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Godden v. Franco

Court of Chancery of Delaware

August 21, 2018

MATTHEW GODDEN AND TOBIAS BACHTELER, Plaintiffs,
v.
HARLEY V. FRANCO, Defendant.

          Submitted: August 14, 2018

          Samuel T. Hirzel, II, Melissa N. Donimirski, Elizabeth A. DeFelice, HEYMAN ENERIO GATTUSO & HIRZEL, LLP, Wilmington, Delaware; Kevin H. Marino, John D. Tortorella, John A. Boyle, MARINO, TORTORELLA & BOYLE, P.C., Chatham, New Jersey; Kostas D. Katsiris, VENABLE LLP, New York, New York, Counsel for Plaintiffs.

          Elena C. Norman, Richard J. Thomas, Benjamin M. Potts, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Robert M. Sulkin, Gregory J. Hollon, MCNAUL, EBEL, NAWROT & HELGREN PLLC, Seattle, Washington, Counsel for Defendant.

          MEMORANDUM OPINION

          LASTER, V.C.

         Plaintiffs Matthew Godden and Tobias Bachteler acted by written consent to terminate defendant Harley Franco from his positions as President and CEO of Harley Marine Services, Inc. ("HMS Inc.")[1] At the time they took action by written consent, the plaintiffs comprised two of the four members of the board of managers of three Delaware limited liability companies: HMS Holdings 1, LLC ("Holdco 1"), HMS Holdings 2, LLC ("Holdco 2"), and HMS Holdings 3, LLC ("Holdco 3"). As their names suggest, the three Holdco entities constitute a three-tiered holding company structure for HMS Inc.

         The plaintiffs acted by written consent at each of the three Holdco entities, but the top-tier LLC-Holdco 3-is the most important. Its LLC agreement contains provisions (i) specifying the voting standard for its board of managers to make any decisions regarding Franco's employment agreement, (ii) authorizing the board of managers of Holdco 3 to determine the officers of its subsidiaries, including HMS Inc., and (iii) committing the parties to the LLC agreement to conform the composition of the governing boards of Holdco 3's subsidiaries to the size and makeup of the board of managers of Holdco 3. It also contains a provision binding Franco to abide by the terms of the Holdco 3 LLC agreement, and Franco is personally a party to the Holdco 3 LLC agreement for purposes of that provision.

         The plaintiffs moved for summary judgment seeking a lengthy list of declarations regarding the validity of the actions they took. Several of those requests have been rendered moot. This decision grants the plaintiffs' motion as to the following declarations:

• The decision to terminate Franco under his employment agreement was an Interested Party Decision as defined in Section 1.10(a)(iv) of the Holdco 3 LLC agreement.
• Because the termination decision was an Interested Party Decision under Section 1.10(a)(iv) of the Holdco 3 LLC agreement, the only votes required to make the decision were those of the Independent Manager and the Macquarie Manager, as those terms are defined in the Holdco 3 LLC agreement.
• Under Section 4.1(a) of the Holdco 3 LLC agreement, the Independent Manager and the Macquarie Manager could act by written consent to make the decision to terminate Franco under the employment agreement, and the resulting written consent constitutes validly binding action by the board of managers of Holdco 3.
• Assuming that the board of managers of Holdco 3 made the termination decision, that decision would not be self-executing at each of Holdco 3's subsidiaries, nor would it be a legal nullity at Holdco 3's subsidiaries. Instead, the parties to the Holdco 3 LLC agreement would be bound contractually to take implementing action at each of Holdco 3's subsidiaries to make the decision effective.
• Assuming that the board of managers of Holdco 3 made the termination decision, then as a party to the Holdco 3 LLC agreement who committed personally to abide by its terms, Franco would be bound contractually to implement the board of managers' decision at Holdco 3's subsidiaries. The extent to which Franco would be obligated to comply with that contractual commitment for purposes of action at HMS Inc. raises knotty issues of Washington law.
• Assuming that the board of managers of Holdco 3 made the termination decision, then Franco does not cease serving as Chairman of the Board of the Holdco 3 Board of Managers until implementing action is taken by HMS Inc.
• Under Section 4.5 of the Holdco 3 LLC agreement, the parties agreed that the composition of the governing boards of the Holdco entities, HMS Inc., and all of its subsidiaries must be the same.

