony Azar (appointed by MACC).[8] The properties themselves are managed by Defendant Capstone Multifamily Group, LLC, a North Carolina limited liability company affiliated with Azar and MACC.[9]

         The Plaintiffs purchased the apartment complexes in August 2017.[10] Several months before the investment, the Plaintiffs had been introduced to the Defendants.[11]At that time, Azar told the Plaintiffs that he and the other Defendants had experience in managing apartment complexes, hiring appropriate staff, and negotiating with contractors.[12] Based on these representations, the Plaintiffs decided in the fall of 2017 to offer the Defendants the opportunity to participate in a joint venture to manage the properties.[13] The parties then executed an operating agreement and put in place the ownership structure described above.[14]

         According to the Plaintiffs, it soon emerged that the Defendants' representations about their experience and capabilities were false.[15] Although the Defendants claimed to have expertise in property management, they "severely overestimated the [p]roperties' capital expenditures budget."[16] Worse, the Defendants allegedly breached several provisions of the operating agreement.[17] For example, the Defendants violated the operating agreement's unanimity requirement by making important decisions for CSM and CSP without obtaining the Plaintiffs' consent.[18] The Defendants also breached the operating agreement by refusing to keep the Plaintiffs reasonably informed about developments at CSM and CSP.[19]

         The Plaintiffs complained to the Defendants about this alleged misconduct. According to the Plaintiffs, the Defendants struck back, via a letter they sent on July 2, 2018, to counsel for Blatt and NH Cohen Capital LLC, the placement agent for the CSP investment.[20] The letter accused Blatt of misconduct, including making several misrepresentations about his experience and qualifications in the CSP private placement memorandum ("PPM").[21] For instance, according to the letter, the PPM falsely claimed that Blatt "was involved in turning around a list of multifamily developments, none of which appear to have been associated with Blatt, and several of which were actually demolished."[22] The letter also asserted that the PPM misrepresented the fees Blatt received from the investment.[23] Further, the letter quoted one of Blatt's former associates, who accused Blatt of "circulat[ing] an unofficial version of the PPM with markedly different terms, in an effort to defraud investors and others."[24] The letter ended with a demand that Blatt and CapStack withdraw as a manager and member of CSM.[25]

         The Plaintiffs rejected the demand.[26] Approximately two weeks later, the Defendants sent a second letter to counsel for Blatt and NH Cohen.[27] The Defendants reiterated their demand that the Plaintiffs withdraw from the joint venture.[28] The Defendants also stated that they intended to "notify investors of the facts and circumstances relating to the CSP . . . private placement memorandum and closing."[29] The Defendants then said, "We believe that investors, and the [Securities and Exchange Commission ("SEC")], would be most comfortable with the situation if David Blatt returned the funds taken at closing and he were no longer involved in the management of the investment."[30] The letter was sent on July 18, and it requested that Blatt take these steps by July 27.[31]

         The Plaintiffs interpret the July 18 letter as threatening to disclose the allegations about Blatt to investors and the SEC unless the Plaintiffs withdrew from the joint venture.[32] According to the Plaintiffs, the statements about Blatt in the July letters are false.[33] In any event, as a result of the letters, Blatt resigned as a registered broker with NH Cohen on July 19.[34]

         Instead of acceding to the Defendants' demands, the Plaintiffs commenced this action on July 27. Their Complaint asserts nine claims, including fraud, breach of contract, breach of fiduciary duty, tortious interference with contract, and defamation and/or trade libel.[35] The same day the Complaint was filed, the Plaintiffs moved for a TRO under Court of Chancery Rule 65(b). The Plaintiffs seek an order "temporarily enjoining Defendants and their respective partners, officers, agents, servants, employees, and those persons in active concert or participation with them, from making defamatory and libelous statements about Plaintiffs to the SEC, investors in CSP . . ., or any other third parties."[36] The Defendants oppose the request; I heard argument on the TRO on August 15.

         II. ANALYSIS

         A TRO "may be issued when the movant demonstrates that: '[1] it has a colorable claim, [2] faces a likelihood of imminent, irreparable harm if relief is not granted, and [3] will suffer greater hardships if the TRO is not granted than the defendants would if the relief were granted.'"[37] "Of the three factors, irreparable harm is the most important; it is the sine qua non for this form of relief."[38] "The purpose of a temporary restraining order is to preserve the status quo to enable the plaintiff to adequately . . . prepare his case and demonstrate his entitlement to ultimate relief."[39]

         Here, the Plaintiffs seek a TRO enjoining the Defendants' speech. Specifically, the Plaintiffs ask this Court to temporarily enjoin the Defendants from making allegedly defamatory statements about the Plaintiffs to the SEC, investors in CSP, or any other third parties. In other words, the Plaintiffs seek a prior restraint.[40]That request must be denied for several reasons.