         This decision does not declare that Godden and Bachteler acted validly by written consent to terminate Franco. Franco has raised a narrow dispute of material fact as to whether Godden met one of the qualifications necessary to act as the Independent Manager at the time he exercised the written consent. Summary judgment as to this issue is denied.

         I. FACTUAL BACKGROUND

         The facts for purposes of this decision are drawn from the exhibits to the verified complaint, the pleadings (which have closed), and the affidavits and documents that the parties submitted in connection with the plaintiffs' motion for summary judgment. Because the plaintiffs moved for summary judgment, the defendant receives the benefit of any reasonable inferences that can be drawn from the record.

         A. The Holdco Structure

         HMS Inc. is a marine transportation company. Through various subsidiaries, it conducts multiple lines of marine-related business, operates approximately 120 vessels, and employs approximately 800 people. HMS Inc. is not a Delaware corporation; it was formed under the laws of the State of Washington.

         Harley V. Franco founded HMS Inc. in 1987. In 2008, Franco sold a significant equity stake in HMS Inc., amounting to beneficial ownership of just under half of its stock, to Macquarie Capital, a private equity firm.[2] To comply with regulatory requirements, the parties created a complex, multi-tiered ownership structure.

         Four tiers of ownership are relevant to this proceeding. In the first tier, Holdco 1 owns 100% of the equity of HMS Inc. Holdco 1 has two members, constituting the second tier: Macquarie owns a 23.36% member interest in Holdco 1, and Holdco 2 owns a 76.64% member interest in Holdco 1. Holdco 2 itself has two members, constituting the third tier. At this level, Macquarie owns a 17.78% member interest in Holdco 2, and Holdco 3 owns an 82.22% member interest in Holdco 2. Holdco 3 likewise has two members, creating the fourth tier of ownership. At this level, Macquarie owns a 15.44% member interest in Holdco 3, and HMS Partners, LLC, owns a 84.56% member interest in Holdco 3. Franco controls HMS Partners, LLC; to avoid introducing another HMS-based abbreviation, this decision calls it "Franco Partners." The following organization chart depicts the resulting structure:

         (Image Omitted)

         Each of the three Holdco entities is a Delaware LLC. The three LLCs are governed by virtually identical LLC agreements. Each LLC agreement was executed initially as of May 14, 2008. All three have been amended in parallel over the years. The currently operative versions are the Second Amended and Restated LLC agreements, each dated June 18, 2014.[3] The terms of the agreements reflect their coordinated preparation.

         Each Holdco is a manager-managed LLC, and the business and affairs of each Holdco is governed by a board of managers (the "Board of Managers"). Section 4.1(a) of each LLC agreement provides that the each Board of Managers shall have four members. Section 4.1(b) specifies that the members shall be as follows:

(i) two (2) managers who are Citizens of the United States to be selected by [Franco Partners] (each, a "Franco Manager");
(ii) one (1) manager to be selected by [Macquarie] (the "Macquarie Manager");
(iii) one (1) manager who is a Citizen of the United States that is independent from and is not under the Control of or under common Control with [Macquarie], [Franco Partners] or any of their respective Affiliates (including pursuant to any contract or by virtue of being an existing or former employee of [Macquarie], [Franco Partners] or any of their Affiliates) who shall have prior (i) senior management experience in either the petroleum or shipping industry; and (ii) financial experience with responsibility to manage a profit/loss statement greater than $50, 000, 000.00, to be jointly selected by [Macquarie] and [Franco Partners] (the "Independent Manager") . . . .

         At the time of the events giving rise to this dispute, Franco and Richard Padden were the Franco Managers, Bachteler was the Macquarie Manager, and Godden was the Independent Manager. Godden also served as a Senior Vice President and Chief Operating Officer of HMS Inc.