         First, the Plaintiffs have failed to establish that irreparable harm will likely result absent a TRO. The filings in this case are a matter of public record; none of the parties' papers have been filed under seal. Indeed, the Plaintiffs themselves attached to the Complaint the letters that contain the purportedly defamatory material.[41] As a result, the allegedly false information the Defendants intend to convey to the SEC and other investors is already accessible to the public. It is unlikely, then, that further dissemination of this publicly available information would work irreparable harm on the Plaintiffs. Moreover, the Defendants represented at oral argument that NH Cohen, which received the July letters, has already disclosed the supposedly defamatory allegations to the Financial Industry Regulatory Authority. The Defendants also represented that, as a result of this disclosure, the SEC already has or will initiate an investigation into the allegations. These developments cast further doubt on the efficacy of Plaintiffs' attempt to demonstrate that future speech threatens irreparable harm.

         Second, the Plaintiffs' request runs afoul of the "traditional maxim that equity will not enjoin a libel."[42] This rule traces back to equity's traditional refusal "to exercise jurisdiction over a claim for defamation based on a prayer for injunctive relief."[43] The rule now rests on additional considerations, primarily "the importance afforded to the constitutional protections of speech."[44] Regardless of the rationale supporting the rule, "[t]he upshot is the same: a court of equity generally cannot issue an injunction in a defamation case."[45]

         The principle that equity will not enjoin a libel has special force in the context of pretrial requests for injunctive relief. Some American jurisdictions "have endorsed permanently enjoining a defendant from repeating speech found defamatory in an adversarial proceeding."[46] Under this exception to the traditional rule, "once a judge or jury has made a final determination that the speech at issue is defamatory, the speech determined to be false may be enjoined."[47] I need not decide whether this Court may enjoin speech that has been adjudged defamatory after a full trial on the merits.[48] Assuming such an injunction would be within the jurisdiction and power of equity, that is not the situation before me. Instead, the Plaintiffs ask me to temporarily enjoin future speech based solely on a finding that the Complaint pleads a colorable claim for defamation or trade libel. Colorability, in the TRO context, requires only that the claim not be frivolous; if a plaintiff pleads a non-frivolous claim of wrongful conduct and shows a threat of resulting imminent irreparable harm, a TRO may issue.[49] A finding that the plaintiff's claim is likely to prevail is not required. In my view, to enjoin speech upon such a showing would amount to an unconstitutional prior restraint.

         When an injunction against speech is entered before a full trial on the merits, "it is almost always treated as an unconstitutional prior restraint."[50] The reason is straightforward: while such an injunction is in force, it "restrain[s] even speech that may ultimately prove to be protected."[51] Likewise, "since preliminary injunctions are often easier to get than final determinations on the merits and are granted based on less evidence and less deliberation, the danger that the court will get it wrong and mistakenly restrict protected speech is even greater."[52] Thus, "[i]n all but the most exceptional circumstances, an injunction restricting speech pending final resolution of constitutional concerns is impermissible."[53] This rationale applies with equal force to First Amendment protections as well as the protections of speech and press found in the Delaware Constitution.[54] Indeed, the Delaware Constitution appears to explicitly prohibit prior restraints, providing that "any citizen may print on any subject, being responsible for the abuse of that liberty."[55]

         Here, it is unclear whether the speech the Defendants propose to engage in is constitutionally unprotected defamation. At oral argument, the Defendants vigorously disputed the Plaintiffs' contention that their threat, or promise, to speak was intended as coercive or retaliatory, or their words false. The record in this case is sparse, and neither side has taken any discovery. Again, the standard for evaluating the Plaintiffs' claims at this stage-colorability-is exceedingly easy to satisfy; it requires only that a plaintiff state "a non-frivolous cause of action."[56]Thus, it may turn out that, contrary to the allegations in the Complaint, the accusations against Blatt are true, and that the Defendants did not use those accusations to extort concessions from the Plaintiffs.[57] In that case, a TRO enjoining the Defendants from repeating the allegations about Blatt to other parties would have the effect of forbidding the Defendants from engaging in constitutionally protected speech. The rule against speech restraints prior to a merits determination is designed to address precisely this situation.[58] Accordingly, even if the Plaintiffs could state a colorable claim for defamation and demonstrate a likelihood of imminent, irreparable harm, they would not be entitled to the TRO they seek.