         Section 4.1(d) of each of the LLC agreements states that "[t]he Board Members shall elect a Chairman of the Board to preside over meetings of the Board of Managers." It further states:

For a ten (10) year period commencing on the date of the closing of the Acquisition, the Chairman of the Board shall be Franco (unless Franco declines or is unable to serve as Chairman of the Board), but only if (i) [Franco Partners] retains the right to appoint at least (1) Board Member and (ii) Franco has not been terminated by HMS Inc. "for cause" under his Employment Agreement. Thereafter, the Chairman of the Board shall be a Citizen of the United States elected annually by the Board of Managers.

         At the time of the events giving rise to this dispute, Franco served as the Chairman of the Board for each Board of Managers.

         For purposes of this litigation, there are three key respects in which the Holdco 3 LLC agreement differs from the lower-tier LLC agreements. First, Franco executed the Holdco 3 LLC agreement personally and became a party in his individual capacity "for purpose of Section 15.13." That section provides as follows:

Franco hereby covenants and agrees for the benefit of the Company and the Members
(a) to cause [Franco Partners] to perform all of its obligations under this Agreement,
(b) that he shall at all times maintain Control of [Franco Partners], and
(c) to abide by the provisions set forth in this Agreement and in the limited liability company agreements (as amended, modified or restated from time to time) of Holdco 1 and Holdco 2 that apply to him in his individual capacity.[4]

         This decision refers to Section 15.13 as the "Personal Commitment Provision." The LLC agreements for Holdco 1 and Holdco 2 do not contain a Personal Commitment Provision, and Franco is not a party to those LLC agreements in his individual capacity.

         Second, the Holdco 3 LLC agreement contains language that authorizes the Board of Managers of Holdco 3 to select the officers of Holdco 3's subsidiaries (the "Subsidiary Officer Provision"). In Sections 4.10 through 4.17, the Holdco 3 LLC agreement identifies various officer positions of Holdco 3, including the positions of President and Chief Executive Officer. In Section 4.19, titled "Officers of Subsidiaries," the Holdco LLC agreement states: "All officers of the other Company Entities shall be selected by the Board of Managers in its sole discretion." In Section 1.10, the LLC agreement defines "Company Entities" to mean, "collectively, [Holdco 3], Holdco 1, Holdco 2, and HMS Inc., including all subsidiaries of HMS Inc. as set forth on Appendix I attached hereto." The LLC agreements for Holdco 1 and Holdco 2 do not contain a comparable provision, which is unsurprising: Given that the Subsidiary Officer Provision seeks to authorize the Board of Managers of Holdco 3 to appoint officers for all of its subsidiaries, it would be counterintuitive and potentially conflict-generating to include a similar provision in the lower-tier agreements.

         Third, the Holdco 3 LLC agreement contains language that obligates the parties to that agreement to conform the governing boards of all of Holdco 3's subsidiaries so that they correspond to the composition of the Board of Managers of Holdco 3 (the "Subsidiary Board Provision"). Titled "Boards of Managers and Directors of the Company's Subsidiaries," Section 4.5 of the Holdco 3 LLC agreement states:

The composition of the board of managers or the board of directors, as applicable, of each other Company Entity . . . shall consist of the same number of managers or directors, as applicable, and shall also consist of the same persons as that of the Board of Managers (collectively, the "Boards").
The Members shall have the same rights to designate members of the Boards of the other Company Entitles as they have to designate Board Members, and such designation rights shall be subject to the same limitations and conditions as apply to their rights to designate Board members.
In any instance in which [Holdco 3] or any other Company Entity has the right to designate [1] a member of the board of managers or the board of directors, as applicable or [2] an observer of any Company Entity based on the HMS Percentage Interest held by Franco, directly or indirectly, [Holdco 3] shall comply, and shall cause each other Company Entity to comply, with the direction of [Franco Partners] with respect to the designation of a person to the board of managers or the board of directors, as applicable, or as an observer.
The Members acknowledge and agree that any amendment to the number of Board Members or change of any Board Member shall also amend and apply to the composition of the Boards of each other Company Entity.
The manner of meeting and acting of the Boards of the other Company Entities shall be consistent in all respects with this Article IV.[5]

         As with the Subsidiary Officer Provision, the LLC agreements for Holdco 1 and Holdco 2 do not contain comparable provisions, and logically so, since the parties were basing the governing boards of the subsidiaries off of the Board of Managers of Holdco 3.

         B. The Washington Action and the Delaware Derivative Action

         In late May 2018, Godden advised Macquarie that Franco had been misappropriating funds from HMS Inc. Macquarie retained litigation counsel, who obtained books and records from HMS Inc. to evaluate whether the allegations were true. Macquarie then engaged AlixPartners LLP to review the books and records. AlixPartners corroborated Godden's allegations to Macquarie's satisfaction. Franco disputes whether the allegations have any basis in fact.

         After receiving corroboration from AlixPartners, Macquarie asked Franco to step down temporarily from his positions. In response, on July 2, 2018, Franco filed suit against Macquarie in Washington state court (the "Washington Action").[6] In his complaint, Franco alleged that Macquarie had breached its fiduciary duties by trying to force him out of office and pressure him into selling HMS Inc. He also sought declarations regarding the corporate governance structure of HMS Inc. under Washington law.

         On July 3, 2018, Macquarie filed a derivative action against Franco in this court (the "Delaware Derivative Action"). In its complaint, Macquarie sought a declaration that there was good cause to terminate Franco and remove him from all of his board and officer positions. Macquarie also sought compensatory damages.

         C. The July 5 Board Meeting And The Dismissal Of The Delaware Derivative Action

         At 11:00 a.m., on July 5, 2018, Godden and Bachteler purported to hold an emergency meeting of the board of directors of HMS Inc. (the "Contested Meeting").[7] They later claimed that they also convened the Contested Meeting on behalf of the governing boards of the Holdcos and HMS Inc.'s subsidiaries. They have asserted that during the Contested Meeting, they voted on behalf of all of the governing boards of the entities to terminate Franco's employment for cause.

         Franco and Padden received notice of the Contested Meeting but did not participate. Franco has taken the positon that Godden and Bachteler only called a meeting of the board of directors of HMS Inc. He also contends that because he and Padden did not attend, a quorum did not exist, and no action was validly taken during the Contested Meeting.

         The plaintiffs have represented that they are not relying on any action taken during the Contested Meeting for purposes of their motion for summary judgment. This decision relies on that representation and does not delve into any of the disputes about the Contested Meeting. This approach is the functional equivalent of assuming, for purposes of analysis, that the Contested Meeting was not validly called on behalf of any entity other than HMS Inc. and, in any event, lacked a quorum for taking action. This assumption comports with the standard governing a motion for summary judgment under Rule 56, in which the non-moving party receives the benefit of the doubt on any contested issues of fact.

         After the Contested Meeting, Godden and Bachteler believed that they had terminated Franco from his positions as President and CEO of HMS Inc. Terminating Franco had been the principal goal of the Delaware Derivative Action, so on the afternoon of July 5, Macquarie filed a notice of voluntary dismissal without prejudice. After convening a status conference, I granted the dismissal.[8]

         D. The Written Consent

         Before and during the status conference, Franco raised objections to the validity of the actions taken during the Contested Meeting. To address those objections, on the evening of July 5, 2018, Godden and Bachteler purported to take action by written consent on behalf of the Boards of Managers of the Holdcos, the board of directors of HMS Inc., and the governing boards of each of HMS Inc.'s subsidiaries (the "Written Consent"). This decision addresses only whether the Written Consent took valid action on behalf of the Boards of Managers of the Holdcos. It analyzes that issue from the standpoint of the Board of Managers of Holdco 3. That entity is the important one, because Franco signed its LLC agreement personally, and its LLC agreement contains the Personal Commitment Provision, the Subsidiary Officer Provision, and the Subsidiary Board Provision. The analysis is the same for the other Holdcos, but the implications are limited to those entities.

         The Written Consent stated as follows:

NOW, THEREFORE, BE IT RESOLVED, that the employment of Franco with HMS [Inc.] is hereby terminated for cause pursuant to Section 6.1(d) of that certain Employment Agreement, dated August 15, 2008, by and between HMS [Inc.] and Franco;
FURTHER RESOLVED, that Franco is hereby removed as the President and Chief Executive Officer of each, and from any other officer positions he holds with any of the Companies and any ...

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