         The Plaintiffs try to avoid this conclusion by characterizing their defamation claim as one for "trade libel," and then suggesting that the Complaint also states a claim for tortious interference with business relations. According to the Plaintiffs, a TRO is appropriate in such a circumstance under J.C. Pitman & Sons v. Pitman, a case decided by this Court over seventy years ago.[59] There, Chancellor Harrington held that "a continued course of wrongful action may, ordinarily, be stopped by injunction, although it includes a trade libel."[60] Under Pitman and similar cases from other jurisdictions, an injunction may be granted where "the trade libel furthered another tort that independently warranted equitable relief."[61] I note that Pitman does not deal specifically with interim as opposed to final injunctive relief-the case was before the Chancellor on a general demurrer, the equivalent of a motion to dismiss the complaint.[62]

         In my view, Pitman does not support the Plaintiffs' request for injunctive relief. Pitman does not define the tort of trade libel, but this Court has since had occasion to describe the doctrine's historical evolution. The concept of trade libel "initially covered statements 'disparaging the quality . . . of property,' then expanded 'to encompass any injury to economic advantage arising from false derogatory statements.'"[63] The Second Restatement embodies this expanded view of trade libel, classifying it as a subset of the tort of "injurious falsehood."[64] The Restatement defines injurious falsehood as follows:

One who publishes a false statement harmful to the interests of another is subject to liability for pecuniary loss resulting to the other if
(a)he intends for publication of the statement to result in harm to interests of the other having a pecuniary value, or either recognizes or should recognize that it is likely to do so, and
(b) he knows that the statement is false or acts in reckless disregard of its truth or falsity.[65]

         "The purpose of an injurious falsehood claim . . . is to protect economic interests of the injured party against pecuniary loss as opposed to [t]he purpose of a defamation claim[, ] which is to protect reputation."[66]

         In other words, as traditionally understood, trade libel addressed false statements about a competitor's products-statements of a kind that could damage or destroy a competitor in ways not readily remediable by ex post facto damages.[67]Some jurisdictions, concerned that free speech could be used as a bludgeon to destroy competition without effective redress at law, were receptive to the idea that such malicious business falsehoods were subject to injunctive restraint, particularly when the statements invoked another tort doctrine as well.[68] Here, the Plaintiffs' trade-libel claim is not of the traditional variety; it does not involve disparagement of goods. Instead, the Plaintiffs allege that the Defendants have falsely accused Blatt of lying in an offering memorandum, thereby harming the Plaintiffs' pecuniary interests. In my view, these allegations are insufficient to overcome the longstanding rule forbidding pretrial injunctions against speech. Indeed, that rule would lose much of its vitality if the Plaintiffs' argument were accepted.

         Assuming that she is gainfully employed, it should not be difficult for the typical defamation plaintiff to allege that purportedly false speech injured her pecuniary interests. Presumably, a false accusation that such a plaintiff is a liar would hurt her earning capacity. And even if that could not be proved at trial, a court considering a TRO would likely be forced to accept as true a plaintiff's allegation that defamatory statements about her integrity harmed her ability to pursue economic activity. Thus, by characterizing a defamation claim as one for trade libel (and including in her complaint a separate tort, perhaps for intentional infliction of emotional distress), a plaintiff could circumvent the well-established prohibition on prior restraints. The exception would come nigh to swallowing the rule. Such an outcome could chill protected speech.[69]

         Accordingly, assuming Delaware law, following Pitman, permitted issuance of a TRO to prevent a traditional trade libel accompanied by an independent tort supporting equitable relief-as the Plaintiffs urge me to find-such is not the situation here. Rather, the Plaintiffs in this case seek to exploit the expanded scope of trade libel to overcome the rule against pretrial speech restraints. Because the Plaintiffs' request for a TRO risks restraining speech before this Court determines whether it is constitutionally protected, the application must be denied.[70]

         Finally, I note an additional consideration. At oral argument, it appeared that a primary concern of the Plaintiffs is to prevent the Defendants from making the purportedly defamatory allegations to the SEC. Although I need not decide the question here, I assume that the Defendants are at least conditionally privileged to reveal these allegations to the SEC. Like other administrative agencies, the SEC performs quasi-judicial functions.[71] The Complaint suggests that the Defendants seek to have the SEC investigate the allegations about Blatt, and perhaps initiate proceedings against him. Under the Second Restatement, "[a] witness is absolutely privileged to publish defamatory matter concerning another in communications preliminary to a proposed judicial proceeding or as a part of a judicial proceeding in which he is testifying, if it has some relation to the proceeding."[72] By contrast, many jurisdictions, perhaps including this one, [73] have held that such communications receive only a qualified privilege.[74] In any event, the possibility that the statements the Defendants wish to make to the SEC are privileged[75] weighs against entry of the TRO.

         For the reasons above, the Plaintiffs' request that I enter a temporary restraining order is DENIED. To the extent the foregoing ...

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